Johnson Controls International plc (JCI) — Q4 2019 Transcript

Good morning and thank you for joining our conference call to discuss Johnson Controls’ fourth quarter fiscal 2019 results. The press release and all related tables issued earlier this morning as well as the conference call slide presentation can be found on the Investor Relations portion of our website at johnsoncontrols.com. With me today are Johnson Controls’ Chairman and Chief Executive Officer, George Oliver; and our Executive Vice President and Chief Financial Officer, Brian Stief. Before we begin, I would like to remind you that during the course of today’s call, we will be providing certain forward-looking information. We ask that you review today’s press release and read through the forward-looking cautionary informational statements that we’ve included there. In addition, we will use certain non-GAAP measures in our discussions and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted EBITA and adjusted EBIT margins exclude restructuring and integration costs as well as other special items. These metrics are non-GAAP measures and are reconciled in the schedules attached to our press release and in the appendix to the presentation posted on our website. Additionally, all comparisons to the prior year are on a continuing ops basis excluding the results of Power Solutions. GAAP earnings per share from continuing operations attributable to Johnson Controls’ ordinary shareholders was $0.77 for the quarter and included a net charge of $0.01 related to special items which Brian will address in his comments. Adjusting for these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.78 per share compared to $0.57 in the prior-year quarter. Now, let me turn the call over to George.

Thanks, Antonella, and good morning everyone. Thank you for joining us on today's call. Before I get into the details of the quarter, I thought I would kick things off with a quick look back at our year to recap some of our strategic initiatives and financial commitments. Starting with Slide 3, one of the most significant strategic achievements in 2019 was the successful divestiture of Power Solutions and the subsequent capital deployment actions. I am extremely pleased with our execution from start to finish. Large transactions like this never go completely as planned and usually take longer than expected to execute. Our teams effectively navigated the transaction process, monetizing the business with lower-than-expected tax leakage, resulting in net cash proceeds of $11.6 billion.

Thanks George and good morning everyone. So, let's get started with the year-over-year bridge of EPS on Slide 7. As you can see, our operational performance including synergies and productivity savings contributed $0.09 and this was partially offset by $0.01 of investments. We also benefited in the quarter from the redeployment of the Power Solutions proceeds from both the share count and net financing charge perspective which added $0.12 and $0.05 respectively. And below-the-line items netted to a $0.04 headwind which resulted in fourth quarter EPS of $0.78 which was up 37% year-on-year. So, let's move to Slide 8 and take a look at segment results on a consolidated basis. You can see sales of $6.3 billion increased 3% on an organic basis and this was led by 4% in our Field businesses. And this is partially offset by some softness in our Product businesses which was flat in the quarter. I would point out that in Q4; we were facing our most difficult comp from the prior year up 8% in aggregate with every segment facing its toughest comp. Within the Field businesses, total service revenues grew 4% in the quarter which was consistent growth across all three regions. As you know, growing and expanding our service offerings has been an area of significant internal focus and we've now established a consistent cadence of mid-single-digit growth for the past two years. Going forward, we look to augment our service growth, enabled by digital solutions to continue driving similar growth levels in service. As you know, our service business represents just over $6 billion in revenues, which is about 40% of our field revenue base and this provides us with a very profitable, resilient revenue stream as we move forward. We continue to convert our project backlog in Q4 as well, driving install revenue, up 4% and this was solid growth across all regions. Segment EBITDA of $990 million grew 7% organically and this was driven by the volume leverage from the field, strong price-cost realization and products, and our ongoing productivity and synergy savings. Lastly, Q4 segment EBITDA margin expanded 60 basis points to 15.8%. And as you can see in our margin waterfall, underlying operational improvement contributed 100 basis points. And this was partially offset by some product and run rate sales force investments as well as a minor headwind through pension and other items. So let's review each segment in more detail.

