Welcome and thank you for standing by. At this time, all participants are in listen only mode. Today's call is being recorded. If you have any objections, you may disconnect at this point. I now turn the meeting over to Ms.
Katie Campbell. Ma'am, you may begin.
Thank you, Jen, and welcome to the review of Johnson Controls' 2nd quarter 2016 earnings call. If you didn't already receive it, the slide presentation can be accessed at our Investor page at johnsoncontrols.com. This morning, President, Chairman and CEO, Alex MolinaRoli, will provide some perspective on the quarter as well as some progress updates on our transformation. He will be followed by Vice President and Chief Financial Officer, Brian Stief, who will review the results of the individual businesses as well as the company's overall financial performance. Following those prepared remarks, we will open the call for questions and we are scheduled to end at the top of the hour.
Before we begin, just want to remind you that today's comments will include forward looking statements that are subject to risks, uncertainties and assumptions that could cause the actual results to be materially different from those expressed or implied by such forward looking statements. The factors that could cause results to differ are discussed in the cautionary statement included in today's news release and the presentation document. We also remind you to review the extended disclosures related to the proposed transaction with Tyco, which can also be found in the earnings documents today. With that, I will turn it over to Alex.
Great. Thank you, Kathy. Good morning, everyone. So I'm extremely pleased to talk to you today about our results and our outlook and our future. Before I get started, I'd just like to make a couple of comments.
I was reflecting about our discussion at the Analyst Day in December and I thought I might just spend a couple of minutes reviewing a few things with everyone. In December, we talked about opportunity, opportunity that was in front of Johnson Controls and what a bright future that we had. And at that meeting we committed to a few things. One is execution and that's both our strategic and financial execution and meeting our commitments. Transformation, of course at the time we were really talking about the Adient spin off and Hitachi integration.
Of course things have changed since then, but we continue to be committed to transforming our business. Making strategic acquisitions in those that made sense and where it makes sense in order to support our growth platforms, continuing on our drive for operational excellence. We've seen that in the maturation of our TransConference operating system and we continue to see and realize tangible results. Building our growth platform, a platform that includes both building technologies and energy storage and a focused separate automotive company with a shifted orientation toward growth and increasing shareholder value, focused on our multi industrial company vision to create value through improved cash flow, improved margins and a sustained top line. I hope you're seeing this through our actions and that we're laser focused in order to make this vision a reality.
So let's start on Slide 7. So for the Q2, I'm really pleased to talk about what our team was able to accomplish. We're able to execute and make significant progress as we transform ourselves into 2 leading global We saw organic growth across all of our businesses this quarter. In Systems and Services North America, we continue to see positive momentum with revenues up 9% in the quarter and strong orders secured of 7%. Our backlog is up 2%.
If you recall, it was flat last quarter and so we continue to add to our backlog. And our North American pipeline is up 8% driven by activity in healthcare, higher ed and public transportation. In North America, we're seeing strong year over year growth in most of our HVAC businesses and we continue to gain share with a focused account management and solutions based approach. We continue to make investments in our future. We're launching new products and direct expansion.
We've made increased investments that are chillers through our screw products and we have new investments in our Metasys control systems. In fact, we're launching a new launch here in June for our Metasys controls. For Power Solutions, our investments in additional capacity in China is paying off in a really big way. Record shipments for the quarter up 60% versus prior year. We've more than doubled our aftermarket shipments and we've grown our original equipment shipments over 20% and sales of AGM units in China are nearly twice what they were last year this quarter.
Operational execution demonstrates our ability to continue to deliver as we affect our transformation. Our segment margins are up 160 basis points including the contributions from Johnson Controls Hitachi and along with some offsets as we continue to invest in new products and sales people to fuel our future growth. Our adjusted EPS is over 18% up over prior year. Feedback from our customers as we move toward our Adient spend and our Tyco merger is extremely positive. In May, we'll be at the EPG conference, we'll have an opportunity to talk about some of the feedback that we're getting.
So I'll leave those comments to them. But just suffice to say that our customers both from an automotive perspective and our customers in our buildings business are pretty excited about the opportunity in front of us. Speaking of our building efficiency business, we've had some great wins in the quarter. We secured a 20 year contract, dollars 68,000,000 with Norfolk Navy Base for energy in our Energy Solutions business. And we've also got a partnership with Target to replace 3,600 rooftop units at 225 Target stores and this is a 3 year project in order to improve the efficiency of the units that they currently have with more efficient HVAC equipment.
Our automotive seating order wins continue to accelerate during the first half of twenty sixteen where we have nearly the same amount of orders in the first half of this year that we had all of last year. And our interiors joint venture, which is deconsolidated, has secured business of over $7,000,000,000 since we announced we made the announcement last summer. Our Johnson Controls Hitachi joint venture integration is going extremely well. The strong quarter in Q2 and exceeded our planned expectations. Great performance in Taiwan, Japan and in China where we continue to take share in VRF.
