Johnson Controls International Plc quarterly report, Q1 FY2017

Business context and reporting period

Johnson Controls International plc’s unaudited Form 10-Q covers the three months ended December 31, 2016, the first quarter of fiscal 2017. The company combines Johnson Controls and Tyco, whose merger closed September 2, 2016; Johnson Controls was the accounting acquirer. The October 31, 2016 spin-off of Automotive Experience to Adient is reported as a discontinued operation. Comparisons with the prior-year quarter are therefore significantly affected by the addition of Tyco and the Adient separation.

Financial performance and position

Unless otherwise noted, amounts are in U.S. dollars and millions. Income-statement and cash-flow comparisons are for the three months ended December 31.

• Sales rose 51%; management said sales increased 2% excluding the Tyco merger and foreign-currency effects. Gross margin improved 300 basis points. Reported sales growth includes Tyco, which contributed $2,275 of sales; prior-year figures do not include Tyco.
• Continuing income before tax was nearly flat. Continuing income attributable to shareholders increased, while net income and diluted EPS declined, reflecting the Adient discontinued-operation loss, restructuring charges, higher financing costs, and a larger share count.
• Adient’s discontinued operations contributed a $43 loss attributable to Johnson Controls in the quarter, versus $170 of income in the prior-year quarter. The current period includes only one month of Adient results; the prior period includes three months.
• Operating cash outflow was primarily driven by about $1.2 billion of income-tax payments related to the Adient spin-off, as well as unfavorable working-capital movements. Capital expenditures were $371, up from $282.
• At December 31, cash was $377; total debt was $13,250 ($2,379 short-term, $520 current long-term, and $10,351 long-term), versus $12,759 at September 30. Debt was 40% of total capitalization, compared with 35%. Total assets were $48,788, down from $63,179, largely reflecting the Adient spin-off and reclassification of assets.
• Management-defined working capital was $1,887, up from $369 at September 30. The company reported current assets of $10,966 and current liabilities of $11,459; management’s working-capital measure excludes cash, debt and held-for-sale balances.
• Comprehensive loss attributable to Johnson Controls was $332, including substantial foreign-currency translation losses. The filing reports a $703 consolidated translation adjustment for the quarter.

Material changes, outlook and risks

• The Tyco merger added security, fire protection and life-safety businesses and associated debt, goodwill and intangible assets. Preliminary purchase accounting included $16.4 billion of merger-related goodwill; valuation adjustments remained possible during the measurement period.
• The Adient spin-off was completed October 31. The company recorded a $2.05 billion dividend from Adient in financing cash flows and transferred $564 million of cash to Adient. Final cash and working-capital adjustments were expected in fiscal Q2.
• Management reported $130 million of Tyco merger transaction and integration costs. Restructuring and impairment costs were $78 million, including $15 million of asset impairments. A $101 million discrete tax benefit from changes in entity tax status contributed to the effective tax rate of negative 7%; the prior-year rate was 22%.
• Management expected the fiscal 2017 restructuring plan to reduce annual continuing-operation costs by about $60 million, with most benefits expected in fiscal 2018; about half the annual savings, net of execution costs, was expected in fiscal 2017. The fiscal 2016 plan was expected to reduce annual costs by about $135 million, with completion expected in fiscal 2018.
• Building Technologies & Solutions backlog was $8.1 billion at quarter-end; management cautioned that backlog is not necessarily indicative of revenue in the fiscal year. Power Solutions sales increased 9% and segment EBITA rose 8%, supported by volume and pricing/mix.
• Management said liquidity was adequate and expected operating needs, capital spending, dividends, pension contributions and debt maturities to be funded from operations and, if needed, borrowing. The company and its financing subsidiary were in compliance with debt covenants and had undrawn revolving facilities of $2.0 billion and $1.0 billion, respectively.
• Risks include execution of Tyco integration and expected synergies, disruption from portfolio transactions, tax treatment and transaction-related liabilities, economic and market conditions, currency and commodity movements, and litigation. The company recorded a $156 million net asbestos liability, based on estimates extending claims projections through 2069; actual liabilities and insurance recoveries could differ materially. Environmental reserves were $45 million. Management did not expect known environmental or other routine litigation matters to materially affect results.
• After quarter-end, the company issued $500 million of 4.5% senior unsecured notes due 2047 on February 2, 2017. The interim financial statements were reviewed, not audited; the auditor reported no material modifications needed based on its review.

Important facts for investors to verify

1. Separate underlying performance from the Tyco merger and the Adient spin-off when interpreting the 51% sales increase and year-over-year earnings.
2. Assess cash generation after the unusually large spin-off-related tax payment and working-capital outflows, and track subsequent operating cash flow.
3. Monitor debt levels, refinancing and interest costs, liquidity-facility availability, and covenant compliance.
4. Evaluate whether restructuring savings and Tyco integration benefits are achieved, and whether purchase-accounting estimates or integration costs change.
5. Review exposure to tax examinations and transaction-related litigation, and the assumptions supporting asbestos insurance recoveries and liabilities.