Thanks Brian. Before we open up the line for questions, I want to provide you with our outlook for 2020. Let's start by walking through the waterfall chart on Slide 17. Overall, we expect low to mid-single-digit organic revenue growth which will drive approximately $0.15 of earnings. Additionally, we will have the continued benefit of synergies and productivity savings which we will realize over the course of the year and will contribute an additional $0.15 of earnings. As Brian mentioned last quarter, we are moving forward with a plan to continue repurchasing our shares. We expect to deploy approximately $2.2 billion of Power Solutions sale proceeds during the course of fiscal 2020 which is expected to result in an incremental benefit to earnings of about $0.33. This assumes we continue to hold the remaining $1 billion of Power Solutions sale proceeds on hand. Other small items will result in a $0.04 headwind. These items net to our fiscal 2020 EPS guidance range before special items of $2.50 to $2.60. This represents earnings growth in the range of 28% to 33%. And full details of our guidance are included on Slide 18. Our guidance is based on strong underlying EBIT growth of 8% to 12%, driven by solid top-line performance and synergy and productivity benefits. Lastly, as a portion of the benefit related to the deployment of the Power Solutions sale proceeds will benefit fiscal 2021, I wanted to provide an updated framework for how our earnings are expected to progress as we move forward. As you can see on Slide 19, the incremental run rate benefit of proceeds deployed in 2020 and a reduction in corporate cost are expected to contribute an incremental $0.06 of earnings. This takes our fiscal 2020 EPS to a range of $2.56 to $2.66 on a run rate basis. This would be prior to the deployment of the remaining $1 billion of Power Solutions sale proceeds as well as any operational growth or benefits from additional capital deployment in 2021. Over the last two years, we have made significant progress in aligning our portfolio, improving our underlying fundamentals, and reinvesting back into the businesses. As we move forward, it is all about execution and controlling what is in our control. Although we are watching the macroeconomic environment closely, we feel good about our position entering fiscal 2020 as our backlog provides us visibility in our Field businesses, our service business tends to be more resilient, and we continue to benefit from self-help and our capital deployment. We remain focused on driving execution and delivering for our customers and shareholders. With that, let me turn it over to our operator to open the line for questions.

Hey thanks. Good morning, guys.

Good morning, Gautam.

Good morning.

So, George, I was wondering if you could just talk about the applied HVAC pipeline? What are you seeing in terms of front log if you will, projects, RFPs, what have you? Any slowdown yet to speak of in that domain?

No. I mean, as you've seen we continue to execute very well in the commercial HVAC space. When you look at our revenues in the quarter, we're up 8% with strong growth for both applied equipment and service and that was spread across North America and APAC. We've had light commercial unitary up mid- to high single-digits. And a lot of that has been a result of the new products we've been launching with our rooftop products. If you look at orders, the orders show a 3% in the quarter but that’s off a strong plus 9% last year. So that's important to note. And when you look at where that's occurring, it's pretty broad-based. So then if you go and look at our pipeline on projects, we continue to have a very strong pipeline that we're working pretty much across the globe and converting and that has given us confidence with the backlog we have going into 2020 and the continued progress we see - continuing maybe a little bit lower on our growth rate mid- to single-digit here through the course of 2020. But I believe that that gives us confidence that we're going to be positioned here to deliver on the commitments we made here in 2020.

Okay. And just a quick follow-up. On consolidation, you guys have kind of earmarked $1 billion for M&A. I just wondered if you could update us on your pipeline there? And do you think there's going to be any broader consolidation, any bigger moves in the space? And just your thoughts on how things might shake out with Ingersoll becoming an independent climate company and CCS spinning. Any thoughts on that? Thank you.

Yes, Gautam. Let me just give you my perspective. I think in any industry there's always opportunity for consolidation. But I think it's been clear based on what we've been doing with the reinvestments we've been making in products with the work that we're doing to build out our channels globally that we're focused on continuing to execute for our customers, being able to build strong pipelines of potential orders converting and ultimately executing. And I think, as we look at the future and a lot of this is tied to what we talked about with the Chief Customer Digital Officer that we've added, we see an incredible opportunity to take a very strong portfolio and position ourselves to be able to outperform on a go-forward basis. And so that's our focus. When we look at M&A, we certainly are working pipelines as we look at each of our product businesses and our regional footprint. And we're opportunistic looking at opportunities that would strengthen our organic investments. But the focus for us is continuing to execute, delivering strong performance and then continuing to do bolt-ons as needed.