We're making great progress in our market plans across Europe and Asia and we're beginning to see increased backlog and basis design work in North America. We're making product investments within our base business in order to support the joint venture and you'll see this impact of the increased spending when you see our Product North America segment this quarter. We're reducing our tax rate for the year from 19% to 17%. We benefit from the continuous long term tax planning initiatives that we have underway. I'd like to address our top line growth.
If you noted in our Q1 earnings call, as we continue to gain momentum in our future top line, we're not converting the pipeline as quickly as we originally expected. So we now estimate our sales growth for BE to be 2% to 4% for the year, but we're and we're very encouraged what we see in North America. Unfortunately, we have some headwinds in the Middle East and our industrial refrigeration business, mostly driven by the lower oil prices and in the region. A little bit of softness in China, more than what we expected in new construction starts, but overall when we look at our pipeline and our backlog, we're pretty pleased. For Power Solutions, we're updating our estimates to 4% to 6% growth for the year.
It's positive share growth in North America and in China, but it's being impacted by lower lead prices. We're also seeing some warmer weather in Europe and North America than we expected, but we really feel very good about what's happening within Power Solutions. In auto, we're increasing our estimates. In the past, we talked about a decline of 2% to 3%. We think we'll be able to have that as we see benefits from in the U.
S. From higher SUV mix, more content, luxury segment is doing well and that helps drive our volume. We have Bruce here and so later on he will be able to answer some specific questions that you might have. Our pipeline and backlog continues to build. We continue to effectively manage our cost and improve our productivity.
And so as a result, we're able to increase our full year guidance. This is a result of a strong operating performance as well as the reduction of our go forward tax rate and Brian will cover more about that in future slide. Move to Slide 8, let's talk about the financial highlights. I'll hit this quickly so Brian will get into more detail. We really have a lot of moving pieces on our top line with the deconsolidation of the Interiors joint venture.
It's about $1,000,000,000 and the addition of our Johnson Controls Hitachi revenue is about $740,000,000 but as I noted earlier, we're seeing overall organic growth in all of our businesses that results in a 3% organic growth for the quarter, 3% in BE, 5% in Power Solutions, 2% in Automotive. Segment income is up 22% excluding FX with margins up 160 basis points, EPS up 18%. I'd like to talk a little bit about auto. Record profitability in the quarter with reduction levels ahead of our plan levels and we're benefiting both from the restructuring actions and our operational efficiencies. Great margin expansion, 2 50 basis points.
Power Solutions has higher volumes that are being offset by China launch costs. We have so we're seeing 10 basis points improvements in margins. And B segment income is benefiting from the Johnson Controls Hitachi joint venture, higher volumes and that is being offset by our continued product and sales force investments that will drive our future growth. Let's go to Slide 9 and talk about the Johnson Controls Tyco merger. There's a lot of discussion about the recent announcement and what the impact is on our plans.
We are moving full steam ahead. We are executing against our day 1 and we are making tremendous progress. Your teams are working well together. I'm really personally energized by the strategic nature of the deal and the opportunities it presents. Every day as we get involved in this, I see more and more opportunity.
We have the executive steering committee that George Oliver and myself lead along with integration teams from both companies. We are on a clear path to capture the value of this unique combination. As you all know, Tyco filed the S-four on April 4. We received HSR regulatory approval during the quarter and we do expect all the remainder approvals to be received within our timeline. We anticipate that the Johnson Controls and Tyco shareholder meetings will happen in the July August timeframe and we're targeting October 1 as the merger date.
I know many of you are aware many of you have been asking about the new treasury regulations that were recently released. Early this morning, we filed an 8 ks jointly with Tyco confirming that following the review of the U. S. Treasury's temporary and proposed tax regulations issued on April 4 that we will proceed with the merger and continue to expect 650,000,000 dollars of previously announced synergies over the next 3 years after closing. Those synergies will include operational and tax synergies.
We'll provide additional updates on the progress at the EPG conference in May when George and I will be presenting together. Let's move on to Slide 9 and talk about Adient. The Adient separation is on track to be a successful independent public company. Great momentum, just talked about great new business wins, record profitability and tremendous progress both on the organization and on the business. Bruce has executive team already in place and his Board of Director appointments is substantially complete.
The project management office which is being led by our Vice President of Enterprise Operations, Jeff Williams is on track toward our targeted internal day 1 of July 1. So we've got plenty of time in order to make sure that we are successful on the public date. The Form 10, we expect to file by the end of April and you should expect the separation costs to be within the disclosed range that we talked about earlier $400,000,000 to $600,000,000 Half of these costs come from IT. We're targeting a spend date of October 31, 2016 and Adient will be a foreign domiciled entity when we spend. Adient's employees, plants and income is primarily outside the United States And as a result, we expect the effective tax rate for Adient to be in the range of 10% to 12%.
