TE Connectivity Ltd.
ITEM 1. BUSINESS
General
TE Connectivity Ltd. (“TE Connectivity” or the “Company,” which may be referred to as “we,” “us,” or “our”) is a global industrial technology leader creating a safer, sustainable, productive, and connected future. Our broad range of connectivity and sensor solutions, proven in the harshest environments, enable advancements in transportation, industrial applications, medical technology, energy, data communications, and the home.
We became an independent, publicly traded company in 2007; however, through our predecessor companies, we trace our foundations in the connectivity business back to 1941. We are organized under the laws of Switzerland. The rights of holders of our shares are governed by Swiss law, our Swiss articles of association, and our Swiss organizational regulations.
We have a 52- or 53-week fiscal year that ends on the last Friday of September. Fiscal 2020, 2019, and 2018 were each 52 weeks in length and ended on September 25, 2020, September 27, 2019, and September 28, 2018, respectively. For fiscal years in which there are 53 weeks, the fourth quarter reporting period includes 14 weeks, with the next such occurrence taking place in fiscal 2022.
COVID-19 Pandemic
A novel strain of coronavirus (“COVID-19”) was first identified in China in December 2019 and subsequently declared a pandemic by the World Health Organization. To date, COVID-19 has surfaced in nearly all regions around the world and resulted in travel restrictions and business slowdowns or shutdowns in affected areas. The COVID-19 pandemic negatively affected our sales and operating results during fiscal 2020, and we expect that it will continue to have an impact on our financial condition and results of operations in the near term and may have a material impact on our financial condition, liquidity, and results of operations in future periods. See “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for discussion regarding the impact of the COVID-19 pandemic on our financial results. Also, see “Part I.
ITEM 1A. RISK FACTORS
Investors should carefully consider the risks described below before investing in our securities. These risks are not the only ones facing us. Our business is also subject to general risks that affect many other companies. Additional risks not currently known to us or that we currently believe are immaterial may also impair our business operations, financial condition, and liquidity. Many of the risks listed below are, and will be, exacerbated by the COVID-19 pandemic and any worsening of the economic environment.
Risks Relating to the Macroeconomic Environment and Our Global Presence
Conditions in global or regional economies, capital and money markets, and banking systems, and cyclical industry demand may adversely affect our results of operations, financial position, and cash flows.
Our business and operating results have been and will continue to be affected by economic conditions regionally or globally, including the cost and availability of consumer and business credit, end demand from consumer and industrial markets, and concerns as to sovereign debt levels including credit rating downgrades and defaults on sovereign debt and significant bank failures or defaults. Any of these economic factors could cause our customers to experience deterioration of their businesses, cash flow, and ability to obtain financing. As a result, existing or potential customers may delay or cancel plans to purchase our products and may not be able to fulfill their obligations to us in a timely fashion or in full. Further, our vendors may experience similar problems, which may impact their ability to fulfill our orders or meet agreed service and quality levels. If regional or global economic conditions deteriorate, our results of operations, financial position, and cash flows could be materially adversely affected. Also, deterioration in economic conditions, expectations for future revenue, projected future cash flows, or other factors have triggered and could trigger additional recognition of impairment charges for our goodwill or other long-lived assets. Impairment charges, if any, may be material to our results of operations and financial position.
Foreign currency exchange rates may adversely affect our results.
Our Consolidated Financial Statements are prepared in United States (“U.S.”) dollars; however, a significant portion of our business is conducted outside the U.S. Changes in the relative values of currencies may have a significant effect on our results of operations, financial position, and cash flows.
We are exposed to the effects of changes in foreign currency exchange rates on our costs and revenue. Approximately 60% of our net sales for fiscal 2020 were invoiced in currencies other than the U.S. dollar, and we expect non-U.S. dollar revenue to continue to represent a significant portion of our future net sales. We have elected not to hedge this foreign currency exposure. Therefore, when the U.S. dollar strengthens in relation to the currencies of the countries where we sell our products, such as the euro or Asian currencies, our U.S. dollar reported revenue and income will decrease.
We manage certain cash, intercompany, and other balance sheet currency exposures in part by entering into financial derivative contracts. In addition to the risk of non-performance by the counterparty to these contracts, our efforts to manage these risks might not be successful.
We have suffered and could continue to suffer significant business interruptions, including impacts resulting from the COVID-19 pandemic.
Our operations and those of our suppliers and customers, and the supply chains that support their operations, may be vulnerable to interruption by natural disasters such as earthquakes, tsunamis, typhoons, tornados, or floods; other disasters such as fires, explosions, acts of terrorism or war, or disease or other adverse health developments, including impacts resulting from the COVID-19 pandemic; or failures of management information or other systems due to internal or external causes. In addition, such interruptions could result in a widespread crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could affect demand for our end customers’ products. If a business interruption occurs and we are unsuccessful in our continuing efforts to minimize the impact of these events, our business, results of operations, financial position, and cash flows could be materially adversely affected. The COVID-19 pandemic is currently impacting countries, communities, workforces, supply chains, and markets around the world, and as a result, we have experienced disruptions and restrictions on our employees’ ability to travel, as well as temporary closures of our facilities and the facilities of our customers, suppliers, and other vendors in our supply chain. As a
result of the COVID-19 pandemic, some of our employees have transitioned to working from home on a full-time or part-time basis, which may increase our vulnerability to cyber and other information technology risks. The COVID-19 pandemic has had, and we expect that it will continue to have, a negative impact on our financial condition and results of operations in the near term and may have a material impact on our financial condition, liquidity, and results of operations in future periods. The extent to which the COVID-19 pandemic will further impact our business and our financial results will depend on future developments, which are highly uncertain and cannot be predicted. Such developments may include the further spread of the virus to additional persons and geographic regions; the severity of the virus; the duration of the pandemic; the impact on our suppliers’ and customers’ supply chains and financial positions, including their ability to pay us; the actions that may be taken by various governmental authorities in response to the outbreak in jurisdictions in which we operate; and the possible impact on the global economy and local economies in which we operate. Further, to the extent the COVID-19 pandemic adversely affects our business, results of operations, or financial condition, it may also have the effect of heightening many of the other risks described in this “Risk Factors” section.
We could be adversely affected by a decline in the market value of our pension plans’ investment portfolios or a reduction in returns on plan assets.
Concerns about deterioration in the global economy, together with concerns about credit, inflation, or deflation, have caused and could continue to cause significant volatility in the price of all securities, including fixed income and equity securities, which has reduced and could further reduce the value of our pension plans’ investment portfolios. In addition, the expected returns on plan assets may not be achieved. A decrease in the value of our pension plans’ investment portfolios or a reduction in returns on plan assets could have an adverse effect on our results of operations, financial position, and cash flows.
Disruption in credit markets and volatility in equity markets may affect our ability to access sufficient funding.
The global equity markets have been volatile and at times credit markets have been disrupted, which has reduced the availability of investment capital and credit. Downgrades of sovereign debt credit ratings have similarly affected the availability and cost of capital. As a result, we may be unable to access adequate funding to operate and grow our business. Our inability to access adequate funding or to generate sufficient cash from operations may require us to reconsider certain projects and capital expenditures. The extent of any impact will depend on several factors, including our operating cash flows, the duration of tight credit conditions and volatile equity markets, our credit ratings and credit capacity, the cost of financing, and other general economic and business conditions.
We are subject to global risks of political, economic, and military instability.
Our workforce; manufacturing, research, administrative, and sales facilities; markets; customers; and suppliers are located throughout the world. As a result, we are exposed to risks that could negatively affect sales or profitability, including:
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changes in global trade policies, including sanctions, tariffs, trade barriers, and trade disputes;
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regulations related to customs and import/export matters;
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variations in lengths of payment cycles and challenges in collecting accounts receivable;
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tax law and regulatory changes in Switzerland, the U.S., and the EU among other jurisdictions, including tax law and regulatory changes that may be effected as a result of tax policy recommendations from quasi-governmental organizations such as the Organisation for Economic Co-operation and Development (“OECD”), examinations by taxing authorities, variations in tax laws from country to country, changes to the terms of income tax treaties, and difficulties in the tax-efficient repatriation of cash generated or held in a number of jurisdictions;
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employment regulations and local labor conditions, including increases in employment costs, particularly in low-cost regions in which we currently operate;
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difficulties protecting intellectual property;
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instability in economic or political conditions, including sovereign debt levels, Eurozone uncertainty, inflation, recession, and actual or anticipated military or political conflicts;
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the impact of the United Kingdom’s withdrawal from the EU on January 31, 2020 (commonly referred to as “Brexit”), subject to a transition period that is set to end on December 31, 2020, could cause disruptions to, and create uncertainty surrounding, our business, including affecting our relationships with existing and potential customers and suppliers. The effects of Brexit, including long-lasting effects of Brexit on EU market access, will depend on more permanent agreements between the United Kingdom and the EU to be negotiated during the transition period; and
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the impact of each of the foregoing on our outsourcing and procurement arrangements.
We have sizeable operations in China, including 17 principal manufacturing sites. In addition, approximately 20% of our net sales in fiscal 2020 were made to customers in China. Economic conditions in China have been, and may continue to be, volatile and uncertain. In addition, the legal and regulatory system in China is still developing and subject to change. Accordingly, our operations and transactions with customers in China could be adversely affected by changes to market conditions, changes to the regulatory environment, or interpretation of Chinese law.
In addition, any downgrade by rating agencies of long-term U.S. sovereign debt or downgrades or defaults of sovereign debt of other nations may negatively affect global financial markets and economic conditions, which could negatively affect our business, financial condition, and liquidity.
Changes in U.S. federal tax laws could result in adverse consequences to U.S. persons treated as owning 10% or more of our shares.
Although we are a Swiss corporation, recent U.S. tax law changes have expanded application of certain ownership attribution rules and cause certain of our non-U.S. subsidiaries to be treated as Controlled Foreign Corporations (“CFCs”) for U.S. federal income tax purposes. A U.S. person that is treated for U.S. federal income tax purposes as owning, directly, indirectly, or constructively, 10% or more of our shares may be required to annually report and include in its U.S. taxable income its pro rata share of certain types of income earned by our subsidiaries that are treated as CFCs, whether or not we make any distributions to such U.S. shareholder. A U.S. person that owns 10% or more of our shares should consult a tax adviser regarding the potential implications to it of these changes in U.S. federal income tax law. The risk of U.S. federal income tax reporting and compliance obligations with respect to our subsidiaries that now are treated as CFCs may deter our current shareholders from increasing their investment in us, and others from investing in us, which could impact the demand for, and value of, our shares.
Risks Relating to the Industry in Which We Operate
We are dependent on the automotive and other industries.
We are dependent on end market dynamics to sell our products, and our operating results could be adversely affected by cyclical and reduced demand in these markets. Periodic downturns in our customers’ industries can significantly reduce demand for certain of our products, which could have a material adverse effect on our results of operations, financial position, and cash flows.
Approximately 40% of our net sales for fiscal 2020 were to customers in the automotive industry. The automotive industry is dominated by large manufacturers that can exert significant price pressure on their suppliers. Additionally, the automotive industry has historically experienced significant downturns during periods of deteriorating global or regional economic or credit conditions. As a supplier of automotive electronics products, our sales of these products and our profitability have been and could continue to be negatively affected by significant declines in global or regional economic or credit conditions and changes in the operations, products, business models, part-sourcing requirements, financial condition, and market share of automotive manufacturers, as well as potential consolidations among automotive manufacturers.
During fiscal 2020, approximately 10% of our net sales were to customers in the aerospace, defense, oil, and gas end market, 9% of our net sales were to customers in the industrial equipment end market, and 9% of our net sales were to customers in the commercial transportation market. The aerospace and defense industry has undergone significant fluctuations in demand as a result of economic and political conditions, including the impact of the COVID-19 pandemic. Demand in the oil and gas market is impacted by oil price volatility. The industrial equipment industry is dependent upon economic conditions, including customer investment in factory automation, intelligent buildings, and process control systems, as well as market conditions in the rail transportation, solar and lighting, and other major industrial markets we
serve. Demand in the commercial transportation industry is impacted by the economic environment and market conditions in the heavy truck, construction, agriculture, and recreational vehicle markets.
We encounter competition in substantially all areas of the electronic components industry.
We operate in highly competitive markets for electronic components and expect that both direct and indirect competition will increase in the future. Our overall competitive position depends on various factors including the price, quality, and performance of our products; the level of customer service; the development of new technology; our ability to participate in emerging markets; and customers’ expectations relating to socially responsible operations. The competition we experience across product lines from other companies ranges in size from large, diversified manufacturers to small, highly specialized manufacturers. The electronic components industry has become increasingly concentrated and globalized in recent years, and our major competitors have significant financial resources and technological capabilities. A number of these competitors compete with us primarily on price, and in some instances may have the benefit of lower production costs for certain products. We cannot provide assurance that additional competitors will not enter our markets, or that we will be able to compete successfully against existing or new competitors. Increased competition may result in price reductions, reduced margins, or loss of market share, any of which could materially and adversely affect our results of operations, financial position, and cash flows.
We are dependent on market acceptance of our new product introductions and product innovations for future revenue.
Substantially all markets in which we operate are impacted by technological change or change in consumer tastes and preferences, which are rapid in certain end markets. Our operating results depend substantially upon our ability to continually design, develop, introduce, and sell new and innovative products; to modify existing products; and to customize products to meet customer requirements driven by such change. There are numerous risks inherent in these processes, including the risk that we will be unable to anticipate the direction of technological change or that we will be unable to develop and market profitable new products and applications in time to satisfy customer demands.
Like other suppliers to the electronics industry, we are subject to continuing pressure to lower our prices.
We have historically experienced, and we expect to continue to experience, continuing pressure to lower our prices. In recent years, we have experienced price erosion averaging from 1% to 2% each year. To maintain our margins, we must continue to reduce our costs by similar amounts. We cannot provide assurance that continuing pressures to reduce our prices will not have a material adverse effect on our margins, results of operations, financial position, and cash flows.
We may be negatively affected as our customers and vendors continue to consolidate.
Many of the industries to which we sell our products, as well as many of the industries from which we buy materials, have become more concentrated in recent years, including the automotive, data and devices, and aerospace and defense industries. Consolidation of customers may lead to decreased product purchases from us. In addition, as our customers buy in larger volumes, their volume buying power has increased, enabling them to negotiate more favorable pricing and find alternative sources from which to purchase. Our materials suppliers similarly have increased their ability to negotiate favorable pricing. These trends may adversely affect the margins on our products, particularly for commodity components.
The life cycles of certain of our products can be very short.
The life cycles of certain of our products can be very short relative to their development cycle. As a result, the resources devoted to product sales and marketing may not result in material revenue and, from time to time, we may need to write off excess or obsolete inventory or equipment. If we were to incur significant engineering expenses and investments in inventory and equipment that we were not able to recover, and we were not able to compensate for those expenses, our results of operations, financial position, and cash flows could be materially and adversely affected.
Risks Relating to Our Operations
Our results are sensitive to raw material availability, quality, and cost.
We are a large buyer of resins, chemicals, additives, and metals, including copper, gold, silver, aluminum, brass, steel, and zinc. Many of these raw materials are produced in a limited number of countries around the world or are only available from a limited number of suppliers. In addition, the prices of many of these raw materials continue to fluctuate. If we have difficulty obtaining these raw materials, the quality of available raw materials deteriorates, or there are significant price increases for these raw materials, it could have a substantial impact on the price we pay for raw materials. To the extent we cannot compensate for cost increases through productivity improvements or price increases to our customers, our margins may decline, materially affecting our results of operations, financial position, and cash flows. In addition, we use financial instruments to hedge the volatility of certain commodities prices. The success of our hedging program depends on accurate forecasts of planned consumption of the hedged commodity materials. We could experience unanticipated hedge gains or losses if these forecasts are inaccurate.
In accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC established annual disclosure and reporting requirements for those companies who use tin, tantalum, tungsten, or gold (“conflict minerals” or “3TG”) mined from the Democratic Republic of the Congo (“DRC”) and adjoining countries (together with the DRC, the “Covered Countries”) in their products. These requirements, as well as new and additional regulations like the EU’s Conflict Minerals Regulation, could affect the sourcing, pricing, and availability of 3TG used in the manufacture of certain of our products, and may result in only a limited pool of suppliers who can demonstrate that they do not source any 3TG from the Covered Countries. Accordingly, we cannot provide assurance that we will be able to obtain non-conflict 3TG in sufficient quantities or at competitive prices. Further, since our supply chain is complex, we may face reputational challenges with our customers and other stakeholders if we are unable to sufficiently verify the origins and chain of custody for all conflict minerals used in our products through our due diligence procedures.
We may use components and products manufactured by third parties.
We may rely on third-party suppliers for the components used in our products, and we may rely on third-party manufacturers to manufacture certain of our assemblies and finished products. Our results of operations, financial position, and cash flows could be adversely affected if such third parties lack sufficient quality control or if there are significant changes in their financial or business condition. If these third parties fail to deliver quality products, parts, and components on time and at reasonable prices, we could have difficulties fulfilling our orders, sales and profits could decline, and our commercial reputation could be damaged.
Our future success is significantly dependent on our ability to attract and retain management and executive management employees.
Our success depends to a significant extent upon our continued ability to retain our management and executive management employees and hire new management and executive management employees to replace, succeed, or add to members of our management team. Our management team has significant industry experience and would be difficult to replace. Competition for management talent is intense, and any difficulties we may have to retain or hire members of management to achieve our objectives may have an adverse effect on our results of operations, financial position, and cash flows.
Security breaches and other disruptions to our information technology infrastructure or violations of data privacy laws could interfere with our operations, compromise confidential information, and expose us to liability which could materially adversely impact our business and reputation.
Security breaches and other disruptions to our information technology infrastructure could interfere with our operations; compromise information belonging to us, our employees, customers, and suppliers; and expose us to liability which could adversely impact our business and reputation. In the normal course of business, we rely on information technology networks and systems, some of which are managed by third parties, to process, transmit, and store electronic information, and to manage or support a variety of business processes and activities. Additionally, we collect and store certain data, including proprietary business information and customer and employee data, and may have access to confidential or personal information in certain of our businesses that is subject to privacy and security laws, regulations, and customer-imposed controls. Specifically, we are subject to the laws of various states and countries where we operate or do business related to solicitation, collection, processing, transferring, storing, or use of consumer, customer, vendor, or
employee information or related data, including the EU’s General Data Protection Regulation, which went into effect in May 2018, and the California Consumer Privacy Act of 2018, which went into effect in January 2020. In addition, several other countries in which we operate or do business, such as China, have enacted or are considering enacting laws that require personal data relating to their citizens to be maintained on local servers and impose additional data transfer restrictions. If countries in which we operate or do business adopt data localization or data residency laws, we could be required to implement new or expand existing data storage protocols, build new storage facilities, and/or devote additional resources to comply with the requirements of such laws, any of which could have significant cost implications.
Despite our cybersecurity measures (including employee and third-party training, monitoring of networks and systems, and maintenance of backup and protective systems) which are continuously reviewed and upgraded to mitigate persistent and continuously evolving cybersecurity threats, our information technology networks and infrastructure may still be vulnerable to damage, disruptions, or shutdowns due to attack by hackers or breaches, employee error or malfeasance, power outages, computer viruses, telecommunication or utility failures, systems failures, natural disasters, pandemics (including COVID-19), or other catastrophic events. In recent years, we have been the target of attempted cyber intrusions, and must continuously monitor and develop our systems to protect the integrity and functionality of our information technology infrastructure and access to and the security of our employees’, customers’, and suppliers’ data. Security breaches and other disruptions to our information technology infrastructure or violations of data privacy laws could result in legal claims or proceedings, liability or penalties under privacy laws, disruption in operations, and damage to our reputation which could materially adversely affect our business. While we have experienced, and expect to continue to experience, threats to our information technology networks and infrastructure, to date none of these threats have had a material impact on our business or operations. In addition, as a result of the COVID-19 pandemic, some of our employees have transitioned to working from home on a full-time or part-time basis, which may increase our vulnerability to cyber and other information technology risks.
Covenants in our debt instruments may adversely affect us.
Our five-year unsecured senior revolving credit facility (“Credit Facility”) contains financial and other covenants, such as a limit on the ratio of Consolidated Total Debt to Consolidated EBITDA (as defined in the Credit Facility) and limits on the amount of subsidiary debt and incurrence of liens. Our outstanding notes’ indentures contain customary covenants including limits on incurrence of liens, sale and lease-back transactions, and our ability to consolidate, merge, and sell assets.
Although none of these covenants are presently restrictive to our operations, our continued ability to meet the Credit Facility financial covenant can be affected by events beyond our control, and we cannot provide assurance that we will continue to comply with the covenant. A breach of any of our covenants could result in a default under our Credit Facility or indentures. Upon the occurrence of certain defaults under our Credit Facility and indentures, the lenders or trustee could elect to declare all amounts outstanding thereunder to be immediately due and payable, and our lenders could terminate commitments to extend further credit under our Credit Facility. If the lenders or trustee accelerate the repayment of borrowings, we cannot provide assurance that we will have sufficient assets or access to lenders or capital markets to repay or fund the repayment of any amounts outstanding under our Credit Facility and our other affected indebtedness. Acceleration of any debt obligation under any of our material debt instruments may permit the holders or trustee of our other material debt to accelerate payment of debt obligations to the creditors thereunder.
