Johnson Controls International plc (JCI) — Q4 2018 Transcript

Good morning and thank you for joining our conference call to discuss Johnson Controls fourth quarter fiscal 2018 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, George Oliver; and our Executive Vice President and Chief Financial Officer, Brian Stief. Before we begin, I would like to remind you that during the course of today’s call, we will be providing certain forward-looking information. We ask that you review today’s press release and read through the forward-looking cautionary informational statements that we’ve included there. In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins exclude restructuring and integration costs as well as other special items. These metrics are non-GAAP measures and are reconciled in the schedules attached to our press release, and in the appendix to the presentation posted on our website. GAAP earnings per share from continuing operations attributable to Johnson Controls ordinary shareholders was $0.83 for the quarter and included a net charge of $0.10 related to special items. These special items primarily relate to restructuring and integration costs in the quarter. Adjusting for these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.93 per share compared to $0.87 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 the call today. Let’s get started with a high-level review of what we have accomplished over the last 12 months starting on Slide 3. 2018 was a year of significant progress for Johnson Controls. We executed on our commitments and exited the year with strong momentum. We made significant strides on all of our target metrics and key initiatives. And I will touch on a few of those in just a minute. We executed a disciplined approach to capital allocation, paid down nearly $2.6 billion in debt, and returned excess cash to shareholders, including $300 million in share repurchases and almost $1 billion in dividends. We established the cash management office and challenged the team to drive operational improvements by establishing sound fundamental processes and metrics across the organization, which resulted in a 30% increase in cash from operations year-over-year and improved free cash flow conversion to 88%. We changed our annual and long-term compensation incentives to better align with shareholder priorities. Lastly, we have made significant progress over the past several months related to the strategic review of Power Solutions. We have assessed multiple options and are now in the final stages of that review as we weigh all possibilities before reaching a final decision. We will provide an update when complete. While I am very proud of what the team accomplished this year, there is still a lot of opportunity ahead of us. And we are taking action to make sure we capture it. Turning now to our scorecard on Slide 4. In the interest of time, I won’t spend a lot of time on each item listed here on the slide, but these were eight major commitments that we made to you at the start of the year and how we performed against each of those. Contributing to our successes here is our effort to better align senior leadership with driving execution and creating a performance culture. Over the course of the year, we focused on setting more grounded expectations with increased transparency and accountability. Just to touch on a few of these themes, you will notice that the top four all pertain to improving the organic growth trajectory within buildings. In 2018, we delivered 5% organic growth in aggregate across our Buildings platforms, which compares to our original guidance of low single digits. One of the major drivers of the upside was improved execution in our service businesses across all of our regions, which is the result of the work we began in 2017 to expand our commercial capabilities, strengthen operations, and increase our service technician capacity. Service revenues grew 4% for the full year, and we exited with Q4 growth of 6% with momentum continuing into next year. We set and exceeded an aggressive target to increase our global sales capacity in Buildings, adding 950 salespeople net of attrition, representing roughly an 11% increase in the existing salesforce. Additionally, by applying our commercial excellence principles, we were able to improve sales productivity for both the new and veteran salesforces. The combination is visible in the 7% organic order growth performance across our field businesses this year. Against a backdrop of healthy end-market demand, orders for our service equipment and install businesses should see continued strength in 2019. You will notice two yellow checkmarks on organic growth in Power and underlying EBIT margin expansion. In both cases, we came in at the low end of our original targets. On the margin front, although we are at the low end of what we communicated to you at the start of the year, we navigated through an accelerating inflationary environment and offset all with $30 million of costs with incremental price in 2018. We also continue to reinvest in our businesses, primarily through engineering and R&D within our products divisions, but also the incremental costs and under absorption associated with the salesforce additions I just mentioned. Lastly, on free cash flow, we exceeded our target for 80%-plus conversion at 88% for the year, driven by solid performance and underlying cash from operations as well as a disciplined CapEx reduction. Turning over to Slide 5. Buildings field orders continued to accelerate in the quarter, up 9% year-over-year organically. Underlying order strength in the quarter was broad-based with all three regions up high single digits or better. We are seeing continued strength across most of our core product domains, including bookings for installation and service. Orders for large applied systems grew low double digits in both North America and EMEA/LA. I am very proud of the work our teams have done over the course of this year, driving 7% organic order growth for the full year. Our project pipeline remains robust, and we expect continued order momentum across our end markets as we look into 2019. Turning now to Slide 6. Let me recap the financial results for the quarter. Sales of $8.4 billion increased 3% on a reported basis and 6% on an organic basis with 8% growth in Buildings and 2% in Power. Adjusted EBIT of approximately $1.2 billion grew 4% on a reported basis and 9% when adjusting for the impacts of the Scott Safety divestiture, foreign exchange, and lead. Favorable volume and mix as well as the benefits of cost synergy and productivity savings more than offset incremental organic investments back into our business. Overall, EBIT margins expanded 10 basis points year-over-year on a reported basis or 50 basis points excluding the impact of the Scott Safety divestiture, FX and lead. Underlying performance was led by Buildings, which expanded core margins by 60 basis points in the quarter. Adjusted free cash flow in the quarter was approximately $1.3 billion, which brings the full year to $2.3 billion, representing 88% conversion. Brian will discuss our performance in more detail later in the call, but I would like to recognize the cash management office as well as the numerous dedicated individuals throughout the organization who put in a tremendous amount of effort this year, significantly improving our cash processes and positioning us to deliver strong free cash flow. Slide 7 bridges our EPS growth year-over-year with respect to some of the items I just discussed, as well as the number of other small items, which impacted us during the quarter. Adjusted earnings per share was $0.93, up 7% over the prior year. With that, I will turn it over to Brian to discuss the performance within the segments.

