Welcome to Johnson Controls First Quarter 2017 Earnings Call. Your lines have been placed on listen only until the question and answer session. This conference is being recorded. If you have any objections, please disconnect at this time. I will now turn the call over to Antonella Franzen, Vice President of Investor Relations.
Good morning and thank you for joining our conference call to discuss Johnson Controls' Q1 fiscal 2017 results. The press release and all related tables issued earlier this morning as well as the conference call slide presentation can be found on the Investor Relations portion of our website atjohnsoncontrols.com. With me today are Johnson Controls' Chairman and Chief Executive Officer, Alex Meliarelli President and Chief Operating Officer, George Oliver and our Executive Vice President and Chief Financial Officer, Brian Stief. Before we begin, I would like to remind you that during the course of today's call, we will be providing certain forward looking information. We ask that you view today's press release and read through the forward looking cautionary informational statements that we've included there.
In addition, we will use certain non GAAP measures in our discussions and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted EBITDA and adjusted EBIT margins exclude transaction, integration and separation costs as well as other special items. These metrics are non GAAP measures and are reconciled in the schedules attached to our press release. All comparisons to the prior year are on a combined basis, which excludes the results of Adient, which is presented in discontinued operations and includes the results of Tyco net of conforming accounting adjustments and recurring purchase accounting. Now let me quickly recap this quarter's results.
Sales of $7,100,000,000 in the quarter increased slightly year over year on a reported basis. Organic growth of 1% was partially offset by the net impact of FX, M and A and lead pass through pricing. Earnings per share from continuing operations attributable to Johnson Controls ordinary shareholders was $0.39 and included net charges of $0.14 related to special items. These special items were primarily composed of transaction, integration and separation costs as well as non recurring purchase accounting charges, which were partially offset by discrete tax items. Adjusting for special items, non GAAP adjusted diluted earnings per share from continuing operations was $0.53 per share compared to $0.48 in the prior year quarter.
Now, let me turn the call over to Alex.
Thanks, Antonella. Good morning, everyone. Before I get into the details of the Q1, I'd like just take 1 minute and if we turn to slide 5 and your deck to talk about the key priorities and we talked about this when we were together in December. I just want to remind everyone what it is that we're focused on before we get into some of the specifics. When you think about this merger and the intangibles of this, it's bringing together 2 cultures of these 2 great companies.
And we shared with you that we have put together a vision, mission, values and we talked about that at the Investor Day. We're well on our way in our journey to institutionalize this framework that we shared with you across our enterprise. At the same time, we remain focused on delivering our operating and financial plans. And we started off Q1, I'd say not exactly where we wanted to on the growth front, but certainly ahead of our plan on both margin and expansion of our earnings. And I remain confident in our ability to achieving our commitments for the full year.
We're deeply engaged in a process of developing a new strategic plan for the combined company. It's informed by our insights from our customers and the convergence of technology. Evaluating our portfolio is an ongoing process that we do here and we're ensuring that we're investing in the right businesses, not just because they're good businesses, but they're right businesses for Jones Controls. We've installed a disciplined capital allocation strategy. We talked about that in December, which balances our investments for future growth and returning capital to shareholders.
Our current set of businesses are well positioned for the right markets for the long term and I'm confident we'll continue to execute and drive shareholder value. Let's turn to slide
6. And let's talk about
our start. We started off this year with a great start with solid activity, particularly around our integration activities. I'm incredibly proud of what's been accomplished by the team. If you think about our Q1 with the spend of Adient and the merger activities around Tyco, I feel and George will get into the details. I feel very good about our start.
The Q1 profitability in both our buildings and power better than we expected and our teams are focused on what's in their control and they remain focused on execution. We began to realize our cost synergies and we're actually a bit ahead of where we expected for the quarter and that bodes well for the future. In terms of our end markets, the non residential market continues to improve. Specifically, the institutional markets continue to be strong And we saw good order activity there, particularly in health care. More importantly, our sales teams are excited about the opportunity to work together and our quoting pipeline remains very active and cross selling activity continues to build.
As you know and I just referenced, we completed the Adient spin off at the end of October and I'd just like to take the opportunity to wish Bruce McDonald and his team continued success at Adient. Let's go to slide 7. So we put this slide in just to remind everyone about our investments in Asia Pacific. And it really occurred to me that we wanted to make sure that we continue to talk about that. And so I'd just like to spend a few minutes updating you on our progress.
We've heard us talk about Asia Pacific, China and how excited we remain about the growth opportunities in the near term and also in the long run. And we're seeing both top line and bottom line improvement. We see performance across all of our businesses. In buildings, the organic growth is in the low to mid single digit range. And in power, we're seeing excellent results growing north of 20% year on year on an organic basis.
We're really seeing the benefit of these strategic investments we've made over the past few years. Importantly, we continue to improve our profitability in this region with several 100 basis points of margin expansion. We're leveraging the expanding infrastructure that we have and the infrastructure of our customers and a growing middle class and our scale continues to accelerate both our growth and our improved profitability. I'm also impressed with what's been accomplished. We've been at Hitachi and our integration with Hitachi over a year and all the work that's been put in place to implement our Johnson Controls operating system within the Hitachi joint venture is continues to contribute an even stronger margin year year over year improvement.