This adds significant value and improved cash flow for our shareholders. It over to
Brian. Thanks, Alex, and good morning, everyone. So we had a very strong underlying Q2 quarter here. As you saw in our press release, our reported results do include transaction integration and separation costs associated and a couple of non recurring tax items that net to 7 and a couple of non recurring tax items that net to $765,000,000 which resulted in a net charge of $1.68 in the current quarter. We've included a summary of these items in the appendix, but given their size, let me just provide a brief overview on those three items.
As far as the transaction integration separation costs, as you can imagine, those relate primarily to the Adient separation. And as Alex mentioned, those are in line with the previously provided amounts of $400,000,000 to $600,000,000 As far as the restructuring charge of $229,000,000 that relates to the automotive business as well as the ongoing stranded cost reductions that we're going after as we move toward the Addison separation date of tenthirty 1. I would just note that substantially all of the automotive restructuring will be funded in fiscal 'seventeen and beyond. There were 2 items in the tax charge. One item is really consistent with some of our previous divestiture transactions, GWS, Interiors and Electronics, where we had a $780,000,000 non cash charge and this relates to the required accounting for earnings which are offshore which were previously deemed to be permanently invested which no longer will be and we need to provide a book charge on that.
But again, it's a non cash charge. The second piece of that is a benefit of $15,000,000 that came through in the 2nd quarter. That really reflects the Q1 impact of our tax rate reduction from 19% to 17%. As I talk through the business unit results and the financials, I'll exclude the impact of these three items from my comments as these items were excluded from previously issued guidance. And then also consistent with Q1, the formation of the Automotive Interiors joint venture, which occurred in July 2015 and the closing of the Johns Controls Hitachi joint venture in October of 2015, those do impact the comparability of quarter to quarter results and I'll comment on that as we move through the slides.
So moving to Slide 11, building efficiency 2nd quarter sales of $3,200,000,000 were up 33% from the prior year. If you adjust that for the impact of the Hitachi joint venture as well as FX, our sales grew 3%. We did see strong systems and services North American growth, which is up 9% year over year as we continue to see strength in our North American branch business. Ex foreign exchange, Asia was up 3%, Europe was down 4% and Latin America, although small, was down 15% from the prior year. Orders in the quarter, excluding the Hitachi Venture and FX were up 5% for the 2nd consecutive quarter.
We did experience share gains and Services North America where orders increased 7% year on year. In addition, our Asian orders were also strong at 9% and we did experience some softness in Latin American orders, which were down 19%. And as Alex mentioned, backlog is up to $4,700,000,000 a 2 percent improvement. Year on year segment income of $245,000,000 was up 43% excluding the impact of FX due to the contribution from the Hitachi joint venture as well as higher volumes in North America and Asia. I would point out that the integration of our Itachi business is now well underway and VRF product and sales force investments are being made on a global basis.
Given these aggressive global integration efforts, the Johnson Controls Hitachi's actual results are really becoming difficult to measure on a standalone basis. However, we estimate that BE had mid single digit segment income growth exclusive of the joint venture. Just as an example, as you will see in our Form 10Q, you will see VRF product investments impacting the products North America segment margins throughout fiscal 2016. Overall, BE segment margins of 7 DE segment margins of 7 point 8% were up 50 basis points from the prior year, so strong quarter from BE. Turning to Slide 12, in Power Solutions, sales were compared to the last year.
However, if you adjust for FX and the lower lead prices, sales were actually up 5%. In terms of units, overall 2nd quarter shipments were up 3% with the Americas up 2%, Asia up 28% and Europe down 4%. We continue to see strong AGM growth with year over year volumes up 18% to 3,100,000 units and Q2 global OE and aftermarket volumes each increased 3% year over year. Segment income in the quarter of $264,000,000 was up 3%, excluding FX, primarily the result of higher unit volumes, partially offset by the planned launch costs associated with capacity investments we're making in China. Segment margins were up 10 basis points in the quarter and remain above our expectations on a year to date basis.
Moving to automotive, who had another very strong quarter, sales were down 18% compared to last year. But as Alex mentioned, adjusting for the interiors consolidation and FX, sales were actually up 2% on strong global production and we saw production up North America 5%, China 4% and Europe 3%. Seating volumes in North America and Asia continue to be very strong, although we did see some weakness in Europe and South America within the Q2. In China, where we go to market primarily through unconsolidated joint ventures, as you know, our 100% sales improved by 51% in the quarter to $2,900,000,000 Adjusting for the interiors joint venture NFX, China sales were up 9%, which compares very favorably to industry production of 4% in China. For the quarter, segment income of $3.24 was up 26% year over year.
Total automotive margins of 7.5% were at a record level of 2 50 basis points and that's 140 basis points if you adjust for the interiors deconsolidation. And these significant positive results reflect the benefits of the higher volumes as well as ongoing restructuring benefits at automotive as well as continued operational efficiencies around JCOS. Turning to Slide 14. On a consolidated basis, overall, 2nd quarter revenues were down 2% to 9,000,000,000 dollars but that was driven by the deconsolidation of the auto interiors business and the unfavorable impact of FX offset by the consolidation of the Hitachi joint venture. Excluding the impact of these items, sales were up 3% with all three businesses showing year over year increases.
