Johnson Controls International plc (JCI) — Q2 2020 Transcript

Good morning, and thank you for joining our conference call to discuss Johnson Controls' second quarter fiscal 2020 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.

Thanks, Antonella, and good morning, everyone. Thank you for joining us on today's call. I hope you and your families are staying safe and healthy during these extraordinary times. You may have noticed from our slide presentation, we are taking a very different approach compared to our traditional quarterly earnings call format. In order to focus our discussion on addressing the impacts from the COVID-19 pandemic, as well as the steps we have taken as a company to partially mitigate the financial impacts and position the company to capitalize on the eventual recovery. Although we have withdrawn our guidance for the year, I will provide some color commentary on how we are thinking about the second half later in the call. We'll allow plenty of time for your questions. Let's get started on Slide 3. Clearly, we are navigating through unprecedented times. The ongoing COVID-19 pandemic has had profound impacts on the way we live our daily lives and the way companies run their businesses. We believe most of these impacts are largely transitory, but the dramatic slowdown in global economic conditions presents very real challenges.

Thanks, George, and good morning, everyone. So let's start with a quick look at our year-over-year EPS bridge on Slide 10. Volume and mix including the estimated sales impact from COVID-19 of $350 million to $390 million was a $0.10 headwind and this was offset by $0.04 of mitigating actions and a $0.02 tailwind in non-controlling interest as a result of lower earnings in our consolidated Hitachi joint venture. The net $0.05 to $0.07 estimated EPS COVID impact we discussed on Slide 8 is included in these three columns. As expected, synergies and productivity save net financing charges and share account with tailwinds in the quarter.

Thanks, Brian. Let me spend a few minutes on our thoughts for the second half of our fiscal year on Slide 17. We are planning for an organic revenue decline in the range of 15% to 20%, with the most significant impact expected in Q3. As I mentioned, we have taken numerous actions both temporary and permanent in nature to help mitigate the financial impact. The benefit of these actions will keep the net decrementals on the revenue decline in the low 20s, which speaks to the value of the mitigating actions we are taking. It is important to keep in mind that the $400 million to $450 million of mitigating actions are in addition to the $150 million of synergies and productivity we have committed for the year, of which $80 million is expected to be delivered in the second half. Our focus is on controlling what we can control and that is ensuring we are financially and strategically well positioned when we exit this crisis. The permanent actions we have taken will ensure we have a lean cost structure while protecting our product and channel investments to lead the new norm as we go forward. As the largest pure play buildings provider, we are leading the change to provide more resilient and flexible building spaces, safer environments, touchless or frictionless access and remote monitoring service delivery. This combined with our position as a leader in intelligent and sustainable building solutions enables us to deliver the outcomes that matter most to our customers. Depth and breadth of our product portfolio combined with proven expertise and an expansive global footprint provides us with a unique advantage as the evolution of the built environment accelerates. With that, operator, please open up the lines for questions.

Thank you. Good morning, everyone. Hope you're all well.

Good morning, Jeff.

Good morning, Jeff.

Good morning.

Just two from me real quickly. George, we did see a pretty abrupt impact on your orders and obviously, this is an unprecedented situation. But I wonder if you could spend a little time on what the forward order horizon looks like. Is there wavering in the pipeline? How are people feeling about new construction projects? Obviously, the backlog is nice and gives you some support for a while, but just wondering what's on the new horizon to backfill the backlog?