Thanks, George, and good morning. So starting with Slide 8, let’s take a look at performance of Buildings on a consolidated basis. You can see that building sales in the quarter of $6.2 billion increased 8% organically with our product revenues up 9% and field up 7%, led by a strong 6% growth in service and accelerating growth in project installations, which grew 7%. Divestitures, primarily the sale of Scott Safety, were a 3 percentage point headwind, and FX was about a 1 percentage point headwind. Buildings consolidated EBITA of $939 million grew 11% organically with strong growth in both our field and shorter cycle products businesses. Buildings EBITA margin expanded 10 basis points to 15.2%, which includes a 50 basis point headwind from the divestiture of Scott Safety and FX. So on a normalized basis, our margins expanded a solid 60 basis points. As you can see in the margin waterfall, synergy and productivity savings and favorable volume leverage and mix contributed 120 basis points, which includes positive price cost in the quarter. This was partially offset by 50 basis points of planned incremental product and sales capacity investments. As George mentioned, field orders increased 9% organically and our backlog is up 8% to $8.4 billion. Now let’s review each of the segments within Buildings. So turning to Slide 9 in North America. Sales of $2.3 billion grew 8% organically as we saw project installation activity accelerating 10% with service growth up 4%. We saw another quarter of solid performance in applied HVAC and controls platforms, which grew mid-single digits organically, led by an 8% growth in core applied HVAC equipment installation and service. Fire and security grew high single digits with balanced growth across each platform, led by mid-teens growth in security project installations. Our solutions business, which is only about 10% of North America’s revenue, grew high teens on a relatively easy prior year compare. This business can be a bit choppy for an order and revenue standpoint on a quarter-to-quarter basis. So if you look at North America adjusted EBITA of $336 million, it grew 7% year-over-year, and EBIT margin was flat at 14.5% as we saw the benefits of volume leverage and synergy and productivity savings offset by the planned salesforce investments and an unfavorable mix as we saw installed revenues grow at more than twice the rate of service in the quarter. Orders in North America increased to a strong 8% organically, driven by applied HVAC orders up low double digits and fire and security orders up mid-single digits. Backlog of $5.4 billion increased 6% year-over-year. So moving to EMEA/LA on Slide 10. Sales of $948 million grew 6% organically with continued strength in service, which was up 8%. We saw an inflection in project installations, which grew 4%, as we worked off the lower backlogs as we entered 2018. Growth was positive across all regions and across all lines of business, with the exception of the Middle East HVAC business. Europe grew high single digits driven primarily by a rebound in Industrial Refrigeration and HVAC and orders in Europe increased high single digits organically in Q4 led by strong demand in IR, HVAC, fire suppression, and security. In the Middle East, revenues were up slightly as continued growth in service was mostly offset by continued softness in HVAC project installations. In Latin America, revenues increased high single digits led by strength in our security monitoring business, in addition to solid growth in controls and fire suppression. Adjusted EBITDA of $103 million increased 8% on a reported basis, with 15% organically. EBITDA margins expanded 60 basis points to 10.9%. But again, this includes 30 basis points headwinds from foreign currency. The underlying margin improvement of 90 basis points was a result of favorable volume/mix and productivity and synergy savings, which was again offset by salesforce investments. Orders in EMEA/LA increased 10% with solid growth in all regions across both service and project installations. Our backlog ended up at $1.5 billion, up 9%. So moving to Slide 11 on Asia-Pac, sales of $689 million grew 4% organically, driven by strength in service. Project installation revenue grew modestly for strong growth in fire and security and IR, offset by continued weakness in HVAC. Adjusted EBITDA of $105 million declined 4% year-over-year. Adjusted EBITDA margin declined 90 basis points to 15.2%, where we again saw the benefit of productivity savings, cost synergies, and favorable volumes more than offset by salesforce additions and underlying margin pressure. As we highlighted for you at the end of Q3, we did expect to see some margin pressure in Q4 related to the highly competitive environment in China, but we do expect our margins to stabilize in the early part of fiscal 2019 and expect overall modest margin expansion throughout fiscal 2019. Asia-Pac orders increased 8% driven primarily by service orders, which were up 20% in the quarter. Our backlog increased 11% to $1.5 billion. So turning to global products in Slide 12, our sales increased a very strong 9% organically to $2.2 billion with high teens growth in Building Management Systems, high single digit growth in HVAC and Refrigeration Equipment, and low double digit growth in Specialty Products. In BMS, we saw strong growth across our controls, fire detection, and security businesses. Sales across the HVAC and Refrigeration Equipment grew high single digits, with global residential HVAC growing just over 20% in the quarter, which was aided by a relatively easy prior year compare. We did see favorable weather which drove higher replacement demand, and we gained market share with new product introductions as well as the expansion of our distribution footprint. We also saw strong price realization in the channel during the quarter. Global light commercial HVAC grew low single digits led by mid-single-digit growth in North America despite a tough mid-teens prior year compare. IR equipment revenues grew mid-single digits in the quarter, led by high-teens growth in North America. Our applied HVAC equipment business grew low double digits reflecting strength in our indirect channels in both North America and Asia. Finally, our low double-digit growth in Specialty Products was driven by increased demand for fire suppression, with broad-based growth across all of our regions. Segment EBITA of $395 million was up 3% on a reported basis but up 18% if you exclude the impact of the Scott Safety divestiture. Our reported segment EBITA margins of 60 basis points include a 100 basis point headwind related to Scott Safety. Our underlying segment margins expanded 160 basis points in the quarter to 17.8%, where we saw higher volume leverage and mix positive price costs in the quarter and the benefits of cost synergies and productivity savings, partially offset by the planned channel and product investments we’ve discussed before. So let's move to Slide 13 and talk about Power Solutions. Sales of $2.2 billion increased 2% organically on a tough prior year compare, driven mostly by a decline in unit shipments, primarily in our aftermarket channel. Total battery shipments declined 1% year-over-year with shipments to OE customers up 5% and aftermarket shipments down 2%. On a comparative basis, we shipped a record number of batteries in Q4 of last year after a relatively soft Q3. Our growth in OE shipments outpaced global market growth and also reflects several new business wins that we expect to continue as we move forward. In addition to tough prior year compares, shipments to the aftermarket channel were impacted by about 1% percentage point related to Hurricane Florence. Global shipments of start-stop batteries increased 20% year-over-year, with strong growth in the Americas, China, and EMEA. Segment EBITA for Power was $424 million, decreasing 2% on the reported basis and 1% organically. The margin declined 80 basis points year-over-year to 19.4%, which included a 10 basis point headwind for FX. Power's underlying margins declined 70 basis points, reflecting continued pressure around transportation costs, some unfavorable volume and mix, and lower fixed cost absorption in our plants. Those items were offset by some favorability in productivity savings. Freight costs remain elevated and we expect some continued pressure in the near-term on transportation costs as we work to offset these incremental costs through pricing, as we renew agreements with our customers. On Slide 14, corporate expenses were down 11% year-over-year to $95 million, and again, we made good progress on the synergy and productivity savings front. So let me turn to Page 15 and talk about cash flow. Our reported cash flow was $1 billion in the quarter, and if you exclude the planned integration and restructuring payments and a non-recurring tax payment of about $300 million, our adjusted free cash flow was a strong $1.3 billion in Q4. For the full year, adjusted free cash flow was $2.3 billion, which is up roughly $1 billion over the prior year. As George mentioned, this represented free cash flow conversion of 88%. For the full year, we delivered significant improvement in cash from operations and also reduced our CapEx spend by about $200 million relative to our original plan of $1.25 billion. Going forward, we'll continue to use a very disciplined CapEx approach. If I look forward to fiscal 2019, adjusted free cash flow conversion will approximate 90%. This guidance excludes special cash outflow items of about $300 million to $400 million and also excludes the $600 million tax refund that we expect either in late fiscal 2019 or early fiscal 2020. Turning to the balance sheet on Slide 16. Our balance sheet position continues to improve with net debt down nearly $1 billion sequentially in the quarter to $10.8 billion. Our net debt to EBITDA leverage is 2.2 and our net debt to cap declined to 33.8%. During the quarter, we repurchased 1.2 million shares for $45 million, and for the year, we repurchased 7.7 million shares for $300 million in line with our original plans. Additionally, as we look to 2019, we're now in a better position to return more cash to our shareholders. The Board of Directors has approved an additional $1 billion share repurchase authorization, which is in addition to the $900 million that remains in prior authorizations. We expect to complete approximately $1 billion of share repurchases during fiscal 2019. Finally, let me just touch on a couple of other items on Slide 17 before I turn it back over to George. I'd like to give you a quick update on U.S. tax reform. As you know, our original assessment was that the effect on our fiscal 2019 rate could be in the range of up to a rate of 16% to 18%. As we work through the details of the provisions of the new tax code, we now expect our effective rate to be 16% in fiscal 2019, which compares to the 13% rate in fiscal 2018. Lastly, as we mentioned on the third-quarter call, we've got a new revenue recognition accounting standard that will become effective for us in the first quarter of 2019. The impact of the standard on buildings is not significant, but for Power Solutions, even though there's not a significant impact on EBITA, there is an impact on revenue, and as a result, there'll be a gross-up in sales which will impact our EBITA margin rate by over 200 basis points. We have provided in the appendix to the deck normalized financials for the quarters for Power, so you can update your models with the new information.

