Thanks so much. Our next session is with Johnson Controls, and we're going to be hosting a fireside chat with Marc Vandiepenbeek, Executive Vice President and CFO of the company. Thanks so much for being here. We're very, very excited. Let's start. Let's kick it off.
Yeah, thanks for having us.
Yeah, of course. So maybe the first question, and can you talk about resegmentation? What drove the decision, and how does it reflect changes in operating philosophy and org charts?
Yeah, the resegmentation is really coming from a change in our operating model. GSEI used to be organized with two independent operating models. We had our building solutions operating model that was really our field-based business where we do our systems and services. We had our global products operating model, which was really the team that makes the products and finds channel partners, distributors to actually sell those products. We had those two operating models kind of working at the same time and often competing on the same turf. What we saw is a lot of inefficiency when we were operating that way. The goal was to bring those two operating models together and be really market-focused. How do we win more customers on a particular turf?
Some of our customers want an OEM that stands behind the system and services the assets over its life and hopefully is there for the replacement down the line. Some of our customers do not see that value and just want to buy the equipment and install or maintain or manage it themselves, or they have a different kind of CPQ associated with how they buy. Instead of having two teams trying to figure out the market and figure out how they play best, we decided they need to be combined together, look at the market opportunity, and just win more customers in the market.
That change in organization model is really a first step in simplifying how we run the company, being much more oriented against what the customer needs and the customer success looks like, and also starting to work on a more verticalized approach to how we approach those markets. What does a healthcare customer look for, regardless of the channel we take? What does a higher-end customer look for, regardless of how we address that customer from a channel standpoint, and really get after a higher entitlement of growth, but also profitability?
Excellent. Thanks so much. Another question is cash conversion will be approaching 100% this year. What are the key drivers? I know that you are not committing to 100%, but what would need to happen operationally to achieve 100% on a sustained basis going forward?
First, how we got where we are. As soon as I took over, focusing on cash conversion, quality of earnings overall was critical. We unwound our factoring program. We simplified our supply chain and procurement process. That drove really two clear benefits: a much better management of our cash inflow, account receivable, the way we bill customers, the way we collect on that bill, the way we manage that process across our businesses, and then how we manage our procurement, getting better entitlement on how we manage our supply base, how we manage terms with that supply base, and how we buy overall. That has driven, over the last 18 months, a massive improvement in the cash flow conversion. That has allowed us to get past some of the structural headwinds we have from a cash tax standpoint.
We've talked about it in the past, and a slightly elevated level of CapEx as we were making certain investments in the business. I would say for us to continuously improve on that cash conversion and me being comfortable telling you it's 100% all the way, we still got to work a lot on our inventory. That has to do with the work that's being done on lean management and really simplifying and taking a lot of waste in how our manufacturing process works and how on-time delivery improves over time. There is a lot that can be unlocked from an inventory management from a cash standpoint in the future.
This is not a one or two-quarter adventure because it means transformation of supply chain, transformation of process within the factory, elimination of waste and scrappage, and a lot of processes need to come in to actually drive that. There is, by the way, margin improvement also associated with that. The inventory benefit that comes with that will be a big tailwind over the next couple of years. Hopefully, when we get on the other side of that, we will provide better visibility on a 100% cash.
Does the reorg, in terms of that, you no longer have this manufacturing organization and distribution organization sort of doing this intercompany transfer, does that help structurally sort of to simplify the system with inventory down the line?
It's a good first step to bring the sales and operations team more aligned into what's needed in the system and providing buying signal or selling signal earlier in the cycle because those teams are now under one roof.
We've seen some of the benefits, but more to come.
More to come. I think we transformed the organization on April 1st. Give us a couple quarters to actually optimize and run that.
Okay, so more to come. Sorry, okay, fine. That's better. Okay. Another question is most multi-industrial companies now exclude M&A amortization from earnings. How do you think about this, particularly as your cash flow approach is 100%?
Yeah, ultimately, the goal is to move to cash EPS. That's when we've done a lot of interviews with our key shareholders. They wanted us to move ultimately to a cash EPS kind of view of our financials as soon as we had clear visibility on that 100% conversion. It's a little bit connected with my earlier comment. As soon as we've cleared that threshold, and I can confidently tell you that, I think it's going to be easier for us to give you a cash EPS number. It is clear that the need and request for a pure transparent cash EPS is the solution long term.
