Johnson Controls International Plc quarterly report, Q3 FY2011

Filing identity and reporting period

Important identity discrepancy: The supplied filing is Tyco International Ltd.’s Form 10-Q, not a Johnson Controls International plc filing. It reports the fiscal third quarter ended June 24, 2011, and the nine months ended that date; comparisons are to June 25, 2010. Amounts are in U.S. dollars unless noted.

Financial performance and liquidity

Quarter revenue included $219 million of favorable foreign-exchange effects; nine-month revenue included $302 million. The nine-month operating-income increase included a $227 million net divestiture gain, primarily from selling a majority interest in Electrical and Metal Products. Nine-month net income also included $160 million from discontinued operations, including the European water business sale gain.

Service revenue was $1.957 billion for the quarter and $5.702 billion for nine months; it represented 46% and 45% of revenue, respectively, versus 41% in both comparable 2010 periods. Quarterly segment results: Security Solutions revenue was $2.165 billion and operating income $327 million; Fire Protection revenue was $1.200 billion and operating income $146 million; Flow Control revenue was $928 million and operating income $103 million. Flow Control operating income declined 8.8% in the quarter, primarily because of weakness in Water & Environmental Systems.

At June 24, cash and cash equivalents were $1.629 billion, total debt $4.187 billion, and shareholders’ equity $14.177 billion. Cash was down from $1.775 billion at September 24, 2010. Current assets were $6.818 billion and current liabilities $4.618 billion. The company reported $1.5 billion of committed revolving facilities, undrawn except for $40 million reserved to backstop commercial paper. Debt to total capital was 23%.

Nine-month investing cash use was $515 million, including $548 million of capital expenditures, $451 million to acquire ADT customer accounts, and $228 million for business acquisitions; divestiture proceeds were $711 million in continuing operations. Financing cash use was $1.269 billion, including $1.3 billion of share repurchases and $342 million of dividends. Working-capital changes reduced operating cash flow by $621 million. Management expected fiscal 2011 capital expenditures to exceed fiscal 2010 spending and depreciation.

Material changes and business developments

• Revenue growth was modest overall despite gains in Security Solutions and Fire Protection; the sale of Electrical and Metal Products removed $390 million of prior-year quarterly revenue and about $1.0 billion of prior-year nine-month revenue from comparisons.
• Security Solutions benefited from Broadview Security and Signature Security Group acquisitions, customer-account growth, and higher average monthly revenue per customer. Fire Protection cited improved product demand, pricing actions, and expansion of recurring services.
• Tyco realigned businesses into three core segments: Tyco Security Solutions, Tyco Fire Protection, and Tyco Flow Control. The prior-period segment presentation was recast.
• Tyco sold a 51% interest in Electrical and Metal Products for approximately $713 million in proceeds. It completed the acquisition of a 75% stake in KEF for about $300 million on June 29, 2011, after quarter-end, and agreed on July 6 to acquire Chemguard, subject to customary conditions.
• Total backlog was $9.920 billion, up 4.8% from September 24, 2010; management expected approximately 89% to be filled within 12 months.

Outlook, risks, and unusual items

• Management said cash, operating cash flow, and available credit were expected to be sufficient for operational and business needs, including dividends and repurchases. It intended to use cash for core-business investment, productivity, strategic bolt-on acquisitions, and shareholder returns. No earnings or revenue guidance is stated in the supplied text.
• Tyco expected approximately $150 million of restructuring and restructuring-related charges in fiscal 2011. Restructuring and asset-impairment charges were $74 million for the first nine months.
• Pre-Separation tax liabilities remain a significant uncertainty. Tyco expected to pay about $188 million to Covidien and TE Connectivity before the end of calendar 2011; it said the maximum potential future payments under the tax-sharing agreement were not determinable. Certain IRS matters could require litigation.
• Ongoing DOJ and SEC discussions concerning potential FCPA compliance issues could result in material fines, injunctions, a compliance monitor, or other penalties; Tyco could not estimate the potential loss. A German competition investigation also had no estimable loss range.
• Asbestos exposure: approximately 4,400 lawsuits and 5,100 estimated viable claims were pending. The recorded net asbestos liability was $91 million, based on a $327 million liability and $236 million insurance-recovery asset; actual amounts could differ substantially.
• Environmental remediation costs were estimated at $24–$79 million, with a best estimate of $31 million recorded. Other notable matters include a $25 million pension-fund withdrawal assessment under arbitration, disputed former-management claims, and uncertain tax and legacy legal exposures.
• Other unusual reporting considerations: the quarter’s effective tax rate was 13.8%, compared with an 11.5% tax benefit in the prior-year quarter; nine-month rates were 19.2% and 8.3%. Fire Protection’s prior-year service/product revenue classification was not restated, though management said the misclassification was not material.

Most important facts for investors to verify

1. Confirm the issuer: this document is Tyco International Ltd., not Johnson Controls International plc.
2. Separate recurring operating performance from currency effects, acquisitions, divestitures, and the $227 million nine-month divestiture gain; assess how much of reported earnings growth is repeatable.
3. Review working-capital cash absorption, planned capital spending, customer-account acquisition costs, and the sustainability of dividends and buybacks relative to cash generation.
4. Assess tax-sharing, FCPA/DOJ/SEC, competition, asbestos, environmental, and pension-related exposures, including whether recorded reserves and insurance recoveries remain adequate.
5. Track post-quarter KEF integration and the proposed Chemguard acquisition, as well as backlog conversion and Flow Control’s continuing Water & Environmental Systems weakness.