All right, everybody. We're, I think we're finally ready to get on with the next presentation. Sorry for the delay. Excited to have in person with us today, Olivier Leonetti, from JCI's C-CFO. Olivier, great to, great to see you.
Great to see you in person for the first time.
I know. It's amazing. I can't believe it, all the Zooms. It feels like we've met before, but this is. It's great to have you here. Let's kick it off. Look, nice quarter.
Thank you.
First, why don't we start there? Before we get into the quarter, look, there's been you've been at JCI now for what? three years, a little over three years. Maybe just talk to us about like the evolution of the company over the last three years, the cost transformation journey, where you are today versus where you were and where you're going.
It's unusual to have this kind of question. I was pleased that you know, you ask it. The transformation of the company has been remarkable. I mean, if you look at this company, we have been in business for 140 years. We are very proud of our heritage created in Milwaukee, Wisconsin. We have a strong culture. We were before a set of holding companies. We have been an operating company for about three years+ , not much more. Over the last three years, the transformation of the company around all the elements of the value chain has been remarkable. From the way we deploy capital in R&D to the way we build products, the way we go to market, the way we service. On all the elements of transformation has been remarkable.
That was behind the productivity program, this transformation, and much more to come. I believe we have just at the start of a multi-years journey when it comes to the transformation of Johnson Controls. We talk about why I believe that during this conversation.
Great. Why don't we get right into it, right? You talked about this, you know, $550 million in cost outs that you promised, you know, with $250 million coming in cost of sales, another $300 million in SG&A. Maybe just talk to us about the progress that you made, how confident you feel in the synergies for this year, and then we'll talk about the longer term perspective as well.
We feel very confident about our ability to deliver on this productivity program. We have announced the number you mentioned at the start of the year, we're on track. We believe we're not going to get done. When it comes to the transformation of the P&L shape of the company, you're going to have a few transformations going on. One, as we drive a richer mix of products, more solutions, more services, better deployment of installation, you will see an increase of the mix. As we run the operations better, as the supply chain is less being disrupted, you would expect the cost of manufacturing to improve. We have a fair amount of work still to be done in scaling our SG&A.
We think today that we are again in a journey when it comes to the transformation of the P&L, in the evolution of the productivity. That's why we have said we should have enough levers to have a level of incremental, which is in the 30% range.
Is that the right way then to think about all of the synergies coming through this year, beyond this year, 30% incremental margins, assuming, you know, supply chain, which has started to ease, normalizes, you should be able to deliver on that going forward?
Correct.
Okay, great. Let's talk about the supply chain, right? You were able to over-deliver on the margin expansion that we saw in the North America buildings business this quarter. I think everybody was expecting 100 basis points. You put up 190. How much of the improvement was really dependent on supply chain finally starting to ease? What confidence level do you have throughout the rest of the year on being able to deliver on the targets that you've set forth?
If you look at the Building Solutions business, we used to call that the field business. It's a long cycle business.
I still call it the field business.
Yeah. You book an order today, you deliver with the supply chain disruptions 12 months after that. When you lock a contract at a certain price, when inflation is transitory, you can understand where we have ended up. Even if you can renegotiate, you could have a margin impact. We have been reacting quickly in changing the margin on the orders, and the margin on the orders has been improving regularly all through the last four quarters. In the current quarter, the margin in store is still increasing sequentially in orders. That's orders. Now, let me answer to your question about in the P&L. We are now realizing the rich margin backlog in the P&L. You started to see that actually in the December quarter.
The gross margin of the Building Solutions business in Q1 was higher year-on-year. Not the segment operating margin. Why? Because of the scaling of SG&A. Why? Because we have been investing in rationalizing our ERP footprint, we have invested in services, we have invested in digital. In Q2, the gross margin has been increasing year-on-year even more, and that has covered the SG&A and the SG&A in $ is going to be now the investments are going to be more muted in the second half.
Mm.
That's what is happening. We believe that the Building Solutions margin in the second half is going to keep increasing. Now in the P&L, the Building Solutions is going to take over in term of margin performance. You should see strong improvement in the second half. You ask level of confidence. Level of confidence for a few reasons. One, the backlog is strong, the backlog is resilient, the backlog has a strong margin. Resilient mean we haven't seen any cancellation or pushout. The backlog is $12 billion growing 8% year-on-year. That give us confidence. We have also a strong performance in the service business, starting now to perform at double-digits, low-teens rate, and we think we are just at the start. We have leverage on the SG&A line.
When you look at the macro, at the commercial level, the commercial market is growing and some actually institutions see the growing, the commercial market growing even faster than before because of all those indicators. The last one is the strength of the pipeline. We feel confident with the guide we gave you, including from a margin standpoint.
It's a lot of goodness to unpack there, but let's take each piece.
Right.
SG&A. It seems to me that on a sequential basis, then you're not expecting much of a change in the SG&A line so that you can scale. As revenues increase, you can scale and leverage that SG&A. Is that fair?
