Johnson Controls International plc (NYSE:JCI) Q1 2023 Earnings Call Transcript

Johnson Controls International plc (NYSE:JCI) Q1 2023 Earnings Call Transcript February 1, 2023

Operator: Welcome to Johnson Controls First Quarter 2023 Earnings Call. Your lines have been placed on listen-only until the question-and-answer session. This conference is being recorded. If you have any objections, please disconnect at this time. I will turn the call over to Jim Lucas, Vice President, Investor Relations.

Jim Lucas: Good morning, and thank you for joining our conference call to discuss Johnson Controls first quarter fiscal 2023 results. The press release and all related tables issued earlier this morning, as well as the conference call slide presentation can be found on the Investor Relations portion of our website at johnsoncontrols.com. Joining me on the call today are Johnson Controls Chairman and Chief Executive Officer, George Oliver; and Chief Financial Officer, Olivier Leonetti. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of Johnson Controls.

These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors and cautionary statements in our most recent Form 10-Q, Form 10-K and today’s release. 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 Oliver: Thanks, Jim, and good morning, everyone. Thank you for joining us on the call today. Let’s begin with Slide 3. Fiscal 2023 is off to a strong start with solid Q1 results. Our teams across the globe have executed well delivering strong financial performance for our shareholders, while pushing the pace of innovation to provide our customers with the next phase of digital solutions across our vectors of growth. During the quarter, we accelerated growth across to our service-based businesses, drove higher margins and delivered profitability at the high end of our adjusted EPS guidance range. Overall, organic revenue grew at a healthy pace and our $11.3 billion backlog remains resilient, growing 11% year-over-year.

Our service strength was resilient and remains a key competitive differentiator. While order timing, supply chain realization and China policies have impacted our global products in field install order flow during the quarter, we are seeing incremental improvements in order momentum heading into Q2. As we mentioned over the last few quarters, we remain focused on the fundamentals of our business in improving our operational execution. Our teams have done a great job advancing our initiatives to accelerate growth and optimize the efficiency of our cost structure. During the quarter, we delivered $90 million in productivity cost savings, and are on track to reach our $340 million savings target over the course of this fiscal year. We are also committed to our prudent approach to capital allocation, reinvesting in new products and technology to drive long-term shareholder value while continuing to return capital to our shareholders.

We recently announced our plans to enhance our growing industrial heat pump portfolio with the acquisition of Hybrid Energy. Acquisitions are an integral part of our growth strategy and by investing in Hybrid’s patented high temperature heat pump technology, we are continuing to strengthen our leading global product portfolio and provide our customers with the most efficient sustainable building solutions. We are well-positioned to capitalize on large growth opportunities across our dynamic product portfolio and field business. Through our integrated domain expertise, global coverage and scale, we are leading the way towards smart, healthy, and sustainable buildings for our customers. While the global macroeconomic environment remains uncertain based on our strong start to Q1 and our expectations for the remainder of the year, we are raising the lower bookend of our adjusted EPS guidance range for the year.

Now turning to Slide 4. During the quarter, our OpenBlue platform continued to expand as we enhanced our capabilities leveraging the power of AI and providing customers with unique insights. A good example is the deployment of OpenBlue enterprise manager at a leading tech manufacturer to help them meet their energy and sustainability goals. In addition, we have recently installed OpenBlue companion at their facility to enhance employee productivity and space utilization. From advancing predictive analytics to integrations at the edge, our full suite of solutions empowers our customers to meet their carbon emission goals and create a healthier, more productive workspace for their people. To date, we have enhanced the existing connectivity of over 11,000 chillers through OpenBlue, representing a 79% increase year-over-year.

Moving on to Slide 5. Our digital service journey has accelerated since we launched our innovative OpenBlue platform in fiscal 2021. At that time, we entered the first phase of our digital transformation with a focus on enhancing data mining capabilities. Over fiscal 2022, we launched the OpenBlue gateway enabling data access at scale and increased connectivity across our growing installed base. We are now positioned for the next phase of our journey as we standardize our field operations globally. Linking the benefits of real time monitoring of connected devices to our extensive service network. We can provide our customers with faster response times while optimizing the deployment of our global field service presence. We are beginning to see the results of our digital offerings enabling service growth.

