Johnson Controls International plc (JCI) CEO George Oliver on Q1 2019 Results - Earnings Call Transcript

Johnson Controls International plc (NYSE:JCI) Q1 2019 Earnings Conference Call February 1, 2019 9:30 AM ET

Company Participants

Antonella Franzen - VP and Chief IR and Communications Officer

George Oliver - Chairman and CEO

Brian Stief - EVP and CFO

Conference Call Participants

Gautam Khanna - Cowen & Company

Jeffrey Sprague - Vertical Research Partners

Nigel Coe - Wolfe Research

Steve Tusa - JPMorgan

Tim Wojs - Robert W. Baird

Josh Pokrzywinski - Morgan Stanley

Noah Kaye - Oppenheimer

Deane Dray - RBC Capital Markets

Operator

Welcome to Johnson Controls First Quarter 2019 Earnings Call. [Operator Instructions] This conference is being recorded. If you have any objections, please disconnect at this time.

I will turn the call over to Antonella Franzen, Vice President and Chief Investor Relations and Communications Officer.

Antonella Franzen

Good morning and thank you for joining our conference call to discuss Johnson Controls first quarter fiscal 2019 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 Web site at johnsoncontrols.com.

With me today are Johnson Controls' Chairman and Chief Executive 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 review today's press release and read through the forward-looking cautionary informational statements that we've included there.

In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins exclude restructuring and integration costs as well as other special items. These metrics are non-GAAP measures and are reconciled in the schedules attached to our press release, and in the appendix to the presentation posted on our Web site.

Given the announced sale of our Power Solutions business, the results of Power are reported as discontinued operations. The focus of this call will be on continuing operations. GAAP earnings per share from continuing operations attributable to Johnson Controls ordinary shareholders was $0.12 for the quarter and included a net charge of $0.14 related to special items. These special items primarily relate to integration cost and discrete tax items in the quarter. Adjusting for these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.26 per share compared to $0.21 in the prior year quarter.

Now let me turn the call over to George.

George Oliver

Thanks, Antonella, and good morning everyone. Thank you for joining us on our call today. What I thought I'd do is start with a brief strategic overview then turn it over to Brian to review the financial results and end with an update on 2019 guidance.

As we discussed with you on last quarter's call, 2018 was a year of significant progress for Johnson Controls, having set and achieved several ambitious goals to improve the operational performance with a bottoms-up and top-down approach. This included harmonizing our various legacy policies, establishing better processes around cash generation, better aligning our top executives to driving the fundamentals of our businesses in concluding the strategic review of Power Solutions.

Although I said it last quarter, I really can't thank our employees around the globe enough for all of their hard work, extra hours, and in many cases assuming new responsibilities. As we've entered into 2019, our goals are the same, continue to build upon the success in 2018 to further improve the operating fundamentals of our businesses and across all of our key initiatives. We have dedicated teams in place working on the power separation, and I can tell you at this point everything is progressing well, and we are on track to close no later than June 30.

We continue to see the return on investment from several years of elevated R&D spend and engineering spend as a percent of sales aimed at refreshing our product portfolio. For those of you who joined us at this year's AHR Expo in Atlanta, I am sure you walked away with a good sense with some of the new products we are bringing to the HVAC and building controls market.

New product introductions are continuing to ramp in 2019, and we are well-positioned to continue gaining share across our product categories. We have built a complete global portfolio of proven solutions to help our customers design, build, retrofit, and manage the next generation of safe, smart, and connected buildings.

As a global leader in sustainability and energy efficiency, our approach to innovation focuses on enabling our customers and communities to reduce energy consumption, lower operating costs and minimize the environmental footprint of their facilities. We achieved this with tools and technologies that make those facilities smarter by using sensor-based automated monitoring of environment and security systems, as well as data mining and artificial intelligence whether that be the latest release of our Metasys software platform, our smart connected chillers, or our cloud-based digital solutions offerings. We were able to offer compelling value propositions across all of our key verticals.

As we continue to drive top line growth, we'll remain focused on improving returns in increasing our operating leverage. We continue to strengthen our processes around large project approvals to ensure we are achieving appropriate margin rates. We have enhanced pricing desks, and have set consistent productivity metrics across sales, service and installation to drive improved performance.

Turning to slide four, orders in our field businesses increased 7% organically. And as you can see on the slide, although we are beginning to lap more difficult prior year comparisons our momentum increased sequentially. The increase in orders was driven by mid teens growth in global, commercial HVAC and mid single-digit growth in fire and security, partially offset by a significant decline in our North America solutions business. Brian will provide you with some order details in his segment review, but we continue to see broad-based strength in our order books across all three regions, and across most of our core product platforms.

Our backlog ended the quarter at $8.5 billion, up 7% organically versus the prior year, which puts us in a much better position in 2019 with strong visibility to execute on our revenue expectations. Our project pipeline remains robust and we continue to see -- expect continued order momentum across our end markets over the course of the year. Taking into consideration the increasingly difficult comps as we move throughout the year, we expect continued strong order growth in the mid to high single-digit range.

