Johnson Controls International plc
Q1 2015 Earnings Call Transcript

Published: 22 Jan 2015

[Operator:]

Welcome and thank you for standing by. [Operator Instructions]. Now I will turn today's meeting over to Glen Ponczak. Thank you. Sir, you may begin.

[Glen Ponczak:]

Well thanks, Candy, and welcome to everybody on the call to review Johnson Controls first quarter 2015 earnings. Just so you know the slide presentation if you don't have it can be accessed at JohnsonControls.com by clicking the Investors link at the top of the page and then scroll down to the events calendar section. This morning Chairman and CEO, Alex Molinaroli, will provide some perspective on the quarter and review some of the details on the announcements we made last night regarding a definitive agreement to form an HVAC related joint venture with Hitachi. He will be followed by Executive Vice President and Vice Chairman, Bruce McDonald for a review of the business unit results and then Executive Vice President and Chief Financial Officer, Brian Stief will review the company's overall financial performance and following those prepared remarks, we will open up the call for questions and we are scheduled to end a little bit before the top of the hour. I just wanted to note that both Alex and Bruce are joining us this morning from the World Economic Forum in Davos, Switzerland. So please forgive us if there is any grumblings that cause any delays or other transmission issues over the next hour. Before we begin, I would like to remind you and refer you to our full forward-looking statements disclosure that is in the news release and also in the slide deck and remind you that today's comments will include forward-looking statements that are subject to risks, uncertainties and assumptions that could cause actual results to be materially different from those expressed or implied by such forward-looking statements. Those factors include required regulatory approvals that are material conditions for the proposed transaction to close, the strength of the U.S. or other economies, automotive vehicle production levels, mix and schedules, energy and commodity prices; availability of raw materials and component products, currency exchange rates and cancellation or changes to commercial contracts as well as other factors discussed in Item 1A of Part One of Johnson Controls most recent annual report on Form 10-K for the year ended September 30, 2014. Johnson Controls disclaims any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this presentation. With that, we will move the call to Switzerland and Alex.

[Alex Molinaroli:]