Gross margin for the quarter of 19.1 percent was up 200 basis points versus the prior year as we continue to see the favorable impact of the Johnson Controls operating system efforts as well as improved product mix. You'll note that SG and A was up 6% from last year. This really reflects the consolidation of Hitachi joint venture as well as the products and sales force investments that are being made in BE and then that's partially offset by the deconsolidation of interiors and ongoing cost reduction activities within the company. Equity income of $117,000,000 was 43% higher than year ago levels and that relates primarily to the interiors joint venture as well as some of the joint ventures within the Hitachi consolidated venture that we have. Overall, 2nd quarter margins were 9.2%, 160 basis points better than 2015.
Turning to Slide 15, net financing charges of $74,000,000 were slightly higher than last year. I guess the highlight on the page is that we have reduced our effective tax rate from 19% 17% related primarily to tax planning associated with the Adient spin off and of course that gave us a $0.02 benefit in the quarter. This is a sustainable rate at the 17% level in the near term and we continue to see the tax rate benefits of our global tax planning initiatives that are being put in place in connection with our portfolio transformation over the last couple of years. Income attributable to non controlling interest is up $41,000,000 compared to last year that primarily relates to the contribution of the John's Controls Hitachi joint venture and as we've talked before that venture has several majority owned ventures within it as well. And so that year over year increase is significant.
Overall, very strong second quarter results with diluted earnings per share at $0.86 up 18% versus $0.73 a year ago. Turning to the balance sheet and cash flow at quarter end, our net debt to cap ratio of 40% compares to the prior year 2nd quarter of 41.2% and 39.1 percent at twelvethirty onetwenty fifteen. Our net debt of $6,700,000,000 is down $700,000,000 versus a year ago and level with twelvethirty onetwenty 15 and our capital spending remains in line with our target for fiscal 'sixteen of $1,300,000,000 Turning to cash flow, I'm pleased to report that our Q2 cash flow of 4 $100,000,000 is an improvement of $300,000,000 versus the prior year and that includes $100,000,000 of transaction integration and separation costs. However, I should also point out in the Q2 of last year, we did have $200,000,000 of one time tax payments, but still on a net basis were plus $200,000,000 for the quarter. So we're making progress in this area.
We still have some work to do, but we had a good second quarter. And then finally, we plan to resume our share repurchase program shortly and expect to buy back 500,000,000 of shares by the end of fiscal 'sixteen. Moving to Slide 17 and our guidance, we expect 3rd quarter earnings per share of $1.01 to $1.04 which will be up 11 percent to 14% from the prior year. And consistent with prior guidance, this would exclude any transaction integration and separation costs or any other one time items that we would have in Q3. And then lastly, we are raising our full year guidance from $3.70 to 3 $0.90 up to 3.85 dollars which is up 13% to 17% from fiscal 2015.
And this really reflects the momentum we have from our strong year to date operational performance as well as the reduction in our effective tax rate from 19% to 17%. So with that, Kathy, we can open it up for questions.
Operator, we'll now start the Q and A. We have a long queue today. So if you could please limit it to one question and one follow-up and then get back in the queue, it would be much appreciated. Operator?
Thank you. We will now begin the question and answer And our first question comes from the line of Colin Langan from UBS. Your line is now open.
Great. Thanks for taking my question. I guess my question is pretty straightforward, but any update on the stranded costs post the Adient spend? I think at the Investor Day, you said it was $150,000,000 to $200,000,000 Is that still the range or is that actually maybe looking worse or better?
The $150,000,000 to $200,000,000 is still a good number and we're on track to take those costs out prior to entering fiscal 'seventeen. And I guess
one and then one maybe quick follow-up here. Any color on free cash flow conversions? That would be a popular topic among investors. Do you think the 77% is still on track and you're on track to get us to your midterm of, I think, 80%, 85%?
5? Yes. I think Colin, when we put the free cash flow conversion slide together at Analyst Day, we did have a couple of pro form a adjustments in there for tax payments that would be one time related to transactions. But we were a couple of $100,000,000 ahead in the Q2 and we were $100,000,000 ahead in the Q1. Some of that might be a bit of timing, but I think the 77% that we gave you, I'd like to think there's a bit of upside to that, but we're certainly comfortable with the 77% still.
Okay. All right. Thank you very much. I'll get back in the queue. Thanks, Tom.
Thank you. And our next question comes from the line of Josh Pokrzywinski from Buckingham Research. Your line is now open.
Hi, good morning guys.
Good morning.
Good morning, Josh.
Just a follow-up on the BE guidance. I think the 2% to 4% probably more in line with where you guys are tracking on sales and orders. But could you maybe hash out how that looks on an EBIT basis because clearly margins are performing better here in the interim?
