江森自控 (JCI) 2017 Q3 法說會逐字稿

Welcome to Johnson Controls' Third Quarter 2017 Earnings Call.

(Operator Instructions) This conference is being recorded.

If you have any objections, please disconnect at this time.

I will turn the call over to Antonella Franzen, Vice President of Investor Relations.

Good morning, and thank you for joining our conference call to discuss Johnson Controls' third quarter fiscal 2017 results.

The press release and all related tables issued earlier this morning, as well as the conference call slide presentation, can be found on the Investor Relations portion of our website at johnsoncontrols.com.

With me today are Johnson Controls' Chairman and Chief Executive Officer, Alex Molinaroli; President and Chief Operating Officer, George Oliver; and our Executive Vice President and Chief Financial Officer, Brian Stief.

Before we begin, I'd like to remind you that during the course of today's call, we will be providing certain forward-looking information.

We ask that you view today's press release and read through the forward-looking cautionary informational statements that we've included there.

In addition, we will use certain non-GAAP measures in our discussion.

And we ask that you read through the sections of our press release that address the use of these items.

In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins exclude transaction, integration and separation costs as well as other special items.

These metrics are non-GAAP measures and are reconciled in the schedule attached to our press release.

All comparisons to the prior year are on a combined basis, which excludes the results of Adient and includes the results of Tyco, net of conforming accounting adjustments and recurring purchase accounting.

GAAP earnings per share from continuing operations attributable to Johnson Controls' ordinary shareholders was $0.59 for the quarter and included net charges of $0.12 related to special items.

These special items were primarily composed of transaction and integration costs, a mark-to-market pension as well as restructuring and impairment charges.

Adjusting for these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.71 per share compared to $0.61 the prior year quarter.

Now, let me turn the call over to Alex.

Thanks, Antonella.

Good morning, everyone.

Thanks for joining the call today.

So as you read in the release and our slides this morning, we reported a quarter of solid EPS growth, strong margin expansion driven by the continued progress with our synergies and our productivity action.

I'm on Slide 5. As you will hear from George in more detail, we continue to be below our overall revenue plan.

And I'd just like -- want to point out that many of our businesses and our regions are seeing some good growth, and others have fallen short.

So it's not across the board.

Also, I need to point out that within buildings, it would be wrong for me to say that I'm sure the merger itself and some of the changes that have come along with that, have created some near-term distractions that have contributed to us not achieving our top line objectives.

We believe we can get that back on track.

Our teams will, however, continue to offset the revenue shortfall by our continued driving of synergy and productivity benefits.

Given our year-to-date performance and the expectations for the fourth quarter, we are guiding to the low end of our prior range.

And we expect our full year adjusted earnings per share to be in the range of $2.60 to $2.62.

This will be a 13% EPS growth year-over-year, strong growth, but not quite where we expected to be when we laid out our guidance in December.

Although we haven't achieved all of our objectives, I do remain confident that our strategy and the strategic platform that we're creating, the decisions we're making around integration and organization are positioning us well to serve our customers today and in the long term.

It's going to help us lean our cost structure, and ultimately, will drive both top line and bottom line results.

And finally, let me talk about cash conversion.

This is clearly a need that needs to and will improve.

In addition to the large cash outflows this year related to the tax payments and the merger transaction, we've also made some operational decisions that have affected our underlying cash conversion.

Brian will talk about these in some detail, and George will address it also.

So let's go to Slide 6 and that's to kind of give you an overcap -- overview of a recap of our results.

The total company sales for the quarter increased 1% year-over-year to $7.7 billion.

Organically, our sales grew similarly at 1% year-over-year.

Organic growth in buildings, a little over 2%, partially offset by a modest decline in our power business of 2%.

And George will provide more color in the trends in both of those businesses.

Adjusted EBIT dollars are up 15% year-over-year.

We saw a solid profitability growth in the segment EBITA level, primarily driven by the continued focus on cost synergies and productivity initiatives.

And we benefited also from the lower corporate cost and amortization expense versus prior year, the corporate synergies and the Scott Safety transaction respectively.

Adjusted EBIT margins expanded 150 basis points in the quarter to 13%.

If you adjust for impact of FX and lead, margins actually expanded 170 basis points year-over-year.

And lastly, EPS for the quarter was up 16% year-over-year to $0.71.

With that, I'll turn it over to George, talk about the integration and also the business performance.

Thanks, Alex, and good morning, everyone.

Let me start on Slide 7 by providing an update on the integration.

The new organization's structure in buildings is now in place, and we have selected the best athletes and have asked them to play new positions on the field.

Region by region, business by business, we have completely realigned the leadership structure in order to eliminate cost and redundant layers of management, as well as to optimize sales and service productivity.

Naturally, this degree of change in a merger of this size brings with it the potential for short-term challenges as the players familiarize themselves with the playbook.

With this in mind, we made a deliberate strategic decision to move as quickly as possible to implement our new organizational structure, recognizing this may result in a few false starts in the near term, but will result in a winning strategy in team in the medium and long term.

We remain fully committed to achieving our synergy and productivity savings targets and have made great progress during the quarter, delivering roughly $80 million or about $0.07 in year-over-year savings.

We continue to track towards the high end of the original $250 million to $300 million range in cost synergies and productivity savings for the year.