Hello, everyone. I think we said that if we don't like the questions we probably won't be able to hear very well, maybe that is what we are doing. So let's talk about the first quarter. I'm incredibly pleased with what we were able to accomplish. Hopefully as you go through this you can see we are gaining some momentum. I look forward to talking about our Hitachi deal and hearing your questions. As you saw in the release, we did have revenue increase of 1% and if you look at our business across the globe, currency translation particularly in Europe cost us 4% growth so we would have had 5% growth without the translation. Segment income of $768 million that’s 18% over last year and if you look at all of our businesses, the margins are improving and all of that for the most part is being driven by initiatives that we had in place and the work that being done with our Johnson Controls Operating System. Our $0.79 is a little better than what we expected when we were giving out our guidance for the first quarter in December and that really has to do with everyone meeting and exceeding their targets. The thing that I'm probably most proud is that we are seeing a continual increase in our margins, we have 110 basis point increase from this quarter to last quarter and we continue to see that as something that we can expect on an ongoing basis. If you go to the second page, we talk about the environment we are in and it seems to be changing. I mean North America is stronger than we expected and it will be interesting to see what happens with fuel costs down what it is going to do to mix. We will talk about that later. In Europe, down 2% and I think that is pretty much what we expected, it is in the range of where we expected and then China up 6%, you will see our orders and our revenues exceed that and it has a lot to do with how we participate in the China market and our gains in share. Our aftermarket battery demand, it's really back to normal not a new normal. Last year we had some real issues with volumes and this year we are really seeing things come back to what I would consider normal. Inventories are stable. We had a real cold spell for a while and at this point it's hard to predict what is going to happen in the next few weeks, but so far our volumes are up. You see up 4% in Q1 and one thing that is not in here, I don't think it is in the release, I'm not sure, but our AGM sales are up over 30%. And so that speaks to the North American adoption rate. One of the recent vehicles that was launched was the F150. And then a lot of questions around our demand in our commercial HVAC, as you saw, it didn't show up in our backlog yet and we did in anticipate that it would but what we do see is our pipeline getting more full particularly in some of our institutional customers that we hadn't seen in the past. I highlight K-12 as being the largest increase. And then I skipped over the commodity cost. So at this point what we forecast for the year at our current commodity cost, we are seeing a benefit that’s being offset by the translation loss that we are having, particularly driven by the euro. So we have a near-term headwind that has to do with how quickly we’re receiving some of the translations versus our commodity cost, but by the end of the year we think that it is going to not be material. We will keep updating you on that but at this point that is the way that we are going to talk about it is commodity cost offsetting the euro. If you go to our first quarter highlights on page 5, we got a good bit accomplished. The first thing we will talk about is Hitachi and you know that has been something we have been working on quite some time. We are very happy the fact that we actually signed that yesterday here in Davos and we are going to be releasing a lot of the new products and talk about them at the ASHRAE Show, the heating and air-conditioning show that’s in Chicago next week. Last quarter we talked about, we increased our dividend 18%, up 18% and that should keep us moving in-line with the multi-industrial dividends. So in all the things that you are seeing us do, talk about the buyback, we are 1/3rd of the way through our buyback, all of these things are showing our commitment to our capital allocation and capital structure consistent with where we are trying to take the company. A couple of other people announcements happened over the last few weeks. One that is notable is Jeff Williams, I'm not sure if many of you know Jeff Williams or not. He is one of our best operations people in the company. He has grown up in the automotive business. He currently runs our - he had run our seating business in automotive and prior to that he has had many commercial and operational jobs but he is one of the steering committee members of our manufacturing counsel and he has agreed to take a job so we can take our operating system to the next level. He will be working for me at corporate and we will be taking the net steps towards our operation systems implementation around manufacturing, purchasing and engineering. If you look to the right of the slide it's something that I don't want to get lost. You can see the product portfolio is starting to fill out and you can look and see some of the brands that you will start to know us by. Within ADT, there is multiple brands but you can see our York brand and our Hitachi brand. We are not going to talk about branding so much today but over time we will talk about how we are going to position those brands and in particular how the Hitachi brand along with the products is going to be very important to us. On the next slide, on slide 6, let's talk about the joint venture. So when you put our two entities together in the joint venture and then you add it to the current capabilities that Johnson Controls has, we’ve become the largest commercial air-conditioning company in the world and we also between the Hitachi, our existing products, the Hitachi joint venture and the ADT acquisition, our portfolio in the commercial business is really second to none. And we’re very proud of that and I think that is going to help us in the light commercial area along with some of our distribution changes that we are going to be able to have a business that is not so dependent just on the high end. When we looked at Hitachi, there is a couple of things that were important. One was the VRF technology, the second thing that was important is their distribution particularly in China. We immediately become the number two player in China and then across Asia in general with the Hitachi brand and their products makes us a player immediately. Let's go through the investments in the business. So the revenue is around $3 billion, at this point we haven't sorted out whether we will consolidate this or not. We will sort that out over the next quarter and keep you updated. We can talk more about that if you have questions. Ownership, Johnson Controls 60%, Hitachi 40%. The initial margins 4% to 5%; those margins are being dragged down quite a bit because of the residential part of their business and so that is an opportunity for improvement. The commercial margins on the business are similar to the margins that we see in the rest of our commercial businesses. We expect to close in the fourth quarter and this is obviously very consistent with where we are trying to take the company particularly our investments in BE. When you look at why Hitachi and what we get and what we look like after the joint venture, we talked about, I talked about the number two position in China in VRF that is incredibly important. The manufacturing footprint that we get that’s outside of North America and the Americas mostly in Asia. We also get scroll compressor technology and that is something that we have been lacking, that’s going to allow us to be more vertically integrated in some of our light commercial and residential offerings over time. There is some engineering that has to happen but I think that is a real opportunity for us that we haven't been able to exploit particularly because of our scale that should help our cost position over time. The brand, Hitachi brand, particularly for these type of products first being a Japanese brand, fits with these products and Hitachi with their quality. They are known for their quality and their technology and the distribution channels that we get outside of North America. We do get some residential air-conditioning technologies. As I said today it's not near as profitable as we would like it to be and it is an opportunity for us to improve that. The next slide, on slide 8 is one that I think is representative of how we see Hitachi and Johnson Controls and how they complement each other. This puzzle, the blue shaded being what Johnson Controls had already had products between the ADT acquisition and our York products. To the red or whatever that color is - red or orange color where we see the products that we get that complement us where either we have a position that is small and we can extend it or we don't have a position around the products that we have and of course this doesn't include the scroll technology that we will get with the acquisition, but these are the go-to-market products that we will have. We also could represent this by brands because we are going to be selling these products through multiple channels and so we will have not only a technology strategy but a brand strategy to go with it. So with that I'm going to turn it over to Bruce and we can talk about each one of the businesses.

[Bruce McDonald:]

