JOHNSON-CONTROLS-INTERNATIONAL-PLC Earningcall Transcript Of Q2 of 2024
chief executive officer, George Oliver; and chief financial officer, Marc Vandiepenbeeck. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements. Actual results may differ materially from those indicated by forward-looking statements due to a variety of risks and uncertainties. Please refer to our SEC filings for a detailed discussion of these risks and uncertainties, in addition to the inherent limitations of such forward-looking statements. We will also reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are contained in the schedules attached to our press release and in the appendix to this presentation, both of which can be found on the investor relations section of Johnson Controls' website. I will now turn the call over to George. George R. Oliver -- Chair and Chief Executive Officer Thanks, Jim, and good morning, everyone. Thank you for joining us on the call today. Let's begin with Slide 3. We were very pleased to deliver fiscal third quarter results that exceeded almost all of our targets. Organic sales growth was 3%, which was in line with our guidance of low single digits. We delivered a robust 150 basis points of segment margin expansion to 17.9%, which exceeded our guidance of 17%. We are also proud of our free cash flow generation during the quarter, which was more than $500 million higher than the comparable period one year ago. Service led the way, once again, with 9% growth, which continues to validate our transformation efforts. It is encouraging as we continue to build momentum toward meeting our full year financial objectives. Orders grew 5% during the quarter. We expect some quarterly fluctuation in our order pattern, given the strong demand for our data center solutions. With the investments we have made over the last few years in technologies for data centers, the launch of a dedicated organization and our one-of-a-kind offerings, we remain well positioned in this fast-growing segment, with solutions that are clearly resonating with customers. We have built a leading position in data centers in North America, due to a unique and compelling customer value proposition. As our customers expand internationally to meet the rapidly growing demand for data centers, we grow alongside them as they choose to partner with Johnson Controls around the world. Our backlog grew 10% in the quarter, as we continue to see demand for our solutions, both systems and services. The growth in orders and backlog give us increased confidence in our ability to continue delivering sustainable long-term growth. As part of our ongoing business transformation, we announced two divestitures, our residential and light commercial HVAC business and our air distribution technologies business. These two transactions represent roughly 20% of current sales. At the same time as our earnings results, we announced this morning that I informed the board, it is time to initiate our CEO succession plan. Following recent significant milestones in our portfolio transformation and as we move to the next phase of growth, I believe that now is the right time to begin the process of identifying the next leader of the new Johnson Controls. Accordingly, the board has engaged a nationally recognized search firm and begun a comprehensive search for the company's next CEO. Once my successor has been named, I will remain chair of the board to help facilitate a smooth transition. I am confident in our position as Johnson Controls enters its next chapter, and I remain committed to supporting the full team as we work to ensure Johnson Controls realizes its full potential. Along with the initiation of the company's succession plan, we also announced that as part of our ongoing board refreshment efforts, and following a constructive dialogue with Elliott Management, Patrick Decker has been appointed to our company's board of directors effective immediately. Patrick brings experience to our board, and having led a transformation of his prior company, and his appointment reflects our commitment to continuously refreshing our board to ensure the skills and experiences of our directors appropriately reflect our ongoing transformation. Lastly, before moving to the next slide, we are tightening our full year adjusted EPS guidance to a range of $3.66 to $3.69 from a range of $3.60 to $3.75. Marc will give additional details later in the call. We have made tremendous progress on our business transformation into a simpler, higher-growth company, positioned to deliver more consistent, predictable results. Turning to Slide 4. We have made good progress on simplifying our portfolio. Most recently, on July 23, we reached an agreement to sell our residential and light commercial HVAC business to the Bosch Group in an all-cash transaction. The transaction includes 100% of our North America Ducted business and our 60% interest in our Global residential joint venture with Hitachi. The total transaction is valued at approximately $8.1 billion, which results in approximately $6.7 billion of consideration to Johnson Controls. We are expecting net proceeds of approximately $5 billion after tax in transaction expenses, the majority of which will be used to accelerate returning capital to shareholders and also address leverage. The residential and light commercial HVAC transaction is expected to close in approximately 12 months, subject to required regulatory approvals and other customary closing conditions. We expect to report the operating results of the business in discontinued operations beginning in the fiscal fourth quarter of 2024. In addition, on June 18, we agreed to sell our air distribution technologies business to Truelink Capital. The sale of air distribution technologies is also an important step in simplifying our manufacturing footprint, with the elimination of nearly 30% of our manufacturing facilities. Taken together, these two transactions represent significant milestones in our portfolio transformation. We are now even better positioned going forward as a pure-play provider of comprehensive solutions for commercial buildings. Our efforts in turning into results and the value of our transformation is coming into focus. Slide 5 presents a pro forma look at the new Johnson Controls, representing the composition of our company going forward. Following completion of the two divestitures described earlier, we will be a simpler, higher growth company focused almost exclusively on our engineered solutions offerings. These solutions include commercial HVAC, fire, controls, security and services, forming the smart building trifecta of energy-efficient equipment, clean electrification and digitalization. The benefits of our transformed portfolio include an enhanced