The indentures governing our outstanding senior notes contain covenants that may require us to offer to buy back the notes for a price equal to 101% of the principal amount, plus accrued and unpaid interest to the repurchase date, upon a change of control triggering event (as defined in the indentures). We cannot provide assurance that we will have sufficient funds available or access to funding to repurchase tendered notes in that event, which could result in a default under the notes. Any future debt that we incur may contain covenants regarding repurchases in the event of a change of control triggering event.
The market price of our shares may fluctuate widely.
The market price of our shares may fluctuate widely, depending upon many factors, including:
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our quarterly or annual earnings;
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quarterly or annual sales or earnings guidance that we may provide or changes thereto;
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actual or anticipated fluctuations in our operating results;
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volatility in financial markets and market fluctuations caused by global and regional economic conditions and investors’ concerns about potential risks to future economic growth;
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changes in earnings estimates by securities analysts or our ability to meet those estimates;
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changes in accounting standards, policies, guidance, interpretations, or principles;
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tax legislative and regulatory actions and proposals in Switzerland, the U.S., the EU, and other jurisdictions;
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announcements by us or our competitors of significant acquisitions or dispositions; and
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the operating and stock price performance of comparable companies and companies that serve end markets important to our business.
Risks Relating to Strategic Transactions
Future acquisitions may not be successful.
We regularly evaluate the possible acquisition of strategic businesses, product lines, or technologies which have the potential to strengthen our market position or enhance our existing product offerings, and we have completed a number of acquisitions in recent years. We anticipate that we will continue to pursue acquisition opportunities as part of our growth strategy. We cannot provide assurance that we will identify or successfully complete transactions with acquisition candidates in the future. We also cannot provide assurance that completed acquisitions will be successful. If an acquired business fails to operate as anticipated or cannot be successfully integrated with our existing business, our results of operations, financial position, and cash flows could be materially and adversely affected.
Future acquisitions could require us to issue additional debt or equity.
If we were to make a substantial acquisition with cash, the acquisition may need to be financed in part through funding from banks, public offerings or private placements of debt or equity securities, or other arrangements. This acquisition financing might decrease our ratio of earnings to fixed charges and adversely affect other leverage measures. We cannot provide assurance that sufficient acquisition financing would be available to us on acceptable terms if and when required. If we were to complete an acquisition partially or wholly funded by issuing equity securities or equity-linked securities, the issued securities may have a dilutive effect on the interests of the holders of our shares.
Divestitures of some of our businesses or product lines may have a material adverse effect on our results of operations, financial position, and cash flows.
We continue to evaluate the strategic fit of specific businesses and products which may result in additional divestitures. Any divestitures may result in significant write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our results of operations and financial position. Divestitures could involve additional risks, including difficulties in the separation of operations, services, products, and personnel; the diversion of management’s attention from other business concerns; the disruption of our business; and the potential loss of key employees. There can be no assurance that we will be successful in addressing these or any other significant risks encountered.
Risks Relating to Intellectual Property, Litigation, and Regulations
Our ability to compete effectively depends, in part, on our ability to maintain the proprietary nature of our products and technology.
The electronics industry is characterized by litigation regarding patent and other intellectual property rights. Within this industry, companies have become more aggressive in asserting and defending patent claims against competitors. There can be no assurance that we will not be subject to future litigation alleging infringement or invalidity of certain of our intellectual property rights or that we will not have to pursue litigation to protect our property rights. Depending on the importance of the technology, product, patent, trademark, or trade secret in question, an unfavorable outcome regarding one of these matters may have a material adverse effect on our results of operations, financial position, and cash flows.
We are a defendant to a variety of litigation in the course of our business that could cause a material adverse effect on our results of operations, financial position, and cash flows.
In the normal course of business, we are, from time to time, a defendant in litigation, including litigation alleging the infringement of intellectual property rights, anti-competitive behavior, product liability, breach of contract, and employment-related claims. In certain circumstances, patent infringement and antitrust laws permit successful plaintiffs to recover treble damages. The defense of these lawsuits may divert our management’s attention, and we may incur significant expenses in defending these lawsuits. In addition, we may be required to pay damage awards or settlements, or become subject to injunctions or other equitable remedies, that could cause a material adverse effect on our results of operations, financial position, and cash flows.
If any of our operations are found not to comply with applicable antitrust or competition laws or applicable trade regulations, our business may suffer.
Our operations are subject to applicable antitrust and competition laws in the jurisdictions in which we conduct our business, in particular the U.S. and the EU. These laws prohibit, among other things, anticompetitive agreements and practices. If any of our commercial agreements and practices with respect to the electronic components or other markets are found to violate or infringe such laws, we may be subject to civil and other penalties. We may also be subject to third-party claims for damages. Further, agreements that infringe these antitrust and competition laws may be void and unenforceable, in whole or in part, or require modification to be lawful and enforceable. If we are unable to enforce our commercial agreements, whether at all or in material part, our results of operations, financial position, and cash flows could be adversely affected. Further, any failure to maintain compliance with trade regulations could limit our ability to import and export raw materials and finished goods into or from the relevant jurisdiction, which could negatively impact our results of operations, financial position, and cash flows.
We could be adversely affected by violations of the U.S. Foreign Corrupt Practices Act, the United Kingdom’s Bribery Act, and similar worldwide anti-bribery laws.
The U.S. Foreign Corrupt Practices Act, the United Kingdom’s Bribery Act, and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business. Our policies mandate compliance with these anti-bribery laws. We operate in many parts of the world that have experienced governmental corruption to some degree, and in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. Despite our training and compliance program, we cannot provide assurance that our internal control policies and procedures always will protect us from reckless or criminal acts committed by our employees or agents. Violations of these laws, or allegations of such violations, could disrupt our business and result in a material adverse effect on our results of operations, financial position, and cash flows.
Our operations expose us to the risk of material environmental liabilities, litigation, government enforcement actions, and reputational risk.
We are subject to numerous federal, state, and local environmental protection and health and safety laws and regulations in the various countries where we operate and where our products are sold. These laws and regulations govern, among other things:
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the generation, storage, use, and transportation of hazardous materials;
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emissions or discharges of substances into the environment;
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investigation and remediation of hazardous substances or materials at various sites;
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greenhouse gas emissions;
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product hazardous material content; and
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the health and safety of our employees.
We may not have been, or we may not always be, in compliance with all environmental and health and safety laws and regulations. If we violate these laws, we could be fined, criminally charged, or otherwise sanctioned by regulators. In
addition, environmental and health and safety laws are becoming more stringent, resulting in increased costs and compliance requirements.
Certain environmental laws assess liability on current or previous owners or operators of real property for the costs of investigation, removal, and remediation of hazardous substances or materials at their properties or at properties at which they have disposed of hazardous substances. Liability for investigation, removal, and remediation costs under certain federal and state laws is retroactive, strict, and joint and several. In addition to cleanup actions brought by governmental authorities, private parties could bring personal injury or other claims due to the presence of, or exposure to, hazardous substances. We have received notifications from the U.S. Environmental Protection Agency, other environmental agencies, and third parties that conditions at a number of currently and formerly-owned or operated sites where we and others have disposed of hazardous substances require investigation, cleanup, and other possible remedial action and require that we reimburse the government or otherwise pay for the costs of investigation and remediation and for natural resource damage claims from such sites. We also have independently investigated various sites and determined that further investigation and/or remediation is necessary.
While we plan for future capital and operating expenditures to maintain compliance with environmental laws, we cannot provide assurance that our costs of complying with current or future environmental protection and health and safety laws, or our liabilities arising from past or future releases of, or exposures to, hazardous substances will not exceed our estimates or adversely affect our results of operations, financial position, and cash flows or that we will not be subject to additional environmental claims for personal injury, property damage, and/or cleanup in the future based on our past, present, or future business activities.
Our products are subject to various requirements related to chemical usage, hazardous material content, and recycling.
The EU, China, and other jurisdictions in which our products are sold have enacted or are proposing to enact laws addressing environmental and other impacts from product disposal, use of hazardous materials in products, use of chemicals in manufacturing, recycling of products at the end of their useful life, and other related matters. These laws include but are not limited to the EU Restriction of Hazardous Substances, End of Life Vehicle, and Waste Electrical and Electronic Equipment Directives; the EU REACH Regulation; and the China law on Management Methods for Controlling Pollution by Electronic Information Products. These laws prohibit the use of certain substances in the manufacture of our products and directly and indirectly impose a variety of requirements for modification of manufacturing processes, registration, chemical testing, labeling, and other matters. These laws continue to proliferate and expand in these and other jurisdictions to address other materials and other aspects of our product manufacturing and sale. These laws could make the manufacture or sale of our products more expensive or impossible, could limit our ability to sell our products in certain jurisdictions, and could result in liability for product recalls, penalties, or other claims.
Risks Relating to Our Swiss Jurisdiction of Incorporation
As a Swiss corporation, we have less flexibility with respect to certain aspects of capital management involving the issuance of shares.
As a Swiss corporation, our board of directors may not declare and pay dividends or distributions on our shares or reclassify reserves on our standalone unconsolidated Swiss balance sheet without shareholder approval and without satisfying certain other requirements. In addition, our articles of association allow us to create authorized share capital that can be issued by the board of directors, but this authorization is limited to (i) authorized share capital up to 50% of the existing registered shares with such authorization valid for a maximum of two years, which authorization period ends on March 11, 2022, approved by our shareholders at our March 11, 2020 annual general meeting of shareholders and (ii) conditional share capital of up to 50% of the existing registered shares that may be issued only for specific purposes. Additionally, subject to specified exceptions, Swiss law grants preemptive rights to existing shareholders to subscribe for new issuances of shares from authorized share capital and advance subscription rights to existing shareholders to subscribe for new issuances of shares from conditional share capital. Swiss law also does not provide much flexibility in the various terms that can attach to different classes of shares, and reserves for approval by shareholders many types of corporate actions, including the creation of shares with preferential rights with respect to liquidation, dividends, and/or voting. Moreover, under Swiss law, we generally may not issue registered shares for an amount below par value without prior shareholder approval to decrease the par value of our registered shares. Any such actions for which our shareholders must vote will require that we file a preliminary proxy statement with the SEC and convene a meeting of shareholders, which would delay the timing to execute such actions. Such limitations provide the board of directors less flexibility with respect to our capital management. While we
do not believe that Swiss law requirements relating to the issuance of shares will have a material adverse effect on us, we cannot provide assurance that situations will not arise where such flexibility would have provided substantial benefits to our shareholders and such limitations on our capital management flexibility would make our stock less attractive to investors.
We might not be able to make distributions on our shares without subjecting shareholders to Swiss withholding tax.
We anticipate making distributions to shareholders through a reduction of contributed surplus (as determined for Swiss tax and statutory purposes) in order to make the distributions on our shares to shareholders free of Swiss withholding tax. Various tax law and corporate law proposals in Switzerland, if passed in the future, may affect our ability to pay dividends or distributions to our shareholders free from Swiss withholding tax. There can be no assurance that we will be able to meet the legal requirements for future distributions to shareholders through dividends from contributed surplus or through a reduction of registered share capital, or that Swiss withholding rules would not be changed in the future. In addition, over the long term, the amount of registered share capital available for reductions will be limited. Our ability to pay dividends or distributions to our shareholders free from Swiss withholding tax is a significant component of our capital management and shareholder return practices that we believe is important to our shareholders, and any restriction on our ability to do so could make our stock less attractive to investors.
Currency fluctuations between the U.S. dollar and the Swiss franc may limit the amount available for any future distributions on our shares without subjecting shareholders to Swiss withholding tax.
Under Swiss law, the registered share capital in our unconsolidated Swiss statutory financial statements is required to be denominated in Swiss francs. Although distributions that are effected through a return of contributed surplus or registered share capital are expected to be paid in U.S. dollars, shareholder resolutions with respect to such distributions must take into account the Swiss francs denomination of the registered share capital. If the U.S. dollar were to increase in value relative to the Swiss franc, the U.S. dollar amount of registered share capital available for future distributions without Swiss withholding tax will decrease.
We have certain limitations on our ability to repurchase our shares.
The Swiss Code of Obligations regulates a corporation’s ability to hold or repurchase its own shares. We and our subsidiaries may only repurchase shares to the extent that sufficient freely distributable reserves (including contributed surplus as determined for Swiss tax and statutory purposes) are available. The aggregate par value of our registered shares held by us and our subsidiaries may not exceed 10% of our registered share capital. We may repurchase our registered shares beyond the statutory limit of 10%, however, only if our shareholders have adopted a resolution at a general meeting of shareholders authorizing the board of directors to repurchase registered shares in an amount in excess of 10% and the repurchased shares are dedicated for cancellation. Additionally, various corporate law proposals in Switzerland, if passed in the future, may affect our ability to repurchase our shares. Our ability to repurchase our shares is a significant component of our capital management and shareholder return practices that we believe is important to our shareholders, and any restriction on our ability to repurchase our shares could make our stock less attractive to investors.
Registered holders of our shares must be registered as shareholders with voting rights in order to vote at shareholder meetings.
Our articles of association contain a provision regarding voting rights that is required by Swiss law for Swiss companies like us that issue registered shares (as opposed to bearer shares). This provision provides that to be able to exercise voting rights, holders of our shares must be registered in our share register (Aktienbuch) as shareholders with voting rights. Only shareholders whose shares have been registered with voting rights on the record date may participate in and vote at our shareholders’ meetings, but all shareholders will be entitled to dividends, distributions, preemptive rights, advance subscription rights, and liquidation proceeds. The board of directors may, in its discretion, refuse to register shares as shares with voting rights if a shareholder does not fulfill certain disclosure requirements in our articles of association. Additionally, various proposals in Switzerland for corporate law changes, if passed in the future, may require shareholder registration in order to exercise voting rights for shareholders who hold their shares in street name through brokerages and banks. Such a registration requirement could make our stock less attractive to investors.
Certain provisions of our articles of association may reduce the likelihood of any unsolicited acquisition proposal or potential change of control that our shareholders might consider favorable.
Our articles of association contain provisions that could be considered “anti-takeover” provisions because they would make it harder for a third party to acquire us without the consent of our incumbent board of directors. Under these provisions, among others:
·
shareholders may act only at shareholder meetings and not by written consent, and
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restrictions will apply to any merger or other business combination between our company and any holder of 15% or more of our issued voting shares who became such without the prior approval of our board of directors.
These provisions may only be amended by the affirmative vote of the holders of 80% of our issued voting shares, which could have the effect of discouraging an unsolicited acquisition proposal or delaying, deferring, or preventing a change of control transaction that might involve a premium price, or otherwise be considered favorable by our shareholders. Our articles of association also contain provisions permitting our board of directors to issue new shares from authorized or conditional capital (in either case, representing a maximum of 50% of the shares presently registered in the commercial register and in case of issuances from authorized capital, until March 11, 2022 unless re-authorized by shareholders for a subsequent two-year period) without shareholder approval and without regard for shareholders’ preemptive rights or advance subscription rights, for the purpose of the defense of an actual, threatened, or potential unsolicited takeover bid, in relation to which the board of directors, upon consultation with an independent financial advisor, has not recommended acceptance to the shareholders. We note that Swiss courts have not addressed whether or not a takeover bid of this nature is an acceptable reason under Swiss law for withdrawing or limiting preemptive rights with respect to authorized share capital or advance subscription rights with respect to conditional share capital. In addition, the New York Stock Exchange (“NYSE”), on which our shares are listed, requires shareholder approval for issuances of shares equal to 20% or more of the outstanding shares or voting power, with limited exceptions.
Global legislative and regulatory actions and proposals could cause a material change in our worldwide effective corporate tax rate.
Various legislative and regulatory proposals have been directed at multinational companies with operations in lower-tax jurisdictions. There has been heightened focus on adoption of such legislation and on other initiatives, such as:
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the OECD’s initiative to develop agreed-upon best practices to prevent base erosion and profit shifting, which contemplate changes to numerous long-standing tax principles related to the distribution of profits between affiliated entities in different tax jurisdictions,
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EU and other country efforts to adopt certain OECD proposals and modified OECD proposals (including the Anti-Tax Avoidance Directive, state aid cases, and various transparency proposals), and
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tax policy changes in the U.S., such as additional federal tax reform measures, new tax regulations, and revisions to the Model Income Tax Treaty.
If these proposals are adopted in the main jurisdictions in which we do business, they could, among other things, cause double taxation, increase audit risk, and materially increase our worldwide corporate effective tax rate. We cannot predict the outcome of any specific legislative proposals or initiatives, and we cannot provide assurance that any such legislation or initiative will not apply to us.
Legislation in the U.S. could adversely impact our results of operations, financial position, and cash flows.
Various U.S. federal and state legislative proposals have been introduced in recent years that may negatively impact the growth of our business by denying government contracts to U.S. companies that have moved to lower-tax jurisdictions.
We expect the U.S. Congress to continue to consider implementation and/or expansion of policies that would restrict the federal and state governments from contracting with entities that have corporate locations abroad. We cannot predict the likelihood that, or final form in which, any such proposed legislation might become law, the nature of regulations that may be promulgated under any future legislative enactments, the effect such enactments and increased regulatory scrutiny may have on our business, or the outcome of any specific legislative proposals. Therefore, we cannot provide assurance that any such
legislative action will not apply to us. In addition, we are unable to predict whether the final form of any potential legislation discussed above also would affect our indirect sales to U.S. federal or state governments or the willingness of our non-governmental customers to do business with us. As a result of these uncertainties, we are unable to assess the potential impact of any proposed legislation in this area and cannot provide assurance that the impact will not be materially adverse to us.
Swiss law differs from the laws in effect in the U.S. and may afford less protection to holders of our securities.
As we are organized under the laws of Switzerland, it may not be possible to enforce court judgments obtained in the U.S. against us in Switzerland based on the civil liability provisions of the U.S. federal or state securities laws. In addition, there is some uncertainty as to whether the courts of Switzerland would recognize or enforce judgments of U.S. courts obtained against us or our directors or officers based on the civil liability provisions of the U.S. federal or state securities laws or hear actions against us or those persons based on those laws. We have been advised that the U.S. and Switzerland currently do not have a treaty providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. Some remedies available under the laws of U.S. jurisdictions, including some remedies available under the U.S. federal securities laws, would not be allowed in Swiss courts as they are contrary to Switzerland’s public policy.
Swiss law differs in certain material respects from laws generally applicable to U.S. corporations and their shareholders. These differences include the manner in which directors must disclose transactions in which they have an interest, the rights of shareholders to bring class action and derivative lawsuits, and the scope of indemnification available to directors and officers. Thus, holders of our securities may have more difficulty protecting their interests than would holders of securities of a corporation incorporated in a jurisdiction of the U.S.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our principal executive office is located in Schaffhausen, Switzerland. As of fiscal year end 2020, we owned approximately 18 million square feet and leased approximately 9 million square feet of aggregate floor space, used primarily for manufacturing, warehousing, and office space. We believe our facilities are suitable for the conduct of our business and adequate for our current needs.
We manufacture our products in over 25 countries worldwide. Our manufacturing sites focus on various aspects of our manufacturing processes, including our primary processes of stamping, plating, molding, extrusion, beaming, and assembly. We consider the productive capacity of our manufacturing facilities sufficient. As of fiscal year end 2020, our principal centers of manufacturing output by segment and geographic region were as follows:
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, we are subject to various legal proceedings and claims, including product liability matters, employment disputes, disputes on agreements, other commercial disputes, environmental matters, antitrust claims, and tax matters, including non-income tax matters such as value added tax, sales and use tax, real estate tax, and transfer tax. In addition, we operate in an industry susceptible to significant patent legal claims. At any given time in the normal course of business, we are involved as either a plaintiff or defendant in a number of patent infringement actions. If infringement of a third party’s patent were to be determined against us, we might be required to make significant royalty or other payments or might be subject to an injunction or other limitation on our ability to manufacture or sell one or more products. If a patent owned by or licensed to us were determined to be invalid or unenforceable, we might be required to reduce the value of the patent on our Consolidated Balance Sheet and to record a corresponding charge, which could be significant in amount.
Management believes that these legal proceedings and claims likely will be resolved over an extended period of time. Although it is not feasible to predict the outcome of these proceedings, based upon our experience, current information, and applicable law, we do not expect that the outcome of these proceedings, either individually or in the aggregate, will have a material effect on our results of operations, financial position, or cash flows.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Holders
Our common shares are listed and traded on the NYSE under the symbol “TEL.” As of November 4, 2020, there were 18,230 shareholders of record of our common shares.
Performance Graph
The following graph compares the cumulative total shareholder return on our common shares against the cumulative return on the S&P 500 Index and the Dow Jones Electrical Components and Equipment Index. The graph assumes the investment of $100 in our common shares and in each index at fiscal year end 2015 and assumes the reinvestment of all dividends and distributions. The graph shows the cumulative total return for the last five fiscal years. The comparisons in the graph are based upon historical data and are not indicative of, nor intended to forecast, future performance of our common shares.
(1)
$100 invested on September 25, 2015 in TE Connectivity Ltd.’s common shares and in indexes. Indexes calculated on month-end basis.
Issuer Purchases of Equity Securities
The following table presents information about our purchases of our common shares during the quarter ended September 25, 2020:
(1) These columns represent the acquisition of common shares from individuals to satisfy tax withholding requirements in connection with the vesting of restricted share awards issued under equity compensation plans.
(2) Our share repurchase program authorizes us to purchase a portion of our outstanding common shares from time to time through open market or private transactions, depending on business and market conditions. The share repurchase program does not have an expiration date.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data. The data presented should be read in conjunction with our Consolidated Financial Statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report. Our consolidated financial information may not be indicative of our future performance.