Okay. Thanks, Alex and good morning, everybody. So starting with the automotive here on slide 9, we had a strong quarter as you can see. If you look at the sales line and all our businesses I will talk about the underlying sales excluding FX and you can see that we would have been up about 2% not really for the euro impact here and to a lesser extent the yen. Margins, great performance by the business going up 26% and you can see at the bottom of this slide, seating margins were up 90 basis points in the quarter to 5% and interiors margins were up 170 basis points to 3.6%. Up on the right we have kind of noted the fiscal Q1 production levels and maybe against that backdrop I will just tell you how our geographic revenues came in. So in North America we were at 3% versus the 5% so a little bit below. Here we are really seeing the impact of some of the business that is rolling off as a result of some of our quoting disciplines in the last year to 18 months. In Europe down 1%, we performed up 1%. Really what you are seeing there is the impact of luxury volumes being a lot more interior contents are benefiting from that and then China, the production we estimate was up about 6% and our sales as we noted here were up 15%. In China, we are kind of benefiting from a few trends. One, SUV market is really starting to take off and if you just look at 2014 as a proxy for the quarter, SUV volumes in China were up 32%. Luxury vehicles even though we source of a lot of the content from Europe even into the next second tier luxury vehicles, those were up 21% in 2014 and then if you look at our sales mix being more heavily weighted towards the European and North American manufacturers, the Chinese owned brands are losing share so what you are seeing is the VWs, the GMs and the alike, Ford, gaining share at the expense of the Chinese owned brand. So really those are the three reasons why our business has substantially outperformed the market and I would probably be remiss if I also didn't mention the sort of strides that we are making growing our metals business. If we flip over to slide 10 for building efficiency, here you can see sales were up 5% and if we take out the impact of the ADT acquisition and FX, it would have been up 1% in the quarter so some growth but not the robust levels that we expect to see over the back half of the year here. North America, our revenues were up 3%, Asia up 1% and you can see Latin America down double digits, so kind of a mixed bag on a regional basis. In terms of the margins and here we are sort of showing it with and without GWS, but if you look at BE ex-GWS, margins in the quarter were 6.7% which is 110 basis points better than last year. And there we are really benefiting from improved operational performance and the beneficial impact of ADT being enriching to our margin. We were pleased to see the momentum that we saw last year in GWS carry forward here in the first quarter. Revenues were down slightly 3% but margins improved significantly and I would note that while the GWS business did benefit from about a $13 million contract settlement gain which was in our guidance, even backing that out was solid margin expansion in the quarter. Also on the right, we talk about our backlog being down 4% adjusting for FX and from an orders perspective generally speaking about level with last year if we adjust for foreign exchange and the fact that we had $150 million deal, Hawaii Department of Transportation order in the prior year. That’s an exceptionally large order, for us a large order I would say in Building Efficiency. A mega order would be $20 million so that sort of puts the $150 million kind of in perspective. I think the only other thing I would comment here is in the light commercial part of our business like our unitary business on the ADT side, we did see order activity up mid-single digits so as we talked about when we bought ADT getting that increased exposure in the lighter commercial part of the market should start to benefit us and we did see that in our order intake in the quarter. I usually give backlog and order information by geography. In the interest of time I won't do that today but Glen can certainly follow up in the future, you can follow up with Glen in terms of what the regional outlook was. Then on page 11, I will flip over to Power Solutions. Here you can see our sales were up 4%. If we adjust for foreign exchange and lead, sales were up 8%. So we are pleased with that. In terms of our segment income, you see up 4% but I would remind everybody that in the last year's Q1 we had a $19 million non-recurring gain associated with the consolidated joint venture. If you sort of back that out to make an apples-and-apples comparison, our margins were up about 90 basis points so we are pleased with the performance here. As Alex mentioned, AGM volumes are up 31%, OE and aftermarket were each up 4% overall. I put a comment here about managing lead volatility and for some of you that have been following us for a while you know that in times of rapidly moving lead prices we can experience some windfall gains or losses as it takes time for our sort of indexing contracts with our customers to roll off or on and as we sort of buy cores and things like that. So the last three or four years have been in a pretty stable environment where lead has kind of been in that $2000 to $2100 type range. We did see lead commodity prices dip down fairly significantly more than double digit here towards the end of the first quarter. That is going to introduce a little bit of volatility to our earnings and that is something that I would just remind people that we do have that and it can inflate or deflate our reported margins and on a quarterly basis something that can introduce some earnings volatility. It is not a long-term issue but on a quarter-over-quarter basis it can. And then lastly and maybe before I turn it over to Brian, I will just update folks on where we are with the portfolio initiatives. So obviously I'm not going to talk about Hitachi again here but maybe just focusing on the other two major initiatives we have. So on our automotive interiors joint venture that we are working on with Yanfeng Automotive Trim Systems really substantial progress in the quarter. We have received regulatory approvals in most of the major geographies. We are going through in terms of China; you have to go through a formal valuation process to get SASAC approval. We expect to have that done by the end of February and get SASAC approval at the end of March which would then trigger us signing our joint venture in April and we are on track with that which would then facilitate start of operation at the beginning of our fourth quarter on July 1. So a lot of work kind of behind the scenes on this one but I think we are pretty confident in terms of getting the approvals here by the end of April and starting this thing up at the beginning of the fourth quarter. And then in terms of GWS, really pleased with how it's going, strong buyer interest, very strong buyer interest. We expect that we will be in a position to announce who this business will be sold to probably in early Q3. Within GWS, we have a joint venture in Australia and Canada with Brookfield Asset Management and as part of this transaction, we had a buy/sell type arrangement with Brookfield where they could either step into our shoes with the successor owner of this business or they could buy us out and then during the quarter we sort of resolved that with Brookfield agreeing to buy our shareholding. We expect that will close here in the second quarter and we will get proceeds of about $200 million. So good news out there and in terms of the three big initiatives we have a lot of progress in 90 days and so with that I will turn it over to Brian.