With roughly $0.18 achieved through the third quarter, we continue to expect to achieve $0.09 in the fourth quarter, which would total $0.27 in savings for the full year.

I am proud of the work we've done across the organization and the significant progress we are making on achieving merger-related cost synergies.

As I review the regional performance in buildings, I will touch on some cross-selling wins.

Let's turn to Slide 8. On a reported basis, building sales in the quarter were flat versus the prior year at $6.1 billion as 2% organic growth was entirely offset by the impact of FX and net divestitures.

Our field business, which, as a reminder, represents about 65% to 70% of total building sales, grew 1% organically year-over-year with mixed performance across the regions.

We saw continued momentum in our global applied HVAC business, which grew in the mid-single-digit range.

Fire and security, the legacy Tyco installation service businesses, declined in the low single-digit range, partly due to a tougher comp with the prior year.

Let me quickly walk through the regions starting with North America.

As many of you know, North America is the largest region for both legacy businesses, and therefore, creates the greatest opportunity for growth, from both a top and bottom line perspective.

This is also the region that has undergone the most significant amount of change.

At the beginning of the third quarter, we put in place a new regional organizational structure, which combined fire and security with HVAC and controls with 27 P&L leaders.

This structure eliminates an organization layer while increasing our sales management and selling capacity.

This now gives us an opportunity to make sure our processes are consistent, that we harmonize the way we go to market where it makes sense, and we take advantage of scale.

These 27 leaders are a mix of legacy Johnson Controls and legacy Tyco leadership, who know a lot about where they came from but have a learning curve with the rest of the business.

This added a bit of pressure to the quarter.

Organic revenue growth was flat year-over-year with orders down 4%.

Keep in mind, order activity can be lumpy.

And when adjusting for the timing of large orders, year-over-year order growth was relatively flat.

As we now have been operating in this structure for a few months, we are continuing to make progress improving the level of depth and expertise of the P&L leaders.

Although there has been some short-term impact, I am very pleased with the progress that has been made over the quarter, including the success we have had with cross-selling wins.

We designed and implemented a new sales operating model to enable our customers to buy how they want to buy.

For example, during the quarter, we won a large project in the health care vertical.

The fire team secured the order to install a fire detection system in a new building, as well as the retrofit work in 2 existing buildings.

Embracing the one-team approach, the fire team brought in their HVAC colleagues, who were able to successfully displace a large HVAC competitor.

Moving to Asia Pacific.

We had a strong quarter all around.

Despite the concerns of softening macroeconomic conditions, both organic revenue growth and orders were up in the high single digits, driven by China and Northeast Asia.

Contributing to the growth was a strong increase in service revenue.

We have added additional technicians in China and Japan, and we are seeing nice growth as a result.

Additionally, the team had several cross-selling wins in the quarter, which contributed to the high single-digit order growth.

For example, the team secured a nice win in Hong Kong for cooling systems in 19 rail stations.

By leveraging cross-business relationships, the team was able to secure this win over a [ceded] competitor.

Moving to EMELA.

The macroeconomic indicators are mixed across the region.

Within our businesses in Europe, low single-digit growth in Continental Europe was partially offset by a decline in the U.K. resulting in overall modest growth.

The Middle East, on the other hand, continues to be challenged.

However, the decline has moderated to the mid-single digits.

Lastly, Latin America continues to grow organically, primarily driven by our subscriber business.

Overall, orders in the EMELA region were down modestly.

Looking now at our product business, which represents the remaining 30% to 35% of buildings, sales increased 4% organically year-over-year, a nice sequential improvement from the 1% decline we saw last quarter.

We continue to see very strong growth in our North America residential and light commercial HVAC business, which grew high single digits organically, benefiting from a significant amount of new product launches despite beginning to lap more difficult comparisons.

Our Hitachi business also grew high single digits organically aided by a recovery in the timing of shipments we discussed last quarter.

Additionally, as expected, our fire and security product businesses have stabilized and are holding flat with the prior year.

Buildings EBITDA increased 7% year-over-year to $908 million.

The segment margin expanded 110 basis points to 15% as strong synergy and productivity savings, modest volume leverage and favorable mix more than offset planned incremental product and channel investments during the quarter.

Turning to orders in backlog on Slide 9. Total building orders increased 1% year-over-year organically, up 3% when adjusting for the timing of large orders, driven by 4% increase in product orders, which drove the revenue growth in the quarter, given the book-and-ship nature of that business.

Field orders were flat with the prior year and strong growth in Asia Pacific was partially offset by a decline in North America and EMELA, as I previously mentioned.

In terms of the order pipeline, we are seeing continued momentum in the U.S. market with stable growth in nonresidential construction verticals year-over-year and expect to see orders growth in our North American field business next quarter.

Backlog of $8.4 billion was 3% higher year-over-year, excluding the impact of foreign exchange and M&A.

In summary, the teams are coming together well, having been very engaged with every member of the team through this process.

I remain convinced that the strategy of this combined entity is going to continue to unlock significant value for customers, employees and shareholders.

Turning to Power Solutions on Slide 10.

Sales increased 6% year-over-year on a reported basis to $1.6 billion driven by the impact of lead pass-through, which benefited Power's top line by roughly 8 percentage points.

Organic sales were down 2%, driven by a 3% decline in global unit shipments with declines in both the OE and aftermarket channels.

