Johnson Controls International plc (NYSE:JCI) Q2 2024 Earnings Call Transcript

Johnson Controls International plc (NYSE:JCI) Q2 2024 Earnings Call Transcript May 1, 2024

Johnson Controls International plc beats earnings expectations. Reported EPS is $0.78, expectations were $0.754. JCI isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

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

Jim Lucas : Good morning, and thank you for joining our conference call to discuss Johnson Controls’ Second 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; and 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 actual results or future expectations change materially. Please refer to our SEC filings for detailed discussions 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 to 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. Let’s begin with Slide 3. We were very pleased with our second quarter performance as our adjusted EPS came in at the high end of our guidance. Sales growth returned this quarter, following the cyber disruption at the start of the fiscal year. And our team delivered strong margin expansion. This was driven by productivity and conversion of our higher margin backlog. Orders noticeably rebounded in the quarter up 12% year-over-year. This was driven by continued strength in data centers, which I will talk about in an upcoming slide. Our backlog remained at record levels, growing 10% to $12.6 billion. And the quality of the backlog is strong, as I mentioned.

Customers continue to come to Johnson Controls because of our ability to deliver attractive outcomes. The fact is, our focus on delivering engineered solutions for commercial buildings continues to serve as a differentiator for Johnson Controls, allowing us to deliver unparalleled value. With the business performing at a high level, free cash flow continues to improve, and we are taking action to further strengthen our balance sheet. Most recently, we reached a broad settlement with a nationwide class of public water systems related to our AFFF product. Additionally, we announced that we discontinued use of our receivable factoring programs. Our efforts are turning into results, and the value of our transformation is coming into focus. Going forward, we remain active in pursuing strategic alternatives of certain non-core product lines that do not align with our focus on being a comprehensive solutions provider for commercial buildings.

While we do not have any updates to provide at this time, we continue to make good progress on the exploration of alternatives for some of these assets. The results from the quarter and the performance of our team give us confidence that we will continue to build momentum into the second half, and we will be able to meet our financial objectives for the year. Marc will discuss these in more detail later in the call. Please turn to the next slide. I want to take an opportunity to discuss how we see the composition of our company going forward. The core of Johnson Controls is our engineered solutions offering. These solutions include commercial HVAC controls, fire, security, and services. Our solutions center around our domain expertise, forming the smart building trifecta of energy efficient equipment, clean electrification, and digitalization.

We have created one end-to-end operating model that we now have deployed around the globe, which allows us to better serve our customers more efficiently with greater predictability. Our solutions include both systems and services that focus on maximizing the opportunities around the life cycle of the equipment. These solutions are enhanced further by our digitally enabled offerings, which allow us to provide tailored outcomes for the customers which we serve. Our systems business begins at the engineering and design phase. It is managed through installation of the project. The systems business is an important vehicle to capture a service event, and we have created a scalable service model that is driving more consistent growth. And that carries higher margins.

The service business will continue to be a positive contributor to our long-term margin expansion. Our solutions operating model is enabled by connected equipment throughout the building, allowing us to collect data that drives a consistent and enjoyable occupant experience with repeatable outcomes. We create incredible value for our customers, which is clearly demonstrated by our results in the most recent quarter. The transformation of our portfolio into a pure-play provider of comprehensive solutions for commercial buildings is an opportunity. Once complete, we will be able to flow additional resources to the most attractive opportunities. Part of our commitment to discipline capital allocation remains ensuring that we are deploying resources to the right opportunities.

Turning to the next slide, Johnson Controls plays an important role in serving the rapidly growing data center market. We provide cooling needs for the top hyperscale and co-location data center customers. The demand for data centers is accelerating globally with the next-generation of data centers projected to be designed for more than one gigawatt of power consumption. We have intentionally positioned the company to benefit from this emerging trend due to our relentless innovation efforts and inherent strategic advantages. These include, one creating leading technologies around a broad range of air-cooled and water-cooled chillers to support the exponential growth in cooling demand. Two, investing in R&D teams in world-class test laboratories to design, build, test, and demonstrate performance of equipment over the entire data center operating envelope.

