Johnson Controls International plc

Good morning. Welcome to Johnson Control's first quarter 2020 earnings call. Your lines have been placed on listen only until the question and answer session. To ask a question, please press star one on your touchtone phone. 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 and Chief Investor Relations and Communications Officer Ma'am, you may begin.

Good morning, and thank you for joining our conference call to discuss Johnson Control's first quarter fiscal 2020 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 Control's Chairman and Chief Executive Officer, George Oliver, and our Vice Chairman and Chief Financial Officer, Brian Steefe. Before we begin, I'd 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 EBIT A 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 website. Additionally, all comparisons to the prior year are on a continuing ops basis, excluding the results of Power Solutions. GAAP earnings per share from continuing operations attributable to Johnson Control's ordinary shareholders was 21 cents for the quarter and included a net charge of 19 cents related to special items, which Brian will address in his comments. Excluding these special items, non-GAAP adjusted diluted earnings per share from continuing operations was 40 cents per share compared to 26 cents in the prior year quarter. Now let me turn the call over to George.

Thanks, Antonella, and good morning, everyone. Thank you for joining us on today's call. Before we get into the details of the quarter, I would like to provide a few thoughts as we look ahead to the rest of fiscal 2020. Starting on slide three, we continue to see good momentum across the majority of our key performance metrics, with Q1 providing a strong start to the year. We saw 70 basis points of margin expansion this quarter. This resulted from a reduction in structural costs, improved project execution, accelerated service growth, expansion in gross margins, and driving innovation. All of these initiatives will remain key focal points for us as we go forward. We've also made significant progress in improving our cash generation profile with important steps towards better management of our trade working capital and continued discipline around CapEx spending. We still have more work to do to bring free cash conversion up to 100 percent on a sustainable basis but I am extremely pleased with the progress we have made to date. As we will discuss on the next slide, orders were flat in the quarter, but I am confident, given the continued strength we see in our pipeline, we will see acceleration in Q2. Our primary end markets, commercial HVAC, building controls, fire and security remain healthy, and we are well positioned as leaders in each market. We have significantly strengthened our balance sheet over the course of the last nine months with ample flexibility when it comes to future capital deployment opportunities. Finally, as I've said many times in these calls over the last couple of years, we remain intently focused on execution and building a strong performance culture to drive sustained performance and maximize shareholder value. Turning to some of the details for the quarter, starting with orders on slide four. Orders for our field businesses were flat in aggregate in Q1, as we faced tough prior year comparisons given the timing of announced price increases. Last year, our announced price increases were effective in January, which resulted in a pull forward into Q1 fiscal 19. This year, we accelerated our announced price increases to be effective in October, which resulted in a pull forward into late fiscal 19. Looking forward, our order pipeline remains robust with an attractive mix of service and a balanced profile of small and large projects. We expect order growth in Q2 to be in the mid-single-digit range, and we remain very confident in our low to mid-single-digit growth target for the full year. Backlog ended the quarter at $9 billion, up 6% organically versus the prior year, and up 2% on a quarter sequential basis, which provides high visibility through 2020. Turning now to slide five for a quick recap of the financial results in the quarter. Sales of $5.6 billion increased 3% on an organic basis. Within the field businesses, total service revenues grew 3% in the quarter on top of mid-single digit growth in the prior year. Our service business represents over $6 billion in revenues, or a little more than 40% of our field revenue base, and provides us with a very profitable, resilient revenue stream. As growing and expanding our service offering has been a key priority, we recently appointed a dedicated global service leader. Ganesh Ramaswamy joined the team from Danaher and will drive improved consistency of fundamentals across our global direct channel, leverage our infrastructure and investments, and work closely with regional leaders to execute on our strategic priorities. With the strength and depth of our portfolio, we have a tremendous opportunity to strengthen our core service business while building and deploying new service solutions leveraging our digital capabilities. Adjusted EBIT of $448 million grew 13% on an organic basis, driven by solid 7% growth in segment profit and a continued focus on reducing corporate expense. Overall, underlying EBIT margins expanded 80 basis points year-over-year, excluding a 10 basis point headwind from FX. Adjusted EPS of 40 cents increased 54% over the prior year with solid operational performance and a significant contribution from the deployment of proceeds related to the power solution sale. Adjusted free cash was an outflow of under $100 million in the quarter, in line with our normal seasonal patent, but a significant improvement over the last two years. With that, I will turn it over to Brian to discuss our performance in more detail.