So I think that what you probably heard and I'd maybe this is a good opportunity to even talk about a little bit is what you're seeing is we're seeing an improvement in Hitachi better than what we expected. But one of the things that's causing us a little bit of tentatively this year is we're spending an awful lot of money in the core business outside of the Hitachi joint venture in order to build a pipeline. So our sales efforts in North America, Europe and parts of Asia and South America are outside of the joint venture. And so that will impact our core margins a bit. So when we talk about our margins, it's going to be very difficult for us to talk about core margins versus consolidated margins, because BE business more than what we expected.
And we're seeing some leverage on the BE business more than what we expected even though we're making the investments we're making. I don't know that we have a guidance at this point, but we probably just need to follow-up on that. Okay, that's fair. And then just as
a follow-up, I noticed when you guys reiterated the $650,000,000 of synergies, it didn't quite get bucketed out. Should we still think of it as a $500,000,000 of operational $150,000,000 attacks? And maybe as a corollary to that, you mentioned some of these integration teams coming together and the excitement building. Do you think that means that those numbers look conservative or realizing them earlier or how should we think about some of that early excitement?
Well, I think that the early excitement should translate into more synergies. Obviously, when you get teams together, they're probably more excited about the revenue opportunities than anything else. And that's one of the things that we still haven't talked about. And hopefully we'll be able to at a minimum start giving examples. But what I would say if you want to break out the 650, obviously the new regulations do have would have an impact on our tax planning.
And so it wasn't without us having to go back and revisit what the tax planning would be to see what we could recover from the new regulations. But I don't know we're comfortable talking about what the split is, but the new regulations did have an impact on us, but we are going to be able to achieve tax synergies, but they're global tax synergies. It's not always in the U. S. When you look at where our opportunity is.
So I don't know if you have any more comment on that.
Yes. I would just add to that. I mean, we came up with the synergy numbers of $500,000,000 $150,000,000 I mean, that was early on in the process. And we obviously had ranges around each of those areas, synergies from costs and synergies from taxes. And I would just say that as we've gone back and looked at the opportunities for global tax planning as well as understanding Tyco's tax footprint and their understanding of ours, the range that we had for tax, we're still very comfortable that we're going to be able to be within the range of tax synergies that we quoted previously.
So I think from our standpoint, it's full speed ahead.
Perfect. Thanks for the color guys.
Thanks, Josh. Thank you. And our next question comes from the line of Robert Barry from Susquehanna. Your line is now open.
Hey guys, good morning.
Good morning, Robert.
I had
a question on tax as well. I just wanted to clarify. So as we think about JCI ex Adient, so the piece that's merging with Tyco, Is it going to be joining with Tyco having this 17% tax rate?
Is that the idea?
Yes. I mean, I think what we're saying Rob is our tax rate in the near term we think is sustainable at 17%. So when I say near term that takes us through fiscal 2017. The Tyco tax rate I think has historically been in that 17% to 18% range. So if you put the 2 companies together and then layer on over a 3 year period that we think there's $150,000,000 of tax synergies, I think that's kind of the way to think about it.
So as we put the 2 companies together, I mean, we're just going to have to kind of work through what the ultimate rate is. But I think we've been talking in terms of 17% to 18% and I would say that the guide down to JCI is 17% is it means that we think we may do a little better than that.
Got you. Yes, okay. Yes, I just wanted to clarify that. And then maybe just
wanted to make sure that you also kind of the news on this was the adding tax rate was something that we had talked about previously also.
Yes, indeed. And it was pretty striking to see it at that level. So I was curious if somehow the split between the 2 impacted the way the business would look as it entered the merger?
No. In fact, big part of the integration process is to make sure that we do our planning that we do tax planning during the I mean, I'm sorry, the separation for the last year.
Got you. And then maybe just on BE, it looks like there's definitely some good momentum building there, especially in North America. I think, Alex, you called out healthcare and education was where you were seeing the strength. And so perhaps is government lagging? Any color on the verticals?
And then if you could also just comment on pricing as this order momentum builds, is the pricing of the backlog, would you say accretive or dilutive to the segment margins? Thank you.
I think that I don't know that's a price these are mostly contracts. So I think that it's really a variable margin play. I don't know that we're really looking at a fixed cost play. So I do think that it's accretive, but Now it's going to come down to the mix of the size of projects. Typically the larger the project, the lower the margin, but also it has lower SG and A to go along with that.
So I think that we are going to see accretive the business is going to be accretive as volume runs through it, particularly as we have pull through. Again, a lot of this business is not Performance Contracting business. So a lot of this business is core construction business, which means it's going to drag along equipment and controls, which will have accretive component to our business. Those are real positives. The other thing that I'd say is around the verticals.
We talked about transportation. I would call that really more of a state and local government vertical which is infrastructure related. That seems to be holding up. Education, healthcare, we're also and we didn't talk about in our comments, we're also seeing in our commercial business is doing pretty well and that's really on the back of our CBRE business. We are seeing significant orders through our relationship with CBR Rigidella.
