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

All right. Good morning, again, to everybody. Thank you for joining us here on day 1 of the 8th Annual Credit Suisse Industrials Conference. We're going to keep the theme of HVAC -- of HVAC going, again. We're delighted to be joined by Johnson Controls. With me, we have George Oliver, Company's CEO; and Olivier Leonetti, now CFO. I believe that George is going to make a couple of opening remarks. So with that, I would like to turn the floor over to him before Q&A. And if anybody has any questions, feel free to email me, and we'll try to take them into consideration.

Terrific. And thanks, John, for having us. It is great to be with you, and I'd like to start with a few opening comments, as you suggested, and then we can get into the Q&A. I'd start by saying we wrapped up our fiscal year at the end of September and reported 2020 results. It was exactly 1 month ago. In summary, we executed very well in what was an extraordinarily challenging environment. We saw a sequential improvement across all of our businesses from both a sales and order perspective. And our aggressive cost actions in response to the volume declines has resulted in the best-in-class decrementals over the last 2 quarters. We remained extremely engaged with our employees, customers and partners around the world and accomplished our strategic goals and initiatives for the year. We did further strengthen our balance sheet and liquidity profile, while at the same time, we returned over $3 billion in capital to shareholders through both dividend as well as share buybacks. And we stayed on offense, maintaining a high level of organic investment in our businesses with continued innovation, and we filled key leadership positions across the top leadership team. And we entered the next stage of our evolution as Johnson Controls with the launch of OpenBlue, which is our fully integrated digital platform. And lastly, we provided some initial views on fiscal 2021 that demonstrates our commitment to accelerating growth, expanding operating margins and returning capital to shareholders. Our portfolio is very well aligned with the strong secular trends, including sustainability in energy efficiency, urbanization in smarter and safer buildings and infrastructure. And I think Johnson Controls, as you look at where we are today, we are uniquely positioned to serve these trends with a holistic approach that leverages the most comprehensive product portfolio in the industry, combined with the largest installed base and the broadest direct channel footprint across the globe that enable extensive go-to-market advantages. And just quickly on the business model and portfolio. We have positioned the company now as a pure-play building solutions provider, and we have the broadest portfolio of intelligent building solutions in the market with annual revenues of roughly $22 billion. We hold leadership positions in very attractive industries with very favorable secular growth trends, as I mentioned. When you look at our HVAC and building controls, we have $12 billion in revenue that's skewed heavily towards institutional and commercial infrastructure. And we also have a $9 billion global Fire & Security platform with a very large installed base and high service attachment and a lot of interactive qualities, particularly on the security side. And with our digital transformation platform, OpenBlue, this is what is uniquely positions us to be able to serve smart buildings of the future with a very comprehensive suite of solutions that connect both the IT of a building with the OT, all of that together that leverage data analytics, artificial intelligence and machine learning and then leverages the incredible channel that we have globally to deliver outcome-based solutions for our customers. And all of these attributes play very well into addressing the immediate needs around indoor air quality and healthy buildings. And I believe that there is no one better positioned to help customers operate healthy and safe buildings. Just a note on sustainability and ESG, in general, both are core to our vision, mission and the values that we have as a company. And we are very well positioned from a product portfolio standpoint to address our customers' goals to lower greenhouse gas emissions with nearly half of our revenue coming from products designed to exceed minimum efficiency requirements and significantly reduce greenhouse gas emissions. We have made over a dozen global commitments to fight climate change and support sustainable development. And finally, in addition to the depth and breadth of our product offering, we also have one of the largest direct channel footprints with unmatched history and expertise in the buildings environment and best-in-class team of sales and service engineers. This is another clearer competitive advantage for us. And then from a strategic perspective, as we look at 2021 and beyond, we're focused on. Number one, accelerate top line growth. We have a number of strategic initiatives aimed at driving above-market growth over the next few years, including increasing new product launches, increasing our service attach rates and revenue per user and scaling the launch of OpenBlue. Second is to continue to optimize our G&A structure. We will continue to -- our focus on expanding margins and increasing profitability with a renewed focus on managing operating expenses lower over time. And third, disciplined capital allocation. By the end of 2021, we will have successfully redeployed 100% of the Power Solutions proceeds. Our balance sheet is in excellent shape with leverage still below our target range and ample sources of liquidity. And cash generation has improved tremendously over the last few years, and we're in the range of 100% free cash conversion, which will throw off nearly $2 billion in available cash. Given the relative ROI profiles, we continue to buy back our stock, while at the same time, maintaining an active M&A pipeline. So with that, John, I'll turn it back to you and look forward to any questions you have.

