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

Great. Good afternoon, everybody. Let's get started. I'm Tim Wojs, and thanks for joining us at Baird Sustainability Conference. I cover commercial and residential building products here at Baird. And we're absolutely delighted to have Johnson Controls with us this afternoon. One of the largest global HVAC companies. And JCI really fits the sustainability theme really well, just given the drive globally to reduce building emissions, and that will be something we'll talk about more in detail today. And there's also a developing margin story here that we think is very positive, and we'll talk with George about that as well. So joining us from the company, Chairman and CEO, George Oliver; we have Katie McGinty, who's the VP and Chief Sustainability Government and Regulatory Affairs Officer; Antonella Franzen, who is VP and Chief Investor Relations and Communications Officer; and then Ryan Edelman, who is Executive Director of IR. In terms of format, George is going to go through some prepared remarks, and then we'll run through some Q&A. So feel free to e-mail me any questions via your web browser. And I'll do my best to get those answered. And with that, I'll turn it over to George and Katie.

Perfect, and thanks, Tim, and thanks for having us. We do appreciate the opportunity to chat with you today. What we thought we'd do this afternoon is take a slightly different approach, particularly given this venue, to focus on sustainability and walk through a short presentation before we get into your questions. As some of you may have seen on our fiscal Q1 earnings call in late January, we announced an ambitious set of new ESG commitments. These commitments build upon the leadership position we've established across all 3 elements over the last 2 decades and accelerate our efforts to achieve net zero and address the larger climate needs of the planet. I've asked Katie, who leads our sustainability effort for us at Johnson Controls, to help provide a bit more detail on how we plan to do that. I'm going to start with a few overview slides for those of you who may be less familiar with Johnson Controls, starting on Slide 3. We have a long history of innovation and building efficiency, dating back to late 1800s with the invention of the electric thermostat. Since the merger of Tyco, our strategic [Technical Difficulty] for the company has been to establish ourselves as a leading solution provider to smart, healthy and sustainable buildings. The evolution of buildings towards these 3 themes is underway, and we are very well positioned to address the changing needs of our customers as they look to transform the environments where people live, work, learn and play. Please turn to Slide 4. We have a global team of 100,000 employees with deep industry knowledge and expertise serving more than 4 million customers in 150 countries around the world. Next slide. We are one of the industry's largest portfolios of intelligent building solutions with an unmatched direct channel presence, including over 16,000 technicians worldwide. We have an expansive global reach, coupled with local talent that can provide end-to-end project life cycle management in every key geography. Our comprehensive portfolio of advanced solutions serves a wide array of vertical markets, from K-12 schools and hospitals to airports, sports -- stadiums, data centers and commercial office buildings. Our connected technologies and digital capabilities are helping our customers optimize their asset performance, enhance occupant experience and meeting their own energy efficiency and sustainability goals. In fiscal 2020, we generated sales of just over $22 billion with a balanced mix between integrated systems installations, service and indirect product sales. And we have one of the broadest portfolios of leading brands across our core building systems portfolio, HVAC, building automation and controls, fire and security and industrial refrigeration. Please turn to Slide 6. In July 2020, we launched our new digital transformation platform, OpenBlue. This open architecture platform enables us to leverage a large installed base of equipment, sensors and devices to collect data from both inside and outside of the building, push that data to the cloud where we can apply analytical software packages and infuse AI-based technologies and ultimately drive enhanced outcomes for our customers. We complement this platform with an expansion partner ecosystem that includes some of the most recognizable technology players in the world to help us deliver a differentiated solution and create attractive value proposition for our customers. Turning to Slide 7. Our latest offerings under the platform is OpenBlue Healthy Buildings. By combining our comprehensive suite of connected solutions, we have created a holistic menu of options that prevent customers from having to choose between the health and safety of their space and sustainability and efficiency. This offering not only assists our customers with safely returning to normal, ensuring the delivery of clean air, frictionless access, temperature monitoring and contact tracing, it also helps meet the sustainability goals of individual places in the planet. This is done through optimizing building performance and operations and reducing the carbon emissions of buildings and infrastructure. We have over 27 solutions in this offering to serve an addressable market that we've sized at $10 billion to $15 billion, and we believe we'll grow a double-digit CAGR over at least the next 5 years, regardless of whether or not COVID-19 is eradicated. With that, I'll turn things now over to Katie.