I'm proud of our Asia Pacific team.
I want to give them a shout out and I'm confident that they'll continue to grow while continuing to improve our profitability. Let's move to slide 8 and talk about the quarter. Sales in the quarter were basically flat with prior year $7,100,000,000 on a reported basis. Organically sales grew a little over 1% with a modest decline in buildings more than offset by increased volume and favorable and a favorable mix in power. We continue to see strong growth in startstop.
Georgia will give you more details on that in a few minutes. Continued profitability and EBITDA of 10% year over year on a reported basis and if you adjust for FX and led up 13%, extremely strong execution across all of our businesses. Adjusted EBIT margins expanded 90 basis points overall, far exceeding our expectations of 30 basis points. EPS for the quarter was up 10% versus prior year at $0.53 Above the top end of our range of an adjusted range of $0.50 to $0.52 great start to the New Year and look forward to getting into the details. With that, I'll turn it over to George and George can give you some good news
through the businesses. Thanks, Alex and good morning everyone. Before I get into the detailed business review, I thought I'd start with a quick integration update on slide 9. As I discussed with you at our Investor Day back in December, I've been spending quite a bit of my time with our business unit leaders across the organization, getting deeper into the businesses and developing our strategies as a go forward company. I've also had the opportunity to meet with several of our sales teams.
And I can tell you that energy levels are high with some early wins in the quarter, which set us up for future revenue synergy opportunities. Let me share with you a few of these recent wins, which highlight collaboration among the teams. Building off a strong legacy building efficiency performance record, a government customer contacted our branch regarding a fire system issue with another competitor's equipment. Our local branch teams worked together to secure a life safety repair project including a complete Simplex Grinnell fire alarm system. In Canada, our fire team was able to leverage a strong Johnson Controls customer relationship to secure an order for a very large fire sprinkler project.
And in Latin America, the joint team had a combined win, including a building management system, HVAC, access control, video and a communication system for a hospital. Again, these are just a few examples of early wins. On the cost synergy side, we have implemented a strong governance structure to track costs and all related synergies. As we laid out for you in December, we expect to capture $250,000,000 to 300 $1,000,000 in cost synergies and productivity savings in 2017. And as Alex mentioned, we are off to a strong start.
We achieved roughly $50,000,000 in synergies and productivity or about $0.05 on an EPS basis in the quarter. We expect to capture a similar amount in the 2nd quarter. And then based on the timing around things like headcount reductions, we expect to achieve $0.07 in the 3rd quarter and $0.08 in the 4th quarter. The integration of 2 large organizations requires a lot of heavy lifting, commitment and leadership. Not all decisions are easy, but we have a strong team leading the process, ensuring we execute on decisions made and we move forward to the next step.
Both the integration team and the businesses are guided around 4 main objectives: grow, integrate, change and operate. We are making good progress and I look forward to keeping you updated on our continued success. Let's turn now to a review of the businesses, starting with Building Technologies and Solutions on slide 10. On a reported basis, building sales declined 2% or a little less than 1% organically to $5,200,000,000 in the quarter. When you look at the field side of the business, which represents about 70% of total sales, organic growth was relatively flat overall, with a few positives and a few areas of pressure.
We had strong growth in applied HVAC systems, which was up mid single digits. In Fire and Security, both North America and the rest of world grew in the low single digit range. On the other hand, performance contracting continues to face pressure tied to federal government budget delays as well as a tougher prior year comparison, while industrial refrigeration is pressured by the oil and gas and process end markets. These two businesses were down about 20% in the quarter on a year over year basis. On the flip side, our products business, which represents the remaining 30% of sales, declined 3% organically year over year.
We continue to see very strong growth in UPG, which was up low teens driven by increased shipments in both residential and light commercial. The strength in UPG was more than offset by a mid single digit decline in fire and security products related to the high hazard heavy industrial end markets. Turning to orders. Overall growth of 2% year over year, excluding FX and M and A was driven by a 3% increase in field orders, which was partially offset by a 3% decline in our quick turn product orders, which pressured our sales growth in the quarter. We have seen some early signs of stabilization on the orders front in Industrial Refrigeration, which is encouraging.
Additionally, we expect the decline in Fire and Security Products to ease with revenues starting to flatten out. This stabilization combined with the timing of backlog conversion gives us confidence in improved sales growth in the 2nd quarter. Backlog of $8,100,000,000 was up 6% year over year and up 2% sequentially excluding the impact of foreign exchange and M and A. Buildings EBITDA increased 3% year over year or 6% excluding the headwind from foreign currency to $578,000,000 The margin increased 60 basis points year over year to 11.1 percent benefiting from strong productivity savings and the early traction we're seeing on cost synergies, which more than offset planned incremental product and channel investments during the quarter. Also contributing to the increased margin was the Hitachi JV, which continues to execute well with another quarter of solid operational improvement, although aided by an easy comparison to the prior year.
