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

And welcome to day 2 of the Wolfe Industrials & Transports Conference. My name is Nigel Coe, and I cover the multi-industry sector here at Wolfe Research. Today is unusually -- normally, the first day is the busiest day. Today is actually the busiest day. We've got, I think, 40 companies across the spectrum and we've got 18 multi-industrials. So it's going to be pretty hot and heavy today. It's going to be a bit busier around the floor. And obviously, the priority is to make sure the coffee doesn't run dry. So that's the big priority today. Look, it's early days, but I think the feedback I'm getting is it doesn't feel like demand has fallen off a cliff. It feels like things are hanging in pretty well. And also pricing seems to be kind of going through and -- despite the rollback in China tariffs. So it might be setting up for a decent second quarter. Second half, too early to tell, but that's sort of the feedback that we're getting so far. My coverage is round trip back to the pre-Liberation Day highs. The 3 best-performing stocks year-to-date are GE Vernova, JCI and 3M. You probably wouldn't have made that call 12 months ago, by the way, but I think it does speak to the power of self-help. And in my experience of covering the sector for 20 years, the genuine self-help stories tend to be the best within the multis. Companies that go from average to good, good to great tend to be the best. And when you have a CEO change, that becomes a potentially very powerful multiyear story. So maybe we can start the webcast. I certainly think that JCI ticks that box. So for the benefit of the webcast, I just want to say welcome to the day 2 of the Wolfe Transport & Industrials Conference. I'm going to kick off the day with the JCI team. Very happy to welcome to the stage Joakim Weidemanis.

Weidemanis.

And Marc Vandiepenbeeck. And I'm sorry to -- I'm so sorry for Joakim with your names.

Well done, Nigel.

But I wasn't practicing all night for that, by the way. But thank you very much, gentlemen. And maybe we can kick off the fireside. But maybe Joakim, maybe some opening remarks and we'll get into Q&A.

Yes, sure. Three Europeans on stage.

Yes. Yes.

But as we were chatting, we both lived here for a decade, so...

Yes, yes.

So I joined 9 weeks ago from a company called Danaher. Maybe some of you are familiar with Danaher. And I joined the company for a number of different reasons. I looked at a lot of different things. But what impressed me was the market-leading franchises that we have, not only on the high-performance York chiller, HVAC product lines, and the Metasys control platforms, but also our, what I would call, enviable field position. We have 40,000 people in the field and built over decades. And these are not high school grads who joined us yesterday, these are highly technically skilled individuals who are also, from a human point of view, skilled at dealing with customers and complex situations. So when you have that kind of capability, both strong technology capabilities, as well as an enviable field position that takes, like I said, decades to build, you really have something very compelling to work with. And then we can discuss how well we've productized our technological capabilities and how much leverage we're getting out of our field teams at this point in time. But -- so I saw that as a really compelling advantages of this company. And then, of course, the mission, I should have started with the mission. But the mission, what we do when you think about it, when human society advances, it really happens in buildings, and not any kind of buildings, but where more intellectual, more sophisticated work is done. Of course, the latest and biggest growth vector in this space, needless to say, is the -- are the manufacturing sites of intelligence, aka data centers, right? But you also have medical advances that take place in buildings, advanced health care, advanced manufacturing of pharmaceuticals or based on biologics. All of those buildings require mission-critical indoor climates. And that's really something that plays to some of the strengths of our franchises there. So I think all of those things were really compelling reasons for me to join. And then the fact that I've spent most of my career improving businesses, and we can chat a little bit about my Danaher background. So of course, here, I saw an opportunity to join a team and leverage all the things I've learned over the years. And a 1 plus 1 equals much more than 2 over time. So those are some of the reasons, Nigel.

That's great. I was going to kick off with the question about why JCI. because I'm sure during your career, you've had plenty of opportunities to move and you see all the companies. So talk about some of the great things about JCI. But in your first 2 months on the job, what would you say are the areas to sort of add muscle or maybe areas of improvement?

