Johnson Controls International plc (JCI) — Q3 2017 Transcript

Good morning and thank you for joining our conference call to discuss Johnson Controls' third quarter fiscal 2017 results. The press release and all related tables issued earlier this morning, as well as the conference call slide presentation, can be found on the Investor Relations portion of our website at johnsoncontrols.com. With me today are Johnson Controls' Chairman and Chief Executive Officer, Alex Molinaroli; President and Chief Operating Officer, George Oliver; and our Executive Vice President and Chief Financial Officer, Brian Stief. Before we begin, I'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 view today's press release and read through the forward-looking cautionary informational statements that we've included there. In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins exclude transaction, integration, and separation costs, as well as other special items. These metrics are non-GAAP measures and are reconciled in the schedules attached to our press release. All comparisons to the prior year are on a combined basis, which excludes the results of Adient, and includes the results of Tyco, net of conforming accounting adjustments and recurring purchase accounting. GAAP earnings per share from continuing operations attributable to Johnson Controls' ordinary shareholders was $0.59 for the quarter and included net charges of $0.12 related to special items. These special items were primarily composed of transaction and integration costs, a mark-to-market pension as well as restructuring and impairment charges. Adjusting for these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.71 per share compared to $0.61 in the prior year quarter. Now, let me turn the call over to Alex.

Thanks, Antonella. Good morning, everyone. Thanks for joining the call today. So if you've read in the release and our slides this morning, we reported a quarter of solid EPS growth, strong margin expansion, driven by that continued progress with our synergies and our productivity actions. I'm on Slide 5. As you'll hear from George in more detail, we continue to be below our overall revenue plan. And I just want to point out that many of our businesses and our regions are seeing some good growth and others have fallen short. So it's not across the board. Also, I need to point out that within Buildings, it would be wrong for me to say that I'm sure the merger itself and some of the changes that have come along with that have created some near-term distractions that have contributed to our not achieving our top-line objectives. We believe we can get that back on track. Our teams will, however, continue to offset the revenue shortfall by our continued driving of strategy and productivity benefits. Given our year-to-date performance and the expectations for the fourth quarter, we are guiding to the low-end of our prior range and we expect our full-year adjusted earnings per share to be in the range of $2.60 to $2.62. This will be a 13% EPS growth year-over-year, strong growth, but not quite where we expect it to be when we laid out our guidance in December. Although we haven't achieved all of our objectives, I do remain confident that our strategy and the strategic platform that we're creating, the decisions we're making around integration and organization are positioning us well to serve our customers today and in the long term. It's going to help us lean out our cost structure. And ultimately, will drive both top line and bottom line results. And finally, let me talk about cash conversion. This needs to and will improve. In addition to the large cash outflows this year related to tax payments and the merger transaction, we've also made some operational decisions that have affected our underlying cash conversions. Brian will talk about these in some detail. And George will address it also. So, if you go to Slide 6, it's to kind of give you an overview of or recap of our results. The total company sales for the quarter increased 1% year-over-year to $7.7 billion. Organically our sales grew similarly, 1% year-over-year. Organic growth in Buildings is a little over 2%, partially offset by a modest decline in our power business of 2%. And George will provide more color and the trends in both of those businesses. Adjusted EBIT dollars are up 15% year-over-year. We saw solid profitability growth in the segment EBITA level, primarily driven by the continued focus on cost synergies and productivity initiatives. We benefited also from the lower corporate costs and amortization expense versus prior year, the corporate synergies and the Scott Safety transaction respectively. Adjusted EBIT margins expanded 150 basis points in the quarter to 13%. If you just for impact of FX and lead, margins actually expanded 170 basis points year-over-year. And lastly, EPS for the quarter was up 16% year over year to $0.71. With that, I'll turn it over to George, to talk about the integration and also the business performance.