Thanks, Brian. Before we open up the line for questions, I want to provide you with our outlook for 2019. Let's start by walking through the puts and takes embedded in our 2019 guidance on Slide 18. As Brian mentioned, our tax rate for fiscal 2019 increases to 16% from the 13% effective rate reported in fiscal 2018, and this equates to a $0.12 headwind year-over-year, which normalizes our fiscal year 2018 EPS to $2.71. We expect mid single-digit organic growth, which will drive approximately $0.28 of earnings, primarily driven by improved volumes and price. Additionally, we will have the continued benefit of synergies and productivity savings, which we will realize over the course of the year that will contribute an additional $0.23 of earnings. As you are all aware, the U.S. dollar has continued to strengthen; based on recent rates, we expect this to result in an $0.08 foreign currency headwind year-over-year. Additionally, the carryover of the salesforce investments, as well as a few cents of incremental investments in our product businesses, are expected to total about $0.07. All of these factors contributed to our fiscal 2019 EPS guidance range before special items of $2.90 to $3.05, representing growth in the range of 7% to 13%, adjusting for the impact of the increased tax rate. The full details of our guidance are included on Slide 19. Our guidance is based on strong underlying EBIT growth of 8% to 12%, driven by strong top line performance in synergy and productivity benefits. While we are pleased with our 2018 results and continuing momentum into 2019, there is still a lot of opportunity ahead, and we remain focused on driving execution. With that, let me turn it over to our operator to open the line for questions.