So we're hitting on a lot of key initiatives and the market seems to be holding up with an 8% pipeline in front of us.
Great. Thank you.
Thank you. And our next question comes from the line of Mike Wood from Macquarie Capital. Your line is now open.
Hi, thanks for that color on the commercial verticals. Could you also provide some trends on commercial in terms of split between renovation activity and new construction, what you're seeing in the pipeline? And also maybe the various size tonnage equipment and where you're seeing most of that pipeline come from? Thank you.
So this is kind of a global picture. If you look at it from a global perspective, actually our large tons business is not doing well as more of our mid market or mid ton expense and that's primarily driven by markets like the Middle East, markets that are driven by infrastructure spending. When you look at North America, I think what we're seeing is basically the same thing. It's kind of a mid market on a revenue, but on the secured, there's some very, very large infrastructure project. So I think today our mix would probably more toward midsize equipment.
I think that the secured pipeline is looking toward larger projects and larger tonnage.
And you'd mentioned Hitachi exceeding expectations initially, is that sales or margins? And do you have a clear plan at this point now with how to fix the resi business or has that began?
No, Alyssa, I would tell you on the Hitachi we're seeing both the top line has been something that's been a pleasant surprise, tremendous growth particularly in the Asian markets and market share and it's we're also seeing margins better than what we expected. So I think in both counts we're seeing with Hitachi. As it relates to residential, right now the plan that we have residential, we have a lot of new products that are out in the marketplace. We're making some initiatives, but nothing transformative at this point. Thank you.
Thank you. And our next question comes from the line of Julian Mitchell from Credit Suisse. Your line is now open.
Hi, thank you. Just the first question maybe on the Power Solutions. You had obviously enjoyed exceptional margin expansion. And then obviously that seems to be sort of leveling out a little bit. I just wondered if you could call out how severe and how long do you expect the headwind from those China launch costs to be?
Was that sort of a blip that you saw in Q2 and the second half margin expansion should be more considerable? Any color there?
Yes. So when we talked at the December meeting, we actually guided margins down 50 basis points from 17.5% to 17%. And I think we called out at that meeting that there was going to be some China launch costs certainly throughout fiscal 2016. So we're starting to see those now. Even with those, we had a 10 basis point improvement in Power Solutions margins and year to date, they're still pretty strong.
So there will be more of that in the second half of the year. And then as you know, we're also in the middle of constructing a plant in the north in China. And so I think the investments in some of the launch costs in China, we're going to continue to see for a period of time. But I would tell you sitting here today when we look at the margins for Power Solutions, the 17% that we guided to in December, we're well ahead of that pace right now for fiscal 'sixteen.
Got it. Thank you. And then back to building efficiency, I think there's been sort of very mixed and mostly negative sort of comments on China construction for quite some time. Your own sort of Asia orders though have been very good actually, up 9% to 10% the last 6 months. So maybe give us some background as to how you're able drive that, any particular verticals or countries that you think are key behind that sort of very high single digit above market average growth?
This is Alex. So what I would tell you is that China has been a headwind for us with the exception of what we're seeing through Hitachi in our VRF business. So that business is growing pretty quickly. When you look outside of China, I don't know that you can point to one particular country, but across the board, the ASEAN countries we're seeing growth. And what I would tell you is for as I said to China, it's kind of a mixed bag.
We're it's choppy. We're seeing some orders. We saw I wouldn't call it momentum. We saw some sprouts here in the last few months. We're also seeing some new infrastructure projects that are on the board when you look out West.
And so we're hopeful that it will come back with some stimulus money here.
Great. Thank you very much.
Thank you. And our next question comes from the line of Jeffrey Sprague from Vertical Research Partners. Your line is now open.
Thank you. Good morning. Good
morning, Jeff.
A couple of follow ups. First, just on the Target deal, I'm intrigued by that. Your name doesn't usually come to the top of mind when I'm thinking kind of big retail retrofit jobs. So congrats on that. But could you elaborate on what drove that?
Was there it sounds like there is some performance contracting tied to it. And do you have a pipeline of some additional opportunities there?
No, actually it wasn't a performance contract. It was based off of energy savings, but it really wasn't a performance contract. And I think that what you should see is that over time, I think we'll continue having more activity there, but it's probably something that we are underutilized. I agree it's something that you don't see a lot. I do think that we have a set of new products that makes us more competitive in that market.
And so we probably haven't been approaching it aggressively. So hopefully you'll see more in the future.
And on the government side, Alex, things have been hung up there for a while. This Navy project broke free. Do you have a decent sized front log on the U. S. Government side in particular?
And how do you
think that plays out over the balance of the year?
Yes, I think that I think we talked about $150,000,000 if our members recall that got hung up. I think we're going to see about half of that and the Navy project would be in that half as it relates to projects that were hung up. Moving forward,
we still
have a headwind around the U. S. Federal government related to our historical plans. So we're not really counting on that this year to be to save our day until we get kind of through this fiscal situation that we have with the U. S.