Recall the Hitachi JV closed early in the Q1 of 2016, but the benefit from restructuring actions and plant productivity initiatives did not begin to bear fruit until the Q2. We would expect that as we move forward in 2017, the magnitude of year over year profit improvements generated by the Hitachi JV will become smaller. Turning now to Power Solutions on slide 11. Sales increased 9% year over year on a reported basis and 7% organically to $1,900,000,000 As a reminder, the organic change excludes the impact of lead pass through, which benefited Power's top line by just over 2 50 basis points. Overall, global unit shipments increased 5% year over year, driven by aftermarket shipments, which were up 7%.
Globalstar stock shipments continued to expand with a 27% increase year over year with another quarter of significant growth in China and the Americas. Power Solutions segment EBITDA increased 8% on a reported basis or 12% excluding foreign currency and lead to $390,000,000 Power's margin was down 20 basis points year over year on a reported basis, including a 110 basis point headwind from the impact of higher lead cost. Underlying margins, excluding the impact of lead, increased 90 basis points year over year driven by leverage on higher volumes and favorable product mix, both higher aftermarket and higher start stop shipments. Now let me turn the call over to Brian to walk through corporate and the consolidated financial details of the quarter and our outlook for the 2nd quarter.
Thanks, George. Good morning. So for the first time, we will be reporting corporate as a standalone segment. I think this provides a bit more transparency to the true underlying EBITDA performance of our businesses. This segment is really comprised of enterprise wide costs like executive management costs, public company costs other functional administrative costs that really aren't directly attributable to our primary businesses.
Our corporate segment expense did decrease 12% year over year and this was primarily due to some of the productivity initiatives and the merger synergies that we had identified as part of the planning process last year and both were a bit better than expected in the quarter. If I turn to slide 13, there are a lot of moving pieces in this quarter relative to the special items and also the fact that Adient is for the first time reported as a discontinued operation. Given the size of some of the special items, let me just briefly comment on each of those. The first being transaction integration and separation costs associated with our portfolio activities. That was roughly $134,000,000 and the way to about that is about half of it is transaction related and half of it is integration related.
We had a restructuring impairment charge for 78,000,000 dollars The majority of that would be severance related. We had a lump sum pension buyout in the Q1. And as a result of that, which was done in connection with the Adient spin off, there's a requirement to go through a remeasurement of the liability and assets in the Q1 and that resulted actually in $117,000,000 gain in Q1. We had some non recurring purchase accounting expenses that Antonella referred to. The 2 primary areas there are the inventory step up amortization, which is now fully behind us at the end of Q1.
And also we continue to amortize the backlog asset that was set up as part of purchase accounting. And then lastly, there was a discrete tax benefit related to some planning at our foreign entities that resulted in $101,000,000 benefit. The net of all that is a $14,000,000 or $0.14 charge, which when added to the $0.39 reported gets to the $0.53 that we've been talking about this morning. So as I go through my comments, I will exclude these special items and also the comparison will be the pro form a combined financials that we put out on fiscal 2016 in the November 8 ks that we filed. So overall, 1st quarter revenues were up slightly at $7,100,000,000 If you exclude FX led and M and A activity, organic sales were up 1%.
Gross margin was constant at 31.2% and SG and A was down 3%, which is reflective of the cost reduction initiatives that we have across our business in the merger synergies. If you move to equity income of $55,000,000 it was 20% higher than year ago levels, again related primarily to the strong Hitachi year over year performance. And then as Alex mentioned for the Q1, we delivered double digit segment EBIT growth and we had EBIT margins of 10.7%, which were 90 basis points better than the first quarter 2016. Again, both of those exceeded our expectations for the quarter. If we turn to page 14, net financing charges were $119,000,000 which were slightly higher than last year and our effective tax rate as we communicated on Analyst Day was at 15%, which compares favorably to last year's rate of 17%.
Hitachi continues to perform well and that is also the reason for the increase to $40,000,000 in the minority interest add back line item on the income statement that's up $11,000,000 year over year. And then overall, we had a really strong first quarter with diluted EPS of $0.53 versus $0.48 a year ago. And our business unit management team has really continued to deliver strong results during this period of transformation and the level of integration activity that's going on across our company. So turning to cash flow on slide 15. Our first quarter adjusted cash flow was an outflow of $300,000,000 As mentioned at Analyst Day, there are a number of one time expected payments that we realized in the Q1.
The most notable is the $1,200,000,000 tax payment we made related to the Adient spin off. We also had some other items related to Adient's cash outflow for the quarter of $300,000,000 and then we had some restructuring and change control payments of $300,000,000 and transaction integration and separation costs of a couple of $100,000,000 which would include Adient. So Q1 has historically been a cash outflow quarter for us. So the adjusted free cash flow number is consistent with our expectations and we remain focused on delivering the $2,100,000,000 in adjusted free cash flow for the year. If we move to the balance sheet at quarter end, we had net debt to cap of $33,600,000 versus $39,700,000 at year end.