Speed is the key, so we are investing to accelerate the pace of innovation. And three, creating leading domain expertise to provide complete package solutions that drive outcomes, such as high efficiency chiller plant, space cooling, critical environmental monitoring, security systems, and fire safety and asset protection systems while providing service for the entire life cycle of the asset. Underscoring these advantages is our core identity as a comprehensive solution provider for commercial buildings. This enables us to fulfill more than cooling needs for our customer, which makes us a preferred partner that can expand with our customers across all geographies. In fiscal 2023, our sales to data centers were approximately $2 billion. We continue to see solid demand for our solutions, which is evident in our orders.

This is reinforced by the fact that our fiscal first half orders for data centers have already surpassed the orders we booked for all of fiscal 2023. With orders growing, we have been investing in capacity to be able to execute on our accelerated data center backlog. Our strong presence in data centers starts with our advanced chiller technology. Given the amount of heat generated at data centers, our customers are looking for solutions that maintain constant temperatures in even the most extreme environments. In addition to chillers, we have extended our offerings with both air handling units and computer room air handlers. Our cooling solutions continue to advance, and we are working on next generation technologies to keep up with the growing needs of data centers.

The case study on this slide was for a half gigawatt facility that is being expanded now to a full gigawatt. The project included the deployment of our chillers, air handlers, and just as important, we have secured a planned service agreements for all of the chillers. Our pipeline for data centers remains very healthy, and we are continuing to expand our capacity to meet this strong demand. We remain excited about the opportunities in this fast-growing vertical and look forward to updating you on our progress in the future. Before I turn the call over to Marc to go through the financial details, I want to say how proud I am of the Johnson Controls team. While we faced some challenges in the first fiscal quarter, and we’ll continue to navigate a dynamic environment, we delivered on our commitments to our customers to drive value for our shareholders.

Now with that, I’ll turn it over to Marc.

Marc Vandiepenbeeck : Thanks George and good morning everyone. Let me start with summary on Slide 6. Total revenue of $6.7 billion was flat year-over-year, while organic sales grew 1%, a strong high single digit service growth more than offset continued weakness in China systems business and declines in the global Residential HVAC. Segment margins expanded 70 basis points to 14.5% as we delivered strong productivity and [convert with] (ph) higher margin backlog. Adjusted EPS of $0.78 was up 4% year-over-year and at the high end of our guidance range of $0.74 to $0.78. Operations contributed $0.06 of the growth in the quarter, benefiting from recover momentum following the cyber incident at the end of our last fiscal year, as well as improved productivity.

Below the line, we saw headwinds from net financing charges due to higher interest rates. Overall, we are pleased with the strong adjusted EPS performance in the quarter. On the balance sheet, we ended the second quarter with approximately $800 million of available cash and net debt increased to 2.4 times, which is within our long-term target range of 2 times to 2.5 times. For the fiscal first half, excluding the impact of the receivable factoring unwind, adjusted free cash flow improved $166 million year-over-year. As we end the use of factoring, we will continue to focus on further improvement on our core buildings and collection capabilities, leading to continued improvement in our cash performance over time. We’ve also made tremendous progress in reducing our inventory levels and expect further improvement in the second half.

Let’s now discuss our segment result in more details on Slide 7 through 9. Beginning on Slide 7, organic sales in our global product business declined 1% year-over-year, with volume declines offsetting price. We saw low single digit growth in commercial HVAC, highlighted by mid-teen growth in light commercial. Our applied HVAC declined mid-single digit against a tough year-on-year comp. Fire and security declined low single digit against tougher comps, as decline in fire suppression more than offset growth in fire detection and security videos surveillance. Industrial refrigeration grew over 25%, with another strong quarter in EMEA/LA. Global residential HVAC declined low single digit driven by low single digit decline in global ductless residential primarily in Europe.

Our global ducted residential business declined mid-single digits, with a mid-single digit decline in North America, offsetting strength in Latin America. Dealer growth is up high double digit, with channel inventory normalizing and distributors sell through continuing to increase. We see momentum building in our North America market. [Adjustment] (ph) segment EBITDA margins expanded 30 basis points to 18.9% as positive price cost and improved productivity more than offset mixed headwinds. Moving now to Slide 8 to discuss our building solutions performance. Orders regained momentum with strong 12% growth in the quarter. Overall service orders grew 13% with broad-based growth across the regions. Systems orders grew 12% as North America offset declines in EMEA/LA and APAC Organic sales increased 2% in the quarter, led by service growth of 8%.

