Johnson Controls International plc (NYSE:JCI) Q1 2024 Earnings Call Transcript

Johnson Controls International plc (NYSE:JCI) Q1 2024 Earnings Call Transcript January 30, 2024

Johnson Controls International plc beats earnings expectations. Reported EPS is $0.51, expectations were $0.5.

Operator: Good morning, and welcome to the Johnson Controls First Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation there will be an opportunity to ask questions. [Operator Instructions]. Please note today’s event is being recorded. I would now like to turn the conference over to Jim Lucas, Vice President, Investor Relations. Please go ahead.

Jim Lucas: Good morning and thank you for joining our conference call to discuss Johnson Controls’ first quarter fiscal 2024 results. The press release and related tables that were 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. Joining me on the call today are Johnson Controls’ Chairman and Chief Executive Officer, George Oliver; Chief Financial Officer, Olivier Leonetti; and newly appointed Chief Financial Officer, Marc Vandiepenbeeck. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements. Actual results may differ materially from those indicated by forward-looking statements due to a variety of risks and uncertainties.

Please note that we assume no obligation to update these forward-looking statements even if the actual results or future expectations change materially. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties in addition to the inherent limitations of such forward-looking statements. We will also reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are contained in the schedules attached to our press release, and in the appendix of this presentation, both of which can be found on the Investor Relations section of Johnson Controls website. I will now turn the call over to George.

George R. Oliver: Thanks, Jim, and good morning, everyone. Thank you for joining us on the call today. Now let’s begin with Slide 3. We are gaining momentum as we exit the first quarter. Our team has been unbelievable in managing through the recent cyber disruption which occurred early in the quarter. While it is challenging to comprehensively quantify the overall business impact as we recovered from the incident, we are back on track. In fact, over the course of the last 120 days since the cyber incident, we have connected with many of our key customers, solidifying already strong relationships and strengthening their trust and confidence in Johnson Controls. It is clear from their feedback that our value proposition continues to resonate, and customers believe in our products and services.

As we enter the new calendar year we are seeing positive signs. During the quarter, we delivered solid first quarter results, generally in line with our forecast. The fundamentals of our business are strong as we met expectations for sales, margins, and adjusted EPS in the face of headwinds from the cyber disruption, ongoing weakness in global residential HVAC, and significant slowing in China. Olivier will discuss the details of our financials more specifically later in the call. Looking forward, we expect fiscal 2024 to return to more normalized seasonality in our businesses and the operating environment to be more in line with what we saw prior to the pandemic and recent supply chain disruptions. Our position of building a leading digital building solutions platform continues to be core to our strategy, and we are pleased with the strength of our applied HVAC business, especially as we serve the fast growing data center market.

We are updating our fiscal 2024 guidance today, reducing the full year adjusted EPS range by $0.05, reflecting growing headwinds in China. Our commercially focused portfolio and long cycle backlog driven businesses, in addition to our record backlog, gives us more clarity of improvement as fiscal 2024 progresses. Before we continue, I would like to take the time to thank Olivier for his partnership over the last few years, and wish him the best of luck in the next chapter of his career. When Olivier informed me that he was taking a role outside the company, we implemented our internal succession plan, and I am very pleased that Marc Vandiepenbeeck is assuming the role of CFO. Marc has been with Johnson Controls for nearly 20 years, with increasing responsibility in finance roles, including CFO of Building Solutions North America.

Last year, we moved Marc into an operating role as President of EMEALA. Marc brings deep finance expertise and understanding of our customers, global markets, and operational knowledge. I am confident that we will continue to build on the foundations already in place, and I look forward to partnering with Marc in his new role. Now turning to Slide 4, I’d like to highlight the strong foundation of operational excellence at Johnson Controls and our value creation framework. We are capturing the secular trends across sustainable and healthy buildings. We have the right strategy and operating system in place to create value for our shareholders and as part of our commitment to disciplined capital allocation, we remain focused on deploying resources to the right opportunities.

Our team has made great progress the last two years, creating a digital services model, and our investments have been a key enabler. The addition of FM Systems gave us increased capabilities to serve our customers as they improve their workplace environments. Digital is a strong enabler to creating recurring revenue, retaining customers, and supporting higher sustainable service growth rates. Within service we are changing the game from deploying a mechanical contractor to creating multiple options for our customers. We are increasing job size, improving margins, and creating scalable solutions. In addition, we are maximizing value creation through digitally enabled offerings and accelerating our life cycle solutions entitlements across all of our domains.