During the first quarter, service orders and revenue grew 10% year-over-year, with continued growth, we are in a great position to reach the goal we set out at our Investor Day in fiscal 2021 to capture $2 billion in additional service revenue by 2024. On to Slide 6, with nearly 40% of the world’s carbon emissions coming from commercial and industrial buildings, the goal of achieving net zero starts at the building level. Through our vast sustainable infrastructure partnership ecosystem, we play in an integral role in helping our customers achieve these targets no matter where they are in their decarbonization journey. Starting with our established advisory services and goal setting partnerships with KPMG and Accenture, we help customers take the first step to accelerate and solve their decarbonization and efficiency goals.

We are also able to help fast track our customers’ net zero targets through carbon reduction services, collaborating with leading renewable energy supply and distributed energy providers. With our comprehensive customer solutions and strategic partnerships, we are positioned to take full advantage of favorable regulatory tailwinds and continued momentum. During Q1, we realized over $200 million in organic revenue, growing over 20% year-over-year with orders over the last 12 months, growing at 6%. Turning to Slide 7. The Healthy Buildings opportunity remains attractive as our customers invest in indoor environmental quality improvements post-COVID. Solving for the indoor air quality and energy consumption challenges of hybrid work models is driving a compelling intersection of our Healthy Buildings and sustainability strategic growth vectors.

We are in a leadership position, thanks to OpenBlue indoor air quality as a service, which continued to gain momentum in Q1 as well as our leading IAQ and space management capabilities in OpenBlue Enterprise Manager. In our Healthy Buildings business, trailing 12-month orders increased 11% year-over-year, and our pipeline of $1.2 billion remains strong. Looking forward, we expect continued growth momentum as the value of indoor environmental quality improvements delivers benefits for our customers. On to Slide 8. We are honored to be continually recognized for our dedicated sustainability efforts. Among other honorable recognitions, two of Johnson Controls leaders were awarded for their efforts. Chief Sustainability Officer, Katie McGinty, was named one of 2022’s most influential women executives for sustainability leadership by Women Inc.

magazine. Anu Rathninde, President of Asia-Pacific, received the ESG Exploration Character Award of the Year from the 2022 ESG Pioneer 60 awards by Jiemian. I am proud of our team for leading by example and executing on our values. I will now turn the call over to Olivier to go through the financial details of the quarter. Olivier?

Olivier Leonetti: Thanks, George, and good morning, everyone. Let me start with the summary on Slide 9. Total sales grew 4% with organic sales increasing 9%, comprised of 10% price and a modest volume decline. FX was a 6% headwind during the quarter. We saw strong performance across our longer cycle field businesses, which grew 10% in the quarter. Our shorter-cycle Global Products business grew sales 7%, impacted by a slowdown in residential demand. Adjusted segment EBITDA increased 15% with margins expanding 140 basis points to 13.7%. Positive price costs and improved productivity more than offset unfavorable business mix. Adjusted EPS of $0.67 was at the high end of our guidance and increased 24% year-over-year. During the quarter, we absorbed an additional $0.01 of FX headwinds versus the prior guide.

Free cash flow returned to the normal seasonal pattern with the usage to start the year. In addition, inventory levels were impacted by softness in residential as well as continued supply chain disruptions, which while improving impacted our ability to satisfy green demand in commercial. Turning to our EPS bridge on Slide 10. Overall, operations contributed $0.19 versus the prior year, including an $0.11 cent benefit from our productivity programs for which we are on track to meet our targeted savings for the year. In the quarter, FX was a $0.04 headwind below the line higher net financing charges and corporate expense were offset by a lower share count and favorable non-controlling interest. Please turn to Slide 11. Total orders for our field businesses increased 5%.

As George stated earlier, orders in the quarter were affected by timing and COVID related impacts in China. Order timing are the largest impact within our in-store business, which grew 1% in the quarter. We were encouraged by 10% order growth in our service business driven by double digit growth in both EMEA/LA and APAC. Field backlog remains at record levels, growing 11% to $11.3 billion, $800 million increase versus the prior year while growing $250 million sequentially. Our global products third-party backlog grew more than 30% over the prior year to $2.8 billion. Let’s now discussed our segment results in more details on Slides 12 and 13. Sales in North America were up 10% organically with broad-based growth across the portfolio. Our install business grew 12% with low-double-digit growth in both retrofit and new construction.

Overall, HVAC and controls continues to gain momentum, growing mid-teens year-over-year, while Fire & Security increased high single digits. Order timing mainly impacted North America as orders increased 6% with solid growth of 7% in our service business. New construction orders grew over 50%, primarily in HVAC in aggregate Fire & Security orders grew low single digits. Total backlog ended the quarter at $7.5 billion up 16% year-over-year. Segment margins decreased 30 basis points year-over-year to 11.3% as positive price cost and ongoing productivity benefits were offset by unfavorable project mix. Sales in EMEA/LA grew 12% organically with strong performance in applied commercial HVAC and Fire & Security. Our service based business was strong in a quarter growing mid-teens year-over-year with recurring revenue contributing low-double-digit growth.