Systems revenue was down 2% as declines in APAC and EMEA/LA more than offset high single-digit growth in North America. Building solution backlog remains at a record level, growing 10% to [12.6%] (ph). Service backlog grew 3%, and systems backlog grew 11% year-on-year. Let’s discuss the building solutions performance by region on Slide 9. Orders in North America increased 19% in the quarter, driven by 26% growth in systems. We continue to experience strong demand in data centers, which led to nearly 50% growth across our HVAC controls platform. Fire and security orders grew low single digit. Sales in North America were up 8% organically with strong growth across our HVAC and Controls platform up mid-teens year-over-year. Overall, our system business grew 9% while service grew 6%.

Segment margins expanded 110 basis points year-over-year to 13.6%, driven by the continued execution of higher margin backlog and strength in a higher margin service business. Total backlog ended the quarter of $8.9 billion, up 15% year-over-year. In EMEA/LA, orders were up 8%, with strong double-digit growth in service offset by a decline in system due to a strong year-over-year compare. Consistent with our strategy there is an increased focus to drive higher margin into our backlog. Controls had a strong order intake with solid growth in Europe and Latin America. Sales in EMEA/LA grew 4% organically, with low teen service growth offsetting a decline in our system business, predominantly driven by Latin America and Middle East HVAC businesses.

Our service business benefited from strong double-digit growth from both recurring and shorter cycle transactional businesses. Industrial refrigeration another solid quarter with low-teen growth year-over-year. Segment EBITDA margin expanded 170 basis points to 8.4%, driven by improved productivity, positive mix from the growth in service, and by the conversion of higher margin systems backlog. The backlog was up 10% year-over-year to $2.4 billion. In Asia Pacific, orders declined 9% as we remained selective of the jobs we booked into the China system backlog. Overall, APAC service orders grew high single digits, driven by high single digit growth in our recurring contracts. Sales in Asia Pacific declined 23%, as the system business was impacted primarily by the continued weakness in China.

Our service business grew 7% in the quarter with strong growth in our shorter cycle transactional business. Segment EBITDA margins declined 80 bps to 11% as weakness in China offset positive mix from our service business. Backlog of $1.3 billion declined 18% year-over-year. Now let’s discuss our third quarter and fiscal year ‘24 guidance on slide 10. We enter our seasonal strong third quarter with good momentum, evidenced by our robust order and resilient service. Our margin-rich backlog remains at historical levels. And our global product book-to-bill business have stabilized. We are introducing third quarter sales guidance of approximately low single-digit growth which assumes one more quarter of top-line pressure in our system business in China.

We expect strong contribution from North America and EMEA/LA, especially from the regained momentum in our service business. Global product is expected to return to growth as our book-to-bill orders remain positive through the second quarter. For the third quarter, we expect segment EBITDA margin to be approximately 17% and adjusted EPS to be in the range of $1.05 to $1.10. We are maintaining our full year guide. We expect sales growth of approximately mid-single digit led by continued momentum in our service business, stabilization in our global products and a cautious second half outlook for China. Segment margins are expected to expand approximately 50 basis points to 75 basis points through productivity improvement, positive mix from the service business and conversion of a higher margin backlog.

Our adjusted EPS guidance range is unchanged and is expected to be approximately $3.60 to $3.75. The high-end of the guide assumes accelerated recovery in China normalized channel inventory levels in North America resi and service acceleration. Excluding the impact of unwinding the receivable factoring, we continue to expect adjusted free cash flow conversion of approximately 85% for the full year. Our working capital metrics continue to improve, supported by our first half performance. In summary, we remain confident in our ability to deliver on our financial and operational commitments. With that, operator, please open the lines for questions.

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] And today’s first question comes from Steve Tusa with JPMorgan. Please go ahead.

Stephen Tusa: Hi, good morning.

Marc Vandiepenbeeck: Good morning Steve.