Yes. Let me start, Jeff, by just giving my thoughts on the non-residential construction and then I'll give you a sense of where we are here in April. We are tracking the macro trends and third-party data closely. I would say that we've had incredible discussions with our customers and understanding what their plans are. I would say that as we look at our order pipeline, although it's still up, it has moved to the right, purely timing. What I would say is about a quarter. Certainly because of that it is what drove us to take the actions that we're taking now, both temporary as well as the permanent cost structure changes. And I do believe that there will be some continued disruptions here which we have limited visibility today. But I think it's kind of tough to look beyond the next six to nine months. I believe short term, our backlog position as Brian discussed positions us here to bridge the gap. And if I were to play out what's happened here when I look at Q2, we did have a demand air pocket and it started certainly in China, Hong Kong, Japan, some of our larger markets in Asia Pacific. Then with the shutdowns that occurred in North America and EMEA/LA, that continued, and we see that continuing here in the third quarter. We did see an impact on service a bit, but that was mainly because of sites being shut down. We do expect that to come back pretty well here as we get through the quarter. So as we laid out our plan based on what we learned in the second half of March obviously, we looked at April and we said orders would potentially be down somewhere in kind of high teens, 20%. Based on the daily activity that I've seen and we're watching this every day, it's coming in at about that level. What I would say within that Asia Pacific is better. So what you can see in the pipeline and the orders suggest that that will get back to a more normal level by the fourth quarter. And so that is encouraging based on what we're seeing happening in APAC. But certainly as you would expect with all of the shutdowns that occurred in EMEA/LA as well as in North America until our customers come back to work and we're actively engaging with them, it's hard to put that clearer picture together. But based on the interactions I've seen, I am fairly confident that over the next three months we'll see continued improvement. So, although it's kind of high teens orders in April, that will continue to improve as we go through the second half.

Thanks for that. And maybe a follow-up, maybe it's for Brian. But on the $400 million to $450 million of cost reductions, how much of that is kind of structural in nature that we could think about carrying over into next fiscal year?

So as you would expect, we started early. What we saw happening in China, obviously, we have a big footprint there. And so we began immediate actions. Now some of the actions are temporary, such as unpaid time off, furloughs, and reduced employee compensation, travel reductions, and other employee compensation. You can imagine all of those actions. The other is looking at this from a structural standpoint that we've been able to now proceed with and we'll have a much bigger impact as we move forward. As we look at the world today and what has happened, what I would tell you has really changed the way we're working virtually. Very quickly we had all of our salaried teams working remotely with full security as well as access to Microsoft Teams and the like so we could stay engaged. As we look forward, it gives us opportunities to think differently and think about our cost structure and ultimately enhance our productivity. As you look at the actions we took of the $400 million to $450 million of the mitigating actions expected to come through in the second half, about 80% are temporary, and then the other impact in the quarter are the structural actions that we're taking. Recognizing that, that's only really the benefit of about one quarter. Then as you project that into 2021, we actually have a margin structure that with the volumes that we're anticipating, we’ll actually have a better margin structure. When we look at the buckets of cost, about 60% is compensation and benefits, and that's the result of the furloughs and other employee compensation and some of the restructuring. You get 30% that’s indirect spend and about 10% in facilities, Jeff.

All right, thanks for that. That’s all I have. I will talk soon.

Hey guys good morning.

Good morning, Steve.

Good morning, Steve.

Good morning, Steve.

Thanks for all the detail on the breakout and all this cost. Lots of big numbers being thrown out there. Temporary, you guys seem to be doing some structural stuff as well. So that seems to be a positive. Any color at all on how this 15% to 20% breaks down quarter-to-quarter, or should we just assume that it's within a band kind of stable for third and fourth quarters?

Yes, so Steve, as we looked at the third and fourth quarters and tried to model this and how it's going to play out based on what we learned in March, certainly the larger impact will be in Q3. We are tracking Asia-Pacific to be better because they are now in recovery mode. But as you look at EMEA/LA and North America, April will be the toughest month and that'll continue to get better through the quarter. But if you look at the two quarters, the larger impact is going to be in Q3.

Got it.

And so that's why as we saw this happening, we took the actions that we took on proactively with the temporary actions and then really then went into the next phase of our permanent cost reductions, which is going to play out well not only in the second half but will set us up well for 2021. And that's what gets us to the net decrementals to be in the low 20s in the second half. When you look at that combined with the addition of the $150 million of the planned synergies and productivity that we’ll achieve for the year, about $80 million of that is actually in the second half of the year.

Got it.

Just to help you with the models as well, below the decrementals, I mean, we continue to take a hard look at our corporate cost structure. I have taken additional actions really as a result of the COVID situation, so our corporate expense now which original guidance was $330 to $340, we would now be in that $265 to $275 range. For net financing cost, even though we've taken on some more debt since we suspended our share repurchase program, those two pretty much offset. So net financing costs, we're going to retain at that $245 to $255 level. When you look at minority interests or non-controlling interests as a result of some of the pressures that we're seeing in our Hitachi joint venture, our original guidance for non-controlling interest was $210 to $220 and we're moving that down now to $150 to $170, given the pressure we're seeing in Hitachi. Those are kind of three below-the-line items that'll be helpful to you as you update your models.