Government. But we are glad to see that we were able to get that project freed up. There are probably a few more, but we'll get about half of what we expected.
Yes, thank you.
And then just a quick one on Adient, should we still be kind of thinking dividend roughly two turns on EBITDA?
I'm going to let Bruce talk to you about that.
Well, actually I think on the slide in the deck here when we talk about the Adient separations, we're just finalizing that with our advisors. The first turn here of the Form 10, it won't have the dividend in there, but that's something that is top of mind for us and we're working with Brian and his team on that.
All right. Thank you.
Thanks, Jeff. Thank you. And our next question comes from the line of Richard Kwas from Wells Fargo. Your line is now open.
Hi, good morning everyone. Just a follow-up on Power. So start, stop coming in at 18% for the quarter. That's good growth, but down pretty considerably from the 3040s run rate that you've been realizing over the last several quarters. Just curious in terms of it was your timing of launches around in North America or China that affected the growth rate?
How should we think about the progression of the growth rate?
Well, two things. One is the numbers are getting bigger and the second thing is that we're capacity constrained. So if you remember as we talked about last year, things were happening much quicker than what we expected. And so as we're putting in capacity, we're chasing a little bit here.
And Alex, are the economics still the same with regards to the price and the margin dollars 2 times, 3 times on sales and operating profit respectively?
Pretty much. Even though you see the basis small, you can kind of you kind of have to look through the numbers. But if you look at our unit growth rate and you look at margin growth rate, you can sort of see it. It's just so many moving parts with lead costs and FX, but we are seeing that and as we're able to continue that capacity, more and more of that will get realized on the bottom line. But yes, we're still seeing it.
Okay. And then just a quick one on auto for Bruce. So in the deck it says European softness on production here in Q1 or fiscal Q2, I should say. You've had production get raised here recently. Just curious, is that a customer specific issue or what's going on?
Rich, it really just relates to some business that we have that's rolling off. So as you know last couple of years we had some business losses that we didn't renew in Europe. And so we're just sort of seeing the tail end of that.
And that would be pure seating, not including interiors?
Correct.
Okay. All right. Thank you.
Thank you. And our next question comes from the line of Pat Archambault from Goldman Sachs. Your line is now open.
Great. Thanks again. Yes, just 2 from me. Number 1 is, what's the pricing like on those seating contracts? I mean, it just strikes me as obviously a fairly remarkable acceleration, right, to do sort of all of what you did in bookings in half a year in terms of compared to what you did a year ago in the whole year.
Is this I mean, are you finding that the environment is just willing to take in some new orders at reasonable pricing? Or is this kind of an aggressive push to kind of reassert yourself at your proper share? How should we think about that?
Yes. So it's well first of all I mean it's great progress and I think when you think about the rationale for spinning off the automotive business, it's really been because we wanted to free up automotive to reinvest their cash flows to grow the business. And so if you were to look at our reinvestment ratio in the auto business compared to our closest North American competitor, we would see is that our reinvestment ratio is about 30% or 40% lower than theirs. And so our growth has been stunted because of our lack of commitment on future CapEx and engineering spend. So it's not that we are chasing things at lower prices here.
It is our business and probably the best way to think about it, Pat, you've been around for a while is we have a long 20, 30 year track record of aggressive growth in automotive and we're giving them back the access to resources and let them flourish again and that's what we're seeing in the first half.
Got it. All right. Thanks, Bruce. And just one other side, when I mean more generally, it just feels like in the last 4, 5 months, like the noise on not noise, but the discussions on 48 volt have gone up a lot. Can you just remind us like sort of your positioning there and how much of an opportunity that could be for you?
Yes. So I think that for us the 48 volt discussion is one that's a positive discussion because as we've talked about our technology portfolio and the fact that vehicles will move from a one powertrain to another powertrain. We'd rather see an incremental move and one that's not 100% disruptive, but more of an evolving portfolio. And for us, this is something that we've actually predicted. The timing of it is something that's unique around the discussion, but I do think it makes an awful lot of sense and we're encouraged by it.
If you look at our investments in R and D, it's directly related to low voltage lithium ion products.
And just to follow-up really quickly, I mean is this are these products that you could see in the market within kind of a 2 year timeframe? Is it that soon?
No, I think you're I mean if you think about the cycles of the automotive business, I mean you'll probably have some pilot projects, but you're really talking about 5 years plus out just because of the product cycle times.
Okay, got it. Thanks guys. That's all I had.
Thank you. And our next question comes from the line of Noah Kaye from Oppenheimer. Your line is now open.
Good morning and thank you. Let's start with billing efficiency. You had mentioned the new Medisys launch in June. So as you work towards the Tyco merger and the integration there, I was wondering to what extent are you already starting to design building automation products for integrating some of their fire and security products and controls? It seems like a good opportunity.
