Business context and reporting period
Issuer identity discrepancy: The supplied filing is for Tyco International Ltd., not Johnson Controls International plc. It is an unaudited Form 10-Q for the fiscal quarter ended March 25, 2011, covering the quarter and six months compared with periods ended March 26, 2010. Tyco’s continuing businesses were Tyco Security Solutions, Tyco Fire Protection and Tyco Flow Control; it had sold a majority interest in Electrical and Metal Products.
Financial performance
Amounts are in U.S. dollars; millions unless stated otherwise.
| Metric | Quarter | Six months |
|---|---|---|
| Net revenue | $3.992bn, down 2.5% year over year | $8.371bn, up 1.5% |
| Operating income | $437m, versus $425m | $1.143bn, versus $830m |
| Income from continuing operations | $320m, versus $308m | $810m, versus $605m |
| Net income attributable to Tyco shareholders | $315m, versus $310m | $974m, versus $612m |
| Diluted EPS | $0.66, versus $0.65 | $2.01, versus $1.28 |
| Operating margin | 10.9%, versus 10.4% | 13.7%, versus 10.1% |
Operating margins are calculated from reported revenue and operating income. The six-month operating income includes a $233m net gain on divestitures, primarily related to the sale of Electrical and Metal Products. Six-month net income also includes $165m of income from discontinued operations, largely reflecting the $168m pre-tax gain on the European water business sale. The effective tax rate was 15.1% for the quarter and 21.4% for six months, versus 14.7% for both prior-year periods; the six-month increase primarily reflected tax on the Electrical and Metal Products transaction.
- Revenue mix: Quarterly product-sales revenue fell to $2.118bn from $2.395bn, while service revenue rose to $1.874bn from $1.699bn. Service represented 47% of quarterly revenue, versus 41% a year earlier.
- Segments, quarter: Security Solutions revenue increased 12.3% to $2.079bn and operating income rose 3.5% to $323m; Fire Protection revenue increased 2.5% to $1.109bn and operating income rose 24.3% to $128m; Flow Control revenue declined 2.4% to $804m and operating income declined 5.5% to $86m.
- Cash flow, six months: Operating cash flow was $913m, down from $1.007bn; investing activities provided $85m versus using $692m; financing activities used $937m versus providing $63m. Working-capital movements reduced operating cash flow by $574m.
- Liquidity and debt: Cash was $1.840bn at March 25, 2011. Total debt was $4.131bn, including $4.129bn long-term debt; reported debt-to-total-capital was 23%. The company had $1.5bn of undrawn revolving credit facilities. Cash less total debt was approximately $2.291bn of net debt.
- Capital allocation: Six-month capital expenditures were $361m; share repurchases were $1.0bn; dividends paid were $224m. The company reported shareholders’ equity of $13.9bn.
Material changes, outlook and management commentary
- Quarterly revenue declined mainly because Electrical and Metal Products contributed $336m in the prior-year quarter but was no longer consolidated after its sale. Six-month revenue increased despite the divestiture, led by Security Solutions and Fire Protection; Flow Control remained weaker.
- Security Solutions’ growth included Broadview Security, acquired in May 2010, adding approximately 1.4 million customer accounts. The segment reported 8.9 million accounts and 12.7% trailing 12-month attrition at quarter-end, compared with 7.4 million accounts and 13.1% attrition a year earlier.
- Tyco expected approximately $200m of restructuring and restructuring-related charges in fiscal 2011; $44m had been incurred in the first six months. Management expected fiscal 2011 capital spending to exceed both fiscal 2010 spending and depreciation.
- Backlog was $9.7bn, up 2.5% from September 2010; approximately 88% was expected to be filled in the next 12 months. Management said cash, available credit and operating cash flow should cover foreseeable operating and business needs. No full-year revenue or earnings guidance is provided in the supplied filing text.
- Tyco agreed to acquire Signature Security Group for approximately AUD171m and 75% of KEF Holdings for approximately $300m; both transactions were expected to close in the second half of fiscal 2011.
- On April 28, 2011, after quarter-end, the board authorized a new $1.0bn share repurchase program. The company also reported the 2010 program was substantially completed.
Risks, contingencies and unusual items
- Tax matters: Tyco recorded $554m of liabilities related to guarantees and indemnifications under the Tax Sharing Agreement with Covidien and TE Connectivity. The IRS disputes include significant pre-Separation matters; the company warned resolution could materially affect financial results, cash flows or the effective tax rate. Proposed civil fraud penalties were estimated at $30m–$50m and are covered by the agreement’s sharing provisions.
- Government investigations: DOJ and SEC discussions concerning potential FCPA issues remained ongoing. Tyco could not estimate potential loss; material fines, injunctions, a compliance monitor or other penalties were possible. A German competition investigation also had an unquantifiable potential loss.
- Asbestos and environmental: Approximately 4,400 asbestos lawsuits and 5,300 estimated viable claims were pending. The recorded asbestos net liability was $91m, based on a $302m liability and $211m insurance-recovery asset; actual amounts could differ materially. Environmental remediation costs were estimated at $25m–$80m, with a best estimate and recorded amount of $34m.
- Other claims: A pension-fund withdrawal assessment against SimplexGrinnell was approximately $25m and remained in arbitration; Tyco had made no provision and believed payments were recoverable. Former executives sought approximately $134m in compensation-related claims. Tyco also disclosed continuing litigation and other ordinary-course claims.
- Other notable items: A $1.0bn share repurchase and divestiture proceeds supported capital returns and liquidity, while the large working-capital outflow reduced operating cash generation. Tyco stated that market-risk exposure had not materially changed and that derivatives were not used for trading or speculation.
Important facts for investors to verify
- Confirm the issuer: the filing identifies Tyco International Ltd., not Johnson Controls International plc.
- Separate recurring operating performance from the Electrical and Metal Products divestiture gain and European water disposal gain when evaluating earnings growth.
- Review cash conversion and working-capital trends, especially the $574m six-month working-capital use and lower operating cash flow.
- Track the outcome and possible financial exposure from tax-sharing matters, FCPA/SEC/DOJ discussions, and the German competition investigation.
- Monitor restructuring costs, capital spending, acquisition closings, backlog conversion and the subsequent share-repurchase authorization.