Johnson Controls International plc (JCI) Earnings Call Transcript & Summary

All right. Again, we are really excited to have Johnson Controls with us. Certainly, a lot of great performance here over the last couple of years under George Oliver. George has been Chairman and CEO of JCI since September 2017 after a brief but important role as President and COO. And then Brian joined JCI in 2010 after 30 years at PwC and was appointed CFO in 2014. So George, maybe I'll just turn it over to you in case you want to make any brief comments, and then we'll go into the fireside chat.

Yes, sure. Well, as you said, we've had a couple of very strong years here over 2018 and 2019. We're off to a good start in 2020 in our first quarter and positioned, again, to have a very good year in 2020. So maybe we just get into the Q&A?

Sure. Sure. So I asked you this last year. I'm going to ask you this again. Maybe it's the last time I really can ask you this. But you -- when JCI bought Tyco, there were a lot of questions about how the integration would go. You set some big targets, $1.2 billion of cost of synergies and $1.10 of EPS. Have you seen -- it seems like you've seen all of those synergies. And maybe you could sort of reconfirm that. And then in terms of revenue synergies, which is maybe more interesting now, right, you had talked about $500 million as your revenue synergy goal. Maybe you could sort of update us, even probably it's all blended together, but maybe talk about that.

Yes. So I'll give you a strategic overview, and then Brian maybe can reinforce and talk about the financials here that have come through during the integration. But from a strategy standpoint, it was the idea that we could put 2 leadership companies in buildings, both HVAC and building controls, combined with electronic fire, electronic security and the like. And that together, given the trends in buildings, would position a leader in the building space and that has played out. And of course, through that process, we also divested the Power Solutions business. So today, we are a true pure-play buildings business. And when you look at the strategy of not only combining the technologies, whether it be all of our digital assets and how we're positioned within buildings, controls, security, fire, we've had -- made incredible progress on how those platforms have come together and positioned ourselves not only to do what we've done historically with those but also being able to now leverage the data that we extract with all of the sensoring and capabilities to be able to create new business models and ultimately create new outcomes and solve bigger problems for our customers. So strategically, absolutely what we saw then has been the way it's been played out. And from an overall -- from a synergy standpoint, as you know, if you go back 2.5 years ago, we embarked on making sure that we were positioned in market back with a sales force that enabled us not only to take any one of our platforms but our combined platforms to be able to be positioned to outperform the industry. So we've added, from a sales force standpoint, over 1,500 salespeople globally. And we've been very disciplined within the segments that we compete in. And then more important, how do we then -- with all of that combined capabilities, how do we actually disrupt the building space and enable us to be able to deliver on that with our new solutions. So that's been a big focus. When you look at our growth rate, combination of our sales force and then our reinvestment within products and technology, we have elevated that reinvestment rate that has enabled us, when you look at any one of our platforms, to get into a competitive position or leadership position to be able to be positioned to gain market share and outperform. So the combination of the sales force, the leadership and technology and then the combined portfolio, as you've seen in the last couple of years, as we built not only our backlog but begin to execute on that backlog, we've been able to achieve mid-single-digit growth consistently over the last couple of years. And we have a backlog that, year-on-year in the first quarter, was up 6%. And then more important on that backlog or that installed base, including the backlog, is how do we build services that -- from a long -- when you project going forward, creating a recurring revenue that's much more predictable, utilizing our technology and our capabilities. So I think from a strategy -- from a synergy, revenue synergy, that has played out as -- exactly as we've expected. And maybe Brian can touch upon the financials.

Andy, the $1.2 billion that you referred to, there was -- a couple of hundred million of that that was tax, and I would say we've delivered that and more. I think we were originally thinking in terms of mid-teens rate. And as you know, we've been at 13.5% the last couple of years. When you look at the remaining $1 billion, that was really productivity save and synergy. And that assumed we had Power with us the entire period. Given the Power divestiture in April of last year, that number is now $900 million. And we've delivered through fiscal '19 about $750 million of that, and we've got $150 million baked into our guidance for the year. In Q1, we delivered $30 million. So we're right on track to deliver around the $900 million we committed to 4 years ago.

Excellent. So George, let me follow up on a couple of things you said. First, you talked about service, and service has been a big initiative of yours. I remember when you came in, you said sort of was up flat, 1%, and you needed to make it a mid-single-digit business. And it seems like you've done that. But it's still only, what, 25% to 30% in JCI? So like what more can you do because it seems like it's still a big opportunity on your installed base?

