Johnson Controls International plc — Q2 FY2018 Form 10-Q
Reporting period: Three and six months ended March 31, 2018; unaudited. The company supplies building systems and services, HVAC and security products, and automotive batteries through its Buildings and Power Solutions businesses. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Net sales | $7,475 | $7,267 | $14,910 | $14,353 |
| Gross profit | $2,220 | $2,281 | $4,389 | $4,395 |
| Gross margin | 29.7% | 31.4% | 29.4% | 30.6% |
| Income from continuing operations attributable to Johnson Controls | $438 | $(148) | $668 | $224 |
| Diluted EPS from continuing operations | $0.47 | $(0.16) | $0.72 | $0.24 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $533 | $(1,519) |
Q2 reported sales rose 3%; management said sales increased 1% excluding foreign exchange, lead-cost pricing effects and divestitures. For the six months, reported sales rose 4%, or 2% on the same adjusted basis. Revenue growth reflected favorable currency translation and higher segment sales, partly offset by divestitures. Q2 gross profit declined 3%, and gross margin fell 170 basis points; higher operating costs, including costs to meet Power Solutions demand, weighed on margins. Lower SG&A and a substantially lower tax provision than in the prior-year quarter contributed to the earnings improvement.
- Segments: Q2 sales were $5.63 billion for Building Technologies & Solutions and $1.85 billion for Power Solutions. Segment EBITA was $615 million and $314 million, respectively. Combined segment EBITA was $929 million, down from $956 million. Six-month total segment EBITA was $1.97 billion, up from $1.78 billion; Global Products benefited from the Scott Safety sale gain and prior-year purchase accounting effects.
- Cash flow and investment: Six-month capital expenditures were $497 million, versus $634 million. Investing cash flow was $1.60 billion, including $2.11 billion of divestiture proceeds, chiefly Scott Safety. Operating cash flow was positive compared with substantial prior-year outflow, principally because of prior-year Adient-related tax payments and other outflows.
- Debt and liquidity: At March 31, total debt was $12.10 billion, cash was $268 million and net debt was $11.83 billion. Net debt was down 11% from September 30, 2017; net debt to total capitalization fell to 36.2% from 39.3%. Company-defined working capital was $2.13 billion, up 32%, primarily due to inventory and currency effects. The company reported no draws on its revolving credit facilities and stated that liquidity was adequate for projected needs; it was in compliance with debt covenants.
- Other balance-sheet measures: Total assets were $49.95 billion, down from $51.88 billion at September 30, 2017. Goodwill was $19.81 billion and net intangible assets were $6.63 billion.
Material changes and unusual items
- The company completed the Scott Safety sale in October 2017 for approximately $2.0 billion net of cash divested, recording a $114 million pretax gain. Net proceeds of about $1.9 billion were used to repay merger-related debt; the outstanding TSarl term loan was approximately $1.7 billion at quarter-end.
- U.S. tax reform produced a provisional $101 million noncash tax benefit from deferred-tax remeasurement and a provisional $305 million transition-tax charge in Q1. Management said these estimates remained subject to refinement. The six-month effective tax rate was 31%, versus 62% in the prior year; Q2 rates were 14% and 129%, respectively.
- FY2018 restructuring and impairment charges totaled $158 million in the first half. The company estimated the plan would reduce annual operating costs by approximately $150 million when fully realized, with benefits substantially realized in 2020. It expected FY2018 savings, net of execution costs, to equal about 45% of that annual reduction.
- On March 12, 2018, Johnson Controls announced it would explore strategic alternatives for Power Solutions. The filing gives no transaction outcome or committed timetable and warns that a transaction may not occur and could involve execution and other risks.
- The company reported Q2 transaction and integration costs of $64 million. The six-month results also include the Scott Safety gain and restructuring charges; comparisons with FY2017 are affected by different tax items, restructuring, pension mark-to-market gains and discontinued Adient results.
Outlook, risks and contingencies
Management said capital resources and liquidity were adequate to fund expected operating needs, capital expenditures, dividends, share repurchases, pension contributions and debt maturities. The filing does not provide a clear full-year sales, earnings or EPS guidance figure. Backlog for Building Technologies & Solutions was $8.9 billion at March 31; management cautioned that backlog is not necessarily indicative of revenue for the fiscal year.
- Litigation: Subsidiaries face lawsuits alleging contamination from PFOS/PFOA-containing firefighting foam, including putative class actions and other claims. The company said outcomes and ultimate exposure are difficult to predict and that exposure could be material; it is pursuing insurance coverage. It also reported approximately 540 possible individual claims in Pennsylvania for which complaints had not been filed.
- Other contingencies: The company recorded a $174 million net asbestos-related liability, based on estimated claims and insurance recoveries, and noted actual liabilities or recoveries could differ significantly. Environmental reserves were $47 million. A Qatar airport subcontractor arbitration award of approximately $50 million remained outstanding while the company pursued annulment and a related claim.
- Business and market risks: The filing highlights foreign exchange, commodity and raw-material costs, customer demand and vehicle production, integration and transaction risks, evolving regulation and trade restrictions, tax-law uncertainty, and the uncertain outcome of the Power Solutions strategic review. The company also noted new EU data-protection requirements and potential penalties under GDPR.
Key facts for investors to verify
- How much reported sales and earnings growth reflects underlying volumes and pricing versus currency translation, lead-cost pass-throughs, divestitures and one-time items.
- Whether the company can sustain gross margins and realize the projected restructuring savings while managing higher operating and execution costs.
- Final U.S. tax-reform calculations and their effect on the effective tax rate, cash taxes and repatriation plans.
- Progress, structure and potential financial effects of the Power Solutions strategic-alternatives review.
- Debt repayment and liquidity trends, including cash generation after the Scott Safety proceeds were applied to debt.
- Developments in PFOS/PFOA litigation, asbestos estimates, the Qatar arbitration and related insurance recoveries.