Before I move to the summary of our first-quarter results, just a quick comment on the macro environment, as evidenced by the continued strength in our orders in revenue, our end markets remained healthy. Generally speaking, we are not seeing a notable slowdown in any of our internal leading indicators as our short cycle book-to-bill trends, service growth in both small and large project bookings remain robust.

We continue to monitor global economic conditions. And although it seems clear that GDP growth rates in some key regions are beginning to moderate to some degree, we feel good about our position. We have made the right technology investments and have expanded our sale force as well as distribution footprint. We have been expanding capabilities in our service business which is over $6 billion in annual revenue with roughly two-thirds recurring in nature. In addition to leveraging our industry-leading installed base, we have developing new technologies enabling us to create new value propositions for our customers. We are focused on execution and are continuing to take our cost and drive productivity.

Turning now to slide five, let me recap the financial results for the quarter. Sales of $5.5 billion increased 6% on an organic basis led by 7% growth in products and 5% growth in the field businesses. Adjusted EBIT of $400 million grew 10% on a reported basis and 15% on an organic basis despite the anticipated pressure in our Asia-Pac business and the carryover impact of sales capacity investments driven by solid growth in segment profit as well as lower corporate expense. Overall, underlying EBIT margins expanded 60 basis points year-over-year excluding the impact of FX and M&A.

Adjusted EPS of $0.26 increased 24% over the prior year driven by solid top line performance and a modest benefit from below the line items. Adjusted free cash was an outflow in the quarter of approximately $200 million better than the historical use of cash in Q1. The cash management office continues to execute well driving improvements across our cash fundamentals.

With that, I will turn it over to Brian to discuss our performance in more detail.

Brian Stief

Thanks, George, and good morning everyone. So, let's start on slide six and take a quick look at the year-over-year EPS bridge. As you can see, segment operating performance stand at $0.08 versus the prior year quarter. This was partially offset by $0.02 of continued product and channel investments and the carryover run-rate impact our fiscal '18 sales force investment. I would also note that net financing charges provided a $0.02 benefit primarily driven by favorable interest rates and some FX gains. This was more than offset by a slightly higher year-over-year tax rate and some pension amortization and FX headwinds.

So let's move to slide seven. Buildings on a consolidated basis had total sales of $5.5 billion, which was up 6% organically. This was led by strength in products of 7% and field businesses which were 5% driven by continued strength in both service and project installation activity which grew 6% and 4% respectively.

Segment EBITDA of $590 million grew 9% organically driven by strong growth in both our field and shorter cycle products businesses despite some continued high investment levels. I would note that fiscal Q1 is typically our lowest quarter from a volume leverage standpoint given the seasonally lower revenues in our buildings business. Our segment EBITDA margin expanded 30 basis points on a reported basis to 10.8%. And as you can see in a vertical chart, this includes 90 basis points of underlying operational improvement partially offset by continued product investment as well the run-rate sale force investments and indirect channel cost expansion cost.

Now, let's review each segment within buildings. Starting with North America on slide eight, you can see that sales grew 6% organically to $2.1 billion with install activity up 6% and service up 5%. We saw another quarter of strong performance in our applied, HVAC and Controls platforms which grew in aggregate mid-single digits organically led by 5% growth in core applied, HVAC equipment installation and service. We also saw fire security grow mid-single digits led by high single digit growth and fire and our solutions business, which was up 30% and quarter and I just find out as you know that the Solutions business can be quite choppy on both in order intake and revenue standpoint quarter-to-quarter.

Adjusted EBITDA of $253 million grew 8% on a organic basis. North America EBIT margin expanded 30 basis points to 12% as we saw the benefits of volume leverage and synergy and productivity save partially offset by the year-over-year impact of our run rate sales force investments and unfavorable mix as install revenue growth outpaced service growth in the quarter, margin was also impacted by mix within the individual platforms.

Orders in North America increased 5% organically driven by applied HVAC orders of mid-teens. We do thank this benefit is partly from some equipment pull-forward ahead of prices and fire security was up mid-single digits including strength and project installation and service. This growth was partially offset by a significant decline in large orders and solutions, which as I mentioned earlier, can be quite choppy. Backlog of $5.4 billion increased 4% year-over-year.

Now let's move to EMEA/LA on slide nine. There we saw sales of $907 million, which grew 4% organically with continued strength and service partially offset by a modest decline in project installations. Growth was positive in most regions and across most lines of business. Europe grow mid-single digits led by continued recovery in IR and HVAC, which combined a roughly one-third of the revenues for the segment.

Orders in Europe increased 10% organically led by strong demand and IR security and HVAC. In the Middle East, we saw revenue decline low double-digits as continued growth and service activity was more than offset by softness, we're seeing in HVAC project installations but this was also driven by a tough compared with the prior year, which was up strong double-digits. Latin America revenues increased mid-single digits led by strengthen our security long-term position business and solid growth in IR on fire suppression.

Adjusted EBITDA of $77 million increased a strong 17% organically and our EBIT margins expanded 70 basis points to 8.5% and this includes 30 basis points headwinds from FX. The underlying margin increased 100 basis points as favorable volume and mix and productivity and synergy save more than offset the run rate impact is other sales force investments in '18.