Thanks, George, and good morning, everyone. So let's get started with a look at our year-over-year EPS bridge on slide six. You can see that operational performance, including synergies and productivity save, contributed $0.06. Deployment of the power solutions proceeds benefited both our year-over-year share count and net financing charges, which added $0.06 and $0.03, respectively. Other net items in the first quarter were roughly a penny. This results in our first quarter adjusted EPS of 40 cents, up 54 percent year-on-year. So, let's move to slide seven and look at our segment results on a consolidated basis. Sales of 5.6 billion increased 3 percent organically, led by 4 percent growth in our field businesses and 2 percent in global products. Segment EBITDA of $625 million grew 7% organically, driven by volume leverage from the field, strong price-cost realization in our products businesses, and continued productivity save and cost synergies. Lastly, Q1 segment EBITDA margin expanded 40 basis points to 11.2%. To look at the margin waterfall, underlying operational improvement contributed 50 basis points, and this included a 10 basis point headwind related to a retail business in North America. This was partially offset by 10 BIPs related to other items in the quarter. Now let's take a look at each segment in more detail. So starting on slide 8, North America, North America's sales grew 3% organically with balanced growth in both install and service activity. Growth was led by fire and security, which grew mid-single digits in the quarter, led by higher install activity. Our applied HVAC and control businesses increased low single digits in the quarter, given the double-digit growth in equipment last year. Performance solutions declined low double digits this quarter due primarily to a tough prior year compare of over 30%. As we expected, adjusted EBITDA increased 2 percent, and EBITDA margin was in line with the prior year at 12 percent. Favorable volume leverage and benefits from synergy and productivity save were offset by a 30 basis point headwind related to our retail business. And as we mentioned on our Q4 call, we expected to see continued margin headwind in retail given the change in mix to increase project revenue. Orders declined in the quarter, as George mentioned, and this was primarily due to the timing of price increases in our applied HVAC business, which did provide a three-percentage point headwind. We expected to start the year off a bit slower in North America, but we're confident that orders will accelerate to mid-single-digit range in Q2, given current pipeline activity. Backlog in North America remained strong at $5.8 billion, up 7% year-over-year. Turning to Amila on slide 9, sales grew 7% organically with install up 10% and service up 5%. Growth was positive across all regions and across HVAC and controls, fire and security, and industrial refrigeration. Our HVAC and controls business grew high single digits, helped in part by easier prior year compare, but also benefiting from order strength in the back half of 2019 for our shorter cycle controls business. Growth was particularly strong in Europe, which increased low double digits. And in the Middle East, which was a soft spot through fiscal 19, we saw mid single digit growth. Fire and security grew mid-single digits with solid growth across both install and service activity and in all regions, led by mid-teens growth in our subscriber business in Latin America. Industrial refrigeration, which was predominantly in Europe, remains a bright spot in the region and was up high teens in the quarter with solid growth in both install and service. Adjusted EBITDA increased 21%, and EBITDA margin expanded 120 basis points to 9.7%. We continue to benefit from favorable volume leverage, as well as our continued efforts around reducing structural costs and improving project execution in this business. Our orders in Amela increased 4%. This was led by continued strength, in our controls platform, particularly in Latin America. Borders in Europe were up slightly on a tough prior year compare, and backlog ended the quarter at 1.7 billion, up 8% year on year. So let's move to slide 10 in APAC. APAC sales grew 3% organically, led by higher demand for project installations, which grew 5% in the quarter. Fire and security, which as you know represents about 30% of APAC sales, saw continued strength up low single digits overall. Age tracking controls, which represents the remaining 70% of APAC sales, was relatively flat year over year. Adjusted EBITDA increased 8% with margins up 60 basis points to 11.4%. Favorable volume leverage, productivity and synergy save, and improved execution were partially offset by a higher mix of install versus service in the quarter. Asia PAC orders were up 1% against a tough 9% prior year compare, consistent with the trend we've seen over the last several quarters. Backlog in APAC increased 2% year-over-year to $1.6 billion. I just point out that the environment in APAC remains competitive and the economic conditions in some areas remain uncertain. We continue to experience macro-related headwinds in some of our key markets in Asia, including the ongoing trade dispute and now the coronavirus, which are overhangs in China, as well as the ongoing unrest in Hong Kong. That being said, We are seeing nice improvement in the underlying fundamentals in our APAC businesses, but we are monitoring these situations very closely. So, let's turn to slide 11, global products. Global product sales in the quarter increased 2 percent organically, driven primarily by strong price realization. We saw BMS sales grow high single digits in this quarter, despite a low double-digit compare in the prior year, and this was led by strength in our security products business. HVAC and refrigeration equipment was flat, with mixed performance across the individual platforms. I'd also point out that we have recently restructured our distribution channels in Canada to allow us to better serve the residential and light commercial markets and to accelerate our growth. Toll Resi HVAC declined low single digits, driven by a high single-digit decline in our APAC residential business, as well as a mid-single-digit decline in our North American business. Let me go through that in a bit more detail. So as we detailed for you last quarter, we expected continued pressure in our APAC residential business, primarily due to the softer market conditions in Japan. Our North American business declined was negatively impacted in the quarter by the Canadian distribution restructuring I mentioned previously, as well as the lower-than-expected shipments in our furnace business due to lower heating degree days in the quarter. Given the low double-digit prior year compare, we expect this weakness to continue into the second quarter. Light commercial unitary grew low single digits on a low-teens prior-year compare with sales in North America flat due to weakness in our national accounts business. Our VRF business continues to outperform, growing mid-single digits, while our applied HVAC equipment declined mid-single digits primarily due to the pressures in APAC. We continue to see very strong demand for replacement chillers in North America. IR equipment grew mid-single digits in the quarter helped by a relatively easy prior year compare. Finally, specialty products grew low single digits on solid demand for fire suppression products, particularly in North America. Product segments EBITDA increased 6%, and the EBITDA margin expanded 40 basis points as the underabsorption on lower volumes was more than offset by positive price costs and the ongoing benefit of cost synergies and productivity. So let's move to slide 12 in corporate expense. Corporate expense was down 13% year-over-year to $81 million, driven primarily by the continued benefits of synergy and productivity save, as well as our ongoing actions to reduce our cost structure, given the power solutions divestiture. On slide 13, free cash flow, Reported Q1 free cash flow was just under $400 million. Excluding a little more than $100 million in one-time cash outflows related to integration and the $600 million tax refund that we received in the quarter, adjusted free cash was an outflow of less than $100 million, which is a $100 million improvement versus last year. This was primarily due to continued improvement in working capital management, as we saw trade working capital as a percentage of sales decline 60 basis points. We continue to expect adjusted free cash flow conversion of 95%, excluding the $300 million in one-time cash outflows related primarily to integration and the $600 million tax refund. So let me turn to the balance sheet on slide 14. Net debt was up slightly as we continued to deploy cash toward share repurchases, despite Q1 being our seasonally weak cash generation quarter. You can see share repurchases in the quarter were $650 million, roughly in line with the cadence that we expect for the full year. Before I turn it back to George for his closing remarks, I want to briefly mention a couple items on slide 15. First, during the quarter, we recorded a restructuring impairment charge of $111 million. About half of that is cash and about half of that is non-cash. And the cash impact of that we'll expect to see in the current year and is included in our guidance. The cash restructuring charge reflects costs associated with the final year of the JCI Tyco merger integration activities as well as the ongoing reduction in costs related to power solutions divestiture. Secondly, in the quarter, we recorded a non-cash charge of $30 million related to Swiss tax reform, and this will not impact our 13.5 percent rate for the year. And then lastly, we also adopted a new accounting standard related to operating leases, which results in a gross-up of other non-current assets and other current and non-current liabilities in our balance sheet. So, overall, we're off to a great start in fiscal 20 with strong earnings and cash flow and improving margins. And with that, I'll turn it back over to George.

