Great. So the mic is on, that means we're live. Thanks, good morning, and thanks to join us for our fireside chat with JCI. And very pleased to welcome Marc Vandiepenbeeck. I've been practicing that all morning, by the way, so but very pleased to have you here, Marc. I know this is your first investor conference-
It is.
So, I promised Jim I'll be nice and polite and not ask too many tough questions, but there'll be one or two in there somewhere. So Marc, you're obviously, I think you were CFO as of 1 February. So you're three, four months into the role. I think it'd be a good place to start, you know, kind of bring in some perspective to what you've seen as CFO, seen the whole organization, areas you're changing, areas for improvements. You know, any kind of state of the union would be good.
Absolutely. So just wanna start by saying I've been with the company for 20 years. New to the role, but not new to the organization. That comes with baggage, obviously, but also come with a deep understanding of what needs to happen and success. Mic doesn't work? All right. So I would tell you the first and most important things I've focused on is, we are really trying to align operational performance and financial performance into a single spectrum. And trying to drive operational performance first to align with our financial performance and commitment. That means two things. That means a little bit more conservative in our perspective in terms of what we outlook and what we commit. It also means getting after our base cost.
Over the last 12 months, as you know, we've done a lot to rationalize our cost structure and get after a pretty serious delayering of the organization. It also means playing a more active role into transforming the organization and delivering that very last mile of structure. Finally, a lot of good work had been done on rethinking our portfolio and our operating model. And I think delivering that last mile of transformation in that operating model and removing the variation, and really deciding what are the assets within the company that fit and match that operating model, and what doesn't fit and match. I think they're gonna mic change me one more time.
Yes. Apologize. I think...
1, 2, 1, 2.
Yep, sound good.
All right. So that operating model that George has been working on for the past 5-7 years, really understanding the businesses that match that operating model and don't match that operating model. And how do we really get to that entitlement from a financial and operating performance on that, a comprehensive solution provider for building is critical. And we realize it's about a quarter of our portfolio that really doesn't match that, either because the vertical markets those businesses play, or the end market in which those businesses play, don't really lend themselves for that whole life cycle solution entitlement we're trying to create at JCI.
Okay, great. So based on the news reports yesterday, it sounds like you've got a couple of large new shareholders. And I'm sure, like lots of your large shareholders, I'm sure they're saying, you know, "We wanna see better margins, we wanna see more consistency, we wanna see better free cash conversion, probably more cash coming back to shareholders," et cetera, et cetera. It sounds like based on your comments about last mile of transformation, sounds like you don't disagree with that thesis. Maybe, maybe just talk about, you know, where you see opportunities for improving margins, better cash flow, et cetera.
It's all about taking variation out of our operating model and deploying that operating model globally. The first thing, you know, we made a change last quarter in unwinding our factoring, but both the quality of our earnings and the predictability and quality of our cash flow is a critical priority, and you do that two ways. First of all, you remove those variables that make it hard to compare quarter-over-quarter. And factoring was, at some point, a great way to finance the company, but created some lack of clarity, I would say, in our operating cash flow.
The second thing is, as you deploy that operating model, it's not just about pure operating performance, but it's also about commercial focus and bringing all of the commercial team in subsegments of the market where the value of our products, the attached service and parts opportunity, as well as the overall capability of our engineering solution, play best. I always say we have an incredible market opportunity. We play in about a $400 billion market. So as a $25-$30 billion company, we don't lack market opportunity. But within that $400 billion market, only a portion of that market really plays well from a margin, from a cash, from a value proposition standpoint with the product and solutions we have.
And so having that operating model fully deployed, reducing the variation in those market as to what it deliver, will allow us to have a more predictable, financial performance, but also better cash. When customers see value in your product, you are more easily able to negotiate terms. When those customers are just there to get the lowest cost possible for a particular solution, they're also probably gonna negotiate down the terms, and therefore the cash opportunity that you have from a payment standpoint. So really deploying that last mile and then returning that cash back to shareholder at 100% is a continued commitment.