Orders in EMEA/LA increased 9% led by solid growth in Europe and Latin America across both service and installation. In the Middle East, orders decline low double-digits again driven by a top compare with the prior year. Overall backlog ended at $1.6 billion up 15% organically.

So let's move date back on slide 10, sales of $613 million gross 6% organically driven by an acceleration and project installations, which grew 8% in the quarter growth and install was led by HVAC and Investor Relations. Adjusted $66 million declined 9% on an organic basis. And as expected EBITDA margin declined 160 basis points to 10.8% as the benefit of the favorable volume was more than offset by the higher install mix, run rate, sales force investments and the as expected competitive pressures in China.

Asia-Pac orders increased a strong 9% in the quarter driven primarily by service and we are beginning to see some improvement in year-over-year secured margins, particularly in service, which should benefit the latter half of this year. Overall backlog increased 12% to $1.5 billion.

Turning to global products in slide 11, sales increased 7% organically and this was on top of a mid-single digit growth last year. Sales totaled $1.8 billion in the quarter. Buildings Management Systems grew low double-digits with strength across all three of our platforms control security and fire detection. Sales across our HVAC and IR equipment businesses grew high single-digits collectively and global residential HVAC, which is you know include sales to our consolidated Hitachi JVs in Japan and Taiwan grew mid-single digits in the quarter.

North American revenue HVAC grew high single-digits benefiting from favor or weather trends and strong price realization. And our global light commercial HVAC grew mid-teens in the quarter with North America up low-teens. IR equipment revenues declined low double-digits in the quarter due to a very difficult prior year compare, which was up a strong double-digits.

Our applied HVAC equipment business grew high-teens reflecting strength in our indirect channels in both North America and Asia. We saw specially products grow mid-single digits on strong demand for fire suppression products. And this was broad-based across all regions, particularly in a APAC.

Segment EBITDA of $194 million was up 15% organically and the margin expand 60 basis points driven by higher volume leverage and mix, positive freight costs in the quarter, and the benefit of cost synergies and productivity save partially offset by our continued product and channel investments.

So let's move to corporate on slide 12, corporate expense with down 11%, the $93 million as we continue to see the benefits of our cost reduction initiatives. For the full-year on a continuing ops basis, we expect corporate expense in the range of $380 million to $395 million. This does not include any take out like the Power Solutions divestiture, which will begin post transaction close. As a reminder, overtime we expect to reduce corporate expense by about $50 million.

Moving to cash flow on slide 13, as George mentioned, reported cash flow was an outflow in the quarter, slightly above $200 million. If you exclude a little less than a $100 million of integration and transaction costs, adjusted free cash flow in the quarter was an outflow of a couple $100 million. And as you know, our first fiscal quarter is typically a cash outflow, but we will place with the continued year-over-year improvement we're seeing in the cadence of our cash generation.

For fiscal '19, we expect adjusted free cash flow conversion of approximately 95%. As I mentioned on the Q4 call, this excludes special cash outflows of $300 million to $400 million related to some special integration costs, and a $600 million tax refund that we expect either in Q4 or in early fiscal '20.

Moving to the balance sheet on slide 14, you can see that our gross and net debt increase to $1 billion sequentially as planned, which reflects a higher CP balance to support a Q1 trade working capital needs as well as a more aggressive share buyback program that we implemented. Assuming a June 30 close for Power Solutions, we expect to pay between $3 billion and $3.5 billion of its outstanding debt in Q4 with a portion of the net proceeds. This will result in a reduction of financing costs of about $25 million or $0.02 in the fourth quarter which is included in the full-year guidance that George will provide.

Our net debt to cap increased to 36.6% from 33.7% in Q4, related primarily to the share repurchases as well as a reduction in equity related to a Q1 adoption of a new income tax accounting standards. Given our current stock price, we are being very aggressive with our buyback program. We made significant progress toward our full-year share repurchase target of a $1 billion, which will be completed before the closing of the Power Solutions transaction.

In Q1, we were purchased just over $14 million shares to approximately $465 million. I would also note that we expect to utilize a portion of the power sale proceeds later in the year to purchase additional shares, which is expected to contribute about $0.03 in incremental earnings for the year. Given our planned share, we post strategy for fiscal '19. We now expect our diluted weighted average shares to be approximately $905 million for the year.

Finally, let me touch on a couple other items on slide 15, before I turn it back over to George for fiscal '19 guidance. First based upon some additional tax planning that's been done in part related to the pending sales, Power Solutions, we now expect our effective tax rates and continuing ops in fiscal '19 to be approximately 13.5%.

As Antonella mentioned, the results of Power Solutions are now reported as discontinued operations and all historical financial information is presented in the comparable basis. We are well underway with the separation activities and expect the sale to close no later than June 30, and also mentioned the Power Solution shut adjusted free cash flow in the quarter of about $100 million, which is right in line with expectations.

And lastly, all the guidance that we provide will be on a continuing ops basis. And we have provided normalized financials in the appendix for competitive purposes, so you can update your models.