Excellent. The next one is a direct quote from your CEO. The quote is, "I'm taking an objective fresh look at our strategy and how to best further optimize our portfolio. I will share more at a later point in time about what I think is good for Johnson Controls as I deepen my understanding of our business and markets and customer needs." I guess the question is clearly we're still very early, and the statement says that we're early. Looking from the outside, how comprehensive will the review process be?
Oh, there's going to be no stones unturned. I think Joakim is taking a clear, unencumbered look at every part of the portfolio, understanding customer and how we serve customers, understanding our operating principles, how we are actually delivering the services and product to those customers. That leads to both a strategic view of what those businesses need to take, but also a view on what the entitlement of profit and growth rate is. As we go through that review of the portfolio, he's going to have an unemotional view on what we do with those businesses. There are going to be multiple possible outcomes. Again, the man has been eight weeks in the seat, so give him a little bit of room to actually do the hard work of understanding deeply those businesses.
It could lead to us deciding some of those assets are not part of the portfolio. It could lead to us deciding some of those assets could be run a whole lot better, and we could drive those businesses to better cash performance and help us support that long-term 100% free cash flow conversion. Not every part of the organization is going to grow double digit. For those parts of the portfolio that are growing a little slower than the rest of the portfolio, what do you do about it? What are the operating changes you need to make whether you decide to keep that asset or not?
Excellent. No, that's terrific. Meanwhile, I think you sort of brought up some sort of thoughts about M&A, but as we are undergoing this review, what is happening with M&A? How should we think about M&A at JCI going forward? As I said, cash is clearly improving, cleaned up a lot of the portfolio. Any regions or product technology verticals that really stand out? As I model M&A or a capital allocation, what's a good placeholder for M&A spend?
First, I'll address the short-term part of that question. We are going to close the transaction on our divestiture in the fourth quarter. We have a healthy pipeline of M&A targets that we're looking at, and I'll describe in a little bit more detail where we're spending our time there, but nothing in the short term that will require action. We are going to redeploy the vast majority of the net proceeds, about $5 billion, against a quick share repurchase strategy in the fourth quarter. After that, between the health of our balance sheet and the continued performance on free cash flow, we have a lot of ability to acquire larger companies. The goal here is not to do something massively transformative.
It's very much trying to acquire new technologies that are complementary to our kind of terminal HVAC business, whether it's for particular verticals that we see growing faster than others, or whether it's for a particular region where we see the opportunity growing. Yes, of course, there's assets we're looking at that would bring great capability from a data center vertical. We're also looking at assets that would give us capability to continue leveraging on the growth we're seeing, for example, in Europe in HVAC, where we're seeing the heat pump market, commercial heat pump market, continue to grow very rapidly and where we want to keep up pace with demand.
Our controls business is really a world-class one, and we continue to try and create differentiated solutions and continue to invest into new technologies that allow us to continuously differentiate our product and provide solutions to particular vertical markets that are beneficial to us.
That's great. Speaking about data centers, can we talk about Silent-Aire?
Yeah.
Clearly seems like a competitive advantage as it gets you into the data hall. I do not think people appreciate that you are bigger, just generally bigger in data centers than two of your large public competitors combined.
Yeah. Yeah. Oh, yeah, combined for sure. So Silent-Aire is improving. As you know, we acquired that business five years ago, and it took us a little bit to really understand the backlog of what that business had actually signed up to prior to the acquisition and be able to pivot and help the customers ultimately drive the value of the product they're looking for. That business continues to do extremely well, growing in the high double digit. As you know, data center is about.
High double digits.
High double digit, yeah. That business, data center overall, not just Silent-Aire, but that's about 10%, just under 10% of our revenue. Silent-Aire is about a third of that. They continue to see increased demand, regardless of the momentum that's happening at the chip level, because the solution they have in the data hall works for liquid to air or liquid to liquid solutions and provides kind of thermal efficiency that I think are very hard to get from other competitors. They really have a very differentiated solution on a product that historically was very commoditized and very standard. They've really created differentiated solutions that our customers enjoy.
Wow. Okay. So can you just help us? Who is the typical data center customer for JCI? Are you over-indexed to hyperscalers, colos, enterprise? Any comment on geographies?
When you have that large of a presence in a market and you have five or six companies that are that large in that particular market, you are naturally a little bit more indexed towards those particular players than you would otherwise like. Yes, we have a very strong, very good relationship with all hyperscalers. They define where the market is heading. They really create earlier on the template that some of the colocators and some of the smaller software companies will ultimately design against. Yes, it is tilted more towards hyperscalers, but it provides benefit for us to play across the board. While we have a lot of relationships with the hyperscalers, we deal with pretty much all of the larger global colocators. From a geographic standpoint, we have seen more success in North America than we have in other regions.
