Johnson Controls International plc ($JCI)

Great. Okay. So good morning, everyone. I just want to say thank you for making the day 2 of the conference here. We're going to have a trio of industrial companies on stage, beginning with Johnson Controls. My real pleasure to welcome back to stage, Joakim Weidemanis, CEO of JCI; and Marc Vandiepenbeeck. I'm glad I got that other way because these are 2 more challenging and I'm glad I didn't -- I'm glad I got through that.

Perfectly normal where we come from.

But Joakim, Myles, thanks for being here. It's always a pleasure. And Joakim, maybe I'll hand over to you for some open remarks.

Yes. Thank you, Nigel. Thank you all for being here. So I'm a little bit more than a year into this role. And just to go back to why did I join and what did I find after I got here. So I always -- what I learned before I joined the company was that this company has some unique proprietary technological capabilities within thermal management broadly, meaning HVAC and controls, but also in other areas. Question was whether we have been leveraging that enough to drive outsized performance? The answer is no, we have not. And then I saw that we had a company with one of the industry's largest field footprints, about 50,000 people in the field. And the question is if we have been leveraging that enough historically to drive competitive advantage through, for example, life cycle services. And my hypothesis was that we hadn't fully leveraged that yet. And a year in, I found those things to be true. And -- but I'm even more excited now about our opportunities to unlock our potential, not just in those 2 areas, but in particular, in those 2 areas. And we can talk a little bit more about the progress we're making in doing that by implementing what we call our business system, which is how we're going to run the company, how we're going to improve the company. And perhaps for those of you who have heard some of our earnings calls, that's really about simplification, acceleration with lean principles that other companies that perhaps some of you follow have applied over many, many years. And then in addition, with digital and AI approaches. And so the acceleration and lean, I think about that as be able to do work that took weeks, to be able to do it in days now and the amplification with digital and AI. We have now plenty of examples where we're able to take work that takes days and turn it into hours and even minutes sometimes. So we're making good progress in standing up and implementing our business system. And that was important to get going to start to drive some performance improvement while we took a little bit of time to figure out where we are with the different parts of the portfolio. And so I'm glad -- I'm pleased that we've made some progress on clarifying for ourselves internally, where we are and that we've distilled down then for each of the businesses, what the expectations, what we can expect realistically, what the expectations are in our leaders as well as probably most importantly, clarified for our leaders, what our strategic priorities are. Because I think when you're trying to improve a company at a pace, that's very important to offer clarity to people on where we're going and what we're going to prioritize versus all the 59 other things that we're not going to work on right now. So some good progress there. We had a decent quarter. Our last quarter. Orders were up 30%. Our backlog is a record backlog, $20 million sales growth, now it's 6%. We expect that to -- that growth rate to improve over time. EBIT margins up 200 -- almost 300 basis points and a decent cash conversion here and a lot more to do, which is the fun part of being part of this team.

That's great. That's a great way to set the table, and you touched on a lot of topics are, I want to dive into as well.

But I'll kick off the Q&A. I'll come back to the audience halfway through with any questions that you have. Look, I think it'd be remiss to not start with -- you talked about the progress, but maybe just talk about what you've accomplished in the first year, where the sort of the changes most advanced, what needs to be done, where do you need to do to build muscle, kind of progress report on where we are?