Well, thanks, George, and hello, everyone. Thank you so much for having us here with you today. I hope all of you, your families are keeping healthy and well. So this picture here is really critical because it shows that kind of integrated approach that George was just referring to. Now that approach is important because it enables our customers to move beyond trade-offs to a trade-up, to a trade-up that is about clean air and efficiency and climate, all taken together. OpenBlue smart technologies enables that because that platform helps our customers cut energy consumption by up to about 50%. So that substantially bends the emissions curve, and it creates headroom so that we can have that extra energy that might be required for ventilation and filtration systems to ensure the clean air piece. So OpenBlue really does deliver all 3 in terms of helping people, places and the planet. So just looking at why it really is urgent as well that we deliver both clean air and emissions cuts. Well, buildings today are a significant part of the climate problem. Buildings represent about 40% of global greenhouse gas emissions. And because most of those buildings do not have digital controls, we see numbers like this. Even in COVID, where building occupancy was down, some 80%, we only saw in many of those buildings about a 20% reduction in energy consumption. Now clearly, that's not satisfactory. We can and we have to do better. And that's where the OpenBlue digital platform comes in, enabling us to rightsize the energy needs, the carbon footprint of the building to the occupants and the functionality in that building. Buildings that are truly smart can be truly sustainable. When we look at the market that is emerging here, we are very excited. The secular trends that are driving buildings today are many, they're multiple and they're reinforcing. So it's climate, it's energy efficiency, it's clean air. Those are the key themes. We see both a big push and pull that mandates and money in this market. So our customers are asking for just that kind of integrated solution. And [Technical Difficulty] to tell you, investors, C-level decision-makers are understanding that carbon risks have to be mitigated in all asset classes, including buildings. Government is acting in a big way, too. Policies in Europe and the United States at the federal level, just to take 2, are pushing what's being referred to as renovation wave. In Europe alone, that is calling for a doubling of the pace of building upgrades, creating an addressable market to the tune of hundreds of billions of dollars. And I just kind of -- I could pause here for a second. I have been at this climate equation, global warming climate change policy for a long time since way back 1989 when I was a staff person to then Senator Al Gore. Climate policy has always been about solar and wind and electric vehicles, and that is really good stuff. Buildings have never had this kind of prominent front and center attention, [Technical Difficulty] when you put the whole equation together, when you put COVID together, with companies with net zero commitments, with buildings being 40% of the equation, with the demand for efficiency and reducing costs, it just makes it so that buildings have to be center of the game, and it really is a game changer. Now as George said, in the context of those market trends, Johnson Controls is extremely well positioned because the solution sets now are the most efficient pieces of equipment, but absolutely enabled by a digital platform. And that platform really is the key way or maybe the only way to achieve the variety of the ambitious target, efficiency, clean air and climate. And we see governments getting that picture too. Some jurisdictions now are literally legislating that equipment and buildings need to be smart ready, the controls built in. Maybe because of all of this, it's not today or yesterday that Johnson Controls has understood that sustainability is our business. Nearly half of our revenues already come from -- some $11 billion in FY '19 coming from products and services that cut energy use, that improve sustainability. And when it comes to sustainability, broadly, we've been a leader for a long time. We've been reporting for 20 years, emphasizing transparency around sustainability metrics. We were among the very first industrials to sign up to the UN Global Compact. And we today are in, not our first or second, but literally our third-generation of environmental commitments. Since 2002, we have already cut our energy intensity by more than 50% and our greenhouse gas intensity by more than 70%. Just recently, we are a pioneer again, becoming one of the first industrials to float a Green Bond in the U.S. capital markets. But the trends today tell us that good just isn't good enough. And that's why we decided to raise the bar on ourselves even higher. And just a few weeks ago, committed to do more and across every element, the E, the S, the G of sustainability. To share just a few highlights here, we are going further and faster than the Paris Climate Treaty calls for. So we have signed up for absolute emission cuts that are on a 1.5-degree C path instead of 2 degrees, the more ambitious path in the climate treaty. And we are achieving -- setting out to achieve net zero carbon emissions by 2040, a decade ahead of the 2050 date of the Paris accord. So all of this is also why we also announced we will be dedicating 75% of our new product development dollars to tackling climate change, and we're also adding a gating function internally for capital investments to ensure that they are driving carbon cuts as well. Looking quickly at the social and governance pillars here, all of this is why we are going to further drive our performance-based culture by ensuring we attract the very best talent, and we're aiming to double in that regard, the representation of women and minorities, in our leadership ranks over the next 5 years -- is why our Board is playing an even more active role on sustainability. And in terms of ensuring accountability and delivering on our goals, it's also why executive and leadership compensation at Johnson Controls is now linked to sustainability and diversity goals as well. Finally, just wanted to share that internally, at Johnson Controls, our team is all-in owning and driving our sustainability ambitions. But it is nice to know that the world is noticing too. And we're grateful to be included in now some 40-plus sustainability indices. We're recognized by the CDP, which is formally the Climate Disclosure Project, in their leadership band top 12% in the world. Very recently, we were included again in the Global 100 Leaders by Corporate Knights. And announcing here today, we just were named for the 14th time among the most ethical companies in the world by Ethisphere Institute. So we are working hard, working fast. And as we know, we can always get there further and better by teaming. So last, we'd just share that we were pleased earlier this week, or I guess it was last week, to join with 52 other companies in the Amazon Climate Pledge, where together, we are committed to net zero and [Technical Difficulty] 10 years early from the Paris accord, so by 2040. And with that, Tim, I think...