Stephen Tusa: Can you just maybe talk about — was there anything that was pushed from 1Q into 2Q? And then, I guess looking at the guidance, fourth quarter definitely looks like a step-up here even more so than before. What gives you the confidence even at the lower midpoint to see that kind of ramp from 2 to 3 to 4 at this stage?

Marc Vandiepenbeeck: Yes. So in terms of push from Q1 to Q2, we had some orders that did slip due to the cyber incident and the recovery in the momentum. I wouldn’t say it’s material in terms of what pushed from 1 to 2, there was some smaller ones. But the strength of our orders in Q2 is really coming from the fundamental positive trend we are seeing in our data center business and some other core businesses. Now in terms of the guide for the balance of the year and maybe first address third quarter, if you look at the third quarter guidance, we provided over a $1.05 to $1.10, we feel very strong about Q3. We regained momentum during the second quarter and that gives us strong confidence especially when we enter the third quarter.

All of the short-cycle businesses we have been talking about have seen very strong order during the second quarter and we continue to see that momentum building, as we enter the third quarter. And that gives us the confidence that our book-to-bill global product businesses, resi business, and of course, our business solutions service business will achieve the target we’ve set for them. You know that China is still facing one more quarter of revenue pressure in Q3 but the order momentum there remains very, very strong. And we are really expecting a very strong sequential performance in both EMEA/LA and North America. And so if you think about the guidance about the balance of the year, we are still showing the same range, as we did to the prior quarter, even though we created a pretty strong second quarter at the high-end of the guide we have provided.

And if we look at the second half and the balance of the year, what you need to see and what we’re expecting to see from a guidance standpoint is the China business will have to accelerate its momentum both on order and on revenue. We would also need to see the resi business with a sequential quarter-over-quarter growth to increase. And you know that business is facing some additional variability associated with the fact that we are switching refrigerant, as part of the market change. And finally to achieve the very high-end of that guidance, we would have to achieve improved service growth on where we closed the second quarter and where we see the third quarter lending. So — and Steve, I would also remind you that looking comparatively into the second half, we have much easier comps than we did in the first half.

Stephen Tusa: And then lastly, just any updates on deal timing?

George R. Oliver: Yes. So as I said in my prepared remarks Steve, we are making good progress. As we have said, these businesses are outside the core and represent roughly about 25% of our sales, while they are non-core, they are good businesses that are adding value. So we are remaining focused on maximizing shareholder value. And like I said pretty much across the Board making good progress. and we’ll keep you updated as we continue through with these businesses.

Operator: Thank you. And our next question today comes from Nigel Coe with Wolfe Research. Please go ahead.

Nigel Coe: Thanks, good morning everyone. Hi, guys. Just — Marc, I think you just alluded to the warranty add-back in products. Maybe just — could you just maybe just flesh that out a little bit, why that wasn’t considered operating, why that’s a discrete-item? And then on the fourth quarter guide, I mean, I think the implication is like low-double digit organic growth in the fourth quarter to get to that mid-single digits, even the low-end of mid-single digits for the full year. So is that the intention? Do you actually see a pathway to low double-digit organic growth, even though it is easier comp is still quite a tough bar.

Marc Vandiepenbeeck: So let me start first with the global product quality issue, which is really not a warranty issue. It really is a quality issue. The reserve really relates to an anticipated remediation action we need to address in a very recently identified firmware issue within some of our legacy products that are sitting in the field. We are currently testing that firmware update within those [divide] (ph) and we’re developing a remediation plan for this particular issue and we’ll announce when we are done with the full remediation. There’s been no reports of any injuries or damage related issue with that issue. These kind of problems are very unusual, fairly rare, particularly for field devices like this. Now when it comes to the — your second part of your question, I’m sorry, I forgot what you asked.

Nigel Coe: Yes. The low double-digit implied organic sales growth in the fourth quarter.

Marc Vandiepenbeeck: We see closer to higher single-digit growth for the balance, to be honest with you. That’s the answer. Yes.

Nigel Coe: Okay. And then my follow-up question is on the factoring change. Obviously I think most of us agree that good news to try and clean up the kind of cash generation. Just wondering what other measures you are considering to improve the quality of the free cash flow? And in particular, is there any change in the way that you are sort of approaching the market via JC Capital?