Antonella Franzen - Johnson Controls International Plc Alex A. Molinaroli - Johnson Controls International Plc George R. Oliver - Johnson Controls International Plc Brian J. Stief - Johnson Controls International Plc.

Nigel Coe - Morgan Stanley & Co. LLC Deane Dray - RBC Capital Markets LLC Jeffrey Todd Sprague - Vertical Research Partners LLC Shannon O'Callaghan - UBS Securities LLC Gautam Khanna - Cowen and Company, LLC Julian Mitchell - Credit Suisse Securities (USA) LLC (Broker) Steven Eric Winoker - Sanford C. Bernstein & Co.

LLC Joshua Pokrzywinski - The Buckingham Research Group, Inc..

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' first quarter 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 at johnsoncontrols.com.

With me today are Johnson Controls' Chairman and Chief Executive Officer, Alex Molinaroli; 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 statement that we've included there.

In addition, we will use certain non-GAAP measures in our discussion, 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 EBITA 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 schedule 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 $7.1 billion 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&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 first quarter, I'd like to just take one minute, if we turn to slide 5 in 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, the intangibles of this is bringing together two cultures of these two great companies and we shared with you that we have put together our vision, mission, values and we talked about that at the Investor Day.

We're well on our way on 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 achieve 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 on 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 the right businesses for Johnson 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. Now, we started off this year with a great start with solid activity particularly around our integration activities. And we're currently proud of what's been accomplished by the team.

If you think about our first quarter with the spin 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 first quarter profitability in both our Buildings and Power are 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 expect it 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 healthcare. 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. You've heard us talk about Asia-Pacific, particularly 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 organic basis.

We're really seeing the benefit of these strategic investments we've made over the past few years. More importantly we continue to improve our profitability in this region with several hundred 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 improve profitability. I'm also impressed with what's been accomplished.

We've been at Hitachi in our integration, 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 $7.1 billion on a reported basis.

Organically sales grew a little over 1% with a modest decline in Buildings more than offset by increased volume and a favorable mix in Power. We continue to see strong growth in start-stop. George will give you more detail on that in a few minutes.

Continued profitability and EBITA of 10% year over year on a reported basis and if you adjust for FX and lead, up 13%, extremely strong execution across all of our businesses. Adjusted EBIT margins expanded 90 basis points overall, far exceeding our expectation of 30 basis points.

EPS for the quarter was up 10% versus prior year at $0.53, above the top end of an adjusted range of $0.50 to $0.52, a 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 go through the businesses..

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 & Solutions on slide 10.

On a reported basis, Buildings sales declined 2% or a little less than 1% organically to $5.2 billion 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 continued 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 continued 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&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 second quarter. Backlog of $8.1 billion was up 6% year over year and up 2% sequentially, excluding the impact of foreign exchange and M&A.

Buildings EBITA increased 3% year over year, was 6% excluding the headwind from foreign currency to $578 million.

The margin increased 60 basis points year over year to 11.1%, 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 first quarter of 2016, but the benefits from restructuring actions and plant productivity initiatives do not begin to bear fruit until the second quarter. 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 $1.9 billion. As a reminder, the organic change excludes the impact of lead pass-through, which benefited Power's top line by just over 250 basis points.

Overall, global unit shipments increased 5% year over year, driven by aftermarket shipments, which were up 7%. Global start-stop 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 EBITA increased 8% on a reported basis or 12% excluding foreign currency and lead to $390 million. 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 second 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 EBITA performance of our businesses.

This segment is really comprised of enterprise-wide costs like executive management costs, public company costs, and 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 million, and the way to think about that is about half of it is transaction-related and half of it is integration-related.

We had a restructuring and impairment charge for $78 million. The majority of that would be severance-related. We had a lump sum pension buyout in the first quarter. And as a result of that, which was done in connection with the Adient spinoff, there's a requirement to go through a remeasurement of the liability and assets in the first quarter.