Thanks, Brian. Before we open up the line for questions, I just want to reiterate that we continue to expect our fiscal 2020 earnings per share before special items to be in the range of $2.50 to $2.60, which represents earnings growth of 28% to 33%. We have included the full details of our guidance as previously provided in the appendix to the slides. Our first quarter results reflect a strong start to the fiscal year and a continued commitment to solid execution and to improving the underlying fundamentals of our business. I am confident that we are well positioned to deliver continued long-term shareholder values. With that, operator, please open up the lines for questions.

Thank you, sir. At this time, we will begin our Q&A session. If you would like to ask a question, please press star 1 on your touch-tone phone. Please ensure that your line is unmuted, and please record your name and affiliation to be introduced. In respect of time, we ask you to limit yourself to one question and one follow-up question. Our first question is from Nigel Coe with Wolf Research. Mr. Koh, your line is open.

Thanks. Good morning, guys.

Good morning, Nigel.

Good morning, Nigel. Just obviously nice margin trends in the Asia-Pac and EMA Latin America segments. You've had some challenges, especially in Asia-Pacific. Do you feel like you're now in a better position going forward? And based on the backlog and the mixed kind of outlook, do you expect to continue to see sort of margin leadership from those two segments?

Yeah, Nigel, we've made really nice progress, as Brian talked about, within the margin structure within AsiaPAC. You know, with growth being in low single digits, we've worked, you know, this quarter we delivered 60 basis points year on year. And that's also with unfavorable mix with our installed growth growing faster than service. But I think the fundamentals, the way that we're pricing, the way that we're selling value, all of that is playing out within the structure. And we believe that now with the fundamentals, we're going to continue to improve on a go-forward basis.

I would just add to that that in 2018, Nigel, as you probably recall, we took a restructuring charge and some of that related to our European businesses. And I think we're really seeing the benefit in 19 and now into 20 of the results of some of those actions that were taken in 2018.

Great, thank you. And then my follow-up is your comments on the residential HVAC markets. We all know it's quite a warm winter, well, very warm winter, but the comments on continued challenges in 2Q, is that more a function of some of the restructuring you're doing in Canada, or is that a reflection more of the market?