Great, very helpful. Just one last one from me. If you are down at kind of the lower end of the range of that in Q3, kind of the 15 to 20, I mean does that mean install related stuff, because I would think services would maybe hold up a little better or maybe there's some shutdown impacts? Does that mean install is down like in the 30s?

No, no. When you look at the way this plays out, the install—the pressure on install is actually access to sites and all the shutdowns that have occurred in EMEA/LA, it started in China. So when you look at what happened in China in the second quarter, our install was down about 30%, I believe, or thereabouts. That will be coming back in the third and fourth quarters. When you look at service in Asia Pacific, it was down about 7%. Now a lot of that is purely because of access to facilities in the sites that we provide service to. In EMEA/LA and North America, certainly, that started at the end of March and that's continuing through April. So we do see an impact. When I provided those previous numbers, those are orders. As far as revenue, we’ll be similarly at the higher end of the decline here in April, but we believe that will sequentially get better as the quarter plays out. Installs mainly face access to sites, and then service was purely temporary because of the shutdowns. We believe that April will be the toughest month, and we'll get better monthly on a go-forward basis.

Totally makes sense. Okay. Thanks guys. Appreciate it.

Hi, good morning guys.

Good morning, Scott.

Thanks for the color on everything. So it’s early in the morning. But I'm just kind of curious, George, about a couple of your comments regarding what perhaps the building customer may do going forward, whether it's UV light, filtration, or some sort of retrofit to perhaps improve the air quality of the building. Is it too early to have those conversations with your customers? Is everybody just scrambling to stay alive right now? Is that a real theme you think that there will be a fair amount of spending that needs to occur to clean the air?

Yes Scott, what I would say is we’re in very active engagements with our customers in defining what the new norm is going to be and what technology can do to ultimately address some of the new challenges. Some of what you discussed is absolutely front and center. Initially, it’s as simple as adding IR scanners so that we can do temperature checks and the like, it's sanitation, it's enhanced filtration and other technologies that can ultimately drive purification of the air. What I talked about in my prepared remarks, I would categorize it in four key buckets. What we learned in this hospital response, in this healthcare response is, I think, there is a view that that space is going to be much more flexible, and that's across verticals and what can be done to create flexible space. It's going to be safer environments as you say, not only the air purification but then touchless and frictionless, everything within buildings and infrastructure. What I would say is it's going to be more automation that ties to more automation, which ultimately plays to our strengths. Those are the trends. I would tell you that we are very actively engaged with other CEOs and with a bunch of our customers in really defining what the new norm will be, and then from an innovation standpoint, we are already deploying resources, very actively working in partnership with our customers to be able to deliver on these types of solutions.

Okay. That sounds interesting. So just to somewhat separate less positive topics, just when you think about your backlog, is there a certain percentage of it that you can consider to be at high risk? Like hotels, things like that, that just – the projects just may not get off the ground in the next few years?

So right out of the gate we have really gone through all of the backlog recognizing that there are going to be some industries that are going to be extremely challenged given the impact that this has had. Most of what we've seen from that has been where projects have been pushed to the right. Although we've seen short term, the inability to convert, I would tell you the activity is still very high. We've had thousands of customer engagements via video meetings continuing to stay engaged and ultimately executing on their demand and being able to support them. When I look at the backlog where it was actually up 4%, that's purely because of the way how things played out from a revenue turn standpoint. I believe that – and the pipeline is actually up then, although there'll be some that are going to be delayed and potentially canceled because of the state of the industry, I think that there's new demand that's backfilling that that's coming into the pipeline as fast, given what we see today.

I would just add to that we haven't done a backlog review of the $9 billion. As George said, sitting here today, we have not seen a significant number of cancellations. We have seen more delays versus cancellations. It's something we monitor every month in the ops meetings that we have with our business units, and we'll keep a close eye on it.