That's really related to the fact that as part of the Adient spin out, there was a $4,000,000,000 reduction in our equity and as a result that drove the increase in the ratio. Also during the quarter, we completed our previously announced debt exchange offers related to both the legacy JCI and Tyco Debt and we also made $535,000,000 of scheduled debt repayments in the quarter. I would also just point out that beginning in Q2, we commenced the share repurchase program and expect to buy back about $200,000,000 to $250,000,000 of our shares during the rest of fiscal 2017. And again, as we've mentioned, this is really focused on countering the dilutive impact of stock option exercises. And then finally, I'd just comment that we continue to evaluate our overall capital structure in order to take advantage of opportunities related to the current interest rate environment as well as the timing of our future debt maturities.
So if we move to slide 17, just a couple of things I'd like to point out here. We've already talked about Adient being reflected as a discontinued operation. Just as a reminder, beginning in the Q3 of this year, we will be changing our segment reporting for the buildings business. At this time, we will for the 1st and second quarter, we'll continue to report segments for, I would say the legacy BE business in the same four segments we've reported previously. And then Tyco will be reported as a single standalone business within the buildings set of businesses.
And as you may recall from analyst meeting, when we get to the Q3, we'll have a global products segment and then we will have our installation project service business really our field business in 3 geographies North America, Europe, EMEA and Latin America and Asia. Also as we move through fiscal 2017, we'll continue to have some special items and our guidance that we give here today will quarter harmonize the backlog definitions between Johnson Controls and Tyco. The primary adjustment related to the way both legacy companies had treated renewable service contracts. And so the backlog that we're reporting here that's up 6% reflects those new definitions. Moving to slide 18, which shows a waterfall for our Q1 results.
You can see the $0.05 year over year EPS improvement. That really comes from cost synergies and productivity savings, which drove $0.05 along with volume mix, which is $0.02 both in line with our expectations. In fact, the cost synergies and productivity savings is a couple of pennies higher. That was partially offset by planned investments in our Buildings and Power Solutions businesses, which was a $0.02 impact and then the favorable tax rate was really offset by the FX headwinds we had in the quarter. All in all, dollars 0.53 which represents a 10% growth over the prior year and we really are off to a solid start as we move through fiscal 2017.
If I turn to page 19 and fiscal 2nd quarter, you can see here that our organic sales will be up 2% and EPS at $0.48 to $0.50 which is up 7% to 11% year over year. And this reduction in Q2 earnings compared to Q1 earnings sequentially is consistent with the historic patterns of both Johnson Controls and Tyco and really is a result of the seasonality in our Power Solutions business where our customers go through a strong customer stocking period in the months of October through December. The waterfall also shows the benefits of synergies and productivity improvements. That does remain at $0.05 through the Q2. I would tell you that the Q1 synergies and productivity savings were really a lot of the low hanging fruit that we were able to quickly move on as part of the integration activities.
I think as we get the processes and procedures in place here over the next quarter to ring fence both the legacy Tyco business as well as our federal business, I think we'll begin to see the second half ramp up in synergy savings. And then I've got a last slide here that I just wanted to go through relative to the phasing in the first half and second half of our EPS build, just to provide some context around this. You can see that the normal seasonality is contributing a lion's share of the improvement in the second half along with the ramp up in the synergy saves that we expect. And as Alex mentioned, we're really running a bit ahead of our Q1 target. So I think that bodes well for us looking at the second half of the year.
But all in all, we remain very confident in delivering a very strong fiscal 2017 and we reaffirm our full year guidance of $2.60 to 2 point 7 $5 which will represent year over year increase of anywhere from 13% to 19%. So with that Antonella, we can then open up for questions.
Thanks, Brian. Operator, could you please provide the instructions for the Q and A session and open up the lines? Thank you. And our first question comes from Nigel Coe with Morgan Stanley.
Thanks. Good morning, everyone.
Good morning, Nigel.
So George, you addressed in your prepared remarks the impact of the heavy industrial declines on the pharmaceutical products. I'm just curious that the field and product growth divergence is by 6 points this quarter. And it's a theme we've seen echoed by some of your competitors. I'm just wondering in addition to that pressure from the heavy industrial weather we're seeing some channel inventory clearance and any perspective on that would be helpful. Then as it relates to the guidance of 2 to 4 for building this year, just given the first half order trends and the 1Q performance?
Are we already looking at the 2% zone for the full year?
Nigel, I think the first question was related to the fire and security products within the heavy industrial high hazard space?
Is Mark just interested in the divergence between field and product trends and the extent to which we're seeing inventory clearance in products?
Yes. So let me start with the field within Fire and Security. We have been building and this holds true also for the legacy JCI Building Efficiency business. We've been building orders consistently about 3% or 4% over the last year or so and that's been building the backlog. And what we're beginning to see is actually the conversion of that backlog within the fire and security space.
And so both businesses both North America and rest of world up somewhere 2% to 3%, which actually is a reflection of the progress we've made with orders and building the backlog. Relative to products, products are a shorter cycle turn business. And as we've seen our Q1 last year was pretty good within the firing security space. So now we have the last of our tough compare within the Q1 within Fire and Security. I believe we've seen the inflection point based on the current trends that we see with the activity that's taken place.
A lot of this is being driven by the Middle East. And so the Middle East when you look at both combined businesses is down pretty significantly. That's driving both the Middle East field business as well as our product businesses. We've seen some real bright spots here over the quarter with some nice wins in orders coming through. And I think that bodes well here as we project the remainder of the year both within the industrial refrigeration business, within the BE legacy BE business as well as now the flow of our product businesses supporting the heavy industrial high hazard end markets within the legacy Tyco product businesses.