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Orders were up 5% led by over 20% growth across our Fire & Security platforms, which was partially offset by declines in HVAC and industrial refrigeration. Backlog was up 5% year-over-year to $2.2 billion. Segment EBITDA margins declined 310 basis points to 7.7% as a result of unfavorable mix and dilutive price cost, which offset favorable volume leverage and the benefits of cost savings during the quarter. Sales in Asia Pacific increased 7% driven by mid-single-digit growth in our commercial HVAC & Controls platform. Service performed well in the quarter growing low double digits, benefiting from our shorter cycle transactional business, primarily in HVAC & Controls. China grew 1% in the quarter impacted by COVID induced lockdowns. As China continues to reopen, we are encouraged with the momentum building within that region.

Orders decline 1% as low-double-digit growth in service was offset by a decline in HVAC & Controls installation. Overall, install orders declined 5% organically. Backlog of $1.6 billion declined 1% year-over-year. Segment EBITDA margins increased 40 basis points to 10.5% driven by positive price cost and productivity savings, which offset lower volumes and FX headwinds over the quarter. Sales in our shorter cycle products business increased 7% in the quarter, benefiting from strong price realization of 11%. Commercial HVAC product sales were up low double digits with strength in light commercial driven by over 20% growth in North America and EMEA/LA respectively. Applied HVAC sales were up low double digits with continued demand in chiller within our data center and market.

Outside of North America, our global residential HVAC sales were up low single digits. North America Resi HVAC declined 20% as the overhaul market softened and we were challenged by unfavorable product mix in the channel. Our HVAC business grew mid-single-digits led by more than 25 growth in applied within EMEA/LA, as well as strong demand from our Hitachi commercial heat pump in EMEA. Fire & Security products grew high single digits in aggregate led by continued demand in North America and in the Middle East for our Fire Detection products. EBITDA margins expanded 580 basis points to 20.3% driven by positive price cost and the benefit of productivity savings. Turning to our balance sheet and cash flow on Slide 14. We ended Q1 with $1.5 billion in available cash and net debt at 2.2 times, which is within our target range of 2 to 2.5 times.

Now let’s discuss our fiscal 2023 guidance on Slide 15. We were pleased with our start of the year and are encouraged by the continued strength and resilience in our order and backlog. Our backlog grew double digits and remains at record level. We are providing Q2 organic sales guidance of approximately 10% growth with price being the principal contributor. Segment EBITDA margin is expected to expand 100 to 110 basis points and adjusted EPS is an expected range of $0.72 to $0.74, which represents year-over-year growth of 15% to 18%. On a full year basis, we’re raising the low end of the wide range we introduced to beginning the year. While we are encouraged with our strong start to the year and our current second quarter outlook, we continue to take a cautious outlook for the full year given the ongoing macroeconomic uncertainty.

Our full year adjusted EPS guidance range of $3.30 to $3.60 represent growth of 10% to 20%. The top third of our EPS range signifies our base case scenario. This account for normalized GDP growth, continued growth, vectors acceleration and conversion of our existing backlog. The low end of this range provides a bookend reflecting a potential macro downside scenario, which accounts for a potential degradation of global GDP that we believe will be offset by our resilient services and commercial market presence, along with additional cost mitigation actions. On the top line, we anticipate high-single-digit to low-double-digit organic growth with price representing about 10%. We anticipate segment EBITDA margin expansion of 90 to 120 basis points as we continue to execute our higher booked margin backlog throughout the fiscal year.

Full year free cash flow conversion is expected to be between 80% to 90%. Operationally, we continue to improve our working capital management and expect further improvements from the gradual reduction of inventories as the supply chain normalizes. As George mentioned, we are pleased with the strong start to the fiscal year. Whilst supply chain disruptions continue to impact our global products business, we see positive momentum in our field based services. Across our vectors of growth, our pipeline remains robust and we are well positioned to capture secular tailwinds while continuing to improve our operational execution as we navigate through the first half of the fiscal year. With that operator, please open up the lines for questions.

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Q&A Session

Operator: Our first question is going to come from Nigel Coe from Wolfe Research. Nigel, your line is open.

Nigel Coe: Thanks, and good morning, everyone.

George Oliver: Good morning, Nigel.