OE unit shipments declined 6% versus last year with particular weakness in the U.S. and EMEA, related to lower OEM production volumes, which declined at a similar rate.

On the aftermarket side, which account for roughly 75% of our volumes, unit shipments declined 2% year-over-year.

Weakness in the aftermarket channel was more prevalent in EMEA and China, where customers delayed order decisions based on the drop in LME lead prices throughout the quarter.

Given the typical restocking that takes place in the late summer months, we expect low to mid-single-digit organic growth in the fourth quarter.

Global shipments of Start-Stop batteries continue to expand with a 17% increase year-over-year, despite a difficult plus 22% prior year comparison, including another quarter of significant growth in China and the Americas.

The decline in EMEA was tied to the lower level of production in Europe.

Power Solutions segment EBITA of $304 million increased 8% on a reported basis or 7%, excluding foreign currency and lead.

Power's margin expanded 40 basis points year-over-year on a reported basis, including a 120 basis points headwind from the impact of higher lead cost.

On an EBITA dollar basis, lead was a slight tailwind in the third quarter.

Underlying margins, excluding the impact of lead, increased 160 basis points year-over-year, driven by favorable price mix as well as productivity benefits partially offset by lower volume leverage.

Now, let me turn the call over to Brian to walk through corporate and the consolidated financial details of the quarter, as well as our outlook for the fourth quarter.

Thanks, George, and good morning, everyone.

So on Slide 11, you can see that our corporate expenses were $23 million or 16% lower than last year as we continue to see the benefits from the ongoing synergy and productivity actions we have in place.

And we continue to feel that the corporate expenses for the full year will fall at the low end of the $480 million to $500 million range we originally provided.

Before we go into the financial highlights section year, I'd just comment that our results for the quarter do reflect some special items, again transaction and integration cost, restructuring costs and primarily, mark-to-market charges.

Those are outlined for you in the appendix, both for Q3 on a year-to-date basis.

And as I go through the commentary, I'll exclude those items from my comments.

I'll also just say that I'm going to move through the financial highlights section pretty quickly here because I'd like to spend a little bit more time in the area of free cash flow.

So on Slide 12, you can see that our sales in the quarter were up 1% to $7.7 billion on both a reported and organic basis.

And SG&A expenses are down 6% quarter-over-quarter, again reflecting our team's ongoing focus on cost and synergy realization.

If you'll look at equity income of $69 million, significantly higher than a year ago.

And that again demonstrates a strong performance of the Hitachi nonconsolidated joint ventures as well as some Power Solutions joint ventures.

So for the quarter, EBIT was up 15% to $1 billion.

And overall EBIT margins of 13% were very strong, up 150 basis points from 2016.

Moving to Slide 13.

You can see that net financing costs are up $124 million versus last year.

And that's primarily due to the debt issuances that we discussed with you last quarter.

Our effective tax rate of 15% continues to compare favorably to our prior year rate of 17%.

And you can see that our income attributable to noncontrolling interests is $74 million, which was up $18 million from the prior year.

And that continues to reflect the strong performance of the Hitachi joint ventures.

The overall diluted EPS for the quarter of $0.71 is up 16% versus the $0.61 a year ago.

Moving to Slide 14.

Just a quick EPS waterfall here for Q3.

You can see that we delivered our targeted $0.07 benefit from cost synergies and productivity savings in the quarter.

Organic growth in buildings and some favorable mix in buildings and power provided additional $0.03.

And we, again, picked up the $0.02 from the tax rate.

These were partially offset by incremental investments in our business of $0.01 and $0.01 of foreign exchange.

I would just comment that each of these bridge items are right in line with the Q4 -- or Q3 waterfall guidance we gave on our second quarter call.

So now, let's move to free cash flow.

Given the significant cash impacts of special items during the year, we've provided a reconciliation for you, both for Q3 and Q4 -- I'm sorry, Q3 year-to-date.

The items that we have called out relate to transaction integration costs and restructuring costs as well as the tax payments.

When you look at our Q3 and year-to-date adjusted free cash flow of $200 million, it's obviously well below where we would typically be at that -- at this point in the year.

And I'd just like to make a few comments on a few specific items here.

As Alex mentioned, there were some specific operational decisions that were made in the quarter, which have resulted in cash outflows versus our original guidance.

These include a $400 million inventory build in Power Solutions as well as the establishment of our hedge of our stock-based deferred compensation liabilities.

And I'll comment on each of those in a second.

In addition to those 2 items, the timing of dividends from several of our equity affiliates have been delayed pending further discussion with our minority partners on whether those dividends -- when those dividends will be paid or if they'll be reinvested in the business.

So talking about the Power Solutions inventory build, it was really driven by customer request to ensure that we meet their stocking demands during the fourth quarter of this year and the first quarter of fiscal '18.

I just commented in the first quarter fiscal '17, we incurred incremental service and support costs and likely lost business opportunities through the inventory shortages that we had during the peak season.

And we want to minimize that as we move in to this year's second half of the calendar year.

In addition, the lower sales volumes in Q3 and Q2 increased our overall inventory levels.

Consistent with Johnson Controls' past practice, pre-Tyco merger and the Adient spinoff, we made a decision in Q3 to hedge our stock-based deferred compensation liabilities in order to reduce the future income statement volatility associated with the movements in our stock price.