Yes. Yes, so in addition to being excited about the strengths, I'm also equally excited about the work ahead here. And I talked about it in the investor call, and you were with us, Nigel, is about in terms of how we, overall as a company, just simply need to become much more oriented towards customers and competitors versus internally oriented. And that sort of sound like a nice theoretical thing to say. But when you break that down in practical things and you look at -- and I've spent a lot of time in the field. As I said, I'm still fairly new, so 9 weeks in. But I've been in 9 countries, I think, by now. I have visited, I think, well beyond 100 customers. I've sat with hundreds of our frontline colleagues, frontline as in sales, service, R&D, as well as manufacturing. I've walked 18 plants, heading to my 20th -- will be 20 plants by the end of this week. So I'm really getting a flavor for what's needed here. But in terms of the customer orientation, what I mean is when you look at your field team and you see how much time they're spending on things that are really nonvalue-added things -- and of course, everybody in every company needs to do their expense reports, so that's not what I'm talking about. Yes, unfortunately. Me, too. But there are just internal processes that are not optimized yet that would enable us to free up time for the people that build capacity in the field without hiring more people. And that's not going to happen without leadership at different levels being customer-oriented and being obsessed with trying to help our frontline people with serving customers and giving them back more capacity. So it's a very -- just a very practical example of when I say we want to -- we need to be more customer and more competitor-oriented, right? So I see that as an opportunity. I do see -- I alluded to it here before with some of the unique technological capabilities we have. Like I said, not only, but in particular, on the high-performance chiller HVAC product lines. We have unique skills. And a chiller is really 5 subsystems. And for those of you who follow automotive, I'm sure you've heard automotive companies talk about a car as being a number of subsystems and then there's the overall subsystem. We have unique capabilities in all of the 5 subsystems that make up an HVAC chiller. I do believe humbly that we have more skills, and a number of them are on subsystems that some of our competitors don't. So we have degrees of freedom and innovation, how we can turn those into more differentiated products, typically more vertically differentiated products. So I'm super excited about bringing that into how we plan the future product portfolio. So those are just a couple of examples about how you would turn this notion of being more customer oriented into something that both creates more growth and leverage from the assets you have in place. The field teams is where that I started with here. So...

Great. You 3 are definitely doing the game, that's for sure. So the question we get a lot is how applicable -- I mean, I think we've all heard of Danaher. I think we've got a lot of admirers of Danaher Business System here. How applicable do you think the Danaher Business System is to JCI? I'm thinking not just in the manufacturing side, but also on the services side as well.

Yes. Well, 100%. But I could have said 200%, but that's not possible, right? So let me just walk you back. I started at Danaher 14 years ago. I met the individual who ran Danaher at the time before that. And we connected on the topic of how you build unbeatable execution engines. And I had done a lot of work in a prior company that maybe some of you know called Mettler-Toledo, and our business system was called Spinnaker. So I spent 6 years there building out Spinnaker on the commercial side of things. So we were really trying to accelerate organic growth. And we were really -- the way we did it, there's some fundamentals for how you drive continuous improvement, how we captured and defined best practices so that you can train people all over the world. 1.0 in year 1. Next year, you do 2.0 and then you do 3.0. And our -- the unique skill we really built was deploying capability at scale to the front lines. And the notion was whoever has the most capable front lines wins. And that proved -- I mean, I learned -- I mean, that was a little while ago, right? But 1 or 2 of you in here, I think, follow that company at that point in time, too. And that's played out year over year over year in Mettler-Toledo, as you know and -- but the fundamentals were built at that point in time. So I met the gentleman who ran Danaher at the time. Danaher was very strong at lean, more in the factories, a little less so elsewhere. And we've sort of aligned on the simple truth that you can apply the lean principles in commercial as well, and some of the approaches I had learned in commercial could be brought to Danaher. And so I joined Danaher. And with the team there, we evolved the Danaher Business System to be far beyond factories. So over the last 14 years in Danaher -- and I'm sure you've seen that in investor presentations how much we, at the time, they know, talk about what we did on sales, on marketing, on service, on how to accelerate innovation and so on. All of those things are 100% applicable at Johnson Controls. So -- and think about it this way. We have about 35,000 people in our factories, maybe just a little bit more than that. We have 40,000 or more people in the field. And so -- and it's not really about the cost. Although, of course, we always look after the cost, it's what leverage can you get out of these capable people. And the lean -- what's lean for those of you who don't know it, it's really a way of running companies and what you do -- it's not a manufacturing thing. It used to be in the '70s and so on. But it's a way to align an entire organization around your customers and then you engage all of your employees over time, of course not day 1, in hunting for waste and thereby improving processes, creating flow, being able to do things faster because you get rid of obstacles, quality, rework, waiting time, things like that. And by being able to do things faster at better quality, you're able to be much more competitive. And whether that's on-time delivery or lead times from factories, or whether that's response time from your team, that you can be there in 3 hours or 6 hours versus your competitor who can be there in 18 hours. The principles all apply in all these functions. So that's a little bit probably more context than you wanted, but that's why.