Very good. Yes, very good, Katie. And so Tim, that's a quick overview of the work we're doing and all about sustainability. So on that, let's open it up for questions.

Yes. Yes. No, I really appreciate all the detail and I really appreciate all of the slides there. So thank you. Maybe just to start off, George. You've been with JCI for a little over, I think, about 5 years now and Tyco before that. How is the conversation with the customer evolved or changed over the last 5 to 10 years? I mean, you are starting to see big corporations start to talk about net zero emissions and those types of things. And so how has the conversation evolved with them both on the sustainability side, but also kind of balancing that with the cost of the sustainability.

Yes. So what I would say, Tim, what I've seen here over the last 3 or 4 years, it's really -- I've been running the company over the last 3.5, it's -- we've taken the company. And in line with our strategy of putting the 2 companies together, JCI and Tyco, we saw these trends underway, and we felt that by putting those 2 portfolios together, we'd be uniquely positioned to be able to capitalize on these trends. And although some of those trends were slow-moving initially, they are accelerating. When you look at what we do today by domain, typically, most of the decision-making was at the lower level of our customers. And a lot of times, it was operational decisions relative to how they made choices. What's happened now with the way that the commitments are being made around zero -- getting to zero net carbon emissions, all of this is being elevated to the C-suite. And commitments are being made. And then with those commitments, you've got to partner with companies like ourselves and how do we actually achieve those goals and commitments because ultimately, once the commitments are made, they're being tracked, right? They're being tracked so that every year, you have to disclose the progress you're making against those commitments. And as Katie said, when you look at buildings, it is a big opportunity. When you look at the carbon footprint, 40% of the carbon footprint, 10% of that is construction around cement and steel and the like, 30% of the carbon footprint is around building operations. And so we are uniquely positioned, not only with a strong HVAC portfolio, but that, combined with our building controls and automation and now with OpenBlue with our platform to be able to manage all of the data is what enables us to be able to not only address, more recently, it's around how do I elevate our air quality at the same time I'm reducing energy. And so that all comes together with the intelligence that we create within the building, and then it's optimized with the output that we can create. And so what I would tell you, Tim, just in the last year, all of this has been put on steroids, the discussions that we're having at the most senior levels within our customer base not only strategizing indoor air quality, but that combined with sustainability has significantly changed here over the last, I'd say, really 18 months -- 18, 24 months. And I think for us, it does play. It's right in line with our strategy and how we ultimately differentiate what we can do as a partner to our customers.

And could you maybe just elaborate on basically the assets you have, maybe relative to some of your building peers? You've got the building management system, you control more of your kind of direct access to your customers. You've got security as well. So can you maybe just kind of talk about how OpenBlue and the product development there is really kind of giving you an advantage in the marketplace as you kind of go-forward over the next 3 to 5 years?

Yes. So think of the portfolio, about half of it is HVAC. So we have an incredible portfolio with HVAC. We've been investing multigenerational. So we had elevated our reinvestment rate over the last 3 or 4 years. So we're now -- as we said during our earnings call, we have 150 new products. A big chunk of that is around HVAC portfolio. This is not only in investing in low GWP refrigerants but overall, the system being more efficient and the like. And then also, that's an important element. But that combined with building control, so we have our Metasys building controls. And then with the building controls, in addition to that, the other digital platforms within the building. So you have multiple security platforms and fire platform. All of that, what we've been working on over the last 4 years with the reinvestment is bringing all of those digital platforms together into one architecture. And then developing a data platform that enables us to be able to leverage all of the data that we extract from our systems as well as other building systems and then utilizing that data to optimize outputs. And the outputs are typically, we can go into a building, reduce energy 30%, 40%, 50%, just optimizing how that building is being operated. And then you can combine that with occupancy, for instance, and get to our -- what we call our clean air delivery rate, which ties to, depending on the space and the size of the space and the occupancy, how much turnover you need in an hour to make sure that, that space is healthy and safe. So it's all of those attributes that allow us to be able to not only solve individual problems, but holistically, how do I elevate the healthy and safe element of the building at the same time spend on reducing the energy that's required to be able to produce that outcome. And that's what is unique and what we see happening with these three, what I would say, Tim, is 3 big secular trends: sustainability. And that, as Katie said, that has changed significantly with how that's being viewed and the importance of buildings and infrastructure. It's about health and safety, it's elevating the need to get to a higher standard and get to more of a certification of what a healthy and safe building is. And then connectivity, which is not only enabling the 2 of those, but also for the occupant experience within the building or within the infrastructure. Those are the value propositions that now play to our strengths with how we've been executing on our strategy.