Nigel, what I would say, it's both. When you look at our performance here in Q1, You know, it's been mainly globally, you know, we're down a bit, and a lot of that's driven by our performance or the market in Japan, which we're down in line with the market in Japan. In North America, it's been two. When you look at the overall furnace market, we're extremely strong in that space, and that market is down kind of high single digits, and right now that's continuing. And when you look at our restructuring of our Canadian distribution channels. What we've done is we've taken multiple channels, we've consolidated that, and now we're going to be expanding our points of distribution to be able to effectively now be much better positioned to accelerate growth in that region. That is all playing out here in the first and second quarter, and we'll be positioned in the second half to be able to pick up from a growth standpoint from there. Thanks, George. Thanks, Brian.

Thank you for your question. Our next question is from Jeff Sprague with Vertical Research. Mr. Sprague, your line is open.

Thank you. Good morning, everyone. And thanks for pulling your call up to kind of accommodate all of us. I appreciate that. George, on the price kind of pull forward on orders, you know, we normally think of that being, you know, potentially kind of a residential phenomenon, but not something that would kind of you know, impact the larger company given the nature of kind of applied and commercial projects. Can you just kind of speak to, you know, how broadly, you know, the timing of orders might have been affected by pricing and your kind of visibility on Q2 orders?

Yeah, I mean, we've historically, we've had our price increases in January. And as we've been working on price costs over the last couple of years, you know, we've made a lot of progress. And so as we have been planning for 2020, you know, we made a decision to pull forward. And with that, with the announcements, there is a behavior that goes along with those announcements. And when you look at last year in, for instance, in North America, we had high teens growth in our product last year in North America because of the price, you know, being effective in January. When we announced the increase in coming, you know, being pulled into October, Certainly we benefited in the fourth quarter of last year because of the same phenomenon. So there is, you know, there is a behavior around our price increases. What I would tell you, Jeff, is that the underlying activity is very strong across the board. Our pipelines pretty much across the board are high single digits, you know, mid to high single digits. And so my confidence in being able to deliver you know, low to mid single-digit order growth in the second quarter and be positioned here for the year is very strong, and that ultimately correlates to the revenue that we're projecting for the total year.

And, Jeff, just to quantify the impact of that for you, when you look at our overall field orders, they would be up low single digits on an underlying basis.

Okay. Thank you for that. And just on investment spend not called out in the bridge – Has this now kind of normalized and it will just kind of track with revenue growth from here, or should we expect kind of other initiatives maybe to pop up and be part of the earnings equation?

Yeah, as we've committed over the last couple of years, our reinvestment in the sales channels as well as the reinvestment in products, now as a percent of revenue is flattening out in 2020 and beyond. And so what's happening, Jeff, is that we're continuing – to add sales in line with what we see, you know, with the market activity to be. So we're continuing to add sales, but we're getting productivity with all of the expansion that we've done over the last couple of years. In engineering and R&D, we're continuing to obviously increase the dollars with the reinvestment, but maintaining that now as a percent of the overall revenue that's being achieved. And so we feel good, and we're also similarly, we're doing, you know, combining the footprint, making sure that we're getting good productivity on the dollars that we're spending, and ultimately tracking that to the new product introductions that we're bringing to market to make sure that we're getting the appropriate volumes and returns on those investments.

Great. Thank you. Appreciate it.

Thank you for your question. Our next question is from Dean Dre with RBC Capital Markets. Your line is open, sir.

Thank you. Good morning.

Good morning, Dean.

Good morning. I just want to follow up on Jeff's questions on pricing. And, George, just so we're clear, will price increases be more of a dynamic decision based upon material costs, or will there be a strategy around anticipating customer behavior? But just to address the timing of price increases going forward.

Yeah, you know, what I'd say, Dean, if you go back two years ago, we had, you know, negative price costs and the market, you know, with the market changes, we weren't positioned to be able to move quickly to stay ahead of that. We've made significant improvement now building out our strategic pricing capability across our businesses. So it is more dynamic where we're tracking the markets, we're tracking our win-loss, we're making sure that we're selling value and bringing value propositions to our customers and instead of this just annual price increase. Now, there is, you know, historically, that's what's happened within the industry we're in. But I believe that now we're much more dynamic relative to what's happening in the markets that we're serving. And as a result of that, you saw nice progress, you know, with our price cost last year, where we actually turned the headwind that we had in 2018 to a tailwind in 2019. And that's continuing now in 2020 with probably – I estimate over a point of our top line will be driven by, you know, continued very positive price cost.

Thank you. And then just as a follow-up, now that they've declared the coronavirus a global health emergency, I know your 2020 guidance does not anticipate impacts, but it's likely happening given all the shutdowns going on. Any sense of where and how you're tracking, steps you're taking internally, just anything you could share would be helpful. Thanks.

