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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to Johnson Controls Second Quarter 2019 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 and Chief Investor Relations and Communications Officer.
Good morning and thank you for joining our conference call to discuss Johnson Controls second quarter fiscal 2019 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 Web site at johnsoncontrols.com.
With me today are Johnson Controls' Chairman and Chief Executive Officer, George Oliver; and our Executive Vice President and Chief Financial Officer, Brian Stief.
Before we begin, I would like to remind you that during the course of today's call, we will be providing certain forward-looking information. We ask that you review today's press release and read through the forward-looking cautionary informational statements that we've included there. In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins exclude restructuring and integration costs as well as other special items. These metrics are non-GAAP measures and are reconciled in the schedules attached to our press release, and in the appendix to the presentation posted on our Web site.
Given the sale of our Power Solutions business, the results of Power are reported as discontinued operations. The focus of this call will be on continuing operations. GAAP earnings per share from continuing operations attributable to Johnson Controls ordinary shareholders was $0.26 for the quarter and included a net charge of $0.06 related to special items. These special items primarily relate to integration cost in the quarter. Adjusting for these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.32 per share compared to $0.26 in the prior year quarter.
Now let me turn the call over to George.
Thanks, Antonella, and good morning everyone. Thank you for joining us on today’s call. Let me start with some of the high level strategic highlights from the quarter, beginning on Slide 4.
We delivered another quarter of solid results with continued improvement across a majority of our underlying fundamental metrics. The investments we’ve made throughout the sales organization and into new product development, combined with our ongoing efforts around commercial excellence, continue to drive strong organic top line growth across the board. We continue to grow our service business. A key element of our overall strategy in enhancing value for our buildings customers. And as I will share with you in just a second, these efforts are increasingly being acknowledged by our customers.
With the exception of Asia Pacific, margins were higher in each segments as we remain focused on driving productivity optimizing our cost structure and improving our pricing discipline across our product categories as well as in our project businesses. Operational leverage is improving, which will become more evident over the next several quarters as the pricing we’ve built into the system over the last 12 months fully matures and raw materials and tariff impacts have stabilized.
Although we were impacted by some timing of orders being booked in the quarter, our order pipeline remains robust, still tracking in the mid to high single-digit range for the year. And our backlog continues to built with an attractive mix of service and balanced profile of short and long cycle project activity. With this as our backdrop, we remain confident in our outlook for the second half of fiscal 2019.
Regarding Power Solutions, we announced the closing of the sale this morning about 60 days ahead of schedule, which allows us to accelerate the return of capital to our shareholders. As Brian will discuss with you later in the call, we've updated our assumptions with respect to the timing of the use of proceeds. And those assumptions and now reflected in our updated 2019 guidance.
I'd like to thank Joe Walicki as well as the thousands of Power Solutions employees around the globe, and wish them all the best as they started their journey under the stewardship of Brookfield. I'd also like to thank our separation team who were putting countless hours over the past several months in order to bring this transactions to a close, truly a tremendous effort. Looking forward, we will continue our journey as a pure play building solutions provider with a commitment to enhancing value for our customers with integrated solutions that create more intelligent, efficient and sustainable buildings and infrastructure.
We are committed to driving execution and we are well-positioned to continue investing for growth across the portfolio. As a case in point, I wanted to highlight a few examples of how our strategy is playing out in the recent months. Let me start with an example that represents the core of Johnson Controls legacy as a sustainability company. We have had a long-standing relationship with the University of Hawaii and are in the process of executing the second phase in the University's multiyear energy efficiency and renewable energy project, which envisions the entire university system panning 10 campuses across the state becoming a net zero energy consumer by 2035.
We were awarded our first energy performance contract back in 2010 and are proud to continue our partnership with the expectation of producing a substantial amount of energy savings over the next 20 years and hoping the University achieve their goal of being one of the first higher education campuses in the nation to be free of the need to rely on fossil fuels.
The middle picture on the bottom of the page is Bee’ah's iconic new headquarters building currently being constructed in the UAE. For those of you who are not familiar, Bee’ah is one of the Middle East pioneering developers of sustainable solutions. Just last week along with our partners at Microsoft and Bee’ah, we announced a joint agreement to collaborate on what will be one of the most sustainable and smartest buildings in the Middle East wholly powered by renewable energy sources with zero net energy consumption and a LEED platinum rating.
Importantly, this building will come to represent a global showcase for artificial intelligence capability and smart building solutions. It is expected to be the first building in the region and one of the first in the world to have fully integrated AI capabilities. Leveraging the Johnson Controls digital vault, which is our proprietary cloud-based data analytics solution, along with our data enabled EDGE devices and software, Bee’ah will have a completely integrated system with capabilities to optimize energy efficiency, comfort, safety and sustainability as well as enable the building's occupants to increase productivity.