Thanks, Alex, and good morning, everyone. Let me start on Slide 7, by providing an update on the integration. The new organization structure in Buildings is now in place. We have selected the best athletes and have asked them to play new positions on the field. Region by region, business by business, we have completely realigned the leadership structure in order to eliminate cost and redundant layers of management as well to optimize sales and service productivity. Naturally, this degree of change in a merger of this size brings with it the potential for short-term challenges as the players familiarize themselves with the playbook. With this in mind, we made a deliberate strategic decision to move as quickly as possible to implement our new organizational structure, recognizing this may result in a few false starts in the near-term, but will result in a winning strategy and team in the medium and long term. We remain fully committed to achieving our synergy and productivity savings targets. We have made great progress during the quarter delivering roughly $80 million or about $0.07 in year-over-year savings. We continue to track towards the high end of the original $250 million to $300 million range in cost synergies and productivity savings for the year. With roughly $0.18 achieved through the third quarter, we continue to expect to achieve $0.09 in the fourth quarter, which would total $0.27 in savings for the full year. I am proud of the work we've done across the organization and the significant progress we are making on achieving merger-related cost synergies. As I review the regional performance in Buildings, I will touch on some cross-selling wins. Let's turn to Slide 8. On a reported basis, Building sales in the quarter were flat versus the prior year at $6.1 billion, as 2% organic growth was entirely offset by the impact of FX and net divestitures. Our field business, which as a reminder represents about 65% to 70% of total Building sales, grew 1% organically year over year with mixed performance across the regions. We saw continued momentum in our global applied HVAC business, which grew in the mid-single-digit range. Fire and security, the legacy Tyco installation and service businesses, declined in the low-single-digit range partly due to a tougher comparison with the prior year. Let me quickly walk through the regions, starting with North America. As many of you know, North America is the largest region for both legacy businesses and therefore creates the great opportunity for growth from both a top and bottom line perspective. This is also the region that has undergone the most significant amount of change. At the beginning of the third quarter, we put in place a new regional organizational structure, which combined fire and security with HVAC and controls with 27 leaders. The structure eliminates an organization layer, while increasing our sales management and selling capacity. This now gives us an opportunity to make sure our processes are consistent, that we harmonize the way we go to market where it makes sense and we take advantage of scale. These leaders are a mix of legacy Johnson Controls and legacy Tyco leadership, who know a lot about where they came from, but have a learning curve with the rest of the business. This added a bit of pressure to the quarter. Organic revenue growth was flat year-over-year, with orders down 4%. Keep in mind, order activity can be lumpy and when adjusting for the timing of large orders, year-over-year order growth was relatively flat. As we've now been operating in this structure for a few months, we are continuing to make progress improving the level of depth and expertise of the leaders. Although there has been some short-term impact, I am very pleased with the progress that has been made over the quarter, including the success we have had with cross-selling wins. We designed and implemented a new sales operating model to enable our customers to buy how they want to buy. For example, during the quarter, we won a large project in the healthcare vertical. The fire team secured the order to install a fire detection system in a new building as well as the retrofit work in two existing buildings. Embracing the one team approach, the fire team brought in their HVAC colleagues, who were able to successfully displace a large HVAC competitor. Moving to Asia Pacific, we had a strong quarter all around, despite the concerns of softening macroeconomic conditions. Both organic revenue growth in orders were up in the high-single-digit driven by China and Northeast Asia. Contributing to the growth was a strong increase in service revenue. We've added additional technicians in China and Japan, and we are seeing nice growth as a result. Additionally, the team had several cross-selling wins in the quarter, which contributed to the high-single-digit order growth. For example, the team secured a nice win in Hong Kong for cooling systems in 19 rail stations. By leveraging cross-business relationships, the team was able to secure this win over a seeded competitor. Moving to EMEA, the macroeconomic indicators are mixed across the region. Within our businesses in Europe, low-single-digit growth in Continental Europe was partially offset by a decline in the UK, resulting in overall modest growth. The Middle East, on the other hand, continues to be challenged. However, the decline has moderated to the mid-single-digit. Lastly, Latin America continues to grow organically, primarily driven by our subscriber business. Overall, orders in the EMEA region were down modestly. Looking now at our product business, which represents the remaining 30% to 35% of Buildings sales, increased 4% organically year-over-year. A nice sequential improvement from the 1% decline we saw last quarter. We continue to see very strong growth in our North America residential and light commercial HVAC business, which grew high-single-digit organically, benefiting from a significant amount of new product launches, despite beginning to have more difficult comparisons. Our Hitachi business also grew high-single-digits organically aided by a recovery in the timing of shipments we discussed last quarter. Additionally, as expected, our Fire & Security product businesses have stabilized and are holding flat with the prior year. Trailing EBITA increased 7% year-over-year to $908 million. The segment margin expanded 110 basis points to 15%, a strong synergy and productivity savings modest volume leverage in favorable mix more than offset planned incremental product and channel investments during the quarter. Turning to orders and backlog on Slide 9, total Building orders increased 1% year-over-year organically, up 3% when adjusting for the timing of large orders, driven by a 4% increase in product orders, which drove the revenue in the quarter given the book and shift nature of that business. Field orders were flat with the prior year and strong growth in Asia Pacific was partially offset by a decline in North America and EMEA, as I previously mentioned. In terms of the order pipeline, we are seeing continued momentum in the U.S. market, with stable growth in non-residential construction verticals year-over-year. We expect to see orders growth in our North American field business next quarter. Backlog of $8.4 billion was 3% higher year-over-year, excluding the impact of foreign exchange and M&A. In summary, the teams are coming together as well, having been very engaged with every member of the team through this process. I remain convinced that the strategy of this combined entity is going to continue to unlock significant value for customers, employees, and shareholders. Turning to Power Solutions on Slide 10. Sales increased 6% year-over-year on a reported basis to $1.6 billion, driven by the impact of lead pass-through, which benefited power's top line by roughly 8 percentage points. Organic sales were down 2% driven by a 3% decline in global unit shipments with declines in both the OE and aftermarket channels. OE unit shipments declined 6% versus last year with particular weakness in the U.S. and EMEA related to lower OEM production volumes, which declined at a similar rate. On the aftermarket side, which composes roughly 75% of our volumes, unit shipments declined 2% year-over-year. Weakness in the aftermarket channel was more prevalent in EMEA and China, where customers delayed order decisions based on the drop in LME lead prices throughout the quarter. Given the typical restocking that takes place in the late summer months, we expect low to mid-single-digit organic growth in the fourth quarter. Global shipments of start-stop batteries continue to expand with a 17% increase year-over-year, despite a difficult plus 22% prior-year comparison, including another quarter of significant growth in China and the Americas. The decline in EMEA was tied to the lower level of production in Europe. Power Solutions segment EBITA of $304 million increased 8% on a reported basis, or 7% excluding foreign currency and lead. Power's margin expanded 40 basis points year-over-year on a reported basis, including a 120 basis points headwind from the impact of higher lead costs. On an EBITA dollar basis, lead was a slight tailwind in the third quarter. Underlying margins excluding the impact of lead increased $160 basis points year-over-year driven by favorable price mix as well as productivity benefits partially offset by lower volume leverage. Now let me turn the call over to Brian to walk through corporate and the consolidated financial details of the quarter, as well as our outlook for the fourth quarter.