Thanks. Good morning, George and Brian, and Antonella.

Good morning, Nigel.

Good morning.

Right. So I'm sure this is a question you don't really want to address, but I think it has to be asked at least. I'm sure you were hoping to have an announcement about the outcome of your portfolio review that had a lot of press reports around potential bidders for that business. Can you maybe just talk about how you narrowed the range of options for Power? If you have maybe just address that and alternatively, is everything still on the table?

Yes, what I would say, Nigel. We've gone through a very thorough process and have been assessing multiple options. I would tell you, we've been very disciplined in making sure that whatever the outcome is that we're going to be positioned to be able to create the most shareholder value. A little bit disappointed around the timing, but it's something that we can't control. What I would say is that we have made significant progress. There are a significant number of considerations that we've taken into account. What I believe is most important now is making the right decision versus keeping to a set timeline. We are evaluating all of the multiple options before we reach the final decision; as I said, all options are still on the table.

Okay. I'll leave it there, maybe there'll be other questions then. And maybe just turning into the cash flow outlook for 2019, maybe this is for Brian, maybe just talk about what CapEx number is in there? I'm sorry if I missed that in your prepared remarks. And then the one-timers, the $3 million to $4 million of one-timers, can you just maybe just talk about those? Are there discrete tax items in there as well?