Great. No, that was a very helpful introduction. Appreciate that. Maybe before we dive a little bit deeper into the business and how you're driving that top line growth acceleration just a couple of items around what you've laid out on your fourth fiscal quarter around some framework and guidance items. I mean, as we sit here in December, we now have October and November in the rearview mirror, anything you'd like to share on how you're progressing on the fourth quarter?

Yes. We continue to make good progress across the company. And I'd say relative to our Q1 guidance, which assumes organic top line decline of 5% to 7%, 20 to 40 basis points of margin expansion and EPS in the $0.39 to $0.41 range, I'd say we're tracking pretty well to plan. And with any quarter, the last month tends to be the most important. So we'll see how December plays out. But so far, we feel pretty good about how things are developing. And in line with all of our growth initiatives, we're very confident that as we continue to execute, no matter what the economy does, we're going to be well positioned to be able to outperform.

Great. And maybe just one last one around the guidance. And so you left some breadcrumbs on a full year '21 kind of picture and we're all doing the back-of-the-envelope math. So I figured I might as well just ask you directly the question, but you've laid out that you want Johnson Controls to reach this incremental margin, this goal of 30%. I think you've been very vocal on that. If I just do the back-of-the-envelope math this year, it looks like we're going to fall short of that. How do we think about this year as a springboard to get to that 30%? Or are we all just using these breadcrumbs and the real math is different?

So let me start, John, by saying, we made significant progress on the cost structure over the last several years as a result of both the integration as well as the restructuring that we have completed, whether it be at the corporate level or the work we've done on the manufacturing and supply chain through our JCMS or procurement. We've improved our gross margins over the last 2 years through the implementation of our -- it's been both the global strategic pricing models. And more disciplined now on the way that we're executing projects and ultimately managing inflation. And all the work we've done to lower the fixed cost based of the enterprise gives us tremendous confidence that we are very well positioned to achieve the 30% volume leverage. And to be clear, we will have some headwinds, as we've said in fiscal '21, as we unwind some of the temporary cost benefits we experienced last year in response to COVID-19. And we currently expect a net headwind of roughly about $40 million in '21, and that we get a little bit of a benefit in the first half, offset by some headwind in the second half. So we'll continue to look at additional opportunities to streamline these temporary costs out on a permanent basis, and that's what we're working to do. We've identified additional restructuring actions that we could take, and we're going to be very proactive in the current environment. So the 30% incrementals at this stage is not aspirational. And maybe Olivier, maybe you can provide some perspective where you're kind of new to this and have certainly formed a point of view.

No. Certainly, so let me complement a bit. Again, I started about a quarter ago and what we have done as an organization over the last 3 years has been remarkable. And we have created now the conditions to go to another level, John. So the 30% incremental is not an aspiration. Your question is, can we do that this year, which is an abnormal year? The answer is we're going to try, but that's not we -- what we are flagging at this stage, would improve rate but not to the full extent. And let me maybe give you a bit of colors around the various levels. So from a pricing standpoint, we don't think we have achieved our best potential. If you look at gross margin, if you look at, one, us increasing the service mix, we believe we can grow services faster than company average. I would remind you, John, that today's services, in terms of margin rate, all in, is twice the level of profit relative to the company average. So service mix will increase margin, more discipline around installation will increase margin. And also on the supply chain, we have done a lot of progress. But if you look at design to value, platforming our products, footprint optimization, we believe that those examples will increase margin. And if you go to OpEx, and I will finish on this, if you look at, today, us relative to competition, we have made a lot of progress. But again, we believe we have opportunity to standardize and centralize our footprint. So we believe we are targeting today to close the gap in profitability to our peers, and we are on track to do that.

Great. And maybe sticking with you, Olivier. Can you talk a little bit about what you found really attractive to Johnson Controls and the opportunity here? And also a welcome. This is the first time we have you at the conference. So appreciate it.