And with that, I'll turn it back over to George.

George Oliver

Thanks, Brian. Before we open up the line for questions, I want to provide you with our outlook for 2019 continuing operations. Let's start by walking through the year-over-year impact of the significant items embedded in our 2019 guidance on slide 16. As I mentioned on the fourth quarter call, we expect mid-single digit organic growth and buildings, which will drive approximately $0.20 of earnings. We expect this growth to be primarily driven by improved volumes and price. We will also have the continued benefits of synergies and productivity savings in buildings in corporate, which we will realize over the course of the year they will contribute an additional $0.19 cents of earnings.

Additionally, as Brian discussed the benefit in fiscal 2019 related to the deployment of a portion of the Power Solution sale proceeds is expected to add about $0.05 of earnings. The carryover impact of the sales force investments as well as a few cents of incremental investments in our product businesses are expected to total about $0.07. As you are all aware, the U.S. dollar has continued to strengthen. Based on quarter end rates, we expect this to result in a $0.06 foreign currency headwind year-over-year.

Lastly, as you can see, there are various other items, which led to a $0.10 headwind with the most notable being a $0.03 headwind from tax and a $0.02 headwind from both pensions and amortization. All these factors contributed to our fiscal 2019 EPS guidance range before special items of a $1.75 to a $1.85. This represents growth in the range of 10% to 16%. The full detail of our guidance is included on slide 17. Lastly, as a significant portion of the benefit related to the deployment of the Power Solution sale proceeds will benefit fiscal 2020, I wanted to provide a framework for how our earnings are expected to progress as we move forward.

As you can see, on slide 18, the incremental benefit of proceeds deployed in 2019, additional share repurchase in 2020 and a reduction in corporate costs is expected to contribute an incremental $0.50 to $0.60 of earnings, which takes our fiscal 2020 EPS in the range of $2.25 to $2.45. This would be prior to any operational growth or benefits from additional capital deployments.

Recognizing that we will not receive the full benefit of our reduce share account in fiscal 2020 there will be an incremental benefit of $0.10 to $0.20 in fiscal 2021. Over the last two years, we've been merging two businesses into one and have made a significant amount of progress. During that time, we have reinvested heavily back into the businesses.

Now, it's about capitalizing on those investments with how we are going to market. We have been building backlog, which provides us visibility in our field businesses. We've been strengthening our service business, which tend to be more resilient and our short cycle products business is seeing good growth across all three platforms. We are watching closely what is happening economically around the globe and our focuses on execution, and delivering for our customers. We feel good about our position in a very attractive market, and we expect to grow our underlying operations at or above the market for industrial peers as we look ahead.

With that, let me turn it over to our operator to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question in the queue is from Gautam Khanna from Cowen & Company. Your line is now open.

Gautam Khanna

Yes, thanks, good morning, and I appreciate the detail.

Antonella Franzen

Good morning, Gautam.

Brian Stief

Good morning.

George Oliver

Good morning, Gautam.

Gautam Khanna

I was wondering if, George, if you could just maybe directly address the capital allocation with the proceeds of the Power Solutions bin -- just to be clear, we should expect or we should model in that besides the $3 million to $3.5 million of debt repayment, it's all going to be directed at share repurchase, is that a fair conclusion?

George Oliver

That is correct. As I said, we're very much focused on executing on the strategy, delivering on the growth, delivering the operational performance, and ultimately delivering results, and our plan today is to take the proceeds from the Power Solutions sales, and as we have said, deploy those as quickly and as efficiently as we can as we -- once we complete the transactions.

Gautam Khanna

Got it, that's very helpful. And just in terms of M&A appetite, I mean, do you guys have really any interest in North American resi HVAC as an area of acquisition growth?

George Oliver

Well, Gautam, as you know we've been investing heavily back into our products over the last three or four years. We feel very good about our portfolio and the progress we've made and -- with the new products we bring into market, although we are not a leader in that space today, we feel very good about the progress we're making with the share gains that we're making and how we're positioned for the future. So at this stage, we're continuing to focusing on executing on the investments we've made and ultimately delivering the results.

Gautam Khanna

Thanks a lot, guys, appreciate it.

George Oliver

Thanks.

Operator

Next question is from Nigel Coe with Wolfe Research. Your line is now open.

The next question is from Jeffrey Sprague with Vertical Research Partners. Your line is now open.

Jeffrey Sprague

Thanks. I was speechless by that last question.

George Oliver

Good morning, Jeff.

Brian Stief

Hi, Jeff.

Jeffrey Sprague

Good morning. Hey, just a couple of things from me. First, Brian, as you may know, there's a lot of noise out there in kind of tax right now with this deductibility issue creating some uncertainty. You know, I assume your guide encapsulates all that, but can you give us a little bit of a update on what change to get you to this lower tax rate in '19 than you were previously thinking, and is there any upward risk to that rate if some of these tax law changes take full effect?