We continue to make the investments in our products. So we have not slowed the investments. And I think as the market begins to recover, we're going to be positioned extremely well to be able to capitalize on that recovery.
Okay. And then the part on the $0.02 to $0.04 for the full year in building, is the high end of that range a stretch at this point?
Yes. So when you look at the orders that we've had and the backlog that we've built, so the orders in the Q1 up about 2%, but the backlog was up 6 percent year on year, 2% sequentially organically. And so although we're a little bit off where we expected, just recognize that in the Q1, we only expected modest growth within buildings in the Q1. And so we came in a little bit short of that. And we were going to accelerate during the course of the year to be able to deliver on the 2% to 4% organic growth for the year.
Now that being said, now that we're off to a little bit slower start than we expected that will put pressure to get to the higher end of that organic growth range. But we're still positioned with the orders that we've been able to generate, the backlog that's in place, our ability to be able to get into that range most likely to the lower to mid end of that range that we provided guidance to back in December.
Yes. Nigel, this is Alex. So from a buildings perspective, I probably ham and egged this a little bit between myself and George. I would agree with what George said. I think that what we're seeing is the backlog continue to develop.
Just the sheer math of it would tell you that we're probably going to be at the mid range of that or lower. So that being offset, well, the positive is I think the synergies are coming a lot faster than what we expected. I think as we move forward, I'm just glad we continue to build the backlog eventually that's got to flow. But what we do have is we do see the cost coming through question comes from Deane Dray with RBC Capital Markets.
Thanks. Good morning, everyone.
Good morning. Good morning,
Deane. Good morning, Deane. Good morning, Deane. Good morning, Deane. Good morning, Deane.
Good morning, Deane. Good morning, Deane.
Good morning, Deane. Thanks. Good morning, everyone.
Good morning. Good morning, Deane.
Just to follow-up on Nigel's question. Can we extend that same discussion to the overall core revenue growth guidance for 2017, the 2.5 to 4.5? I don't think I heard that explicitly reaffirmed, but maybe some color on that?
I think it's probably a bit of a carry on to what Alex and George said regarding buildings. I mean, I think 2.5% to 4.5% consolidated is very doable for us at this point in time. I mean, I think Power Solutions continues to perform extremely well. And if some of the backlog starts to flow in the back half of the year on the building side, I think we're very comfortable that 2.5% to 4.5% is a target we can get.
That's good to hear. And then on the reference in performance contracting, the government delays, maybe you can expand on that. Is that anything unusual? Is it election related? Is it a pause potential infrastructure spending?
Just some context around that please.
So I'll take this because it needs a little bit of historical context with Jobs Controls to understand. I think that we knew this was coming because 1.5 years ago at the end of fiscal 2015, I guess that would have been, what we saw that had to do with all the budget issues with the federal government is a significant decline in our secured sales in the federal government business. As I think you know or at least you'll again understand is that business flows really over an 18 month period. So now we're seeing the result of that federal government business that really never came back. It's kind of the new normal of that business, which is a significant part of our performance contracting portfolio, normally secured in the Q4 of each fiscal year.
And that new normal is now what's kind of flowing through book. So I think if you had a historical context of Johnson Controls, this is sort of the output of the the secured sales challenge that was due to the federal government that I think is kind of a new normal quite frankly. I mean who knows what the future bodes, but at least over the last year and a half is kind of a new normal.
That's helpful color. Thank you.
Thank you. And our next question comes from Jeffrey Sprague with Vertical Research Partners.
Thank you. Good morning, everyone.
Good morning, Jeff.
Good morning. Hey, I was wondering if
you've been able to dig
a little bit deeper into kind of the whole quarter adjusted debate and analysis. Obviously, there's not a lot of import export with guys driving around and trucks and the like. So I kind of get that relative to your service business. But what can you share with us on kind of on the product side your importexport flows and another frame of reference?
Sure. So there's border adjustment and there's a whole Mexico conversation and they're related but not completely. And I think we'll have to kind of wait to see how the dust settles. But if you just look if we just take as a reference point, because I think what most people are using is essentially the House blueprint as kind of a tax policy and a border adjustment. I assume that's kind of your reference point too, Jeff?
Yes, exactly.
If you think of it that way, we are we've modeled it what the impact would be say the 20% tax rate and a border adjustment, it's kind of neutral to us. If you look at the overall effect, because we are a net importer mostly because of our battery business. But it's complicated, because our supply chain, we take core batteries into Mexico. We manufacture batteries for the Mexico market and for the U. S.
Market. We bring batteries back in the U. S. And then we finish them in the U. S.
And so when you look at our total cost and our value chain, it's a very complicated equation and we really don't know the details of the tax plan. But the best we can tell when we do our own modeling, we're kind of net neutral on this.