margin profile, less complexity and a more focused operating model. In addition, these divestitures further increase our exposure to the fast-growing data center vertical to nearly 10% of sales from 7% as of fiscal year 2023. We expect this percentage to further increase over time given the robust demand we are seeing in this key vertical. While we will continue to look at opportunities to further enhance the portfolio, we believe that the largest elements of the portfolio transformation are now complete. Turning to Slide 6 to discuss our focused business model and how we plan to deliver more consistent, predictable outcomes for our customers and maximize value for shareholders over the life cycle of buildings. Johnson Controls has a unique value proposition for our customers that directly translates to shareholder value creation. Our ability to serve our customers over the life cycle of the building allows us to deliver safe, healthy and sustainable buildings. As a simpler and more streamlined company, we are now better positioned to leverage our integrated domain expertise, coupled with our extensive branch network to significantly expand margins. Our journey with the customer provides system and service solutions that maximize the opportunities around the life cycle of the asset, delivering outcomes to the customer that save energy, reduce emissions and optimize building life cycle costs, all while improving the overall occupant experience. Most importantly, our ability to drive direct outcomes ensures that we have long-term customers that use several of our services, which creates a compounded impact for the customer and for our shareholders. In fact, $1 of systems revenue has the potential to generate up to 10 times the revenue over the life cycle of the solution. It all starts with our local teams supported by our centralized engineering teams to provide operational excellence throughout the construction of the new building, starting with the product and technology development through the installation of the new systems. This grows the installed base. Throughout system deployment, our teams are building customer intimacy and confidence in our team to ensure we are creating linkage with our service offering. We have redoubled our focus to build this initial relationship and greatly improved our operational execution over the past few years to drive an enhanced margin profile and grow service. Simply put, service and maintenance delivers recurring revenue for us, and this provides resilient revenue throughout economic cycles. Moving to parts and repairs. Our service organization is digitally enabled and unlocks additional value by collecting data from the connected equipment within the building. Leveraging this data lets us detect issues before they occur, leading to reduced downtime and cost savings for the customer. The last part of the cycle is the building retrofit, including the monetization and technology refresh of existing systems. We work closely with the building owner to discuss life cycle planning and the prioritization of the building needs. We have found this to be the perfect opportunity for Johnson Controls to sell additional domains. By compounding the effects of this cycle, we are able to deliver solutions to our customers, leading to significant margin expansion. The ongoing transformation of our portfolio into a quality pure-play provider of comprehensive solutions for commercial buildings means that we can service these buildings to deliver outcomes that matter. Accordingly, we are extending our journey with our customers, while capitalizing on attractive opportunities in the market. Together, this delivers value across our stakeholder base for customers, employees and for our shareholders. With that, I'll turn it over to Marc. Marc Vandiepenbeeck -- Chief Financial Officer Thanks, George, and good morning, everyone. Let me start with a summary on Slide 7. Total revenue of $7.2 billion grew 3% organically as strong high single-digit service growth more than offset continued weakness in China system business. Segment margin expanded a robust 150 basis points to 17.9%, as we delivered another strong quarter of productivity and converted our higher-margin backlog. Adjusted EPS of $1.14 was up 11% year over year and exceeded the high end of our guidance range by $0.04. Operations contributed $0.18 of the growth in the quarter, as improved productivity and the conversion of higher margin backlog more than offset higher corporate costs related to additional IT investments, cybersecurity enhancement costs and increased centralization of functional costs. Below the line, we saw favorability from a lower share count. As we continue to build a more consistent and predictable business, we are pleased with the strong adjusted EPS performance in the quarter. On the balance sheet, we ended up the third quarter with approximately $900 million in available cash and net debt decreased to 2.3x, which is within our long-term target range of two to two and a half times. Year to date, adjusted free cash flow improved approximately $700 million year over year to $1.3 billion. We remain on the path to driving higher free cash flow conversion more consistently. Let's now discuss our segment results in more detail on Slide 8 through 10. Beginning on Slide 8. Organic sales in our global products business grew 3% year over year, with price offsetting a modest volume decline. Commercial HVAC remained a bright spot for the business, growing mid-single digits against a tough comp of mid-teens growth a year ago. fire and security declined low single digit, as a decline in fire suppression more than offset growth in fire detection and security video surveillance. Industrial refrigeration grew approximately 20%, with strong double-digit growth in both North America and EMEA/LA. Overall, global residential grew mid-single digits in the quarter. Global Ductless residential grew low single digits as strong double-digit growth in APAC more than offset continued declines in Europe. In conjunction with improvement in North America residential market, our Global Ducted residential business grew 10%, with strong double-digit growth in both North America and EMEA/LA. Adjusted segment EBITDA margin expanded 240 basis points to 24.5%, as positive price cost and improved productivity more than offset mix headwinds from ongoing weakness in China. Now moving to Slide 9 to discuss our building solutions performance. Order momentum remained healthy with 5% growth in the quarter. Overall, service order grew 12%, with a broad-based growth across the region. Systems order grew 2% at North America offset decline in APAC. Organic sales increased 4% in the quarter, led by service growth of 9%. Systems revenue grew 1% as