Okay. Thank you. That's encouraging. Good luck guys. Stay safe.

Likewise.

Thanks.

Thanks. Good morning guys.

Good morning, Nigel.

Good morning.

So I want to go back to the second half outlook, recognizing that the 15%, 20% is a planning range. Could you maybe just, I mean, I think Steve might have tried—kind of dug into this a little bit, but how do you see service within that 15% to 20%? And then if you could break out how you view Fire, versus Security, versus HVAC service within that kind of range you put out there?

Yes, so we look at—I'll give you a sense on Q2 and then how that continues to play out here over the third and fourth quarters. When you look at products, let's start with products down 8% in Q2, which will continue at a little bit worse in Q3 mainly because of the residential HVAC, which we talked about in the prepared remarks. When you look at the mix of that it will be pretty much across all of the domains. Although BMS is actually holding up pretty well, our digital businesses are holding up well, so most of the decline is being driven by HVAC, as well as Fire & Security. When you look at the Field, the Field was down 3%, service was up one, but that was with North American EMEA/LA up offset with the decline in Asia Pacific down 7%. As I said earlier, I believe that service, we will see some short term impacts in service even in EMEA/LA in North America here over the next one to two months. I believe that the service based on our backlog and the demand from L&M, will continue to come back over time. On the install side, as I said, we have a good backlog and purely—it’s right now it's purely because of the shutdowns that’s impacting our ability to be able to convert the install revenue. As we saw, as I said, it's going to start off at the higher end of that impact. In some cases maybe a little bit worse because even in China, we saw our install get impacted by 30% with the complete shutdown. But as that goes forward with more access to customer sites into projects, we see that continuing to improve through the quarter with service coming back sooner than the total install.

So would you expect sales to be within that range at the low end, or would it be below the low end of that 15%?

Yes, so Nigel, as everyone we’re trying to project what we see happening. This is really based on what we've seen in the last few weeks. I am encouraged that because we've been deemed essential everywhere we work across the globe, recognize that we've stayed pretty much in operations, although we've had some disruptions, we maintained our operations because of the criticality of what we do, supporting our customers. Most of the impact is purely because we haven't had the access to be able to perform what we do at customer sites. A lot of this depends on how countries open up, and how businesses open up and sites open up. So it's really dependent on that, Nigel. Based on what we see here in April, I'm encouraged by the framework we have provided, that we are in line with that.

Okay, and I recognize it.

Another way to think about that, Nigel, is our service business is roughly what, 25%, 30% of the consolidated. We're giving a range here of 15% to 20% enterprise wide. If you look at that and say our products business is about $8 billion, our service business is $6 billion and the remaining is the install piece. I think the service decline is going to be lower than the 15% to 20% range we're giving. Install will be on the higher end. Products is just somewhat dependent upon how we ramp up in some of our manufacturing facilities. George mentioned in his comments that right now we are in pretty good shape. We’re monitoring some things in Mexico and India, but some of it is dependent upon how quickly we can ramp back up from a manufacturing standpoint. The 15% to 20% is intended to be kind of a broad guidepost, but service would be lower on the low end or lower certainly than the 15% to 20% range.

Okay. Yes, that is what I was trying to get to. George, can you quickly just address in China and Asia Pacific in April which businesses you've seen spring back quickly and which businesses are still somewhat depressed?

When you look at Asia Pacific in total, it's pretty mixed. Starting with China, most companies are back to work. I wouldn't say things are back to total normal, but I would say probably in the 80% to 90% area. We're coming back nicely. We've seen some nice pickup in orders and activity there. Obviously, there's still travel restrictions within the country. We are watching, what I would say, we're watching a couple of other areas closely, Singapore and India because of the current lockdowns and there are some pressures there. So when you look at our headquarters, we're back full operations at our headquarters in Shanghai. Overall, I think we're using that as a model and understanding how that plays out across these other countries. We do expect continued challenges in the region in the second half of the year with the larger impact in Q3. If you look specifically at your question on China, I would say the biggest impact, as I said earlier, overall it's about 6% of our consolidated revenue. The revenues were down about 35% organically in the Field-based businesses. A lot of this was driven by our install business in China. Even with that, the good news is that with the work we've done around gross margins with pricing and productivity, our margins are up nicely. On a go-forward basis, we feel good with the recovery that's going to play out and that seems to be happening as we sit here today through April. In terms of products, we also have had the impact in products. It's about 5% of the total segment. As Brian talked about, we do have our facilities running again. The customers are coming back up, but it's not – I wouldn't say it's at 100%, but it's encouraging that the activity has picked up significantly here over the last few weeks.