We are extremely excited to have been selected to participate in this groundbreaking project, which allows us to demonstrate our preeminent position as a leading smart and sustainable building solution provider. In mid April, we officially opened our new 900,000 square foot state-of-the-art rooftop center of excellence in Norman, Oklahoma, which has been the primary design, manufacturing and testing campus for ducted HVAC business for nearly 50 years.
This expansion project represents a multiyear investment effort aimed at upgrading our innovation and manufacturing capabilities, specifically for our high-efficiency rooftop HVAC business. We've added almost 400,000 square feet of additional laboratory and manufacturing space and renovated an existing 150,000 square feet of office and meeting spaces. This new capacity provides us with the full capability to conduct on-site complex system development and meet regulatory compliance, performance, safety and reliability standards for units up to a 150 tons. This will allow us to increase our speed to market, provide unmatched quality assurance for our customers and supports the development of the industry-leading energy-efficient technology.
Turning to orders on Slide 5. As you can see from the chart, we're lapping more difficult prior year comparisons. Orders in our field businesses increased 2% organically, due to some timing in both the current and prior year periods that are skewing the results. Importantly, our project pipeline remains robust, still tracking in the high single-digit range. Based on our historical conversion rates, I’m confident in achieving a mid to high single-digit order growth rate in the second half despite the increasingly difficult comps.
Brian will provide you with some order details in his segment review, but we continue to see broad-based activity across all three regions and across most of our core product platforms. Our backlog ended the quarter at a strong $8.8 billion, up 6% organically versus the prior year, which not only supports our second half revenue assumptions, but also provides visibility into 2020. Generally speaking, our end markets remain healthy with no notable slowdown in any of our internal leading indicators as our short cycle book-to-bill trends, service growth and both small and large project bookings remain robust.
Turning now to Slide 6. Let me recap the financial results for the quarter. Sales of $5.8 billion increased 6% on an organic basis, led by 7% growth in products and 6% growth in the field businesses. We continue to see solid growth from our service businesses across the globe, which were up 5% in the quarter. Our project business is also performing well with installation revenue up 6% in the quarter.
Adjusted EBIT of $469 million grew 10% on a reported basis, which includes a headwind from FX of just over $20 million in the quarter. Excluding FX, adjusted EBIT grew 16% on an organic basis, driven by solid growth in segment profit as well as lower corporate expense. Overall, underlying EBIT margins expanded 70 basis points year-over-year excluding the impact of FX and M&A. Adjusted EPS of $0.32 increased 23% over the prior year driven by solid top line performance and a modest benefit from below the line items.
Adjusted free cash flow of approximately $200 million in the quarter brought us back to slightly positive for the first half, which is consistent with our normal seasonal pattern and our expectation we laid out to you on the Q1 call. We’ve made significant progress in this area over the past year and we are well on track to reach our targeted 95% conversion for the year.
With that, I will turn it over to Brian to discuss our performance in more detail.
Thanks, George, and good morning, everyone. So let's start on Slide 7 and look at our year-over-year EPS bridge. As you can see operational performance including synergies and productivity contributed about $0.10. And this was partially offset by $0.02 of continued product investments and the carryover run rate of our fiscal '18 sales force additions. We also saw some other items create $0.02 worth headwinds related primarily to FX, and its below the line items. But as George mentioned, overall EPS in the quarter was up 23%.
So moving to Slide 8, let's take a look at buildings on a consolidated basis. Sales of $5.8 billion increased 6% organically led by continued strength in our shorter cycle product segment, which was up 7% and 6% growth in our field businesses where we saw continued strength in service and project installation, which were up 5% and 6%, respectively. The continued strength in our field business is a reflection of the strong backlog we've been doing over the past several quarters.
Total segment EBITDA of $671 million grew 11% organically, driven by strong growth from our field and product businesses as well as ongoing productivity and cost synergy save. Total segment EBITDA margin expanded 50 basis points on an organic basis to a 11.6%. And as you can see in the waterfall underlying operational improvement contributed about 100 basis points and this was partially offset by the product investments and run rate sales force additions.
Now let's take a look at each segment within building, starting with Slide 9 North America. Sales of $2.2 billion grew 5% organically, driven by continued strength in both install and service, which were up 5% and 4%, respectively. Both applied HVAC & Controls and Fire & Security continue to outperform growing in the mid-single digits. Our solutions business declined low single digits this quarter, but as you know this business can be a bit choppy quarter-to-quarter on both in order intake and revenue basis.
Adjusted EBITDA of $259 million grew 7% on an organic basis and EBIT margins expanded 20 basis points to a 11.8%. We saw the benefits from synergy and productivity save as well as modest volume leverage partially offset by the run rate sales force investments and some unfavorable mix on selected platforms. Orders in North America increased 2% organically and orders for applied HVAC were up low single digits overall, reflecting a year-over-year decline in equipment orders. This was due primarily to the timing impacts of some price increases in both years.
I would point out that on a year-to-date basis, HVAC equipment orders were up low teens. Fire & Security field orders were up low single digits in the quarter, while our solutions business saw order growth in the high single-digits. Backlog of $5.6 billion increased 5% year-over-year. I will just also point out that our current North America order pipeline supports in mid to high single-digit order growth in Q3.