No, that's great. And by the way, we can go with 200%. 200% is a thing. So we'll go with that. Just wanted to...

I'm quite quantitative. So...

Look, you said you're not ready to come out with sort of a strategy update on JCI. You're 2 months, I'm not going to press on that. But I do wonder on pricing. Now -- and the market leadership. You made some great strides on sort of pricing, especially in Europe and Latin America. But I'm just wondering, especially on the solutions side, because there's no single product to price there. So I'm just wondering any conclusions you've made so far on the ability to optimize price and price better for value?

Hey, you want to take that one?

Yes, sure. So first of all, the dynamic of pricing a solutions business, as you alluded to, is a little bit more complicated than our pure product, right? You can compare a product 1 year and the next, and you can easily say have improved price 6% year-on-year. On the solutions, because of the scope of the job and the different things, it becomes a little bit more complicated. But I'll tell you 2 things. The first one is we do a whole lot less installed than what people really believe. So as part of our portfolio of systems, there's a big component of products, and we've been able dynamically to really improve our pricing processes to be able to command more price and sell more value. How you do that is you orient the commercial teams, and Europe is a great example, towards the parts of the market that are more attractive. One of the benefit JCI has is we operate an extremely broad and wide market with a ton of opportunity. And when that happens, you have a tendency to have a commercial team, if you let them go the way they want, to focus on everything and anything instead of laser-focusing on parts of the market where you have a higher service attach, it's easier to sell value. Your product can actually become differentiated and you can actually command price on the differentiated technology we provide instead of chasing the more transactional parts of the market. So our ability to command price in those markets has been around focusing the teams, again the subsegments of the market that are operating better. Now there's a whole lot more work to do. Europe is in the early stage of that improvement and there's more improvement to come. And we got to continually look at where and how we find the teams on System and how do we improve our entitlement on attachment rate, and that will get that flywheel of pricing accelerating much faster. But the days that you're alluding to where we had more challenges on commanding price and managing price are far behind us. We are able to now have a clear visibility on cost and pricing, and our ability to attain a full pricing demand and margin demand on most of the markets.

Okay. That's great. And then maybe just think about the reorganization that's underway right now, the new segmentation. I don't want to talk about segmentation as it sounds like a great driver. But you are moving from 4 segments to 3 segments, it does feel like more of a commercial realignment than just a simple rejigging of the reporting. I'm just wondering how this changes the customer-facing part of the organization and making just more efficient decisions and streamlining.