Thanks, George, and good morning, everyone. On Slide 11, you can see that our corporate expenses were $23 million or 16% lower than last year, as we continue to see the benefits from the ongoing synergy and productivity actions we have in place. We continue to feel that the corporate expenses for the full year will fall at the low-end of the $480 million to $500 million range we originally provided. Before we go into the financial highlight section here, I'll just comment that our results for the quarter do reflect some special items again transaction and integration costs, restructuring costs, and primarily mark-to-market charges those are outlined for you in the appendix both for Q3 and on a year-to-date basis. As I go through the commentary, I'll exclude those items from my comments. I'll also just say then I'm going to move through the financial highlight section pretty quickly here, because I'd like to spend a little bit more time in the area of free cash flow. So on Slide 12, you can see that our sales in the quarter were up 1% to $7.7 billion. It's also reported on an organic basis. SG&A expenses were down 6% quarter-over-quarter again reflecting our team's ongoing focus on cost and synergy realization. If you look at equity income of $69 million, significantly higher than a year-ago, and that again demonstrates the strong performance of the Hitachi non-consolidated joint ventures as well as some Power Solutions joint ventures. So for the quarter, EBIT was up 15% to $1 billion and overall EBIT margins of 13%, were very strong up 150 basis points from 2016. Moving to Slide 13, you can see the net financing costs were up $124 million versus last year and is primarily due to the debt issuances that we discussed with you last quarter. Our effective tax rate of 15% continues to compare favorably to our prior year rate of 17%, and you can see that our income attributable to non-controlling interest is $74 million, which was up $18 million from the prior year, and that continues to reflect the strong performance of the Hitachi joint ventures. The overall diluted EPS for the quarter of $0.71 is up 16% versus the $0.61 a year-ago. Moving to Slide 14, just a quick EPS waterfall here for Q3, and you can see that we delivered our targeted $0.07 benefit from cost synergies and productivity savings in the quarter. Organic growth in Buildings and some favorable mix in Buildings and Power provided an additional $0.03, and we again picked up the $0.02 from the tax rate. These were partially offset by incremental investments in our business of $0.01 and $0.01 of foreign exchange. I will just comment that each of these bridge items are right in line with the Q3 waterfall guidance we gave on our second quarter call. So now let's move to free cash flow, given the significant cash impacts of special items during the year, we've provided a reconciliation for you both for Q3 and Q3 year-to-date. The items that we have called out relate to transaction integration costs, and restructuring costs as well as the tax payments. When you look at our Q3 and year-to-date adjusted free cash flow of $200 million, it's obviously well below where we would typically be at this point in the year. And I'd just like to make a few comments on a few specific items here. As Alex mentioned, there were some specific operational decisions that were made in the quarter, which have resulted in cash outflows versus our original guidance. This included a $400 million inventory build in Power Solutions as well as the establishment of our hedge of our stock-based deferred compensation liabilities. And I'll comment on each of those in a second. In addition to those two items, the timing of dividends from several of our equity affiliates have been delayed, pending further discussion with our minority partners on whether those dividends will be paid or whether they will still be reinvested in the business. So talking about the Power Solutions inventory build that was really driven by customer requests to ensure that we meet their stocking demands during the fourth quarter of this year and the first quarter of fiscal 2018. I just comment that in the first quarter of fiscal 2017, we incurred incremental service and support costs and likely lost business opportunities due to inventory shortages that we had during the peak season, and we want to minimize that as we move into this year's second half of the calendar year. In addition, the lower sales volumes in Q3 and Q2 increased our overall inventory levels. Consistent with Johnson Controls past practice pre-Tyco merger and the Adient spin-off, we made a decision in Q3 to hedge our stock-based deferred compensation liabilities in order to reduce the future income statement volatility associated with the movements on our stock price. As many of you know, Q4 is always a strong cash quarter for Johnson Controls and