We've held that commitment so far, and as we go through some of the strategic change we've talked about, redeploying the vast majority of that capital back to shareholders is absolutely a core priority.
Just to make that clear, so, free cash flow minus dividends? ... that commitment is to return that capital to shareholders?
100%.
What about the capital release from the portfolio sales? We'll get onto that in a bit more detail, but would that, is that in the same prism?
It's in the same range. I would tell you that when you dispose of as much as 25% of your portfolio, you're gonna have to rightsize also your debt portfolio to maintain kind of the target and the rating we have committed to and we want to remain at. So some of the cash will be redeployed against debt repayment, but what's not going towards debt repayment will go entirely back to shareholder. We have a history of doing that as we disposed of our battery business back in 2019. We returned the entirety of that capital to shareholder, and at that time was a very large portion of our capitalization. We know the playbook.
That was a reverse Dutch tender.
What's that?
That was a reverse Dutch tender.
That was the reverse Dutch tender, followed by an ASR, followed by an open market repurchase. So we used every tool possible-
Yep.
At the time, we had to redeploy a third of our capital back to shareholder. That was a complex structure. We know that playbook well, and we're happy to do the same thing-
Okay
... again, this time.
Should have mentioned, guys, I'm gonna give you one opportunity for questions. So if you do have any questions, I'll tee you up in about five minutes or so. Let's go back to margins. So the opportunity to improve margins. I think that... Can you maybe just talk about the opportunities you see from a service transformation to improve margins?
Yep.
Versus pure cost reduction/restructuring, versus maybe product selectivity? I think those are the three major buckets that I see.
Yep.
Maybe just talk about those in a bit more detail.
So the margin, and I'll start first in the cost and SG&A that we've addressed over the last 12, 18 months, but we really accelerated over the last 6 months, reducing that base cost of operating, delayering the organization, and really refocusing the resources on where we see the greater market opportunity. I think we are in the really ninth inning of that game. There's always more to get done. You never stop that game, and you know, there's not a penny of savings that I don't think we should try and get after. But the next change will be more part of our operating model and not a big reorganization and cost-out structure that we've done over the past 12 months.
Back to that operating model, where we have seen variation in our ability to get after that service attach and get that up into a range that we feel is our entitlement. You know, probably 5 years ago, our service attach rate was in the 30s. We're now approaching high 40s-50s. But I always try and say that our entitlement is closer to what you would see with our elevator peers, where the best ones have 70s, 80s, sometimes 90% attach rate. So we really need to focus that commercial organization on the system side to play in parts of the market where we know we have a high chance of attaching a service on the back end.
It happens to be that the part of the market where the margins are the most attractive from a systems standpoint, generally also the parts of the market where the service attach is the, is the greatest. And so that mix and that growth of service over the long term will do great thing in terms of, of margin leverage. Overall, our service margin is much greater than our systems margin, but especially as that flywheel continue to grow and our ability to deliver more parts and more opportunity for our customer to expand the serviceability of their, of their assets, that will really change the mix of profit and lift our margin further. That's where the opportunity of margin expansion is at JCI.
Okay, that's... So the service attachment, accelerated service growth rates, is where you see the best opportunity for margin expansion?
Absolutely.
So you mentioned they're better than the systems overall systems margins. I mean, are you prepared to maybe disclose what those service margins actually are?
I would say in most markets, they're almost double than the systems-
Okay
... margin. So you really think about that multiple. Now, there's part of our systems market where the margins are very high, where we really have differentiated products, either because of great technology we've deployed or really thanks to the engineering we have. So particularly on data center, we've created a highly engineered solution that really lend themselves really well with the need of that particular vertical, and we've been able to drive both volume and improvement on margin on a market that historically wasn't a great market from a net operating margin standpoint.
Okay. And then, you know, as part of the... Maybe, maybe just talk about that, you know, the service attach rates I think were, my memory fails me. I think they may be 20% or so back in FY 2020. Now, I think they're 48%.