Yes. I think, so I can go deeper into the business system, which is something that just needs to build and will drive continued improvements in performance in parallel as we work on implementing and executing on the strategy that we've defined. But maybe I'll start with the people side of things. It's important to make sure you have the right people on the bus. And for those of you who follow Jim Collins or read books he's written, he talks about first two who and then the what. So we've made a couple of changes in the senior most team. We have a new CHRO. We have a new North America leader, who's an internal promotion. The CHRO was outside higher, one of the most talented CHROs in America, I would argue. We have the new Asia-Pac leader, and we're working on a couple more changes that have been announced internally, and we're trying to staff up, of course, with the team that's going to help us win here in this space. So that's on the first two who and then the what. And on the what, we've clarified, like I said, our strategic priorities and no surprise, we'll come to that, I'm sure. But we want to help humans unlock their potential with the help of AI. We have important things that we can do for our hyperscaler and colos customers. I think as many of you know, 30-plus percent of all the energy that they struggled to secure for the data centers has to be diverted to going away from compute. We have the capabilities, and we've made a couple of moves that improve, strengthen those capabilities to reduce that 30% to something materially less, which is a very strong value prop in that space. Second strategic pillar is really about -- if you think about some of the innovations, scientific discoveries have been made over the last couple of decades that are now in full deployment in human society. I'll just take one example. It's the pharmaceutical industry. All the old factories were chemical plants, so all the new plants are biologics plants. As you can hear, you can't -- you need a very different plant to manufacture biology. And the indoor operating conditions, temperature, humidity control pressure, particularly, in the air and the tolerances, very, very tight tolerances that you need to keep that in operating condition and as requirements are much, much higher in biologics, which sort of plays to some of our strengths, not just in HVAC and controls but of course, what they manufacture is very valuable to us, so they need to detect it, both from fire and securities. So that's strategic pillar #2. And strategic pillar #3 is basically help the world decarbonize, or if you choose to think of it that way, with increasing energy costs, the payback on upgrading to a new HVAC unit or a control system or a digital system that helps you optimize how you run your sophisticated system, is of interest to a lot of our customers. So in those 3 strategic pillars, we've then gone and developed road maps that are now showing up in all of our R&D work. So we've reprioritized what we're doing, and we're aligning along these 3 vectors here. And I think that's going back to this point about clarity, if you're running a large organization, we have 100,000 people around the world. You can't be running after 15 things. And so just by making quite a bit of progress, not just on the PowerPoint, but translating this into, like I said, the product road maps and where we start to shift, how we focus our commercial efforts and so on, is gradually in our leading indicator starting to show that we're going to continue to be able to improve the performance of this company.

Is having a clear mission at the very high level and then everything else put this down from there.

Yes, exactly.

Okay. And then I don't want to spend too much time on [indiscernible] and ESG, but is that still a really important part of the conversation because from a water perspective, ESG, there's no question, it's kind of gone into the shadows at this point in time.

Yes.

But is it still a very real conversation with customers?

Yes and no. So I mean, increasingly, and it was, by the way, it was always about cost reduction. It was -- in addition to that, it could be -- people could improve their ESG performance. But if you think about it, in most countries around the world, I'm not talking about us as private consumers of electricity in our homes, but industrial consumers, have seen electricity cost increases of up to 30% over the last couple of years. And the projections are, I'm sure many of you study that, is that, that is going to continue. And if you're -- well, I gave you the data center example, right? But even the biopharma manufacturing is -- the biologics manufacturing is 7x as energy intensive as the traditional pharmaceutical manufacturing. So as part of their COGS, energy cost, is suddenly a line item that is visible. It used to not be. And so therefore, if you're able to offer solutions that will help people to use 30%, 40% less energy for what they're trying to do, there's a good payback on that. And the payback is improving with the increasing energy costs. So that's one aspect. And then, of course, in Europe, in particular, there's a big need to shift away from gas in particular, which comes from somewhere far East. And, get away from fossil fueled, heating, for example. So heat pumps, so it's more an electrification question, where people are trying to get away from certain types of fuels. So there's a lot of different aspects of our decarb strategy that is not about ESG.

Okay. And I do want to get into some of the -- sort of maybe just an update on trading conditions. But before we do that, you talk about services. I'd be curious how the services strategy is evolving. And we tend to think of all services as good aftermarket recurring revenue, et cetera. You called out some changes to the U.S. security services. So just maybe touch on that as well.

Yes. So services are about 30% of what we do. And in the domains, the product areas where we play, HVAC controls, fire and security. There's a healthy service business in each one of those areas. From a top line point of view, we continue to do very well, HVAC controls and fire. Here over the 2 recent quarters, we've been a lot softer in security, really what we're doing is we're going through our portfolio of contracts that we have. And we're making sure that pricing, margins, et cetera, are in good balance. And there was a need to rebalance. And so that came with a little bit of sacrificing of top of growth, but no EBIT dollars.

Okay.