historically for Tyco as well. We expect to deliver adjusted free cash flow of approximately $900 million, which is slightly higher than last year on a pro forma combined basis of JCI and Tyco. I'd like to do a little walk here to take you back to the original guidance that we've provided of $2.1 billion. If you adjust that for the decline in our earnings per share for the year, you arrive at a number between $1.9 billion and $2 billion. So the bridge that I'd like to kind of take you through here is for the first three quarters of this year, we've got adjusted cash flow of $200 million as you see on the chart. We've got Q4 projected cash flow of $900 million to get to the $1.1 billion. And then if you add to that the inventory build in Power Solutions, the equity hedge of $100 million, and the delayed dividends from the JV of $100 million, you get to a $1.7 billion. Then on top of that, we have seen in the quarter, and a little bit and late in the second quarter of build in receivables within the Buildings business. That relates in part to the fact that we're consolidating a lot of activities into our shared service centers globally right now merging the Tyco locations with the JCI shared service centers. We've seen a little bit of a build in receivables that we need to go after here in the fourth quarter and in the fiscal 2018. I would also kind of step back and look at the trade working capital as a percentage of sales. If we were to target trade working capital as a percentage of sales in the Buildings business to be around 12%, and the Power Solutions business to be around 20%. I think we've got about $500 million plus opportunity to go after some trade working capital opportunities here beginning in the fourth quarter through fiscal 2018. Our free cash flow is below plan levels and we recognize it's been very choppy in 2017 both in terms of the number of adjustments that we're talking you through, as well as overall free cash flow conversion rates. We're committed to improving working capital in 2018, and we think the gap between our reported cash flow and our adjusted free cash flow should tighten. We also think that our free cash flow conversion rate should now be above the 80% level, as certain of the operational items that I just talked about should in fact turn in the fourth quarter late in the fourth quarter or into fiscal 2018. Moving to Slide 16 on the balance sheet. At the end of the third quarter, our net debt to capital ratio is 41.2% up from 40.3% the prior quarter. As most of you know, we are moving forward with the share repurchase program in the second half of this year. It was up by about $500 million in the second quarter, and year-to-date we've repurchased 10.2 million shares for about $426 million. We would expect the full year repurchases to be in the range of $650 million and $750 million. Just talking through a couple of other items that you'll see in Q4. We'll see the items related to restructuring transaction integration costs and income taxes, we also will have our normal mark-to-market on pension and OPEB in the fourth quarter. In addition to that I would mention that we've got the reportable segment change for Buildings that will be made in our fourth quarter of fiscal 2017. As part of our earnings in Q4, we will provide restated quarters our new segment basis for Buildings. Finally, I just wanted to confirm that the sale of our Scott Safety business to 3M is expected to close in Q1 of 2018, and the net proceeds of between $1.8 billion and $1.9 billion will be used to pay down the $4 billion term debt that was incurred in connection with the Tyco transaction. Turning to Slide 18, as far as Q4 guidance is $0.86 to $0.88 which was up 13% to 16% versus $0.76 last year. We've got a year-over-year waterfall, as we've mentioned before, we continue to believe there will be $0.09 of benefit related to cost synergies and productivity savings. We'll have volume and mix of $0.01, which reflects some price cost pressure that we expect to see as we move through the fourth quarter. Our effective tax rate of 15% compares favorably to the prior year of 17, so that contributes a couple of $0.01. I would just comment, we continue to evaluate additional tax synergy opportunities related to the Tyco merger. Finally, continued investments in our Buildings and Power businesses represent a $0.01 impact in the fourth quarter. So overall, our organic growth is now estimated to be 2% to 3% over last year with overall EBIT margin expansion of 70 to 90 basis points. As far as full-year guidance on Page 19, given our reduced Q4 organic revenue growth, we are guiding full year EPS to the low end of the range previously provided that range is $2.60 to $2.62, which represents a year-over-year increase of approximately 13% versus $2.31 on a pro forma basis last year. With that, Antonella, we can open it up for questions.