And that resulted actually in a $117 million gain in Q1. We had some non-recurring purchase accounting expenses that Antonella referred to. The two 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 in our foreign entities that resulted in a $101 million benefit. The net of all that is a $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 forma combined financials that we put out on fiscal 2016 in the November 8-K that we filed. So, overall first quarter revenues were up slightly at $7.1 billion. If you exclude FX, lead, and M&A activity, organic sales were up 1%.

Gross margin was constant at 31.2% and SG&A was down 3%, which was reflective of the cost reduction initiatives that we have across our business and the merger synergies. If you move to equity income of $55 million, 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 first quarter 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 of 2016 and again both of those exceeded our expectations for the quarter.

If we turn to page 14, net financing charges were $119 million 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 million in the minority interest add back line item on the income statement, it's up $11 million 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 really continue 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 million.

As mentioned at Analyst Day, there are a number of one-time expected payments that we realized in the first quarter. The most notable is the $1.2 billion 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 million and then we had some restructuring and change control payments of $300 million and transaction, integration and separation costs of a couple of hundred million 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 $2.1 billion 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 33.6% versus 39.7% at year-end.

That's really related to the fact that as part of the Adient spin-out there was a $4 billion 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 million of scheduled debt repayments in the quarter.

I would also just point out that beginning in Q2 we commenced a share repurchase program and expect to buy back about $200 million to $250 million 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 you 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 third quarter of this year, we will be changing our segment reporting for the Buildings business.

At this time, for the first 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 third quarter, we'll have a Global Products segment. And then, we will have our Installation Project Service business, really our field business in three 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 exclude any the impacts of those special items.

And, lastly, I just wanted to point out that we did end the first quarter, harmonized 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 what we're reporting here that's up 6% reflects those new definitions.

Moving to slide 18, which shows the waterfall for our first quarter 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 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 $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, in fiscal second 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 the 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 second quarter. I would tell you that the first quarter synergies and productivity savings were really a lot of the low-hanging fruit that we're able to quickly move on as part of integration activities.

I think as we get the processes and procedures in place here over the next quarter to ringfence 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 bill.

Just to provide some context around this, you can see that the normal seasonality, it's contributing a lion's share of the improvement in the second half along with the ramp-up and the synergy saves that we expect and as Alex mentioned, we're really running a bit ahead of our first quarter 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 $2.75, which will represent a year-over-year increase of anywhere from 13% to 19%. So with that, Antonella, we can it open up for questions..

Thanks, Brian.

Operator, could you please provide the instructions for the Q&A session and open up the lines?.

Thank you. Thank you. Our first question comes from Nigel Coe with Morgan Stanley..

Thanks. Good morning, everyone..

Good morning, Nigel..

Good morning, Nigel..

So, George, you addressed in your prepared remarks the impact of the heavy industrial declines on the fire and security products. But I'm just curious that the field and product growth divergence is about 6 points this quarter. And it's something we've seen echoed by some of your competitors.

I'm just wondering if in addition to that, that pressure from the heavy industrial, whether we're seeing some channel inventory clearance, and any perspective on that would be helpful.

And then as it relates to the guidance of 2% to 4% for Buildings this year, just given the first half order trends, and the 1Q performance, are we already looking at the sort of 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?.

It's more – just interested in the divergence between field and product trends, and the extent to which we've seen inventory clearance in products..

Yes, 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 the world up somewhere 2% to 3%, which actually is a reflection of the progress we've made with orders in building the backlog.

Relative to products, products are a shorter, your shorter cycle turn business, and as we've seen our first quarter last year was pretty good within the fire and security space. So now we have a – the last of our tough compare within the first quarter 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 taking 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 and 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 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 investment 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 2% to 4% for the full year in Buildings, is the high end of that range a stretch at this point?.

So when you look at the orders that we've had and the backlog that we've built, so the orders in the first quarter up about 2%, but the backlog was up 6% year on year, 2% sequentially organically.

And so although we're a little bit off what we expected, just recognize that in the first quarter, we only expected modest growth within Buildings in the first quarter. 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 low or to mid end of that range that we provided guidance to back in December..