Thanks, good morning.

Good morning.

George, it sounds like you your voice sounds a bit creaky. So hopefully, I'll get through to the questions here. So maybe just talk about pricing broadly speaking. Obviously, Asia-Pac is a bit more challenging but how are you seeing pricing across the board, especially with raw materials starting to move to and then maybe just comment on price costs and how that shaped up this quarter versus expectations?

If we look back at the last two years, we faced challenges in 2018, but we started to overcome them towards the end of that year. This set us up well for 2019, where we saw an increase in our top line growth by about two or three points. This growth helped us achieve a favorable price-to-cost ratio in 2019. As we prepare for 2020, we are committed to maintaining discipline in our pricing strategy. We project that this will contribute approximately 1% to our overall top line. Together with our productivity efforts, this will help offset inflation, and we expect to remain price-cost positive throughout 2020. It's also important to mention that the effect of pricing on our margin rate is expected to be relatively neutral in 2020.

Yes, great. Thanks George. And then Brian I wanted to dig into some of the cash flow items for next year. So, you're flagging $0.3 billion of one-time outflows just maybe just talk about that. And then the tax refunds obviously as-expected, but does that come up that item? And then on the conversion question, to what extent is pension income putting pressure on that conversion next year? And then the final point I know there's four points here. There's a large outflow this quarter in disc ops, just wondered if you could just discuss that as well. Thank you.

The significant outflow in discontinued operations this year is due to the tax payment related to the gain from the Power sale. Regarding the $600 million tax refund, we've been mentioning this for several quarters now and expect to receive it in the first half of 2020, hopefully around December or January. However, due to its size, it had to go through a committee for approval. We are also highlighting the $300 million outflow, which pertains to current cash costs associated with previous restructuring charges, as well as the ongoing efforts to support the $150 million in synergies that we aim to achieve related to our $900 million target for fiscal 2020. Was there one more question?

Sorry yes. The pension income. To what extent is that putting some pressure on conversion?

Yes, I mean pension income provides some pressure for us as does the joint venture dividends being less than our equity income, but we also get some benefit from our amortization as well. But net-net, I think when we look at our free cash flow conversion target next year at 95% as I think about how that improves on a go-forward basis to get closer to 100%, I would say there's two areas. One would be to close the gap between equity income and our joint venture dividends that we get on an annual basis. And secondly, I still think there's some improvement in trade working capital that will come through continued efforts of our cash management office team around the globe.

Okay. Thank you very much.

Thank you. Good morning everyone.

Hi Jeff.

Good morning Jeff.

Good morning. Could we dig in a little bit more George into synergy and productivity? And I'm kind of sure at this point of the game just getting a little blurry on what's synergy and what's productivity, but I'd be a little more explicit on what it is you still have yet to capture? What is kind of embedded in that number? And I'm sure you're never going to stop seeking productivity but will this bring that program to a close in 2020?

Yes. As Brian mentioned, we are still well-positioned to deliver strong synergy and productivity in 2020. Looking ahead, our cost base allows us to achieve ongoing productivity, with normal productivity potentially generating about 30 basis points of net margin expansion. Our goal is to maintain a strong pipeline of opportunities to reduce structural costs. Additionally, in all our operations, whether in manufacturing or field services, we are focused on driving continuous operational improvements going forward. Even beyond 2020, we will have a robust pipeline for productivity to continue expanding margins.

And George just looking at backlog I think it goes a little bit to one of the earlier questions, right? Some of the macro indicators for whatever they're worth, right? Dodge starts the ABI, the put-in-place data, all is kind of wobbling here. And it really hasn't shown up in your orders or really any of your peers' orders yet. I just wonder, if there's any additional insight you could share on maybe what you think the disconnect is there and your visibility to convert backlog as you look into 2020?