Thanks, Brian. Operator, can you please open up the lines and provide instructions for asking a question?

Thank you. Good morning, everyone.

Good morning.

Good morning.

Hey, maybe we can start with, Alex, your opening comments you referred to some of the distractions on the integration. And maybe George was referencing the same thing about some false starts. But maybe you could give some examples or some specifics around where that might have been seen in the quarter and how that has been addressed as we look at fiscal fourth quarter?

Yes, so the two things that I'd point out is - one is kind of clear when Brian talked about our receivables issue. If you look at it, as we started moving to shared services I think there is a distraction there. So either some cash, it wasn't collected. Process has changed, people have moved and locations have moved as it relates to some of our collections. So that's one that's pretty easy to get your head wrapped around. We'd like to think that we were not going to have, that things are going to hit the ground. But obviously, if you just look at - if you see the underlying receivables, it was some of the stuff that Brian talked about, you can see that that is something we can get back. But we lost a few days if you look at our DSO. If you think about where the - I think George referenced the largest part of our business being North America. That is where both businesses came together. As we came together, it's just - you can't point to a specific thing and say, well, we lost a project or somebody got distracted. But you just know, because those changes happened right after the end of the second quarter. I mean, we timed it to make sure that we got through the second quarter and then we made the changes. So it's just logical to understand when you go through that kind of change in your field organization, that you're going to have a little bit of time that people need to adjust to the new bosses and new organization. But in the end, when you get out in front of the customer that hasn't changed, so the reason we have confidence that this is a short-term challenge and one that's hard to put your finger on is that, that when you get in front of the customer the people that recall on the customer service and the customer - and their boss at the local level has not changed. But when you look above that, much leaner structure and much more logical structure, one that's going to work for a long term, but it's just - it just change. I think that it would be naive for us to think that that didn't have somewhat of an impact, probably on some of our order secured is my guess. So hopefully, orders aren't lost, it's just - we just got to go through a process. So that's the way - George, you probably have more color on it. But that's the way that I would characterize it. North America would probably be the place that we're going to see, is where we see it.

Yeah, just a little bit to add, Deane. I would say that, when you look at the Buildings organization, you've taken two very large organizations. Although we talk about legacy JCI, legacy Tyco, we're running these businesses across the globe together. You can imagine from a leadership standpoint, the changes that had to occur. I am more confident than ever, the way that the teams have come together. The sales management, sales capacity that we've created, while taking out layers of management, that is going to translate to accelerate growth. Our pipeline, although we didn't convert in the quarter, we see a very nice pipeline built across the globe with opportunities, and the quoting activity as a result of that pipeline is increasing. I'm developing more confidence every day that as we put these organizations together, building off the strong customer relationships that we had within the legacy structures, working together now into an operating system, we're now seeing that coming through.

Got it. And then, just as a follow-up on the free cash flow situation for the quarter. For Brian, is that $500 million trade working capital opportunity? That sounds like a new target. Just the degree of confidence and going after that, the pace of which you think you can begin to ring that out and does this change in any way the JCI longer-term goal of reaching 90% free cash flow conversion by 2020?

No, the 90% is still intact, Deane. As far as the $500 million, that's a target that's based upon where we think our optimal position is on trade working capital as a percentage of sales in each of our businesses. Historically, Building Efficiency and Tyco, I think when their trade working capital is well under control, we feel in a combined basis that a target of 12% there makes sense. We're 150 basis points higher than that right now. When you look at Power Solutions, we are of the view that 20% is a historic targeted level that we think is optimal. We're at 22.5% to 23% right now. If you do the math on that, you pretty quickly get to a number of about a $0.5 billion that should be achievable, and we've got teams that are going after it.

Deane, some of that is some of the same stuff that we have talked about. We have an optimal level of inventory within Power Solutions that is not as high as it is today. But one of the things that we've done is we've gone through - because of the customer issues we had last year, the orders we missed and the service penalties we paid. We put capacity, and as you know, our capital spending is pretty high in North America. We put capacity in that will help us in the future. But this year, we're needing to put inventory in order to get through the season. I think we've got some capacities going in place that will help us offset some of the need for inventory in the future too.

Hey, good morning, guys.

Good morning.

Good morning.

Al, and then we can talk a little bit more about what's going on in your Power business. You guys have leading market share in the business. And I know, last quarter, you suggested that your Power team is feeling good about the rest of the year. And then you missed your own quarterly projections by a significant amount. We know that part of the issue is customers waiting for lead price reductions. But why wouldn't that have been somewhat of a concern last quarter and something that maybe your teams could have been better prepared, so just sort of commentary on visibility around that Power business going forward?