Okay thanks George.

Hi, good morning.

Good morning, Julian.

Maybe, good morning. Maybe just following up on that mix aspect, so is it fair to assume that your decremental margin outlook for the second half should be embedding or could be embedding a fairly handsome margin mix tailwinds just because service is down a lot less than install? And maybe just clarify that. And also how are you seeing the discipline on pricing across service, install, and products, in terms of maybe the marketplace, as well as your own discipline in pricing practices?

Let me start with the first question there, Julian. When we talked about in the quarter and second quarter, install was down greater than service in Asia Pacific. That was true as well as in North America and EMEA/LA. Where we had a little bit of mix here in the quarter coming through because service was down less than install. When you look moving forward, that will probably still be true as it plays out, right. So the install will be—there will be pressure there with the install coming back, service, we believe, will come back quicker, but we've seen pressure in both. When you talk about pricing, we've been very successful in continuing to execute on price. For the year, we're still expecting about a point on the top line coming through our price realization, and that has continued even through this period of time with the pandemic.

That's helpful. Thank you. And then my second question really just around the free cash flow conversion. So you've raised that guidance for the year. If you could clarify perhaps what's changed on the capital spending front for fiscal 2020 and how confident you are that you'll be able to get those sizable working capital cash tailwinds in the second half? Are you seeing payment terms proving fairly regular? Is it easy to manage that balance of receivables and payables?

The free cash flow conversion going now from 95% to greater than 100% is really a function of the net income pressure we're going to see in the second half. As it relates to the metrics, I would tell you at the end of the second quarter, trade working capital as a percentage of sales, we saw a 10 basis point improvement year-over-year, not as much as in the first quarter, but still we continue to make progress. It is an area we’re watching very closely in today's environment. I think DSO is flat in the quarter and it's an area that we're watching closely as we move forward. But I think with the policies and practices that we've got in place now through our cash management office, it’s going to be a challenging environment from a cash flow standpoint. We'll manage our trade working capital appropriately and we feel pretty good about landing someplace north of 100% right now.

Great, thank you.

Yes, thanks. Good morning everyone. Hope you are all well.

Hey, Joe, good morning.

George, maybe my first question, I know a couple of people have touched on this service versus install piece. But clearly, like the service has held up better in China during the COVID-19 shutdowns. From a service perspective, how much of the business does not need to be on-premise, how much of it is kind of subscription-based and can be more resilient in this downturn?

Yes, so getting back to the service, service held up in Asia Pacific better than the overall install and in China was down almost in line with the install but coming back faster if I misled you there. When we look at now, and it's mainly because of access to facilities and sites that we provide service to. The rest of it overall Asia that only impacted overall Asia being down 7% with our install in Asia down even greater than that in total. Just to clarify on the first question.

Hey George, why don't you let me jump in on this one a little bit?

Yes.

Joe, I think one way to think about it is when you look at our total service revenue, about half of it is performance service agreements, and the other half would be more non-recurring, time and material, and things of that nature. Clearly, when you look at that part, that's performance service arrangement, some of that is going to still require to be on-premise but some of it will be remote like monitoring and such. I don’t have it all to that level of detail, but that's one split you can think of as you're trying to think about the piece that's more resilient. Taking the performance in APAC during the quarter, clearly you can see that service held better than the install side. Even if you take a look at the global financial recession in the 2008, 2009 period, you would see something very similar to that as well. Service went down, but clearly not to the extent that install did. Your point is well taken, service is much more defensive, particularly in this type of environment, and will definitely hold up better.

Helpful, thank you. And if I could maybe just follow-up with Brian just from a balance sheet perspective. Obviously, pending the buyback at this point, I guess just from a timing standpoint, how would you guys think about reinstituting a buyback and being a little bit more aggressive with capital deployment from here?

