Johnson Controls International Plc quarterly report, Q3 FY2018

Johnson Controls International plc — Form 10-Q Summary

Reporting period: Fiscal third quarter and nine months ended June 30, 2018. The financial statements are unaudited; comparisons are with the corresponding 2017 periods unless stated otherwise. Johnson Controls operates globally in building technologies and services and automotive batteries (Power Solutions).

Financial performance

Metric	Three months ended June 30, 2018	Nine months ended June 30, 2018
Net sales	$8.12 billion, up 6%	$23.03 billion, up 5%
Gross profit / margin	$2.47 billion / 30.4%; margin down 120 basis points	$6.86 billion / 29.8%; margin down 120 basis points
Income from continuing operations	$804 million	$1.56 billion
Net income attributable to Johnson Controls	$723 million, up 30%; diluted EPS $0.78	$1.39 billion, up 89%; diluted EPS $1.49
Operating cash flow	Not separately reported for the quarter	$1.26 billion, versus cash use of $1.30 billion
Capital expenditures	Not separately reported for the quarter	$782 million

Quarterly sales growth reflected higher volumes across Buildings and Power Solutions, favorable currency translation and Power Solutions pricing/mix, partly offset by divestitures. Year-to-date sales also benefited from currency translation and higher lead costs passed through in pricing. Operating cash flow improved substantially against the prior year, which included large Adient spin-off-related tax payments and other outflows.

Quarterly gross margin pressure reflected higher Power Solutions operating and transportation costs and currency impacts, partly offset by volume and mix benefits. SG&A fell 5% in the quarter and 8% year to date, helped by productivity and synergies, divestitures and, year to date, the Scott Safety gain. Net financing charges declined to $101 million in the quarter and $332 million year to date.

Balance sheet, debt and liquidity

• At June 30, cash and cash equivalents were $283 million; total debt was $11.96 billion and net debt was $11.67 billion. Net debt was down 12% from September 30, 2017, and net debt to total capitalization declined to 36.0% from 39.3%.
• Current assets were $12.47 billion and current liabilities $11.30 billion. Management-defined working capital was $2.45 billion, up from $1.61 billion at fiscal year-end, principally due to higher inventory and lower other current liabilities.
• The company reported $1.56 billion of short-term debt and $10.37 billion of long-term debt. Scott Safety sale proceeds were used to repay merger-related debt; the company also made significant debt repayments during the period.
• Management said liquidity was adequate for projected needs. The company and TSarl had undrawn revolving facilities, and the company estimated it could borrow up to $1.6 billion based on average borrowing levels on committed credit lines. The company and TSarl were in compliance with debt covenants.

Material changes and segment results

• Building Technologies & Solutions sales increased 3% in the quarter; segment EBITA increased 3% to $942 million. Building Solutions North America and Asia Pacific EBITA grew, while EMEA/LA and Global Products declined slightly.
• Power Solutions sales increased 14% to $1.84 billion in the quarter, while segment EBITA rose 2% to $310 million. Higher volumes and favorable pricing/mix were partly offset by costs to meet customer demand, lower equity income and incremental investment.
• Year-to-date total segment EBITA increased 8% to $3.22 billion. Global Products benefited from volume/mix and the Scott Safety gain, but divestitures and higher costs offset some gains.
• The company completed the Scott Safety sale to 3M in October 2017 for approximately $2.0 billion net of cash divested, recording a $114 million pretax gain. Net proceeds of approximately $1.9 billion were used toward debt repayment. Fiscal 2018 investing cash flow also included $2.10 billion of business-divestiture proceeds.
• The company reorganized Buildings reporting segments effective July 1, 2017; comparative segment results were revised to reflect the new structure.

Outlook, management commentary and risks

• Management expected approximately $150 million of annual operating-cost reductions from the fiscal 2018 restructuring plan, with benefits substantially realized in 2020; approximately 45% of the annual savings, net of execution costs, was expected in fiscal 2018. Earlier restructuring plans also carry expected savings, with remaining reserves expected to be paid in cash.
• Management said it was reviewing strategic alternatives for Power Solutions, with the review expected to conclude by the release of fiscal 2018 fourth-quarter earnings. The filing gives no transaction outcome or specific financial guidance; timing, structure, completion and benefits remained uncertain.
• U.S. tax reform produced provisional first-quarter items: a $101 million noncash deferred-tax benefit and a $305 million transition-tax charge. The company said estimates could change as it finalized its accounting. The nine-month effective tax rate was 22%, versus 38% in 2017; quarterly rates were approximately 12%.
• Material litigation exposure includes AFFF-related PFOS/PFOA lawsuits and claims against subsidiaries. The company stated that ultimate exposure was difficult to predict and could be material, while maintaining that it had defenses and pursuing insurance coverage. Asbestos-related net liability was $180 million at June 30, 2018, based on long-term estimates of claims and insurance recoveries.
• A Qatar airport subcontractor arbitration award of approximately $50 million remained outstanding; the company had filed annulment proceedings and was pursuing a related claim against the project steering committee. The award accrues interest at 9.56% on a portion of the balance.
• Other stated uncertainties include tariffs and trade restrictions, economic and automotive production conditions, commodity and raw-material availability and prices, foreign exchange, integration and synergy delivery, and tax-law changes. Management reported disclosure controls were effective and no significant quarterly change in internal control over financial reporting.

Most important facts for investors to verify

1. Progress and final terms, if any, from the Power Solutions strategic review.
2. Whether gross-margin pressure and elevated costs to meet Power Solutions demand persist, and how restructuring savings develop.
3. Cash generation, working-capital requirements, debt repayments and liquidity as the business funds dividends and other commitments.
4. Final tax-reform accounting and the effect of the transition tax and other discrete tax items on future results.
5. Developments in AFFF litigation, asbestos estimates and insurance recoveries, and the Qatar arbitration matter.
6. How much reported sales growth reflects underlying volumes versus currency, lead-cost pass-through and divestiture effects; Buildings backlog was $8.8 billion but was not necessarily indicative of revenue timing.