I would say APAC comes second, and then we need to look at Europe and our opportunity there. It's not so much a capability standpoint. It's an ability to regionalize some of the solutions. The pace of growth in Europe for data centers is not as good as what you see in other regions because of the complexity around the regulatory environment that is creating some hard burns for actually most of the hyperscalers as when they decide to locate themselves. The availability of power is a problem globally, but it's particularly difficult to see a path to that power in Europe in the midterm. There are a lot of geopolitical moving pieces that are happening there.
Some of that demand may shift a little bit east or south, depending on what Europe decides to do from an energy and a regulatory standpoint on data centers.
On APAC, is it outside of China, or would APAC include China?
It's mostly outside of China, but we have a deep relationship with some of the larger colocators in China. It's a very competitive market onshore China. We're playing our part, and we're seeing some good growth there. It is a much tougher market with really very creative, I would say, local competitors that have provided very differentiated solutions for that market.
Gotcha. No, thanks so much. What are the missing pieces in your data center portfolio? For example, some of your competitors have entered the CDU market fairly recently. Any thoughts there?
Yeah, it's a market we look at in deep details. I would say it all comes down to how far down the chip you want to go and whether the economics of that terminal value chain will work out over time. Right now, there's a lot of CDU solutions. Right now, we're seeing not a lot of differentiation from a value or capabilities. It is just availability. That availability game will die down very quickly. We will only enter, I would say, the data room if we can find a way to create differentiated, integrated solutions with what's happening outside of the data room and drive value for our customers. Chasing a highly commoditized, very temporary part of the segment of the market like CDU may not be our first bet.
No, we've heard it's very interesting, and I'm really curious to see how the industry will develop. That, for example, folks who really have deep technological expertise in chillers are well positioned as we go to two-phase cooling for sort of more complex architecture, that that creates an opening for more sophisticated players. Is that the right way of thinking about it?
That's absolutely the right way of thinking about it. Ultimately, it may eliminate the need for a CDU midterm. That creates a completely different paradigm on how you manage the whole terminal loop within the data room. We are designing some solution right now that would address some of those needs. There are some capabilities we will ultimately potentially look outside of the company to acquire to be able to double down on the technology differentiation there.
How much visibility do you have in your data center order book beyond 2025?
Oh, we have great visibility. That order book continues to grow. I mean, our backlog overall has grown 12% year on year. So we have, across data centers and all of other verticals, we have very strong visibility on what's coming. The health of our pipeline in data centers continues to improve. So it's not like you've seen a dampening. There's been a little bit of a shift of where the demand comes in, you know what I mean? Like a little bit less from hyperscalers that we still see a high demand, and you see a more fragmented demand coming from different colo and mid-market software players.
Ultimately, we are able to address all of those needs, particularly because the standards have come a lot from the hyperscalers, and the market knows we have a differentiated solution there that can help those software players be extremely competitive from a cost to cool their infrastructure standpoint.
Just so I have my notes correct, and Devin is in the audience, but this high double digit, is that Silent-Aire order numbers? Is it total data center?
It's total data center.
Is it orders or revenue, sorry?
Both.
Okay. Okay. That looks good. Maybe just we'll finish with data centers. Do you see the timetable for rollout of GB300, introduction of Rubin, because the timeline is changing?
Shifting a little bit, yeah.
Are you seeing this impact what your customers are doing?
It changes a little bit the type of technology, the timing, and the type of technology they intended on implementing originally.
Okay. So it does. Okay.
It shifts some things to the right. It does not change the demand overall for the terminal needs. It changes the type of architecture that ends up being deployed. We have those solutions across the board. I think the more advanced, less tested technologies are being pushed a little bit more to the right, which is good. It gives everybody more time to validate the capability there. I think what you are seeing is the more complex data center customers are starting to understand that the blades, the racks, the CDUs, the air inside the data room, and the infrastructure are not four or five different parts of the terminal envelope. They are all one single unit.
They need to be able to find a modularized approach to each component to be able to play actively and be able to react to the need of what the terminal load is going to be at the chip level across that need. That containerized, that modularized approach, we see it across the board because the timing of the deployment of particular chips will constantly evolve. It's slowing down a little bit now. In two years from now, we're going to talk about a reacceleration, and then it's going to lead to different changes there.