As many of you know, Q4 is always a strong cash quarter for Johnson Controls, and historically, for Tyco as well.

And we expect to deliver adjusted free cash flow of approximately $900 million, which is slightly higher than last year on a pro forma combined basis of JCI and Tyco.

I'd like to do a little walk here to take you back to the original guidance that we provided of $2.1 billion.

If you adjust that for the decline in our earnings per share for the year, you arrive at a number of between $1.9 billion and $2 billion.

And so the bridge that I'd like to kind of take you through here is for the first 3 quarters of this year, we've got adjusted cash flow of $200 million as you see on the chart.

We've got Q4 projected cash flow of $900 million to get to the $1.1 billion.

And then if you add to that, the inventory build of Power Solutions, the equity hedge of $100 million, the delayed dividends from the JV of $100 million, you get to $1.7 billion.

And then on top of that, we have seen in the quarter and a little bit late in the second quarter, a build in receivables within the buildings business.

And that relates, I think in part, to the fact that we're consolidating a lot of activities into our shared service centers globally right now, merging the Tyco locations with the JCI shared service centers.

And we've seen a little bit of a build in receivables that we've got to go after here in the fourth quarter and into fiscal '18.

I would also kind of step back and look at the trade working capital as a percentage of sales.

And if you look at, I guess I would call it, our entitlement as to if we would target trade working capital as a percentage of sales in the buildings business to be around 12% and in the Power Solutions business to be around 20%, I think we've got about a $500 million plus opportunity to go after some trade working capital opportunities here beginning in the fourth quarter through fiscal '18.

Our free cash flow is below planned levels, and we recognize it's been very choppy in '17, both in terms of the number of adjustments that we're talking through, as well as overall free cash flow conversion rates.

We're committed to improving working capital in '18, and we think the gap between our reported cash flow and our adjusted free cash flow should tighten.

And we also think that our free cash flow conversion rate should now be above the 80%, as certain of the operational items that I just talked about should, in fact, turn in the fourth quarter -- late in the fourth quarter or into fiscal '18.

Moving to Slide 16 on the balance sheet.

At the end of the third quarter, our net debt-to-cap ratio is 41.2%, up from 40.3% the prior quarter end.

And as most of you know, we are moving forward with the share repurchase program in the second half of this year.

It was up by about $500 million in the second quarter.

And year-to-date, we've repurchased 10.2 million shares for about $426 million.

And we would expect the full year repurchases to be in the range of $650 million to $750 million.

Just quickly talking through a couple of other items that you'll see in Q4.

We'll see the items related to restructuring, transaction integration costs and income taxes.

We also will have our normal mark-to-market on pension and OPEB in the fourth quarter.

And in addition to that, I would mention that we've got the reportable segment change for buildings that will be made in our fourth quarter of fiscal '17.

And as part of our earnings in Q4, we will provide restated quarters on our new segment basis for buildings.

And then finally, I just wanted to confirm that the sale of our Scott Safety business to 3M is expected to close in Q1 of '18, and the net proceeds of between $1.8 billion and $1.9 billion will be used to pay down the $4 billion TSARL debt that was incurred in connection with the Tyco transaction.

Turning to Slide 18.

As far as Q4 guidance, it was $0.86 to $0.88, which was a 13% to 16% increase versus $0.76 last year.

We've got a year-over-year waterfall.

As we've mentioned before, we continue to believe, there'll be $0.09 of benefit related to cost synergies and productivity savings.

And we'll have volume and mix of $0.01, which reflects some price cost pressure that we expect to see as we move through the fourth quarter.

Our effective tax rate of 15% compares favorably to the prior year of 17%, so that contributes a couple of pennies.

And I would just comment, we continue to evaluate additional tax synergy opportunities related to the Tyco merger.

And finally, continued investments in our buildings and Power businesses represent a $0.01 impact in the fourth quarter.

So overall, our organic growth is now estimated to be 2% to 3% over last year, with overall EBIT margin expansion of 70 to 90 basis points.

As far as full year guidance on Page 19, given our reduced Q4 organic revenue growth, we are guiding full year EPS to the low end of the range previously provided.

That range is $2.60 to $2.62, which represents a year-over-year increase of approximately 13% versus the $2.31 on a pro forma basis last year.

And with that, Antonella, we can open it up for questions.

Thanks, Brian.

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

(Operator Instructions) Our first question comes from Deane Dray with RBC Capital Markets.

Maybe we can start with Alex.

Your opening comments, you referred to some of the distractions on the integration.

And maybe George was referencing the same thing about from some false starts.

But maybe you could give some examples or some specifics around where that might have been seen in the quarter, and how that has been addressed as we look at fiscal fourth quarter?

Yes.

So the 2 things that I'd point out is, one -- one is kind of clear when Brian talked about our receivables issues if you look at it.

As we started moving to shared services, I think that -- I think there's a distraction there.

So either some cash that wasn't collected -- processes change, people have moved, and locations have moved as it relates to some of our collections.

So that's one that's pretty easy to get your head wrapped around.

We'd like to think that we're not going to have -- that things are going to hit the ground.

But obviously, if you just look at -- if you see the underlying receivables with some of the stuff that Brian talked about, you can see that it's something we can get back.

But we we've lost a few days if you look at our DSO.