Yes. I mean when you look at our service business today, it's about a $6.5 billion, $7 billion business. When you look at the 3 regions, it's very high margin. It's where we create the most amount of value for our customers. And my view on that is that not only with our core and how do we get a much higher attach rate of service because of the value that we can bring as the OEM, but more important now with the solutions that we deploy and the integration of the solutions and the use of data. We have an incredible position now to be able to enhance not only the value that we do on the core, but now even more important, creating a whole new level of value for the customers that we serve. And that's through not only the way that we're creating a single architecture of all of the digital platforms, how we're ultimately positioning to manage -- or extract to manage data from multiple data streams. And then depending on -- from a customer back standpoint, depending on the vertical that we're supporting, what are the additional problems that we're ultimately solving or outcomes that create value for their business and how they ultimately grow and support their customers. So I believe that our service business should not only, based on the core, continue to expand, but accelerate beyond that because of the digital capabilities that we can deploy. So what we've done is as we looked at all of our service businesses, how do we, number one, standardize what we do; how do we begin to leverage those service platforms globally; and then how do we build new digital capabilities that, depending on the customers that we're working with, that ultimately address their needs and ultimately deliver on what they're looking to accomplish with their digitalization strategies. That's, in essence, the service strategy.

So like just 2 follow-ups there. Like if I compared it to a baseball game, like what inning are you in of the service-related build-out? Sorry. And then the other one is attachment rate. Like do you know your attachment? I'm sure you do. Can you tell us your attachment rate? And where do you think it could be?

So what I would say is we're in the early innings, that when you look at a business that requires a reinvestment that we make and the leadership product that we deploy and then the service capabilities that we expand upon, it does -- you would -- it would suggest that we get a higher attach rate out of the gate because you can create a lot more value as the OEM over the life cycle and how do you create that value proposition to get a higher attach rate. Now that's, in essence -- in Fire & Security, it's a higher attach rate because of the monitoring in that aspect of the service that we provide. Historically, in HVAC, it's been lower. And what we're doing is developing business models or new services that give us an opportunity to get a higher attach rate and then with that, how do we add on services beyond it, whether it be energy savings or better utilization of space or other outcomes that historically, we haven't been positioned to provide that type of service. And so I believe that not only is it a higher attach rate, but then from a revenue per customer, we have an incredible opportunity to create new services.

So just following up on that. Everybody focuses on the HVAC portion of JCI but not as much on the Fire & Security. And when they do, they tend to ask, let's just say, pointed questions on that side. But to your point about attachment rates and digitization of the business, like it seems like Fire & Security growth has actually been as good or better for you guys than the HVAC growth if I look over the last year or 2. Is that a true statement? What's the sort of prognosis for Fire & Security that you view?

Yes. If you look at the mix, I mean, I think it depends regionally, there's been different mix of growth. But on average, I would say that we've achieved mid-single-digit growth consistently over the last 2 years. I'd say that, that's been supported both by HVAC as well as Fire & Security. Just recently, in the first quarter, we were mid-single-digit growth, both products as well as our field-based businesses. And so I think what we're seeing is that we are leveraging the combined customer base that we serve now since we did the merger and integration. And I think we're getting much more opportunity to be able to bring our combined capabilities. I think that's helping Fire & Security. And then from a service standpoint, being able to leverage our footprint, the combined footprint that we have, we're also picking up -- that's been contributing to the acceleration of service growth and being able to service our customers with the full service. So it's -- I think overall, it's not one or the other. It's really taking the combined capability that it's been critical to the success that we've had.

So let me back up and ask you about visibility then the context. You mentioned the 6% backlog growth. Obviously, Fire & Security has been doing reasonably well. But if you look at orders, they have declined over the last few quarters. And so we get the question of, "Well, so look at the orders, they've declined. Who cares about backlog?" So how do you -- you've said that your pipeline is up mid to high single digits. How has that translated over time? And how does that give you confidence in sort of getting back to the low to mid-single-digit growth from a revenue basis?

So the first priority when I took over back in late 2017 was to get visibility to our pipeline, to our customers, to opportunities and to put together a sales operating system that we could track not just pipeline but conversion and then, ultimately, to revenue, conversion of orders, conversion of revenue. And that has been pretty good here over the last couple of years and our visibility to what's happening in the market. And so when we say the pipeline is continuing to grow mid-single digits or mid to upper single digits through last year was because that's what we see coming into the pipeline. And those are projects that as we've expanded our sales force, and we've identified opportunities, then we have a probability of conversion on those pipelines. We are comfortable that for this year, for instance, we've said we're going to convert orders kind of low to mid-single digits. And we're comfortable that for the year that, that's going to be the case. Now we've had some tough compares in the first quarter. And on that basis, we had relatively low growth in the first quarter, but that's going to normalize, come back in the second quarter based on what we see today, and that seems to be playing out as we had expected. And so it's both not only the orders but also continued backlog growth that gives us confidence in how we convert to revenue that we are positioned to deliver on the organic revenue growth of low to mid-single digits.