But the -- in general, I'm super excited about, in particular, in HVAC and controls the service opportunity. In our -- as an industry, HVAC, not just us, but as an industry, the OEMs have much lower attach rates, service contract attach rates to their equipment than in most of the industries I've come from. And we're also at a much [indiscernible] take [ Atlas Copco Ingersoll Rand ] air compressors, that in many cases, are installed sort of 10 feet to the right, attach rates or sometimes 2x other rates. And there's there are different reasons for that, which may be it was a discussion for another day, but it's how you productize your services, make sure they're differentiated, differentiation anchored in what you can do in your system, different kinds of data, algos and things like that help the differentiation. So our industry hasn't done quite as much of that. And then there's a commercialization you do that where we're sort of early stages, but it's no magic. It's of course not a mystery of what needs to be done. And then you have the execution side, which, of course, with the increasing number of connected devices that we have out there, the economics of serving our customers are changing here rapidly. And as the cost of connectivity has come down too, that's increasing rapidly.

And is the primary driver services increase the attachment rates on the chillers, or is it more kind of just evolving the revenue model into other things?

It's not so much the revenue model yet. We're working out some stuff there, but that's too early to discuss. I think it's going to be attach rates. But then as we're pointing the company more towards some of the verticals that we were discussing before, that have for them up time, and because of what we do, is more mission-critical, both from an uptime point of view and a cost point of view. The service opportunity is bigger for data centers than it is for a building like we're sitting in right now, for the obvious reasons, right? So I'd say it's driving the attach rates overall. And then as a result of where we're pointing the company, the attach rates are going to come up and the service opportunity is going to be bigger.

Okay. I want to save my voice and I know you're struggling a little bit with...

Thank you

Thank you, [indiscernible]. But Marc, maybe just give us an update...

[indiscernible] hope it's not a virus.

Okay. Well, Me too, brother.

I spent 6 years in medical diagnostics. So I thought it was something like that. I wouldn't say it.

I would. Okay. Marc, back to maybe the guidance for 3Q, you're guiding for 6% organic, 6% in 4Q as well. Obviously, a lot of questions around the huge backlog strength, order strength versus the conversion of that into revenues? Maybe just touch on that, in terms of what we've seen during the quarter and how that backlog versus revenues?

Yes. First, the continued growth in our backlog will support an acceleration in revenue growth. And the underlying question is, why not just right now? And why is it taking a little bit longer? There's 2 elements to that. The first one is simply our ability to convert some of that backlog in the very, very short term in the next quarter or so, is there by 2 things, not so much capacity, but the ability for our customer to take delivery. What we see a lot in the data center world is the chaos around the construction side that pushed to the road sometimes deliveries a quarter or 2, we think that's not a permanent issue, and we have the ability to keep up there. The other thing is, naturally, we have a very large business in North America in data center. We are ramping up the production of that output that the timing of that ramp-up is really back-end loaded this year. we have opportunity to do better than the 6% we've kind of guided for Q3 and therefore, Q4 as well. based on both that ability for the customer to take delivery and our ability to ramp up quicker. And then very transparently, we have a large business in the Middle East that's been impacted by the conflict. Europe will have probably a soft quarter in Q3 and Q4, probably very low single digit. For an annualized business, that's about $4 billion, $4.5 billion of revenue. That's a bit of a [indiscernible] cost or price growth. But if you look at North America, we're expecting that to grow in the high single-digit starting now and probably accelerating into '27, if you remember, for us, '27 will start in October.

Yes. That's right. So you think that -- as we get -- kick into early 2027, we'll see that acceleration in North America?

Particularly in North America, yes.

Okay. And the Middle East, you touched on that. It seems like that's been contained at this point. Is it -- how do you characterize that?

So transparently, the amount of disruption we saw in March and April has started to taper down a little bit as the quarter unfolds, but it's not back to normal by any stretch of the imagination. And not a lot of what we sell and service in the Middle East is actually manufacture in the region, except for a factory. We have a joint venture partner in Saudi Arabia. But a lot of those products are purchased from our factories in either in Europe or in Asia, and the logistics of transportation right now in the region are affected by what's happening with the conflict. And there's also an enormous backlog of shipping that needs to happen. So even when things reopen, getting your ticket in line to be able to deliver to the customer on time has remains a challenge. The team has done an outstanding job navigating the conflict right now. But it's disrupted that business still in Q3 and then our ability to predict what the summer will bring is a little bit difficult at this stage.