So the guidance at 90% free cash flow for fiscal 2019 includes roughly $1 billion of CapEx. So it is on a comparable level with where we ended this year, Nigel. As far as the special items for fiscal 2019, that represents really a lot of the integration costs and restructuring that we've taken as part of the whole Johnson Controls Tyco integration. If you recall the $1 billion in savings over the four-year period, we've commented that was probably about a dollar for dollar cost to save, and that really reflects the remaining portion of the cost to deliver the $1 billion. There are not any unusual or non-recurring tax items in that amount.

Okay. And then just a quick one on top of that. The cash tax rate, is that going forward, is that going to be similar to the GAAP tax rate?

It will be certainly closer than it's been in the past. I think 2019 could be quarter-to-quarter, may be a little choppy. But for the year pretty normalized, and then when we get to 2020, it should be back very close.

Okay. Thank you, guys.

Hi, good morning. Maybe just the first question on the Buildings margin guidance. I think you've guided that to grow about 40 basis points to 60 basis points in fiscal 2019. If I look at the Q4 margin performance, you are up about 60 basis points, excluding Scott Safety, and I would have thought that maybe with less investment spend, maybe less price cost headwind, your margin improvement may accelerate from Q4. So maybe just help us understand what are some of the offsets, is it tariffs or mix or something?

Yes, Julian. We've made a lot of progress here when you look at the overall margins and when you look at the aggregate of what we're forecasting here for 2019. What we'll see is very nice progress on the price cost within our products business and that's coming through as you've seen here in the last couple of quarters. Then within our field businesses, when you look at the field businesses, we've got the headwind of the salesforce investments that we've made through the course of 2018 and that becomes especially in the first half of this year, some headwind on the margin rate. If you look at the overall margin rate, we pick up about 30 basis points on volume with the continued strong organic performance, we pick up about 60 basis points of productivity and synergy savings. That is being offset with the reinvestments that we have, a little bit of a headwind that we have from the salesforce expansion that we made, and then some incremental investments here in products. As we go through the course of the year though, as we position now through 2019 and into 2020, you'll see those headwinds subside because now that we've got the growth machine working. We've got the orders now at a rate that we believe is well above the market. We're now driving our service growth and with the investments we've made in products, that's ultimately what's going to drive the growth and the overall margin expansion longer-term. There is a little bit of headwind here in 2019, but we feel good about the 40 to 60 basis points that we've guided here for our Buildings business here in 2019.

Thanks. And then just my follow-up question would be – apologies if I missed. But any clarity you could give on the impact of tariffs? Maybe just what you saw the fiscal 2018 impact from tariffs was on a gross or net basis, what you're assuming it is for fiscal 2019 and maybe just any detail on how it affects the two segments differently?

Julian. When we looked at this, in total, for the total years, so we started to get hit with the 232s in 2018 and then subsequent to that the 301s. When you put order of magnitude across both, it's roughly about a - I'm going to say roughly about a $130 million, $140 million, and we saw about half of that come through in 2018. I would tell you from a pricing standpoint, as you all know, we got behind the price cost curve early in the year in 2018. We've been very aggressive with price through second, third, and fourth quarters. We're in a very good position right now from a cost standpoint taken into account, all of our inflationary costs including tariffs that on a go-forward basis, we're going to start to see price cost being positive throughout the year, with the work that's been done from a pricing standpoint. We feel that we've taken all of the 301s even the full potential headwind that that would potentially create. We've packed that into our cost base, and we've taken the pricing actions to be able to offset that.

Very helpful. Thank you.

Hey, good morning guys.

Good morning.

Good morning.

George, field and installation picked up nicely in the quarter to 7%, helping you get to overall field revenue growth of 7%. Are we at the point, given your increased salesforce, where you can feel revenue growth can basically match field backlog growth and installation growth at the same time? Can you sustain that mid single-digit growth that you saw? And separately, just on the applied HVAC product acceleration, are you seeing new products really starting to gain traction or is it just a strong institutional market there?