What I would start by saying, about 6% of our revenue is achieved in China. So overall, it is significant, but in the grand scheme, relatively small. We've been working very well across all of our teams that are positioned in China. We've got not only all of the business units totally aligned, but we've got full support of our EHS professionals, our facilities leaders and security, where we get a daily update from our AsiaPAC leader, certainly a top priority for us to make sure that all of our people are safe and protecting them. As you know, most provinces have mandatory holiday extension now through February 10th, and that most of the travel within China now has been curbed or curbed significantly. And so, what we're also assessing the supply side, you know, to have a pulse on what's happening with our supply. You know, there could be some supply chain disruptions. To date, it's been minimal. What I would say, it is a fluid situation in that we're monitoring it very closely. At this stage, Dean, it's hard to assess, you know, difficult to assess, but, you know, could have some deferral of activity. And certainly we'll have to keep everyone updated.

Understood. Thank you.

Thank you for your question. Our next question is from Scott Davis with Melius Research. Your line is open, sir.

Hi. Good morning, guys. Good morning, Scott.

I don't want to fixate too much on the price thing because it's been beaten to death, but it's pretty interesting that after all these years – Pointing it forward to October, were the competitors then, did they do the same thing, or were you out there for a whole quarter with higher prices generally than your competitors, and that would have had some negative volume impact perhaps?

Yeah, I believe that given the way that price increases occur within the industry, we're now ahead. And so, therefore, we had the issue that last year we had a very strong first quarter with our HVAC equipment. And then this year, because we had pulled it forward, we had seen some of that benefit, Scott, in the fourth quarter of last year. And then what I would tell you is that when you look at the underlying pipeline and how the pipeline converts, we have a very strong pipeline. It's high single digits. We usually, you know, there's pretty good predictability of how we convert and the percent. And so I have confidence that we're going to get back to, like I said, kind of low to mid single digit order growth in the second quarter and for the year. very strong pipeline to deliver the mid-single digits. So, I mean, overall, we're in line with where we thought we'd be.

Okay. Yeah, it's just the mechanics are interesting. My follow-up is just on the replacement chiller, the North America replacement chiller market. Is there a sense, I've never seen the data out there on kind of the age of the installed base when you're talking about the the bigger chillers. Is there a sense that the installed base is old and there's a long tail, that there's a greater sense of upgrading or replacement for energy efficiency? Some of that is a little bit obvious, but just trying to get a sense of how long that tail of demand is.

Yeah, I mean, it's all of the above. I think given the value proposition with our new chillers and the ability to be able to reduce energy consumption and and drive efficiency, there's certainly a big value proposition there. And so it's looked at in total value. So when you look at what their current cost is to maintain and what the energy consumption is, we typically will go in and create a value proposition that not only we can improve their operating cost, but also reduce energy. So you got to look at it as in total cost. And so I think as we now launch new products, we bring our digital capabilities in how we optimize the operation of the equipment, how that integrates with the overall building systems, I think is a real attractive value proposition for our customers. So we're seeing a nice pickup there.

Okay. Thanks, helpful. Thanks. Good luck, guys, and good job this year. Thank you. Thanks, Scott.

Thank you for your question. Our next question is from John Walsh with Credit Suisse. Your line is open, sir.

Hi. Good morning. Good morning.

Good morning.

I guess a question around the retail business. You've kind of called it out the last couple of quarters. It's now in the bridge. Just wondering, it can be lumpy. How long should we expect to kind of hear you calling out the retail headwind as it relates to the North America business?

John, our retail business, when you size the business, it's roughly about 900 million. We have a presence globally. We are the industry leader in loss prevention, inventory intelligence, traffic insights. It's a very profitable business because there's a high value proposition for our retail customers. And now, that all being said, there's been lots of change in the industry given the proliferation of online shopping and requiring, as we look at our overall offering, more towards digital solutions, a lot more installations that occurred during the quarter. But I believe that with the value proposition, the way that we're aligned, we're going to continue to see the business perform, but there's going to be a different mix within the business. So it's something that we're watching carefully. We're working very closely with each one of our retail customers and laying out what the year looks like and how we're going to be positioned to be able to support you know, support their year. But it is, you know, given what's happening within the retail space, there is a lot of change that's happening. And we're going to make sure that we're positioned to be able to capitalize on that change and support the customers through that.

Great. Thank you for that. And then I guess, you know, in the past, you've talked about, you know, the impact around PFAS and the AFFF. Wondering if you can just provide us any kind of update there.

John, there's no change in our position. You have to keep this in perspective. Tyco and ChemGuard make life-saving firefighting foam, not PFAS chemicals. And Tyco and ChemGuard purchase compounds that contain trace amounts of PFAS, which they blend to make the foam. And their firefighting foam is made to exacting military standards. The majority of the foam at issue is specified and used by the U.S. government and military and therefore is subject to the government contractor's defense. And so Tyco Fire Products and ChemGuard have always acted responsibly in producing these firefighting foams, and therefore we feel confident in our ability to defend these claims. But I also would like to share a few other facts. You know, PFAS chemicals have been used by other companies since the 1940s in many products and applications, and we didn't start producing firefighting foam until the mid-1970s, which was over 30 years later. And these foams are used only intimately and predominantly at very specific sites, such as military bases. And then last is when you look at third-party scientific studies that also recognize that firefighting foam accounts for only a very small percentage of PFAS that has historically been used in this country. So overall, position hasn't changed. We feel very good, you know, given what we've done for our government military customers and certainly our you know, there's really no additional updates.