Our team’s model has a strong foundation and we will continue to accelerate the pace of change. At the same time, we have successfully removed many layers of cost across the organization. But we know there is more work to be done. We serve an incredible market, and it is on us to capitalize on the opportunities in front of us. We will continue to simplify and standardize across our portfolio. As we continue to focus on simplifying the company, we are always assessing opportunities to advance our transformation into a comprehensive solutions provider for commercial buildings. As part of the continuous evaluation of our portfolio, we are in the early stages of pursuing strategic alternatives of our non-commercial product lines, in line with our objective to maximize value to our shareholders.

We are very excited about our future and are confident we are on the right path to simplify our portfolio, drive margin expansion, deliver consistent cash flow, while serving our customers in the best possible way. I will now turn the call over to Olivier to go through the financial details of the quarter. Olivier.

Olivier C. Leonetti: Thanks, George and good morning, everyone. Let me start with the summary on Slide 5. As George discussed at the beginning of the call, our team did an incredible job responding to the cyber incident. The disruptions we experienced during the quarter were factored into the guidance we provided last month. Total revenue of $6.1 billion was flat year-over-year, while organic sales were down 1% as continued declines in global residential HVAC and accelerated weakness in China’s in-store business more than offset mid-single digit growth in service and continued growth in applied HVAC. Segment margins declined 90 basis points to 12.8%, impacted by tough comps in our shorter cycle global products business, coupled with ongoing weakness in China’s macro environment.

Adjusted EPS of $0.51 exceeded our guidance of $0.48 to $0.50 as we return to more normalized seasonality. The quarter was impacted by lost momentum from the cyber incident, accelerated weakness in China, and tough comps in our global products business. Below the line, we saw headwinds from net financing charges due to higher interest rates and increased debt levels in line with historical trends. On the balance sheet we ended the first quarter with approximately $1.8 billion in available cash and net debt increased to 2.2 times, which is within our long-term target range of 2 to 2.5 times. The elevated cash position was a direct result of positive action to mitigate the potential impacts of the cyber incident on cash flow. Adjusted free cash flow improved $180 million year-over-year, and we anticipate further improvement as we progress through the fiscal year.

Let’s now discuss our segment results in more detail in Slide 6 through 8. Beginning on Slide 6, organic sales in our global products business declined 1% year-over-year, with volume declines offsetting price. Global products saw continued strength in commercial HVAC, which grew low single digits after growing low double digits in the comparable period one year ago. We have been investing in our applied HVAC business for the last couple of years, deploying resources to align to more attractive opportunities, resulting in further share gains in calendar 2023. Fire and Security declined low single digits. We believe that the majority of the tough year-over-year comparisons in the shorter cycleandric [ph] business have bottomed out, and we should see a return to growth in calendar 2024.

Industrial refrigeration had another strong quarter, growing over 35%, driven by EMEALA. Global residential declined high single digits driven by greater than 20% decline in North America which more than offset low single digit growth in the rest of the world. North America continues to face market softness and we believe we have one more quarter with these challenges before the industry begins to see growth in the second half of the year. We’re improving our North America market share and see momentum building. Despite ongoing weaknesses in the European heat pump market, rest of world benefited from strong growth in Japan. Our book to bid business continues to normalize with improved lead times and our global product third-party backlog decreased 10% from the prior year to $2.3 billion.

Adjusted segment ABA margins declined 240 basis points to 17.9% as we benefited from insurance proceeds from a warehouse fire in the comparable period last year. We are beginning to see better cost absorption in our factory and expect global products margins to improve throughout the rest of the fiscal year. Moving to Slide 7 to discuss building solutions performance. Orders increased 1% as mid-single digit order growth in North America and EMEALA was more than offset by greater than 30% decline in APAC, which was primarily the result of further deterioration of the China-installed business. As the China real estate market continues to weaken and the outlook remains mixed, we have begun to optimize our go-to-market strategy and have become more selective in the business we pursue.

Organic sales were flat in the quarter against a tougher comparison of low double-digit growth in the prior year quarter. Install declined mid-single digits and more than offset mid-single digit growth in service. Segment margins declined 10 basis points as accelerated weakness in China offset positive mix in the quarter. Building Solutions backlog remains at record levels, growing 7% to $12.1 billion. Service backlog is flat and installed backlog grew 8% year-over-year. Let’s discuss the building solutions performance by region on Slide 8. Orders in North America increased 6% as we continue to see strong demand across our HVAC and controls platform, growing high single digits following heightened growth in the comparative period a year ago.