And then if you look -- think about where the -- I think George referenced the largest part of our business being North America, and that is where both businesses came together.

And as we came together, it's just, you can't point to a specific thing and say, "Well, we lost a project or somebody got distracted." But you just know because those changes happened right after the end of the second quarter.

I mean we timed it to make sure that we got through the second quarter and then we made the changes.

And so it's just logical to understand when you go through that kind of change in your field organization that you're going to have -- you're going to have a little bit of time that people need to adjust to, the new bosses and new organization.

But in the end, when you get out in front of the customer, that hasn't changed.

So the reason we have confidence that this is a short-term challenge and one that's hard to put your finger on, is that when you get in front of the customer, the people that were calling on the customer, servicing the customer and their boss at the local level has not changed.

But when you look above that, a much leaner structure, a much more logical structure, one that's going to work for the long term.

But it just -- it's just change.

And I think that it would be naïve for us to think that, that didn't have somewhat of an impact, probably on some of our orders secured is my guess.

And so hopefully, orders aren't lost, it's just -- we've just got to go through a process.

So that's the way -- George, you probably have more color on it, but that's the way that I would characterize it.

North America, probably the place that -- we're going to see it is where we see it.

Just a little bit to add, Deane.

I would say that when you look at the buildings organization, you taken 2 very large organizations.

And although we talk about legacy JCI and legacy Tyco, we're running these businesses across the globe together.

And so you can imagine from a leadership standpoint, the changes that had to occur.

And I am more confident than ever the way that the teams have come together and the sales management, the sales capacity that we've created, while taking out layers of management that, that is going to translate to accelerate the acceleration of orders and growth.

Our pipeline, although we didn't convert in the quarter, we see a very nice pipeline build across the globe with opportunities.

And the quoting activity as a result of that pipeline is increasing.

So I'm developing more confidence every day that as we put these organizations together, building off of the strong customer relationships that we had within the legacy structures working together now into one operating system, we're now seeing that coming through.

Got it.

And then just as a follow-up on the free cash flow situation for the quarter.

For Brian, is that $500 million trade working capital opportunity, that sounds like a new target.

Just the degree of confidence in going after that, the pace of which you think you can begin to ring that out.

And does this change in any way the JCI longer-term goal of reaching 90% free cash flow conversion by 2020?

No.

The 90% is still intact, Deane.

And as far as the $500 million, that's a target that's based upon where we think our optimal position is on trade working capital as a percentage of sales in each of our businesses.

And historically, Building Efficiency and Tyco, I think when their trade working capital is well under control, we feel on a combined basis that a target of 12% there makes sense.

And we're 150 basis points higher than that right now.

And when you look at Power Solutions, we're of the view that 20% is a historic targeted level that we think is optimal.

And we're at 22.5% to 23% right now.

So if you do the math on that, you pretty quickly get to a number of about $0.5 billion that should be achievable.

And we've got teams that are going after it.

Deane, some of that is some of the same stuff that we talked about.

We have an optimal level of inventory within Power Solutions that is not as high as it is today.

But one of the things that we've done is we've gone through -- because of the customers that we had last year, the orders we missed in the service penalties we paid, we put capacity in.

As you know, our capital spending is pretty high in North America.

We put capacity in that will help us in the future.

But this year, we're needing to put -- put inventory in order to get through the season.

I think we've got some capacity that's going in place that will help us offset some of the need for inventory in the future, too.

Our next question comes from Andrew Kaplowitz.

Alex, maybe you can talk a little bit more about what's going on in your Power business.

You guys have leading market share in the business.

And I know last quarter, you suggested that your Power team was feeling good about the rest of the year.

And then you missed your own quarterly projections by a significant amount.

We know that part of the issue was customers waiting for lead price reductions.

But why wouldn't that have been somewhat of a concern last quarter and something that maybe your teams could have been better prepared for?

So just sort of commentary on visibility around that Power business going forward.

Yes, that's a good question.

What I would say is it's not a North American phenomenon because of the closed loop system in North America.

I think both in Asia, specifically China, and Europe, we see that phenomenon.

And I think there's just been a lot of tension within the business, how much -- how much -- in order to motivate your customers, how much do we want to do to pull orders forward, which would mean essentially, we would give them relief early versus being able to deal with the price changes as they happen.

So I think that we were probably hopeful that we could pull some stuff into the quarter.

I think that naturally, it's going to happen.

I think we'll see it happen in the fourth quarter.

And it's hard to -- the only thing I can tell you for sure is we haven't lost any share.

And it's -- the team is just as frustrated as you are because it also -- the double dinger, it also has hit us in the inventory.

If you think about our inventory in Power, it's not only the inventory you build for purpose but the fact that we didn't get the sales coming out in the quarter that we expected.

So I don't think it's we didn't have our eye on the ball.

I think we're probably a little optimistic that we could pull in front of the price changes for lead.

And, Alex, when you talk about sort of the low to mid-single-digit growth in the business going forward, is it -- is that still optimistic?

Or is that sort of realistic now based on what you see?

I think it's realistic.

I think that quarter-to-quarter, we obviously are seeing some volatility.

But if you just look at the orders that we have, we are going through a change where a lot of our customers are now moving to AGM products.

So I think one of the limiting factors is are we going to have -- are we going to have the batteries to be able to serve that market as we move forward?