So I would start Jeff by the macro indicators when you look at ABI or Dodge forecast, they do suggest they are a little bit lower but they have stabilized. And when you look at some of the areas where we have strength, obviously institutional, we still believe that that has yet to peak in some of the end markets that we support there. And I think that's driving a lot of the order pipeline and the conversion of that pipeline. So what I would tell you is that when we projected the year in 2020, we're starting with a nice backlog. We have suggested that the order rate will slow a bit to kind of low mid-single digits based on what we see in the pipeline today. And the two combined is what gives us confidence that we are positioned to be able to deliver kind of low to mid-single-digit growth throughout the year. Certainly, we're watching this closely and making sure that from a cost standpoint that we're going to do what's necessary to adjust as needed. And what I would say is that for us, our service business is about a little better than $6 billion globally. And if you've seen our progress in the last two years, we've been able to sustain our growth rate up over 4%. So we were short of 4% two years ago. And then this past year we're north of 4%. And our goal is that we believe with the installed base that we have that we've built that there's still a tremendous opportunity to build our service business. So at the same time that we're watching the big project in that pipeline and making sure that we're going to be able to adjust appropriately as this plays out, we also are working hard to be able to execute on our service strategy that we believe that if it does soften much, we're going to be positioned well with our service franchise to be able to try to make up for some of that softness.

Great. Thank you.

Hey, guys. Good morning.

Good morning.

Good morning, Steve.

Can you discuss what you are observing specifically in China regarding larger equipment and services? Overall, it seems that things are holding up quite well. Your company appears to be leading in growth in that area. Can you provide any insights on whether there are any upcoming timelines in the next 18 months, or do you anticipate a slowdown? Are there concerns regarding project phases, or do you believe conditions will remain strong in the foreseeable future?

China represents approximately 6% of our total company, translating to about $900 million from the Field segment and $400 million from Global Products. In the Field business, China is a significant market for us in the Asia-Pacific region, accounting for roughly 35% to 40% of it. We are experiencing strong revenue growth, with low double-digit organic growth driven by HVAC equipment and our expanding services during this quarter. We are now moving past the challenging backlog we faced, which affected margins. I recently spent over a week in China, visiting cities like Shanghai, Chongqing, and Chengdu, where I engaged with teams, customers, and local governments. I returned feeling optimistic about the progress we're making. We're strategically positioning our capabilities to leverage infrastructure expansion and similar opportunities. While growth may moderate somewhat due to ongoing trade tensions, I remain confident about the prospects in the Chinese market. Additionally, we will ensure our competitiveness in terms of cost and the value we deliver through our projects. That’s my current perspective.

Great. Thanks a lot for all the detail and the comprehensive answer. Thanks.

Hi good morning and congratulations Brian on the Vice Chairmanship.

Thank you. Thank you.

In terms of I guess my first question just looking at the EBIT margin guide fiscal 2020, so it's up 60 to 80 bps with some corporate cost reduction within that. Just wondered when you're thinking across the four segments, do we think about that expansion being sort of APAC margins flattish and the other three in 2020 being up say 50 bps? Is that the right way to think about the segments in 2020?

Yes. Looking at our position, we are set to expand margins as we’ve indicated by 40 to 60 basis points for the entire year, expecting improvement across the board. Our Global Products segment is anticipated to perform at around 70 basis points. In our Field-based businesses, particularly in EMEA/LA, we are seeing good leverage. However, North America is expected to be lower margin, roughly around 30 to 40 basis points, primarily due to the overall mix. The margin expansion will break down to about 20 basis points from volume mix and an additional 50 basis points from synergies and productivity improvements, although there will be some pressure from APAC and other areas within our portfolio. Overall, while we expect improvement across all segments, the strongest gains will come from Global Products, along with continued performance in EMEA/LA and early recovery in APAC.

Thank you very much. And then my second question just around that Global Products residential revenue aspect. So you had, as you said, down low double-digits revenue in Global Resi HVAC in Q4. Just wondered if you could give a bit more color around the Asian piece? You talked about Japan and Taiwan being culprits. Is there something going on market share-wise there? I think numbers in Japan have been okay. So I just wondered what your outlook was on that Asian piece within Global Resi HVAC?