Yes. I mean, first of all, it's super logical. And quite frankly, most companies have had that org model for quite some time. So it's good that we did that. I mean this work was all done before I -- or the preparation for it was all done when I joined, and I had the pleasure of 3 days in to announce it to the organization. But -- and you could say, wow, how about that? But you know what, it was just logical and it's a model I'm super familiar with. And I mean, so what was it about? I mean in the past, we had a separate team, commercial team, that covered all of our indirect sales channels. They were separate from the people who -- the 40,000 who are in the field were separate. And it doesn't matter what the logic of that was, but of course, there was some at the time. And what we simply did was to say, look, whoever is responsible for Germany or whoever is responsible for the Midwest in the United States, that individual, that team, should be responsible for the whole market and for the entire customer journey and experience. And meaning all channels, all work done. And so of course, as you can imagine, when you move from 2 silos to 1 team, you do look at a market more holistically, right? So makes sense. And some of the side benefits of that, a little anecdote -- and this is work that was started quite some time ago and it's continuing. But when you start to look at the market not in silos like that, of course, you see that, oh, combined, maybe we don't have the market share that we aspire to. And you know what, different customer segments prefer to buy in different ways that maybe depending on where they are at in their journey. So it's not necessarily so that one business is only direct or it's only indirect, right? So you need to look at the customer's buying journey. And so we're seeing already some of the early benefits of this where we have teams saying, hey, you know what, we probably could add a little bit more indirect channel here? Or you know what, we probably shouldn't go indirect for these and these kinds of solutions because for a number of different reasons. The life cycle opportunity is much bigger here, so we want to be much closer to that opportunity upfront. So from a commercial point of view, it just made total sense. And then the -- other than the 3 geographical segments, Americas, EMEA, APAC, we've got 2 groups of teams. One group is basically the group that's -- let's call them responsible for the products and the solutions. So these are the innovation models. Well, start with product management, product strategy planning, things like that. And they're leveraging the innovation centers, the innovation capabilities that we have and then they turn that into products that we then manufacture. And of course, some of our manufacturer -- some of our products are more standardized and some are more configured to order. So when you're in a little bit of a configure-to-order business, it's not bad to have innovation or some parts of R&D have good ties to manufacturing, right? So it makes a lot of sense to have that kind of grouping. And then what was created was -- what will be the foundational group for whatever we choose to call it over time, but our operating system, our business system. And that's a group that's really responsible for very much, akin to what I did at Mettler-Toledo, right, or at Danaher, basically defining, developing practices, having some continuous improvement capabilities and then deployment capabilities to help the regions become more capable. But also in the factories, of course. Now that's nascent, but we have created a group like that. And so very exciting. I'm very excited about that to not have to start from scratch on that coming in.

I'm going to take 2 more questions, and then I'm going to throw it open to the audience. I would just -- I want to sort of like maybe address 2 urban myths about JCI. One would be that Fire & Security is a solid business, but maybe not the highest multiple, the highest growth. There's a perception that it's lower margin, it dilutes down your margin. So maybe just take a crack at that one. But also, if I can just throw in as well, you do too much installations, too much labor. Is there an opportunity to optimize that part of the business? So maybe just those 2.