Some of the challenges -- the reasons why it's only 17% growth in AGM, which is not as high as it's been, is part of it is we're capacity constrained.

So our customers are going through changes.

And we're putting the capacity in as fast as we can.

I think the market's there on an overall basis because you just look at the build and the replacement cycles.

The market's there.

The timing of it is something that we don't control.

And it got away from us this quarter because it caught us both on the inventory and the sales.

Our next question comes from Nigel Coe with Morgan Stanley.

I just want to go back to cash flow.

You built about $1.1 billion of trade working capital this year.

And, Brian, you're saying there's about $0.5 billion of relief from that.

So I'm just wondering the message that you came in postmerger, kind of low on working capital.

And you had to rebuild some of that.

And as a result, you've lost some business.

And therefore, now you've kind of gone above that target range, you have to now dial back.

So that's the first part of the question.

And the second part is you're not really assuming much working capital benefits in 4Q.

Is that right?

And if so, why is that?

Yes.

So the fourth quarter benefits, I mean if you look at the bridge that we provided to get to the $1.9 billion, I think there's going to be -- late fourth quarter into the first quarter, I do think we're going to see, at least, $200 million of the inventory build flush out.

And then I think the dividends from the JVs, we also are still of the view that, that is going to be received.

As I mentioned, we're sitting in a situation now where we're discussing with our joint venture partners whether there's going to be dividends to each of the partners or whether or not we're going to reinvest in the business.

But we believe, at this point, that that's a timing item as well.

And then on the receivable build of a couple of hundred million dollars, I would expect that we would start to see some of that turn as well as we get after this trade working capital initiative that we've got moving forward with here.

So I do think that there's $400 million of that bridge that I gave you that we're going to see come back in relatively short order between now and mid fiscal '18, which should improve our cash flow north of the 80% level that we had originally targeted for fiscal '18.

As far as your first question on optimal levels of trade working capital, I mean there's no doubt that we have gone backwards in the first 9 months of this year.

The biggest pieces of that tended to be the inventory build at Power and the receivable we've talked about.

There were also -- payables is also about a $100 million headwind there.

So I think when we look at our overall initiatives for fiscal '18, we're going to work to our trade working capital as a percentage of sales of 12% at buildings and 20% at Power.

And we think, we think that's a good place to be both from a customer standpoint and from a company standpoint.

Our next question comes from Jeff Sprague with Vertical Research.

Just back on cash flow here.

Can you give us a sense of what you're expecting for CapEx in 2018 relative to 2017?

So Jeff, if you look at Power Solutions, we're finishing the AGM capacity in North America.

And we've got 2 plants that we're finishing up in fiscal '18 early '19.

So it's a pretty heavy year from the standpoint of, I would call it, growth CapEx in Power Solutions.

As you know, this year, we guided to $1.250 billion to $1.3 billion.

I think we're going to be in line with that.

I'm guessing next year could be in the $1.4 billion range plus or minus.

That's kind of what we're thinking right now, given the Power Solutions investments.

And just trying to get my head around the conversion.

Obviously, on the cash flow miss year, I could understand not want wanting to over-promise for next year.

But let's call it a $100 million headwind on CapEx if you've got this big of a working capital swing.

Actually, it feels like the number could be -- could have a 9 handle on it.

I mean is there -- is there something else I'm missing there?

I wonder about other kind of charges that are maybe not in the deal integration numbers, et cetera.

What other consideration should we have in mind when we think about 2018 free cash flow?

No, I understand the math you're doing to get a 9 in front of it.

I think we're still in the process of finalizing everything for fiscal '18, Jeff.

And we'll provide more color on this when we go through our '18 guidance.

But I mean suffice it to say, we all recognize that given the poor performance in '17 in certain of the working capital areas, that should certainly provide some tailwinds for us as we go into '18.

And I would say -- but all I'm committed to say right now is it'll be north of 80%.

I think that's the responsible way for us to answer the question, Jeff, at this point.

But your math, we understand your math.

Our next question comes from Steve Tusa with JP Morgan.

What exactly is the hedge for deferred comp?

And I have a follow-up on that.

So we've got stock-based compensation awards that we give to our employees.

And you essentially work with a financial institution.

You give them the money to purchase the shares, and they essentially allow you to provide a hedge against future movement in your stock price.

So to the extent that we buy in at -- I believe in the 10-Q that you'll be seeing, I think we bought in at $42.21.

And that hedge is going to offset movement upward and downward in the stock price versus the $42.21.

So essentially, what it does is it takes the volatility out of your income statement for any movement in your stock price, which is required under GAAP to be either a compensation expense or a compensation benefit as you move through the year.

And did that have any influence on what ultimately, your employees received?

No.

Okay, okay.

And then just looking a bit ahead, and these are just basically items that are probably known at this stage of the game.

And any view on kind of what ForEx looks like if you kind of snapped the line here for 2018?

And any other parts of the bridge in 2018 that are kind of -- what would be more just financially oriented?

We can all kind of do our own math around volume and mix but -- and any planned changes in the tax rate?

And also, are you reaffirming kind of the synergy forecast that you guys gave at EPG?

I assume there's no change there given you're executing well this year.

Yes.

So the synergy number of $250 million, we reconfirm.

The tax rate, we haven't finalized all the effective tax rate work at this point in time for '18, but I would say that it will be 15% or lower.