So let me start with the overall – the backlog, and the work that we've done this year within our salesforce and how we built the backlog. All of that has been broad-based across our field businesses, across HVAC, Industrial Refrigeration to our Fire & Security businesses. I would tell you it's been globally very much broad-based. Now, with that backlog, we've also been able to accrete the booked margins. So we've been booking better margins in backlog, and that's what ultimately is going to support the margin expansion as we go forward here through 2019 and beyond. Now when you look at the growth rates, we've got an 8% backlog going into 2019 that is what gives me tremendous confidence that as we go through 2019, the guidance that we've given is firm because as you look at where we started in 2018, we started off with a backlog around 2%. Ultimately, we were able to accelerate for the course of the year to be able to get to the 5% Buildings organic growth. So in regards to your question, I absolutely believe that you'll start to see the organic revenue growth in line with the order growth that we're achieving. You started to see that in the fourth quarter, and through 2019, you'll start to see those two lines converge, on the installation side. What I'm very excited about is service, from a service standpoint, we've been expanding service. We're trying to expand service as rapidly as we're expanding our install business. As you all know, that's where we get significant improved margins, and across the board, we've expanded our not only our commercial teams but also the fulfillment capabilities to be able to drive service. Recall that we were at modest growth in 2017, like 1% or 2%. We were able to ramp up 3% to 4% to 5% to 6% during the quarters in 2018, and that gives me confidence we're going to see the orders that we've been able to achieve in service begin to convert to stronger revenue here in 2019 and beyond. So in regards to that, I do believe that through the course in 2019, you'll be able to see the convergence of organic revenue to what we've been able to achieve from an order standpoint. Now, the second question?

HVAC.

On the HVAC, when you look at our HVAC performance, I couldn't be more excited about the progress we've made relative to the new products that we brought into the market and the expanded distribution that we've put into place across the globe. If you look at a couple of segments, our North America residential HVAC equipment revenue was up 21%. I would say that, that's to an easy compare from last year. But overall, when you look at whether it's the favorable weather that Brian talked about, the channel expansion that we've made, the price realization, that gives me tremendous confidence here that we're gaining share and making a lot of progress with the new products we've launched. When you look at light commercial, we were up about mid-single digits, but that's to a much tougher compare from last year where we were up double digits. Our global applied HVAC equipment business has launched a lot of new products in that space, and we're beginning to see the pickup with those new products. Now globally, we're roughly at mid single-digit growth. But I would tell you in North America, the success of the products and the expansion that we've had is driving double-digit growth in North America. So I'm very pleased with the progress we're making in that space.

George. Just a quick follow-up on Power Solutions, if you look at the volume mix component in your margin, markets slips, I think plus 30 last quarter to minus 80 this quarter, obviously slower growth this quarter, so a little bit more under absorption. But how much of the change was warrants-related disruption in the quarter? And does that impact go away in Q1 this year?

Yes. So that was part of our challenge that we had with a little bit of volume, and then the margin pressure that we had. I would tell you that most of it was driven by the mix. So when you look at our Power Solutions business last year, the compare, we had a record year of volume in the fourth quarter of 2017. In 2018, our OE volume was up 5%, and then our aftermarket volume was down 2%. So that was a significant impact on the margin rate. Organically, we showed 2% overall, and that was driven by price and mix. But when you look at the mix between OE and aftermarket, that is what drove that margin pressure. That in addition to all of the headwinds that we've had with our transportation and logistics have offset. We had strong productivity, but Power has offset the productivity that we achieved during the quarter. What I see going forward is more balanced mix, as we project the volumes here, as we get into 2019. We are seeing some decent volumes, given that this is our strong season, and I am encouraged based on the volumes I see coming through, and that I think that will normalize the margin rate on a run-rate basis as we go through 2019.

I would just add to that. I think the way to think about the impact of the hurricane and Power is that it was probably roughly a $0.01 in the quarter impact to us.

Appreciate it. Thanks, guys.

Hey, good morning. How are you?

Good morning, Steve.

Just a question on the CapEx. How much this year will be battery CapEx? And then how much out of the billion is battery next year?

I would look – I think in terms of probably a third of the CapEx will be Power Solutions and two-thirds Buildings and corporate.

Okay. And that's going to be kind of consistent for next year or the Buildings CapEx stays flat, and most of the reduction is on the Power side most of the change?

It's going to be pretty consistent Steve, between 2018 and 2019. So one third, two-thirds.

Okay, got it.

Just a comment on that. When we look at CapEx, what we're going through is we're being very disciplined. I mean, we are investing, we are supporting the growth that we're achieving, and we're making sure that all of the capital expense that we incur is truly aligned to being able to achieve this accelerated growth. I can assure you that from a payback standpoint, we're well positioned with these investments.

Yes, absolutely. I’m just curious. So when you kind of look at the improvement in conversion. Is that coming – I’m just trying to kind of discern, is that – part of that is from battery CapEx coming down obviously, as you guys are disciplined on that business, correct? Is that kind of how we’re looking at it?

Yes, I mean, I think there’s probably, when you think about Buildings CapEx versus Power CapEx, there’s probably a 10% to 15% difference in conversion between Power Solutions and the Buildings business. So…

Okay.

