Johnson Controls International plc (JCI) — Q2 2015 Transcript

Thanks, Mitch, and welcome everybody to the call to review Johnson Controls’ 2015 fiscal second quarter earnings. If you don’t have a copy of the presentation, you can go to johnsoncontrols.com, click on the Investors link at the top of the page and then scroll down to the events calendar section. This morning, Chairman and CEO, Alex Molinaroli, will provide some perspective on the quarter, followed by Bruce McDonald, Executive Vice President and Vice Chairman for a review of the business results, and then Executive Vice President and Chief Financial Officer, Brian Stief, who will review the company’s overall financial performance. Following those prepared remarks, we’ll open up the call for questions, and we’re scheduled to end at the top of the hour. Before I begin, I’d like to refer you to our full forward-looking statement disclosure that’s in the news release and also in the slide deck and remind you that today’s comments will include forward-looking statements that are subject to risks, uncertainties, and assumptions that could cause actual results to be materially different from those expressed or implied by such forward-looking statements. Those factors include required regulatory approvals that are material conditions for proposed transactions to close, the strength of the U.S. or other economies, currency exchange rates, automotive vehicle production levels, mix and schedules, energy and commodity prices, availability of raw materials and component products, and cancellations of or changes to commercial contracts, as well as other factors discussed in item 1A of part 1 of Johnson Controls’ most recent annual report on Form 10-K for the year ended September 30, 2015. Johnson Controls disclaims any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this presentation. And with that, I’ll turn it over to Alex.

Good morning, everyone. I’m pleased to speak about the earnings today because I see it as a continuation of the success that the team has been having over the past four to six quarters, particularly amidst all the distractions. I’ll go through some of the highlights, but you’re going to get some details from the rest of the team. One thing to remind yourself of is that as we continue down this path of transforming the company, we’ve been able to meet or exceed the expectations that we set for ourselves, across the board. Each of our businesses had a fantastic quarter. At $9.2 billion of revenues, it is down 3%, but if you take out currency, we’re up 4% for the quarter, which we’ll discuss shortly including our outlook moving forward. We’re pretty pleased with order intake, which will be a highlight of the conversation here today. In Building Efficiency, we anticipated seeing potential sales secured in this quarter, and it came through significantly in our institutional markets. Our segment income is up 18%, indicating great margin improvement across the board. Our earnings per share is at $0.73, which is up $0.20 versus last year. If you look at the businesses, we saw strong order intake in the institutional market which leads us to believe this quarter was not a one-off event, as we have a sustainable outlook for at least the next couple of quarters. Likewise, North American automotive production remains strong, while Europe is stable. China shows growth as well, where our share in the battery business is substantial, particularly with a 30% increase in battery sales in the aftermarket. This reflects positive structural changes and gaining share in Europe. However, as we expand capacity to match demand, we are still testing the limits of our output. I’m very excited about recent victories like the GWS transaction, which has drawn positive feedback from our clients. I also expect our recent agreements with Hitachi to position us strategically well in the growing markets. In conclusion, overall we feel positive about our positioning and operational performance. With that, I’ll turn it over to Bruce.

Thanks, Alex, and good morning, everyone. I’ll start on slide six with Building Efficiency. We were pleased with Building Efficiency’s results for the second quarter. Sales of $2.4 billion were up about 4%, and when adjusting for foreign exchange, sales grew by 9%. North America revenues rose 17%, mainly from the ADT acquisition. Excluding FX, we had growth even in Europe, albeit modest. Furthermore, our order intake was up 14% year-over-year, reflecting a significant turnaround compared to previous quarters. In particular, the education and government markets saw strong growth. Overall, while we had a good quarter and improved our profitability, we expect the pipelines and quoting activity to remain favorable in the upcoming quarters. Power Solutions sales also increased by 2% for the second quarter and were up 8% when stripping out foreign exchange impacts. We observed strong aftermarket growth, especially in Europe, resulting in positive revenue trends. Additionally, I’m pleased to report our strong performance in operational profitability, with our earnings up 36%. Our margin expansion reflects improved performance across both North America and integration benefits stemming from our acquisitions. Regarding our automotive segment, while our revenue impact was felt from the euro's fluctuation, we are encouraged by the North American and European auto production rates we see ahead. We are optimistic about our Automotive's margin improvement driven by these factors and expect positive performance in the upcoming quarters. With that, I’ll turn it over to Brian.

Okay, thanks, Bruce. Good morning, everyone. Following the recent sale announcement of our GWS business, we will start reporting GWS as a discontinued operation. Our Q2 EPS of $0.68 included nonrecurring items. Adjusted EPS for the quarter is $0.73. Top lines revenues are down 3% to $9.2 million, adjusted for currency, indicating strong underlying results across all businesses. Our gross margin increased to 17.1%, and we are witnessing early benefits from our operational initiatives. Our equity income reflects improved profitability from our automotive joint ventures in China, showing our strategic initiatives are working. As we consider our guidance moving forward, we’ve adjusted it down slightly to reflect a more negative outlook on the euro exchange rate; however, we expect to make significant strides in revenue performance due to the improvements in our operational efficiencies. Our cash flow has faced some setbacks, but we have targeted actions in place to recover by the second half of the year. Overall, I'm pleased with the progress we’re making and optimistic about our future. Glen, I believe we can open it up for questions now.

Great, thanks, Brian. Mitch, we’re ready to take questions.

Yes. Good morning.

Good morning.

I just want to ask a couple questions. One around auto production in China and the second around segmentation within Building Efficiency. Look you grew China production significantly yet again. Can you give us some commentary on the up contenting trend in China? How is that affecting your current Seating business, whether you’re seeing it in the locals or the joint venture partners or both? And then also, as we roll forward, assuming that up contenting continues to happen in interiors, how will the recent transaction that you finalized impact your exposure to the China interior segments or just joint venture partners?