Overall, there was broad-based demand in our healthcare, data center, government, and education sectors. Install orders increased 9% year-over-year with solid growth in both new construction and retrofit. Sales in North America were up 4% organically with strong growth across our HVAC and controls platform up low-teens year-over-year. Our Install business grew 4% with continued momentum in new construction up over 25% year-over-year. Organic sales in service grew 4% in a quarter, benefiting from high single digit growth in our recurring revenue contracts. Segment margins expanded 20 basis points year-over-year to 11.5%, driven by the continued execution of higher margin backlog and strength in our higher margin service business. Total backlog ended the quarter at $8.4 billion, up 11% year-over-year.

In EMEALA, orders were up 5% with continuous strength in service up 12%. Demand in institutional gained momentum in the quarter, growing 50% year-over-year, driven by public projects in Europe. Industrial refrigeration had another strong quarter with greater than 45% growth. Sales in EMEALA grew 2% organically, led by high single-digit growth in service with high single-digit growth from our recurring contracts and strong double-digit growth in our shorter-cycle transactional business. Applied commercial HVAC and Fire and Security grew low single digits within the quarter. Segment EBITDA margins of 7.7% remained flat as the growth in service was offset by the conversion of lower margin installed backlog. We anticipate strong margin expansion in EMEALA through the remainder of the fiscal year.

Backlog was up 10% year-over-year to $2.4 billion. In Asia-Pacific, as I mentioned earlier, orders declined 31% due to further deterioration of the China-installed business and were being more strategic in the deals we select. Overall, APAC-severed orders grew low single digits, driven by high single digit growth in our shorter-term transactional business. Sales in the Asia Pacific declined 21% as the installation business was impacted primarily by accelerated weakness in China. Our service business grew 5% in the quarter. The weakness in China’s installed business was broad based across the overall portfolio with HVAC and controls down high-teens and Fire and Security down 20%. Segment EBITDA margins declined 140 basis points to 9.1% as weakness in China offset positive mix in our service business.

Backlog of $1.3 billion declined 21% year-over-year. I would now like to turn the call over to Marc to discuss our second quarter and fiscal year 2024 guidance. Marc?

Marc Vandiepenbeeck: Thank you, Olivier, and good morning, everyone. Before I discuss our guidance on Slide 9, I want to say how excited I am for the opportunity to partner with George as we simplify and transform Johnson Controls into a comprehensive solution provider for commercial buildings. We exited our first quarter with a cyber-incident behind us and the momentum we lost at the start of the year has recovered. We entered the second quarter with a backlog that remains at historical levels, a healthy pipeline of opportunities, and strong momentum in our industry-leading service business. We are introducing second quarter sales guidance of approximately flat year-on-year, which assume continued weakness in China and global residential HVAC.

We expect strong contribution from North America and EMEALA, led once again by our resilient service business. As we return to seasonality more in line with historical patterns, global product has one more challenging quarter before stabilizing in the second half. For the second quarter, we expect segment EBITDA margin to be approximately 14.5%, and adjusted EPS to be in the range of $0.74 to $0.78. For the full year, we continue to expect the top-line growth of mid-single digit led by stronger performance in North America, further improvement in EMEALA, stabilization in global products, and a cautious outlook on China. We expect segment EBITDA margin to expand approximately 50 to 75 basis points for the full year, as price costs remain positive and mix continue to improve throughout the year.

As George mentioned earlier in the call, given the weakening macro outlook in China, we are updating our adjusted EPS guidance range to approximately $3.60 to $3.75. The overall guide assumes a return to normal seasonality, second-half stabilization of global products, and a conversion of higher margin backlog in Building Solutions. We continue to expect adjusted free cash flow conversion of approximately 85% for the full year. The improvement we saw in cash flow for the start of the year demonstrate that our working capital improvement are gaining momentum. With that, operator, please open up the lines for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions]. And today’s first question comes from Scott Davis with Melius Research. Please go ahead.

Scott Davis: Hey, good morning. Good morning, guys. Can you hear me okay, hopefully?

George R. Oliver: Yeah, good morning, Scott. Can you hear us?

Scott Davis: Yeah, fine. Thanks. George, I think it’s been a tough couple quarters. Maybe if we take a step backwards, what do you think long-term this portfolio, the growth rate and margin levels and the cash generation, what is kind of your, I don’t want to call it dare to dream, but what is the vision of where you think you can get two, three, four years down the road when in a more normalized environment?