[Brian Stief:]

Okay. Thanks, Bruce and good morning, everyone. So on slide 13 if you look at our press release we did identify transaction and integration costs associated with the high level of portfolio activities that we have got going on right now of about $20 million, $19 million after-tax or $0.03 in the quarter. As I talk through these financials, I will exclude the impact of those transaction costs which is consistent with the guidance that we provided at our Analyst Day in New York in December. Overall first quarter revenues as Alex mentioned, were up 1% to $10.7 billion with higher underlying revenues in all three of our businesses and this was partly offset by the impact of foreign exchange, excluding FX, revenues would have increased by 5% year-over-year. Gross profit for the quarter of 15.8% was up 90 basis points from last year and we’re seeing good focused operational execution in our businesses and we are also beginning to see the early benefits of our Johnson Controls Operating System implementation which we talked a lot about in New York as well. On a year-over-year basis, SG&A declined by 2% which is the result of ongoing focus on costs across all of our businesses and if you look at equity income, our prior results as Bruce mentioned include a non-recurring gain of $19 million related to consolidation of a joint venture in our Power Solutions business in the first quarter last year excluding that gain, equity income of $102 million would have been up 10% reflecting the continued strong profitability of our automotive joint ventures particularly those in China. Overall, operating income was up $118 million or 18% versus 2014 and our first quarter segment margins of 7.2% were 110 basis points better than 2014, all in all a real strong performance across the board for our businesses in Q1. Turning to slide 14, net financing charges of $71 million were $16 million higher than prior year levels. These higher financing costs were attributable to the financing for the ADT acquisition which was $1.6 billion in the third quarter of last year as well as our ongoing share repurchase program. We have purchased $600 million of our stock back in the first quarter which compares to $1.2 billion that was repurchased last year and as you know that’s part of a three-year $3.6 billion program that we initiated about 18 months ago. For the quarter, our underlying effective income tax rate is about 19%, up slightly from last year's 18.7% and income attributable to non-controlling interest in the quarter was a charge of $39 million which is $6 million higher than last year and again that’s just attributable to our automotive joint ventures in China where we are seeing improved profitability. Overall, very strong first quarter with diluted earnings per share from continuing operations of $0.79, up 20% versus $0.66 a year ago and slightly higher than the guidance that we provided for the quarter. So moving to page 15, I would like to spend a few minutes on our balance sheet and cash flow. Although it's a net outflow in our first quarter which is usual, our free cash flow did improve by $200 million compared to the first quarter of fiscal '14. Trade working capital continues to be an area of focus for us and we are pleased to see about a 50 basis point improvement in year-over-year trade working capital as a percentage of sales when you adjust for FX and the businesses held for sale which would be GWS and Interiors. Capital spending of $280 million for the quarter was slightly lower than our original plan due to some project timing but it compares to $345 million a year ago. I mentioned the buyback of $600 million in the first quarter and I would just point out there that this buyback program we have obviously got flexibility with our ability to turn on or turn off that program depending upon whether there are other investment opportunities with better returns. Our balance sheet position remained solid at the end of the quarter with net debt to cap of about 40.5% that compares to 35.7% at the end of the year, at the end of the fiscal year 2014. I would just point out that if you look at our free cash flow forecast for the remainder of the year plus the net proceeds that we expect from the GWS and Hitachi transactions, that our net debt to cap ratio should be in the mid-30s again by the end of fiscal '15. So our outlook for the second quarter is $0.74 to $0.76 per share again excluding transaction costs which we think will probably again range in the $0.02 to $0.03 per share level and although we do see some headwinds on FX in Q2 as Alex mentioned, we think the all-in fiscal year impact of FX should be largely offset by favorable commodity prices. We remain confident that we will deliver our full-year guidance of $3.55 to $3.70 that we provided at the analyst meeting in New York. So overall I think we have good momentum going into Q2 with riding on the heels of a strong Q1 performance. We have made excellent progress on our portfolio activities and I also think we are beginning to get some traction around the enterprise-wide Johnson Controls Operating System initiatives. So with that Glen, we can open it up for questions.

[Glen Ponczak:]

Yes, Candy, we are ready to take questions. I would ask those who are in the queue to give a main question and a follow-up and if you have more to get back into the queue just so that we give more people a chance to speak. And Candy, we are ready to go.

[Operator:]

[Operator Instructions]. Our first question comes from Colin Langan of UBS.

[Colin Langan:]

On the Hitachi transaction, can you give any color on - are there chances to get out of the 60/40 structure to fully own it over time? Is that an intent long-term, is that embedded in the contract somehow?