Yeah, I’ll take that one, Brian. It’s Bruce here. A couple points. First of all, we’re seeing a shift in the market away from traditional local suppliers toward our products, especially in the Chinese owned brands. Additionally, the luxury and SUV segments are gaining share where we have greater content. We continue to gain share as we benefit from our investments. In references to your question on interiors, we’re looking at revenues being around $8.5 billion in 2015, which is up compared to previous estimates. The growth is primarily driven by China’s market evolution and significant trends in interior quality.

Right. So is it fair to simplify it by saying when you close the interior joint venture, you’ll actually have more exposure to the positive revenue trends in interior in China?

Yes, absolutely.

Second question over in the Building Efficiency side, you talked about the order strength coming from the institutional segment. How did small and mid-commercial in North America perform during the quarter? Where are we on ADTI cross-selling, and what’s the next steps regarding sales distribution?

So I’ll take that. Overall with ADTI, we’re seeing revenue growth but lack detailed pipeline information due to the nature of the business. Business overall saw flat, perhaps softer figures versus a year ago. It's important to note that the commercial market is improving, but we have not fully capitalized on small and mid-commercial opportunities. However, institutional markets are getting stronger, which was unexpected, particularly in sectors like healthcare, where we’re seeing a rising pipeline.

Hi. Thank you. You mentioned the Building Efficiency in Asia was flat. Curious what you’re seeing there in terms of orders. And is the Hitachi portfolio you’re going to be acquiring that includes some of the energy efficiency products like VRF, is that a higher organic growth portfolio than your legacy Building Efficiency portfolio?

Yeah, so I’ll take the second part first. Hitachi is well positioned in Asia, particularly in China, and that part of the market is growing rapidly compared to the rest of our traditional HVAC market. Additionally, we expect double the growth rate for our VRF systems. Regarding Asian orders, our order intake in Asia was up 8% during the last quarter.

And Mike, this is Bruce. Your question about Asian orders, in the quarter, our order intake in Asia was indeed up 8%.

Great. And then also can you just give us an update in terms of what you’re seeing in the China aftermarket for Power Solutions, just in terms of how that market is maturing and how your share is developing there?

We expect to see around 10% growth in the China aftermarket, which is a bit less than anticipated. However, we’re aggressively signing new distributors and observing that most of our growth is still occurring in the OE segment, indicating there's still plenty of opportunity.

Hey, guys. Good morning.

Good morning.

Yeah.

I wanted to ask about the margins in the Building business. They appear to be tracking higher than what you guided at Analyst day. Can you comment on the sustainability of these levels and what might be driving them?

Sure, Rob. Our margin improvement at Building Efficiency is front-end loaded. We had easier comps in the first half of the year due to prior contract charges being behind us. However, as we get stronger backlog levels, we expect to see future margin enhancements as we leverage fixed costs.

Fair enough. Maybe also to follow-up on that, a question about pricing. On the Ingersoll call, they discussed pricing pressures in their Commercial HVAC business in Asia—what do you see concerning pricing in your Building Efficiency backlog?

Our backlog pricing has experienced pressure for the past 24 months due to a lack of institutional work. While the market overall is improving, we haven’t yet seen a significant relief from pricing pressure in our backlog.

Got you. And then maybe as a housekeeping item on the guidance update. It sounds like most of the changes are due to currency impacts, correct?

Correct. The primary impact is indeed the euro exchange rate.

Our guidance adjustments are reflected in the euro currency fluctuations. We've projected a worse understanding of the euro as we move into the second half of the year.

Hi. Yes. Can you hear me?

Hi Pat, yeah.

Yeah.

Just one housekeeping question. You mentioned that the backlog was up 8% excluding currency effects. Can you give us the overall number including currency and how that compares to last quarter?

When we’re discussing orders, we note that North America is our strongest market, and there’s minimal translation impacts due to the size of our North American contracting business. The six-month visibility offers some clarity for future bookings. Expect some lag in revenue recognition based on our contracting arrangements.

That’s helpful. One other quickly, if I may. The margin improvement in Automotive was very good once again. Can you remind us how much of that is leverage versus structural improvements that you’ve been implementing?

Automotive margins improved by 90 basis points. The growth in seating profitability is primarily related to operational leverage. The interior segment saw significant improvements due to structural changes and a successful rollout of the C-class vehicle which has been majorly beneficial to our bottom line.

Given the improved vehicle registrations in Europe, is that an area where you’d consider there to be upside risk in your production guidance?

Yes, we've seen earlier signs of higher production for Q3, and we feel that there are positive tailwinds at play.

Hi, good morning.

Good morning.

Good morning.

Just a couple questions. First regarding the institutional verticals, it seems long overdue for a rebound; can you identify any particular factors driving this improvement?

Overall, we are seeing reserves building up within state and local governments as infrastructure spending picks up, but there’s still a level of uncertainty. We’re encouraged, especially by the improving healthcare pipeline, although it hasn't yet been reflected in orders.

Are you seeing any indirect negative effects in oil-producing states impacting construction trends?

It's difficult to quantify at this point, but we haven't seen any significant impact yet. If there's an effect, it’s not prominently visible in our numbers.

Hi, thanks for squeezing me in. Can you provide insight on how you think about M&A going forward? Considering you've made several recent acquisitions, do you feel more on hold or will you continue to seek opportunities?

We’re looking to strategically invest, but we want to be intelligent about it. We see potential adjacencies in our end markets with an emphasis on growing our Battery and Building segments, particularly in North America and Asia.

Great, thanks, Alex. Thanks everybody for calling. We will be available for any follow-up conversations today. Good luck with the rest of earnings season.