Yep.
So maybe talk about, you know, selectivity on projects, i.e., walking away from projects where there's no service attached on the back end, versus actually going back to your installed base and converting that back to a JCI contract.
Mm.
Maybe just talk about those two.
Yeah, so the project selectivity is not so much walking away from project, but it starts much earlier in the commercial effort. So as you build a pipeline on that $400 million, $400 billion market opportunity, deploying your resource, whether it's marketing, frontline sales, or any sort of lead generation effort you have to try and get after that opportunity, very early on, understanding your market, understanding the vertical that play well, understanding where the customers are looking for solutions are the best position, that's where you actually get to that better margin in systems. Once you do that, and once you get into that part of the market, you don't really have to walk away from anything.
The rest comes naturally. Once you have that revenue, that backlog, I'm sorry, of project opportunity, you have better visibility on the margin expansion in our Building Solutions business. But you also therefore allow the manufacturing side that lends in the Global Products to have better visibility into what type of products they're gonna need, and you now create a better absorption, a better lift, or inventory levels come down because we have better predictability, and the overall cash performance of the overall company improves. I'm sorry, you had a second part of your question that I'm missing now.
I think it's going back to the install base and converting-
Oh, yeah, the service side of that. So once you have refocused the front end of that pipeline, you have a good idea of how to attach that service rate and focus then. You also have a good idea on your existing install base, which are the market players or the market vertical, which are the most attractive from an attached service rate. And by the way, we are, we prefer to service our own product, but we have multiple time attacked the service base of our competitors. If you walk into a large facility like this one, and you go to the chiller room, you're probably gonna see 6 or 8 chillers.
Not all of them are always gonna be York chiller, even though they all should be York chiller. It's the best product on the market. But some of them may be inferior product from other competitor. We will go and try and address the entirety of that install base within that building, and then the flywheel comes in, where we can actually start servicing the controls system or the fire detection or security business, and so that's where really attacking that install base is critical. We have a good idea of where the opportunities are, but I can tell you historically, there are sub-segments of the market where we've played in, where we have installed, where the service opportunity is not always ideal.
To tell you that we'll go after 100% of our install base is not, is not a reasonable expectation, but I think we should be in the two-thirds to 75% range-
That's great
... for sure.
I'll take one more question, then we'll throw it open to the audience. Can maybe talk about the kind of challenges that JCI has experienced on free cash conversion?
Yeah
... and how that changes, and you know, what is your confidence levels that, you know, we can be closer to 100% in 2025 as opposed to 80%?
So first, you gotta understand the fundamentals of our cash flow conversion, and the way our effective tax rate and our cash tax rate have a bit of a disconnect, for good reasons, by the way. You want my effective tax rate to be lower than my cash tax rate to get after the opportunity from a really net opportunity from a tax standpoint. But that delta is 5%-6% right now, and that creates a drag versus 100%. We still have a large pension income. As you know, pension income is not really a cash return to the shareholder.
That drags that performance a couple of points, and we're still making large investment in our ERP, trying to streamline and simplify our business. Then finally, there's great market opportunities, particularly in data center, but other vertical, where we need to build capacity, and we've spent a little bit more than traditionally in deploying that capacity against those growth markets. You put all of that together, I'm really comfortable telling you that we are gonna be about an 85-90+ converter in the future. And it will improve from there. So what needs to happen to improve from there? First of all, that cash tax rate, global minimum tax will actually put pressure on our effective tax rate. Maybe not in the short term, but in the medium to long term, it will.
It will not dramatically change or cash tax rate. So that delta will come together. We've taken action to bring to reduce a little bit of pension income to align better our asset with our liabilities, and that will also give us some lift. And then as we get towards the back end of the deployment of the capital expenditure on our ERP program in the next 18-24 months, that will also provide lift to ultimately much longer term, getting higher than the 85%-90%. As far as historical performance, there's a lot of things that explain where we've been and why we've been there.