[Alex Molinaroli:]

This is Alex. I don't know that is our intent. I think that our ability to dilute what has to do with capital infusions. One of the things that is really important to us is the Hitachi brand and I think if Hitachi pulled out of the JV completely I think that would be difficult for us to maintain the brand. So I think we are going to have a long-term partnership and in fact I think it will probably grow as we met with Hitachi folks over the last couple of years, as other opportunities for us too.

[Colin Langan:]

Okay. Just one follow-up. What has to happen to get the margins back to the rest of the business and how long do you think it will take to get there to the building efficiency average margin?

[Alex Molinaroli:]

For Hitachi?

[Colin Langan:]

Yes, for the Hitachi deal, sorry. Yes.

[Alex Molinaroli:]

So the margins range wildly when you go around the world. In Japan, the margins are low overall, that is a consistency if you look at their competition. If you go to China, our margins are good in China, in Asia in particular. We don't have much sales in North America, we expect those margins to be healthy but the residential is the real drag. So I think the two things I would say is the Japan business which is something that will likely be a drag on margins for a long time, it has to do with the environment there and the residential which is something that we aim to fix or understand better and figure out if it fits with the rest of our business.

[Colin Langan:]

So the issues are Japan which will be a continued laggard and residential which you - think about strategically longer-term?

[Alex Molinaroli:]

That’s correct.

[Bruce McDonald:]

But in terms of order of magnitude it's really about residential. I think within a couple of years if you look at what we are planning on doing the sales growth that we anticipate in North America, I would say it would be two years the commercial side of this business will be comparable. The residential which you can see in the bar, one of the pie charts nearly half of the business and that’s what the real drag is.

[Operator:]

Thank you. Next question Robert Barry of Susquehanna. Your line is open.

[Robert Barry:]

Actually just a couple of quick clarifications on the Hitachi question. The 4 to 5, is that an EBIT margin or an EBITDA margin?

[Bruce McDonald:]

It's an EBIT margin, segment income.

[Robert Barry:]

And has anything changed since the original MOU was announced and in particular, was it always contemplated that half the JV would be residential?

[Alex Molinaroli:]

Yes, it was all the products that they sell. So Hitachi on its own is essentially out of the HVAC business. Their HVAC business which fits inside their clients group is now a joint venture with Johnson Controls so we took all of it. Now strategically and Colin was asking the question about strategically how important this is, that’s also where the compressor technology comes from. We don't want to make a rash decision on what our strategic choices are. We have to understand it better, but yes, it was always contemplated.

[Bruce McDonald:]

One thing I would add to that, Rob, is we used to talk about the business having about 3% margins and the profitability while we have been in discussions on the improved and that would really be attributed to the growth in their business in Taiwan, India and China. Those markets are accretive, highly accretive and we have seen really rapid growth there. That is going to help.

[Alex Molinaroli:]

And just some color on that, so the earnings are better than when we started and of course we are benefiting from the translation of the yen as it relates to what the economics of this deal looks like.

[Robert Barry:]

And then maybe just finally on auto, could you break out what was going on the revenue in seating versus interiors and just how it kind of foots with the outlook for the year to be down 5% to 6%. It looks like you are off to a much better start.

[Brian Stief:]

We are off to a better start. I think if you look at the automotive breakout for the quarter, I mean as we said in the slide, if you take the automotive interiors business, if you look we have got improvement in interiors for the quarter of about 1% and then seating was down about 3% for the quarter. As we mentioned earlier on the slide for automotive, there is 3% all in but if you adjust for FX, we get back to plus 2%.

[Alex Molinaroli:]

Yes, four for seatings and four [ph] interiors ex-FX.

[Brian Stief:]

Rob, one just reminder. When we gave our guidance and set down 5, don't forget we backed out one quarter of interiors. We were assuming that we would lose about nearly $1 billion of sales in Q4. That’s how we got to the down 5%.

[Robert Barry:]

Okay, so they down 5 to 6, is for really seating and interiors as long as you expect to have it?

[Brian Stief:]

Yes, that is right. And we expect the interiors to be gone July 1 of '15. That is the significant item.

[Robert Barry:]

Okay, but bottom line it sounds like the seating piece alone is tracking a little bit better than you thought?

[Brian Stief:]

Correct.

[Operator:]

Thank you. Next question is Emmanuel Rosner with CLSA.

[Emmanuel Rosner:]

Wanted to ask you first about your commercial backlog and orders in the building efficiency business, I was a little bit surprised to see the backlog back in the down territory after showing - being in the green last quarter. Orders flat as well. Can you maybe give a little bit more color on what you are seeing there and more importantly what gives you confidence that we are going to see some better comps in the second half?