So let's move to Slide 10 and EMEA/LA. Sales of $878 million grew 4% organically with continued strength in service, which was up 5% and a return to growth in project installation, which was up 4%. Growth was positive in most regions and across most lines of business.
In Europe, we saw mid single-digit growth led by mid single-digit growth in our Fire & Security business, which accounts for about two-thirds of our revenue in that region. And we saw low double-digit growth in our Industrial Refrigeration & HVAC businesses. Orders in Europe increased mid single digits organically, led by strong demand in IR, security and HVAC.
In the Middle East, revenues declined low single digits as continued growth in service activity was more than offset by softness in HVAC project installations, and in Latin America revenues increased high single digits led by broad-based strength across most platforms. Adjusted EBITDA of $81 million increased 17% organically and EBITDA margin expanded 60 basis points to 9.2%. This included a 40 basis point headwind for FX. So similar to Q1, underlying margins increased 100 basis points as the favorable volume and productivity and synergy save more than offset the run rate impact of our fiscal '18 sales force additions.
Orders in EMEA/LA increased 3%, led by solid growth in Europe and Latin America across both service and project install. In the Middle East, orders declined in a low teens rate driven by continued pressure we're seeing in applied chiller end markets. Backlog ended the quarter at $1.7 billion at 9% organically.
So let's move to APAC on Slide 11. Sales of $628 million grew 12% organically, led by accelerating project installation activity, which grew over 15% in the quarter. We also saw strong growth in our core HVAC and BMS platforms with overall low teens growth in China. Service growth expanded 7% overall and I would note that it was over 20% in China.
Adjusted EBITDA of $76 million increased to 11% on an organic basis and we saw adjusted EBITDA margins flat at 12.1%, which was slightly better than we were anticipating due primarily to the higher volumes. Favorable volume leverage was offset by the higher install mix, run rate sales force investments and the ongoing margin pressures we continue to see in APAC. Asia PAC orders increased 1% with low single-digit growth in project installation, partially offset by a modest decline in service. Backlog is up 8% year-over-year to $1.6 billion.
So global products on Slide 12 increased 7% organically top line, despite a difficult 6% per year comparison to $2.1 billion. BMS grew double digits with continued strength across all platforms. Sales across our HVAC and IR equipment businesses grew mid single digits collectively and we saw global residential HVAC grow low single digits in the quarter.
North America residential HVAC revenue grew a 11% despite a tough high teens growth comp in prior year. And this was benefiting from higher -- from favorable weather trends, strong price realization and the continued expansion of our distribution footprint. Global light commercial HVAC grew mid teens in the quarter with North America up low teens, as we continue to see strong growth in our key national account business.
IR equipment revenues declined high single digits in the quarter due primarily to very difficult high teens growth rates in the prior year. And then finally our applied HVAC equipment business grew mid teens, reflecting strength in our indirect channels in both North America and Asia. Lastly, specialty products grew double digits on strong demand from our fire suppression products with broad-based growth across all regions, particularly in APAC.
Segment EBITDA of $255 million was up 13% organically and products EBITDA margin expanded 60 basis points as the leverage at higher volumes, favorable mix, positive price cost, and synergy and productivity save were slightly offset by ongoing product investment.
So let's move to corporate quickly on Slide 13. Corporate expense was down 8% year-over-year to $104 million. And for the full-year, we continue to expect corporate expense to be in the range of $380 million to $395 million. Free cash flow on Slide 14. Reported cash flow was roughly $100 million in the quarter, which if you exclude the integration and transaction costs, adjusted free cash flow was approximately $200 million. Year-to-date adjusted free cash flow was slightly above breakeven, which is in line with our expectations for the year and our normal seasonal patterns for the buildings business. We remain on track to deliver 95% conversion for the year.
Moving to the balance sheet on Slide 15, you can see our net debt to cap increased sequentially to 37.7%, which primarily reflects the borrowings to support our share buyback program we talked with you about in the first quarter call. We remain aggressive on share repurchase through the first half and we completed $533 million in the quarter to get to our $1 billion share buyback for the first half.
Before I turn the call back over to George, let me update you on the close of the Power Solutions transaction as outlined on Page 16. The net proceeds from the transaction are now $11.6 billion, which was $200 million better than our original projections as we were able to bring our cash taxes down by approximately $200 million. Our intended use to these net proceeds remains unchanged with a debt pay down of $3.4 billion and $8 billion plus of share repurchases.
As you saw in our press release this morning, we did announce a debt tender offering in the amount of $1.5 billion, which we expect to complete in early -- by early June. The other $1.9 billion in debt reduction will occur via normal pay down of debt maturities and commercial paper pay down over the course of the next several weeks. This debt pay down will result in $40 million of interest save in fiscal '19 with a run rate annualized benefit of over $100 million.