Great. Good quarter, and thanks for the update.

Thank you for your question. Our next call or question, I'm sorry, is from Steve Tusa with J.P. Morgan. Your line is open, sir.

Hey, guys. Good morning. Good morning, Steve. Morning, Steve. What's going on in the – I think one of your businesses in North America, I think, was down. It was a solutions business or something. Is that like the performance contracting business? Do you guys still do that stuff?

Yeah. I mean, our solutions business has a large performance contract, Steve. And, you know, as we've always talked – the order intake on that can be pretty choppy given the size of the contracts, and then the flow of those contracts can give you some pretty significant variations quarter to quarter. But it's not a huge part of our business, but it can impact, you know, when we talk about that particular business, you can have some big swings quarter to quarter.

Okay. And then any, just to kind of level set people, any color on – You know, whether the second quarter, anything stand out as far as abnormal seasonality anywhere? You know, you mentioned the orders. You expect the orders to pick up a bit. Anything on free cash or the underlying business results that, you know, we need to kind of keep in mind for second quarter?

Steve, I'll take that. On the organic growth, we're looking at low single digits, and that's, again, against a prior year compare of 6%. When you break that out, the field businesses will be low to mid-single digit, and that's to a compare of 5%. And products will continue low single digits, and that's to a compare of 7%. So overall continued performance on the top line. There will be, as Brian mentioned, within products, you know, some additional pressure here in Q2 on North America resi. But as we go through the year, we still feel very good in the second half of the year. The EBITDA margins expanding in line with the guidance for the year. 40 to 60 basis points, and we see expansion across all segments. And as you know, the normal seasonality to our year is typically 30 percent in the first half, 70 percent in the second half. But because of the share repo this year, it's a little bit more skewed to the first half. And then when you look at the overall consensus, it is in line with our guidance for the year. And the guidance that I reiterated earlier was EPS range of 250 to 260. And that would be an increase, Steve, of 28% to 33%.

Wow, great. I would just add to that, Steve, I think from a corporate expense standpoint, we had a pretty low quarter. As you've probably seen in the past, the second quarter tends to be a little bit higher. So I think our guidance that's out there for corporate expense is still pretty solid as we sit here today. And then when you look at cash flow, I think cash flow, we would continue to see some improvement like we saw in the first quarter. So I think all in all, we feel real good about the second quarter.

Hey, George, just one more quick follow-up on just the general strategic question. I don't think anybody's asked it yet, but obviously a lot of these companies progressing on their splits. You know, how do you guys view any change in your view on kind of the strategic imperative to grow the residential business more, you know, structurally?

I mean, we've been focused. When you look at our strategy, Steve, we've been focused on executing and getting the fundamentals in place, delivering on our commitments, and ultimately driving results. That's the focus for us here in 2020. You know, we've been returning in line with what we committed, a significant amount of capital to our shareholders. And we have a lot of underlying momentum across the organization, whether it be the margin fundamentals on how we're launching new products, we're upgrading our leadership, and ultimately now deploying our digital strategy. So I think, you know, when you look at our positions, that's one that we've been investing heavily in, you know, the residential spaces. We've been investing heavily with new products and technology areas. We are seeing progress because it is a critical element of our line card and how we ultimately support our customers. And so we're going to continue to stay focused on executing, on delivering on the commitments, and certainly keeping a pulse on what's happening within the industry as far as any type of consolidation.

Great. Thanks for the detail, guys, as always. Appreciate it.

Thank you for your question. Our next question is from Julian Mitchell with Barclays. Your line is open.

Hi, good morning. Maybe just a question around the Emilia region. I think the Middle East-Africa piece, for you and a lot of your competitors, that's been pretty soft for much of the past sort of 12, 18 months, albeit lumpy. I think you sounded better, Brian, in the prepared remarks on trends in Middle East-Africa. So maybe just help us you know, understand how you're looking at the applied markets there, and also just remind us of the scale of that piece today.

Yeah, so I'll, Julian, I'll give you the overview of Amelo. We've made a tremendous amount of progress in Amelo over the last couple of years, not only in expanding our footprint, you know, from a sales, from a service standpoint, pretty much across the region. And when you look at our Performance in the first quarter, organic growth 7%. It was both install and service. HVAC and controls up high single digit. Fire and security up mid-single digit. And industrial refrigeration, as Brian said, to an easy compare, but up high teens. We've made tremendous progress. And with that, we've seen good leverage on the margin rate with the volume, good productivity savings and cost synergies. And so overall, we're executing extremely well. Even within the current environment, we're seeing a pipeline continue to expand, and we're converting orders kind of mid-single digit, with the backlog up 8%. So overall, we've done, you know, over the last couple of years, the restructuring, as Brian talked about, the work we've done from a go-to-market is really beginning to play out. Now, that all being said, in the Middle East, certainly part of that, it does represent about 10% or 12% of the overall EMILA revenue. Last year was a tough year. 2019 was a tough year for us. But we're beginning to see, obviously, with the easier comps, the work that we're doing around service and seeing some of the project installations come back. But, I mean, overall, I'd say when you look at the whole region, we've made a lot of good progress in the last couple of years. And competitively, I think we're positioned in an extremely strong position. I don't know, Brian, you want to...