[Alex Molinaroli:]

This is Alex. I will take that and Bruce might have some couple of things to add. I think you probably have to listen carefully. We were always concerned that we weren't going to be able to overcome the Hawaii deal, the $150 million in a quarter for us is a significant amount of secured sales. So I think that was one of the things so we anticipated that our backlog would be down. Obviously the revenues - we are seeing revenue in excess of what our backlog is in excess of what we thought. The reason that we are gaining confidence is if you look at the pipelines for the remainder of the year, you look at our Q2, our Q3 and our Q4, we’re seeing a substantial increase in the pipeline. So we need to translate those into orders so much so I mean we have been - we are talking with the team there about do we have the confidence yet to start hiring salespeople because we don't want to wait until the market is already there before we hire the salespeople. So those are the kinds of conversations that we are having in building efficiency which is a much more positive conversation and kind of bodes to the confidence level.

[Emmanuel Rosner:]

Okay and then just a couple of points of clarification again on the Hitachi joint venture. First of all, does the JV carry any debt? Also curious in terms of the revenue, what is it currently? I know you said $3 billion by 2016 and then just finally on the margin profile, the 4% to 5% is that immediately or was that a 2016 number as well?

[Brian Stief:]

So if you look at the revenues to answer that question first, the $3 billion is a '16 number if you look at the '15 number at current exchange rates, it is probably 2.5, 2.6, something along those lines. As far as the margins of 4% to 5% as we look ahead, those margins at the end of our four- to five-year period, we expect those margins to get up into high single digits and that also would not include opportunities that we have to do better on the residential air-conditioning business. So we will make some decisions on how best to run the residential air-conditioning business going forward and that should actually provide some improvement across the board to all the overall Hitachi joint venture margins.

[Emmanuel Rosner:]

Great. And any debt?

[Brian Stief:]

And as far as debt, there is nominal debt from day one in the voucher.

[Bruce McDonald:]

But the 525 just to be clear is cash-free debt-free number.

[Operator:]

Thank you. Next question is Rod Lache with Deutsche Bank.

[Rod Lache:]

Just wanted to clarify your just previous comment, how do you get to the high single digits within Hitachi excluding the exit from residential? And maybe you can elaborate a little bit more on the ability to extend that business throughout your distribution elsewhere? And then lastly, on Hitachi, what is the reason why it might not be consolidated if you own the majority?

[Alex Molinaroli:]

I will start that and see if we can get them all. It sounds like more than a follow-up. Let me see if I can catch them all. The reason that we would see the margins go up and then we are confident about that is our focus is going to be growing the commercial part of the business, the VRF part of the business and a lot of that would be to continue growth in Asia but also being able to leverage our distribution not only in Europe but in North America, the channel that we will be using is the channel that we acquired through ADT. So we feel fairly confident we will be able to grow the commercial and also will be growing the margins. So what you are going to see is the percent of the residential would go down in our current pro forma because we are essentially saying we are not contemplating doing much different at this point, that’s a strategy yet to be talked about. So we will have more volume at a higher-margin of commercial business which would be our focus. What was your other question?

[Rod Lache:]

The consolidation of it.

[Brian Stief:]

Why don't I take that one, so despite equity ownership interest there are certain other criteria that you need to meet in order to say you have full operational control of a joint venture which would allow consolidation and depending upon how some of the final provisions work in the agreement, we may be in a situation where even though we own 60%, we don't in effect have operational control of that joint venture on a go forward basis. So it really gets down to some technical accounting application of consolidation versus equity accounting rules.

[Alex Molinaroli:]

Yes, so let me add a little detail to that so that you understand. From an operational standpoint, Johnson Controls will be leading the business plan, the operational plan. What Brian is referring to is the multiyear strategic plan that has to be approved unanimously and that essentially is to get right down to the detail that’s essentially what we have to make sure we understand how to account for it. But from an operational standpoint, Johnson Controls will be managing the business. We have the CEO as announced and we also have the CFO which we haven't announced yet.

[Rod Lache:]

And Alex, just to clarify, is that business growing double digit even before you add your distribution? I think you said it was like 2.6 going to 3 next year. Is there an organic trajectory that’s pretty favorable there?

[Alex Molinaroli:]

Well they are growing fast, so there is a lot of consolidated and unconsolidated parts of this business. So I would say that the parts of the business in Asia are growing at that rate. They also have been focused on the commercial - Japan not so much. It's a very mature market as you say very competitive, but I think what we are saying is the markets that are large, China is seeing that growth happening and where we are not seeing it obviously is the other growth market is North America because they don't have any presence in North America and that’s what we will be releasing this week here in ASHRAE.

[Operator:]

Thank you. And next question is Brian Johnson with Barclays.

[Brian Johnson:]

A couple of questions again I guess all related to BE. Given what you just said about the control, how do you foresee the distribution and the product side of Hitachi JCI JV working with your existing branches in the U.S. and in Europe and Asia where it's more still one business with that and you must have thought through, are they going to be to running into each in the market [ph] how do you kind of work on bids together and so forth?

[Alex Molinaroli:]

I'm glad you asked that question because we haven't given a lot of clarity around that. One of the things you will see in the release it talks about that we don't have the sales and service in Japan but Hitachi has that. Johnson Controls in places like North America will actually have control of the distribution. So we will be managing the distribution both through our branch network and through our other channels. The part of this that is actually different is really Japan where it didn't make sense for Johnson Controls to be managing distribution; it makes sense for Hitachi to manage the distribution.