And could I focus on your comment you just made about where you're seeing the growth in Q2? So like obviously, everybody asked about coronavirus. You do have a big China business. So what are you seeing there? And where is the growth concentrated currently? Is it more now in North America? Where is it?

Yes. So let's talk about the coronavirus. I mean given what's happened there, I mean, as we talked about our -- at the earnings call and our update then was that had just started, and so it played out, the coronavirus. And when you think about China, for us, about 6% of our revenue. And when you look at -- just look at what's happening in China the last few weeks, there's not a lot happening in that market. So short term, that's certainly a pressure near term. And then when you look at our Global Products business, when you look at supply chain, we have a big presence within Asia Pac, and a lot of that is driven by our Hitachi JV that we have there. And so as we look at our Global Products business and the flow of those products as well as the supply chain, certainly, given what's happened in China and being pretty much shut down, has got some near-term pressures. But we're confident given -- coming out where we did in the first quarter and the work we've done and the continued productivity and the continued execution that we're well positioned for the year to be able to deliver on our guidance of $2.50 and $2.60. So short term, it's hard to quantify what that impact is with the coronavirus, but I can assure you that we've got a team working every day. Our -- as everyone else has said, our factory started up on the 10th. They started up at a low utilization through the course of the week. Most of our -- now facilities, we have 14 facilities. Now we're in operation. People are coming back to work. We started with not a lot of material flows, but that's starting to loosen up. So we're monitoring that every day to make sure that we're positioned to execute and to mitigate any short-term risk but also confident that we're positioned well for the year. So that's the update from that. Now when you look at our overall growth, North America continues to execute well. We're positioned there for kind of low single digit, from an order standpoint, kind of mid-single digit, low to mid on revenue as well as the progress we're making in EMEA/LA. We had a very strong quarter in EMEA/LA. That's continuing not only from an order standpoint but from an organic revenue growth execution. So I think overall, short term, some -- obviously, some pressures in Global Products in Asia Pac because of the near-term issues that we're working through with the coronavirus, but it's hard to quantify. But for the total year, we're positioned very well.

Got it. So let me ask you a follow-up there around EMEA/LA and to some extent, what's going on in Latin America. It seems like you've restructured in EMEA/LA, and that has been one of the reasons why that business has improved. Maybe talk about what you did and why you're seeing the improvement?

Yes. So when you look at that business back when we started the integration, that was the most challenged business. And we went to work not only restructuring the overall structure within the business, but also from a market back understanding where do we want to be positioned with each of our domains and how do we want to establish our structure to be able to not only grow but be able to leverage. And then we went to work on each one of the cost elements. And the work that -- Jeff Williams had led that region since we did the integration, and just phenomenal progress on how we brought the businesses together. We've restructured the footprint. We've been able to then restructure how we go to market. And we're positioned here, not only from a commercial standpoint to be able to outperform, which we have, but from a cost standpoint to get much better leverage with the cost structure that we have in place today on a go-forward basis. So I think we've made tremendous progress there. And I'm confident that in spite of some of the economic challenges within Europe, we've been able to bring value propositions to our customers that have been very attractive and therefore, now have been able to win business and be positioned to be able to outperform.

So I should ask you about APAC also because that's another sort of big thing, I'm sure, that you're watching for 2020. Coronavirus aside, pricing has been something that I think you focused on there, and the margin looked like it turned a bit in Q1. So maybe confidence level -- again, maybe there'll be extra noise in Q2 around it. But like as you go forward, confidence level that, that business has turned a bit even though it's very competitive, as you know.

Yes. So if you go back to the guidance we provided for the year and the update that we provided during our earnings call prior to the coronavirus, the fundamentals that we're putting in place in Asia Pac are no different than what we're doing in North America and EMEA/LA. When I say fundamentals, we're making sure that from a go-to-market standpoint, understanding the projects that are coming to market, how we value pricing those projects versus cost plus, right? So there's been a major shift in the company in how we're strategically pricing projects. And then that, combined with not only looking at how we execute installation projects, looking at every one of the elements of what we execute and making sure that we're doing that much more efficiently, leveraging best practices and standardization of work and all of that, that's happening. And then from a service standpoint, we've also been focused on -- we've had a lower percentage of service to revenue in Asia Pac and a big focus on how do we continue to expand our footprint of service to be able to get a higher mix of service revenue within that field business. And they've done a nice job over the last year, 18 months of being able to expand services. So it's taken the fundamentals of our strategy right from not only making sure we're positioned to -- from a commercial standpoint with the right footprint, standardizing the work that we do and value pricing that and then ultimately, expanding the service mix that contributes to the margin accretion. So we were in a downturn or -- from a margin standpoint after we put the fundamentals in place and have the leadership in place that we've made a lot of progress in the last year.