Great. And I was wondering also, we're all just kind of sorting out new company, new guidance, a lot of things moving around. Looking at your looking forward now into the back half and kind of what you gave us, I just went back and looked at Q3 last year for both JCI and Tyco. And it was clearly the strongest organic quarter of the year for both companies In the scope of what could be a recovering market maybe not something to be overly concerned about. But as we try to get our model straight here, is there anything we should be thinking about as we lay that second half together off the second quarter guide that you gave us?
No. So I don't know that we could give you much more in the quarter to quarter, but I don't see anything that's unusual this year versus last year. I think what for us at legacy Dumpster Controls in particular as we saw the models that were put together for the Q2 and we knew internally that we were going to have growth, but that we understood our seasonality and we think a lot of folks didn't really understand our seasonality that on the 2nd quarter. So for us the Q2 that we're giving is not a surprise and the back end is also not a surprise. I just think that there's a learning process that's going on between us and a lot of the folks that are following us that didn't don't really understand the seasonality of the battery business.
The battery business is fairly predictable. There are some quarter to quarter lead adjustments, but overall it's fairly predictable. And I think if you look at the back
half of the year with
our backlog and then if you also think about it from the historical perspective, I think we feel relatively comfortable. And that's why we put that slide in that showed both the synergy cost and kind of the back end flow of the business. So George you may have a perspective on the Tyco side.
No. I would say Jeff that within the Tyco portfolio, I think we start to see better compares as it relates to the heavy industrial high hazard end markets. Recognize that within our products business those markets represent about 30% of our revenue of our volume in revenue. And so I think we start to see a better compare there. The Peel businesses are executing well with the continued order growth and the backlog growth that we're seeing.
That's going to play out here, I think, well as we now project the second half of the year. We typically have a seasonal decline in the second quarter. It's typically the slowest quarter because of the install segment of our business. And then it becomes very strong. It strengthens in the 3rd Q4.
So I don't see anything unusual except for that I believe that we're seeing an inflection within some of the key end markets that we serve.
And then one just quick one for Brian maybe. Corporate in the quarter is clearly run rating lower than the annual guide. I assume some of that flexes up on higher sales and the like. But how are you thinking about corporate for the year relative to that $480,000,000 to $500,000,000 guide that you gave us in December?
Yes. I mean, pretty consistent. I mean, I don't think we did have some synergies that came out that $15,000,000 reduction in the quarter related some to cost synergies that were permanent takeouts. There was some expense deferral that will probably come back and end up in the Q2 for us. So I wouldn't necessarily go with that 108 times 4.
I do think there's probably a slight build in corporate expenses into the Q2. So the range we gave before is pretty reasonable still.
Great. Thank you.
Thank you. Our next question comes from Shannon O'Callaghan with UPS.
Good morning.
Hey, Alex, you emphasized Asia in the beginning of the call. I mean, the building efficiency orders in Asia were down about 3%. Just wondering what your view is in that in the context of, I guess, generally sounding pretty bullish on Asia?
Well, when I look at Asia, I guess kind of give you some qualitative. What I see is that the activity is strengthening in Asia. And then if you think about orders being the field part of our business and you think about revenues on the other side, which show up in our things like our Hitachi joint venture, we're seeing a mix change too. So it's not just the projects business, which shows up in our orders. But when you think about our products business, we're going to continue to see strength in things like our VRF products that we've gotten through the Hitachi joint venture.
But I think overall, I would expect that we're going to continue we will start to see orders build in Asia not I mean, they'll that won't be near the pace that we're seeing in Power Solutions because I think we have a unique situation there. But I do think that we're bullish on growth in Asia.
Okay. Thanks. And then maybe one along the same lines there with the Products North America orders for Building Efficiency up 12%. I mean that was probably the strongest area that we see in the company. Maybe just a little bit more color by product and any other flavor there?
Thanks.
Yes. I mean, we've had some real strong performance here within our residential light commercial business. When you look at our product businesses here, even in the Q1, our sales were up in those two businesses up 12% organically. Units actually up even further than that. So that's continuing and we see that coming through strong as we project the business going forward.
We've also seen within the HVAC space some real strong performance in our applied HVAC across the globe. And building off what Alex said about Asia, a lot of that strength is coming through the work that we've done to improve our product as well as expand our channel within Asia. And so we're seeing some nice pickup there within the HVAC. As I said, we have short term seen the pressure with the industrial refrigeration as it relates to the heavy industrial high hazard oil and gas type end markets. But the good news there is that in the quarter we've seen some nice pickup in order activity as well as order secured.
I think that's going to start to benefit us here as we project the remainder of the year. And so I think in the legacy BE portfolio with the exception of the performance contracting with the investments that are being made we're starting to see a pickup within the product channels. And then within the when you look at within the Tyco product businesses, we continue to invest in spite of some of the pressure that's coming through in the end markets that we serve and truly believe that we're at an inflection point. We'll start to see the progress here over the remainder of the year.
Yes. And just I think I'm going to take the opportunity to kind of talk about this performance contract. It's under pressure because of some of the end markets. But one of the things that is going to be important for us as we go forward, we'll talk about the branch businesses that pull through products. So whether it's our applied businesses or our controls business, of course what's happening in products, the performance contracting business is a separate business unto itself.