[Brian Stief:]

So maybe you can think about it Brian in some terms, as a manufacturing joint venture, Hitachi will control the distribution in Japan and we will largely control the distribution outside of Japan.

[Alex Molinaroli:]

And that would include the branding. So what you can expect in places like North America actually all around the world is that we will sell similar or same products through different channels with different brands but you will see the Hitachi brand and you will see the York brand.

[Brian Johnson:]

Okay. So your customers in Europe and China, this will be JCI distributed wholesale product that happens to be manufactured in the JV?

[Alex Molinaroli:]

So in places like China, it is a little more complicated than that because we actually go through a joint venture called Hisense. I don't if you are familiar with Hisense. It's one of the largest appliance manufacturers and white goods manufacturer and seller in China and so that joint venture will stay in place. We may or may not sell also directly. We haven't decided but the Hisense brand and the Hisense organization is very well known and China is a very strong channels so we are going to leverage that.

[Brian Johnson:]

And over on the resi side, is the issue competition in the residential marketplaces worldwide pushing it down? Is it cost structure at the manufacturing? Is it a heavy dependence on the Japanese domestic market which is stagnated for a few decades or is it kind of all of the above?

[Alex Molinaroli:]

It's all of those. I think the Japanese - there is a lot of bias to the challenges in Japan and then you also have to decide do we have the right business models in places outside of Japan? But I would say that it is all of those things, I would probably primarily the Japan business has got very tough margins.

[Bruce McDonald:]

But vis-a-vis the competitor, I think if you just looked at the industry Brian, what you would see is challenged margins in the residential product across the board and Hitachi's business would probably be a little bit less than the industry.

[Brian Johnson:]

Okay, so there isn't really an opportunity to raise price, you have got to look at it internally.

[Alex Molinaroli:]

Yes, and that’s why we are not making any commitments but everything we talk about at this point, we would see what we do with the residential strategically is adding value to the numbers that we talked about at this point. We didn't justify it based on residential.

[Operator:]

Thank you. Next question is Mike Wood with Macquarie.

[Mike Wood:]

This is more of a follow-up to the point you just made. You talked about the sales synergies of Hitachi, are there going to be cost synergies and restructuring post this closing of the JV and what type of incremental margin should we assume?

[Alex Molinaroli:]

I don't know that we have talked yet about the margins, we talked about being accretive and we talked about our hurdle rates, but I guess what I would say is that there will be some restructuring. I think that it will be minor and it will be over a period of time. I don't think there is something that will be having to call out with the possible exception of some of the manufacturing that’s in the East. As it relates to synergies, you can almost like a reserve synergies. If we are able from a cost standpoint, if you think about the compressor technology if we can apply that compressor technology within current Johnson Controls products that’s a real opportunity for us because today we purchase - we buy/sell compressors and the supply chain is not real favorable to us. So this is a real opportunity for us. We will have to make some design changes. So there is real synergies there on the cost side and then also I think from a manufacturing footprint today the manufacturing is primarily in Japan, China, Taiwan. Certainly as we move to the Americas, we will need to look and see if it makes sense for us to move some manufacturing there.

[Mike Wood:]

And the follow-up, I'm having trouble getting to your earnings accretion from the Hitachi JV given the numbers you provided. Is there a higher tax rate in the JV than what you have currently at Johnson Controls?

[Brian Stief:]

We will have to follow up on that. I mean the $0.5 to $0.07 accretion I think the tax rate used in there was the mid-20s so maybe a bit higher than the Johnson Controls tax rate.

[Operator:]

Thank you. Next question is Jeff Sprague of Vertical Research.

[Jeff Sprague:]

Just to shift gears actually, I'm a little bit kind of confused on the raw math FX kind of offset argument. Obviously the foreign exchange has moved pretty dramatically. You said in December that your commodity exposure was minimal because of hedging and indexing and everything. So why is it now you are getting benefits if you were heavily hedged? And maybe you could just walk us through that and how that plays out?

[Alex Molinaroli:]

Fuel is something that we did not anticipate so I think that’s one of the benefits that we are getting that we did not anticipate and in most parts of the world, we are able to get that fairly quickly. We have also - this really kind of bleeds into some of our initiatives if you look at our - the purchasing synergies, purchasing opportunities initiatives we already have underway. Some of that is going to be economics but some of it is also the initiatives we have in place. So I think based off the current economics and what I would say is the wildcard and this is lead mostly from a volatility standpoint, we feel fairly confident on today's exchange rates and today's economics that they do offset.

[Jeff Sprague:]

And then just coming back to Hitachi for a follow-up, the question on restructuring and I'm sure you are still treading lightly here, but saying it might be minor except for possibly manufacturing in the East sounds like except for possibly cuts in Japan. I'm just wondering if you actually have kind of the license to do that, do you need to do that to repair these margins? Is there a significant amount of product coming out of Japan into these other regions and therefore there is kind of an issue with the cost structure?