Nigel, this is Alex. From a Buildings perspective, I probably ham-and-egg this a little bit between myself and George. I would agree with what George said. I think that what we're seeing as the backlog continues 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 on the positive is I think the synergies are coming a lot faster than what we expected. So 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 at a better pace than what we expected..

Okay, thanks for the color, guys..

Thank you. And our next question comes from Deane Dray with RBC Capital Markets..

Thanks, good morning everyone..

Good morning..

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 think 2.5% to 4.5% consolidated is very doable for us at this point in time. 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 Buildings side, I think we're very comfortable at 2.5% to 4.5% as 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 before potential infrastructure spending, just some context around that, please?.

So I'll take this because it needs a little bit of a historical context with Johnson Controls to understand.

I think we knew this was coming because a year and a half ago, at the end of fiscal 2015 I guess that would have been, what we saw and it 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 a new normal of that business, which is a significant part of our performance contracting portfolio, normally secured in the fourth quarter of each fiscal year, and that new normal is now what's flowing through our book.

So I think if you had the historical context of Johnson Controls, this is the output of the secured sales challenge that was due to the federal government that I think is a new normal, quite frankly. Who knows what the future bodes, but at least over the last year and a half, it's 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..

Hi, Jeff..

Good morning..

Good morning, Jeff..

Good morning. Hey, I was wondering if you've been able to dig a little bit deeper into the whole border adjusted debate and analysis. Obviously, there's not a lot of import/export with guys driving around in trucks and the like. So I kind of get that relative to your service business.

But what can you share with us on the product side, your import/export flows and any other 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 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 a tax policy and a border adjustment.

I assume that's your reference point too, Jeff..

Yes, exactly..

If you think of it that way, we've modeled it, what the impact would be of, say, the 20% tax rate and a border adjustment. It's 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 into the U.S., and then we finish them in the U.S. And so when you look at our total cost in 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 net neutral on this..

Great. And I was wondering also, we're all just sorting out, new company, new guidance, there's a lot of things moving around.

Looking forward now into the back half and 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 models 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?.

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 Johnson Controls in particular, as we saw the models that were put together for the second quarter 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 on the second quarter.

So for us, the second quarter that we're giving is not a surprise and the back end is also not a surprise. I just think that this is a learning process that's going on between us and a lot of the folks that are following us that 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 costs and the back-end flow of the business. George, you may have a perspective on the Tyco side..

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 volume and revenue.

And so I think we start to see a better compare there, the field 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, is typically the slowest quarter because of the install segment of our business and then it becomes very strong – it strengthens in the third and fourth quarter.

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 now one just quick one for Brian, maybe, Corporate in the quarter is clearly run rating lower than the annual guide, I have seen 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 million to $500 million guide that you gave us in December?.

Yes, pretty consistent. I don't think – we did have some synergies that came out at $15 million 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 second quarter for us.

So, I would necessarily go with that $108 million x4, I do think there's probably a slight build in Corporate expenses into the second quarter, so the range we gave before is pretty reasonable still..

Great, thank you..

Thank you. Our next question comes from Shannon O'Callaghan with UBS..

Good morning..

Good morning, Shannon..

Hi, Shannon..

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 the context of I guess generally staying pretty bullish on Asia?.

When I look at Asia, I guess to 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 a projects business, which kind of 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, 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 line 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..

We've had some real strong performance here within our residential like commercial business. When you look at our product businesses here, even in the first quarter, 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 pick-up there within the HVAC.

As I said we have short term, seeing 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 pick-up in order activity, as well as orders secured.

And 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 the pick-up 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 and 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..

I think I'm going to take the opportunity to talk about this performance contracting. 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, then 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 investments we've made and we're seeing share gains.

And so that's one of the reasons why we want to separate out because it bodes well for our future. We should see it both from the field side and get leverage at the factory..

Okay, great. Thanks..

Thank you. Our next question comes from Gautam Khanna with Cowen and Company..

Thank you, good morning..

Good morning..

Good morning, Gautam..