No, thank you for your words. I mean, it was a privilege for me to join the Johnson Controls team. George and I have spent a lot of time before to work together. So we knew each other very well. We started before the pandemic, but that's a personal story. I joined for a few reasons. One is the culture of the company. We work with people, and the way we interact with each other is very important to me. So working with the company with a high-performing culture, diversities on top of mind, inclusion is on top of mind. That was important to me. And I've been delighted by what I've discovered since I started. So that's one. Very impressed by the work done by the organization over the last 2 years. That will be another point. And then if I go to the business side, we are serving secular trends, which are very appealing. If you look at sustainability, energy efficiency, safe and smart building organization, those secular trends are attractive, and I believe we are uniquely positioned to serve those secular trends. Let me give you one word on this. In the world of digital, and we want to be in the smart building space, sensing data, analyzing data and acting on this data at the edge is important. And we think -- I think we're uniquely positioned to do that. We have today, from a sensing standpoint, the largest installed base in the industry. In the acting space, we have created an OpenBlue platform to analyze data. And in the act, and George mentioned it, we have the largest fleet of engineers in the market, 16,000 employees, so we can act more than ever before. So strong end markets, unique ability to execute to leverage the trend and ability to gain share and improve profitability. So all those were factors. And after 3 months, I cannot be more excited, even more than when I started, John.

Great, great. So I wanted to spend some time here on OpenBlue, but I feel like before we get there, you did also talk about the new product introductions and increasing the service attachment rate. So maybe just a quick question there. Where are the new products focused? So should we expect them in -- are they in unitary? Are they implied? Are they on the fire side, the security side? And then as you think about that service attachment rate, kind of where are you today? And where would you like to be?

Yes. So I'd say when you look at our reinvestment that we've been making into products, it's been across the portfolio. A big focus on HVAC. And so although we've made a lot of investments and we're beginning to gain share across each one of the platforms right from resi, right up through chillers, we're continuing to invest to be able to lead the industry, be able to continue to gain market share and continue to grow from a product standpoint. And so when you look at the products, it's been, over the last few years, it's been the launch of our YZ chiller, and we continue to expand the tonnages that ultimately we bring to market as we expand that portfolio. When we look at that -- the chiller portfolio beyond the YZ, it's increasing our investments in air-cooled chillers is another good example. We've been very active in the last couple of years reinvesting in rooftops in unitary -- in the unitary rooftop business and filling out, this is a very attractive market as it's driven by replacement, the requirement for replacement capabilities. And this is an area that we've been targeting to go after our primary competitors. And then the new residential product, both in the UPG business in North America, and we've been investing there. And although we're a much smaller player there, we have been -- with the new products we brought to market, we've been gaining market share as well as our JCH business, which from a VRF standpoint, we're at PAC. And that portfolio in Asia Pacific is a very attractive market for us, and we've been growing very, very nicely. And so when you look more broadly from the HVAC, certainly, a big focus for our -- for us has been the BMS portfolio, where we have all of the digital -- or many of the digital assets within a building, building controls, all of the electronic security platforms, electronic fire. And with all of that sensing, as Olivier said, we've got an incredible use of data within the building. And this is what ultimately stimulated, this goes back to the merger, where we began the development of OpenBlue so that we can now, as a building solutions provider, use that data, apply analytics and AI, creating new outcomes and that's through just an incredible channel that we have across the globe and how we serve our market. So those have been the focus areas of our reinvestment. And then recently, with OpenBlue, a big focus on now taking the digital capabilities and creating new services. So depending on the problems that our customers are trying to solve, whether it's return to work, creating a healthier and safer work environment. We've got the full suite, a holistic approach to how we actually solve that problem, not only with HVAC solutions, but also including touchless solutions around access and elevated temperature sensing and a number of other protocols that are incorporated in that. So we've launched a couple of dozen new service offerings, leveraging our digital capabilities that will enable us now to be able to leverage the incredible installed base that we have to be able to upgrade that installed base, utilizing the digital capability and ultimately address some of these new challenges that our customers are facing.

And then just on the service attachment rate aspirations, what do you think your entitlement is there on that?