But that's pushing -- that just pushes the demand to the right, I suppose.

It pushes demand. It's not demand is appearing. It's not demand destruction. Quite the opposite, actually. You saw the order in the quarter didn't slow down in EMEA at all. So that high single-digit order growth rate for the quarter included some solid orders in the mid-single digit in the Middle East. That means really the business confidence is still there. It's really just a pause and people are rightfully so being careful about when they deploy resource and where the deploy resources in an environment that's a little evolving.

Yes. Okay. And then just a quick touch on China. It's a chunky market. It's another huge, but it's mid-single-digit of your total sales. Any raise of light in that market right now?

I would say it's massively improved from probably 12, 18 months ago where we were still struggling. But I think the expectation that China will come back to a high single or double-digit grower like we've been able to benefit over the past decade is probably behind us. It doesn't mean it's going to be a bad market. It's going to be a very healthy market. The strategic pillar that Joakim laid out a few minutes ago, very much applied to the Chinese market. And it took us a little bit of time to pivot both a product team and our commercial team against some of those end markets, but we've made some progress over the last couple of quarters, and we feel we are very well positioned to capitalize on some of those opportunities in the Chinese market.

Sure. That's great. Any questions from the audience? So raise your hand. Otherwise, I'll continue. Order flow has been extraordinarily strong, Joakim. In terms of the pipeline opportunities you see out there right now, I mean, how would you characterize that?

Yes. So our pipeline in general continues to grow. So even if we've had 2 quarters of exceptional order entry, our pipeline is still growing. And I mean, the story is just simply a line with the 3 strategic pillars. And of course, we're following where the world is going, right? So it's not that we invented some unique verticals here. They were there all the time, and we're just over-indexing our effort on those. So there's -- of course, data centers is probably the vertical -- data centers biologics are the 2 verticals that are for us to best visibility into the future because that's where customer, it takes a year or 2 years, sometimes 3 years to stand up these massive campuses that they're building. And in particular, in those 2 areas, we see the pipeline strength. But you also have -- there are massive hospital build-outs in a number of countries as China that race is over. But in India, I was just in India here recently. I mean, India is sort of firing on all cylinders when it comes to the strategic pillars that we have so, that we're focusing on.

It does feel like India might have its moment here.

Yes. Finally. My whole career, I've heard that.

The next China.

Yes.

Couple of topics in the last 10 [indiscernible] you want to touch on here. One is a mark-to-market on where we are with the margin improvement story. Obviously, tremendous momentum in the last 12 months especially in Europe and Asia. Just wondering where we are on the sort of the simplification restructuring program and sort of that time line towards normalizing margins?

Yes, yes. So let's just discuss overall what our margin opportunity -- where it is in relative terms. So I see as -- I think we were talking about it last year, but I see no reason for us not being able to catch up to some of our direct competition. A matter of fact, our EBIT margins were the same in this past quarter as the one we were talking about. Now they have, I think, some challenging headwinds. So it was not one of their best quarters on margins, to be humble about that. But so I still see no reason at all for us to not to catch up and even continue to go past. And that's basically based -- if we stay on gross margin first, we have 40-plus factories out there. We do not need 40 factories. We just simply didn't do that consolidation work that I've been doing in past roles. So we have a very nice opportunity to continue to consolidate our footprint. We started a little bit. We also have in manufacturing, plenty of examples already of how we're able to increase capacity in existing factories. And for those of you who will join us for our Investor Day that's coming up in 2, 3 weeks, you'll see an example of where we've quadrupled the capacity in one site without adding any more floor space. As a matter of fact, we're using 30% less space. This is the direct result of the application of our business system. These are just good old-fashioned lean projects that we've started to work on. So those kinds of things on the manufacturing side will lead to margin improvements. Then on the service side of things, I think we kind of touched upon that. But - if you look at Atlas Copco, for example, an air compressor company, their service margins are hundreds of basis points better than our industry's gross margins and where I think ours could go. Then if you go into SG&A, we're working away at just basically cutting costs because as a result of the residential divestment, of course, there's some stranded cost. So we're making some good progress on that. That's what a good chunk that was showing up on EBIT already. But we have tremendous opportunities to break the connection between our growth rate and how our SG&A cost has grown over the years. And I think you've -- at least that Nigel has heard me talk about how we've doubled the amount of selling hours in a couple of our sales teams, and that now being deployed. That takes time, by the way, to roll out globally, of course. But if you can double the amount of selling hours with customers and a sales team without adding people, it takes time to recruit people, to train people and so on. We'll still be adding some people, but basically doubling the amount of selling hours is going to give us a really nice cost leverage. And then on the R&D side of things, we are going to continue to increase our dollars in R&D because there's more opportunity to differentiate with technology in the areas where we're pointing the company. But you will see, for those of you who join us in 2, 3 weeks, examples of how we've taken the time to get certain new products to market, down significantly with applying our business system. And when you can, for example, take 1 project and say, instead of it's going to take 24 months to deliver, same scope, same cost, all of that and do it in 14 months. you didn't quite double your capacity, but it's pretty darn close, right? So we're going to see some R&D cost leverage there as well. And now this is magic. It's just tried and proven principles applied in other places, and the opportunities are plenty. And that's why one of several reasons why I'm so enthusiastic about our future here.