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 million on an annual basis and industrial refrigeration is probably $400 million to $500 million..

Okay.

And so going forward, given the orders that picked-up at least on the industrial refrigeration side, what are you expecting the full year to be down and what do you think it's going to be net in 2017? Between those two?.

Yeah. 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 execute on the plan.

Now, that being said, with the pick-up 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..

Yeah. 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'd probably had less pressure on it. That's a qualitative, but I think that's the way I think about it..

Okay.

And just to 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, I don't think it impacts us from that perspective at all. I think the only kind of pause it would give is if you making an investment in plant and equipment, you probably have a new formula, which you don't really know what that is yet.

But, it really doesn't affect 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. Our next question comes from Julian Mitchell with Credit Suisse..

Hi, good morning..

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 first quarter. You're guiding to only 20 bps to 30 bps of increase in the second.

What's behind that sort of 70 bps deceleration in margin improvement?.

I think that really relates primarily to the fact that the Hitachi transaction occurred at the beginning of the first quarter 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 second quarter 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 second quarter of last year, obviously, are more comparable to the second quarter of this year than the first quarter 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 second quarter. 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?.

When we gave that 90 bps it had lead out. So the number we're using is neutralized for lead..

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 billion plus number for the year, when do you think we start to 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?.

It could be some – certainly there will be improvement in Q2. I don't know if we'll turn fully positive in Q2.

It would be plus or minus $100 million probably off 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 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-Tyco 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 flow 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's a roadmap to the $2.1 billion 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 million to $300 million synergy target this year, none of that is linked to growth, or is some of that on the cost side, in another words, no large purchases that are volume-related that are on the cost side?.

That's all cost..

But it's not volume-linked cost?.

Correct..

Okay. And then secondly, I'd like to dig a little bit more on to 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 ASHRAE 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 in 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 business probably has to do with more seasonality because a lot of that inventory is owned in the channel.

So I'm not familiar with what you heard at ASHRAE, but when you look at our – if you look at Johnson Controls' working capital and our inventory, it's really more of a Power Solutions conversation than it is HVAC, which 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 have seen an inordinate amount of build-up I think a year ago at this time, when we were having a conversation around UPG. We were talking to the channels because we had some product changes, but I don't know that we have anything inordinate now..

I would say, Steve, just based on the performance that we've seen here, we're turning that pretty quickly. We're producing at a double-digit rate on units. And as you've seen in the UPG channel or 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 of 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 Buildings side, it sounds like it is. Thanks..

So just a footnote, we've seen a change in inventory that's half of our sales rate in our UPG business. So to 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 comes from Joshua Pokrzywinski with Buckingham Research Group..

Hi, good morning guys. Thanks for taking my question..

Good morning..

Good morning..

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 Buildings business, how do you think that's trended over the last call it 18 months? It seems like orders have steadily grinded higher in both JCI and legacy Tyco conversion, or I guess the way we've seen organic growth, it 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 picks up some steam as maybe the channel inventories move around or you get some easier comparisons?.

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 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 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 – not to put words in your mouth, George, but yes, the products business either accelerates or doesn't. And you're talking about maybe 0.5 point of variance, not a point or even multiple points, just given the relative sizing..

Correct. On a flow basis on the products 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..

Think of it as one piece of color on that legacy BE business. I think when we look at it internally, the law 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 with 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 the 40% number walking into the year is from legacy BE when you look at our flow rates is how the math works..

Got it..

Alex, any other final comments before we end the call?.

Yes, I'd just like to finish the call and once again just thank our employees. The amount of change is incredible and I think we've moved past talking about Adient and the spin.

I'm just proud of what we accomplished there but as we run these two companies together, it's – what I feel good about is the momentum that we're gaining around that something, George putting in place around organizational structure while getting the Buildings business organized and as it gets organized, we're going to be able to not only see cost synergies but be able to fulfill the promise of the merger.

And so I want to thank our employees for a great quarter and we're confident about the year, I hope that comes true in this call, it 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. You may disconnect at this time..