Brian Stief

Yes, so I would say that a reduction in the rate, Jeff, to 13.5% was just a function of a lot of planning that was done in contemplation of the Power Solutions sale. You know, we had guided a year or so ago that with -- tax reform is going to impact us by about 2% to 4% prior to any tax planning. And I think our tax team has done a great job of minimizing the impact of tax reforms on our rate and so that 13.5% we're really comfortable with for fiscal '19. As it relates to these proposed reqs that are out that I think you're referring to because we're a fiscal year company, Jeff, that doesn't impact us until 10/01/19, which is our fiscal '20 and at this point in time given the tax structure and footprint that we've got in place, we don't expect a significant impact in 2020 from those proposed reqs.

Jeffrey Sprague

Great, thanks for that. And then George, maybe just on kind of the overall price execution, maybe a little bit of an update on what you're actually seeing on price realization and kind of how your price cost dynamics play out in 2019 and how that plays into your margin outlook?

George Oliver

Sure. As you know in 2018, we made a lot of progress, we started off with a lot of headwinds and through the course of the year executed extremely well, executing on price. And as we planned for 2019, we not only took into account all of the inflationary pressures on the commodities, but also the impact that we're going to see from tariffs, and so we feel very good about the progress we've made and what we continue to make that we've got not only the inflationary pressures, but the tariffs fully covered in our plan. I would suggest at this stage, we'll see -- of the margin improvement, there's probably 10 to 20 basis points of margin improvement that's attributed to price. And I would tell you across the board, cross all of our products as well as across all of our regions we're now seeing margin accretion as a result of the strategy, the pricing strategy that we've deployed.

Jeffrey Sprague

Great thank you.

Operator

Next question is from Andrew Kaplowitz from Citi. Your line is now open.

Unidentified Analyst

Good morning, guys. It's [indiscernible] speaking on for Andy.

Antonella Franzen

Good morning.

George Oliver

Good morning.

Unidentified Analyst

So, your global products business has been quite strong with the high single digits for over a year now, I think, organic growth. Can you talk about your confidence in sustaining that elevated growth and if there's any way to think about sort of how much of it is market driven versus outcomes of everything you've been doing on your product investment?

George Oliver

Now as you know, we've been investing extremely heavily, reinvesting over the last three or four years across each one of the product platforms in what I would say is across the board we are gaining share with the investments we've made, with the new products we're bringing to the market. Brian went through the details here, but if you look at our building management solutions, a combination of all of our digital businesses, we're growing low double-digits and that's a result of the reinvestments we're not only making in our Metasys building controls, but all of the other electronic platforms that now are going to be integrated within our Metasys platform. And so we feel really good about the position that we have in that space.

If you look at the other segments in the HVAC space, you know, residential, we're seeing a nice growth across the globe, and that's a combination of what we're doing in North America as well as within our Hitachi JV. In North America, we are seeing -- I think if you look at the last year, over the last year we've had very strong double-digit growth and as we see ourselves going forward, we see that continuing. So the investments we're making there have been very, very strong. The other is in the light commercial. We're seeing very nice growth in the quarter in our light commercial business globally. That again is double digits. And then when you look at our applied business with the investments we've made not only in our chillers, but in our air handling equipment, and the deployment of that in new projects, we're seeing very nice pickup in share gain, pretty much across the globe. And so I think it's a factor of both the space -- the HVAC space is continuing to expand and with the investments that we had been making and executing on, it's given us an opportunity that within that expansion, we're enabling ourselves to be able to gain share.

Unidentified Analyst

Okay. That's really helpful. And then just as a follow-up, it seems like your applied business has continued to accelerate and I know you mentioned some potential equipment pull forward here at of pricing, but are you also seeing U.S. institutional markets accelerating and how much contribution are you getting from new products like your new chiller that you rolled out?

George Oliver

Yes, so as we look at this space, we do see the institutional vertical is coming back pretty strong, and as you know that we have a very strong position in that, you know, if you look at our North America applied business, when you look at our orders, our orders are up mid-teens, and as I said earlier, a very strong sudden push [ph], and I think that again is because of the verticals we support, the investments we're making in the new products, and then our go-to-market in making sure that we're getting more than our fair share as we execute on the pipeline. Our pipeline right now is up double digits across the globe, and so as you look at our orders globally, we achieved 7% with a backlog up about the same, and with the confidence that I have in the pipeline and the way that we've been converting on that pipeline over the last three or four quarters gives me confidence that we're going to be well-positioned here to deliver on 2019 and beyond.

Unidentified Analyst

Great, thanks guys.

Operator

Next question is from Nigel Coe with Wolfe Research. Your line is now open.

Nigel Coe

Hello. Can you hear me?

Antonella Franzen

Yes, we can hear you.

George Oliver

Good morning, Nigel.

Nigel Coe

Thank God, I mean, just to make clear [indiscernible] music. So that's got to be very clear.

George Oliver

We enjoyed the music, Nigel.

Nigel Coe

Thanks for the second part of the apple here. So just to just be very clear, George, you're encouraged not to bake in all the proceeds $8 billion or whatever it is from the disposable x debt reduction into share repurchases as of 4Q, 1Q next year, is that the message?

George Oliver

That is correct.