Additionally, we noted in the press release this morning that we intend to launch a share tender for up to $4 billion with a price range of $36 to $40 a share. All pertinent details will be filed in a formal offer document later this week. On a final point, I would just like to indicate to you that given the size of the share tender in Q3, it will have a significant impact on our weighted average share count, particularly in the fourth quarter on a standalone basis. As a result, some of our quarterly EPS will not equal the full-year guidance midpoint that we provided in the 1.85 to 1.95.
As you know, our full-year guidance is based upon a weighted average share count for a 12 months, which is now expected to be 880 million shares. And just to frame this for you, in the first quarter, we had $0.26 EPS, in the second quarter we had $0.32 EPS, for the third quarter we expect to have in the low $0.60 EPS, and in the fourth quarter we expect to be in the mid 70s. If you add those up, you end up at about $1.95 and again that is going to be higher than the midpoint of the guidance we gave because of the impact of the fourth quarter share account as a result of the share tender. So finally, we're committed to reduce our corporate costs by about $50 million by the end of fiscal '20.
And with that, let me turn the call back over to George.
Thanks, Brian. Before we open up the lines for questions, just a quick update on our 2019 guidance starting with our EPS walk on Slide 17. The only change to our bridge versus what we shared with you last quarter is the EPS benefit associated with the use of proceeds related to the Power sale. With the earlier close, we've updated all of our assumptions with respect to net interest savings associated with our planned debt reductions as well as the reduction in share count, we should be able to achieve with our planned share tender.
There are no changes to any of our operating assumptions or other below the line items. The additional $0.10 benefit from use of proceeds results in an increase to our adjusted EPS from continuing operations range to $1.85 to $1.95. This represents year-over-year EPS growth of 16% to 23%. Just to reaffirm some of the details of our underlying operating assumptions on Slide 18, again you will see there are no changes with the exception of the two items we’ve a boxed for you.
And just a few final comments before we get to your questions. We are encouraged by our performance year-to-date and feel very confident in our outlook for the second half. Our end markets due remain healthy. Our competitive position is strong and we are well-positioned. As we close an important chapter in the history of Johnson Controls with the Power Solution sale, we're extremely excited to capitalize on the opportunities we have in front of us as one of the industry's leading building solution providers.
With that, let me turn it over to our operator to open the line for questions.
[Operator Instructions] Thank you. The first question in the queue is from Nigel Coe with Wolfe Research. Your line is now open.
Thanks. Good morning and congratulations on closing the deal early.
Thanks, Nigel.
Good morning, Nigel.
Good morning, guys. I’m not that familiar with the modified Dutch auction process. Maybe just why $4 billion, if you kind of push up to $8 billion, could it not have been up to closer to the $8 billion number. And then, does -- once it's closed, does that in anyway restrict you on further repurchases in the open market, ASRs or deal flow?
So as it relates to the modified Dutch auction, I mean, the way that process works, that will be launched this week. And as I mentioned, it's got a floor price of 36, and it's got a top end price of 40. And as the book gets built over the next 20 business days or so, we would expect that tender to be completed sometime in early June. As far as the amount of the tender itself, I mean that was -- there's a lot of discussions with our -- among the management team here and outside advisors regarding what the right limit is for going into the market and buying back shares at this time. And I think $4 billion was a number that we all landed on. I would just point out that there's an opportunity for us to upsize that by $500 million should we decide to do that. So right now I think in terms of $4 billion to $4.5 billion, but our initial play is going to be at the $4 billion level and we'll see how demand plays out. And your second part of the question, Nigel? I’m sorry it was what?
Yes, Brian, so thanks for the detail. Just -- does it in anyway bind you from a time period on further repurchases, so M&A any restrictions following the close of the deal?
No, not at all. Not at all. There's -- the implications of the tender really provide us more optionality after the tender is complete to decide if we move forward share repurchases what approach we may use.
Great. And then just my follow on is, George, here, obviously, you’re expressing a high degree of confidence in your end markets and the order flow. Turning to your short cycle businesses within products, I mean, in '15, '16 we did see some pressure from channel from oil and gas pressures in some of the businesses. Have you seen any signs of pressure in some of the shorter cycle businesses?
Not at all, Nigel. If anything, we’ve seen a very robust market within these businesses. If you look at our -- mainly in our Fire & Security product businesses, we are up low teens and that’s across both all three of the key platforms here, fire detection, security as well as in specialty products with our fire suppression business. In addition, that’s supported with the field up above mid single digits and that's pretty much broad-based across the globe. So there's really no signs right know on the short cycle metrics that would suggest that there's any significant slowdown here.
Great. Thanks very much.
Next question is from Gautam Khanna with Cowen & Company. Your line is now open.
Good morning. This is Jeff on for Gautam. Thanks for taking my question here.
Good morning, Jeff.
So a quick one on the Power proceeds. What's baked into your guide assumption as far as the debt reduction? Is it the $1.5 billion or the $3.4 billion? And also what about -- which -- what repo assumption is baked into that guide, the math like a tender dollar amount for '19?