Yes, it's a good question. What I would say is it's not a North American phenomenon, because of the closed-loop system in North America. I think both in Asia, specifically China and Europe we see that phenomenon. There has just been a lot of attention within the business, how much - to motivate your customers how much do we want to do to pull orders forward, which would mean essentially we would give them relief early versus being able to deal with the price changes as they happen. I think that we were probably hopeful that we could pull some stuff into the quarter. I think that naturally it's going to happen. I think we'll see that happen in the fourth quarter. The only thing I could tell you for sure is we haven't lost any share. The team is just as frustrated as you are, because it also hit us in the inventory. If you think about our inventory in Power, it's not only the inventory you built on purpose, but the fact that we didn't get the sales coming out in the quarter that we expected. We don't have our eye on the ball. We're probably a little optimistic that we could pull in front of the price changes for lead.

And, Alex, when you talk about sort of the low- to mid-single-digit growth in the business going forward, is that still optimistic or is that sort of realistic now based on what you see?

I think it's realistic. I think that quarter to quarter, we obviously are seeing some volatility. But if you look at the orders that we have, we are going through a change where a lot of our customers are now moving to AGM products. One of the limiting factors is whether we're going to have the batteries to be able to serve that market as we move forward. Some of the challenges - the reason why it's only 17% growth in AGM, which is not as high as it's been, is part of it is capacity constraints. Our customers are going through changes and we're putting the capacity in as fast as we can. I think the market is there on an overall basis, because you look at the build and the replacement cycles, the market is there. The timing of it is something that we don't control. It got away from us this quarter, because it caught us both on inventory and on sales.

I just want to go back to cash flow. You built about $1.1 billion of trade working capital this year. Brian, you were saying there is about $0.5 billion of relief from that. So I'm just wondering, the message that you came in post-merger was low on working capital and you have to rebuild some of that. As a result, you've gone above that target range you have to delve back. That's the first part of the question. And then the second part is you're not really assuming much working capital benefit in Q4. Is that right? And if so, why is that?

Yes, so the fourth quarter benefits, I mean, if you look at the bridge that we've provided to get to the $1.9 billion. I think there's going to be late fourth quarter into the first quarter. I do think we're going to see at least $200 million of the inventory build flush out. I think the dividends from the JVs, we also are still of the view that are going to be received. As I mentioned, we're resetting the situation now. We're discussing with our joint venture partners whether there's going to be dividends to each of the partners, or whether or not we're going to reinvest in the business. We believe at this point that that's a timing item. On the receivable of a couple of $100 million, I would expect that we would start to see some of that turn as well as we get after this trade working capital initiative that we've got, we're moving forward with here. I do think that there is $400 million of that bridge that we're going to see come back in relatively short order between now and mid-fiscal 2018, which should improve our cash flow north of the 80% level that we had originally targeted for fiscal 2018. As far as your first question on optimal levels of trade working capital, there is no double that we have gone backwards in the first nine months of this year. The biggest pieces of that tended to be the inventory build of Power and receivable we've talked about. There were also payables and also about $100 million headwind there. When we look at our overall initiatives for fiscal 2018, we're going to work toward trade working capital as a percentage of sales of 12% of Buildings and 20% of Power. We think that's a good place to be both from the customer standpoint and from a company standpoint.

Thank you. Good morning, everyone.

Good morning, Jeff.

I just back on cash flow here. Can you give us a sense of what you're expecting for CapEx in 2018 relative to 2017?

Yes, so if you look at Power Solutions, we're finishing the AGM capacity in North America and we've got two plants that we're finishing up in fiscal 2018, early 2019. It's a pretty heavy year from the standpoint of - I would call it growth CapEx in Power Solutions. As you know this year, we guided to $1.250 billion to $1.3 billion, I think we're going to be in line with that. I'm guessing next year could be in the $1.4 billion range plus or minus just kind of what we're thinking right now given the Power Solutions investments.

And just trying to get my head around the conversion, obviously, on the cash flow miss here. Could you understand not wanting to go over-promise for next year, but it's called $100 million headwind on CapEx if you've got this big of a working capital swing. Actually feels like a number could be - could have a nine handle on it, I mean is there something else I'm missing there, I wonder about other kind of charges that are maybe not in the deal integration numbers, et cetera. What are the considerations we should have in mind, when we think about 2018 free cash?

I understand the math you're doing to get a nine in front, but I think we're still in the process of finalizing everything for fiscal 2018, Jeff. We will provide more color on this, when we go through our 2018 guidance. But suffice it to say we all recognize that given the poor performance in 2017 and certainly the working capital areas that should provide some tailwind for us as we go into 2018. I would say, but I want to commit to say right now it will be north of 80%.