And so as we compare ourselves whether we're gaining share or losing share, if you look at both the applied and the unitary products, we feel very good about the investments we made and we're seeing share gains. And so that's one of the reasons why we wanted to separate that out because it bodes well for our future.
We should see it both
on the fuel side and get leverage at the factory.
Okay, great. Thanks.
Thank you. Our next question comes from Gautam Khanna with Cowen and Company.
Yes. Thank you. Good morning.
Good morning.
Just to follow-up on a couple of those questions. So could you first remind us of the size of the Performance Contracting business as well as Industrial Refrigeration? And maybe what that 20% sales decline meant in terms of absolute dollar decline in the quarter?
The Performance Contracting business is roughly $500,000,000 on an annual basis and Industrial Refrigeration is probably $400,000,000 to $500,000,000
Okay. And so going forward given the orders have picked up
at least on the
Industrial refrigeration side, what are you expecting the full year to be down? Or what do you think it's going to be net in 2017 between those 2?
Yes. Gautam, I mean, I think it's a little bit too early to see what's going to happen here. I think what we've been doing is to try to mitigate the risk that we've seen with the softness that we've experienced and we've been sizing the business appropriately to be able to still execute on the plan. Now that being said, with the pickup in orders that gives us some confidence now that with the actions that are being taken that we're going to be positioned to deliver like I said on the guidance that we provided from an organic standpoint going forward. And hopefully, we'll be able to accelerate some of these orders so we can convert within the calendar year.
But I think at this stage, it's hard to forecast what ultimately the overall impact will be for the year.
Yes. I guess the qualitative, I'd say the performance contracting will remain under pressure for the year. Industrial refrigeration, we've got some good order growth. And so if we can get the conversion on that, it probably has less pressure on it. That's a qualitative, but I think that's the way I think about it.
Okay.
And just a follow-up on Jeff's question about tax reform and
some of the
impacts. Does it have any impact on how you go about restructuring and where you go about restructuring? Does this give you any pause on the pace or maybe the nature of some of the plans you laid out at the Investor Day?
No. No, I don't think it impacts us from that perspective at all. I think the only thing that POSIT would give us if you were making an investment in plant and equipment, you'd probably have a new formula, which you don't really know what that is yet, but it really doesn't affect our the plans that we have in place when you think about our synergy efforts and our productivity efforts.
Thank you very much guys.
Thank you. And our next question comes from Julian Mitchell with Credit Suisse.
Hi, good morning.
Good morning.
My first question would be around the EBIT margin expansion. That was around I think 90 bps year on year in the Q1. You're guiding only 20 bps to 30 bps of increase in the second. What's behind that sort of 70 bps deceleration
in margin improvement?
Yes. I think that really relates primarily to the fact that the Hitachi transaction occurred in the beginning of Q1 in last fiscal year. And coming out of the box with Hitachi, as you may recall, they had lower margins. And as we look at the first quarter of this year moving into the Q2 of this year, the Hitachi piece of that is really what's driving it, because the Hitachi margins, dollar margins and actual margins in the Q2 of last year obviously are more comparable to the Q2 of this year than the Q1 was. So I guess a year ago, we had Hitachi just we just closed the transaction and we didn't really see any of the cost synergies out of that transaction until we started the Q2.
So that's really the primary driver.
Got it. So in Power, there's nothing strange going on with lead or the cost impact of new capacity or anything in the margins?
We gave that 90 bps that had let out. So the numbers you're using is sort of neutralized for let.
Understood. And then secondly just on the adjusted free cash. As you say the Q1 is often an outflow for sort of legacy JCI. When we're thinking about the path to get to that €2,000,000,000 plus number for the year, when do you think we start see positive sort of adjusted free cash? Is that really a second half issue?
Or you think Q2 you'll start to see an improvement?
Could be some well, certainly be improvement in Q2. I don't know if we'll turn fully positive in Q2. It would be plus or minus $100,000,000 probably breakeven. But as we've seen, I think historically in both companies, the second half ramp up is quite significant. And there are a couple of specific things that we're looking at to drive throughout the remainder of this year.
I think a lot of the things that have been done at Hitachi to date have been very focused on cost synergies and there's an opportunity I think at Hitachi from a trade working capital improvement standpoint, which I think could benefit the second half of the year. And then when we talk about the JCI Tycho merger as well, I think there's an opportunity as we work through some of the integration activities that we're going to see some improved trade working capital at the combined business. So I would say those are both probably more back half of the year. And when you take that accompanied with the back ended synergies and the related cash flows that will come off of that and then look at the legacy two businesses and how they generally had a second half cash performance, I think there is a road map to the $2,100,000,000 target we've got.
Great. Thanks. And thanks for all the color in the slides.
Thank you. And our
next question comes from Steve Winoker with Bernstein.
Thanks. Good morning all. I just want
to make sure on the growth versus synergy element here. You guys in that $250,000,000 to $300,000,000 synergy target this year, none of that is linked to growth? Or is some of that on the cost side? In other words, large purchases that are volume related that are on the cost side?
That's all cost.
All cost but it's not volume linked cost?
Correct.