No, I think you summarized it well. I think we had a pretty easy comp in the first quarter of fiscal 19, and so that benefited certainly in the current year. But I think we're better positioned today than we were a year ago, for sure.

Thanks. And then my second question, just around corporate costs, heard the color on second quarter versus first quarter. But for the year as a whole, maybe just highlight – the confidence in that range for corporate costs that you've given on slide 21, particularly in light of a very good performance in Q1? And also, where do we stand today in terms of realized stranded cost reduction since the power divestment and how much stranded cost is still left to come out from that and whether that view has changed in the past nine months?

So our corporate expense guide for the year is 330 to 340, and we ended up at 81 million in the first quarter. That tends to be a lower quarter for us, and so I think there is going to be a tick up in the second and third quarter. So I think that guide of 330 to 340 is still a pretty good number, maybe on the lower end of that, but I think that's probably a good number to use for now. As it relates to the power solutions, stranded costs, takeout, I think we had communicated that we were going to have about a $10 million benefit that we saw in 19. It was going to be about $30 million in 2020. And then the full run rate, $50 million benefit, we would see in 21 forward. We saw probably about what you would expect, a prorated portion of that $30 million here in the first quarter. and we would expect that $30 million to be delivered throughout the course of the year. Great.

Thank you.

Thank you for your question. Our next question is from Andrew Kaplowitz with Citi. Sir, your line is open.

Good morning, guys.

Good morning.

George O'Brien, obviously it was nice to see the tax payment helping your GAAP cash, but adjusted cash was maybe slightly better than your normal seasonal weakness. When you look at 2020, the issues that were going to keep your cash conversion down 95%, such as equity income from your JVs versus dividends and pensions, did you see any more improvement in trade working capital versus your expectations that can help you in 2020? And how are you thinking about your ability to collect dividends from your JVs in 2020?

So the trade working capital as a percentage of sales, as I mentioned, did improve significantly. by 60 basis points quarter over quarter. We saw a day improvement in DSO, a day improvement in DPO. We saw a five-day improvement in days on hand in the inventory side. So all in all, we made progress really across the three key metrics. As we look at the 95% for the year, that type of improvement was contemplated when we gave the 95% I would tell you that, as you know, this is the first year that we're going to end up in a situation where we've got reported cash flow in excess of adjusted cash flow because of that $600 million tax refund we got in the first quarter. But we still tend to be a little bit short of 100% converter because of the level of our CapEx, The fact that we don't get the entire amount of our equity income out in terms of dividends from our JVs, and then we still have this pension income that doesn't come with any cash. Now, that's offset with some amortization benefits. So I think longer term, we're going to get to that 100% level. But sitting here today... the headwinds are still a little bit more than the tailwinds we've got. So our target's 100%, but I think 95% is a good number for this year.

Thanks for that, Brian. And then, Joyce, can you give us more color into the inventory of the stock situation that you had last quarter in Japan and Taiwan? The VHF was still down in Q1 there, but it didn't seem as bad as last quarter. I know you talked about the headwinds in North America impacting Q2. But do you still see the APAC situation not being a headwind as we go into Q2?

So specifically on the unitary commercial, is that what you asked, Andrew?

Yeah, you know, because you said Japan might sort of be an overhang as you go, at least in the Q1. Looks like that may be getting a little better, but just your comments on Japan and Taiwan as we sit here for the next couple of quarters.

Yeah, so when you look at the – we talked a little bit about the, you know, the softness we had in our furnace business, which the market itself was down about 9%. We have a strong presence in that market, and certainly that hit us. And then, you know, Brian did talk a little bit about the restructuring that we're doing in our Canadian distribution, which short-term, you know, we did see a little bit of a headwind. I think as we get through this first and second quarter, that's going to turn into a tailwind. on a go-forward basis, and we're going to significantly increase our points of distribution. And so you see a little bit where you get a lot of different factors playing together here. We think that Q2 will continue to be a little bit soft, but as we get through the year, we're going to be positioned to get back to above-market growth within our business. So does that get at what you're

And, Andy, just specifically related to Taiwan and Japan, as we said last quarter, we expected the stocking to be complete in Taiwan in Q4, and it was. So our Taiwan business was fine on the APAC side. And as expected, we did continue to have some pressure in Japan in our APAC residential business. We do expect that to start flattening out as we get into the second quarter.