Yes. So the debt pay down, so $11.6 billion is net proceeds. Debt pay down is $3.4 billion. The $1.5 billion is actually a tender that's part of the $3.4 billion to buy back that debt. The remaining $1. 9 billion will be taken out over the next several weeks through either normal maturities of debt or commercial paper pay down. So $3.4 billion of debt which will generate $40 million a save this year in annual run rate of a $100 million. As far as the share repurchase, what’s baked into the guidance we've given you is $4 billion in a tender that will be taken out by early June. And then the remaining $4.2 billion we had to make some assumptions relative to what we were earning to calculate our guidance based upon. So we've assumed the remaining $4.2 billion for now will be put on our balance sheet in some intro on -- some interest earning investment. And then as we make final decisions on what approach in share repurchase we’re going to use, we will update the guidance accordingly.
Okay. That’s clear. So any -- that would be incremental. And then maybe one on order pipeline, if I may. So you mentioned Q3 orders are tracking mid to high single digits. Can you kind of dissect that a little bit by HVAC product like unitary, applied, resi, kind of which is the strongest or just any color there would be helpful? Thank you.
Yes, when you look at our -- if you just look at what played through in Q2 is that strong product growth and that’s been pretty much across the board, double-digit growth in our building management systems. Mid to upper single-digit growth in our HVAC platform, and as we talked about in our specialty products, we had nice double-digit growth. So that’s continuing. When you look at our field and our installations as well as service, it's broad-based across all of the domains with the project pipeline that’s been building and what we’ve been able to convert here in the quarter and what we see in the pipeline to convert here in the third and fourth quarter. So it's -- obviously, we are performing very well in HVAC. When you look at our HVAC businesses across the globe, I would say that we are beginning to really accelerate our performance and then with that we're seeing the volumes come through. That is putting a little bit of -- from a mix standpoint at the gross margin level, a little bit of pressure on our business, but overall we’ve been performing well. So just to sum up, I would say, it's broad based. It's across all domains, across all regions and a nice split between both project based business as well as service business with service grown above 5%.
Next question is from Jeff Sprague with Vertical Research Partners. Your line is now open.
Thank you. Good morning, everyone.
Good morning, Jeff.
Good morning. George, you made a comment in your opening remarks about I think operating leverage really picking up or kicking in the higher gear or words to that effect in the back half. I just wondered if you could elaborate on that a little bit more right from our seat, kind of the observed incremental just that the segment levels 28%, which is solid underneath that its actually better, right, with the currency and other noise. But it's not clear to me from the guide that we would observe much more than high 20s, maybe it's 30-ish or so in the back half. But any other color on all those dynamics, the leverage, how price cost is playing through and how to think about how that scales up into the back half will be helpful.
Let me start by saying that when you look at our incremental margins today, Jeff, they were actually in the low 20s and that’s before productivity and investments. So when you look at the mix of that, it's really driven by high teens within our field businesses and upper -- mid to upper 20s in our product base businesses. And so on a go forward basis, when we look at what we're doing both from a pricing standpoint and productivity standpoint, we are -- we’ve a roadmap to get those businesses on the incremental margins to mid 20s. And that's driven by getting our field businesses up to 20% plus in our product base businesses, up to 30% plus over the next couple of years. Now recognize when you look at our price -- pricing activity this year, we made significant progress. Last year we got behind and for the year we were negative. I think it was roughly about $35 million. Now with all of the actions that we took in the second half of last year and then we’ve continued that this year taken into account not only the inflationary pressures, but also the tariffs, we feel very confident that through the course of the year that’s going to continue to accrete margins pretty much across the board and very confident of that. So when you look at the year, we are going to continue to grow kind of mid single digits across the board. That levers nicely. So it's -- when you look at the total year, it's about 30 basis points of leverage. It's about 60 basis points of productivity in synergies that somewhat offset with the reinvestments that we're making, that kind of the business through sales force as well as technology. We do have a little bit of pension headwind and that nets us to being able to achieve about 40 to 60 basis points for the year across all of the businesses.
Great. Thanks for that additional detail. And then just back to redeployment, as I’m sure you know, HVAC consolidation speculation has been ramped for the better part of six months or so. Can you just update us on your view on that? It would seem going ahead with plan A on the tender and the debt reduction would be a fairly clear indication that in the near-term you don't see an opportunity there, but I don’t want to put words into your mouth. Just what do you see kind of the optionality moving forward for this pure play building efficiency company that you’ve created.