Sure. So let's cover installation first. So like Marc said, we do not do installation of everything we do. That's -- let's take that out of the equation right away. Now for the installation that we do today, should we be doing all of that? I don't know. Probably not. But the -- I'm a practical guy. I grew up in the field. I'm not some ex-consultant. I've been a general manager since I was 28 years old. And I've had full scope businesses since I was 28 years old. And so the way you approach such a problem is you look at, for example, the last 300 projects that you did, and then you say did we do installation or not? And then you ask yourself the question, did that improve our win rate? Yes or no. Of course, you look at the scope of installation. And so you develop an opinion on whether it helped you improve your win rate. Then you look at your margins. You look at what you assumed when you quoted and then you look at how you're able to execute. And then you can answer the question, were those margins good enough for us? Or when you see if there's a delta to execute it -- it could be up or down, by the way. But you typically study the ones where you're down versus what you quoted. And you say, why is that? And why is it not down in certain cases? So you'll develop an understanding for what we're capable of doing and where. And by the way, our capabilities are not uniform everywhere for every business line or in every country or every region for that matter, right? And then you look at -- because in this business, as you know, the life cycle services business, what happens after the initial installation, is an important part not just of our revenue profile, but our margin profile, and later on to earn the repeat business. So you look at what's the service contract attached, is there a correlation between if you did installation or not. And you know what, we're doing that work right now. My hypothesis is that our conclusion is going to be that under these and these circumstances, we absolutely want to do the installation because it makes sense along the parameters I talked about. But we're only capable of doing this kind of work, this level of complexity, in certain parts of the organization. So this kind of goes back to lean principles, develop standard work and be clear on where you have the capabilities, give people the tools and so on. And then we'll also conclude that, under these circumstances, we will no longer do installation. And to preempt that question, I don't think that's going to be like a revolution that suddenly we're going to have a downtick in sales that you're going to notice, really not. This is kind of a gradual thing. So that's the answer on the installation side. So we're doing that work right now. By the way, a little reminder, our gross margins, that's -- the installation cost is in the gross margin, right? And if you compare our gross margins to our competitors, it is actually better than most of our peers, right? Not all of them, but the closest peers. Then on the portfolio -- and I promise I won't play this card anymore after this quarter, but I am 9 weeks in, so I will play it when I can because that's just simply the truth, right? But -- so it's too early. It would be presumptuous of me to start drawing conclusions on the portfolio. But what I can tell you is that we're approaching this the way I was brought up to do it. You start with strategy, then you get the portfolio. And whether that's acquisitions or exits, you have to start with a strategy. And strategy starts with markets, just good old fashioned -- most of you went to business school, market segmentations, what are the customer segments, what do they need, how do they buy, who are the competitors, where are we positioned today, what does the winner look like. And then you say, okay, what's the gap and where are we versus what a winner should look like. And then you look at the gap and you say, man, that's big. Or no, it's not that big. And then you have to make capital allocation decisions on internal capital, right? So which ones are the -- which gaps are the most worthwhile to go after. And so that's -- we're doing that work right now. And that's not something you complete in a quarter. That -- and obviously, not only my decision, we will have to go to the Board. And so over the next couple of quarters, we're going to be doing that work. And at the appropriate time, we'll come back and tell you what the conclusion is. My hypothesis, I mean, there could be 2 scenarios. And I'm really not drawing conclusion now at all. But there can be 2 scenarios. Scenario one -- which doesn't mean I'm ranking these now, by the way, they're just simply 2 scenarios. Scenario one is we could choose to become a little bit more focused in our portfolio. And most likely in that scenario, I mean, you could imagine that possibly being HVAC and Controls. And in that scenario, the natural choice would be you don't need to go to business school to come up with this, but -- is that you choose to become a little bit more vertically oriented, specialized, right? In particular, if you have these unique technological skills that I was talking about. And you would double down on higher growth verticals, verticals with a higher life cycle services, content, more pricing potential because of your degrees of innovation. When you choose such a strategy, you have many examples of that out in the market. That's the theory behind that one. But scenario two, and at this point, I think, is just as likely, is just simply that if you think about Danaher. When I left Danaher, we were broadly in health care tech or tools for biotech. And -- but the 3 groups of businesses in Danaher, there were very few synergies between those 3 groups. But they were great businesses, all of them, serving the general -- or a part of the health care market that had good macro characteristics. Now each one of those businesses were great businesses, but they did not all have the same growth potential, short or medium term. They had different margin profiles and they had different cash conversion profiles. And if you take a step back and if you look at the portfolio we have today, I mean, excluding the 10% that we're going to exit, that I think Marc has talked to you about in the past, I mean, you could see that, look, these businesses were serving the same general macro or similar macro trends. And then if -- and here comes the big if, if we develop conviction that we can just simply run these businesses much better, then we could lift the performance of this corporation. And I think all of us would be quite pleased if we could, as a starting point, catch up to the types of margin levels, EBIT levels that some of our near-end competitors have. And over time, do a little bit better. And so we're validating all of that work right now. But I'm sure you're going to ask me the margin question, so I'll park that one until you get to that one. I was going to -- it's the logical one. No, but of course.

We're running short of time, but I want to make sure I open up the mic to the room. Any questions? No? So okay, back to that margin question. Before we get there...

It's the one I asked before I joined. So I mean that's clear.

Before we get there, I just do want to touch on the sort of trade environment. We had a very weak ABI print overnight, 40, one of the weakest I've seen in a while. So just disconnect between what you're seeing on solutions orders versus some of the macro data. Just want to make sure we're not missing sort of wall here in terms of are we going to see a negative number anytime soon?

Yes. So our guide of mid-single digit in Q3, and arithmetically very close to that in Q4, embed some pressure we're seeing in the back end. But very transparently, if you look at the shape of our pipeline, the pace of orders and the health of our pipeline, we don't see yet a very strong signal of softness in the market. Now we are longer cycle than most, right? So a lot of the time it takes for us between approaching something in the pipeline and booking it is longer because we approach customers very early on in the either decision-making process or construction phase, depending on the segment of the market you look at. But we continuously see healthy enough momentum to be able to meet our commitment. If you look geographically at that mid-single digit, EMEA/LA still see much better growth than the rest and that's really on the basis of the fundamentals of the megatrends we've seen Europe. But also the repivoting of that commercial structure I talked about earlier is really starting to yield a lot of goodness. APAC is okay. It's within that company guidance of mid-single digit. And North America is probably just there or right under there, depending on how you look at it. But the core vertical markets that have driven our growth and continue to drive our growth, remain very healthy. Of course, data center. But you have manufacturing remains pretty healthy. Health care, if you exclude life science from there, it's still pretty good. And then the commercial real estate, still pretty good. I mean the Class C offices, it's still one of our greatest market. And then anything below that is very, very soft and probably not growing at all. So yes, there is -- we see the same data that you see. We have the same angst. There's some concern more for us in '26 and what it will do for demand more than what we see for the balance of '25, to be honest.