That's great.

Yes, just add to that, that the numbers are telling exactly that tale. So Tim, for -- I think it's -- I think it's 14 years now, we have been closely observing an energy efficiency indicator study. And it goes out to hundreds and hundreds of building owners and decision makers. And the numbers that we're seeing, first of all, very significant jump. Some 80% of those owners saying that they are driving hard, investing in efficiency, 75%, I think, in the land survey, this whole wellness theme. And one of the interesting things is, I think customers are understanding the criticality of the digital platform to be able to achieve both of those things. Because we saw a just very significant representation, and I believe it was north of 70% saying that their priority investment in new capability is around data and digital integration. Yes. So -- and those themes are just there and growing and stronger, and the numbers in the surveys really are driving on the point.

Right, right. No, that's really interesting. I guess on the other side of OpenBlue, I mean, it does sound like it is going to help drive more attachment from a service perspective as well. And George, maybe if you could talk a little bit about kind of the key drivers of the attachment opportunity, both from investing in the service kind of capabilities. But then also, it does seem like there's more kind of unique digital tools and sensors and things that are unique to JCI, which kind of gives you the right of almost first refusal, I think, on the service contracts. So if you can maybe talk about both of those things as it relates to service attachment rates and the opportunity you have there?

Tim, I'd start by saying when you look at our service business, we have a $6-plus billion service business. And when you look at historically, the strategy up until the last couple of years, it was build the installed base and then you'd ultimately get the entitlement of service. It's mainly great fix, maintain type services on top of that installed base. And a lot of that was mechanical, and some of that was done through longer-term contracts. With our service strategy over the last -- it's actually been the last 3 years, we not only continue to increase our footprint across the globe, but also segmenting our sales force that was specifically focused on executing on our service strategy. At the same time, we've -- in the field, it's driven by the service strategy. So getting everything connected. Up until a couple of years ago, we had many systems that weren't even connected. And so unless you have connectivity, you don't have the opportunity to be able to extract data, use that data to be able to differentiate the services and create more value for the customers we serve. And then with that, you get an attached contract, you get more revenue per customer. And then longer term, you reduce attrition because you can better service that customer. And so as we've been building the strategy, putting the fundamentals in place, putting the metrics in place, when you look at our installed base today, we only have 35% attached contracts. And what we've committed to is on a go-forward basis now with our service strategy and embedding connectivity, the use of data, we're going to drive that service, that attach rate to we believe our entitlement with our mix of HVAC, fire and security overall is about 70% or 80%. And so as we drive that attach rate, we get then a higher attach rate, all of the systems that we deploy, that we engineer and deploy are connected, we get the visibility to the data. And then with the data, we can work to optimize how we actually service and provide value to that customer. And so that is where we are. We're making incredible progress. We've committed this year that we'll increase our growth rate in service 200 or 300 basis points above the market. Recognize, Tim, that we had done a lot of good work prior to the pandemic. We got our service growth rate to above market, around 4%, 5%. Now with the work we've done to differentiate it, not only getting it connected, but now deploying OpenBlue with all that we do, not only in how we differentiate our installs, but more important now, how do we make sure that we digitize everything we do in service is what ultimately is going to continue to accelerate the attach rate, the revenue per customer, the amount of recurring revenue and backlog and then ultimately translating to a higher growth rate that's sustained and accelerating over the next few years.

Right. Okay. Okay. So there's a -- Katie?

Another example of what George is saying are rooftop units. So the premier line, for example, rooftop units already were among the most efficient such units out there. So we were meeting 2023 efficiency targets 5 years ahead of schedule and driving, in some jurisdictions, 50% improvements in efficiency. When you have the smarts built into those systems, and we have a smart wizard built in, it's very easy for the [indiscernible] systems to be immediately loaded. It makes it very easy for us then to even remotely add additional OpenBlue functionality and the specific example of that to the -- to George's point, with respect to how that connects directly to service, so when you have that -- the controls and smarts built in, we can add, for example, fall protection. And so now we have that fall protection built into the system itself, then obviously, we're able to be on top of the service piece of the equation. And lastly, I'll just say, driving home the point that OpenBlue just is a hockey stick function in terms of efficiency, fall protection alone, remote fall protection is a boost efficiency by about 10%.

Okay. Okay. And I imagine it also kind of improves the profitability just of the service technicians in terms of keeping them -- keeping that network kind of actually doing things and kind of chasing down kind of false problems.

So I think it's simple, Tim. It's just simple where -- with more of a -- think of our business going back more mechanical, more break, fix, maintain. Now we digitize -- with OpenBlue, we digitize all that we do. We get incredible efficiency with actually how we serve. To your point, we can do a lot more remotely. And then with that digital content, with the data, we can add a lot more services to what we do. Think of it that way.