I think the challenges from a supply chain and manufacturing standpoint, where we ended up building more inventory than we had traditionally done, to try and improve our processes, as well as the lack of deployment of our operating model in some of the markets, that created more variability in our operating performance. That variability reduced a little bit the quality of our earnings and ultimately impacted our ability to have a high conversion rate and a high quality of earnings.
Okay.
It's a prime focus, I can tell you, of mine for the-
Right.
... for next three quarters.
Good answer. Thank you. Any questions? One at the back here, please. Do we have a mic? Thank you.
Could you elaborate on what has been the big driver of your improved service attachment rate, and if you would need to go from 50 to 75 or greater, what investments need to be made?
Great question. So, not a lot of investments per se, in terms of dollar. It's really back to that redeployment in our sales force. The big change that have happened are really from a commercial resource standpoint, the way we deploy those commercial team and the way we compensate them. We've forced or realigned a lot of that sales force against part of the market where the service attach rate is better. We've also redeployed resource-specific teams that are solely focused on getting after that service opportunity and that service growth. And so it's more the reallocation of resource than an additional investment. But as we continue to grow, there's always more investment in sales resources that we need to do.
But those, I would say, grow in alignment with our orders and our revenue. The long-term game of the service business is really around labor and labor productivity, and that's where our digital offering and our connected asset structure come into play in a big role. What we've really been able to validate by connecting more than 20,000 assets over the last few years is we've now collected more information on how those assets perform, operate. We're being able to be more predictive in our maintenance, and when you're more predictive, you're more productive. But we've also been able to actually start yielding a lot of information on your normal wear and tear that you can expect by type of product, by type of assets.
That allows our frontline labor team to actually be much more productive and show up on the job site with actually the parts and component they need. Having that labor more productive is really a big part of unlocking that growth. The market opportunity from a service standpoint is almost unlimited, but it's about being able to build that labor and workforce, the as productive as possible, and that comes with investment into a digital infrastructure. We've made that investment, now we are leveraging to a greater extent.
Good question. Anyone else? I think that's, that's it. Can we talk about the portfolio, disposals? Maybe just give us a bit, little bit of color on the, the process. Any timelines we're working towards here? Any news we can look forward to?
We are on the really final stages of a multi-year portfolio assessment. In terms of timeline, I wouldn't want to peg ourselves because it never leads to the right outcome. Our critical priority is speed, but first and foremost, maximizing shareholder value. Those two priorities sometimes conflict with each other. As you know, some of those assets have a more complex ownership than an outright sale because of partners that we may have in those assets. But I can tell you that we are doing everything to get after the execution of those transactions and the return back to shareholders of the proceeds as quickly and as efficiently as possible.
So am I to interpret that as saying that perhaps, you know, some of the 25% might get done this year, but some might push a little bit longer than that?
I am not gonna commit on any timeline. We're trying to do as much as possible, as quickly as possible.
Fair enough. That's fair enough. Okay, I appreciate that. Maybe talk about, you know, kind of what you're seeing out there in the market. I mean, I think we saw very strong growth in orders and systems and service during the quarter, backlog expanding very nicely. Is that continuing? Are you still seeing some really good healthy trends out there?
Yeah, the health of our backlog at $12.6 billion has never been that good. The quality of the jobs and the margin we've put in the backlog is also unprecedented. We're gonna continue to see an improvement there for two reason. The first one is the growth we are seeing in the data center vertical with those big, lumpy orders. We are seeing that pipeline continue to grow, and so we think that it's gonna continue to come. The exact timeline of those order are very lumpy, that's why we never really provide guidance on orders. But what comes with that is we've built such tight relationship with those colos and hyperscalers. We're starting to plan with them for data center that are not gonna break ground for another 12-18 months.