And just wondering how much of that might be baked into how you think about synergies versus potential upside and maybe what you think the integration of those product suites will do for your competitive positioning?
So, as you probably know the Medisys platform has been around for a long time. It's an evolved platform and it already has an integrating capability with lots of fire alarm including products like the SunFlex products through open protocols. I think what you're going to see is a much tighter integration. We haven't really gotten into the details of the product planning. You have to remember, we're still 2 public companies and there's certain planning that we can't do until we're further along in this process.
But clearly when we talk about and I think Tycho talks about their Tycho On product and we talk about Medisys, that's really a convergence of technology that will need an integrating platform. What that really looks like, the opportunity to look under the cover, we really
can't do
that yet. So I'm excited about that. It's part of the synergy opportunity. It wouldn't be the near term synergy opportunity. It'd be like the 2nd wave of opportunity.
The 1st wave of opportunity is going to really be cross selling and commercial opportunity.
I will look for that. And then just a question on Power Solutions. You mentioned in your guidance for the year, the change in the guidance earlier. Just wondering how you think about regional volumes in kind of the remainder of the year, North America, China versus Europe and kind of the puts and takes of that, and where you think that might end up impacting pricing?
I think that the mix will be very similar to what it's been up to this point. We've actually gained share. There's been a little bit of market growth in North America. Europe has had a pretty mild weather, haven't lost share, but it's pretty competitive in Europe. And so what I would expect is that our share will continue to grow pivoting toward Asia, specifically China, and we'll see moderate growth in the other regions.
Okay, great. Thank you very much.
Thanks, Noah. Thank you. And our last question comes from the line of Joseph Spak from RBC. Your line is now open.
Thanks for squeezing me in here. Just one quick one on, I guess, the Yangfeng JV where we just get a little transparency. It seems like things have really accelerated there by some of the clues you dropped here. China up 51%, but only 9% ex that JV. And then if you could just sort of back out the margin improvement as well.
Is that I guess, is that just the fruits of some increased business? Because it seems to be way more than China production would have otherwise suggested?
Yes, I just want to clarify. You're talking about the interiors joint venture, correct?
Yes.
Well, yes, keep in mind, Joel, it's a global joint venture. So roughly speaking, it's a little bit more than 50% of China and the balance of it is North America and Europe. Just to remind those on the call that maybe aren't familiar with it, but we've this joint venture we basically took John's Controls business which was a global interiors joint venture operation and combined it with Yanfeng business which was almost all in China. I think they had 1 North American plant. And really the rationale here was combining the Chinese cost base that they brought and access to low cost tooling and capital marrying up with our global footprint and our global customer relationships.
And what you've sort of seen there is putting that all together is we've got a business that's got a return on sales of more than 6%. That's somewhat stunted because of the costs that we're incurring to set it up as a separate entity. See good strong growth and we got a global business that's growing nicely and you see the $7,000,000,000 that's lifetime awards of revenue. So it's not the same as our backlog. But that if I looked at that backlog that's the customer validation of the investment thesis.
And I think if you look underneath that about 2 thirds of the new business is Daimler, BMW and Porsche on business and that's a global mix. So it's not just winning it in one region. So great customer acceptance, the marrying of the customer relationships and the cost base, I mean it just has played out perfectly for us and we're really excited about how that ventures starting off here.
And just to confirm that it's the after tax portion of that JV that's in that you're reporting in that segment income number, right. So I guess the difference suggested sort of something about like a $50,000,000 contribution, which just seems to be a little bit higher than guess some of the initial color you had?
Yes. I don't think they I mean maybe after the call Kathy can straighten you out there. But I think it's not quite I don't think it's $50,000,000 from the interiors joint venture but your point is actually bigger than you said. All of our Chinese equity income which is more than $50,000,000 in the quarter is all after tax income. And I think one of the things that from a value perspective is generally speaking I think people give us a EBITDA type multiple on our equity income rather than a PE type multiple.
And I think there's a lot of value there. We can walk through
the math afterwards. But remember, that's a 30 we've got a 30% interest in that joint venture. And you're correct, it is after tax. So we can walk you through those numbers.
All right.
We can take it offline. Thanks.
Yes. Thanks,
Joe. Okay. Alex, closing comments.
All right. I appreciate it. I thank everyone for joining the call today. And I just wanted to just to mention just as I always do, but it can't go unmentioned is that how could you not be more proud of our employees and what they're accomplishing. We've got a significant amount of things going on.
If you look at the summer we have ahead of us, it's not slowing down, but I think we can see the path to be clear of all this. Things are becoming much more clear for our employees, for our customers and I think that the execution that they are delivering on is something to really be proud of. So I just want to thank our employees and I want to appreciate everyone's great questions and sticking with us through this transformation. We're going to be a great company today and we're going to even be a greater company, a great 2 companies when we come out of this. So thanks a lot.
Have a great day.
Thank you.
Thank you, speakers. And that concludes today's conference call. Thank you all for joining. And you may now disconnect.