(1) Fiscal 2016 was a 53-week year.
(2) Fiscal 2016 included a pre-tax gain of $144 million on the sale of our Circuit Protection Devices business.
(3) Fiscal 2020 included a goodwill impairment charge related to the Sensors reporting unit in our Transportation Solutions segment. See Note 8 to the Consolidated Financial Statements for additional information regarding the impairment of goodwill.
(4) Fiscal 2016 net other income (expense) was recorded primarily pursuant to the Tax Sharing Agreement with Tyco International plc and Covidien plc and included $604 million of other expense related to the effective settlement of tax matters for the years 1997 through 2000 and $46 million of other expense related to a tax settlement in another tax jurisdiction.
(5) For fiscal 2020, 2019, and 2018, see Note 16 to the Consolidated Financial Statements for additional information. Fiscal 2016 included a $1,135 million income tax benefit related to the effective settlement of tax matters for the years 1997 through 2000, partially offset by a $91 million income tax charge related to an increase to the valuation allowance for certain U.S. deferred tax assets. Additionally, fiscal 2016 included an $83 million net income tax benefit related to tax settlements in certain other tax jurisdictions, partially offset by an income tax charge related to certain legal entity restructurings.
(6) Fiscal 2019 included a pre-tax loss of $86 million on the sale of our Subsea Communications business. For additional information regarding discontinued operations, see Note 4 to the Consolidated Financial Statements.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the accompanying notes included elsewhere in this Annual Report. The following discussion may contain forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this Annual Report, particularly in “Risk Factors” and “Forward-Looking Information.”
Our Consolidated Financial Statements have been prepared in U.S. dollars, in accordance with accounting principles generally accepted in the U.S. (“GAAP”).
Discussion of our financial condition and results of operations for fiscal 2020 compared to fiscal 2019 is presented below. Discussion of our financial condition and results of operations for fiscal 2019 compared to fiscal 2018 can be found in “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended September 27, 2019.
The following discussion includes organic net sales growth (decline) which is a non-GAAP financial measure. See “Non-GAAP Financial Measure” for additional information regarding this measure.
Overview
We are a global industrial technology leader creating a safer, sustainable, productive, and connected future. Our broad range of connectivity and sensor solutions, proven in the harshest environments, enable advancements in transportation, industrial applications, medical technology, energy, data communications, and the home.
Summary of Fiscal 2020 Performance
● Our fiscal 2020 net sales decreased 9.5% from fiscal 2019 levels due to sales declines in the Transportation Solutions segment and, to a lesser degree, the Industrial Solutions and Communications Solutions segments. On an organic basis, our net sales decreased 9.9% in fiscal 2020 as compared to fiscal 2019. Our net sales declines included significant unfavorable impacts from the COVID-19 pandemic.
● Our net sales by segment were as follows:
● Transportation Solutions-Our net sales decreased 12.5% due to sales declines in the automotive end market and, to a lesser degree, the commercial transportation and sensors end markets.
● Industrial Solutions-Our net sales decreased 6.1% primarily as a result of sales declines in the industrial equipment and the aerospace, defense, oil, and gas end markets.
● Communications Solutions-Our net sales decreased 3.5% due to sales declines in both the appliances and the data and devices end markets.
● During fiscal 2020, our shareholders approved a dividend payment to shareholders of $1.92 per share, payable in four equal quarterly installments of $0.48 beginning in the third quarter of fiscal 2020 and ending in the second quarter of fiscal 2021.
● Net cash provided by continuing operating activities was $1,991 million in fiscal 2020.
● We acquired approximately 72% of the outstanding shares of First Sensor AG (“First Sensor”), a provider of sensing solutions based in Germany, during fiscal 2020.
COVID-19 Pandemic and Economic Conditions
A novel strain of coronavirus (“COVID-19”) was first identified in China in December 2019 and subsequently declared a pandemic by the World Health Organization. To date, COVID-19 has surfaced in nearly all regions around the world and resulted in travel restrictions and business slowdowns or shutdowns in affected areas. The COVID-19 pandemic negatively affected our sales and operating results during fiscal 2020, and we expect that it will continue to have an impact on our financial condition and results of operations in the near term and may have a material impact on our financial condition, liquidity, and results of operations in future periods.
The COVID-19 pandemic is currently impacting, and we expect that it will continue to impact, our business operations globally, causing potential disruption in our suppliers’ and customers’ supply chains, some of our business locations to reduce or suspend operations, and a reduction in demand for certain products from direct customers or end markets. While a number of our businesses are operating as essential businesses, some have had and continue to have adjusted, reduced, or suspended operating activities at certain locations. In addition, the COVID-19 pandemic may have far-reaching impacts on many additional aspects of our operations, directly and indirectly, including with respect to its impacts on customer behaviors, business and manufacturing operations, inventory, our employees, and the market generally, and the scope and nature of these impacts continue to evolve each day. We expect to continue to assess the evolving impact of the COVID-19 pandemic and intend to adjust our operations accordingly. For example, throughout our operations, we have enacted additional health and safety measures for the protection of our employees, including providing personal protective equipment, enhanced cleaning and sanitizing of our facilities, and remote working arrangements.
We expect that the COVID-19 pandemic will continue to impact several of the markets we serve, in particular the automotive and commercial aerospace markets. We expect these markets to decline in the near term relative to fiscal 2020 and they may decline in future periods. However, despite these market declines, we expect a slight increase in our total net sales in the first quarter of fiscal 2021 as compared to the first quarter of fiscal 2020. See “Outlook” below for additional information.
In response to the current economic environment and our sales declines relative to fiscal 2019, we have taken and continue to focus on actions to manage costs. These include restructuring and other cost reduction initiatives, such as reducing discretionary spending, cutting capital expenditures, reducing travel, and furloughing certain employees. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state, or local authorities or that we determine are in the best interests of our employees, customers, suppliers, shareholders, and the communities in which we operate.
For further discussion of the risks and uncertainties associated with the COVID-19 pandemic, see “Part I. Item 1A. Risk Factors.”
Outlook
In the first quarter of fiscal 2021, we expect our net sales to be approximately $3.2 billion as compared to $3.17 billion in the first quarter of fiscal 2020. This represents a slight increase resulting from sales growth in the Transportation Solutions and Communications Solutions segments, partially offset by sales declines in the Industrial Solutions segment. Additional information regarding expectations for our reportable segments is as follows:
● Transportation Solutions-In the automotive end market, we expect our net sales increase resulting from content growth to be offset by sales decreases resulting from declines in global automotive production in the
first quarter of fiscal 2021 as compared to the same period of fiscal 2020. We expect global automotive production in the first quarter of fiscal 2021 to decline compared to the first quarter of fiscal 2020, but to increase from the fourth quarter of fiscal 2020. We expect our net sales to increase in the sensors and commercial transportation end markets in the first quarter of fiscal 2021 over the first quarter of fiscal 2020. Our sales in the sensors end market are expected to benefit from the acquisition of First Sensor.
● Industrial Solutions-We expect our net sales to decline in the aerospace, defense, oil, and gas end market in the first quarter of fiscal 2021 as compared to the same period of fiscal 2020 primarily as a result of weakness in the commercial aerospace market. We expect the commercial aerospace market to decline over 20% in fiscal 2021 as compared to fiscal 2020.
● Communications Solutions-We expect our net sales to increase in both the data and devices and the appliances end markets in the first quarter of fiscal 2021 as compared to the same period of fiscal 2020. We expect to continue to benefit from cloud infrastructure spending and a recovery in the appliances market in fiscal 2021 as compared to fiscal 2020.
We expect diluted earnings per share from continuing operations to be approximately $0.83 per share in the first quarter of fiscal 2021. This outlook reflects the positive impact of foreign currency exchange rates on net sales and earnings per share of approximately $55 million and $0.04 per share, respectively, in the first quarter of fiscal 2021 as compared to the same period of fiscal 2020.
The above outlook is based on foreign currency exchange rates and commodity prices that are consistent with current levels.
We are monitoring the current macroeconomic environment and its potential effects on our customers and the end markets we serve, including developments related to the COVID-19 pandemic. We have taken actions to manage costs and will continue to closely manage our costs in line with economic conditions. Additionally, we are managing our capital resources and monitoring capital availability to ensure that we have sufficient resources to fund future capital needs. See further discussion in “Liquidity and Capital Resources.”
Acquisitions
During fiscal 2020, we acquired approximately 72% of the outstanding shares of First Sensor for €181 million in cash (equivalent to $201 million using an exchange rate of $1.11 per €1.00), net of cash acquired. This business has been reported as part of our Transportation Solutions segment from the date of acquisition.
We acquired four additional businesses for a combined cash purchase price of $135 million, net of cash acquired, during fiscal 2020. The acquisitions were reported as part of our Transportation Solutions and Industrial Solutions segments from the date of acquisition.
During fiscal 2019, we acquired three businesses for a combined cash purchase price of $296 million, net of cash acquired. The acquisitions were reported as part of our Transportation Solutions segment from the date of acquisition.
See Note 5 to the Consolidated Financial Statements for additional information regarding acquisitions.
Discontinued Operations
In fiscal 2019, we sold our Subsea Communications (“SubCom”) business for net cash proceeds of $297 million and incurred a pre-tax loss on sale of $86 million. The SubCom business met the held for sale and discontinued operations criteria and has been reported as such in all periods presented on our Consolidated Financial Statements. Prior to reclassification to discontinued operations, the SubCom business was included in the Communications Solutions segment.
See Note 4 to the Consolidated Financial Statements for additional information regarding discontinued operations.
Results of Operations
Net Sales
The following table presents our net sales and the percentage of total net sales by segment:
The following table provides an analysis of the change in our net sales by segment:
Net sales decreased $1,276 million, or 9.5%, in fiscal 2020 as compared to fiscal 2019. The decrease in net sales resulted from organic net sales declines of 9.9% and the negative impact of foreign currency translation of 0.8% due to the weakening of certain foreign currencies, partially offset by sales contributions from acquisitions of 1.2%. Price erosion adversely affected organic net sales by $173 million in fiscal 2020. In fiscal 2020, our net sales declines included significant unfavorable impacts from the COVID-19 pandemic.
See further discussion of net sales below under “Segment Results.”
Net Sales by Geographic Region. Our business operates in three geographic regions-Asia-Pacific, EMEA, and the Americas-and our results of operations are influenced by changes in foreign currency exchange rates. Increases or decreases in the value of the U.S. dollar, compared to other currencies, will directly affect our reported results as we translate those currencies into U.S. dollars at the end of each fiscal period. We sell our products into approximately 140 countries, and approximately 60% of our net sales were invoiced in currencies other than the U.S. dollar in fiscal 2020. The percentage of net sales in fiscal 2020 by major currencies invoiced was as follows:
The following table presents our net sales and the percentage of total net sales by geographic region:
The following table provides an analysis of the change in our net sales by geographic region:
Cost of Sales and Gross Margin
The following table presents cost of sales and gross margin information:
In fiscal 2020, gross margin decreased $659 million as compared to fiscal 2019 primarily as a result of lower volume and, to a lesser degree, price erosion and lower manufacturing productivity, partially offset by lower material costs.
We use a wide variety of raw materials in the manufacture of our products. Cost of sales and gross margin are subject to variability in raw material prices which continue to fluctuate for many of the raw materials we use, including copper, gold, and silver. In fiscal 2020, we purchased approximately 160 million pounds of copper, 107,000 troy ounces of gold, and 2.2 million troy ounces of silver. The following table presents the average prices incurred related to copper, gold, and silver:
In fiscal 2021, we expect to purchase approximately 155 million pounds of copper, 105,000 troy ounces of gold, and 2.2 million troy ounces of silver.
Operating Expenses
The following table presents operating expense information:
Selling, General, and Administrative Expenses. In fiscal 2020, selling, general, and administrative expenses decreased $98 million as compared to fiscal 2019 due primarily to reduced selling expenses, cost control measures, and savings attributable to restructuring actions.
Restructuring and Other Charges, Net. We are committed to continuous productivity improvements, and we evaluate opportunities to simplify our global manufacturing footprint, migrate facilities to lower-cost regions, reduce fixed costs, and eliminate excess capacity. These initiatives are designed to help us maintain our competitiveness in the industry, improve our operating leverage, and position us for future growth.
During fiscal 2020 and 2019, we initiated restructuring programs associated with footprint consolidation and structural improvements impacting all segments. The fiscal 2020 actions were due in part to the COVID-19 pandemic. We incurred net restructuring charges of $257 million and $255 million in fiscal 2020 and 2019, respectively. Annualized cost savings related to actions initiated in fiscal 2020 are expected to be approximately $200 million and are expected to be realized by the end of fiscal 2022. Cost savings will be reflected primarily in cost of sales and selling, general, and administrative expenses. For fiscal 2021, we currently expect total restructuring charges to be approximately $200 million and total spending, which will be funded with cash from operations, to be approximately $250 million.
See Note 3 to the Consolidated Financial Statements for additional information regarding net restructuring and other charges.
Impairment of Goodwill. As a result of current and projected declines in sales and profitability, due in part to the impact of the COVID-19 pandemic and projected reductions in global automotive production as of March 2020, of the Sensors reporting unit of the Transportation Solutions segment during the second quarter of fiscal 2020, we determined that an indicator of impairment had occurred and goodwill impairment testing of this reporting unit was required.
As discussed in Note 2 to the Consolidated Financial Statements, during the second quarter of fiscal 2020, we adopted Accounting Standards Update (“ASU”) No. 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating step 2 of the goodwill impairment test. Under the new standard, goodwill impairment is measured as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying value of goodwill. We determined the fair value of the Sensors reporting unit to be $1.0 billion as of March 27, 2020. This valuation was based on a discounted cash flows analysis incorporating our estimate of future operating performance, which we consider to be a level 3 unobservable input in the fair value hierarchy, and was corroborated using a market approach valuation. The goodwill impairment test indicated that the carrying value of the reporting unit exceeded its fair value by $900 million. As a result, we recorded a partial impairment charge of $900 million in the second quarter of fiscal 2020. As of fiscal year end 2020, the Sensors reporting unit had a remaining goodwill allocation of $511 million. See Note 8 to the Consolidated Financial Statements for additional information regarding the impairment of goodwill and our annual goodwill impairment test.
Operating Income
The following table presents operating income and operating margin information:
Operating income included the following:
(1) Represents the write-off of certain spare parts.
See discussion of operating income below under “Segment Results.”
Non-Operating Items
The following table presents select non-operating information:
Interest Expense. Interest expense decreased $20 million during fiscal 2020 due primarily to a lower cost of debt and our cross-currency swap program that hedges our net investment in certain foreign operations. The aggregate notional value of the contracts under this program was $1,664 million at fiscal year end 2020. Under the terms of these contracts, we receive interest in U.S. dollars at a weighted-average rate of 2.4% per annum and pay no interest. See Note 14 to the Consolidated Financial Statements for additional information regarding our cross-currency swap program.
Income Taxes. See Note 16 to the Consolidated Financial Statements for discussion of items impacting income tax expense (benefit) and the effective tax rate for fiscal 2020 and 2019, including the Switzerland Federal Act on Tax Reform and AHV Financing (“Swiss Tax Reform”), increases to the valuation allowance for certain deferred tax assets, and the termination of the Tax Sharing Agreement.
The valuation allowance for deferred tax assets was $4,429 million and $4,970 million at fiscal year end 2020 and 2019, respectively. See Note 16 to the Consolidated Financial Statements for further information regarding the valuation allowance for deferred tax assets.
As of fiscal year end 2020, certain subsidiaries had approximately $29 billion of cumulative undistributed earnings that have been retained indefinitely and reinvested in our global manufacturing operations, including working capital; property, plant, and equipment; intangible assets; and research and development activities. See Note 16 to the Consolidated Financial Statements for additional information regarding undistributed earnings.
Income (Loss) from Discontinued Operations, Net of Income Taxes. During fiscal 2019, we sold our SubCom business for net cash proceeds of $297 million and incurred a pre-tax loss on sale of $86 million. The net sales of the business were $41 million in fiscal 2019. The results for fiscal 2019 represent one month of activity. See Note 4 to the Consolidated Financial Statements for additional information regarding discontinued operations.
Segment Results
Transportation Solutions
Net Sales. The following table presents the Transportation Solutions segment’s net sales and the percentage of total net sales by industry end market(1):
(1) Industry end market information is presented consistently with our internal management reporting and may be revised periodically as management deems necessary.
The following table provides an analysis of the change in the Transportation Solutions segment’s net sales by industry end market:
Net sales in the Transportation Solutions segment decreased $976 million, or 12.5%, in fiscal 2020 from fiscal 2019 as a result of organic net sales declines of 13.5% and the negative impact of foreign currency translation of 0.9%, partially offset by sales contributions from acquisitions of 1.9%. Net sales declines in fiscal 2020 included significant unfavorable impacts of the COVID-19 pandemic. Our organic net sales by industry end market were as follows:
● Automotive-Our organic net sales decreased 12.9% in fiscal 2020 with declines of 18.0% in the Americas region, 16.7% in the EMEA region, and 6.4% in the Asia-Pacific region. Our overall organic net sales decreased as a result of declines in global automotive production; however, our sales decreased at a lesser rate than global automotive production due to content gains.
● Commercial transportation-Our organic net sales decreased 14.4% in fiscal 2020 due to market weakness in the Americas and EMEA regions, partially offset by growth in the Asia-Pacific region.
● Sensors-Our organic net sales decreased 16.3% in fiscal 2020 as a result of weakness across all markets.
Operating Income (Loss). The following table presents the Transportation Solutions segment’s operating income (loss) and operating margin information:
Operating income (loss) in the Transportation Solutions segment decreased $1,319 million in fiscal 2020 as compared to fiscal 2019. The Transportation Solutions segment’s operating income (loss) included the following:
Excluding these items, operating income decreased in fiscal 2020 primarily as a result of lower volume and, to a lesser degree, price erosion and lower manufacturing productivity, partially offset by lower material costs.
Industrial Solutions
Net Sales. The following table presents the Industrial Solutions segment’s net sales and the percentage of total net sales by industry end market(1):
(1) Industry end market information is presented consistently with our internal management reporting and may be revised periodically as management deems necessary.
The following table provides an analysis of the change in the Industrial Solutions segment’s net sales by industry end market:
In the Industrial Solutions segment, net sales decreased $241 million, or 6.1%, in fiscal 2020 from fiscal 2019 due primarily to organic net sales declines of 5.4%. Significant unfavorable impacts of the COVID-19 pandemic were included in our net sales declines in fiscal 2020. Our organic net sales by industry end market were as follows:
● Aerospace, defense, oil, and gas-Our organic net sales decreased 7.8% in fiscal 2020 due primarily to weakness in the commercial aerospace market, partially offset by strength in the defense market.
● Industrial equipment-Our organic net sales decreased 10.7% in fiscal 2020 as a result of market weakness in industrial applications across all regions.
● Medical-Our organic net sales decreased 1.3% in fiscal 2020 due primarily to delays in elective procedures.
● Energy-Our organic net sales increased 4.3% in fiscal 2020 primarily as a result of growth in the EMEA and Americas regions.
Operating Income. The following table presents the Industrial Solutions segment’s operating income and operating margin information:
Operating income in the Industrial Solutions segment decreased $131 million in fiscal 2020 from fiscal 2019. The Industrial Solutions segment’s operating income included the following:
Excluding these items, operating income decreased in fiscal 2020 primarily as a result of lower volume, partially offset by lower material costs.
Communications Solutions
Net Sales. The following table presents the Communications Solutions segment’s net sales and the percentage of total net sales by industry end market(1):
(1) Industry end market information is presented consistently with our internal management reporting and may be revised periodically as management deems necessary.
The following table provides an analysis of the change in the Communications Solutions segment’s net sales by industry end market:
Net sales in the Communications Solutions segment decreased $59 million, or 3.5%, in fiscal 2020 as compared to fiscal 2019 due primarily to organic net sales declines of 3.2%. In fiscal 2020, our net sales declines included unfavorable impacts of the COVID-19 pandemic. Our organic net sales by industry end market were as follows:
● Data and devices-Our organic net sales decreased 2.5% in fiscal 2020 primarily as a result of market weakness in the Americas and EMEA regions, partially offset by increased sales to cloud infrastructure customers.
● Appliances-Our organic net sales decreased 4.4% in fiscal 2020 due primarily to market weakness in the EMEA and Americas regions.
Operating Income. The following table presents the Communications Solutions segment’s operating income and operating margin information:
In the Communications Solutions segment, operating income increased $9 million in fiscal 2020 as compared to fiscal 2019. The Communications Solutions segment’s operating income included the following:
Excluding these items, fiscal 2020 operating income was consistent with fiscal 2019 levels.
Liquidity and Capital Resources
Our ability to fund our future capital needs will be affected by our ability to continue to generate cash from operations and may be affected by our ability to access the capital markets, money markets, or other sources of funding, as well as the capacity and terms of our financing arrangements. We believe that cash generated from operations and, to the extent necessary, these other sources of potential funding will be sufficient to meet our anticipated capital needs for the foreseeable future, including the payments of $250 million of 4.875% senior notes due in January 2021 and €350 million of fixed-to-floating rate senior notes due in June 2021, and compensation payments to First Sensor minority shareholders. We may use excess cash to purchase a portion of our common shares pursuant to our authorized share repurchase program, to acquire strategic businesses or product lines, to pay dividends on our common shares, or to reduce our outstanding debt. The cost or availability of future funding may be impacted by financial market conditions. We will continue to monitor financial markets and respond as necessary to changing conditions, including future developments related to the COVID-19 pandemic. There is uncertainty surrounding the duration and scope of the COVID-19 pandemic and it may have a material impact on our liquidity and financial conditions. We believe that we have sufficient financial resources and liquidity which, along with managing expenses and capital structure flexibility, will enable us to meet our ongoing working capital and other cash flow needs during the COVID-19 pandemic and resulting period of economic uncertainty which included reduced sales and net
income levels for us in fiscal 2020 relative to fiscal 2019 and may include reduced sales and income levels in future periods. For further information on the risks and uncertainties associated with the COVID-19 pandemic, see “Part I. Item 1A. Risk Factors.”