Yes. So, I mean, when I look at where we are, it's been as I’ve communicated multiple times, we are very much focused on execution. We have an incredible portfolio that has historically underperformed. We are beginning to accelerate our performance, beginning to get more consistent performance, delivering on our commitments and as I said there's tremendous runway here as we continue to improve. And that’s been the focus. And so when we announce that we were going to redeploy the proceeds not only in the debt pay down, but also the buybacks it's believing that we’ve got a lot of opportunity here in front of us. We did announce the $4 billion tender. And as Brian mentioned, we'll see how that plays out and we have every intend here to continue with the plan that we have to buy back up to roughly $8.2 billion in buybacks. Now relative to the industry, certainly a lots of speculation. I’m not going to speculate on it. Certainly, when I stepped up to take over, we recognize that the building space is a very attractive end market and we had tremendous opportunity to reinvest and be able to deliver on growth. And that’s what we’re focused on doing. And as you’ve seen others, they’re doing similar, right? They’re streamlining their portfolios and positioning to do the same. But at this stage, I think we have a tremendous opportunity with the investments we've made and the continued investments we're making to be able to deliver a strong performance.
Great. Thank you for the color.
Next question is from Steve Tusa with JPMorgan. Your line is now open.
Hey, good morning.
Good morning, Steve.
Good morning, Steve.
Can you maybe just talk about what you're seeing in China. You put up some pretty good growth there. Obviously, the order slowed a little bit, but maybe just delve into a bit of the dynamics there on HVAC?
Yes, let me start, Steve, by saying it's roughly about 6% of our total revenues and it's broken out into about two thirds in the field and a third in products. And so we were -- this is something we’re watching closely, because as things with all of the trade discussions and maybe seeing a little bit of the slow down we were concerned for the year. I think through the course of second quarter, we are feeling a little bit better that I think as Brian went through the segment, we are seeing good order growth, good pipeline development. And then from a revenue standpoint, we actually did better than what we originally thought and how we converted revenue in the quarter. And so we still want to make sure that we’re watching this closely to make sure that with the investments we're making there, that -- they’re going to play out as planned. But at this stage and the other part I notice from a service standpoint not only is it important to get higher market share in the install base, but we've been very much focused on getting the service revenues. And so right now it is ramping up. It's about a third of our revenues in China. We see this as a big opportunity going forward, especially as we -- if we were to get into a down cycle, this would be a very attractive segment for us.
Thanks for that. Also just following up on Jeff's question, how do you view the market share dynamics of commercial? I know there is really only three major applied guys -- applied suppliers in the U.S. But obviously applied is kind of a loose term, if you will, it's customized work. I mean, when you kind of look at the market structure, do you look at it as three major players in the U.S and pretty consolidated or do you look at it as there's various verticals within, in which there are kind of a range of solutions that compete in those markets. Does that make -- does that question make any sense whatsoever?
Yes. Let me give it a shot. Let me start with the residential, because I think it builds into the commercial. Residential is a space that we’re obviously not in the top two or three. And this is based that we’ve been reinvesting in North America with new product and as well as expanding our distribution and that’s playing through pretty nicely. Our residential North America business was up 11% and that’s to a tough prior year comp.
Right.
And a lot of that not only is the technology and the product, but also of course would be the pricing increases that we've seen here over in the last 12 to 18 months. Now if we talk about commercial, this is where we’ve been relatively strong and then there are three key players here in this space. Certainly that we had over the last decade had underinvested. Over the last two or three years, we’ve significantly ramped up that investment. And I believe with the products that you see coming to market now are going to be very well-positioned to be able to gain more of that share. A big focus, our strength here is in national accounts, so there might be some segmentation of the market with how we serve customers. But I think when you look at our commercial HVAC equipment, it's up 13%.
Yes, I guess, I’m just asking about market structure. I guess a very simple way to ask it a little bit -- put it a little bit more of a finer point. Is it consolidated or am I -- are we looking at it the wrong way? Should it be segmented in a, hey, there are various solutions for these buildings, and so it's not as saturated or consolidated as it would look when we just talk about a chiller, which is basically Carrier, York and Trane, right? That’s kind of what I’m asking.
Well, I mean, when you look at the commercial space, what I would say, it's similar. When you look at the landscape within the market, its similar to the applied space we have five or six key players. Now there's differing footprints and different product mixes within that, but there's mainly five or six key players within the commercial space.
Okay. Would you consider that that saturated and consolidated or not?
I’m not going to -- I mean, at this stage I think I’m not going to speculate, Steve, relative to each of the players in the market positions. But what I would say is that we're focused on the investments we're making and making sure that we've got the right footprint in how we go to market to be able gain market share and grow within the key end markets that we’re serving.
Okay, fair enough. Thanks a lot.
All right.
Next question is from Andy Kaplowitz with Citigroup. Your line is now open.
Hey, good morning, guys.
Good morning, Andy.
Good morning.
George, despite the slowing in field order in the quarter, you obviously seemed quite positive about your pipeline. You made a comment in the presentation, I think for the first time around your field backlog that you now have some visibility into fiscal '20? Could you elaborate on what that means? Do you have enough projects now in backlog where you feel that field sales growth has a good chance of continuing to grow in the mid single-digit range in 2020?