What we've said now, we believe, so what we've been working on the last a couple of years, we've been expanding our footprint, we've been expanding our capacity. At the same time, we've been investing in new services. And so the combination of the 2 now with OpenBlue, we believe, on a run rate basis, we can elevate our service growth 200 or 300 basis points, and it's through not only the new services. It's -- and because of the enhanced service capability leveraging OpenBlue, we get a higher attach rate so to the installed base that we create because there's embedded digital capability within that installed base. We then build the applications that we build off of that digital platform creates more revenue per customer. It ultimately makes it more sticky with our customers, so we can continue to build on that. So it reduces the attrition. And because of that, we're now creating outcomes versus historically, it's been maintaining the systems that we deploy to now, not only continue to maintain the systems, but opening up white space that now is utilizing the data to create new outcomes and create a lot more value. And it's in line with the secular trends that Olivier and I have discussed around sustainability. How do you create a healthier and safer environment, at the same time that you're reducing energy and creating -- being able to deliver on our customers' sustainability goals? And so I think that gives us incredible confidence that we're going to see some improvement this year. But as we begin to accelerate, we're going to get into a run rate that's 200 or 300 basis points higher within our services.

And maybe to complement, if I may, so the attach rate we have in services depends. We have a very diversified portfolio of products, John, as you know. The attach rate varies between 25% and 60%, but on average, about 35%. And based upon OpenBlue and our strategy, we believe we can increase the attach rate for services by 3 to 4 points per year. And as we have indicated, service margin is twice the company average. So we think it's going to be an attractive vector of profitable growth of the company.

Great. Maybe shifting over to OpenBlue. So, so many questions. I could have done 30 minutes just on that. But maybe we could start with maybe the biggest-picture question around is what do you think kind of the total addressable market is for OpenBlue, if you have a number that you can put out there? And then when you think about that opportunity, is this something that you're going to look to put on top of your existing installed base? Does that drive 80% of the growth and then new projects are 20%? Or how do we think about that?

What I would say is when you think about OpenBlue, it does -- it differentiates everything we do. Right from the systems that we design and deploy our digital capabilities into, right through the life cycle and being able to build on top of that installed base with new applications and ultimately deliver new outcomes. So it's across all of what we do and it also includes pushing a lot of intelligence to the edge within our products with the ability that we actually push the intelligence to the edge. And then with that, we can capture that data and utilize that in our algorithms and the like to ultimately create the outcomes that we're going after. And so when you think about the market -- when you think about buildings markets today, and you -- there's a lot of different ways that it's defined, but let's say it's $300 billion or $400 billion. The digital content within a building today is a small percentage of that content. And it's a space that's growing very strong double digits. And so it's the ability to be able to now on top of that, the traditional systems that exist within a building, how do you now leverage the sensing, the analytics, the AI that fundamentally creates -- it really transforms buildings and spaces with the digital content that creates new outcomes. And that's supporting sustainability, utilization, operations -- operational cost and the like. And so for us, as we're bringing these new solutions to the market, that is an area that's going to be growing very strong double digits on top of our traditional base, not only in the installed base, but our ability now to be able to use that capability to expand our services, which the algorithm there is we believe that, that, on a run rate basis, we can get that growth rate up 200 or 300 basis points on a sustained basis going forward. So it's both, John.

So then maybe let me ask a similar question this way. So you have traditional building automation solutions, right? Then the industry started layering on some energy dashboards, right? You were collecting a little bit more data from the system. And if I understand what you're trying to do with OpenBlue is now you're adding kind of a -- an actual controllability and kind of also AI level, it sounds like. And so that's kind of the next evolution. So, one, I want to make sure I understand that correctly. And then second, when I think about who else is trying to do that, so the actual competitors of OpenBlue, to me, this sounds like some of your traditional guys, maybe Honeywell or Schneider, but maybe there's also smaller guys that I don't know if that presents an opportunity to accelerate some of what you're doing or if they could potentially end up being a threat at some point.