Nigel Coe

Okay, that's pretty clear. Can we just turn to -- I got two quick questions, one do you have a handle on the free cash flow profiles to new JCI? Obviously, the old JCI has a very backend loaded free cash generation. How does the new JCI look? Obviously, you had a negative in 1Q, which I think was expected but how does that then progress through 2Q and into second-half of the year?

George Oliver

Yes, I think it's going to be consistent and we will continue to be backend loaded. I mean, if you look at our building's profitability it's in the back half of the year. So I think you can look at this and assume it's going to be pretty consistent with what we've seen historically. First quarter is a cash outflow. We get most of that back plus or minus breakeven, maybe a little positive year-to-date in Q2 and then it will be the back half what we delivered, the majority of the cash to get us to the 95%, but all thanks for tracking for that right now. We're pretty pleased with how it came out first quarter.

Nigel Coe

Okay. And then, turn to China and the competitive nature of that market you pulled out, what specifically you have seen the competition, is it foreign securities, that's HVAC commercial versus residential, it sounds like it's commercial, and you've seen it mainly from local players, or MNCs and any color there will be helpful?

George Oliver

Yes. so I mean, we're making good progress in China when you look at our revenue or up low double-digits pretty much led by HVAC and refrigeration, so we're seeing good execution there, most of our footprint there is in the commercial space, very strong in the applied HVAC, we've got a tremendous position as well as we're position locally with our supply chain, with a very one of our -- let's say highest performing plants and so we're positioned well within that market our orders. When you look at our orders is up almost double-digits and in addition Nigel to making sure that we're building the install base we've been accelerating our service growth and so we're seeing orders in our services now up kind of 20 plus percent in that space. And so, not only are we continuing to expand our install base, but on top of that, being able to execute now in the service opportunities. So when we talk about margins, we did as we look at the overall region is mainly driven by the mix of install, and then the mix of the China growth relative to the overall APAC region. We are beginning to execute and accelerate service growth, which will help mitigate some of that that acceleration of install. But I feel confident that the fundamentals were ultimately driving, how we're going to be positioned for the rest of the year. We'll see continued improvement there.

Nigel Coe

Okay. George you are really the best. Thanks very much.

Antonella Franzen

Thanks.

Operator

Next question is from Steve Tusa with JPMorgan. Your line is open.

Steve Tusa

I wish I had that fancy theme music…

Antonella Franzen

Are you in-charge?

Steve Tusa

Yes. That's good marketing by Nigel.

George Oliver

Good morning Steve.

Steve Tusa

Good morning. The just kind of the -- I know you guys have a lot of different businesses in there. But residential HVAC pricing is obviously been very strong, can you maybe dig into what you're seeing from a price perspective on the kind of core applied side and what you expect to kind of put through for 2019 calendar in the various regions?

George Oliver

Yes, so across the board, we -- as we get into this starting out last year with my transition, we got deep into each one of the segments not only the product segments, but regionally and went about making sure across the board we had good understanding of the cost structure and the inflationary pressures coming through as well as what we could expect from a tariff standpoint. And so, Steve across the board we've been executing strong pricing in every one of our categories, every one of our regions.

Now what I would tell you is that when you look at our growth last year I believe we suggest you it's about 1% or 2% of our growth, given the progress we made across the board that's going to be elevated here in 2019 additional, percentage of our growth and I think given the work we've done, you could see similar type improvements across the other product segments as you're seeing within our residential business.

Steve Tusa

Got it. Okay. And are you seeing any pockets of competitive behavior from your domestic competitors? I know, carriers trying to come out with the new products and it doesn't seem like train is mucking it up. So any anything out of your kind of a domestic kind of North American competitors, you're seeing anybody get aggressive to get new products into the channel?

George Oliver

I mean, I think across the board, there's some, you could go through each one of our competitors and the new products coming to market. I think you would have seen it at AHRI this year that's pretty much across the board. We've been focusing on how do we create value in each one of the segments for our customers? What's, from a technology standpoint, what is going to differentiate us from the competitors, I think we're executing well, and as a result of that, when we bring these new products to the market, there's a much higher value proposition that we make to our customers, which allows us to be able to get additional price. And so, I think you would have seen that there are some other new products coming in the market. I will tell you my assessment, given the investments we're making, I feel very confident with what we're doing and how it compares to our competitors and truly believe that as we continue to move forward with these product introductions, we're going to continue to gain share.

Steve Tusa

Yes, clearly a great presence at AHRI and good nice espresso bar upstairs as well. I appreciate that late in the afternoon. One last question for you, just on kind of seasonality and anything unusual, seasonally here as you move into the second quarter, and how that should behave financially, anything moving around?

George Oliver

No, I mean, what I would say Steve is when you look at the total year. I mean, when you separate Power Solutions, the remaining company we are typically now historically been 30% for staff 70% back half. Obviously, we are off to a nice start here in 2019. I see that continuing. And so, when you look at our performance, we're going to continue to drive strong order growth, we're going to continue to convert revenue, kind of mid-single digit based on the backlog we see and how that's going to flow and then we'll continue to deliver a very strong cash flow, as we continue to execute to the year, so I don't see anything significantly different than what historically we've done.