I think that's a responsible way for us to answer the question, Jeff, at this point. We understand your math.

Hi, guys, good morning.

Good morning.

What exactly is the hedge for deferred comp, and I have a follow up on that?

So we've got stock-based compensation awards that we give to our employees. You essentially work with a financial institution, you give them the money to purchase the shares and they essentially allow you to provide a hedge against future movement in your stock price. To the extent that we buy in. I believe in the 10-Q that you'll be seeing, I think we brought in at $42.21. That hedge is going to offset movement upward and downward in the stock price versus the $42.21. Essentially what it does is it takes the volatility out of your income statement for any movement in your stock price, which is required under GAAP to be either a compensation expense or compensation benefit as you move through the year.

And if that has any influence on what ultimately your employees receive?

No.

Okay, okay. And then just for - I just looking a bit ahead, these are just basically items that no one at this stage of the game. Any view on kind of what ForEx looks like to be kind of snapped a line here for 2018, and any other parts of the bridge in 2018 that are kind of - would be more just financially oriented? We can all kind of do our own math around volume and mix, but any planned change in the tax rate and also are you reaffirming kind of the synergy forecast that you guys gave at EPG, I assume there is no change and you're executing well this year?

Yes, so the synergy number $250 million, we reconfirm that. The tax rate we haven't finalized all the effective tax rate work at this point in time for 2018. But I would say that it will be 15% or lower. As far as FX, I don't think I've got any specific guidance at this point in time on that.

Yes, I mean, if you take a look at kind of how rates have moved particularly now, you could see that we brought down our FX headwind expectations for the year. If rates stay as they are, if we take Q4 as an example, there is really not much of an FX either headwind or tailwind, it's actually pretty neutral. But as you know, rates change, so as we get closer to 2018 will adjust to the more current rates to see what type of impact that gives us.

Yes, hey, everybody, good morning. I guess, I was just on cash flow cash flow again if there are any thoughts or is there any concern just as you kind of trade off working capital that has any impact on kind of the growth algorithm for the businesses?

I'm sorry. You mean not having or having?

I guess, if terms are tighter, I mean, does that have any impact on how you guys think - how growth could come into the P&L in the Buildings business? If maybe in terms of a little less favorable.

No. I don't think so. I don't think that. I don't see, I think that what we're talking about now is we've got some process issues that we need to effect, and in terms that we need to harmonize that's our opportunity. I don't see that we're going to do anything that's going to affect the growth of the business. That's why I think when Brian talked about it being an entitlement, that's - the way that he was framing it. I thought maybe you were talking about Power Solutions; we did lose some growth, because we didn't have the inventory last year or didn't have batteries. You can think you need to have capacity or you need to have inventory. I think at this point, we got the worst of both worlds, because we've got the extra inventory and we're putting capacity. We will be in a similar shape of next year from an inventory and Power. But if you look at receivables and Buildings, I think Brian talked about right, as an entitlement that's not going to affect our growth, and you look at inventory and Power, it's the same thing that we can take our inventory and Power, it's the same thing that we can take our inventory down and not hurt our growth, because we're putting new capacity in.

Yes, good morning, everyone. Thanks so much for taking the question. George, you mentioned earlier that you're starting to see very nice pipeline, and favorable quotation activity. Can you just give us a little more color on maybe where that is geographically or kind of within the segments?

Sure. If you start, let me start with North America, because that's certainly the big focus area. At the new organization that we put together, we freed up a lot of resources. We took out the layers of management to put back into sales management as well as selling capacity. We're putting the businesses together, we got a little bit behind of our hiring plan with our salesforce. But we're significantly increasing our sales capacity as we speak. With the work that we've done, the team has done a nice job in putting together properties in the field. As we're now leveraging the existing customer base that we serve to be able to better serve the customers with a complete portfolio. I talked a little about that in my prepared remarks, making it simpler for the customer to be able to buy from us the total capability. When you look at the pipelines that have been developed across the globe within our direct channels, we are beginning to see that. There's a timing of conversion as we go through this, but it gives me confidence that we're going to begin to see an improvement on a go forward basis. In our product businesses, the team has done a really nice job, not only making sure that we're leveraging our direct channel but also expanding our indirect channels across each one of our product businesses. Not only are we investing in our direct sales capability, but we're also expanding our channels. You'll see some of the bright spots during the quarter in our DX business with a very difficult compare; last year we were up about 17% and were up another 10% this year. That is really an output of some terrific work done in expanding our channel to be able to capitalize on the growth in market share. What I can tell you across the board is, it's certainly a key focus and being able to not only get world-class sales management but increasing capacity in our direct channel as well as our indirect distribution. That will enable us to be able to capitalize on a broader part of the market.