Yes, let me start by saying that when we book projects, on the short end, they turn within three to six months or some can be multi-year. Our average project turn is somewhere around depending on the mix, it's typically about a year. So we are now building a pipeline, as I said, we’ve a very strong pipeline. Pipelines were up high single digits. We continue to add sales force. Now we’re maintaining our sales cost as a percent of revenue now, because we’re getting productivity with the sales force that we had added last year. So in line with that, we continue to expand our sales force. We are going after this pipeline, converting the pipeline and what we are turning now, we have some projects that will support the second half, but there is -- a lot of the projects that we are executing today that will set us up with backlog for 2020. And so, that’s what gives me confidence that as we continue to execute through 2019 that we will see that -- we will see continued progress here as we are setting up 2020.
Okay, George. At this point though in the year, you would say above the average visibility into the next year versus what you've seen?
Absolutely. I mean, we have -- we are halfway through the year. Like I said and with the pipelines that we have, all of our pipelines attract across the board now. We can see that by segmentation, by region, by install, by service and through our regular reviews, monthly reviews, I'm very encouraged in our ability to be able to continue to support the execution through the second half of 2019, but even more important now, setting up for that continuing in 2020.
And Brian, I just wanted to ask you about cash flow. Obviously, you’ve kept the guide at 95% conversion. Seasonally, we'd expect a bigger ramp up in the second half of the year. You talked in the past about needing to go after pockets of inventory that you have in your business, maybe standardizing cash collection in some of your smaller markets and collecting more from your JVs. So can you give us the confidence level that you have to get more cash out of your business in these areas, and how important are they to reach the goal for the year?
I think if you look at last year and the third quarter, our free cash flow, adjusted free cash flow was $0.5 billion. We are expecting about $600 million in Q3 of this year. And then last year Q4 was about $900 million and we're expecting -- I'm rounding number here, $1 billion, $1 billion plus in Q4 of this year. So with those numbers, we deliver the 95% free cash flow. I would tell you from the standpoint of improvements that we are making, if you look at year-over-year trade working capital as a percentage of sales, we’ve made a 40 basis point improvement in March of last year to March of this year. And I also look at things sequentially and sequentially we've gone from 12.1% at the end of the first quarter to 12% at the end of the second quarter. So, we are seeing improvements in trade working capital as a percentage of sales. Now having said that, if I look at trade working capital globally and where we've made progress with our cash management office over the last 15 months or so, I would tell you that payables, we standardize terms with our vendors. I think we've got things in really good working order in most major locations as it relates to payables. When I look at inventory, I would say there's probably a couple of pockets, one in Japan, one in North America that we need to go to work on. But we are talking huge numbers. It's probably $50 million to $100 million of opportunity. And the area that I think we really can continue to improve on is accounts receivable and we've kind of got all hands on deck on that as we speak and we are going to see that gradually improve and actually that improvement is what’s driving some of the year-over-year improvement that we are going to see in the back half of this year versus the back half of last year. And then the last thing I'd say relative to joint venture dividends, we continue to have conversations with our joint venture partners, regarding whether or not we take out current dividends or reinvest those in the business and we will update you as we move through the rest of the year. Most of those conversations take place in the back half of our fiscal year with decisions made at that time. So we are hopeful that over the next several months here, that we can get some positive developments relative to our joint venture dividends as well. But that’s all kind of baked into our 95% guidance we provided.
Appreciate all the color. Thanks, guys.
Next question is from Deane Dray with RBC Capital Markets. Your line is now open.
Good morning, everyone. This is David Lu on for Deane. I just have one question. I know you mentioned orders tracking on mid to high-single digits for the third quarter, but did you see any level of pull-in of customer spending from the second half of the year into the first half to get ahead of tariffs or price increases? Any material impact there?
No, I think we saw a normal flow in the quarter and we track these year-on-year, but nothing unusual or significant as far as that.
David, the only thing we talked about last quarter remember is in North America we did see some pull-forward from Q2 to Q1, but nothing from second half into first half.
Got it. And then if I can just sneak one more in. Any update on tariff headwinds? I know the list three tariffs kind of stay at the 10% range, but you were projecting for I think 130 to 140 of total headwinds between 2018 and 2019. Could we potentially see some upside from lower cost increases here?
That’s about the range that on a 2-year basis the impact that we are seeing, and as I've said earlier that, we are well positioned from a pricing standpoint to offset those. Certainly, we’ve been planning our supply chain so that on a go-forward basis, we can mitigate some of that. But our plan right now is we are planning for these tariffs and that’s what ultimately is in our guidance.
Great. Thank you very much.
Thank you.
Next question is from Tim Wojs with Baird. Your line is now open.
Hi, everybody. Good morning.
Good morning, Tim.
Good morning, Tim.
Just wanted to go back to pricing and just try to -- George, is there a way to kind of frame what pricing in backlog and your orders is right now versus what might be running through the P&L or what that looked like maybe a year-ago?
Yes. So, the easiest way to frame it up is a year-ago pricing on our revenue was -- impacted our revenue by 1% to 2% and then pricing this year is going to be 2% to 3%. And so, think about it as an order of magnitude what’s coming through on price. And so that is in our product businesses, it's shorter cycle. So you see the realization quicker. You will see realization on service increases quicker and then the one that's been more of a -- of a cycle time impact is the work we are doing around our installation project-based business.