And as far as FX, I don't think I've got any specific guidance at this point in time on that.

Antonella?

Yes, I mean if you take a look at kind of how rates have moved particularly now, you could see that we brought down our FX headwind expectation for the year.

So I mean if rates stay how they are, I mean if we take Q4 as an example, there's really not much of an effect, either headwind or tailwind.

It's actually pretty neutral.

But as you know, rates move, so as we get closer to 2018, we'll obviously adjust to the more current rates to see what type of impact that gives us.

Our next question comes from Tim Wojs with Baird.

I guess I was -- just on cash flow again.

Is there any thought -- or is there any concern just as you kind of trade off working capital that, that has any impact on kind of the growth algorithm for the businesses?

I'm sorry, you mean not having or having?

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

No, no, no, I don't think so.

I don't think that -- I don't see -- I think that what we're talking about now is we've got some process issues that we need to fix and some terms that we need to harmonize.

That's our opportunity.

I don't see that we're going to do anything that's going to affect the growth of the business.

That's why I think when Brian talked about it being an entitlement, I think that's the reference -- the way that he was framing it.

I thought maybe you're talking about Power Solutions.

We did lose some growth because we didn't have inventory last year or didn't have batteries.

And you can either think you need to have capacity or you need to have inventory.

I think at this point, we got the worst of both worlds because we've got extra inventory and we're putting capacity in.

So we won't be in that shape -- we won't be in a similar shape again next year from an inventory and power.

But if you look at receivables, receivables and buildings, I heard Brian talk about right, as an entitlement, that's not going to affect our growth.

And you look at inventory and power, it's the same thing; that we can take our inventory down and not hurt our growth because we're putting new capacity in.

Okay, great.

And then just what's the -- as you look at kind of price cost, that's been a theme this earnings season, I mean how will you guys frame that the price cost discussion heading into fiscal '18, particularly in the building side?

Yes, so if you look at buildings in the third quarter, we're up 110 basis points on margin.

That was driven by volume leverage.

We've got the synergies and productivity, as well as now we're seeing the growth come through the products businesses, which is a higher mix.

Now that was somewhat offsetting some price costs of about 20 basis points.

And that's mainly driven by steel, copper, aluminum, as well as some refrigerant.

And so as we look at this going forward, we'll still have the strong synergies productivity.

We'll continue to see increasing volume leverage.

We'll get the mix of our products beginning to accelerate, but we are going to see continued headwind here in the fourth quarter, which we're estimating now to be about 20 basis points.

Our next question comes from Noah Kaye with Oppenheimer.

George, you mentioned earlier that you're starting to see a very nice pipeline and favorable quotation activity.

Can you just give us a little more color on maybe where that is geographically or kind of within the segments?

Sure.

So if you start -- let me start in North America because that's certainly the big focus area.

The new organization that we put together, we freed up a lot of resources that when we took out the layers of management to put back into sales management as well as selling capacity.

Now as we're putting the businesses together, we've got a little bit behind of our hiring plan with our sales force, but we're significantly increasing our sales capacity as we speak.

And then with the work that we've done, the team has done a nice job in putting together processes in the field as we're now leveraging the existing customer base that we serve to be able to better serve the customers with a complete portfolio.

And I talked a little bit about that in my prepared remarks, making it simpler for the customer to be able to buy from us the total capability.

So when you look at the pipelines that have been developed across the globe within our direct channels, we're beginning to see that.

Now, there's timing of conversion as we go through this.

But it gives me confidence that based on what we see, we're going to begin to see an improvement on a go-forward basis.

In our product businesses, the team has done a really nice job, not only making sure that we've got -- we're leveraging the channel, our direct channel but also expanding our indirect channels across each one of our product businesses.

So not only are we investing in our direct sales capability, but we're also expanding our channels.

You'll see that some of the bright spots during the quarter and our DX business with a very difficult compare.

Last year, we were up about 17%.

We're up another 10% this year.

That is really an output of some terrific work that's been done in expanding our channels to be able to capitalize on the growth in the market share.

So what I can tell you across the board, it's certainly a key focus in being able to not only get world-class sales management, but increasing capacity in our direct channel, as well as our indirect distribution that will enable us to be able to capitalize on a broader part of the market.

Okay, great.

And then just on Power Solutions, Alex, I think you mentioned kind of some capacity shortages around AGM.

With all that we're seeing and reading around kind of changes to drive change across the auto industry, is AGM demand kind of trending globally the way that you thought it would as you look out the next couple of years, or is it perhaps accelerating?

How do we think about that and kind of your own capacity-build plans?

Yes, that's a good question.

There's so much being written about every -- all this, this whole topic.

But what we're seeing is probably going to move faster than we can afford to even meet the capacity.

So I think we're going to have to be -- we're going to have to make sure that we've put the capacity in the right place and leverage it, because I think it's just going to escalate.

What we do see people trying to do is put some batteries in that aren't quite AGM-capable.

And then what we find is they come back later and say we need to do something else.

And our capacity plans are pretty significant.

Our share is really high.

I think there'll probably be more demand, which will be a good problem to have.

I just think we're going to have to be pretty choosy, I think, on who we serve.

I think that's where we're going to be in the next few years.

Our next question comes from Julian Mitchell with Credit Suisse.

Just wanted to circle back on the Power Solutions division.