As of fiscal year end 2020, our cash and cash equivalents were held in subsidiaries which are located in various countries throughout the world. Under current applicable laws, substantially all of these amounts can be repatriated to Tyco Electronics Group S.A. (“TEGSA”), our Luxembourg subsidiary, which is the obligor of substantially all of our debt, and to TE Connectivity Ltd., our Swiss parent company; however, the repatriation of these amounts could subject us to additional tax expense. We provide for tax liabilities on the Consolidated Financial Statements with respect to amounts that we expect to repatriate; however, no tax liabilities are recorded for amounts that we consider to be retained indefinitely and reinvested in our global manufacturing operations. As of fiscal year end 2020, we had approximately $5.3 billion of cash, cash equivalents, and intercompany deposits, principally in our subsidiaries, that we have the ability to distribute to TEGSA and TE Connectivity Ltd. but we consider to be permanently reinvested. We estimate that up to $0.8 billion of tax expense would be recognized on the Consolidated Financial Statements if our intention to permanently reinvest these amounts were to change. Our current plans do not demonstrate a need to repatriate cash, cash equivalents, and intercompany deposits that are designated as permanently reinvested in order to fund our operations, including investing and financing activities.
Cash Flows from Operating Activities
Net cash provided by continuing operating activities decreased $463 million to $1,991 million in fiscal 2020 as compared to $2,454 million in fiscal 2019. The decrease resulted primarily from lower pre-tax income levels.
The amount of income taxes paid, net of refunds, during fiscal 2020 and 2019 was $257 million and $338 million, respectively. We do not expect a significant change in our income tax payments as a result of Swiss Tax Reform. See Note 16 to the Consolidated Financial Statements for additional information regarding Swiss Tax Reform.
Pension contributions were $47 million and $45 million in fiscal 2020 and 2019, respectively. We expect pension contributions to be $69 million in fiscal 2021, before consideration of any voluntary contributions. For additional information regarding pensions, see Note 15 to the Consolidated Financial Statements.
Cash Flows from Investing Activities
Capital expenditures were $560 million and $749 million in fiscal 2020 and 2019, respectively. We expect fiscal 2021 capital spending levels to be approximately 5% of net sales. We believe our capital funding levels are adequate to support new programs, and we continue to invest in our manufacturing infrastructure to further enhance productivity and manufacturing capabilities.
During fiscal 2020, we acquired five businesses, including First Sensor, for a combined cash purchase price of $336 million, net of cash acquired. During fiscal 2019, we acquired three businesses for a combined cash purchase price of $296 million, net of cash acquired. See Note 5 to the Consolidated Financial Statements for additional information regarding acquisitions.
During fiscal 2019, we received net cash proceeds of $297 million related to the sale of our SubCom business. See additional information in Note 4 to the Consolidated Financial Statements.
Cash Flows from Financing Activities and Capitalization
Total debt at fiscal year end 2020 and 2019 was $4,146 million and $3,965 million, respectively. See Note 11 to the Consolidated Financial Statements for additional information regarding debt.
During fiscal 2020, TEGSA, our wholly-owned subsidiary, issued €550 million aggregate principal amount of 0.00% senior notes due in February 2025. The notes are TEGSA’s unsecured senior obligations and rank equally in right of payment with all existing and any future senior indebtedness of TEGSA and senior to any subordinated indebtedness that TEGSA may incur.
TEGSA has a five-year unsecured senior revolving credit facility (“Credit Facility”) with a maturity date of November 2023 and total commitments of $1.5 billion. The Credit Facility contains provisions that allow for incremental commitments of up to $500 million, an option to temporarily increase the financial ratio covenant following a qualified
acquisition, and borrowings in designated currencies. TEGSA had no borrowings under the Credit Facility at fiscal year end 2020 or 2019.
The Credit Facility contains a financial ratio covenant providing that if, as of the last day of each fiscal quarter, our ratio of Consolidated Total Debt to Consolidated EBITDA (as defined in the Credit Facility) for the then most recently concluded period of four consecutive fiscal quarters exceeds 3.75 to 1.0, an Event of Default (as defined in the Credit Facility) is triggered. The Credit Facility and our other debt agreements contain other customary covenants. None of our covenants are presently considered restrictive to our operations. As of fiscal year end 2020, we were in compliance with all of our debt covenants and believe that we will continue to be in compliance with our existing covenants for the foreseeable future.
Periodically, TEGSA issues commercial paper to U.S. institutional accredited investors and qualified institutional buyers in accordance with available exemptions from the registration requirements of the Securities Act of 1933 as part of our ongoing effort to maintain financial flexibility and to potentially decrease the cost of borrowings. Borrowings under the commercial paper program are backed by the Credit Facility.
TEGSA’s payment obligations under its senior notes, commercial paper, and Credit Facility are fully and unconditionally guaranteed on an unsecured basis by its parent, TE Connectivity Ltd.
Payments of common share dividends to shareholders were $625 million and $608 million in fiscal 2020 and 2019, respectively. See Note 18 to the Consolidated Financial Statements for additional information regarding dividends on our common shares.
In March 2020, our shareholders approved a dividend payment to shareholders of $1.92 per share, payable in four equal quarterly installments of $0.48 per share beginning in the third quarter of fiscal 2020 and ending in the second quarter of fiscal 2021.
Future dividends on our common shares, if any, must be approved by our shareholders. In exercising their discretion to recommend to the shareholders that such dividends be approved, our board of directors will consider our results of operations, cash requirements and surplus, financial condition, statutory requirements of applicable law, contractual restrictions, and other factors that they may deem relevant.
In fiscal 2019, our board of directors authorized an increase of $1.5 billion in our share repurchase program. We repurchased approximately 6 million of our common shares for $505 million and approximately 12 million of our common shares for $1,014 million under the share repurchase program during fiscal 2020 and 2019, respectively. At fiscal year end 2020, we had $1.0 billion of availability remaining under our share repurchase authorization.
Summarized Guarantor Financial Information
In March 2020, the SEC adopted amendments to the financial disclosure requirements of Regulation S-X for subsidiary issuers and guarantors of registered debt securities and for affiliates whose securities are pledged as collateral for registered securities. The amended disclosure requirements permit alternative disclosures of summarized financial information for subsidiary issuers and guarantors and allow for these disclosures to be made outside the Consolidated Financial Statements and accompanying notes. We elected to early adopt these amendments in fiscal 2020.
As discussed above, our senior notes, commercial paper, and Credit Facility are issued by TEGSA and are fully and unconditionally guaranteed on an unsecured basis by TEGSA’s parent, TE Connectivity Ltd. In addition to being the issuer of our debt securities, TEGSA owns, directly or indirectly, all of our operating subsidiaries. The following tables present
summarized financial information, excluding investments in and equity in earnings of our non-guarantor subsidiaries, for TE Connectivity Ltd. and TEGSA on a combined basis.
(1) Includes $3,275 million and $2,562 million as of fiscal year end 2020 and 2019, respectively, of intercompany loans receivable from non-guarantor subsidiaries.
(2) Includes $20,016 million and $16,033 million as of fiscal year end 2020 and 2019, respectively, of intercompany loans payable to non-guarantor subsidiaries.
Commitments and Contingencies
The following table provides a summary of our contractual obligations and commitments for debt, minimum lease payment obligations under non-cancelable leases, and other obligations at fiscal year end 2020:
(1) Debt represents principal payments. See Note 11 to the Consolidated Financial Statements for additional information regarding debt.
(2) Interest payments exclude the impact of our interest rate swap and cross-currency swap contracts. Interest payments on debt are projected for future periods using rates in effect as of fiscal year end 2020 and are subject to change in future periods.
(3) Operating leases represents the undiscounted lease payments. See Note 12 to the Consolidated Financial Statements for additional information regarding leases.
(4) Purchase obligations consist primarily of commitments for purchases of goods and services.
(5) The above table does not reflect unrecognized income tax benefits of $414 million and related accrued interest and penalties of $42 million, the timing of which is uncertain. See Note 16 to the Consolidated Financial Statements for additional information regarding unrecognized income tax benefits, interest, and penalties.
(6) The above table does not reflect pension obligations to certain employees and former employees. We are obligated to make contributions to our pension plans; however, we are unable to determine the amount of plan contributions due to the inherent uncertainties of obligations of this type, including timing, interest rate charges, investment performance, and amounts of benefit payments. We expect to contribute $69 million to pension plans in fiscal 2021, before consideration of any voluntary contributions. See Note 15 to the Consolidated Financial Statements for additional information regarding these plans and our estimates of future contributions and benefit payments.
(7) Other long-term liabilities of $874 million are excluded from the above table as we are unable to estimate the timing of payment for these items.
Legal Proceedings
In the normal course of business, we are subject to various legal proceedings and claims, including patent infringement claims, product liability matters, employment disputes, disputes on agreements, other commercial disputes, environmental matters, antitrust claims, and tax matters, including non-income tax matters such as value added tax, sales and use tax, real estate tax, and transfer tax. Although it is not feasible to predict the outcome of these proceedings, based upon our experience, current information, and applicable law, we do not expect that the outcome of these proceedings, either individually or in the aggregate, will have a material effect on our results of operations, financial position, or cash flows.
Off-Balance Sheet Arrangements
In certain instances, we have guaranteed the performance of third parties and provided financial guarantees for uncompleted work and financial commitments. The terms of these guarantees vary with end dates ranging from fiscal 2021 through the completion of such transactions. The guarantees would be triggered in the event of nonperformance, and the potential exposure for nonperformance under the guarantees would not have a material effect on our results of operations, financial position, or cash flows.
In disposing of assets or businesses, we often provide representations, warranties, and/or indemnities to cover various risks including unknown damage to assets, environmental risks involved in the sale of real estate, liability for investigation and remediation of environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities and legal fees related to periods prior to disposition. We do not expect that these uncertainties will have a material adverse effect on our results of operations, financial position, or cash flows.
At fiscal year end 2020, we had outstanding letters of credit, letters of guarantee, and surety bonds of $249 million.
As discussed above, in fiscal 2019, we sold our SubCom business. In connection with the sale, we contractually agreed to continue to honor performance guarantees and letters of credit related to the SubCom business’ projects that existed as of the date of sale. These guarantees had a combined value of approximately $600 million as of fiscal year end 2020 and are expected to expire at various dates through fiscal 2025. Also, under the terms of the definitive agreement, we are required to issue up to $300 million of new performance guarantees, subject to certain limitations, for projects entered into by the SubCom business following the sale for a period of up to three years. At fiscal year end 2020, there were no such new performance guarantees outstanding. We have contractual recourse against the SubCom business if we are required to perform on any SubCom guarantees; however, based on historical experience, we do not anticipate having to perform. See Note 4 to the Consolidated Financial Statements for additional information regarding the divestiture of the SubCom business.
Critical Accounting Policies and Estimates
The preparation of the Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenue and expenses. Our significant accounting policies are summarized in Note 2 to the Consolidated Financial Statements. We believe the following accounting policies are the most critical as they require significant judgments and assumptions that involve inherent risks and uncertainties. Management’s estimates are based on the relevant information available at the end of each period.
Revenue Recognition
We account for revenue in accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers. Our revenues are generated principally from the sale of our products. Revenue is recognized as performance obligations under the terms of a contract, such as a purchase order with a customer, are satisfied; generally this occurs with the transfer of control. We transfer control and recognize revenue when we ship product to our customers, the customers accept and have legal title for the product, and we have a right to payment for such product. Revenue is measured as the amount of consideration that we expect to receive in exchange for those products and excludes taxes assessed by governmental authorities and collected from customers concurrent with the sale of products. Shipping and handling costs are treated as fulfillment costs and are included in cost of sales. Since we typically invoice our customers when we satisfy our performance obligations, we do not have material contract assets or contract liabilities. Our credit terms are customary and do
not contain significant financing components that extend beyond one year of fulfillment of performance obligations. We apply the practical expedient of ASC 606 with respect to financing components and do not evaluate contracts in which payment is due within one year of satisfaction of the related performance obligation. Since our performance obligations to deliver products are part of contracts that generally have original durations of one year or less, we have elected to use the optional exemption to not disclose the aggregate amount of transaction prices associated with unsatisfied or partially satisfied performance obligations as of fiscal year end 2020.
We generally warrant that our products will conform to our, or mutually agreed to, specifications and that our products will be free from material defects in materials and workmanship for a limited time. We limit our warranty to the replacement or repair of defective parts, or a refund or credit of the price of the defective product. We do not account for these warranties as separate performance obligations.
Although products are generally sold at fixed prices, certain distributors and customers receive incentives or awards, such as sales rebates, return allowances, scrap allowances, and other rights, which are accounted for as variable consideration. We estimate these amounts in the same period revenue is recognized based on the expected value to be provided to customers and reduce revenue accordingly. Our estimates of variable consideration and ultimate determination of the estimated amounts to include in the transaction price are based primarily on our assessment of anticipated performance and historical and forecasted information that is reasonably available to us.
Goodwill and Other Intangible Assets
We account for goodwill and other intangible assets in accordance with ASC 350, Intangibles-Goodwill and Other, as updated by ASU No. 2017-04, Simplifying the Test for Goodwill Impairment.
Intangible assets include both indeterminable-lived residual goodwill and determinable-lived identifiable intangible assets. Intangible assets with determinable lives primarily include intellectual property, consisting of patents, trademarks, and unpatented technology, and customer relationships. Recoverability estimates range from 1 to 50 years and costs are generally amortized on a straight-line basis. Evaluations of the remaining useful lives of determinable-lived intangible assets are performed on a periodic basis and when events and circumstances warrant.
We test for goodwill impairment at the reporting unit level. A reporting unit is generally an operating segment or one level below an operating segment (a “component”) if the component constitutes a business for which discrete financial information is available and regularly reviewed by segment management. At fiscal year end 2020, we had five reporting units, all of which contained goodwill. There were two reporting units in both the Transportation Solutions and Industrial Solutions segments and one reporting unit in the Communications Solutions segment. When changes occur in the composition of one or more reporting units, goodwill is reassigned to the reporting units affected based on their relative fair values. We review our reporting unit structure each year as part of our annual goodwill impairment test, or more frequently based on changes in our structure.
Goodwill impairment is evaluated by comparing the carrying value of each reporting unit to its fair value on the first day of the fourth fiscal quarter of each year or whenever we believe a triggering event requiring a more frequent assessment has occurred. In assessing the existence of a triggering event, management relies on several reporting unit-specific factors including operating results, business plans, economic projections, anticipated future cash flows, transactions, and marketplace data. There are inherent uncertainties related to these factors and management’s judgment in applying these factors to the impairment analysis.
When testing for goodwill impairment, we identify potential impairment by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, a goodwill impairment charge will be recorded for the amount of the excess, limited to the total amount of goodwill allocated to the reporting unit.
Fair value estimates used in the goodwill impairment tests are calculated using an income approach based on the present value of future cash flows of each reporting unit. The income approach is supported by guideline analyses (a market approach). These approaches incorporate several assumptions including future growth rates, discount rates, income tax rates, and market activity in assessing fair value and are reporting unit specific. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairments in future periods.
See Note 8 to the Consolidated Financial Statements for information regarding our early adoption of ASU 2017-04, our interim goodwill impairment test, and partial impairment charge of $900 million recorded in the second quarter of fiscal
2020. We completed our annual goodwill impairment test in the fourth quarter of fiscal 2020 and determined that no impairment existed.
Income Taxes
In determining income for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments affect the calculation of certain tax liabilities and the determination of the recoverability of certain deferred tax assets, which arise from temporary differences between the income tax return and financial statement recognition of revenue and expense.
In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent years, and our forecast of taxable income. In estimating future taxable income, we develop assumptions including the amount of pre-tax operating income in various tax jurisdictions, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses.
We currently have recorded significant valuation allowances that we intend to maintain until it is more likely than not the deferred tax assets will be realized. Our income tax expense recorded in the future will be reduced to the extent of decreases in our valuation allowances. The realization of our remaining deferred tax assets is dependent primarily on future taxable income in the appropriate jurisdictions. Any reduction in future taxable income including any future restructuring activities may require that we record an additional valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in such period and could have a significant impact on our future earnings.
Changes in tax laws and rates also could affect recorded deferred tax assets and liabilities in the future. Management is not aware of any such changes that would have a material effect on our results of operations, financial position, or cash flows.
The calculation of our tax liabilities includes estimates for uncertainties in the application of complex tax regulations across multiple global jurisdictions where we conduct our operations. Under the uncertain tax position provisions of ASC 740, Income Taxes, we recognize liabilities for tax and related interest for issues in tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and related interest will be due. These tax liabilities and related interest are reflected net of the impact of related tax loss carryforwards, as such tax loss carryforwards will be applied against these tax liabilities and will reduce the amount of cash tax payments due upon the eventual settlement with the tax authorities. These estimates may change due to changing facts and circumstances. Due to the complexity of these uncertainties, the ultimate resolution may result in a settlement that differs from our current estimate of the tax liabilities and related interest. These tax liabilities and related interest are recorded in income taxes and accrued and other current liabilities on the Consolidated Balance Sheets.
Pension Plans
Our defined benefit pension plan expense and obligations are developed from actuarial assumptions. The funded status of our plans is recognized on the Consolidated Balance Sheets and is measured as the difference between the fair value of plan assets and the projected benefit obligation at the measurement date. The projected benefit obligation represents the actuarial present value of benefits projected to be paid upon retirement factoring in estimated future compensation levels. The fair value of plan assets represents the current market value of cumulative company and participant contributions made to irrevocable trust funds, held for the sole benefit of participants, which are invested by the trustee of the funds. The benefits under our defined benefit pension plans are based on various factors, such as years of service and compensation.
Net periodic pension benefit cost is based on the utilization of the projected unit credit method of calculation and is charged to earnings on a systematic basis over the expected average remaining service lives of current participants, or, for inactive plans, over the remaining life expectancy of participants.
Two critical assumptions in determining pension expense and obligations are the discount rate and expected long-term return on plan assets. We evaluate these assumptions at least annually. Other assumptions reflect demographic factors such as retirement, mortality, and employee turnover. These assumptions are evaluated periodically and updated to reflect our actual experience. Actual results may differ from actuarial assumptions. The discount rate represents the market rate for high-
quality fixed income investments and is used to calculate the present value of the expected future cash flows for benefit obligations to be paid under our pension plans. A decrease in the discount rate increases the present value of pension benefit obligations. At fiscal year end 2020, a 25-basis-point decrease in the discount rate would have increased the present value of our pension obligations by $143 million; a 25-basis-point increase would have decreased the present value of our pension obligations by $131 million. We consider the current and expected asset allocations of our pension plans, as well as historical and expected long-term rates of return on those types of plan assets, in determining the expected long-term rate of return on plan assets. A 50-basis-point decrease or increase in the expected long-term return on plan assets would have increased or decreased, respectively, our fiscal 2020 pension expense by $12 million.
At fiscal year end 2020, the long-term target asset allocation in our U.S. plans’ master trust is 5% return-seeking assets and 95% liability-hedging assets. Asset re-allocation to meet that target is occurring over a multi-year period based on the funded status. We expect to reach our target allocation when the funded status of the plans exceeds 115%. Based on the funded status of the plans as of fiscal year end 2020, our target asset allocation is 67% return-seeking and 33% liability-hedging.
Accounting Pronouncements
See Note 2 to the Consolidated Financial Statements for information regarding recently adopted accounting pronouncements.
Non-GAAP Financial Measure
Organic Net Sales Growth (Decline)
We present organic net sales growth (decline) as we believe it is appropriate for investors to consider this adjusted financial measure in addition to results in accordance with GAAP. Organic net sales growth (decline) represents net sales growth (decline) (the most comparable GAAP financial measure) excluding the impact of foreign currency exchange rates, and acquisitions and divestitures that occurred in the preceding twelve months, if any. Organic net sales growth (decline) is a useful measure of our performance because it excludes items that are not completely under management’s control, such as the impact of changes in foreign currency exchange rates, and items that do not reflect the underlying growth of the company, such as acquisition and divestiture activity.
Organic net sales growth (decline) provides useful information about our results and the trends of our business. Management uses this measure to monitor and evaluate performance. Also, management uses this measure together with GAAP financial measures in its decision-making processes related to the operations of our reportable segments and our overall company. It is also a significant component in our incentive compensation plans. We believe that investors benefit from having access to the same financial measures that management uses in evaluating operations. The tables presented in “Results of Operations” and “Segment Results” provide reconciliations of organic net sales growth (decline) to net sales growth (decline) calculated in accordance with GAAP.
Organic net sales growth (decline) is a non-GAAP financial measure and should not be considered a replacement for results in accordance with GAAP. This non-GAAP financial measure may not be comparable to similarly-titled measures reported by other companies. The primary limitation of this measure is that it excludes the financial impact of items that would otherwise either increase or decrease our reported results. This limitation is best addressed by using organic net sales growth (decline) in combination with net sales growth (decline) to better understand the amounts, character, and impact of any increase or decrease in reported amounts.