[Bruce McDonald:]

Yes, Jeff, this is Bruce. Maybe just to help you out there, some of the Japanese production today is in facilities that are shared with Hitachi and so as part of this arrangement, we aren't buying some of the plants and so we have to relocate it more into China. And so if you think about the arrangements that we have made with Hitachi around the plant that we haven't bought in the workforce, that’s why we are saying - even though we plan to move some work out of those shared facilities, the cost of the joint venture is minimal.

[Alex Molinaroli:]

I don't want to get into specifics but we do have a plan obviously we are not going to detail it here. But we do have the right to make the - the joint venture has the right to make financial decisions that may have the right returns. We are not handcuffed in any way. So I am not too concerned about that. I understand the question but I think there is something that we will be able to match particularly our growing businesses is when you think about China and North America, we will be able to match our manufacturing with where the business is.

[Jeff Sprague:]

And if I could, just a quick one. Could you give us any color or comment on price realization in the U.S. and in HVAC? Obviously you and a lot of people are out there. Do you see signs that that’s sticking, kind of what your confidence factor is on that as you move into the beginning part of the calendar year here?

[Alex Molinaroli:]

We are only two weeks into the price increase for us. Our timing was first of January for the most part and for the majority of it. That’s a great question and we expect it to stick and we have mechanisms in place for that to happen, but for me to say that it is or it isn't at this point it is just a little early.

[Operator:]

Thank you. Our final question is Rich Kwas with Wells Fargo Securities.

[Rich Kwas:]

Just following up here on Hitachi with the scroll technology, does that influence your decision whether you keep resi or not - adopting that technology being able to manufacture and become more vertically integrated? Is that one of the inputs here in the decision process or can you divest of resi and still become as vertically integrated as you potentially could be?

[Alex Molinaroli:]

I don't think it impacts it. It is an opportunity so it might change the - I would look at it differently. We have made at this point a commitment to stick with the residential business that we have. If you look at the opportunity that we now have around design, this is an opportunity for synergies. I'm still in the same place that I was that even though we are subscale, we are going to try to find ways to fix some of that but we also think it's an important part of the business and having the scroll technology is just going to make it even better. But it's not something that is going to tip us either way.

[Rich Kwas:]

And then does the light commercial piece because the light commercial product can be interchanged with the residential product on the VRF side, is this just kind of wait and see, we will see what we can do on residential and then make a decision? But you could - the plan is to be able to leverage the technology and stick that product through the light commercial channels with ADT, etcetera?

[Alex Molinaroli:]

To where it makes sense, absolutely. Where we have the opportunity and we will have to do some design changes. There is some real practical things that have to be done and we also have to once we get the engineering done have to get it tested and trialed, but we do see opportunity in all of our products that use the technology. We are not limiting anything.

[Rich Kwas:]

Okay, and then last quick one just on shifting the power. Europe, it was a pretty mild winter last year so that it hurt your volumes. What are you seeing so far in the European piece as you are moving through the March quarter here?

[Alex Molinaroli:]

Actually I don't know this quarter. I can tell you that [inaudible] the momentum was strong and you could look at it two different ways. Last year there was lots of inventory in the channel in the first quarter and we had a mild winter so it was a really, really tough quarter for Europe last year, the first quarter and we saw that. We saw the channel not being as full and we saw a little bit better help from the standpoint of weather. So the first quarter was much better and our expectation is that we should see that continue at least from a moderate standpoint moving forward because it was very weak if you remember last year in Europe.

[Bruce McDonald:]

We have pretty easy comparables Rich, for the next couple of quarters with the destocking that we saw last year and AGM volumes being very strong there where we have significantly higher share. And we talked in the last four or five calls about new business wins that we have made in share gains. So in the quarter, this quarter our volumes in Europe were up 7%. We expect to see upper single-digit for the next couple of quarters based on those factors.

[Glen Ponczak:]

Thanks, Rich. We have got to cut it pretty short here. Alex, do you have any final questions before they kick you out of your room?

[Alex Molinaroli:]

Yes, let me get this done to see who is coming in next. I want to thank our employees. As you look at the environment that we are in, some of it external and some of it internal because of all the changes that we have going on, I'm incredibly pleased with what we have accomplished. I think that it's just a testament to the people at Johnson Controls and leadership and the fact that we are rallying around the strategy. I hope that you recognize the fact that we have had a blueprint that we’re following and for the most part I would say that we are on or maybe sometimes even further ahead than I expected. So with the Hitachi thing mostly behind us, that was the one that I was mostly concerned about being able to meet the timeline of some of our portfolio actions. I feel really confident about the rest of the year around our portfolio and our margin improvements. So with that I really thank you and talk to you next quarter.

[Operator:]

Thank you for your participation. That does conclude today's conference. You may disconnect at this time.