Okay. Okay, great. And then, I think you had mentioned this, but I missed it. On the gross margins is -- I think they’re down slightly year-on-year, year-to-date. Is that really more a function of mix relative to price cost or anything else that’s kind of running through there?
Yes, the two areas that we’ve had the pressure, let me start with APAC. It's been -- mainly we’ve been foreshadowing that here this year because of what we had in backlog. That’s going to play out in the second half of the year, but with the work we are doing that will begin to improve and we will see that in 2020. The other is the mix of -- when you look at North America -- when you look at the domain together, we are performing in HVAC very well, and at the gross margin level, that's less in Fire & Security. But other than that, we are getting price and margin expansion across all domains and across all regions in the plan as we execute on the second half.
Great. Well, good luck on the second half. Thanks.
Thanks.
Thanks.
Next question is from Josh Pokrzywinski with Morgan Stanley. Your line is open.
Hi. Good morning, guys.
Good morning.
Good morning, Josh.
Hey, Josh.
We’ve covered a lot of ground on the quarter, maybe shifting gears thinking about where we are at in the cycle. I think one of your competitors yesterday -- I will put words in their mouth a little bit, it seems like we are in a bit of a golden age for HVAC and kind of building investment in general that between energy, efficiency and greenhouse gas emissions that folks are just spending a lot more and putting a lot more attention on that, which seems to favor the JCI portfolio. Within that, do you feel like you are winning your entitlement or have you seen new entrants or kind of new product lines pop up in the space? First question there.
So, you are absolutely right. The opportunity that we have around sustainability and energy reduction does play to our strengths. I highlighted a couple of examples that we’ve recently won. We are executing with the University of Hawaii and the other is a new project that is all focused on sustainability and being the smartest building in the Middle East. So the reason why we are well positioned not only do we have leadership HVAC, which as we know is a significant consumption of energy, but that combined with our building management systems and our ability to optimize not only the equipment, but beyond the equipment, the rest -- the use of the building is what ultimately delivers on the vision of our customers. And so what I would tell you is that in our building management systems, we had double-digit growth. I mean we are at low teens in the quarter. And that's the way that we serve the market today. What’s happening is, as we move forward, those capabilities are converging. It's enabling us now to use our digital vault, which is our proprietary cloud-based data solution to be able to deliver on what I would say is entitlement of energy reduction. And so for us, I think in spite of the cycle, that’s going to be an attractive space for us and one that we are well positioned.
Got it. So you don’t see anything competitively changing or new entrants or anything like that?
No, what I would say is that it's a combination of having leadership product, having technology platforms and then having a footprint in the key markets that you're serving that is close to customers and being able to take their vision with ours and convert it into what the next generation solution is going to be and that’s what we are doing.
Got it. And then just to pivot a little bit off of that, how pleased are you today with your mix, George? I think looking at some of the other folks in the HVAC landscape or in the buildings landscape, you do a bit more your own installation and you have kind of a wider range of service from the super high-end stuff to I think the things that would be maybe a bit more locally competitive. Within this kind of new regime for building investment, do you think JCI's organization does too much, too little, the right amount as it pertains to kind of product mix and what that ultimately means for operating leverage?
So let me just simplify it. When you look at the portfolio, we are about -- say about 40% installed, about 35% or 30% service and about 25% product. And what I would tell you is the investments we are making product is to put ourselves in a leadership position across each of the platforms. I think we are making great progress. We are now where we would like to be, but we are on track to the plan that we’ve got in place with the reinvestments. And if you look at our -- and that is core not only for our direct channel, but also making sure that we leverage all distribution to lead the industry. The second is our field based businesses. We’ve got an incredible footprint across the globe and it's not only leveraging the product, but also our technology platforms that enable us to bring compelling solutions that ultimately drives sustainability, energy reduction and ultimately efficiency for the customers that we serve. And while we’ve done well, especially during the cycle is that we’ve had significant growth in our installed business, creating that installed base and what I’ve been doing here since I've taken over is, put a big focus on service, that are field-based businesses we have significant opportunity to expand our services and how we service that installed base. And so that is an another area that we believe that we can -- there's a lot of room to grow. It's very attractive from a margin standpoint and it's going to be a key contributor to our long-term success.
Great. Thanks. I will leave it there.
Great. Operator, I'd like to turn the call over to George for some closing comments.
So, thanks again all of you for joining our call this morning. As I said earlier, our end markets remain healthy. We are strengthening our competitive position, and I believe we are well positioned not only for the remainder of this year, but setting up 2020. We are very excited now with the sale of Power Solutions to capitalize on the opportunities that we have in front of us and truly position Johnson Controls as the industry's leading building solutions provider. So on that, I look forward to seeing many of you soon, and operator that concludes our call.
This concludes today’s call. Thank you for your participation. You may disconnect at this time.