George R. Oliver: Yeah, so let me start, Scott, by just saying that, as you know we’ve been through a significant transformation here into becoming a comprehensive solutions provider for commercial buildings. And then as part of that, continuing to focus on how do we transform the business model and how we bring our differentiated solutions to our customers in the commercial space. And so, as you look at what we’ve been doing, we’re well-positioned to invest and lead in the overall building solution space, capitalizing on significant secular trends, sustainable buildings, smart, healthy buildings. We’ve been allocating our resources and building out the capabilities. When you look at the content of how we differentiate the solutions, it’s not only through the leadership of the product, the applied product and continued investment that we’re making in product, but also now deploying those products with a leadership platform with Open Blue that we believe is going to now lead the industry.

And that all is converting into how we change the outcomes for the customers that we serve. And that’s through our engineered commercial solutions and converting what we do within building solutions to a digitally enabled service. So when you look at the margin structure as we go forward, not only are we getting a more focused approach to the differentiation with the value proposition right from engineering through install to then ultimately getting the life cycle services. When you project the overall performance going forward, we believe that from a growth standpoint will be well above market, capitalizing on the secular trends with the differentiation. From a margin profile, we’ll have a much higher recurring revenue within our services, demanding a much higher margin with the content of the software-enabled services.

And then from an overall return, when you look at the conversion to cash we’re getting now, for the value proposition we bring we’re getting much more cash up front relative to that value proposition, and ultimately being able to deliver very strong free cash flow. So I would say well above market growth, continued expansion of margins to what we believe is kind of mid to higher teens and then very predictable cash flow with the mix of the content of what we do for our customers.

Scott Davis: That’s helpful, George. And when you think about asset sales, you know, and there’s some nuance here clearly, but is it more a function of simplifying the portfolio so you can execute on those KPIs that you just mentioned, or is it or do the asset sales themselves kind of change the growth and margin profile of the company?

George R. Oliver: No, let me reflect on the transformation that we’ve been going through. We’ve been continuously evaluating the portfolio, kind of where we are with the transformation of a comprehensive solutions provider in commercial buildings, and then making sure that our resources are being deployed to the highest priorities. When you look at the non-commercial product lines, they’re excellent businesses, but they do not necessarily – are they consistent with the go-to-forward strategy over the longer term. And that’s now why, as we are now pursuing the alternatives here, because these are good businesses, and there’s an opportunity with these businesses now to be able to create even more value for our shareholders as we look at the alternatives.

We’re very excited about the future with the prospects that we have and the opportunities that we’re driving towards. We believe that we’re on the right path now to simplify the portfolio, continue to drive margin expansion, deliver much more consistent cash flow, while most important is really differentiating the value proposition that we can bring to our customers, which is going to be fundamental to the growth.

Operator: Thank you. And our next question today comes from Steve Tusa with J.P. Morgan. Please go ahead.

Stephen Tusa: Hi. Good morning.

George R. Oliver: Good morning Steve.

Stephen Tusa: It would be great if Marc could answer this question, but for the second quarter, could you just talk about the various segments and how you get to this 14.5% operating margin target, maybe on a year-over-year and sequential basis, and what do you expect out of them? And I have a follow-up. Thanks.

Marc Vandiepenbeeck: Yeah, thanks, Steve. So first, I want to address the change in guidance, right. Since we issued our guidance in December, the impact of the economic environment in China on our business has deteriorated. And we have factored originally a fairly cautious outlook in China in the initial guide. However, that outlook has further worsened. We refocused the organization going through that tumultuous environment in China. We see a path of recovery to that volume and recovery of the backlog as well in the second half of the year, but it started to bottom out in Q2. We have more clarity on some of the actions we’ve taken around productivity and cost structure, and that support the recovery in that backlog. Now focusing on Q2 on the different business, if you look at our field-based business, Building Solutions, the cyber disruption is really behind us.

And the loss momentum that we had in Q1 is now recovering and supporting the shorter-cycle businesses, particularly our service mix. If you look at North America and EMEALA, particularly, the margin we have put in the backlog over the last six months, but particularly during the first quarter, gives us confidence that we’re going to be able to deliver on the margin rate for those businesses. There’s a lot of benefit of cost actions we’ve taken early on in the year and later last year, but there’s also more return to seasonality in our Global Products business as we see the volume providing marginally in those operations. If you combine all of that, I think we see with confidence that margin being attainable, Steve.