So I guess it's, obviously, unusual to be sort of growing inventories, while sales volumes came in a bit light.

I understand that the guidance is for aftermarket sales to recover in the next few months.

But just thinking about the risks that inventories stay high, how do you characterize inventories today versus a typical time of year or typical seasonality in the battery business right now?

And then also on the Power side, I understand the drawdown of working capital not really having a revenue impact.

But maybe just talk about any profit or EBIT margin impact as you get that adjustment on working capital in Power.

Okay.

Well I'll address the first one.

This is Alex.

What you -- our inventory is higher than it was a year ago, and that's twofold.

One is it's a response to the fact that we -- you may recall, we called out when we were having service problems over the -- actually over the last 1.5 years.

We had service problems in the peak season, because our peak capacity is probably 120% of our total capacity.

And so you have to have inventory to be able to serve our customers.

We've got meetings with our customers, and particularly, North America, our very large customers, who essentially put us on notice that they're not going to be short of batteries anymore.

And so I think we've compensated for that in the way that we have the inventory and we're also putting capacity so that we don't have to have this much inventory on an ongoing basis so a year from now.

So I'd say it's sort of a kind of in between on where we are and where we need to be as we put capacity in.

Our inventory levels won't be quite this high, but they won't be as low as they were a couple of years ago.

But that still keeps us in the range of where Brian was talking about as far as what we believe our entitlement for working capital.

And that certainly is -- within Power Solutions, it really is an inventory story.

Yes, I don't think there's going to be any impact negatively on margins as that inventory turns out.

I mean as we've kind of talked about in the past, sometimes your margin rates can vary depending upon where lead is.

But I don't think there's any downward pressure on margins at Power Solutions as a result of that inventory turnout.

And then just my follow-up would be on the building side.

You've had a big push on trying to reinvest more to take share.

And you had pretty good order numbers in the legacy buildings business this quarter.

So that seems to be working.

When you think about the incremental investment from here, do you think there's a need for another big step-up?

Or do you think that the organic investment in HVAC, in particular, is running around the right level today?

Yes, Julian, this is George.

As you said, we're getting really good traction with the new products that we're being to market.

And when you look at the performance in -- across our portfolio, I think that's beginning to show, whether it be in the residential, light commercial or across applied, as well as within our controls.

And that's where a lot of the investments are being put in.

What I see going forward as we continue to gain the momentum, we're going to continue to reinvest and look at incremental investments that we see as -- given the success we've had in each one of these segments, see a lot of opportunity with the investments we're making.

So we're going to, obviously, take that into account as we're beginning to accelerate and gain market share.

But it gives us a lot of confidence over the investments we are deploying.

We are beginning to see the growth come through.

And it's coming through at very attractive margins.

Yes, I'll just add to that, Julian.

We have some really exciting things that are going to happen over the next couple of years as it relates to some of the products we're developing.

So I think that -- I think it's just going to get better.

And one of the opportunities for us -- particularly, look what's happened not only with Hitachi, but to start business in Asia.

I think you'll see investments there too, where we'll be able to take advantage.

We have a great position and we can take advantage of our position in the marketplace.

Some of that top line that we're getting in through Hitachi, you don't see, particularly in China because it's unconsolidated.

But it's growing pretty well, particularly in China.

Our next question comes from Gautam Khanna with Cowen and Company.

So following up on Jeff Sprague's question about the cash flow.

In Q4, how much of the items that you mentioned that slipped out of Q3, and perhaps this year, do you expect to recover?

So Power's inventory build, the $400 million, the hedge, the dividend and then -- of the receivable, the $200 million receivable, how much is embedded in your expectation for Q4?

So in what we've talked about, none of it is expected to come back in Q4.

We think most of it will come back in first and second quarter of fiscal '18.

Okay.

And so given that -- and I think previously, you've talked about a $300 million tax item coming back to you in Q1 as well.

Should we expect that Q1, and perhaps, Q2 of fiscal '18 will be very, very strong free cash flow relative to history?

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

And, Gautam, the one thing to remember is remember when the cash went up and the tax payment, we had it as one of our reconciling items.

And when the cash came back, we said we would do that as well.

So we won't, we won't take credit for it.

We'll just take the money.

Operator, is -- I'm going to pass it over to Alex just for any last comments.

Let me just wrap up here.

Thank you everyone for the call and all your questions.

I really -- we really appreciate it.

So I just want to make sure that I understand your feedback.

And there's 3 things I'd like to point out: First is the synergy and productivity numbers are doing as well or better than we expected, and we don't really expect that to change.

And so I want to make sure that as we talk about this, that we show that we're making progress there.

Top line, I think, is mixed.

We have some opportunity, but we also are seeing some benefits.

And we haven't lost those benefits, but there's some opportunities for us to make some improvements.

And then clearly, cash flow, we get it.

There's work that needs to be done.

We're a little gun-shy talking about -- as you can see from our responses around how this is all -- how and when this is going to come back.

But we know the opportunities there, and we're committed to make sure that you're going to see the cash flow number is as good or as better than what we've talked about in the past.

So I just want to wrap on that.

And I want to thank our employees, a lot of work, hard work that's being done in order to make this one company.

Thank you very much.

Thanks, Alex.

And operator, that concludes our call.

That concludes today's conference.

Thank you for your participation.

You may now disconnect.