Okay, great. Thanks. And then just on Power Solutions, Alex, I think you mentioned kind of some capacity shortages around AGM. With all that we're seeing and reading around kind of changes to try to change across the auto industry. Is it AGM demand kind of trending globally the way that you thought it would, as you look out the next couple of years or perhaps accelerating. How do we think about that and kind of your own capacity build plans?

It's a good question. There's so much that's been written about this whole topic, but what we're saying is probably going to move faster than we can afford to meet the capacity. We're going to have to be really careful that we put the capacity in the right place and leverage it, because I think it's just going to escalate. We see people trying to put some batteries that are quite AGM capable, and then what we find is they come back later and say we need to do something else. Our capacity plans are pretty significant; our share is really high. I think there will probably be more demand, which will be a good problem to have. I just think we're going to have to be pretty choosy on who we serve. I think that's where we're going to be in the next few years.

Hi, good morning. Just wanted to circle back on the Power Solutions division. It's obviously unusual to be sort of growing inventories while sales volumes came in a bit light. I understand that the guidance is for aftermarket sales to recover in the next few months. But just thinking about the risks that inventories stay high, how would you characterize inventories today versus a typical time of year or typical seasonality in the battery business right now? Then also, on the Power side, I understand the drawdown of working capital not really having a revenue impact. So maybe just talk about any profit or EBIT margin impact as you get that adjustment on working capital in Power. Thank you.

Our inventory is much higher than it was a year ago. That is twofold. One is it's a response to the fact that we had service problems over the last year-and-a-half. We had service problems in the peak season because our peak capacity is probably 120% of our total capacity. So if you have to have an inventory to be able to serve our customers. We had meetings with our customers, particularly in North America, our very large customers who essentially put us on notice that they're not going to be short of batteries anymore. We've compensated for that in a way that we have the inventory and we're also putting in capacity, so that we don't have to have this much inventory ongoing. A year from now, inventory levels won't be quite this high. But they won't be as low as they were a couple of years ago. But that still gets us in the range of where Brian was talking about as far as what we would believe our entitlement for working capital. Within Power Solutions, it really is an inventory story.

I don't think there's going to be any impact negatively on margins as that inventory turns out. I mean, as we kind of talked about in the past, sometimes your margin rates can vary depending upon where lead is. But I don't think there is a downward pressure on margins of Power Solutions as a result of that inventory turning out.

As you said, we're getting really good traction with the new products that we're bringing to market. When you look at the performance across our portfolio, I think that's beginning to show, whether it'd be in residential, like commercial or across applied, as well as within our controls. That's where a lot of the investments are being put in. What I see going forward is, as we continue to gain the momentum, we're going to continue to reinvest and look at incremental investments that we see as - given the success we've had in each of these segments that we see a lot of opportunity with the investments we're making. We'll take that into account as we're beginning to accelerate and gain market share.

Yeah, thanks for fitting me in. So following up on the cash flow. In Q4, how much of the items that you mentioned that slipped out of Q3 and perhaps this year do you expect to recover? So Power's inventory build, $400 million, the hedge, the dividend, and the receivable, the $200 million receivable, how much is embedded in your expectation for Q4?

In what we've talked about, none of it is expected to come back in Q4. We think most of it will come back in first and second quarter fiscal 2018.

Okay. And so, given that, I think previously you've talked about $300 million tax item coming back to you in Q1 as well. Should we expect that Q1 and perhaps Q2 of fiscal 2018 will be very, very strong free cash flow relative to history?

Should be stronger than we've seen historically, that's right.

And Gautam, that one thing to remember is that when the cash went out for the tax payment, we had it as one of our reconciling items. When the cash comes back, we said we would do that as well.

So we won't take credit for it; we'll just take the money. Okay.

Operator, it is - yeah.

Let me just wrap up here. Thank you to everyone for the call and all your questions. We really appreciate it. I just want to make sure that, I understand your feedback. There are three things I would like to point out. First is the synergy and productivity numbers are doing as well or better than we expected. We don't really expect that to change. I want to ensure that as we talk about this that we show that we're making progress there. Top-line is mixed. We have some opportunity. We are seeing some benefits and we haven't lost those benefits, but there are some opportunities for us to make some improvements. Third, clearly, cash flow we get it - there's work that needs to be done. We are a little gun-shy talking about, as you can see from our responses around how this is all - how and when this is going to come back. We know the opportunity there, and we're committed to making sure you're going to see the cash flow numbers as good or as better than what we've talked about in the past. I want to wrap up on that and I want to thank our employees. Lot of hard work is being done in order to make this one company. Thank you very much.

Thanks, Alex. And operator, that concludes our call.