Yes.

Got it. And then just anything around quarterly sequencing when it comes to kind of seasonality of the year? Anything on cash or EPS that we should be aware of?

No, I think historically, we’ve been about 19%, 20% EPS in the first couple of quarters, probably just short of 30% in the third quarter, and then low 30%s in the fourth quarter. Based upon the plan that we put together, we don’t see any major shifts from that Steve.

Great, that’s super helpful. Thanks for the color.

Thank you. Good morning, everyone.

Good morning.

Good morning.

I just want to follow up on Steve’s questions on CapEx. And George you emphasized a point about staying disciplined on CapEx. There were some projects that got deferred. Just give us a sense of what were those projects? And are they being added into 2019, or are they canceled altogether?

Yes, when we did the review, I mean there were certainly things that came out. But there was nothing that was deferred into 2019. I mean, we did it strictly as George mentioned on a return on invested capital basis, and if it didn’t have the payback, it’s something we’re not going to move forward with. You shouldn’t view the reduction in CapEx in 2018 as something that closed into 2019. 2019 will be evaluated on a stand-alone basis between the businesses.

Got it. And then on the salesforce investment, George it would be interested in – since it has had such an impact across your businesses. Could you talk a bit about how the new sales folks have been deployed across the businesses to geographies? And at what point do they become productive? You made a comment earlier about salesforce productivity, and you measured the veteran versus the newer folks and what’s baked into your assumptions into 2019?

Yes. So, right out of the gate, Deane, as I took over last fall, this was front and center and we immediately embarked on putting some type of processes around sales and putting the discipline and getting the right targets and getting the right incentives. Most importantly, segmenting the market and how we serve the market. When you look at our salesforce, we’ve got multiple segments: enterprise selling, HVAC equipment, fire and security, long-term contracts, and short-term service. Getting that right was very important. We did that across the board. Then we said, where is the market growth? How are we going to compete? Where do we need to add? What skill sets do we need? By doing that, we’ve been adding through the course of the year, as I’ve said, we netted 950, and then within that, we’re making sure that as they’re ramping up within each one of their segments, we have an expected level of production during that ramp-up. Every segment is a little bit different in how it works. But I would tell you with the discipline, the process, the accountability, with the incentives, we’ve been exceeding the ramp up in each segment. I have a lot of confidence here based on the output. We’re still expecting here from an order standpoint to be high-single-digit order growth again through the year. We’re getting our salesforce up to speed. I can assure you that this process also allows us to be able to address low performance, to ensure that we’re getting high-quality salespeople coming in, we’re giving them the right targets, they’re ramping up appropriately, and ultimately delivering on the expectations of the reinvestment we’re making.

Thank you.

Yes. Thanks, good morning, everyone.

Good morning.

Good morning.

George, I was wondering if you could give us some context for the consideration of exiting Power Solutions. The math, when we look at it, looks like it could be dilutive if it were sold, assuming reasonable multiples. I’m just curious how you balance the potential for dilution versus the right portfolio long-term; how do you make those trade-offs?

Yes, we’re looking at all of that. When you look at a business and the fundamentals of the business, the ability to be able to create value, both short and long-term, we’ve taken all of that into account. We’re looking at not only continuing to run; I mean this is an incredible business with a market-leading position that is in an attractive vertical and it will be for some time, and we’re focused on how do we continue to deliver value with that. We also made sure, as we look longer-term, that we can position it to create the most shareholder value. It also factors in as we look at the portfolio and how the overall portfolio is performing. We want to continue to be positioned with optionality within Buildings, so we can continue to strengthen our Buildings position because we do have an incredible platform that I believe, with the combination of our strong product technologies and capabilities combined with our channel, we’re positioned extremely well now to capitalize in that space. We take all of that into consideration, and we’ve gone through thorough reviews in this process, we made a lot of progress, and there’s been a lot of learning in some cases. It’s making sure that we do what’s right not only for our investors but also for the employees that are part of that business.

That’s helpful. I appreciate it. Just a quick follow-up: you mentioned the applied business in North America looks really strong. Where do you think we are in that cycle? How many years left do you think we have of mid-to-upper single-digit or perhaps double-digit growth? What’s the underlying market growth you think, and how long might we actually sustain that?