Forward-Looking Information
Certain statements in this Annual Report are “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These statements are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include, among others, the information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance improvements, acquisitions, divestitures, the effects of competition, and the effects of future legislation or regulations. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “believe,” “expect,” “plan,” “intend,” “anticipate,” “estimate,” “predict,” “potential,” “continue,” “may,” and “should,” or the negative of these terms or similar expressions.
Forward-looking statements involve risks, uncertainties, and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. Investors should not place undue reliance on any forward-looking statements. We do not have any intention or obligation to update forward-looking statements after we file this report except as required by law.
The following and other risks, which are described in greater detail in “Part I. Item 1A. Risk Factors,” as well as other risks described in this Annual Report, could cause our results to differ materially from those expressed in forward- looking statements:
● conditions in the global or regional economies and global capital markets, and cyclical industry conditions;
● conditions affecting demand for products in the industries we serve, particularly the automotive industry;
● risk of future goodwill impairment;
● competition and pricing pressure;
● market acceptance of our new product introductions and product innovations and product life cycles;
● raw material availability, quality, and cost;
● fluctuations in foreign currency exchange rates and impacts of offsetting hedges;
● financial condition and consolidation of customers and vendors;
● reliance on third-party suppliers;
● risks associated with current and future acquisitions and divestitures;
● global risks of business interruptions due to natural disasters or other disasters such as the COVID-19 pandemic, which have and could continue to negatively impact our results of operations as well as customer behaviors, business, and manufacturing operations as well as our facilities and the facilities of our suppliers, and other aspects of our business;
● global risks of political, economic, and military instability, including volatile and uncertain economic conditions in China;
● risks associated with security breaches and other disruptions to our information technology infrastructure;
● risks related to compliance with current and future environmental and other laws and regulations;
● our ability to protect our intellectual property rights;
● risks of litigation;
● our ability to operate within the limitations imposed by our debt instruments;
● the possible effects on us of various non-U.S. and U.S. legislative proposals and other initiatives that, if adopted, could materially increase our worldwide corporate effective tax rate and negatively impact our U.S. government contracts business;
● various risks associated with being a Swiss corporation;
● the impact of fluctuations in the market price of our shares; and
● the impact of certain provisions of our articles of association on unsolicited takeover proposals.
There may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, our financial position is routinely subject to a variety of risks, including market risks associated with interest rate and foreign currency movements on outstanding debt and non-U.S. dollar denominated assets and liabilities and commodity price movements. We utilize established risk management policies and procedures in executing derivative financial instrument transactions to manage a portion of these risks.
We do not execute transactions or hold derivative financial instruments for trading or speculative purposes. Substantially all counterparties to derivative financial instruments are limited to major financial institutions with at least an A/A2 credit rating. There is no significant concentration of exposures with any one counterparty.
Foreign Currency Exposures
As part of managing the exposure to changes in foreign currency exchange rates, we utilize cross-currency swap contracts and foreign currency forward contracts, a portion of which are designated as cash flow hedges. The objective of these contracts is to minimize impacts to cash flows and profitability due to changes in foreign currency exchange rates on intercompany and other cash transactions. In addition, we utilize cross-currency swap contracts to hedge our net investment in certain foreign operations. A 10% appreciation or depreciation of the underlying currency in our cross-currency swap contracts or foreign currency forward contracts from the fiscal year end 2020 market rates would have changed the unrealized value of our contracts by $265 million. A 10% appreciation or depreciation of the underlying currency in our cross-currency swap contracts or foreign currency forward contracts from the fiscal year end 2019 market rates would have changed the unrealized value of our contracts by $282 million. Such gains or losses on these contracts would generally be offset by the losses or gains on the revaluation or settlement of the underlying transactions.
Interest Rate and Investment Exposures
We issue debt, as needed, to fund our operations and capital requirements. Such borrowings can result in interest rate exposure. To manage the interest rate exposure, we use interest rate swap contracts to convert a portion of fixed rate debt into variable rate debt. Based on our floating rate debt balances at fiscal year end 2020 and 2019, a 50-basis-point increase in the levels of the U.S. dollar interest rates, with all other variables held constant, would have resulted in an immaterial increase in interest expense in both fiscal 2020 and 2019.
We may use forward starting interest rate swap contracts to manage interest rate exposure in periods prior to the anticipated issuance of fixed rate debt. At fiscal year end 2020 and 2019, we had forward starting interest rate swap contracts which had an aggregate notional value of $450 million and $350 million, respectively, and were designated as cash flow hedges.
We utilize investment swap contracts to manage earnings exposure on certain nonqualified deferred compensation liabilities.
Commodity Exposures
Our worldwide operations and product lines may expose us to risks from fluctuations in commodity prices. To limit the effects of fluctuations in the future market price paid and related volatility in cash flows, we utilize commodity swap contracts designated as cash flow hedges. We continually evaluate the commodity market with respect to our forecasted usage requirements over the next eighteen months and periodically enter into commodity swap contracts to hedge a portion of usage requirements over that period. At fiscal year end 2020, our commodity hedges, which related primarily to expected purchases of gold, silver, and copper, were in a net gain position of $41 million and had a notional value of $312 million. At fiscal year end 2019, our commodity hedges, which related to expected purchases of gold, silver, and copper, were in a net gain position of $1 million and had a notional value of $316 million. A 10% appreciation or depreciation of commodity prices from the fiscal year end 2020 prices would have changed the unrealized value of our forward contracts by $35 million. A 10% appreciation or depreciation of commodity prices from the fiscal year end 2019 prices would have changed the unrealized value of our forward contracts by $32 million.
See Note 14 to the Consolidated Financial Statements for additional information regarding financial instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following Consolidated Financial Statements and schedule specified by this Item, together with the reports thereon of Deloitte & Touche LLP, are presented following Item 15 and the signature pages of this report:
Financial Statements:
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Operations for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Consolidated Statements of Comprehensive Income (Loss) for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Consolidated Balance Sheets as of September 25, 2020 and September 27, 2019
Consolidated Statements of Shareholders’ Equity for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Consolidated Statements of Cash Flows for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Notes to Consolidated Financial Statements
Financial Statement Schedule:
Schedule II-Valuation and Qualifying Accounts
All other financial statements and schedules have been omitted since the information required to be submitted has been included on the Consolidated Financial Statements and related notes or because they are either not applicable or not required under the rules of Regulation S-X.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of September 25, 2020. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 25, 2020.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded our internal control over financial reporting was effective as of September 25, 2020.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies and procedures may deteriorate.
Deloitte & Touche LLP, an independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting as of September 25, 2020, which is included in this Annual Report.
Changes in Internal Control Over Financial Reporting
During the quarter ended September 25, 2020, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information concerning directors, executive officers, and corporate governance may be found under the captions “Agenda Item No. 1-Election of Directors,” “Nominees for Election,” “Corporate Governance,” “The Board of Directors and Board Committees,” and “Executive Officers” in our definitive proxy statement for our 2021 Annual General Meeting of Shareholders (the “2021 Proxy Statement”), which will be filed with the SEC within 120 days after the close of our fiscal year. Such information is incorporated herein by reference. The information in the 2021 Proxy Statement under the caption “Delinquent Section 16(a) Reports” is incorporated herein by reference.
Code of Ethics
We have adopted a guide to ethical conduct, which applies to all employees, officers, and directors. Our Guide to Ethical Conduct meets the requirements of a “code of ethics” as defined by Item 406 of Regulation S-K and applies to our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer, as well as all other employees and directors. Our Guide to Ethical Conduct also meets the requirements of a code of business conduct and ethics under the listing standards of the NYSE. Our Guide to Ethical Conduct is posted on our website at www.te.com under the heading “Corporate Responsibility-Governance-Compliance.” We also will provide a copy of our Guide to Ethical Conduct to shareholders upon request. We intend to disclose any amendments to our Guide to Ethical Conduct, as well as any waivers for executive officers or directors, on our website.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation may be found under the captions “Compensation Discussion and Analysis,” “Management Development and Compensation Committee Report,” “Compensation Committee Interlocks and Insider Participation,” “Executive Officer Compensation,” and “Compensation of Non-Employee Directors” in our 2021 Proxy Statement. Such information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information in our 2021 Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management” is incorporated herein by reference.
Equity Compensation Plan Information
The following table provides information as of fiscal year end 2020 with respect to common shares issuable under our equity compensation plans:
(1) Includes securities issuable upon exercise of outstanding options and rights under the TE Connectivity Ltd. 2007 Stock and Incentive Plan, amended and restated as of September 17, 2020 (the “2007 Plan”), and the Tyco Electronics Limited Savings Related Share Plan. The 2007 Plan provides for the award of annual performance bonuses and long-term performance awards, including share options; restricted, performance, and deferred share units; and other share-based awards (collectively, “Awards”) to board members, officers, and non-officer employees. The 2007 Plan provides for a maximum of 69,843,452 common shares to be issued as Awards, subject to adjustment as provided under the terms of the 2007 Plan.
(2) In connection with the acquisition of ADC Telecommunications, Inc. (“ADC”) in fiscal 2011, we assumed equity awards issued under plans sponsored by ADC and the remaining pool of shares available for grant under the plans. Subsequent to the acquisition, we registered 6,764,455 shares related to the plans via Forms S-3 and S-8 and renamed the primary ADC plan the TE Connectivity Ltd. 2010 Stock and Incentive Plan, amended and restated as of March 9, 2017 (the “2010 Plan”). Grants under the 2010 Plan are settled in TE Connectivity common shares.
(3) Does not take into account restricted, performance, or deferred share unit awards that do not have exercise prices.
(4) Includes securities remaining available for future issuance under the 2007 Plan, the Tyco Electronics Limited Savings Related Plan, and the Employee Stock Purchase Plan. The 2007 Plan applies a weighting of 1.80 to outstanding nonvested restricted, performance, deferred share units, and other share-based awards. The remaining shares issuable under the 2007 Plan and the Tyco Electronics Limited Savings Plan are increased by forfeitures and cancellations, among other factors. Amounts include 930,609 shares remaining available for issuance under our Tyco Electronics Limited Savings Related Share Plan and 1,509,673 shares remaining available for issuance under our Employee Stock Purchase Plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information in our 2021 Proxy Statement under the captions “Corporate Governance,” “The Board of Directors and Board Committees,” and “Certain Relationships and Related Transactions” is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information in our 2021 Proxy Statement under the caption “Agenda Item No. 7-Election of Auditors-Agenda Item No. 7.1” is incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)1.Financial Statements. See Item 8.
2.
Financial Statement Schedule. See Item 8.
3.
Exhibit Index:
‡
Management contract or compensatory plan or arrangement
*
Filed herewith
**
Furnished herewith
(1) The schedules to the Stock Purchase Agreement have been omitted from this filing pursuant to Item 601(b)(2) of Regulation S-K. We will furnish copies of such schedules to the SEC upon its request; provided, however, that we may request confidential treatment pursuant to Rule 24b-2 of the Exchange Act for any schedule so furnished.
(2)Submitted electronically with this report in accordance with the provisions of Regulation S-T
(3) The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
(4) Formatted in Inline XBRL and contained in exhibit 101
ITEM 16. FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
TE CONNECTIVITY LTD.
By:
/s/ Heath A. Mitts
Heath A. Mitts
Executive Vice President
and Chief Financial Officer
(Principal Financial Officer)
Date: November 10, 2020
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Terrence R. Curtin
Chief Executive Officer and Director
November 10, 2020
Terrence R. Curtin
(Principal Executive Officer)
/s/ Heath A. Mitts
Executive Vice President and
Heath A. Mitts
Chief Financial Officer
November 10, 2020
(Principal Financial Officer)
/s/ Robert J. Ott
Senior Vice President and
Robert J. Ott
Corporate Controller
November 10, 2020
(Principal Accounting Officer)
*
Director
November 10, 2020
Pierre R. Brondeau
*
Director
November 10, 2020
Carol A. Davidson
*
Director
November 10, 2020
Lynn A. Dugle
*
Director
November 10, 2020
William A. Jeffrey
*
Director
November 10, 2020
David M. Kerko
*
Director
November 10, 2020
Thomas J. Lynch
*
Director
November 10, 2020
Yong Nam
*
Director
November 10, 2020
Daniel J. Phelan
*
Director
November 10, 2020
Abhijit Y. Talwalkar
*
Director
November 10, 2020
Mark C. Trudeau
*
Director
November 10, 2020
Dawn C. Willoughby
*
Director
November 10, 2020
Laura H. Wright
*
John S. Jenkins, Jr., by signing his name hereto, does sign this document on behalf of the above noted individuals, pursuant to powers of attorney duly executed by such individuals, which have been filed as Exhibit 24.1 to this Report.
By:
/s/ John S. Jenkins, Jr.
John S. Jenkins, Jr.
Attorney-in-fact
TE CONNECTIVITY LTD.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Operations for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Consolidated Statements of Comprehensive Income (Loss) for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Consolidated Balance Sheets as of September 25, 2020 and September 27, 2019
Consolidated Statements of Shareholders’ Equity for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Consolidated Statements of Cash Flows for the Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
Notes to Consolidated Financial Statements
Schedule II-Valuation and Qualifying Accounts
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of TE Connectivity Ltd.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of TE Connectivity Ltd. and subsidiaries (the "Company") as of September 25, 2020 and September 27, 2019, the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows, for each of the three years in the period ended September 25, 2020, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 25, 2020 and September 27, 2019, and the results of its operations and its cash flows for each of the three years in the period ended September 25, 2020, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of September 25, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 10, 2020, expressed an unqualified opinion on the Company's internal control over financial reporting.
Change in Accounting Principle
As discussed in Note 2 to the financial statements, effective September 28, 2019, the Company adopted FASB Accounting Standards Update 2016-02 which codified Accounting Standards Codification 842, Leases, using the modified retrospective approach.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Goodwill -Sensors Reporting Unit within the Transportation Solutions Reportable Segment - Refer to Notes 2 and 8 to the financial statements
Critical Audit Matter Description
The Company’s evaluation of goodwill for impairment involves comparing the carrying amount of each reporting unit to its fair value on the first day of the fourth fiscal quarter or whenever the Company believes a triggering event requiring a more frequent assessment has occurred. The Company uses the income approach based on the present value of future cash flows to estimate fair value. The income approach is supported by guideline analyses (a market approach). These approaches incorporate several assumptions including future growth rates, discount rates, and market activity in assessing fair value and are reporting unit specific. The goodwill balance was $5.2 billion as of September 25, 2020, of which $0.5 billion was allocated to the Sensors reporting unit within the Transportation Solutions reportable segment. As a result of current and projected declines in sales and profitability, due in part to the impact of the COVID-19 pandemic and projected reductions in global automotive production, the Company recorded a partial impairment charge of $900 million during the quarter ended March 27, 2020 for the Sensors reporting unit. The fair value of this reporting unit exceeded its carrying amount as of the annual measurement date and, therefore, no additional impairment was recognized.
We identified goodwill for the Sensors reporting unit as a critical audit matter because of the significant judgments made by management to estimate its fair value, especially considering the reduction of future revenue growth rates and resulting cash flows. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists, when performing audit procedures to evaluate the reasonableness of management’s estimates and assumptions related to forecasts of future revenue and operating margin and the selection of a discount rate.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures for the $900 million impairment charge and the annual quantitative assessment related to the forecasts of future revenue and operating margin (the “forecasts”), and the selection of a discount rate for the Sensors reporting unit included the following, among others:
• We tested the effectiveness of controls over management’s goodwill impairment evaluation, including those over the determination of the fair value, such as controls related to forecasts and management’s selection of the discount rate.
• We evaluated management’s ability to accurately forecast future revenue and operating margin by comparing actual results to management’s historical forecasts.
• We evaluated the reasonableness of management’s forecasts by comparing the forecasts to:
- Historical operating results of the reporting unit.
- Historical operating results of the Company’s other reporting units.
- Internal communications to management and the board of directors.
- External communications made by management to analysts and investors.
- Third-party industry reports for similar products.
- The effects of the COVID-19 pandemic on projections.
• With the assistance of our fair value specialists, we evaluated the reasonableness of the (1) valuation methodology and (2) discount rate by:
- Testing the source information underlying the determination of the discount rate and the mathematical accuracy of the calculation.
- Developing a range of independent estimates and comparing those to the discount rate selected by management.
Income Taxes - Realizability of Deferred Tax Assets - Refer to Notes 2 and 16 to the financial statements
Critical Audit Matter Description
The Company recognizes deferred income taxes for temporary differences between the amount of assets and liabilities recognized for financial reporting and tax purposes. A valuation allowance is provided to offset deferred tax assets
if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Future realization of deferred tax assets depends on the existence of sufficient taxable income of the appropriate character prior to expiration. Sources of taxable income include future reversals of deferred tax assets and liabilities, expected future taxable income, taxable income in prior carryback years if permitted under the tax law, and tax planning strategies. Management has determined that it is more likely than not that sufficient taxable income will be generated in the future to realize a portion of its deferred tax assets, and therefore, a valuation allowance of $4.4 billion has been recorded to offset the Company’s gross deferred tax assets as of September 25, 2020 of $6.7 billion.
We identified the realizability of deferred tax assets as a critical audit matter because of the Company’s tax structure and the significant judgments and estimates made by management to determine that sufficient taxable income will be generated in the future prior to expiration to realize a portion of its deferred tax assets. This required a high degree of auditor judgment and an increased extent of effort, including the need to involve our income tax specialists, when performing audit procedures to evaluate the appropriateness of qualifying tax planning strategies and the reasonableness of management’s estimates of taxable income prior to expiration.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the determination that it is more likely than not that sufficient taxable income will be generated in the future to realize deferred tax assets included the following, among others:
• We tested the effectiveness of controls over management’s estimates of the realization of the deferred tax assets, including those over the estimates of taxable income, the approval of tax planning strategies and the determination of whether it is more likely than not that the deferred tax assets will be realized prior to expiration.
• We evaluated the reasonableness of management’s assessment of the significance and weighting of negative evidence and positive evidence that is objectively verifiable.
• We evaluated management’s ability to accurately estimate taxable income by comparing actual results to management’s historical estimates and evaluating whether there have been any changes that would impact management’s ability to continue accurately estimating taxable income.
• We tested the reasonableness of management’s estimates of taxable income by comparing the estimates to:
- Historical taxable income.
- Internal communications to management and the board of directors.
- Management’s history of carrying out its stated plans and its ability to carry out its plans considering contractual commitments, available financing, or debt covenants.
• We evaluated whether the estimates of future taxable income were consistent with evidence obtained in other areas of the audit, including the effects of the COVID-19 pandemic on projections.
• We evaluated whether the taxable income in prior carryback years was of the appropriate character and available under the tax law.
• With the assistance of our income tax specialists, we evaluated (1) the appropriateness of qualifying tax planning strategies, including that they were prudent, feasible and would more likely than not result in the realization of deferred tax assets and (2) management’s assessment that sufficient taxable income will be generated in the future to realize a portion of the deferred tax assets prior to expiration.
/s/ Deloitte & Touche LLP
Philadelphia, Pennsylvania
November 10, 2020
We have served as the Company’s auditor since 2007.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and the Board of Directors of TE Connectivity Ltd.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of TE Connectivity Ltd. and subsidiaries (the “Company”) as of September 25, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 25, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the financial statements as of and for the fiscal year ended September 25, 2020, of the Company and our report dated November 10, 2020 expressed an unqualified opinion on those financial statements and included an explanatory paragraph regarding the Company’s adoption of FASB Accounting Standards Update 2016-02 which codified Accounting Standards Codification 842, Leases.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Deloitte & Touche LLP
Philadelphia, Pennsylvania
November 10, 2020
TE CONNECTIVITY LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
See Notes to Consolidated Financial Statements.
TE CONNECTIVITY LTD.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
See Notes to Consolidated Financial Statements.
TE CONNECTIVITY LTD.
CONSOLIDATED BALANCE SHEETS
As of September 25, 2020 and September 27, 2019
See Notes to Consolidated Financial Statements.
TE CONNECTIVITY LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
See Notes to Consolidated Financial Statements.
TE CONNECTIVITY LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018
See Notes to Consolidated Financial Statements.
TE CONNECTIVITY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The Consolidated Financial Statements reflect the consolidated operations of TE Connectivity Ltd. and its subsidiaries and have been prepared in United States (“U.S.”) dollars in accordance with accounting principles generally accepted in the U.S. (“GAAP”).
Description of the Business
TE Connectivity Ltd. (“TE Connectivity” or the “Company,” which may be referred to as “we,” “us,” or “our”) is a global industrial technology leader creating a safer, sustainable, productive, and connected future. Our broad range of connectivity and sensor solutions, proven in the harshest environments, enable advancements in transportation, industrial applications, medical technology, energy, data communications, and the home.
We operate through three reportable segments:
● Transportation Solutions-The Transportation Solutions segment is a leader in connectivity and sensor technologies. Our products, which must withstand harsh conditions, are used in the automotive, commercial transportation, and sensors markets.
● Industrial Solutions-The Industrial Solutions segment is a leading supplier of products that connect and distribute power, data, and signals. Our products are used in the aerospace, defense, oil, and gas; industrial equipment; medical; and energy markets.
● Communications Solutions-The Communications Solutions segment is a leading supplier of electronic components for the data and devices and the appliances markets.
Use of Estimates
The preparation of the Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses. Actual results could differ from these estimates.