Steve Tusa

Okay, great. Thanks for the color.

Operator

Next question is from Tim Wojs with Baird. Your line is open.

Tim Wojs

Hey, good morning, everybody.

Antonella Franzen

Good morning.

George Oliver

Good Morning.

Tim Wojs

Maybe just on the building's margins, how much of a kind of the sequential improvement that's implied for the rest of the year? Is really Asia kind of getting back to EIBT margin expansion versus, extra synergy realization or some of the investments?

George Oliver

Yes. When you look at the underlying margins that we're projecting for buildings here in 2019, it's -- was the overall it's going to be 40 to 60 basis points. And that's being driven by strong -- the pickup that we get on the volume in the mix, the strong productivity, synergies productivity that we're delivering, and that's being then offset by this is a few headwinds which we talked about which was we still have the run rate of our sales investments from 2018 coming through the first-half of this year, and that's roughly about 30 -- about 30 basis points.

And then, the other as we do have as Brian talked about some pension headwind as well as equity income that year-on-year is a little bit of a pressure, but operationally with what's coming through not only the growth what's coming through on price is ultimately is what's delivering on that 40 to 60 basis points. That's pretty broad base across each of the businesses. You know, what I would say in APAC, we had said we're going to have pressure in APAC given what we had in backlog that was going to convert the first part of this year, I would tell you that we are executing on the fundamentals, we are improving those fundamentals, we are growing the service business which is higher margin and the combination is what's going to be able to flow through the year and be able to contribute to that 40 to 60 basis points of improvement.

Tim Wojs

Okay, so it sounds like that 30 basis point headwind on investments that should taper as you go through the year?

George Oliver

That is correct.

Tim Wojs

Okay, great. And then just on free cash flow, I know the gap is closer now. It's 95% plus ex-power. What do you guys need to do internally to maybe get that in line with better than earnings? Are there any big buckets that you can tap to, to improve that metric? Thanks.

Brian Stief

Yes. I mean we have made good progress I guess just to comment on trade capital, I mean our DPO year-over-year has improved by six days. Our DSOs improved by a couple days. We are flattish relative to inventory. So if there was an area that I think we need to go to work on a bit more inventory is probably an area that we are going to be spending some more time on in fiscal '19. When you actually look at trade working capital as a percentage of sales, December 31 last year versus December 31 this year, we are actually improved by 130 basis points which is giving some of the basis for why we are moving to a 95% plus free cash flow number here. But I think we are making progress. There are certainly areas that we continue to look at across the globe. I mean we looked at our larger markets first. So I just expect gradual improvement as we move into 2020.

Operator

Next question in the queue is from Josh Pokrzywinski from Morgan Stanley. Your line is now open.

Josh Pokrzywinski

Hi, good morning guys.

Antonella Franzen

Good morning.

George Oliver

Good morning, Josh.

Josh Pokrzywinski

George, just wanted to follow-up on your comment on some of the unitary businesses and the share gains, the investment. I guess the piece that it's harder for us to see is on the distribution side and getting these products out to market. I think historically that's been one of the challenges for anyone trying to gain share. With all the new products, are you finding the ability to kind of add store fronts or add distribution points within in resi and commercial unitary?

George Oliver

Absolutely. As you look at all of the regions certainly we tailor our strategy depending on the region and where we have a strong position, where we have weak positions. We are not only putting our own distribution in place, but also other distributors that we are working with to expand our presence within the each of the key markets that is absolutely tied to reinvestments that we are making within the new products to assure that as we are reinvesting, we are positioned from a go-to market to be able to return to get the returns on that investment. So absolutely, and I think when you look at our relative performance over last year, we have been able to do what we have said relative to continuing to launch new product, expand distribution, and grow at or above the market rate.

Josh Pokrzywinski

Got it, that's helpful. And then just taking a step back on margins and operating leverage at large. We are kind of halfway through the synergy calendar at this point. I guess looking at incremental margins here understanding you can get a little tailwind from price that investment is a drag but obviously something that needs be done. How should we think about structural incremental margins here? Because it seems like some of the synergy upside you are deploying back into business and there is only another year left after '19. Is the underlying incremental margin in the business still around 20% or how should we think about that shift over time?

George Oliver

Yes, so I'd frame in up, if you start 2018, our incremental margins as you suggested in the low 20s. When you look at and a lot of that was driven because we had reinvestment in sales in the sales force ahead of our growth. And we've had historically over the last three or four years, the reinvestments in our product and technology was ahead of our growth. What you see happening in 2019 now that begins -- that reinvestment now begins to level out as a percent of revenue. And so our field businesses should be -- on a go forward basis should be in high teens to low 20s recognizing that that business is very much driven by variable labor. And in the products businesses now with the investments that we have made and the growth that we are achieving should now become more like mid to upper 20s. And so, I think as we get through the year as we lap some of these headwinds that we had in the first half with the year-on-year compares, we are going to start to see some nice leverage going forward. So I would target incremental is to be over the next couple of years kind of mid to -- kind of mid 20s plus over the next couple of years.

