Johnson Controls International plc — Q3 FY2023 Form 10-Q
Reporting period: Three and nine months ended June 30, 2023; comparative periods ended June 30, 2022. Unaudited. Amounts are in U.S. dollars unless noted.
Business context
Johnson Controls supplies building products, systems and services, including HVAC, controls, fire and security, refrigeration, and building-management solutions. It reports four segments: Building Solutions North America, EMEA/LA, Asia Pacific, and Global Products. Management highlights demand for efficient, sustainable and digitally enabled buildings, including services and OpenBlue solutions.
Financial performance
| Metric | Q3 FY2023 | Q3 FY2022 | Nine months FY2023 | Nine months FY2022 |
|---|---|---|---|---|
| Net sales | $7.133bn | $6.614bn | $19.887bn | $18.574bn |
| Gross profit | $2.431bn | $2.200bn | $6.763bn | $6.048bn |
| Gross margin | 34.1% | 33.3% | 34.0% | 32.6% |
| Income before taxes | $793m | $504m | $1.186bn | $1.104bn |
| Net income attributable to Johnson Controls | $1.049bn | $379m | $1.300bn | $771m |
| Diluted EPS | $1.53 | $0.55 | $1.89 | $1.10 |
| Operating cash flow | Not stated separately | Not stated separately | $831m | $811m |
Q3 sales rose 8% as reported and 9% excluding currency and acquisitions/divestitures; nine-month sales rose 7% as reported and 10% on that adjusted basis. Growth reflected pricing and higher volumes. Foreign-exchange translation reduced sales by $100m in Q3 and $598m year to date.
Segment EBITA increased 17% in Q3 to $1.170bn and 16% year to date to $2.913bn. Q3 EBITA increased across all four segments; year-to-date EMEA/LA EBITA declined 12% to $234m, while North America rose 30% to $967m, Asia Pacific rose 10% to $249m, and Global Products rose 14% to $1.463bn.
The effective tax rates were negative 41.5% for Q3 and negative 22.4% year to date, compared with 12.1% and 17.2%, respectively, in 2022. A $438m benefit from uncertain-tax-position reserve adjustments following audit developments and statute expirations was a major contributor to the reported earnings increase. The filing cautions that interim results may not indicate full-year results.
Cash, debt and liquidity
- Cash and cash equivalents were $1.057bn at June 30, down from $2.031bn at September 30, 2022. Nine-month operating cash flow was $831m; investing activities used $576m, including $366m of capital expenditures; financing activities used $1.111bn.
- Total debt was $9.764bn, versus $8.960bn at September 30, 2022. Net debt increased to $8.707bn from $6.929bn; net debt as a percentage of total capitalization rose to 34.8% from 29.9%.
- The company reported $186m of short-term debt and $1.081bn of current long-term debt. It had no commercial paper outstanding and no draws on its $2.5bn and $500m revolving credit facilities. It reported compliance with debt covenants and said liquidity was adequate for foreseeable needs.
- Nine-month cash returned included $613m of share repurchases and $729m of cash dividends paid. The Q3 dividend declared was $0.37 per share; approximately $3.0bn remained under the repurchase authorization.
Material changes and unusual items
- Nine-month restructuring and impairment costs were $844m, up from $554m. They included $498m of impairments associated with businesses classified or previously classified as held for sale and a $184m noncash goodwill impairment for Silent-Aire, following weaker results and a lower near-term forecast. Q3 charges were $81m.
- In Q3, Global Retail no longer met the held-for-sale criteria because a sale was no longer considered probable within 12 months. Reclassification to held and used had no income-statement impact. Another Asia Pacific business was sold on August 1, 2023; a material gain or loss was not expected.
- Management began a restructuring plan in Q3 focused on scaling SG&A to planned growth. Further charges were expected, the plan scope was expected to be finalized in Q4 FY2023, and savings were not yet estimable.
- On July 13, 2023, the company acquired FM:Systems for a $455m base price, with up to $155m of contingent earn-out payments.
- Net financing charges rose to $80m in Q3 from $49m and to $218m year to date from $153m, primarily reflecting higher interest expense.
Outlook, risks and contingencies
The filing provides no specific full-year revenue or earnings guidance. Management described improving margins as supply constraints ease and higher-priced backlog converts to sales, while noting continuing inflation, component availability and supply-chain risks. It also cited softer residential-market demand and project delays. The company reported a $13.3bn backlog and $19.2bn in remaining performance obligations; approximately 65% of the latter was expected to be recognized over the next two years. Backlog is not necessarily indicative of revenue in the coming fiscal year.
Key uncertainties include economic and construction-market conditions, foreign exchange, input costs, geopolitics, cybersecurity, and legal and regulatory developments. Environmental exposure is a notable contingency: environmental reserves totaled $252m at June 30, 2023, including long-term PFAS remediation obligations. The company faces extensive AFFF-related litigation, including more than 4,700 individual or mass actions and more than 600 municipal or water-provider cases, as well as other claims. It says outcomes and ultimate exposure are difficult to predict and that exposure could be material; it is vigorously defending the cases. The filing also discusses asbestos-related liabilities of $421m and related assets of $317m.
Management stated that the company met the emissions performance targets associated with its 2.000% sustainability-linked notes due 2031; the interest rate is therefore no longer subject to increase.
Most important facts for investors to verify
- How much of the sharp earnings increase is attributable to the $438m tax-reserve benefit, and what tax rate is sustainable?
- Whether sales growth, gross-margin improvement and segment EBITA gains persist, particularly in EMEA/LA and residential Global Products markets.
- Cash conversion, receivables and inventory trends: receivables days increased to 58 from 51, and inventory rose 16% from September 2022.
- The scale, timing and cash cost of further restructuring, and whether the impairments indicate continuing business weakness.
- Developments in PFAS remediation and litigation, including regulatory changes, insurance coverage, and whether additional losses beyond recorded reserves become estimable.
- Debt maturities, refinancing costs, the increase in net debt, and the integration and contingent payments for FM:Systems.