And then, Marc, maybe a follow up on to you would be on the -- sorry.

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Yes. I wanted to understand, this is a multi-vertical -- I've lived in multi-vertical businesses my whole career. So I'm going to give you a little more context than maybe you're looking for, but it's important. I think it's important for you when you look at different companies. So when you're in businesses that cover multiple verticals, you always have this dilemma like you can't just choose a too few verticals because then you can't get scale. But if you choose too many, you spread yourself too thin and you can't -- I'll use the word productize, I don't only mean hardware products now, productize your capabilities and make enough progress because you go too broad. And so I wanted to understand if there was a scenario where there are a few many -- enough higher growth verticals, is there -- was there an opportunity to really focus the company to become a little bit more differentiated than might be perceived some of the players in this industry, not just us, perhaps have been to date. So -- because that's about long-term growth opportunities. And by the way, when you dig into verticals and so on, of course, you ask yourself questions not just about growth, you ask about how mission critical is what we do for them, what kind of margin differentiation is there, what kind of life cycle service opportunities and so on. So I asked a series of questions around long-term growth fundamentals. And then, of course, as you can imagine, I ask a lot of questions around current capabilities, not just team, but also in terms of where are we on the journey of -- our execution journey. For example, the margin question, I'm trying to help you here, Nigel. And so what's the opportunity here? And of course, there -- because what has been fun for me over my career has been many, many different things, but I really do enjoy helping make sure we all win, shareholders. I'm a shareholder as well. So of course, I was asking about like what kind of shareholder value creation opportunity is there with those 2 big questions.

So we're a minute over budget. But I do want to get this margin question because it's the elephant also in the room. Maybe just -- you talked about gross margins being above peers, and that's certainly true, [ comparing to ] like Trane or like Carrier. So therefore, the closeness gap, is it primarily an SG&A productivity...

Yes, I don't think so. I think there are a number of buckets. And at a later point in time, after I've worked here for more than 9 weeks, I'll be able to dimensionalize it more precisely. But I'll tell you a little bit so you can understand why I'm still confident to say what I say. There are -- the margin bucket, I would say, number one, is how we run our factories. And applying lean principles, we'll be able to not just eliminate waste, speed up how we run the factories. But when you do that, you invariably take out cost, and not just cost as in COGS, but also capital. So there's -- with 40-plus factories around the world, we're going to have some fun here and we've already gotten started. And then you have the 1,000 people in the field. And some -- many of these people are conservatively spending 15% of their time doing stuff that over time they shouldn't do. So is it easier to grow if you cut that in half? We're trying to grow -- we grew 7% last quarter, right? What if you take the 15%, cut it in half, you give them back 7%. Is it easier to grow 7% if you go -- I think so, I mean that's what I've seen throughout my career. So there, it's more about leverage, and that's both service, gross margin, as well as S, the S cost in SG&A. Then you have the installation example that we talked about. And then on G&A, there's just -- with the exit of residential, of course, with -- Marc already announced the restructuring previously. But there's just lean opportunities in G&A in general, and then there's also a restructuring opportunity beyond what we've talked about, which we're trying to dimensionalize at this point in time. So all those things, I mean, there's enough to go at and that's why I'm really excited to say that I think we cannot just catch up to some of our direct competitors. But over time -- and of course, they're very capable, so they won't stand still. But over time, we're going to be very competitive on margins here. That's not a 1-year thing, but it's not a 5-year thing either. I'll just have to work here for a few more weeks to come back and be a little more specific.

We'll call it 3 years. Okay. That's great. We've got to stop there, otherwise, I'll get in trouble. But Joakim, Marc, thank you very much for the discussion. That was great.

Thanks, Nigel.

Thanks, Nigel. Appreciate it.