Okay. And then secondly, I'd like to dig a little bit more onto the cash side. You've talked about the 10 points of conversion opportunity over time. You just gave us some detail about how the year normally sequences. But George from maybe also an operating perspective, when you think about that trade working capital, some of your competitors I know at Ashry and others are now maybe perhaps maintaining higher inventory levels to accommodate significant growth at least in North America.
How do you deal with that what appears to be a pretty heavy trade working capital, capital intensive business right now?
Let me grab that. I think most of the inventory that you see in that is probably has to do is more seasonality and then because a lot of that inventory is owned in the channel. So I'm not familiar with what you heard at ASHRAE. But if you look at our if you look at John's Controls working capital and our inventory, it's really more of a power solutions conversation than it is in HVAC. It relates to the differences.
And quite frankly, even though our products business is growing significantly, it's not as big a part of our business as it is probably with our peer companies. Our trade working capital, a lot of that sits in our field organization more than it sits in the channels. But when you think about channels and you think about the product stocking, I don't think that we've seen an inordinate amount of buildup. I think a year ago this time when we were having a conversation around UPG, we were stocking the channels because we had some products changes. But I don't know that we have any inordinate right now.
No. I mean, I would say Steve just based on the performance that we've seen here, we're turning that pretty quickly. I mean, we're producing at a double digit rate on units. And as you've seen in the UPG channel, our business there, we're up 12% organically year on year and we're projecting that to continue to be able to outperform the growth in the market. And so I think based on what we've seen, we're efficiently utilizing that inventory and it's turning pretty well.
Okay. All right. Great.
And I just want to make sure on
the building side it sounds like it is. Thanks.
Yes. So I just kind of a footnote. I mean, we've seen a change in inventory that's half of our sales rate in our UPG business. So as George's point, it's turning quick or quicker than it was.
Operator, we have time for one more question. Thank you. Our next question question comes from Joshua Pokrzywinski with Buckingham Research Group.
Hi. Good
morning, guys. Thanks for taking
my question.
Good morning.
Yes. On the backlog conversion, which I think is really what you're trying to say George and Alex on the underpinnings of the second half acceleration in the building business. How do you think that's trended over the last call it 18 months? It seems like orders steadily grinded higher in both JCI and legacy Tyco conversion or I guess the way we've seen organic growth has had some fits and starts and some of that is products which don't really make it into it. Some of that is compares.
But how much of the second half outlook is really just execution on what you have in the backlog already versus hoping the products business kind of picks up some steam as channel inventories move around or you had some easier compares?
Yes. Let me start by giving you the fundamentals of each of the businesses. If you go back historically, the BE backlog turns anywhere from 9 to 18 months. The Tyco backlog on the installed business is 9 to 12 months. And recognize that every project is unique in how we ultimately go to market and execute on these projects.
Now if you look at the total buildings business, about 70% of the business is driven by the field orders. And so when you go back historically and do an average and based on that backlog and the type of projects that are in the backlog and then project what's going to happen here over the next 9 months, We feel very comfortable that with where we are and how those projects are going to convert that we get into what we ultimately guided towards which is the 2% to 4% for the total buildings business because this is a significant piece of that within 2017. And so at this stage, I think it's all about execution. We're going to see some continued orders come in that are quicker turn to supplement that backlog. But it's fairly predictable at this stage where we are through the year and ultimately what we expect here over the next three quarters.
So it sounds like and not to put words in your mouth George, but if the products business either accelerates or doesn't, this is we're talking about maybe 0.5. Of variance not a point or even multiple points just given the relative sizing?
Correct. On a flow basis on the product side, as you know we're continuing to expand our channels across both sets of businesses. That's helping us being able to accelerate the product growth. And that combined with the product that we support our internal channel with sets us up here fairly nicely for the next three quarters and continuing to accelerate the overall growth that we're going to achieve and deliver on the guidance that we provided.
Yes. I think it is one piece of color on the legacy BE business. When we look at it internally kind of a lot of large numbers, when we go into a fiscal year because of the turn rate and you can do this math yourself, we're about 40% confident. About 40% of what we're going to get in a year is already in our backlog. Obviously, as the year goes on that percentage goes up.
So if it was 40% at the beginning of the year you can kind of do your math. And so you can see as we go later in the year as George was saying, we gain more and more confidence or not because it's either in the backlog or it's not. And so hopefully that makes sense. But that kind of a 40% number walking into the year is from a legacy BE when you look at our flow rates is how the math works.
Alex, any other final comments before we end the call?
Yes. I'd just like to finish the call and once again thank our employees. The amount of change is incredible. And I think we've moved past talking about Adient and the I'm just proud of what we accomplished there. But as we bring these 2 companies together, it's what I feel good about is the momentum that we're gaining around something George is putting in place around organizational structure, about getting the buildings business organized.
And as it gets organized, we're going to be able to not only see the cost synergies, but be able to fulfill the promise of the merger. And so I want to thank our employees for a great quarter. We're confident about the year. I hope that comes through in this call. It's just a lot of work for us to do.
But I'm confident we've got the right team doing it. So thanks a lot. Have a great day.
Thanks Alex and thanks everyone for joining. Operator that concludes our call. Thank you. This concludes today's conference. Thank you for your participation.
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