decline in APAC more than offset growth in North America and EMEA/LA. building solutions backlog continues to remain at record levels, growing 10% to $12.9 billion. Service backlog grew 7% and system backlog grew 10% year over year. Let's discuss the building solutions performance by region on Slide 10. Orders in North America increased 5% in the quarter, with mid-single-digit growth in both systems and services. As a reminder, our quarterly order growth can fluctuate based on the timing of certain large projects, particularly in the data center vertical. We remain confident in our competitive position in the data center and our pipeline remains quite robust. Sales in North America were up 8% organically, with continued strength across HVAC and controls, up over 20% year over year. Overall, our system business grew 9%, while service grew 6%. Segment margin expanded 150 basis points year over year to 15.9%, driven by the continued execution of higher-margin backlog, improved productivity and solid service contribution. Total backlog ended the quarter at $9 billion, up 14% year over year. In EMEALA, orders were up 11% with over 25% growth in service. Systems, although were flat as we continue to remain focused on driving higher quality growth with higher margin and improved cash flow conversion. Across the portfolio, we saw strong double-digit growth in controls, fire and security. Sales in EMEALA grew 8% organically, with broad-based growth across the portfolio, Momentum continues to build within our Service business, up 15% year over year, driven by strong double-digit growth from both our recurring and shorter cycle transactional businesses. Our system business grew low single digits, led by strength in controls. Segment EBITA margin expanded 170 basis points to 10.3%, driven by the positive mix from the growth in service and the conversion of higher-margin system backlog. We've made tremendous progress in improving the profitability in EMEALA as well as the mix of higher-margin service. A more disciplined funnel in systems gives us further confidence in continued momentum in margin improvement. Backlog was up 12% year over year to $2.5 billion. In Asia Pacific, orders declined 2% as we have focused on deploying resources to the most attractive part of the market, and remain selective on the jobs we quote and ultimately, book. Given our strong installed base in the region and our continued focus, we saw high single-digit growth in service. Sales in Asia Pacific declined 19% as the Systems business continue to be impacted by ongoing weaknesses in China. Our Service business grew 8% in the quarter, with strong double-digit growth in our recurring revenue contracts. Segment EBITA margin declined 220 basis points to 11.7%, as weakness in China offset positive mix from our Service business. Backlog of $1.4 billion declined 12% year over year. Now let's discuss our fourth quarter and fiscal year 2024 guidance on Slide 11. We entered the fourth quarter with solid momentum, led by our resilient Service business and continued demand in our North America system business. Our margin reach backlog remains at a historical level, and our global products' book-to-bill business have stabilized and returned to growth. We are introducing fourth quarter sales guidance of approximately 7% growth, as strong demand in North America and EMEALA is somewhat muted by one more quarter of slower recovery in the system business in China. global products momentum is expected to continue as our book-to-bill orders remain positive throughout the third quarter and the tough comparison in China base. For the fourth quarter, we expect segment EBITA margin to be approximately 19% and adjusted EPS to be in the range of $1.23 to $1.26. For the full year, we are tightening adjusted EPS guidance to a range of $3.66 and $3.69. We now expect organic sales to grow approximately 3% and segment EBITA margins to expand approximately 110 basis points. Our working capital metrics continue to improve, and our free cash flow performance year to date has been strong. We continue to invest capital in attractive areas, including data center manufacturing expansion and ongoing ERP consolidation. While this will be a slight headwind, we expect adjusted free cash flow conversion of approximately 85% or better for the full year. With our recent announced planned divestiture, I want to highlight some financial details and future reporting on Slide 12. As George mentioned at the beginning of the call, we were extremely pleased with our announced sale of the residential and light commercial HVAC business. This came just a few weeks after we announced that we tend to sell air distribution technologies business. Together, these two transactions represent hopefully 20% of the sale and the majority of the portfolio we have previously highlighted as noncore. We expect to report the residential and light commercial business as discontinued operation with our fiscal fourth quarter results and will provide our official fiscal year 2025 guidance on a continuing operation basis. While the two transaction would be dilutive to EPS prior to any cost offset, we have actions in place to address the stranded cost, and we are working on accelerating some of these actions prior to closing. Through the combination of share repurchase, debt pay down and restructuring, we have a plan in place to fully offset the stranded costs. We will provide more details when we report our fiscal fourth quarter results. Before we open up the lines for questions, I want to conclude with a summary of our recent transformation on Slide 13. We have spent the last few years transforming the company into a comprehensive solution provider for commercial buildings, and this continues to be a differentiator for Johnson Controls. We took a major step in simplifying the portfolio with our two recently announced divestiture, and we believe our one operating model will enable us to deliver more consistent, predictable results. We operate in many attractive markets, which allows us to build our backlog with margin-rich jobs that have a service still throughout the life cycle of building. Our systems backlog, coupled with our resilient Service business, positions us for sustainable and continued margin expansion. As our margins continue to improve, coupled with our commitment to disciplined capital allocation, we would expect double-digit EPS growth. As George mentioned earlier, the result of our portfolio transformation is now a faster-growing, more profitable, less complex and more operationally focused Johnson Controls, and we are excited for the next chapter. With that, operator, please open the lines for questions. Operator Questions & Answers: |
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