Fiscal Year
We have a 52- or 53-week fiscal year that ends on the last Friday of September. Fiscal 2020, 2019, and 2018 were each 52 weeks in length and ended on September 25, 2020, September 27, 2019, and September 28, 2018, respectively. For fiscal years in which there are 53 weeks, the fourth quarter reporting period includes 14 weeks, with the next such occurrence taking place in fiscal 2022.
2. Summary of Significant Accounting Policies
Principles of Consolidation
We consolidate entities in which we own or control more than 50% of the voting shares or otherwise control through similar rights. All intercompany transactions have been eliminated. The results of companies acquired or disposed of are included on the Consolidated Financial Statements from the effective date of acquisition or up to the date of disposal.
Revenue Recognition
We account for revenue in accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, which is a single, comprehensive, five-step revenue recognition model. Our revenues are generated principally from the sale of our products. Revenue is recognized as performance obligations under the terms of a contract, such as a purchase order with a customer, are satisfied; generally this occurs with the transfer of control. We transfer control and recognize revenue when we ship product to our customers, the customers accept and have legal title for the
TE CONNECTIVITY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
product, and we have a right to payment for such product. Revenue is measured as the amount of consideration that we expect to receive in exchange for those products and excludes taxes assessed by governmental authorities and collected from customers concurrent with the sale of products. Shipping and handling costs are treated as fulfillment costs and are included in cost of sales. Since we typically invoice our customers when we satisfy our performance obligations, we do not have material contract assets or contract liabilities. Our credit terms are customary and do not contain significant financing components that extend beyond one year of fulfillment of performance obligations. We apply the practical expedient of ASC 606 with respect to financing components and do not evaluate contracts in which payment is due within one year of satisfaction of the related performance obligation. Since our performance obligations to deliver products are part of contracts that generally have original durations of one year or less, we have elected to use the optional exemption to not disclose the aggregate amount of transaction prices associated with unsatisfied or partially satisfied performance obligations as of fiscal year end 2020. See Note 21 for net sales disaggregated by industry end market and geographic region which is summarized by segment and that we consider meaningful to depict the nature, amount, timing, and uncertainty of revenue and cash flows affected by economic factors.
We generally warrant that our products will conform to our, or mutually agreed to, specifications and that our products will be free from material defects in materials and workmanship for a limited time. We limit our warranty to the replacement or repair of defective parts, or a refund or credit of the price of the defective product. We do not account for these warranties as separate performance obligations.
Although products are generally sold at fixed prices, certain distributors and customers receive incentives or awards, such as sales rebates, return allowances, scrap allowances, and other rights, which are accounted for as variable consideration. We estimate these amounts in the same period revenue is recognized based on the expected value to be provided to customers and reduce revenue accordingly. Our estimates of variable consideration and ultimate determination of the estimated amounts to include in the transaction price are based primarily on our assessment of anticipated performance and historical and forecasted information that is reasonably available to us.
Inventories
Inventories are recorded at the lower of cost or net realizable value using the first-in, first-out cost method.
Property, Plant, and Equipment, Net
Property, plant, and equipment is recorded at cost less accumulated depreciation. Maintenance and repair expenditures are charged to expense when incurred. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, which are 10 to 20 years for land improvements, 5 to 40 years for buildings and improvements, and 1 to 15 years for machinery and equipment.
We periodically evaluate, when events and circumstances warrant, the net realizable value of property, plant, and equipment and other long-lived assets, relying on several factors including operating results, business plans, economic projections, and anticipated future cash flows. When indicators of potential impairment are present, the carrying values of the asset group are evaluated in relation to the operating performance and estimated future undiscounted cash flows of the underlying asset group. Impairment of the carrying value is recognized whenever anticipated future undiscounted cash flow estimates are less than the carrying value of the asset. Fair value estimates are based on assumptions concerning the amount and timing of estimated future cash flows and discount rates, reflecting varying degrees of perceived risk.
Goodwill and Other Intangible Assets
We account for goodwill and other intangible assets in accordance with ASC 350, Intangibles-Goodwill and Other, as updated by Accounting Standards Update (“ASU”) No. 2017-04, Simplifying the Test for Goodwill Impairment.
Intangible assets include both indeterminable-lived residual goodwill and determinable-lived identifiable intangible assets. Intangible assets with determinable lives primarily include intellectual property, consisting of patents, trademarks, and unpatented technology, and customer relationships. Recoverability estimates range from 1 to 50 years and costs are generally
TE CONNECTIVITY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
amortized on a straight-line basis. Evaluations of the remaining useful lives of determinable-lived intangible assets are performed on a periodic basis and when events and circumstances warrant.
At fiscal year end 2020, we had five reporting units, all of which contained goodwill. There were two reporting units in both the Transportation Solutions and Industrial Solutions segments and one reporting unit in the Communications Solutions segment. When changes occur in the composition of one or more reporting units, goodwill is reassigned to the reporting units affected based on their relative fair values.
Goodwill impairment is evaluated by comparing the carrying value of each reporting unit to its fair value on the first day of the fourth fiscal quarter of each year or whenever we believe a triggering event requiring a more frequent assessment has occurred. In assessing the existence of a triggering event, management relies on several reporting unit-specific factors including operating results, business plans, economic projections, anticipated future cash flows, transactions, and marketplace data. There are inherent uncertainties related to these factors and management’s judgment in applying these factors to the impairment analysis.
When testing for goodwill impairment, we identify potential impairment by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, a goodwill impairment charge will be recorded for the amount of the excess, limited to the total amount of goodwill allocated to the reporting unit.
Fair value estimates used in the goodwill impairment tests are calculated using an income approach based on the present value of future cash flows of each reporting unit. The income approach is supported by guideline analyses (a market approach). These approaches incorporate several assumptions including future growth rates, discount rates, income tax rates, and market activity in assessing fair value and are reporting unit specific. Changes in economic and operating conditions impacting these assumptions could result in goodwill impairments in future periods.
Research and Development
Research and development expenditures are expensed when incurred and are included in research, development, and engineering expenses on the Consolidated Statements of Operations. Research and development expenses include salaries, direct costs incurred, and building and overhead expenses. The amounts expensed in fiscal 2020, 2019, and 2018 were $539 million, $572 million, and $606 million, respectively.
Income Taxes
Income taxes are computed in accordance with the provisions of ASC 740, Income Taxes. Deferred tax liabilities and assets are recognized for the expected future tax consequences of events that have been reflected on the Consolidated Financial Statements. Deferred tax liabilities and assets are determined based on the differences between the book and tax bases of particular assets and liabilities and operating loss carryforwards using tax rates in effect for the years in which the differences are expected to reverse. A valuation allowance is provided to offset deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
The calculation of our tax liabilities includes estimates for uncertainties in the application of complex tax regulations across multiple global jurisdictions where we conduct our operations. Under the uncertain tax position provisions of ASC 740, we recognize liabilities for tax and related interest for issues in tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes and related interest will be due. These tax liabilities and related interest are reflected net of the impact of related tax loss carryforwards, as such tax loss carryforwards will be applied against these tax liabilities and will reduce the amount of cash tax payments due upon the eventual settlement with the tax authorities. These estimates may change due to changing facts and circumstances. Due to the complexity of these uncertainties, the ultimate resolution may result in a settlement that differs from our current estimate of the tax liabilities and related interest.
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Financial Instruments
Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, debt, and derivative financial instruments.
We account for derivative financial instrument contracts on the Consolidated Balance Sheets at fair value. For instruments not designated as hedges under ASC 815, Derivatives and Hedging, the changes in the instruments’ fair value are recognized currently in earnings. For instruments designated as cash flow hedges, the effective portion of changes in the fair value of a derivative is recorded in other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the underlying hedged item affects earnings. Amounts excluded from the hedging relationship are recognized currently in earnings. Changes in the fair value of instruments designated as fair value hedges affect the carrying value of the asset or liability hedged, with changes in both the derivative instrument and the hedged asset or liability being recognized currently in earnings.
We determine the fair value of our financial instruments by using methods and assumptions that are based on market conditions and risks existing at each balance sheet date. Standard market conventions are used to determine the fair value of financial instruments, including derivatives.
The cash flows related to derivative financial instruments are reported in the operating activities section of the Consolidated Statements of Cash Flows.
Our derivative financial instruments present certain market and counterparty risks. Concentration of counterparty risk is mitigated, however, by our use of financial institutions worldwide, substantially all of which have long-term Standard & Poor’s, Moody’s, and/or Fitch credit ratings of A/A2 or higher. In addition, we utilize only conventional derivative financial instruments. We are exposed to potential losses if a counterparty fails to perform according to the terms of its agreement. With respect to counterparty net asset positions recognized at fiscal year end 2020, we have assessed the likelihood of counterparty default as remote. We currently provide guarantees from a wholly-owned subsidiary to the counterparties to our commodity swap derivatives and exchange cash collateral with the counterparties to certain of our cross-currency swap contracts. The likelihood of performance on the guarantees has been assessed as remote. For all other derivative financial instruments, we are not required to provide, nor do we require counterparties to provide, collateral or other security.
Fair Value Measurements
ASC 820, Fair Value Measurements and Disclosures, specifies a fair value hierarchy based upon the observable inputs utilized in valuation of certain assets and liabilities. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. Fair value measurements are classified under the following hierarchy:
● Level 1-Quoted prices in active markets for identical assets and liabilities.
● Level 2-Quoted prices in active markets for similar assets and liabilities, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
● Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flows methodologies, and similar techniques that use significant unobservable inputs.
Derivative financial instruments measured at fair value on a recurring basis are generally valued using level 2 inputs.
Financial instruments other than derivative instruments include cash and cash equivalents, accounts receivable, accounts payable, and debt. These instruments are recorded on the Consolidated Balance Sheets at book value. For cash and cash equivalents, accounts receivable, and accounts payable, we believe book value approximates fair value due to the short-
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term nature of these instruments. See Note 11 for disclosure of the fair value of debt. The following is a description of the valuation methodologies used for the respective financial instruments:
● Cash and cash equivalents-Cash and cash equivalents are valued at book value, which we consider to be equivalent to unadjusted quoted prices (level 1).
● Accounts receivable-Accounts receivable are valued based on the net value expected to be realized. The net realizable value generally represents an observable contractual agreement (level 2).
● Accounts payable-Accounts payable are valued based on the net value expected to be paid, generally supported by an observable contractual agreement (level 2).
● Debt-The fair value of debt, including both current and non-current maturities, is derived from quoted market prices or other pricing determinations based on the results of market approach valuation models using observable market data such as recently reported trades, bid and offer information, and benchmark securities (level 2).
Pension Plans
The funded status of our defined benefit pension plans is recognized on the Consolidated Balance Sheets and is measured as the difference between the fair value of plan assets and the projected benefit obligation at the measurement date. The projected benefit obligation represents the actuarial present value of benefits projected to be paid upon retirement factoring in estimated future compensation levels. The fair value of plan assets represents the current market value of cumulative company and participant contributions made to irrevocable trust funds, held for the sole benefit of participants, which are invested by the trustee of the funds. The benefits under our defined benefit pension plans are based on various factors, such as years of service and compensation.
Net periodic pension benefit cost is based on the utilization of the projected unit credit method of calculation and is charged to earnings on a systematic basis over the expected average remaining service lives of current participants, or, for inactive plans, over the remaining life expectancy of participants.
The measurement of benefit obligations and net periodic benefit cost is based on estimates and assumptions determined by our management. These valuations reflect the terms of the plans and use participant-specific information such as compensation, age, and years of service, as well as certain assumptions, including estimates of discount rates, expected return on plan assets, rate of compensation increases, interest crediting rates, and mortality rates.
Share-Based Compensation
We determine the fair value of share awards on the date of grant. Share options are valued using the Black-Scholes-Merton valuation model; restricted share awards and performance awards are valued using our end-of-day share price on the date of grant. The fair value is expensed ratably over the expected service period, with an allowance made for estimated forfeitures based on historical employee activity. Estimates regarding the attainment of performance criteria are reviewed periodically; the cumulative impact of a change in estimate regarding the attainment of performance criteria is recorded in the period in which that change is made.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the basic weighted-average number of common shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding adjusted for the potentially dilutive impact of share-based compensation arrangements.
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Leases
We have facility, land, vehicle, and equipment leases that expire at various dates. We determine if a contract qualifies as a lease at inception. A contract is or contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The right to control the use of an asset includes the right to obtain substantially all of the economic benefits of the identified asset and the right to direct the use of the identified asset.
Lease right-of-use (“ROU”) assets and lease liabilities are recognized at the commencement date of the lease based on the present value of remaining lease payments over the lease term. Lease ROU assets represent our right to use the underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. We do not recognize ROU assets or lease liabilities that arise from short-term leases. Since our lease contracts do not contain a readily determinable implicit rate, we determine a fully-collateralized incremental borrowing rate that reflects a similar term to the lease and the economic environment of the applicable country or region in which the asset is leased.
We have elected to account for fixed lease and non-lease components in our real estate leases as a single lease component; other leases generally do not contain non-lease components. The non-lease components in our real estate leases include logistics services, warehousing, and other operational costs. Many of these costs are variable, fluctuating based on services provided, such as pallets shipped in and out of a location or square footage of space occupied. These costs, and any other variable rental costs, are excluded from our ROU assets and lease liabilities, and instead are expensed as incurred. Some of our leases may include options to either renew or early terminate the lease. The exercise of these options is generally at our sole discretion and would only occur if there is an economic, financial, or business reason to do so. Such options are included in the lease term if we determine it is reasonably certain they will be exercised.
Currency Translation
For our non-U.S. dollar functional currency subsidiaries, assets and liabilities are translated into U.S. dollars using fiscal year end exchange rates. Sales and expenses are translated at average monthly exchange rates. Foreign currency translation gains and losses are included as a component of accumulated other comprehensive income (loss) within equity. Gains and losses resulting from foreign currency transactions are included in earnings.
Restructuring Charges
Restructuring activities involve employee-related termination costs, facility exit costs, and asset impairments resulting from reductions-in-force, migration of facilities or product lines from higher-cost to lower-cost countries, or consolidation of facilities within countries. We recognize termination costs based on requirements established by severance policy, government law, or previous actions. Facility exit costs generally reflect the accelerated rent expense for ROU assets, expected lease termination costs, or costs that will continue to be incurred under the facility lease without future economic benefit to us. Restructuring activities often result in the disposal or abandonment of assets that require an acceleration of depreciation or impairment reflecting the excess of the assets’ carrying values over fair value.
The recognition of restructuring costs require that we make certain judgments and estimates regarding the nature, timing, and amount of costs associated with the planned exit activity. To the extent our actual results differ from our estimates and assumptions, we may be required to revise the estimated liabilities, requiring the recognition of additional restructuring costs or the reduction of liabilities already recognized. At the end of each reporting period, we evaluate the remaining accrued balances to ensure these balances are properly stated and the utilization of the reserves are for their intended purpose in accordance with developed exit plans.
Contingent Liabilities
We record a loss contingency when the available information indicates it is probable that we have incurred a liability and the amount of the loss is reasonably estimable. When a range of possible losses with equal likelihood exists, we record the low end of the range. The likelihood of a loss with respect to a particular contingency is often difficult to predict, and determining a meaningful estimate of the loss or a range of loss may not be practicable based on information available. In addition, it is not uncommon for such matters to be resolved over many years, during which time relevant developments and
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new information must continuously be evaluated to determine whether a loss is probable and a reasonable estimate of that loss can be made. When a loss is probable but a reasonable estimate cannot be made, or when a loss is at least reasonably possible, disclosure is provided.
Recently Adopted Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2017-04, an update to ASC 350. The update simplifies the subsequent measurement of goodwill by eliminating step 2 of the goodwill impairment test. Under the amendments in the update, goodwill impairment should be tested by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments are to be applied on a prospective basis. We elected to early adopt this update and applied it during the quarter ended March 27, 2020. See Note 8 for additional information regarding our interim and annual goodwill impairment tests.
In February 2016, the FASB issued ASU No. 2016-02 which codified ASC 842, Leases. This guidance, as subsequently amended, requires lessees to recognize a lease liability and a ROU asset for most leases. We adopted ASC 842, as amended, in fiscal 2020 using the optional transition method permitted by ASU No. 2018-11, which allows for application of the standard at the adoption date and no restatement of comparative periods. We elected to use the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows the carry forward of historical lease classification of existing and expired leases. In addition, we elected to use the hindsight practical expedient in determining the lease term for existing leases. As a result of adoption, we recorded ROU assets and related lease liabilities of approximately $520 million on the Consolidated Balance Sheet. Adoption did not have a material impact on our results of operations or cash flows. See Note 12 for additional information regarding leases.
3. Restructuring and Other Charges, Net
Net restructuring and other charges consisted of the following:
Net restructuring charges by segment were as follows:
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Activity in our restructuring reserves was as follows:
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Fiscal 2020 Actions
During fiscal 2020, we initiated a restructuring program associated with footprint consolidation and structural improvements, due in part to the COVID-19 pandemic, across all segments. In connection with this program, during fiscal 2020, we recorded restructuring charges of $250 million. We expect to complete all restructuring actions commenced during fiscal 2020 by the end of fiscal 2022 and to incur additional charges of approximately $45 million related to all three classes of costs.
The following table summarizes expected, incurred, and remaining charges for the fiscal 2020 program by segment:
Fiscal 2019 Actions
During fiscal 2019, we initiated a restructuring program associated with footprint consolidation and structural improvements impacting all segments. In connection with this program, during fiscal 2020 and 2019, we recorded net restructuring charges of $5 million and $254 million, respectively. We expect to complete all restructuring actions commenced during fiscal 2019 by the end of fiscal 2021. We anticipate that any additional charges will be insignificant for restructuring actions commenced during fiscal 2019.
Fiscal 2018 Actions
During fiscal 2018, we initiated a restructuring program associated with footprint consolidation and structural improvements primarily impacting the Industrial Solutions and Transportation Solutions segments. In connection with this program, during fiscal 2020 and 2018, we recorded net restructuring charges of $4 million and $142 million, respectively. We anticipate that any additional charges will be insignificant for restructuring actions commenced during fiscal 2018.
Pre-Fiscal 2018 Actions
During fiscal 2020, 2019, and 2018, we recorded net restructuring credits of $2 million, charges of $1 million, and credits of $2 million, respectively, related to pre-fiscal 2018 actions. We anticipate that any additional charges will be insignificant for restructuring actions commenced prior to fiscal 2018.
Total Restructuring Reserves
Restructuring reserves included on the Consolidated Balance Sheets were as follows:
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4. Discontinued Operations
In fiscal 2019, we sold our Subsea Communications (“SubCom”) business for net cash proceeds of $297 million and incurred a pre-tax loss on sale of $86 million, related primarily to the recognition of cumulative translation adjustment losses of $67 million and the guarantee liabilities discussed below. The sale of the SubCom business, which was previously included in our Communications Solutions segment, represented our exit from the telecommunications market and was significant to our sales and profitability, both to the Communications Solutions segment and to the consolidated company. We concluded that the divestiture was a strategic shift that had a major effect on our operations and financial results. As a result, the SubCom business met the held for sale and discontinued operations criteria and has been reported as such in all periods presented on our Consolidated Financial Statements.
Upon entering into the definitive agreement, which we consider a level 2 observable input in the fair value hierarchy, we assessed the carrying value of the SubCom business and determined that it was in excess of its fair value. In fiscal 2018, we recorded a pre-tax impairment charge of $19 million, which was included in income (loss) from discontinued operations on the Consolidated Statement of Operations, to write the carrying value of the business down to its estimated fair value less costs to sell.
In connection with the sale, we contractually agreed to continue to honor performance guarantees and letters of credit related to the SubCom business’ projects that existed as of the date of sale. These guarantees had a combined value of approximately $600 million as of fiscal year end 2020 and are expected to expire at various dates through fiscal 2025. At the time of sale, we determined that the fair value of these guarantees was $12 million, which we recognized by a charge to pre-tax loss on sale. Also, under the terms of the definitive agreement, we are required to issue up to $300 million of new performance guarantees, subject to certain limitations, for projects entered into by the SubCom business following the sale for a period of up to three years. At fiscal year end 2020, there were no such new performance guarantees outstanding. We have contractual recourse against the SubCom business if we are required to perform on any SubCom guarantees; however, based on historical experience, we do not anticipate having to perform.
The following table presents the summarized components of income (loss) from discontinued operations, net of income taxes, for the SubCom business and prior divestitures:
(1) Included a $19 million impairment charge recorded in connection with the sale of our SubCom business.
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5. Acquisitions
First Sensor AG
During fiscal 2020, we acquired approximately 72% of the outstanding shares of First Sensor AG (“First Sensor”), a provider of sensing solutions based in Germany, for €181 million in cash (equivalent to $201 million using an exchange rate of $1.11 per €1.00), net of cash acquired. As a result of the transaction, we recognized a noncontrolling interest with a fair value of €96 million (equivalent to $107 million) as of the acquisition date. The fair value of the noncontrolling interest for First Sensor common shares that were not acquired was determined using the stated price in the Domination and Profit and Loss Transfer Agreement (“DPLTA”) which is considered to be a level 2 observable input under the fair value hierarchy. The First Sensor business has been reported as part of our Transportation Solutions segment from the date of acquisition.