That's helpful, guys. Thank you.

Thank you for your question. Our next question is from Gautam. Kana with Cohen. Your line is open, sir.

Yeah, thanks. Good morning, guys. A couple questions. First, I was wondering, George, can you comment on the M&A pipeline? I know you talked about a billion dollars sort of set aside for potential acquisitions. Where do we stand there?

Yeah, we're constantly looking at Bolton's Gotham. We're continuing to reinvest organically. We've got a pipeline across our businesses where we have gaps, technology or products looking at bolt-ons. So at this stage, you know, there's nothing significant, you know, but we are continuing to strengthen our regional footprint and continuing to look at our product portfolio to make sure that we're making the appropriate plays in line with the organic investments we're making.

Okay, and just as you look at the portfolio, do you see any incremental potential for divestments as we move forward?

Yeah, we've been continuing to review the portfolio across the board, and we've been making small divestitures where businesses that are non-core and businesses that we don't want to continue to reinvest in. But, again, there's been nothing significant there. But that's a process that we continue. We're constantly looking at the portfolio. Gotham.

Hey, Gotham, I would just say to that, I think when you look at the activity in the current year, you know, we've got our Heart and Cooley business. is held for sale right now. We would expect that to close in the current year. And there's some other investments that we'll probably make. But I think you can almost look at our M&A activity in the current year is that the inflows and the outflows will be relatively the same. I don't think there's going to be anything significant in fiscal 20.

That's helpful, Brian. One last one for me. Just as we look out to fiscal 21, what do you think the lingering integration path will be, you know, four plus years on?

Yeah, let me just frame 21. We gave a framework that we gave guidance for 20 and what that ultimately would look like in 2021 as it relates to the deployment of capital with the buybacks and the like. In addition to that, you know, I'm very confident that when you look at the fundamentals that we're building across these businesses from a margin standpoint on a go-forward basis, that we're going to be positioned, we have a pipeline of productivity and savings that ultimately is going to position us to sustain margin improvement year on year, similar to what we've seen here over the last couple of years. So I want everyone to understand that that's going to continue. Now, with that, there is some, you know, restructuring as it relates to some of the takeout of, you know, some of the structure that we have in place across the globe. And, you know, normally that would probably be in the 50, maybe the 50 million, maybe a little bit more range on an annual basis, but with very strong payback within the year relative to the margin rate that we can achieve. So I feel very confident that with the framework that we provided relative to the buybacks and how that's going to play out as we position for 2021 and the work that we've done in reducing the debt cost, and then now with the margin rates that we're achieving, that we're going to be positioned to deliver, you know, what I would say is incrementals that are 30-plus on our incrementals. And so that will position us extremely well to continue margin expansion and be able to deliver, you know, longer term on the margin rate that we originally said we could get to, which is somewhere, you know, 15% to 16%.

Thank you very much, guys.

Thanks, Bethany. Thank you for your question. Our next question is from Nowak A. with Oppenheimer. Your line is open, sir.

Thanks. Good morning. If we could look at North America, you know, we're seeing some improving indicators, forward indicators, ABI, batch momentum. Can you maybe just talk about the pace of quoting activity on the longer cycle project business and what kind of confidence that gives you in sustainability of growing the backlog?

When you look at North America, and if you look at the quarter, organic growth was 3%, a mix pretty much across all of the domains, the capabilities. Margins were flat, but overall the margin rate we did operationally deliver not only with the volume and the productivity, 40 basis points, but that was offset with the retail mix and some of the cost pressure there. When you look at orders, you know, we did talk about the orders down 1%. A lot of that was timed because of the price increases. But when you look at the backlog, backlog was, you know, backlog year on year is up 7% to $5.8 billion. So when you look at the mix of that backlog, that is both short and long-term projects. And as we project the year, you know, we are positioned here for kind of low to mid single-digit top-line growth. We are positioned here to continue to deliver orders that are kind of mid-single digit, low to mid for the year, mid-single digits in the second quarter. And then within the mix of those orders, then we'll be positioned to be able to convert those orders, similar to what we're doing this year as we position for 2021. So the cadence that we have and how we look at backlog and how we look at turn absolutely supports what we're going to achieve for this year. And as we build the backlog, as we plan for 2021, we feel confident that with the pipeline that we're currently working to convert, that will position us well for 2021.

And, operator, with that, I'm going to pass it over to George for some closing comments.

So, thanks, everyone, for joining our call this morning. Again, as we discussed, we're off to a strong start for the year, positioned well to deliver on our full-year commitments. As it relates to orders, I feel very confident in mid-single-digit order growth in Q2, which then ties to the overall guidance of low- to mid-single-digit growth for the full year. And with all of the sessions that are coming up, I do look forward to seeing many of you soon. So on that, operator, that concludes our call.

Thank you, everyone. You may now disconnect. We thank you for participating, and have a great rest of your day.