Nigel Coe: So €“ hi guys. So, yes, you mentioned field €“ timing for field orders coming up plus 1%. So maybe just continue just like double click on what’s causing some of the delays that perhaps you didn’t expect? China, I think I understand, but outside of China.

George Oliver: Yes, when you look at our field orders, what is encouraging? Although, the install was up 1%, services was up over 10%, and we’re very encouraged with the progress we’re making there, Nigel. On the install side, it’s mainly a couple of factors here that impacted us here in the quarter. It was €“ the China €“ the COVID lockdowns, we have incredible pipeline, but because of the disruption and ultimately the delay in getting those closed impacted us in the quarter, and that’s 1% to 2%. And then in our project-based business as we now drive our vectors of growth around sustainability and healthy building. There’s larger projects and a lot of these, it’s hard to predict that timing conversion and so that amounted to another roughly 1% to 2%.

Those are the key drivers, as far as the orders €“ field orders. Nigel, the backlog is up over 11%. The pipeline continues to be strong double digits in our conversion. And so as we’re now executing on the strategy, we are encouraged that our conversion is going to continue very strong here in Q2 and beyond for the year. And then now the way that we’ve been set up here with the backlog being up for the year really does give us a lot of confidence in our ability to be able to deliver on the guide that we provided for the full year.

Nigel Coe: Great, thanks George. And then my follow-up questions on the margin expansion for the full year. You’ve raised the bottom end by 10 basis points. So I’m curious how the mix between the segment change. and I’m referring here to obviously the strengths we saw in global products, the weakness we saw in EMEA/LA. So just wondering if the mix of that margin expansion has changed at all.

George Oliver: We’re making tremendous progress on our margins and it’s not only €“ this has been over the last couple years instilling a discipline around price costs and more important about the value propositions that we’re bringing to the market with our vectors of growth. And so we’ve got €“ you see that not only in our shorter cycle business with our global products and the strength that we’re having in margins that’s combined not only the value proposition, but now also the additional productivity that’s playing through and the leverage that we’re getting on that. And so as we project the current year, we’re going to continue, going to see momentum in margins, because the longer cycle business, we’ve got strong margins and backlog. As we increase the velocity on the turn of these projects, you’re going to start to see much stronger margins come through on the rest of the year. So Olivier, maybe you can comment on the segments.

Olivier Leonetti: Absolutely. So one clarifying point on the orders. We expect as an impact on orders due to the move of the orders from Q1 to Q2 orders in the field to be high single digits in Q2. Regarding the margin, we expect global product margin to remain strong for the rest of the year and we expect the field margin to turn positive in Q2, probably about 51 to 100 basis points at the segment EBITDA level and increase day after significantly with a strong increase as we end the year, Nigel, in the field business.

Nigel Coe: Great. That’s very helpful. Thank you.

Operator: Our next question comes from Joe Ritchie from Goldman Sachs. Joe, your line is open.

Joe Ritchie: Thanks. Good morning, everyone.

George Oliver: Good morning, Joe.

Joe Ritchie: Olivier, I want to pick up off that last point on field margins improving. And so you guys called out unfavorable mix both in North America and EMEA/LA, I want to understand that a little bit better. And then specifically on North America, I know that you guys saw this sequential improvement last quarter, but the margins now have been down year-over-year for the last seven quarters. So just help us understand what’s driving the confidence in those margins getting better from here and what was the issue with unfavorable mix that was coming through the field business this quarter?

Olivier Leonetti: So it would be from a project to €“ project mix or larger projects flowing through in the quarter. If you look at a high level and we have discussed that job before, we have booked orders at a higher level of margin all through last year. And those orders are now starting to flow through the field business. So as indicated to Nigel earlier, we expect the field margin to improve at a segment EBITDA level in Q2 by 50 to 100 basis points and keep increasing thereafter. That would include also our North America business. The expectation for the margin increase in segment EBITDA level for North America into two is expected the increase to be over a full points. So as we keep converting the backlog as we €“ which is at a higher margin, as we keep delivering our productivity initiatives, as we keep increasing the mix of our service business in our companies, which was very strong in Q1, we expect this momentum to continue in Q2, you will see the field margin business to increase, I would say, materially between Q1 and Q4, Joe.

Joe Ritchie: Okay. That’s good to hear. And I don’t usually ask questions on the North America resi business, because it’s a small portion of the overall portfolio, but it was pretty interesting to see that business down 20%. I think you guys called out product mix in the channel. So maybe provide a little bit more color, what’s happening there? That seems to be a little bit lower than what we’ve seen reported so far from some of your peers.