We and First Sensor entered into a DPLTA which was approved by First Sensor shareholders and became effective in July 2020 following registration in the commercial register in Germany. Under the terms of the DPLTA, upon its effectiveness, First Sensor minority shareholders can elect either (1) to remain First Sensor minority shareholders and receive recurring annual compensation of €0.56 per First Sensor share or (2) to put their First Sensor shares in exchange for compensation of €33.27 per First Sensor share. The ultimate amount and timing of any future cash payments related to the DPLTA is uncertain. Following the registration of the DPLTA, the First Sensor noncontrolling interest balance of €96 million (equivalent to $108 million using an exchange rate of $1.13 per €1.00) was reclassified and is now presented as redeemable noncontrolling interest outside of equity on the Consolidated Balance Sheet as the exercise of the put right by First Sensor minority shareholders is not within our control.
Other Acquisitions
During fiscal 2020, we acquired four additional businesses for a combined cash purchase price of $135 million, net of cash acquired. The acquisitions were reported as part of our Transportation Solutions and Industrial Solutions segments from the date of acquisition.
During fiscal 2019, we acquired three businesses for a combined cash purchase price of $296 million, net of cash acquired. The acquisitions were reported as part of our Transportation Solutions segment from the date of acquisition.
We acquired two businesses during fiscal 2018 for a combined cash purchase price of $153 million, net of cash acquired. In fiscal 2019, we received $13 million as a result of a customary net working capital settlement for one of the acquisitions. The acquisitions were reported as part of our Industrial Solutions segment from the date of acquisition.
6. Inventories
Inventories consisted of the following:
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7. Property, Plant, and Equipment, Net
Net property, plant, and equipment consisted of the following:
Depreciation expense was $529 million, $510 million, and $487 million in fiscal 2020, 2019, and 2018, respectively.
8. Goodwill
The changes in the carrying amount of goodwill by segment were as follows:
(1) At fiscal year end 2019 and 2018, accumulated impairment losses for the Transportation Solutions, Industrial Solutions, and Communications Solutions segments were $2,191 million, $669 million, and $489 million, respectively.
(2) At fiscal year end 2020, accumulated impairment losses for the Transportation Solutions, Industrial Solutions, and Communications Solutions segments were $3,091 million, $669 million, and $489 million, respectively.
During fiscal 2020, we completed the acquisition of First Sensor and recognized goodwill of $215 million in the Transportation Solutions segment. Further adjustments to the purchase price allocation may be needed in fiscal 2021. In addition, during fiscal 2020 and 2019, we recognized goodwill in connection with other recent acquisitions. See Note 5 for additional information regarding acquisitions.
We test goodwill allocated to reporting units for impairment annually during the fourth fiscal quarter, or more frequently if events occur or circumstances exist that indicate that a reporting unit’s carrying value may exceed its fair value. As a result of current and projected declines in sales and profitability, due in part to the impact of the COVID-19 pandemic and projected reductions in global automotive production as of March 2020, of the Sensors reporting unit of the Transportation Solutions segment during the quarter ended March 27, 2020, we determined that an indicator of impairment had occurred and goodwill impairment testing of this reporting unit was required.
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As discussed in Note 2, during the quarter ended March 27, 2020, we adopted ASU No. 2017-04 which simplifies the subsequent measurement of goodwill by eliminating step 2 of the goodwill impairment test. Under the new standard, goodwill impairment is measured as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying value of goodwill. We determined the fair value of the Sensors reporting unit to be $1.0 billion as of March 27, 2020. This valuation was based on a discounted cash flows analysis incorporating our estimate of future operating performance, which we consider to be a level 3 unobservable input in the fair value hierarchy, and was corroborated using a market approach valuation. The goodwill impairment test indicated that the carrying value of the reporting unit exceeded its fair value by $900 million. As a result, we recorded a partial impairment charge of $900 million in the quarter ended March 27, 2020. As of fiscal year end 2020, the Sensors reporting unit had a remaining goodwill allocation of $511 million.
We completed our annual goodwill impairment test in the fourth quarter of fiscal 2020 and determined that no impairment existed.
9. Intangible Assets, Net
Intangible assets consisted of the following:
Intangible asset amortization expense was $182 million, $180 million, and $180 million for fiscal 2020, 2019, and 2018, respectively. At fiscal year end 2020, the aggregate amortization expense on intangible assets is expected to be as follows:
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10. Accrued and Other Current Liabilities
Accrued and other current liabilities consisted of the following:
11. Debt
Debt was as follows:
(1) The floating rate senior notes due 2020 bore interest at a rate of three-month London Interbank Offered Rate (“LIBOR”) plus 0.45% per year.
(2) The euro-denominated fixed-to-floating rate senior notes due 2021 bore interest at a rate of 0% until June 2020 and then bear interest at a rate of three-month Euro Interbank Offered Rate (“EURIBOR”) plus 0.30%, with the minimum interest rate of 0%, per year until maturity.
During fiscal 2020, Tyco Electronics Group S.A. (“TEGSA”), our wholly-owned subsidiary, issued €550 million aggregate principal amount of 0.00% senior notes due in February 2025. The notes are TEGSA’s unsecured senior
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obligations and rank equally in right of payment with all existing and any future senior indebtedness of TEGSA and senior to any subordinated indebtedness that TEGSA may incur.
TEGSA has a five-year unsecured senior revolving credit facility (“Credit Facility”) with a maturity date of November 2023 and total commitments of $1.5 billion. The Credit Facility contains provisions that allow for incremental commitments of up to $500 million, an option to temporarily increase the financial ratio covenant following a qualified acquisition, and borrowings in designated currencies. TEGSA had no borrowings under the Credit Facility at fiscal year end 2020 or 2019.
Borrowings under the Credit Facility bear interest at a rate per annum equal to, at the option of TEGSA, (1) LIBOR plus an applicable margin based upon the senior, unsecured, long-term debt rating of TEGSA, or (2) an alternate base rate equal to the highest of (i) Bank of America, N.A.’s base rate, (ii) the federal funds effective rate plus 1/2 of 1%, and (iii) one-month LIBOR plus 1%, plus, in each case, an applicable margin based upon the senior, unsecured, long-term debt rating of TEGSA. TEGSA is required to pay an annual facility fee ranging from 5.0 to 12.5 basis points based upon the amount of the lenders’ commitments under the Credit Facility and the applicable credit ratings of TEGSA.
The Credit Facility contains a financial ratio covenant providing that if, as of the last day of each fiscal quarter, our ratio of Consolidated Total Debt to Consolidated EBITDA (as defined in the Credit Facility) for the then most recently concluded period of four consecutive fiscal quarters exceeds 3.75 to 1.0, an Event of Default (as defined in the Credit Facility) is triggered. The Credit Facility and our other debt agreements contain other customary covenants.
Periodically, TEGSA issues commercial paper to U.S. institutional accredited investors and qualified institutional buyers in accordance with available exemptions from the registration requirements of the Securities Act of 1933 as part of our ongoing effort to maintain financial flexibility and to potentially decrease the cost of borrowings. Borrowings under the commercial paper program are backed by the Credit Facility.
TEGSA’s payment obligations under its senior notes, commercial paper, and Credit Facility are fully and unconditionally guaranteed on an unsecured basis by its parent, TE Connectivity Ltd.
At fiscal year end 2020, principal payments required for debt are as follows:
The fair value of our debt, based on indicative valuations, was approximately $4,550 million and $4,278 million at fiscal year end 2020 and 2019, respectively.
12. Leases
The components of lease cost were as follows:
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Amounts recognized on the Consolidated Balance Sheet were as follows:
Cash flow information, including significant non-cash transactions, related to leases was as follows:
(1) These payments are included in cash flows from continuing operating activities, primarily in changes in other liabilities.
At fiscal year end 2020, the maturities of operating lease liabilities were as follows:
ASC 840 Comparative Disclosures
Prior to fiscal 2020, we accounted for our leases in accordance with ASC 840, Leases. Under ASC 840, rental expense for operating leases was $162 million and $141 million for fiscal 2019 and 2018, respectively.
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The following table presents the future minimum lease payments under non-cancelable operating lease obligations as of September 27, 2019 under ASC 840:
13. Commitments and Contingencies
Legal Proceedings
In the normal course of business, we are subject to various legal proceedings and claims, including patent infringement claims, product liability matters, employment disputes, disputes on agreements, other commercial disputes, environmental matters, antitrust claims, and tax matters, including non-income tax matters such as value added tax, sales and use tax, real estate tax, and transfer tax. Although it is not feasible to predict the outcome of these proceedings, based upon our experience, current information, and applicable law, we do not expect that the outcome of these proceedings, either individually or in the aggregate, will have a material effect on our results of operations, financial position, or cash flows.
Environmental Matters
We are involved in various stages of investigation and cleanup related to environmental remediation matters at a number of sites. The ultimate cost of site cleanup is difficult to predict given the uncertainties regarding the extent of the required cleanup, the interpretation of applicable laws and regulations, and alternative cleanup methods. As of fiscal year end 2020, we concluded that we would incur investigation and remediation costs at these sites in the reasonably possible range of $16 million to $45 million, and we accrued $20 million as the probable loss, which was the best estimate within this range. We believe that any potential payment of such estimated amounts will not have a material adverse effect on our results of operations, financial position, or cash flows.
Guarantees
In disposing of assets or businesses, we often provide representations, warranties, and/or indemnities to cover various risks including unknown damage to assets, environmental risks involved in the sale of real estate, liability for investigation and remediation of environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities and legal fees related to periods prior to disposition. We do not expect that these uncertainties will have a material adverse effect on our results of operations, financial position, or cash flows.
At fiscal year end 2020, we had outstanding letters of credit, letters of guarantee, and surety bonds of $249 million.
We sold our SubCom business during fiscal 2019. In connection with the sale, we contractually agreed to honor certain performance guarantees and letters of credit related to the SubCom business. See Note 4 for additional information regarding these guarantees and the divestiture of the SubCom business.
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14. Financial Instruments and Fair Value Measurements
We use derivative and non-derivative financial instruments to manage certain exposures to foreign currency, interest rate, investment, and commodity risks.
Foreign Currency Exchange Rate Risk
As part of managing the exposure to changes in foreign currency exchange rates, we utilize cross-currency swap contracts and foreign currency forward contracts, a portion of which are designated as cash flow hedges. The objective of these contracts is to minimize impacts to cash flows and profitability due to changes in foreign currency exchange rates on intercompany and other cash transactions. We expect that significantly all of the balance in accumulated other comprehensive income (loss) associated with the cash flow hedge-designated instruments addressing foreign exchange risks will be reclassified into the Consolidated Statement of Operations within the next twelve months.
During fiscal 2015, we entered into cross-currency swap contracts to reduce our exposure to foreign currency exchange rate risk associated with certain intercompany loans. The aggregate notional value of these contracts was €700 million and €1,000 million at fiscal year end 2020 and 2019, respectively. Certain contracts were terminated during fiscal 2020; the remaining contracts mature in fiscal 2022. Under the terms of these contracts, which have been designated as cash flow hedges, we make interest payments in euros at 3.50% per annum and receive interest in U.S. dollars at a weighted-average rate of 5.34% per annum. Upon maturity, we will pay the notional value of the contracts in euros and receive U.S. dollars from our counterparties. In connection with the cross-currency swap contracts, both counterparties to each contract are required to provide cash collateral.
These cross-currency swap contracts were recorded on the Consolidated Balance Sheets as follows:
At fiscal year end 2020 and 2019, collateral received from or paid to our counterparties approximated the net derivative position. Collateral is recorded in accrued and other current liabilities when the contracts are in a net asset position, or prepaid expenses and other current assets when the contracts are in a net liability position on the Consolidated Balance Sheets. The impacts of these cross-currency swap contracts were as follows:
(1) Gains and losses excluded from the hedging relationship are recognized prospectively in selling, general, and administrative expenses and are offset by losses and gains generated as a result of re-measuring certain intercompany loans to the U.S. dollar.
Hedge of Net Investment
We hedge our net investment in certain foreign operations using intercompany loans and external borrowings denominated in the same currencies. The aggregate notional value of these hedges was $3,511 million and $3,374 million at fiscal year end 2020 and 2019, respectively.
We also use a cross-currency swap program to hedge our net investment in certain foreign operations. The aggregate notional value of the contracts under this program was $1,664 million and $1,844 million at fiscal year end 2020 and 2019, respectively. Under the terms of these contracts, we receive interest in U.S. dollars at a weighted-average rate of 2.4% per annum and pay no interest. Upon the maturity of these contracts at various dates through fiscal 2024, we will pay the notional
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value of the contracts in the designated foreign currency and receive U.S. dollars from our counterparties. We are not required to provide collateral for these contracts.
These cross-currency swap contracts were recorded on the Consolidated Balance Sheets as follows:
The impacts of our hedge of net investment programs were as follows:
(1) Recorded as currency translation, a component of accumulated other comprehensive income (loss).
Interest Rate and Investment Risk Management
We issue debt, as needed, to fund our operations and capital requirements. Such borrowings can result in interest rate exposure. To manage the interest rate exposure, we use interest rate swap contracts to convert a portion of fixed rate debt into variable rate debt. We may use forward starting interest rate swap contracts to manage interest rate exposure in periods prior to the anticipated issuance of fixed rate debt. During fiscal 2020 and 2019, we entered into forward starting interest rate swap contracts which had an aggregate notional value of $450 million and $350 million at fiscal year end 2020 and 2019, respectively, and were designated as cash flow hedges. These forward starting interest rate swap contracts were recorded on the Consolidated Balance Sheets as follows:
The impacts of these forward starting interest rate swap contracts were as follows:
We also utilize investment swap contracts to manage earnings exposure on certain nonqualified deferred compensation liabilities.
Commodity Hedges
As part of managing the exposure to certain commodity price fluctuations, we utilize commodity swap contracts designated as cash flow hedges. The objective of these contracts is to minimize impacts to cash flows and profitability due to changes in prices of commodities used in production.
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At fiscal year end 2020 and 2019, our commodity hedges had notional values of $312 million and $316 million, respectively. We expect that significantly all of the balance in accumulated other comprehensive income (loss) associated with the commodity hedges will be reclassified into the Consolidated Statement of Operations within the next twelve months.
Fair Value Measurements
Financial instruments recorded at fair value on a recurring basis, which consist of marketable securities and derivative instruments not discussed above, were immaterial at fiscal year end 2020 and 2019.
15. Retirement Plans
Defined Benefit Pension Plans
We have several contributory and noncontributory defined benefit retirement plans covering certain of our non-U.S. and U.S. employees, designed in accordance with local customs and practice.
The net periodic pension benefit cost (credit) for all non-U.S. and U.S. defined benefit pension plans was as follows:
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The following table represents the changes in benefit obligation and plan assets and the net amount recognized on the Consolidated Balance Sheets for all non-U.S. and U.S. defined benefit pension plans:
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The pre-tax amounts recognized in accumulated other comprehensive income (loss) for all non-U.S. and U.S. defined benefit pension plans were as follows:
In fiscal 2020, unrecognized actuarial gains recorded in accumulated other comprehensive income (loss) were primarily the result of favorable asset performance for our U.S. defined benefit pension plans, partially offset by lower U.S. discount rates and unfavorable asset performance for our non-U.S. defined benefit pension plans as compared to fiscal 2019. In fiscal 2019, unrecognized actuarial losses recorded in accumulated other comprehensive income (loss) were primarily the result of lower discount rates, partially offset by favorable asset performance for both non-U.S. and U.S. defined benefit pension plans as compared to fiscal 2018.
The estimated amortization of actuarial losses from accumulated other comprehensive income (loss) into net periodic pension benefit cost for non-U.S. and U.S. defined benefit pension plans in fiscal 2021 is expected to be $31 million and $9 million, respectively. The estimated amortization of prior service credit from accumulated other comprehensive income (loss) into net periodic pension benefit cost for non-U.S. defined benefit pension plans in fiscal 2021 is expected to be $6 million.
In determining the expected return on plan assets, we consider the relative weighting of plan assets by class and individual asset class performance expectations.
The investment strategies for non-U.S. and U.S. pension plans are governed locally. Our investment strategy for our pension plans is to manage the plans on a going concern basis. Current investment policy is to achieve a reasonable return on assets, subject to a prudent level of portfolio risk, for the purpose of enhancing the security of benefits for participants. Projected returns are based primarily on pro forma asset allocation, expected long-term returns, and forward-looking estimates of active portfolio and investment management.
At fiscal year end 2020, the long-term target asset allocation in our U.S. plans’ master trust is 5% return-seeking assets and 95% liability-hedging assets. Return-seeking assets, including non-U.S. and U.S. equity securities, are assets intended to generate returns in excess of pension liability growth. Liability-hedging assets, including government and corporate bonds, are assets intended to have characteristics similar to pension liabilities and are used to better match asset cash flows with expected obligation cash flows. Asset re-allocation to meet that target is occurring over a multi-year period based on the funded status. We expect to reach our target allocation when the funded status of the plans exceeds 115%. Based on the funded status of the plans as of fiscal year end 2020, our target asset allocation is 67% return-seeking and 33% liability-hedging.
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Target weighted-average asset allocation and weighted-average asset allocation for non-U.S. and U.S. pension plans were as follows:
Our common shares are not a direct investment of our pension funds; however, the pension funds may indirectly include our shares. The aggregate amount of our common shares would not be considered material relative to the total pension fund assets.
Our funding policy is to make contributions in accordance with the laws and customs of the various countries in which we operate as well as to make discretionary voluntary contributions from time to time. We expect to make the minimum required contributions of $45 million and $24 million to our non-U.S. and U.S. pension plans, respectively, in fiscal 2021. We may also make voluntary contributions at our discretion.
At fiscal year end 2020, benefit payments, which reflect future expected service, as appropriate, are expected to be paid as follows:
Presented below is the accumulated benefit obligation for all non-U.S. and U.S. pension plans as well as additional information related to plans with an accumulated benefit obligation in excess of plan assets and plans with a projected benefit obligation in excess of plan assets.
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We value our pension assets based on the fair value hierarchy of ASC 820, Fair Value Measurements and Disclosures. Details of the fair value hierarchy are described in Note 2. The following table presents our defined benefit pension plans’ asset categories and their associated fair value within the fair value hierarchy:
(1) Commingled equity funds are pooled investments in multiple equity-type securities. Fair value is calculated as the closing price of the underlying investments, an observable market condition, divided by the number of shares of the fund outstanding.
(2) Government bonds are marked to fair value based on quoted market prices or market approach valuation models using observable market data such as quotes, spreads, and data points for yield curves.
(3) Corporate bonds are marked to fair value based on quoted market prices or market approach valuation models using observable market data such as quotes, spreads, and data points for yield curves.
(4) Commingled bond funds are pooled investments in multiple debt-type securities. Fair value is calculated as the closing price of the underlying investments, an observable market condition, divided by the number of shares of the fund outstanding.
(5) Other investments are composed of insurance contracts, derivatives, short-term investments, structured products such as collateralized obligations and mortgage- and asset-backed securities, real estate investments, and hedge funds. Insurance contracts are valued using cash surrender value, or face value of the contract if a cash surrender value is unavailable (level 2), as these values represent the amount that the plan would receive on termination of the underlying contract. Derivatives, short-term investments, and structured products are marked to fair value using models that are supported by observable market-based data (level 2). Real estate investments include investments in commingled real estate funds and are valued at net asset value which is calculated using unobservable inputs that are supported by little or no market activity (level 3). Hedge funds are valued at their net asset value which is calculated using unobservable inputs that are supported by little or no market activity (level 3).
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(6) Items to reconcile to fair value of plan assets include amounts receivable for securities sold, amounts payable for securities purchased, and any cash balances, considered to be carried at book value, that are held in the plans.
Changes in Level 3 assets in non-U.S. plans were primarily the result of net investment losses in fiscal 2020 and purchases in 2019.
Defined Contribution Retirement Plans
We maintain several defined contribution retirement plans, the most significant of which is located in the U.S. These plans include 401(k) matching programs, as well as qualified and nonqualified profit sharing and share bonus retirement plans. Expense for the defined contribution plans is computed as a percentage of participants’ compensation and was $60 million, $63 million, and $62 million for fiscal 2020, 2019, and 2018, respectively.
Deferred Compensation Plans
We maintain nonqualified deferred compensation plans, which permit eligible employees to defer a portion of their compensation. A record keeping account is set up for each participant and the participant chooses from a variety of measurement funds for the deemed investment of their accounts. The measurement funds correspond to several funds in our 401(k) plans and the account balance fluctuates with the investment returns on those funds. At fiscal year end 2020 and 2019, total deferred compensation liabilities were $218 million and $203 million, respectively, and were recorded in other liabilities on the Consolidated Balance Sheets. See Note 14 for additional information regarding our risk management strategy related to deferred compensation liabilities.
Postretirement Benefit Plans
In addition to providing pension and 401(k) benefits, we also provide certain health care coverage continuation for qualifying retirees from the date of retirement to age 65 or lifetime, as applicable. The accumulated postretirement benefit obligation was $17 million and $18 million at fiscal year end 2020 and 2019, respectively, and the underfunded status of the postretirement benefit plans was included primarily in long-term pension and postretirement liabilities on the Consolidated Balance Sheets. Activity during fiscal 2020, 2019, and 2018 was not significant.
16. Income Taxes
Income Tax Expense (Benefit)
Significant components of the income tax expense (benefit) were as follows:
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The U.S. and non-U.S. components of income from continuing operations before income taxes were as follows:
The reconciliation between U.S. federal income taxes at the statutory rate and income tax expense (benefit) was as follows:
(1) The U.S. federal statutory rate was 21% for fiscal 2020 and 2019 and 24.58% for fiscal 2018.
(2) Excludes items which are separately presented.