Sure. Let me clarify this, Julian. In Q4, Global Products organic revenue growth remained flat compared to last year's growth of over nine percent. We anticipated a decline in North America Residential due to last year's growth exceeding twenty percent. As we entered the quarter, we recognized that distributors had inventory levels that needed to be reduced. The Asia-Pacific residential business was softer, as Brian mentioned, accounting for about $1.8 billion in annual revenue, largely from the Hitachi joint venture, especially strong in Japan and Taiwan. Overall, there was a low-teen percentage decline, which affected our global products growth by three percentage points. Breaking it down, the decline in Taiwan was partly due to a mild summer, leading distributors to deplete their inventory as the cooling season neared its end in the fourth quarter. Currently, we are seeing inventory levels returning to normal as of the end of September, and we still hold a strong market share there, positioning us well for the future. In Japan, we experienced strong performance in the first three quarters, but the market started to decline in Q4, prompting distributors to reduce their inventory. I recently visited Japan and found that inventory levels are back to where they should be. However, we remain somewhat cautious about potential softness in Q1, which we'll monitor closely. Based on my visit and the in-depth review of our investments, I feel optimistic about our business's prospects and our ability to maintain a solid position in these markets. Nevertheless, we do expect some pressure in Q1 due to the Japanese market.

That’s great. Thank you.

Hey, good morning, guys.

Good morning.

Hi, Andrew.

George in Building Solutions North America you mentioned mix issues Q4 versus Q3 as service is better. But put a really large EBITDA improvement 40 basis points versus last quarter, which I think was down 90 despite Fire & Security growth still being lower than HVAC. So can you give more color into the improvement? I know you just said that retail pressure didn't really go away. Did it abate at all? Or was it really just a better service mix or maybe better sales force productivity?

There's a lot to consider here to help you understand the situation. Overall, as you pointed out, we faced significant challenges in the previous quarter due to mix and related issues. However, in the fourth quarter, we achieved a 40 basis points improvement compared to last year. When we analyze this further, we see that the combination of volume and mix contributed about 20 basis points. We're observing strong volume growth and impressive productivity savings and cost synergies, which increased by 40 basis points. There was some pressure from pensions, but we are nearing the end of the sales investment headwinds. This analysis leads us to the net 40 basis points year-on-year improvement. We are closely monitoring these developments as we enter Q1. It’s important to ensure that we are positioned for continued growth year-on-year. At this moment, I anticipate it may be relatively flat due to the mix and ongoing pressures in retail. Nevertheless, our focus will remain on enhancing productivity and cost savings while pursuing growth.

And Andy, the only thing I would add as a reminder is just keep in mind that in Q3 for North America, part of that decline really had to do with the really strong performance we had in the North America retail business in Q3 of 2018. And we didn't have that same dynamic here in our fourth quarter.

That's helpful, guys. And then George can you talk about the Fire & Security markets in particular? I think you mentioned that Fire & Security products growth was good. Your field orders have hung in there reasonably well. But how much of it is sort of the markets being strong? I know fire detection generally has been pretty strong. How much of it is sort of self-help over the last few years for you guys in markets like security and digital improving the business versus the market? Are you outperforming the market?

Let me start by breaking it down into products and field. Our Fire & Security products saw a 2% increase, although this is against a low double-digit growth from the previous year. Over a two-year comparison, our product businesses are performing exceptionally well. Specifically, fire detection grew by 7% due to reinvestment in new products, expanding our channel and sales force, and effectively converting backlog. In contrast, security remained flat, which is challenging given the high teens growth we saw the previous year. We're continuing to invest in positioning ourselves with the right products and mix for competition in security, particularly in relation to our digital solutions and how we want our portfolio to look. Our fire suppression business is also doing very well, with mid-single digit growth that is broadly spread across the globe. In terms of the Field businesses, we grew by 4%, covering both installation and service across all regions. Our focus on building services remains strong as we develop our service capabilities. Overall, I would say we are outpacing the market with both our product and technology businesses as well as our project and service execution.

Thanks guys.

Good morning, everyone. Can you tell me about your Field backlog? Given your current visibility into fiscal 2020, do you see it extending at least three quarters out, or do you think it might be lower or declining? Additionally, how does that visibility vary across different regions?