I'm just sort of thinking if you're a large hyperscaler customer and maybe GB200 is slipping to the right, but the gap between GB200 and Rubin is getting narrower. On the margin, can you see some change in architecture to say, "Hey, maybe I'm going to, you know, it's less Blackwell, more Rubin down the line as the mix"? Is that or is that too simplistic of a view?
It's a little too simplistic because the applications themselves are changing at the same time. The ability to get those higher chips out there for the larger language model, for the smaller language model, because of the productivity gains that have happened over the last year, you now have a pickup in productivity there that was not anticipated at first. The type of chip and the type of data center is shifting a little bit quicker. There is a whole lot more that comes into play when it comes to data centers, memory, and now you have the power delivery that changes the terminal envelope. There is a very complex ecosystem to be dealt with here.
Thank you. Maybe just can you remind us about your recent capacity additions in North America, sort of brownfield versus greenfield?
Yeah. The largest expansion we have done over the last 12 months was really to be able to keep up pace with the air-cooled chiller demand we were seeing. Mostly investment we have made in our Mexico facility in Saltillo, where we almost doubled the capacity of that plant, simply because the backlog was more than double than it was in the prior year. We said the orders in the first half were double what they were in the whole prior year. As you see that momentum, we built capacity. Now, with Joakim coming on board, there is a clear focus on lean and lean management, particularly lean manufacturing. Lean is not just manufacturing, but it is where it shines the most. We are now very comfortable with the footprint we have.
The goal is how are we going to be able to add 30-40-50% capacity with the existing footprint by optimizing the flow, the structure, and eliminating waste in how we run those facilities to create more output from the existing infrastructure and also improving quality at the end of the day.
Gotcha. You know, sort of one of the themes, I think, is reshoring as, you know, I think the biggest supply player. What do you see in terms of reshoring opportunity in the U.S.? And do you participate in SEMI and BioPharma reshoring? And what are you seeing? What are the good leading indicators to track? Is it start spending? You know, what's a relevant metric for Johnson Controls?
What we track is our quoting activity for those particular verticals. We see a big pickup. There is no question about it on an increasing quoting. Quotes do not always convert to orders, and they have not converted yet to orders. There is huge activity. A lot of people are clearly.
Is it both on SEMI and BioPharma or one specific?
Both.
Okay. Yeah.
Generally, reshoring, there's certain verticals, think about warehouses. Three, four years ago, I would have told you big boom in warehouses, great opportunity for us, growing double digit, and we see no end. It plateaued because the need for those logistical warehouses kind of leveled off in 2023, 2024. We see a pickup in those right now. That means manufacturing or supply chain is pivoting, and people need that space to hold their goods as they transit through the system. That is the best early indicator of knowing that somebody needs to build new capabilities in factoring, warehousing. It's your early indicator because you first buy to distribute, and then you're tired of holding your warehouse and pre-buying from your factory wherever they may be, and you build a factory to replace that capacity. We see that momentum.
Honestly, with how dynamic the geopolitical environment is, I do not want to tell you with clear confidence this is where it is heading. We want to give it a little bit of time. You can see our, you see the same indices I see. ABI is still pretty soft. Dodge Construction momentum is kind of flattening out to cliffing off a little bit. The big key indicators are a little bit softening, but they could quickly pick back up. We do not see that yet in our own internal KPI, as I said it, but at some point, something is going to give.
Have you seen, just let me drill down on BioPharma because it's just the headlines have been quite exciting, and it's hard to tell how real it is. But you've talked to some.
Yeah. We see the demand. Again, it's at the quoting stage.
Yeah, yeah, I know.
You got to convert that to orders. Similarly to what you saw probably two years ago, three years ago in the battery manufacturing craze, where we had three years ago a massive demand in quotes, and we were not seeing those orders coming through. Then everything gave out, and we had tons of orders coming in very quickly. I think it is going to be the same momentum. People are going to build their business case. They are right now trying to figure out what would it cost to build that infrastructure in the U.S., what would it cost to run it, because it is not just chillers, unfortunately. It is a whole bunch of other aspects to that. I think we see that very positively right now.
Can we talk about other verticals in the U.S.? Because looking at the construction spending data, it seems sort of data centers and manufacturing dominate the current construction spending. What are you seeing in other verticals? What's good? What's lagging?