Is it just hiring people in China? Or is it teaching them how to improve attachment rate? I'm sure it's all of the above. But like what have you changed there?

So it's all of the above. I mean it's making sure that we have the right leadership that is very much -- you get the customer at the center of what we do to grow and that, from that, know exactly how do we package solutions that ultimately create value and become attractive, get a higher win rate and then have service acumen that suggests it isn't just doing what historically we've done to maintain the equipment that we deploy. But in the digital world, there's a tremendous opportunity to take not only our building systems and our digital assets that we deploy, but utilizing the data that not only enhances our -- the traditional service but opens up new opportunity to create whole new value propositions. And it's a market that embraces digitalization. It is a market that, from a customer standpoint, embraces digitalization. And so I think we're -- we've got a team there, a core team that's working to customer back and how we capitalize on some significant opportunities with the infrastructure build-out in some key verticals. But I truly believe that, that's going to be a big element as we position the company for the future.

Great. So I want to open it up to the audience in a second. Let me just ask you, last year at this time, sort of I asked you about this sort of interplay between growth and margin, right? And so a lot -- some investors thought that it will be hard for you guys to pull back on investment spend or at least have it in line with sales growth and still grow nicely. Basically, in at least the last quarter, maybe even 2 quarters, you've been able to show that investment spend is just spending at the same rate as sales growth basically. But it's still -- I think the question mark in people's mind is in 2020, can you grow at 70 basis points of margin and low to mid-single-digit growth? Because that's something that seems like a trade-off to some people. In your mind, is it a trade-off or can you do both?

Yes. I don't believe it's a trade-off. I think what you've seen, we were pretty strong out of the gate in the first quarter. The margin improvement, there's many factors that are contributing to the margin improvement. It's not only the work that we've done on pricing. But it's also what we're doing to drive productivity with cost of goods, cost of service or better project execution. At the same time, it's making sure that, on the product side, that we've got new product that we're going to market with. Then certainly, we're getting price for the value of the new product. So there's many contributors here to how we're positioned to not only continue to get the margin improvement while we're sustaining the reinvestment. Because the reinvestment rate, the last 2 years, we've had headwind in the P&L because our sales expansion was greater than our revenue growth for 2 years straight. And we made a commitment that said until we're comfortable that we have the capacity market by market with the skill sets to be able to achieve the growth that we believe that we're entitled to, then -- and as long as we're getting the productivity as we're adding the sales force, we were going to continue to add. And that created a headwind. We're now at a sales as a percent of revenue now -- sales cost as a percent of revenue now has flattened out because we are seeing the productivity of the 1,500 sales associates we put into the field continuing to improve. We're continuing to add to make sure that market by market, we have the right capacity to be able to achieve the growth targets that we're setting. And then from a reinvestment in R&D, same has happened there that we've elevated the reinvestment over the last 3 years to a level now that's sustaining that we can -- within the P&L as a percent of revenue, we're still reinvesting at the same rate. The last 2 or 3 years has been elevating. But given the new product pipeline that we have now coming to market, we feel good about our position not only to maintain but continue to expand our position and being able to gain market share with the new products we're bringing to market. So the answer is both, I mean, that we're going to sustain the reinvestment, we're going to ultimately continue to drive solid execution of price, cost, go-to-market that positions us -- at the segment level, we're positioned to achieve about 50 basis points. At the EBIT level, I think it's roughly about 70 basis points.

70 basis points, yes.

So overall, nice expansion pretty much across the company.

Let me ask you one follow-up there, and then we'll turn it over. So I was actually interested in the comment you made, I think, on the last earnings call about the 30% incrementals, the potential of the business to have 30% incrementals. And maybe clarify for us, that's -- after synergies are over, that's just a normal business. And then you talked about still having the capability to get to that 15% to 16% margin. Last year, on this stage, you were talking about how that was the one thing you were disappointed in. Like, so are we now to the point where you're getting more confidence that this is a 30% incremental business ex synergies and you can get to 15%, 16%?

Yes. So when you look at our margins, that's all in. So everything that we see not only continued productivity, continued discipline with pricing, mix of service, mix of our product incrementals because products tend to be higher than the field-based businesses, continuing to simplify and get productivity out of our field footprint, all of those initiatives continue, although we've made tremendous structural change with the integration. That has given us an ability now with fundamentals that we can now continue to improve. And so on a go-forward basis, what I was suggesting is we're going to continue to improve with every one of those fundamentals that will enable us to be able to -- with a stable market with continued growth, that we're going to be able to deliver those type of incremental margins on a go-forward basis. And when you look at our growth today, all in, synergies and productivity, that's ultimately what we're achieving.