Yes. I'm sure I found Ed Wolf would be intrigued on how you double the number of [indiscernible] now. So maybe we'll talk to you after that.

Yes. Some of it's about management getting out of the way.

On the -- just on -- quickly on the kind of the margins across the segments. Europe and Asia are now within [indiscernible] distance of North America. Do you think that convergence continues going forward? Or do you think North America will always be the most profitable region? And when do you expect to see the real acceleration in operating leverage for North America?

Yes, starting with the last one. North America will see most of it operating leverage improve, thanks to volume. The base cost, there's some opportunity there, of course, and the rationalization and consolidation of our manufacturing footprint plays an important role in the margin improvement in North America, but it's more of a question of how quickly can we get that operating leverage from the volume that will -- that is coming and unwinding that backlog as quickly as we can. That's where over the next year, you will see North America margin rate accelerate that improvement. Now when it comes to North America --sorry, Americas versus its regional tier, you've heard me saying that multiple times, there's really no reason for Europe to be materially different from a margin rate standpoint than where North America is today, except for the fact that we probably under-invested a little bit in Europe over the years in product leadership and in some capacity and technology. We have made tremendous progress over the last 12 months in starting to close that gap, but there's more work to be done. But over time, there's absolutely no reason for Europe not to be very close to the Americas margin as they stand today. And then APAC, we have made a good investment in product mine leadership. It's about continued growth. And you know that, that business has seen us and flows of what was happening in China in different part of the region. But if you look at the opportunity we have in India, as Joakim laid it out, Southeast Asia and then Japan remains one of our most attractive not from a growth standpoint, but from a margin rate than on markets. I think there's a lot to like about impact from a margin rate and honestly, a growth profile as Well.

You said the normalization of margins last year is 3 to 5 years. If I do my genius math, it's now 2 to 4 years, is that...

I think you were the one who I said 3, right?

Yes.

It turned out, you were right.

Okay. There you go. And then in the 2 minutes we've got left. So is that yes?

Yes.

And then in the last 2 minutes, just what's the latest message on the portfolio. There's been some Bloomberg articles about potential divestments?

Yes. Yes. So we -- and that's kind of skimmed over here earlier. But so in my first couple of quarters with the company, we took the Board through each part of our portfolio and looked at how are we positioned tactically, how are we executing rather tactically versus competitors or versus what we think we could do. And then we looked at also our business strategically, how are we positioned strategically, what are the competitive moats and India is in every company in his eyes, no one has the perfect portfolio and not every single business is incredibly differentiated or as much differentiated as you would like. And then as a result of that, we drew certain conclusions on what we would like to do with the portfolio. But the overarching goal here is, of course, to create shareholder value or at least absolutely minimize dilution if we were to exit certain pieces, which we had communicated before I even joined the company that about 10% of the revenues was something we were considering to seek other ownership for. So we are going to be looking at a little bit more than the 10%. We'll keep you posted on the progress on that and -- but the goal here is to create shareholder value.

That's fantastic. So we're out of time. Thanks, Joakim. Thanks, Marc.

Thanks for question.

Looking forward to the Investor Day coming up.

Yes. Great. All right.

That's great.

Thank you. Thank you