So that means our backlog's gonna keep on building up with revenue that go further into the future. So our ability to turn the backlog within the current year is gonna shift a little bit. But it's coming from really great verticals and also very healthy margin. If you look at the field, the Building Solutions system across the different region, Asia Pacific, we've gone through a reset. We see Q4 as really the return to growth. I think you're gonna see that backlog growing again there, and that volume to go back up. In EMEA, the past six months, we've gone through that re-pivoting that I was explaining on the commercial side.
As you know, I wear two hats, and I, I've been taking that team through that repositioning. We are seeing a return to growth in that business in the second half, and now that we have really focused that commercial team against the parts of the market that are the most attractive but also, growing the best, we are gonna see some lift there. And then North America is more mature in the operating model, and we are gonna continue to see a good progression there, both on the systems and the service side.
So I think all of the fundamental tailwind from a decarbonization, electrification of the building, as well as sustainability, I think, are supporting that backlog and that growth in the Building Solutions across the board and across the regions.
Okay, and the EMEA margin return to double digits in the back half of the year, given your background in that region, what's your degree of confidence there?
Yeah. So, I'm very confident that we are gonna get there in Q4. I think Q3 is probably a little early to get there. The goal here is to create a sustainable operating model where we get back to double-digit. Well, get back. We get to, actually, double-digit operating margin in that business. That business hasn't seen that level of return, I think it's 7 or 8 years, so it's almost history there. There is really no market or label or technology reason as to why EMEA shouldn't have similar operating margin as the other region, except for the deployment of that operating system consistently across the market that region covers.
And so we had to reposition a little bit, some of the market, walk away from parts of the market where, the life cycle solution wasn't gonna play well, or we were never gonna get to a critical mass to be able to drive that, profitable operating margin. We need a critical mass to operate at a high level of margin, and if we don't have that high level of, margin, we don't have that critical mass. Then, instead of deploying the business solution, go-to-market strategy, that's why we have a Global Products distribution model that can then, come into that market and still capture, some of that, some of that market in a more efficient way and a better net operating margin for the company.
Great. We're getting close on time here, but I do want to have two more, two more questions on maybe the, current trends. The APAC, you mentioned reset.
Yeah.
So we start to see the turn in the fourth quarter. Kind of 2025, should we expect there to be a strong bounce in that region, or do we just grow normally off a reset base?
It's a bit early for me to talk about 2025. What I can tell you is the quality of the pipeline that the team has been able to rebuild on the back end of having a leading position and being probably more exposed than most towards the large construction aspect of that market, and that's a market that really with what happened in the real estate market really pulled back very, very quickly. We had to re-pivot the resources away from that traditional market where we had a leading position and doubled down on other parts of the market. We've been able to do that. I think we're seeing an improvement in that pipeline. We are seeing the order growth continuing. I think that momentum will continue into 2025, for sure.
Now, will it go to double digit or high single digit? It's difficult for me that early on to already commit to.
No, it's fair enough. And then on in the Global Products portfolio, we've seen, you know, pretty significant headwinds in Residential HVAC, the Fire and Security products business as well, on inventory adjustments. Are we seeing that turn in the back half of the year that you expect?
The destocking on resi has really started to slow down and turn very quickly. The early sign we are seeing from an order standpoint in Q3 are very positive. May and June are gonna be critical for the success, particularly in North America, for the success of that business. I think the early sign of what we're seeing are pretty healthy and actually align with where we've made commitments. But it's a market that's going through a couple of shifts at the same time with the refrigerant change we're seeing in some subsegments of the market, as well as kind of a little bit of conservatism from the distribution channel in their inventory level.
I think that inventory management has now normalized itself, and I think you're gonna see a more traditional seasonality in that business, and we're seeing very much a positive lift. We've dealt a lot with the base cost of that Global Products business, meaning a little bit of volume improvement goes a long way in the bottom line. There's a lot of leverage there, so we are very much focused on that commercial effort, adding more dealers, adding more lines of distribution, to be able to get after that volume increase on the back end and into 2025.
That's great news. All right, Marc, we'll draw a line there. Thank you very much. That was a great discussion. Thank you.