Johnson Controls International plc — Q2 FY2017 Form 10-Q
Reporting period: Three and six months ended March 31, 2017. Figures are in U.S. dollars; financial statements are unaudited. The company’s fiscal year ends September 30.
Business context and comparability
Johnson Controls provides building technologies and services, fire and security products and services, and automotive batteries. The September 2016 Tyco merger materially expanded the business, while the October 2016 Adient spin-off removed Automotive Experience from continuing operations. Consequently, year-over-year comparisons include Tyco in 2017 but not in 2016, and exclude Adient from continuing operations; they are not fully comparable.
Financial performance
| Metric | Three months ended March 31 | Six months ended March 31 |
|---|---|---|
| Net sales | $7.267 billion vs. $4.733 billion (+54%) | $14.353 billion vs. $9.429 billion (+52%) |
| Gross profit / margin | $2.281 billion; 31.4% vs. 27.2% | $4.395 billion; 30.6% vs. 27.0% |
| Income before tax, continuing operations | $393 million vs. $297 million | $778 million vs. $683 million |
| Income tax provision / effective tax rate | $508 million / 129% vs. $41 million / 14% | $481 million / 62% vs. $124 million / 18% |
| Net income (loss) attributable to Johnson Controls | $(148) million vs. $(530) million | $181 million vs. $(80) million |
| Diluted EPS | $(0.16) vs. $(0.81) | $0.19 vs. $(0.12) |
| Cash from (used in) operating activities | Not provided as a quarterly total | $(1.536) billion vs. $621 million |
Quarterly sales rose 4% excluding the Tyco merger and foreign-exchange effects; the six-month increase on that basis was 3%. The quarterly attributable loss from continuing operations was $148 million, compared with income of $218 million a year earlier. The reported net loss comparison also reflects the prior-year Adient discontinued-operation loss. Segment EBITA was $956 million for the quarter and $1.780 billion for six months; these company-defined measures exclude, among other items, corporate expenses, intangible amortization, financing charges, and significant restructuring costs.
Cash, debt and liquidity
- Cash and cash equivalents were $412 million at March 31, 2017, down from $579 million at September 30, 2016. Total debt was $13.476 billion, up 6% from $12.759 billion; debt was 41% of total capitalization versus 35% at fiscal year-end.
- Operating cash outflow of $1.536 billion for the six months principally reflected tax payments associated with the Adient spin-off, including approximately $1.2 billion in the first quarter, and unfavorable working-capital movements. Capital expenditures were $634 million, compared with $543 million in the prior-year period.
- Management said liquidity was adequate. The company and subsidiary TSarl had $2.0 billion and $1.0 billion revolving credit facilities, respectively, with no draws at quarter-end; both mature in August 2020. The company reported covenant compliance.
- Working capital, using management’s adjusted definition, was $1.941 billion versus $369 million at September 30, 2016. The change was attributed in part to Adient-related tax payments, supplier-payment timing and higher inventory.
Material changes, outlook and unusual items
- Tyco merger: Merger-related sales drove much of the reported growth. Management cited cross-selling, expanded reach and combined product and service capabilities as expected growth opportunities. Integration and transaction costs continued to weigh on results.
- Adient spin-off: The company completed the spin-off on October 31, 2016 and retained no equity interest. The 2017 six-month discontinued-operations results include one month of Adient; the reported loss was $34 million, including $79 million of separation costs.
- Scott Safety sale and tax charge: Johnson Controls agreed to sell Scott Safety to 3M for approximately $2.0 billion, with expected net cash proceeds of $1.8–$1.9 billion. Closing was expected in the second half of calendar 2017, subject to customary conditions and regulatory approval. The company recorded a $457 million non-cash tax charge related to the pending sale, a significant factor in the quarter’s tax provision and loss.
- Restructuring: Fiscal 2017 restructuring and impairment costs totaled $177 million through March 31. Management estimated approximately $185 million of annual operating-cost reductions when the plan is complete, expected to be substantially realized in fiscal 2018; fiscal 2017 savings net of execution costs were expected to equal about 60% of that annual reduction. The fiscal 2016 plan was expected to yield approximately $135 million of annual savings.
- Segments and operating factors: Power Solutions sales increased 7% for the quarter and EBITA increased 7%, with pricing and product mix benefits partly offset by lower volumes and higher operating costs. Building Efficiency performance varied by segment; Systems and Service North America EBITA declined, while Asia’s six-month EBITA improved. The company cited softness in some underlying markets and investments in products and channels.
- Capital returns: The company repurchased $119 million of shares in the first six months. In April 2017, it announced an intention to use up to $750 million of its $1 billion authorization during fiscal 2017.
- Management outlook and risks: Management expected to fund fiscal 2017 needs from operations and, if required, borrowings, and said it had sufficient resources for the foreseeable future. Forward-looking outcomes remain subject to merger integration and synergy execution, transaction-related disruption and tax treatment, economic and automotive production conditions, commodity and energy prices, raw-material availability, foreign exchange, and commercial-arrangement changes. No material change to the prior 10-K risk-factor disclosure was reported.
Contingencies and other notable disclosures
- Asbestos-related liabilities were $540 million and related cash, investments and receivables were $388 million; the reported discounted net liability was $152 million. Estimates depend on long-term claims and insurance assumptions and could differ materially from actual outcomes.
- Environmental reserves were $46 million. The company said known environmental matters were not expected to have a material adverse effect.
- The company disclosed merger-related shareholder litigation, including a federal action whose outcome it could not predict; a motion to dismiss had been filed. Management stated that other ordinary-course litigation was not expected to have a material adverse effect.
- Tax examinations or litigation could conclude within 12 months and potentially affect tax expense by up to $150 million, according to the filing.
Important facts for investors to verify
- How much of reported growth and segment EBITA reflects Tyco consolidation, and how much is organic, after adjusting for foreign exchange, acquisition accounting and integration costs.
- The expected timing and net proceeds of the Scott Safety sale, and whether the $457 million tax charge or other tax consequences change.
- Whether operating cash flow recovers after the unusually large Adient-related tax payment and working-capital outflows.
- Progress against restructuring targets, including realization of projected savings and remaining cash costs.
- Debt maturities, borrowing costs, leverage and liquidity as the company funds capital expenditures, dividends, repurchases and pension contributions.
- Developments in asbestos and environmental estimates, merger-related litigation, and tax audits or disputes.