Josh Pokrzywinski

Inclusive of synergies?

George Oliver

That's correct.

Josh Pokrzywinski

Got it. Appreciate the color. Thanks, George.

Operator

Next question is from Noah Kaye with Oppenheimer. Your line is now open.

Noah Kaye

Hi, thanks for taking the question and great to see the continued solid execution. And George, I think I would like to return to the capital allocation question for a minute. You were very clear this morning that the power proceeds will go towards debt pay down and share repurchases. And I guess my question is given that the new JCI is really about smart, safe, efficient, sustainable buildings, how are you thinking about opportunities for additions or adjacencies whether it's HVAC as someone mentioned earlier or lighting? And why wouldn't you be looking to augment the portfolio at this point if it's sort of where you think the cycle is, is it evaluation? Help us understand that.

George Oliver

Yes. I mean we are always looking at the portfolio to make sure that from an organic standpoint we are making the right investments for getting the intended returns on those investments. And what I would say is that we feel really good about the progress we made with our organic investments. And that being said, as we look at the trends, customer trends and industry trends, we are also making sure that we look forward we are making or comparing our organic investments against what can be done from an acquisition or investment standpoint. And so what I would tell you is that as we look at our position, we feel really good about our position with the work that we have done here over the last couple of years.

Now we are always looking at to make sure that as we look at the ability to be able to create value, I will tell you we are always looking to make sure that we are standing on offense and understanding the trends and what we are going to do to be positioned to be able to achieve those trends. So, at this stage given where we are, given the progress we have made with reinvestments, given the success we have had with our sales force, we are focused on executing and being able to deliver on the commitments we have made in delivering strong results.

Noah Kaye

Got it. Appreciate it. Thanks very much.

Operator

Next question is from Deane Dray with RBC Capital Markets. Your line is now open.

Deane Dray

Thank you. Good morning everyone.

Antonella Franzen

Good morning.

George Oliver

Good morning, Deane.

Deane Dray

Hey, just want to go back to slide 18, just to make sure I understand that footnote and maybe it's earnings fatigue, and you have already mentioned it, but what's the -- when you say that the $0.10 to $0.20 benefit is excluded that's coming in fiscal '21. Could you remind us what that piece is?

Brian Stief

Yes. So if you look at the overall $0.75 that we have kind of talked about historically, there was a nickel of that that's in '19 that we talked about for '19 guidance. So then we were saying that was the midpoint of $0.55 in fiscal '20. And then there is midpoint $0.15 in 2021. That's how you get to that full $0.75 we have talked about historically. And the reason there is $0.15 still coming in 2021 is because no matter what share repurchase approach we use, we aren't going to get the full benefit likely in fiscal '20. And so, there will be a carryon effect in 2021 from an EPS standpoint that will get that's really a byproduct of the whatever repurchase program approach we use whether it's open market purchases, whether it's ASR, or whether it's some form of a general combination of those. But the way we have model it now, there is $01.5 more than would come in 2021 to get us to full $0.75.

Deane Dray

Right. That was a great explanation. Thank you. And then for George, couple of times you have mentioned the service opportunity. And I heard you say that today service is two-thirds recurring. And what's the right mix? Or, what's the right ratio there in terms of optimizing the service offering from a margin standpoint?

George Oliver

Yes. So, Deane, we made strategic -- we have made service growth one of our strategic imperatives when I took over. And it's an incredible business. Like I said, it's over $6 billion globally. And traditionally, it's been more of the maintenance and repair of the installed base, getting some recurrent revenue through PSAs, doing some monitoring in the -- within the Fire & Security businesses. And what I would say is we have been incredible opportunity to takeover we have done today in the 60% to 65% is mainly contracts that get renewed for that type of work, and what we are doing today is above and beyond that we are deploying now new solutions utilizing the data, using AI, and now it enables us to be able to optimize not only the maintenance of those -- that equipment, but also beyond what we historically have done to be able to create new value propositions through new business models and leveraging technology.

So, I'm pretty excited about the progress we have made, recognize that we started at a standstill in 2017, our service growth was, I think 1% in 2017, through the course of 2018, we ramped from 3% to 4% to 5% to 6%, and then again in the first quarter here, we are all pretty strong with 6% growth. And so, it's a combination of not only getting a higher percentage of the traditional work that we get on the install-base we create, but it's also creating new business that we deploy on top of that install-base, which is more wide space for us, which is a significant opportunity for us to be able to contribute to the growth.

Deane Dray

Terrific. George, just lastly, any encouraging words for the Patriots on Sunday?

George Oliver

No comments.

Deane Dray

Come on. A guy from Worcester you think would be…

George Oliver

No, go past, I guess.

Deane Dray

Okay, thank you. I got what I was looking for.

Antonella Franzen

Operator, I would like to turn the call over to George for some closing comments.

George Oliver

All right, thanks again everyone for joining our call this morning. As you have seen, we have made a tremendous amount of progress in 2018, and I think most important now is that we are building on that momentum in 2019, and certainly look forward to engaging many of you here over the next few weeks.

Operator, that concludes our call.