Yes, I think the current plan is we'll continue to hold off on the buyback through the end of this year. We think that's a prudent thing to do. We'll reevaluate it as we think about 2021. At this point in time, I would tell you that as far as your models and so forth, I wouldn't assume any buyback for the remainder of fiscal 2020.

Okay. Fair enough. Thank you all.

Good morning guys. Hope you are well?

Good morning.

Good morning. George, how are you thinking about your Fire & Security businesses in general moving forward? When you look at APAC, Field is down 14%, but you see Fire & Security in the Field down only low single digits. So how are you thinking about these businesses, which should be less cyclical than the rest of your portfolio versus that second half guide and down 15% to 20%?

Yes, the Field when you look at Fire & Security for the quarter, the Fire & Security products were only down low single digits and it was a mix. What really drove that was fire suppression, and a lot of that was just timing of projects. On the Field, we were down about 2% and that was our low single digits and it was spread across the regions. When you play that out, we'll see similar type impacts in the third quarter, third and fourth quarter relative to the shutdowns and how that plays out. But it’s a higher mix of service. You see less of an impact in total because of that. That’s what we've got modeled. These businesses have been performing well and in spite of the challenges that we faced and we're prepared to continue to execute.

That's helpful. Maybe the opposite of that is if I just look at applied HVAC in products, it was down in the teens in Q2. I guess most of that was APAC related weakness, but does that suggest applied to be down more than 15% in 2020? Maybe you can give us your outlook and sort of what you're seeing there in terms of larger projects? Are they just sort of getting deferred right now?

Yes, if you look at a commercial applied HVAC, revenue is down mid-single digits and it's mainly driven by the Asia Pacific decline, being down high teens. That was the bulk of it. Orders were about the same, it was down low single digits and it's mainly driven by APAC and the full impact that we saw in the quarter because of the virus. We really, as Brian said, were trending pretty well on our secured orders right through February in EMEA/LA, in North America. That was true with applied. Here's the impact; we think it's temporary. The pipeline is still there. Some of the pipeline is being pushed to the right because of the timing of projects. We still feel very good about our position, what we see in the pipeline, our ability to be able to convert, now obviously pushed to the right.

And Andy, just one thing to jump in here. If you think about the criticality of the things we do both within Fire & Security and HVAC, clearly both are very important, especially in the environment we're currently in. The important point is what George said; there is a higher mix in service in the Fire & Security business versus HVAC. To that point, as service will hold up better, that kind of gives you an indication of the two different platforms.

Great, helpful. Be well guys.

Thanks. Operator, we have time for one more question.

Hi. Good morning.

Good morning.

Maybe just as a follow-up to that question, just wanted to know what you were—I think you talked about the healthcare vertical earlier. I wanted to know what you were hearing on kind of more of the public side, whether that's municipality, federal and maybe also education if you're—if that's part of where that pushing to the right is if decisions are being slower coming out of those verticals. How you're thinking about that?

Yes, what we've seen there—short term, we've seen a push to the right within those projects also. We do believe we have a pipeline now of new projects that are coming in based on the way that we have responded to the crisis and creating new capacity and new capabilities. There are a lot of new projects that have been identified, but when you look at the overall project base, it's been pushed to the right similar to what we've said with some of our other backlog. I do believe that there's going to be some stimulus here in the institutional verticals relative to what's going to happen with the new norm as we discussed earlier, what's going to be required to get these facilities back operational. We see an opportunity there, although we're in the early stages of that. We'll watch that closely because, based on what we do in the buildings we support, I think there's going to be a lot more opportunities. That all being said, I think there are going to be some financial constraints, and we’re going to have to watch that closely as this plays out.

Great. I'll just leave it there. In the interest of time, I appreciate the color.

Yes, just to wrap up the call, I want to thank everyone again for joining our call this morning. We are, as you know, navigating through these challenging times very well. We're well positioned both financially and strategically to capitalize on the recovery as it plays out. Again, I hope that you and your families remain safe. I look forward to speaking with many of you soon. So operator, that concludes our call.