On the ones that are lagging, let's start with the tough one first. Government retail, it's not a surprise. It's softening, and it continues to soften. Retail has been soft for the better part of the last decade, but it's not improving, quite the opposite. And government, naturally, with what's happening with DOGE, you see some softness there. You look at higher ed, the state-owned type of higher ed, it's very soft. The privately owned, it's actually picking up. We see good investments there. If you go to commercial real estate, which is a big part of the market, about 25% or so for us, it's kind of a tale of two cities. The Class A market, people continue to invest. They want great offices, and we see a pickup in demand there.
You go lower in the grade of offices, and the demand like softens really rapidly. I think New York City is a great example. You would see a building like this one, fully utilized, thousands of people coming in. You look at the floor plates. The floor plates are maximized with cubicle and meeting room and space fully utilized and tons of people in there. You are going to see a Class B or C office right next door, half of it dark, completely unutilized. Something's going to give at some point, right? Because we can't just double down on that. That market remains very, very soft. The replacement cycle there has been lengthened quite a bit, and there's a lot of people sitting on the sideline waiting for something to happen in that market.
Hospitals, just to round that out?
Healthcare overall, the hospital particularly, there's a.
All healthcare, yeah.
Yeah. If you look at healthcare overall, very healthy, life science has some softening that's been happening for a couple of years. And so we don't have that tailoring that much anymore. If you look at hospital, there's been a shift in size. The mega hospital construction craze is a little bit behind us in, I'm talking about North America. There's opportunities outside of North America if you think about Southeast Asia and India and some parts of Europe where we see great opportunity there. In North America, it's really around smaller healthcare facilities, more self-contained, but more of them.
That is where our service capabilities come into play because now we are dealing with those hospital groups that instead of having one large campus, have seven or eight satellites, and they want an OEM to be able to serve those satellites across the region and guarantee their service the same way they guaranteed in the big infrastructure. We are seeing great growth there actually as investments are continuously made.
Can we talk about fire and security fundamentals by region? Because Europe seemingly, A, you guys have done a lot of heavy lifting in Europe. Just maybe just talk about fire and security fundamentals by region because big part of the company.
Yeah, it's very small for APAC. So I don't think it's worth talking too much about it. APAC is mostly an HVAC controls market with a little bit of fire and security, but it's fundamentally not large. If you look at Europe, great franchise we have there, very, very strong margin. It's growing well. We got to continue focusing on that success story. Yes, we've done a lot of work on improving the profitability of that business from like mid-single digit two, three years ago to mid-teens right now. But I think the entitlement of that business is much higher. Fire and security continues to be a very healthy market for us in Europe, and we don't see any macro trend that would change that.
In North America, the fire and security market and market we serve are very much tilted towards new construction and mid-market, that Class B, C office I'm talking about. A little bit more exposed than it is in Europe. That is why you've seen the growth of that business in the very low single digit, I would say 0-5% depending on the quarter you look at. I don't think fundamentally we're going to see a change in that market anytime soon. What we need to work on and where Joakim and I are really focused on right now is can we improve the profitability of that business? Can we do something different with that business, or is it part of a bigger portfolio review and something somebody else could manage better than us?
A question. What was your, you know, just talking about fire security, AMELA just pivoting, what were your big personal, big takeaways from the operational turnaround at AMELA under your leadership, and what can be applied to the broader JCI playbook?
It's customer needs-based segmentation. What the team in Europe was trying to do is they had the right products, they had the right footprints, they were just not deploying the resource against the best parts of the market from a product capability standpoint. The goal of running a systems or an install for JCI is ultimately to serve that customer. If you start trying to sell using the branches, selling systems in parts of the market where you're never going to win service, you're going to utilize resource wrong, and you're not going to get your return on your system investment through the service. What you saw in Europe in the last two or three years, you had your flat growth in systems, zero to 1% to 2%. Then you had a double-digit growth, 10%-15%-20% some quarter in service.
That happened simply because the same level of install we were doing the year before, we did it with double the level of attachment rate we did in the year. That drove massive mix in both the quality and the type of margin we could come in on system, but also helped the mix on service overall. That is how you quickly drove a margin improvement. We got to continue to improve that operating system. I think the work that we are doing on lean management over the next two, three years will drive a massive improvement on gross margin and continue to bring better leverage on the SG&A that that organization has.
We're almost out of time. We're right on time. Thanks so much.
No, thank you.
My pleasure.
Yeah.
Thanks for having us here.