Johnson Controls International plc — Q3 FY2017 Form 10-Q
Reporting period: Three and nine months ended June 30, 2017; unaudited. Amounts below are in U.S. dollars. Comparisons are affected by the Tyco merger, completed September 2, 2016, and the October 2016 Adient spin-off. Adient is presented as discontinued operations; the nine-month 2017 period includes only one month of Adient results.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Net sales | $7.683bn | $5.154bn | $22.036bn | $14.583bn |
| Gross profit / margin | $2.431bn / 31.6% | $1.422bn / 27.6% | $6.826bn / 31.0% | $3.966bn / 27.2% |
| Income from continuing operations before tax | $718m | $480m | $1.496bn | $1.163bn |
| Net income attributable to Johnson Controls | $555m | $383m | $736m | $303m |
| Diluted EPS, continuing operations | $0.59 | $0.53 | $0.82 | $1.30 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $(1.321)bn | $696m |
- Q3 sales increased 49%; management attributed most of the reported increase to Tyco. Excluding Tyco and foreign currency translation, sales rose 4%. Nine-month sales rose 51%, or 4% excluding those effects.
- Gross margin expanded year over year, primarily reflecting Tyco’s contribution; management also cited higher Building Efficiency volumes and favorable Power Solutions pricing and mix, partly offset by higher costs.
- Q3 net income attributable to Johnson Controls increased 45%, mainly due to incremental operating income from Tyco, partly offset by higher financing costs. Diluted continuing-operations EPS was $0.59 versus $0.53; total diluted EPS was $0.59 in both periods.
- Nine-month diluted continuing-operations EPS declined to $0.82 from $1.30. The comparison includes a $457m discrete tax charge in FY2017 and different discontinued-operation results; FY2016 also included substantial tax items.
Cash flow, liquidity and debt
- Nine-month operating cash outflow was $1.321bn, versus $696m generated in the prior-year period. Management cited higher tax payments—primarily $1.2bn related to the Adient spin-off—and working-capital movements. Inventory increased $585m and accounts receivable absorbed $319m of cash.
- Investing cash outflow was $832m, including $996m of capital expenditures; financing provided $1.915bn. Cash declined $121m to $458m.
- At June 30, total debt was $14.271bn, up from $12.759bn at September 30, 2016; debt to total capitalization increased to 42% from 35%. Cash was $458m. Long-term debt fair value was $12.6bn.
- Current assets were $13.962bn and current liabilities $11.515bn (current ratio approximately 1.21); both balances include assets and liabilities held for sale. The company’s defined working capital, excluding cash, debt and held-for-sale balances, was $2.653bn versus $369m.
- Management said liquidity was adequate and expected operating cash, supplemented if needed by borrowing, to fund obligations. The company reported compliance with debt covenants and no draws on its $2bn and $1bn revolving credit facilities. It also estimated up to $1.4bn of borrowing capacity on other committed credit lines.
Business developments and material changes
- Johnson Controls’ businesses were Building Technologies & Solutions, Tyco, and Power Solutions. Tyco contributed $2.336bn of Q3 sales and $416m of Q3 segment EBITA; there was no Tyco segment in the Q3 FY2016 comparison. Building Efficiency Asia and Power Solutions reported higher segment EBITA, while Systems and Service North America reported lower EBITA.
- The Adient automotive business was spun off on October 31, 2016, and is reported as discontinued. The balance sheet no longer includes Adient’s former held-for-sale assets and liabilities; the comparative nine-month income statement includes Adient’s historical results.
- The company agreed to sell Scott Safety to 3M for approximately $2.0bn, with expected net cash proceeds of $1.8bn–$1.9bn. Closing was expected in Q1 FY2018, subject to customary conditions and regulatory approval. Scott Safety assets of $2.082bn and liabilities of $247m were classified as held for sale at June 30.
- Building Technologies & Solutions backlog was $8.4bn; management cautioned that backlog is not necessarily indicative of revenue in a given fiscal year.
Outlook, unusual items and risks
- The FY2017 restructuring plan had recorded $226m of charges through June 30. Management estimated it would reduce annual operating costs by about $225m, with benefits substantially realized in FY2018; FY2017 savings net of execution costs were expected to be about 50% of that annual reduction. A prior restructuring plan was expected to reduce annual costs by about $135m, with FY2017 net savings estimated at 35% of the annual reduction. Both plans were expected to be substantially complete in FY2018.
- Q3 restructuring and impairment costs were $49m; nine-month costs were $226m. Q3 transaction and integration costs were $70m. The nine-month effective tax rate was 38%, including the $457m noncash Scott Safety-related deferred tax charge; Q3 effective tax rate was 12%.
- The company cited risks including integration and realization of Tyco merger synergies, portfolio transactions, tax matters, economic and automotive production conditions, input costs, foreign exchange and changes or cancellations in customer arrangements. Management reported no material change to the risk factors in its latest Form 10-K.
- Contingencies include asbestos claims, environmental remediation and other litigation. The recorded asbestos net liability was $147m, based on estimates and insurance recoveries that could differ materially from actual outcomes. Environmental reserves were $48m; management did not expect known environmental matters to have a material adverse effect. The company also disclosed merger-related shareholder litigation; it said it could not predict the outcome of one federal action.
- Management reported effective disclosure controls as of June 30, 2017, with no significant change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- How much future reported growth and margin performance reflects Tyco consolidation versus underlying comparable growth, and the progress in realizing merger synergies.
- Cash conversion and working-capital trends, particularly the large tax-related operating cash outflow, inventory build, and elevated receivable days.
- Debt levels, refinancing needs, borrowing capacity and covenant headroom as the company funds capital spending, dividends, repurchases and restructuring.
- Scott Safety sale timing, net proceeds and the tax consequences; also the stated timing and realization of restructuring savings.
- Potential changes in tax exposures, asbestos estimates and recoveries, environmental obligations, and outcomes of disclosed litigation.