Yes. All of the indices suggest this continued expansion, whether it be ABI or – there are other indices on starts and the like. We’ve been very successful in being able to expand our footprint in capacity and at the same time also be able to get more attractive projects with the pricing that we’ve been putting into place in the market. I’m feeling, I’m still pretty bullish, at least over the next year or two, that this is going to continue based on what we’ve seen with the activity, what we’re quoting on, and a lot of the large projects that I’ve been involved with, with some of the key customers that we support. It’s hard to predict; I hear all the same reports that you hear and some of the concern that we’re at the mid or end of the cycle. Based on what I see today, I still see it continuing, and because of that, we’re doing very well. We’re generating revenue from the expanded footprint in the sales capacity that we put in place.

Thank you, guys.

Good morning. This is David Silverman on for Steve.

Hey, David.

Good morning.

Hey, David.

Good morning. So in the past, you’ve talked about potentially divesting 5% to 10% of the Buildings portfolio that you considered to be non-core. From a portfolio management standpoint, is that kind of still on the table? If so, can you give us an idea of what you might be thinking of as non-core?

Yes. We continued to review the Buildings portfolio. We have made several small divestitures that most don’t hit the radar screen. These are very small businesses that are distractions and we’ve continued to look at those. We’ve also made some small bolt-on acquisitions mainly in our Building Management Systems space. Overall, one of the divestitures you might have seen where, we did a – we entered into a joint venture with Con Ed on our distributed energy storage business here late in Q4. There’s a lot of activity like that, that we’re working on to clean up the portfolio. When you look at the overall 5% to 10%, I would say we’re still in that range. These are businesses that, when you look at our core strategy of strengthening our HVAC platforms and leading in Building Management Systems, these are businesses that might not fit into either of those two categories. They are good businesses, are running well, and timing wise would be the best way to be able to then potentially divest or reinvest that into core HVAC businesses and/or Building Management System. We’re still reviewing the portfolio, still in that ballpark of 5% to 10% of the overall Buildings portfolio.

Yes. I would say as it relates to that. Just think about it, it would be smaller businesses that would be transacted over time. It’s probably a multi-year journey that we’re talking about that gets to that 5% to 10%. As we’ve talked about in the past, the extent that there are non-core Tyco businesses that could be sold, we can use the proceeds from the sale of those businesses to pay down the original Tyco portfolio debt of $4 billion, which is now down to about $1.4 billion after a couple of years. That would be another item that would be taken into consideration as we think about some of the portfolio moves.

Okay, understood. Thanks for all the color.

Hi, good morning.

Good morning.

Good morning.

So also late in the – or I guess early in Q4, we saw the small Lux deal around smart thermostats and home automation. But I was wondering if you were to take a look at your deal pipeline, as it stands today, if there is any color around if it’s more opportunity around consolidating existing building systems you’re already strong in, or if there’s some opportunity to move into places where you might not be as strong in terms of building systems, thinking about a slide you presented a couple of years back around lighting and electrical.

Yes. What I would say is that right now, we’re focused on these acquisitions by being bolt-on, mainly driven by technology or capabilities that we felt as we’re looking at our organic investments required to ultimately lead and/or fill gaps inorganically. These are the size of businesses, so they’re relatively small in the grand scheme. My belief is as we go forward and build more capacity here, we’ll continue to look at opportunities to be able to take our platforms and position them, so we can continue to accelerate. So at this stage, our focus has been execution driving strong organic growth with the investments we’re making. If there are gaps, we’ve been building a pipeline to fill some of the small gaps. There’s been nothing significant at this stage.

Okay. And then one from a higher level perspective here to Buildings. A lot of times these systems are particularly around HVAC are being sold more around energy efficiency. One of the trends we’re starting to see is a movement more toward wellness, moving away from energy star rating to more of a wellness rating. Are you actually seeing this in your business today, or is that not something that’s on the radar screen?

I mean, I can’t speak for our team. I wouldn’t say that I’ve been directly involved in that type of dialog. But I would tell you our teams are absolutely assessing the current trends, happening in HVAC, making sure that from a technology standpoint, we’re leading those trends. When I think about the work we’re doing in our digital solutions, it’s taking all of the data collected through these multiple systems and then optimizing performance and reducing energy, but also now it’s tied to improving comfort, individualized comfort, and a lot of other outputs with the work that we’re doing. A lot of our work around digital solutions in the Controls piece of what we do in HVAC is a critical component to being able to achieve that outcome that I believe you’re talking about.

Great, thank you.

Operator, let’s turn the call back over to George for some closing comments.

Thanks again for all of you joining our call this morning. As you’ve seen, we’ve made a tremendous amount of progress in 2018, and we’re fully committed to building upon that momentum in 2019. I look forward to engaging with many of you here over the next coming days and weeks. So, operator, that concludes our call.