Yes, if you examine our order rate in 2019, we saw a consistent pace of order growth throughout the year, thanks to strong demand in the end markets overall, although there was some softness in the Middle East and a few other areas. However, the demand remained broad-based across all three of our regions. With our efforts to expand our salesforce and service technicians, we believe we are now well-positioned to convert that demand. The mix of projects we have is balanced, including small, mid-sized, and large projects. We are evaluating our backlog and predicting how it will convert over the coming year, most of which is already in the backlog. We anticipate that while we may experience some pressure to maintain the mid to upper single-digit order growth we've seen in the past two years, we might see a shift towards low to mid order growth in our backlog. This projection correlates with our expectation of low to mid-single-digit organic revenue growth for the year. We will monitor this closely, but we are starting the year with a strong backlog.

Got it. My follow-up would be on cadence of month. Can you talk about how the quarter progressed? I mean did momentum strengthen or weaken in any of your geographies or any of your Products or Field businesses? Thank you.

Yes. I mean, when we look at our businesses and it differs a bit. But typically the third month of the quarter is where a lot of projects close and a lot of the shipments get made. So, there is a little bit of an anomaly here on a quarterly basis where the third month is always our strongest which ultimately was the case in the fourth quarter. So, I don't believe that there was any change in the profile of how the quarter played out with what we expected. I think we did see as we knew as the quarter played out that from a residential standpoint that was a little bit of where we saw additional softness from what we were expecting when we started the quarter. But that was probably the only spot that as the quarter played out, it didn't play out as we would have normally expected.

Yes, I think the cadence in Q4 of fiscal 2019 was very similar to the cadence of the monthly in Q4 in 2018. So I don't think there was anything unusual at all.

Got it. Thank you for the color.

Hi, good morning all.

Good morning.

Good morning.

I wanted to follow up on something that has become more relevant lately, particularly in the applied space. The idea of refrigerant upgrades and enhanced energy efficiency has been a topic of discussion in the industry for many years, and it is now gaining traction. George, could you provide insight into how much of the business is related to these energy efficiency upgrades compared to break-fix or new installations, and how those segments have been performing?

Yes. There are several questions within that query. Looking at our current operations, we are introducing new products that are more efficient and in higher demand, which ultimately leads to energy savings. Both consumers and businesses benefit from our performance solutions when we implement new equipment that enhances energy efficiency, providing value for which we are compensated. We are also closely monitoring upcoming legislation regarding HFC refrigerants and their implications. We actively support bipartisan federal legislation that allows the EPA to phase down HFCs in accordance with the Kangalee amendment to the Montreal protocol. Our goal is to collaborate with the industry on a unified approach to the HFC transition rather than dealing with a confusing array of state laws targeting various sectors and transition timelines. Our investments in research and development focus on creating new low GWP product platforms, such as our YZ chillers, in anticipation of these regulations. We are committed to optimizing efficiency while ensuring we effectively navigate the regulatory landscape. We believe this commitment will benefit our customers, shareholders, and the environment.

And then just a follow-up. If I remember back to the Tyco days and I think early in the integration, there were parts of the products business, I think around oil and gas that showed a little bit of surprising cyclicality that were a drag on the business. I think today those are probably some markets that are a little choppy themselves. Is that something that's still in the portfolio? Did some of that leave with Scott? Maybe just kind of update us on how that's performing relative to the whole?

Our fire suppression business maintains a strong position in the oil and gas sector with advanced hazard technologies. This segment continues to perform well. Looking at our field-based businesses, we have made significant restructuring during the downturn and are cautious about how we grow these operations moving forward, focusing on identified opportunities while avoiding areas that do not align with our strategy. As a result, our overall presence is much smaller than it was previously, especially after the divestiture of the Scott Safety business and the restructuring of our field businesses during that period.

Got it. It's helpful. Thanks for the color.

With that operator, I'd like to turn the call back over to George for some closing comments.

Yes. Just to wrap up here today, I want to thank everyone for joining our call this morning. We have made a tremendous amount of progress this year. And we'll build upon that momentum in 2020 as we laid out our guidance and I am looking forward to seeing many of you soon. So operator, that concludes our call.