The income tax expense for fiscal 2020 included $355 million of income tax expense related to the tax impacts of certain measures of the Switzerland Federal Act on Tax Reform and AHV Financing (“Swiss Tax Reform”) and an income tax benefit of $31 million related to pre-separation tax matters and the termination of the Tax Sharing Agreement. See “Swiss Tax Reform” and “Tax Sharing Agreement” below for additional information. In addition, the income tax expense for fiscal 2020 included $226 million of income tax expense related to increases to the valuation allowance for certain deferred tax assets, related primarily to the COVID-19 pandemic. As a result of the pandemic and its negative impact on our current and expected future operating profit and taxable income, we believed it was more likely than not that a portion of our deferred tax assets will not be realized. Depending on the duration and severity of COVID-19 disruptions to our business, additional adjustments to our valuation allowance may be required in future periods. The pre-tax goodwill impairment charge of $900 million recorded during fiscal 2020 resulted in a tax benefit of $4 million as the associated goodwill was primarily not deductible for income tax purposes. See Note 8 for additional information regarding the impairment of goodwill.
The income tax benefit for fiscal 2019 included a $216 million income tax benefit related to the tax impacts of certain measures of Swiss Tax Reform, a $90 million income tax benefit related to the effective settlement of a tax audit in a non-U.S. jurisdiction, and $15 million of income tax expense associated with the tax impacts of certain legal entity restructurings and intercompany transactions. See “Swiss Tax Reform” below for additional information regarding Swiss Tax Reform.
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The income tax benefit for fiscal 2018 included a $1,222 million net income tax benefit associated with the tax impacts of certain legal entity restructurings and intercompany transactions that occurred in the quarter ended September 28, 2018. The net income tax benefit of $1,222 million related primarily to the recognition of certain non-U.S. loss carryforwards and basis differences in subsidiaries expected to be utilized against future taxable income, partially offset by a $46 million increase in the valuation allowance for certain U.S. federal tax credit carryforwards. The income tax benefit for fiscal 2018 also included $567 million of income tax expense related to the tax impacts of the Tax Cuts and Jobs Act (the “Act”) and a $61 million net income tax benefit related to the tax impacts of certain legal entity restructurings that occurred in the quarter ended December 29, 2017. See “Tax Cuts and Jobs Act” below for additional information regarding the Act.
Deferred Tax Assets and Liabilities
Deferred income taxes result from temporary differences between the amount of assets and liabilities recognized for financial reporting and tax purposes. The components of the net deferred income tax asset were as follows:
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Our tax loss and credit carryforwards (tax effected) at fiscal year end 2020 were as follows:
The valuation allowance for deferred tax assets of $4,429 million and $4,970 million at fiscal year end 2020 and 2019, respectively, related principally to the uncertainty of the utilization of certain deferred tax assets, primarily tax loss, capital loss, and credit carryforwards in various jurisdictions. During fiscal 2020, tax loss and credit carryforwards decreased primarily as a result of a $818 million (tax effected) recovery of prior years’ net write-downs of investments in subsidiaries in certain jurisdictions, offset by a corresponding decrease to the valuation allowance. We believe that we will generate sufficient future taxable income to realize the income tax benefits related to the remaining net deferred tax assets on the Consolidated Balance Sheet.
We have provided income taxes for earnings that are currently distributed as well as the taxes associated with several subsidiaries’ earnings that are expected to be distributed in the future. No additional provision has been made for Swiss or non-Swiss income taxes on the undistributed earnings of subsidiaries or for unrecognized deferred tax liabilities for temporary differences related to basis differences in investments in subsidiaries, as such earnings are expected to be permanently reinvested, the investments are essentially permanent in duration, or we have concluded that no additional tax liability will arise as a result of the distribution of such earnings. As of fiscal year end 2020, certain subsidiaries had approximately $29 billion of cumulative undistributed earnings that have been retained indefinitely and reinvested in our global manufacturing operations, including working capital; property, plant, and equipment; intangible assets; and research and development activities. A liability could arise if our intention to permanently reinvest such earnings were to change and amounts are distributed by such subsidiaries or if such subsidiaries are ultimately disposed. It is not practicable to estimate the additional income taxes related to permanently reinvested earnings or the basis differences related to investments in subsidiaries. As of fiscal year end 2020, we had approximately $5.3 billion of cash, cash equivalents, and intercompany deposits, principally in our subsidiaries, that we have the ability to distribute to TEGSA, our Luxembourg subsidiary, which is the obligor of substantially all of our debt, and to TE Connectivity Ltd., our Swiss parent company, but we consider to be permanently reinvested. We estimate that up to $0.8 billion of tax expense would be recognized on the Consolidated Financial Statements if our intention to permanently reinvest these amounts were to change. Our current plans do not demonstrate a need to repatriate cash, cash equivalents, and intercompany deposits that are designated as permanently reinvested in order to fund our operations, including investing and financing activities.
Uncertain Tax Positions
As of fiscal year end 2020, we had total unrecognized income tax benefits of $414 million. If recognized in future years, $393 million of these currently unrecognized income tax benefits would reduce income tax expense and the effective tax rate. As of fiscal year end 2019, we had total unrecognized income tax benefits of $542 million. If recognized in future
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years, $397 million of these currently unrecognized income tax benefits would reduce income tax expense and the effective tax rate. The following table summarizes the activity related to unrecognized income tax benefits:
We record accrued interest and penalties related to uncertain tax positions as part of income tax expense (benefit). As of fiscal year end 2020 and 2019, we had $42 million of accrued interest and penalties related to uncertain tax positions on the Consolidated Balance Sheets, recorded primarily in income taxes. During fiscal 2020, 2019, and 2018, we recognized income tax benefits of $1 million, benefits of $14 million, and expense of $5 million, respectively, related to interest and penalties on the Consolidated Statements of Operations.
We file income tax returns on a unitary, consolidated, or stand-alone basis in multiple state and local jurisdictions, which generally have statutes of limitations ranging from 3 to 4 years. Various state and local income tax returns are currently in the process of examination or administrative appeal.
Our non-U.S. subsidiaries file income tax returns in the countries in which they have operations. Generally, these countries have statutes of limitations ranging from 3 to 10 years. Various non-U.S. subsidiary income tax returns are currently in the process of examination by taxing authorities.
As of fiscal year end 2020, under applicable statutes, the following tax years remained subject to examination in the major tax jurisdictions indicated:
In most jurisdictions, taxing authorities retain the ability to review prior tax years and to adjust any net operating loss and tax credit carryforwards from these years that are utilized in a subsequent period.
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Although it is difficult to predict the timing or results of our worldwide examinations, we estimate that approximately $50 million of unrecognized income tax benefits, excluding the impact relating to accrued interest and penalties, could be resolved within the next twelve months.
We are not aware of any other matters that would result in significant changes to the amount of unrecognized income tax benefits reflected on the Consolidated Balance Sheet as of fiscal year end 2020.
Other Income Tax Matters
Swiss Tax Reform
Swiss Parliament approved the Federal Act on Tax Reform and AHV Financing in September 2018, and it was approved by public vote on May 19, 2019. Swiss Tax Reform eliminates certain preferential tax items and implements new tax rates at both the federal and cantonal levels.
On May 24, 2019, the federal tax authority issued guidance abolishing certain interest deductions effective January 1, 2020. As a result, during fiscal 2019, we recorded a $216 million income tax benefit related primarily to the reduction to the valuation allowance for deferred tax assets. Based on our forecast of taxable income and the abolishment of certain interest deductions, we believed it was more likely than not that additional deferred tax assets for tax loss carryforwards in Switzerland would be realized in the future. The federal provisions of Swiss Tax Reform were enacted into law in the quarter ended September 27, 2019.
In October 2019, the canton of Schaffhausen enacted Swiss Tax Reform into law, including reductions in tax rates. During fiscal 2020, we recognized $355 million of income tax expense related primarily to cantonal implementation and the resulting write-down of certain deferred tax assets to the lower tax rates.
Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act, which was enacted in December 2017, included numerous significant changes to existing tax law, including a permanent reduction in the U.S. federal corporate income tax rate to 21%, effective January 1, 2018; further limitations on the deductibility of interest expense and certain executive compensation; repeal of the corporate Alternative Minimum Tax; and imposition of a territorial tax system with a one-time repatriation tax on deemed repatriated earnings of foreign subsidiaries. In the period of enactment, we revalued our U.S. federal deferred tax assets and liabilities at the 21% tax rate and recorded income tax expense of $567 million primarily in connection with the write-down of our U.S. federal deferred tax asset for net operating loss and interest carryforwards to the lower tax rate. Included in the expense of $567 million was an income tax benefit of $34 million related to the reduction in the existing valuation allowance recorded against certain U.S. federal tax credit carryforwards.
Tax Sharing Agreement
Upon our separation from Tyco International plc in fiscal 2007, we entered into a Tax Sharing Agreement with Tyco International plc (now part of Johnson Controls International plc) and Covidien plc (now part of Medtronic plc) under which we shared certain income tax liabilities for periods prior to and including June 29, 2007. Pursuant to the Tax Sharing Agreement, we entered into certain guarantee commitments and indemnifications.
In fiscal 2020, we, Johnson Controls International plc, and Medtronic plc entered into an agreement to terminate the Tax Sharing Agreement. We believe that substantially all income tax matters that may be subject to the Tax Sharing Agreement have been settled with tax authorities and we do not expect any remaining tax matters to have a material effect on our results of operations, financial position, or cash flows. Accordingly, during fiscal 2020, we recognized an income tax benefit of $31 million and net other income of $8 million representing settlement of the remaining shared pre-separation income tax matters and indemnification balances.
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17. Earnings (Loss) Per Share
The weighted-average number of shares outstanding used in the computations of basic and diluted earnings (loss) per share were as follows:
For fiscal 2020, there were two million nonvested share awards and options outstanding with underlying exercise prices less than the average market prices of our common shares; however, these were excluded from the calculation of diluted loss per share as inclusion would be antidilutive as a result of our loss during the period.
The following share options were not included in the computation of diluted earnings (loss) per share because the instruments’ underlying exercise prices were greater than the average market prices of our common shares and inclusion would be antidilutive:
18. Shareholders’ Equity
Common Shares
We are organized under the laws of Switzerland. The rights of holders of our shares are governed by Swiss law, our Swiss articles of association, and our Swiss organizational regulations. Accordingly, the par value of our common shares is stated in Swiss francs (“CHF”). We continue to use the U.S. dollar, however, as our reporting currency on the Consolidated Financial Statements.
Subject to certain conditions specified in our articles of association, we are authorized to increase our conditional share capital by issuing new shares in aggregate not exceeding 50% of our authorized shares. In March 2020, our shareholders reapproved and extended through March 11, 2022, our board of directors’ authorization to issue additional new shares, subject to certain conditions specified in the articles of association, in aggregate not exceeding 50% of the amount of our authorized shares.
Common Shares Held in Treasury
At fiscal year end 2020, approximately 8 million common shares were held in treasury, of which 5 million were owned by one of our subsidiaries. At fiscal year end 2019, approximately 16 million common shares were held in treasury, of which 4 million were owned by one of our subsidiaries. Shares held both directly by us and by our subsidiary are presented as treasury shares on the Consolidated Balance Sheets.
In fiscal 2020 and 2019, our shareholders approved the cancellation of 12 million and 6 million shares, respectively, purchased under our share repurchase program. These capital reductions by cancellation of shares were subject to a notice period and filing with the commercial register in Switzerland.
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Contributed Surplus
As a result of cumulative equity transactions, including dividend activity and treasury share cancellations, our contributed surplus balance was reduced to zero with residual activity recorded against accumulated earnings as reflected on the Consolidated Statement of Shareholders’ Equity. To the extent that the contributed surplus balance continues to be zero, the impact of future transactions that normally would have been recorded as a reduction of contributed surplus will be recorded in accumulated earnings. Contributed surplus established for Swiss tax and statutory purposes (“Swiss Contributed Surplus”) is not impacted by our GAAP treatment.
Swiss Contributed Surplus, subject to certain conditions, is a freely distributable reserve. As of fiscal year end 2020 and 2019, Swiss Contributed Surplus was CHF 5,513 million and CHF 6,107 million, respectively (equivalent to $4,561 million and $5,195 million, respectively).
Dividends
We paid cash dividends to shareholders of $1.88, $1.80, and $1.68 per share in fiscal 2020, 2019, and 2018, respectively.
Under Swiss law, subject to certain conditions, dividends paid from reserves from capital contributions (equivalent to Swiss Contributed Surplus) are exempt from Swiss withholding tax. Dividends on our shares must be approved by our shareholders.
Our shareholders approved the following dividends on our common shares:
Upon shareholders’ approval of a dividend payment, we record a liability with a corresponding charge to shareholders’ equity. At fiscal year end 2020 and 2019, the unpaid portion of the dividends recorded in accrued and other current liabilities on the Consolidated Balance Sheets totaled $317 million and $308 million, respectively.
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Share Repurchase Program
In both fiscal 2019 and 2018, our board of directors authorized increases of $1.5 billion in our share repurchase program. Common shares repurchased under the share repurchase program were as follows:
At fiscal year end 2020, we had $1.0 billion of availability remaining under our share repurchase authorization.
19. Accumulated Other Comprehensive Income (Loss)
The changes in each component of accumulated other comprehensive income (loss) were as follows:
(1) Includes hedges of net investment foreign currency exchange gains or losses which offset foreign currency exchange losses or gains attributable to the translation of the net investments.
(2) Represents net foreign currency translation adjustments reclassified as a result of the sale of the SubCom business. This net loss is included in income (loss) from discontinued operations on the Consolidated Statement of Operations. See Note 4 for additional information regarding the divestiture of SubCom.
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20. Share Plans
Our equity compensation plans, of which the TE Connectivity Ltd. 2007 Stock and Incentive Plan, amended and restated as of September 17, 2020 (the “2007 Plan”), is the primary plan, provide for the award of annual performance bonuses and long-term performance awards, including share options; restricted, performance, and deferred share units; and other share-based awards (collectively, “Awards”) and allow for the use of unissued shares or treasury shares to be used to satisfy such Awards. As of fiscal year end 2020, our plans provided for a maximum of 77 million shares to be issued as Awards, subject to adjustment as provided under the terms of the plans. A total of 15 million shares remained available for issuance under the 2007 Plan as of fiscal year end 2020.
Share-Based Compensation Expense
Share-based compensation expense, which was included primarily in selling, general, and administrative expenses on the Consolidated Statements of Operations, was as follows:
We recognized a related tax benefit associated with our share-based compensation arrangements of $15 million, $16 million, and $20 million in fiscal 2020, 2019, and 2018, respectively.
Restricted Share Awards
Restricted share awards, which are generally in the form of restricted share units, are granted subject to certain restrictions. Conditions of vesting are determined at the time of grant. All restrictions on an award will lapse upon death or disability of the employee. If the employee satisfies retirement requirements, all or a portion of the award may vest, depending on the terms and conditions of the particular grant. Recipients of restricted share units have no voting rights, but do receive dividend equivalents. For grants that vest through passage of time, the fair value of the award at the time of the grant is amortized to expense over the period of vesting. The fair value of restricted share awards is determined based on the closing value of our shares on the grant date. Restricted share awards generally vest in increments over a period of four years as determined by the management development and compensation committee.
Restricted share award activity was as follows:
The weighted-average grant-date fair value of restricted share awards granted during fiscal 2020, 2019, and 2018 was $92.94, $77.77, and $93.45, respectively.
The total fair value of restricted share awards that vested during fiscal 2020, 2019, and 2018 was $44 million, $48 million, and $50 million, respectively.
As of fiscal year end 2020, there was $72 million of unrecognized compensation expense related to nonvested restricted share awards, which is expected to be recognized over a weighted-average period of 1.8 years.
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Performance Share Awards
Performance share awards, which are generally in the form of performance share units, are granted with pay-out subject to vesting requirements and certain performance conditions that are determined at the time of grant. Based on our performance, the pay-out of performance share units can range from 0% to 200% of the number of units originally granted. The grant-date fair value of performance share awards is expensed over the period of performance once achievement of the performance criteria is deemed probable. Recipients of performance share units have no voting rights but do receive dividend equivalents. Performance share awards generally vest after a period of three years as determined by the management development and compensation committee.
Performance share award activity was as follows:
The weighted-average grant-date fair value of performance share awards granted during fiscal 2020, 2019, and 2018 was $83.30, $71.38, and $92.96, respectively.
The total fair value of performance share awards that vested during fiscal 2020, 2019, and 2018 was $20 million, $30 million, and $19 million, respectively.
As of fiscal year end 2020, there was $15 million of unrecognized compensation expense related to nonvested performance share awards, which is expected to be recognized over a weighted-average period of 1.1 years.
Share Options
Share options are granted to purchase our common shares at prices which are equal to or greater than the market price of the common shares on the date the option is granted. Conditions of vesting are determined at the time of grant. All restrictions on the award will lapse upon death or disability of the employee. If the employee satisfies retirement requirements, all or a portion of the award may vest, depending on the terms and conditions of the particular grant. Options generally vest and become exercisable in equal annual installments over a period of four years and expire ten years after the date of grant.
Share option award activity was as follows:
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The weighted-average exercise price of share option awards granted during fiscal 2020, 2019, and 2018 was $93.39, $76.91, and $93.44, respectively.
The total intrinsic value of options exercised during fiscal 2020, 2019, and 2018 was $39 million, $58 million, and $106 million, respectively. We received cash related to the exercise of options of $55 million, $85 million, and $100 million in fiscal 2020, 2019, and 2018, respectively.
As of fiscal year end 2020, there was $31 million of unrecognized compensation expense related to nonvested share options granted under our share option plans, which is expected to be recognized over a weighted-average period of 1.7 years.
Share-Based Compensation Assumptions
The grant-date fair value of each share option grant was estimated using the Black-Scholes-Merton option pricing model. Use of a valuation model requires management to make certain assumptions with respect to selected model inputs. We employ our historical share volatility when calculating the grant-date fair value of our share option grants using the Black-Scholes-Merton option pricing model. Currently, we do not have exchange-traded options of sufficient duration to employ an implied volatility assumption in the calculation and therefore rely solely on the historical volatility calculation. The average expected life was based on the contractual term of the option and expected employee exercise and post-vesting employment termination behavior. The risk-free interest rate was based on U.S. Treasury zero-coupon issues with a remaining term that approximated the expected life assumed at the date of grant. The expected annual dividend per share was based on our expected dividend rate. The recognized share-based compensation expense was net of estimated forfeitures, which are based on voluntary termination behavior as well as an analysis of actual option forfeitures.
The weighted-average grant-date fair value of options granted and the weighted-average assumptions we used in the Black-Scholes-Merton option pricing model were as follows:
21. Segment and Geographic Data
We operate through three reportable segments: Transportation Solutions, Industrial Solutions, and Communications Solutions. See Note 1 for a description of the segments in which we operate.
Segment performance is evaluated based on net sales and operating income. Generally, we consider all expenses to be of an operating nature and, accordingly, allocate them to each reportable segment. Costs specific to a segment are charged to the segment. Corporate expenses, such as headquarters administrative costs, are allocated to the segments based on segment operating income. Intersegment sales are not material. Corporate assets are allocated to the segments based on segment assets.
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Net sales by segment and industry end market(1) were as follows:
(1) Industry end market information is presented consistently with our internal management reporting and may be revised periodically as management deems necessary.
(2) Effective for fiscal 2020, we are separately presenting net sales in the medical end market. Such amounts were previously included in net sales in the industrial equipment end market.
Net sales by geographic region and segment were as follows:
TE CONNECTIVITY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Operating income by segment was as follows:
No single customer accounted for a significant amount of our net sales in fiscal 2020, 2019, or 2018.
As we are not organized by product or service, it is not practicable to disclose net sales by product or service.
Depreciation and amortization and capital expenditures were as follows:
Segment assets and a reconciliation of segment assets to total assets were as follows:
(1) Segment assets are composed of accounts receivable, inventories, and net property, plant, and equipment.
TE CONNECTIVITY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Net sales and net property, plant, and equipment by geographic region were as follows:
(1)
Net sales to external customers are attributed to individual countries based on the legal entity that records the sale.
22. Quarterly Financial Data (unaudited)
Summarized quarterly financial data was as follows:
(1) Results for the quarter ended December 27, 2019 included $355 million of income tax expense related to the tax impacts of certain measures of Swiss Tax Reform. See Note 16 for additional information regarding income taxes.
TE CONNECTIVITY LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(2) Results for the quarter ended March 27, 2020 included a pre-tax goodwill impairment charge of $900 million relating to the Sensors reporting unit in our Transportation Solutions segment. See Note 8 for additional information regarding goodwill impairment.
(3) Results for the quarter ended June 26, 2020 included $170 million of income tax expense related to an increase to the valuation allowance for certain non-U.S. deferred tax assets. See Note 16 for additional information regarding income taxes.
(4) Results for the quarter ended December 28, 2018 included a pre-tax loss of $86 million on the sale of our SubCom business which was reported as a discontinued operation on our Consolidated Financial Statements. See Note 4 for additional information regarding discontinued operations.
(5) Results for the quarter ended June 28, 2019 included a $214 million income tax benefit related to the tax impacts of certain measures of Swiss Tax Reform and a $93 million income tax benefit related to the effective settlement of a tax audit in a non-U.S. jurisdiction. See Note 16 for additional information regarding income taxes.
TE CONNECTIVITY LTD.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Fiscal Years Ended September 25, 2020, September 27, 2019, and September 28, 2018