Yes. I mean, what I would say is simply put, it takes everything that's happening in a building, all of the data that is consumed in a building, putting it in one single pane of glass, being able to create outcomes that address the challenges that customers are now facing within buildings and infrastructure that historically has been pretty inefficient. And when you look at energy, for instance, HVAC consumes 40% of the energy within a building or within an infrastructure. So a tremendous opportunity to be able to create a lot of value. And then with the current trends of creating a healthier and safe building with recirculating air, there's actually a higher demand for energy. In an optimized building, you can take all of the data and, not only optimize the clean air delivery, the delivery rate, but also being able to reduce the energy that's consumed to be able to create that outcome. That's what makes us unique within the building because of all of the ability, our total ability to be able to manage the data. So when you think about -- when I think about smart buildings, it is the integration. It's the ability to be able to create an open architecture with an ecosystem that we bring the domain and we leverage partners -- technology partners. We've got a number of partnerships that we've established that come into our ecosystem and then we leverage our depth and expertise with theirs that ultimately design and deploy these applications that truly are impactful in how we deliver value for our customers. And so I think what's also happening, John, is that strategically, it's going from a transactional sale into a much more strategic sale and partnership with our customers that are ultimately driving these set of outcomes that we're going after. And so I think for us, it's taking our position that we have, leveraging that position, leveraging the data and then leveraging partners and capabilities that truly differentiate what we can do within the building and with any infrastructure.

Great. And then, I mean, is this -- and I guess, maybe going back to the kind of that competitive landscape. Is it those traditional guys that are also moving here? Or are there -- who are you actually competing? Or do you think that this is kind of really differentiated, there isn't a direct competitor on OpenBlue?

Well holistically -- I mean, incrementally, everyone is developing some digital capabilities within their products, and there's been a trend across all industries in how do you become a digital industrial player in being able to, not only continue to bring leadership product to the market, but also differentiate that product with data and the like. I think what's different within Johnson Controls is the holistic capabilities that we have that ultimately brings all of that data together into one platform as an open architecture that we can leverage partners and other technologies that truly differentiate what we can do in the building. And we can do it most efficiently and we have a channel that is positioned to, not only deploy it, but to be able to maintain it. And with -- as digital moves quickly, how do we make sure that we're constantly upgrading and bringing new solutions and capabilities as we continue to upgrade and expand OpenBlue capabilities across the customer base that we serve. So there's competitors in every element of what we do. Some smaller than others. Some a little bit broader than others. But I think what's different for us, John, is the ability to bring it all together into one platform and truly deliver on the outcomes that our customers are looking for in how we create value.

So then, I guess, right, your branch network then becomes a competitive advantage with this type of solution. So is this rolled out across the entire branch network? Are there just certain geographic regions where you're deploying this? How do we think about the ability of the organization today to bring OpenBlue to customers?

So the time line we had on OpenBlue, we've been working on OpenBlue. We started with the merger, and that was my -- that was a vision that I had set when we did the merger that we had the opportunity to take the 2 portfolios, truly differentiate from a technology standpoint, not only in the products, but also an ability to be able to create a digital platform that truly would lead the industry. We've been working on delivering on that over the last 3 years. And we've made incredible progress. We were planning to launch OpenBlue at the end of the year. What happened was with the pandemic and the ability now to be able to accelerate what we were doing, what we did was we accelerated that to July. We launched the OpenBlue in July. And I think we've made incredible progress. The way that we've been, not only developing the capabilities, but continuing to differentiate that with the new offerings that we've been providing. And so I think from a branch network, we've been positioning the branches. Over the last 18 months, we've been building digital capabilities. Today, we do, do a lot of digital deployment with our building controls and our security systems and in the electronic fire or the traditional systems. We've been standing up capabilities with software and software solutions sellers and capabilities in each of the regions that are set up. And so as we've been developing that, we're leveraging the existing customer base, the existing go to market, but as this evolves into working much more strategically with our customers, we've been developing that capability at the branch level in the field and being able to deploy it. And then setting up all of the amount -- the customer support and the software support and customer service, all of that has been being put into place over the last 12, 18 months. And so we're very well positioned now to continue to accelerate our deployment of these OpenBlue solutions.

Great. Well, I would love to be able to keep going, but unfortunately, we do have a schedule to maintain. So I'd like to just right now, thank both George and Olivier for joining us today. I don't know if there's any closing remarks you'd like to make. This ends pretty abruptly. So I'll just say thank you for your time and look forward to continuing the dialogue.

Terrific. Thanks, John, for having us.

Excellent. All right. Take care, everybody. Thank you.

Okay. See you. Bye-bye.