We could start to scale in the second half. I mean, you speak about the sequential decline, trend. The revenue is going to be more elevated in the second half. The scaling is something you would start to see even more in the Building Solutions business.
Okay, great. Talking about the margin, the gross margin specifically, and the margin that's in your backlog, you just started to see it over the last two quarters. We know that there's been a lag from what you've seen from a pricing perspective in your order book versus what you're actually seeing in your P&L.
Mm-hmm.
It seems like we're probably at the start.
We are
... of what could be very good gross margin expansion in that business going forward.
Correct.
Okay, great. I think one of the things that really stood out to me this quarter was that your install business, really just across geographies, but let's just talk about North America. The install business was growing at a much faster pace than your service business was. But your order rates are a lot faster right now in your service business than install. Service tends to have, what, 2x the margin of install?
Correct.
Okay. talk to us about what you're seeing specifically on the service side of the business and why it's growing at a double-digit figure at this point?
Let me, I will answer to that in a second. Let me speak about install for a second. We want to do install only if we drive a service event. We have demonstrated, we believe we have the insight to demonstrate when you do install, you have customer intimacy. When you have customer intimacy, you drive services. We want to drive install for service, and we want also to optimize the install margin. A few activities, maybe we talk about that later. That's one on install. On services, it's a large market, $140 billion-$160 billion addressable, depending on who you talk to. We have a market share of about 5%-6%. We're the leader of the world. The margin is very rich.
We have a Building Solutions business which allow us to address this market. The growth of services used to be about 3% about three years ago.
Mm-hmm.
It's now 10. The difference in growth rate, Joe, has been due to only more focus on the traditional service model. Better comm design, better training of the engineer, better service events, the management team looking at services day in, day out. That's why it drove the 3 to the 10. The impact of digital, which is going to be the ultimate transformation of this business, where you could really disrupt the local players doing mechanical, that's starting as we speak.
Mm.
We gave you a statistic. We have double the number of chillers being connected last quarter. We believe that all chillers are connected, but they're not connected with edge compute. That's what we're talking about.
Yes
... is connection to an edge compute. We have doubled the connection. By the end of the year, we will have connected only 10% of our chiller install base. You see all the headroom we have in chillers to connect. We will connect controls at the end of the year, and we keep connecting through smart connection, the rest of the portfolio. That would allow the service business to grow even faster. As you connect, you drive insights, you deploy AI, you deploy ML. You start to be really driving an amazing value proposition for your customers. That's why we believe that the service business should grow potentially at an accelerated rate going forward.
That's great to hear. It's interesting you mentioned in that answer, you mentioned deploying AI, right? I mean, it's still early stages and we haven't had a ton of discussions heretofore about AI, but I'm curious, like, how do you see that potentially impacting your service capabilities?
The impact is going to be immense. How immense it's going to be would have to be debated. All of us are looking at this in the industry. We are not unique. Digital is a big part of our strategy. Digital is a big part of developing the full potential of the Building Solutions, and digital and AI go together. Of course, we're talking with the large technology company to deploy AI, and we see today quite amazing impact as you manage data. That's going to be a strong differentiator for our company, Joe.
Mm-hmm.
Strong differentiator.
You talk about, you know, really 10% of your installed base is, has been penetrated.
Chillers.
Chillers. Chiller installed base has been penetrated at this point. I mean, how do we put it into numbers just in terms of, like, what the expectation should be then for your service business going forward? I know 3%-10% is a pretty big leap, but by no means do you expect your service business to grow double digits over the coming years, right?
We believe that this business should grow, above 10%, for sure.
Wow.
No question about it.
Okay. All right. That's punchy.
Mm-hmm.
Yeah. That could be really good for your margins going forward. I guess, maybe taking a step back and we'll kind of discuss the longer-term earnings framework, right? Like, you guys, you know the environment's a lot different than when you gave your original framework. It's really calling to call it like high teens to low 20s type BTS growth. Clearly there's been an uneven path in the last 12 months, right?
Mm-hmm.
Specifically as it relates to all the supply chain issues and inflationary pressures that everybody's experienced. How do you feel about the long-term framework today, from where we are today going forward the next few years?
You go back to some of the themes we have discussed. Better mix of products, more solution, more services, more targeted installation business to drive services. Very competitive set of commercial products with heat pump and new refrigerant. You see a positive impact due to product mix and solution mix. That's going to expand margin. A better manufacturing tool. Again, the manufacturing operation is still being disrupted. We have inefficiencies in manufacturing. That is being worked out. More leverage on the SG&A. Usage of digital to wrap all that around. The margin potential of this company, as we execute, is going to be very strong. I go back to the 30% incremental I discussed earlier.
Yeah. That should basically be our North Star going forward.
Correct.
The one thing I did wanna ask about the North America business that I failed to ask earlier was, you talked about improved velocity this quarter. Maybe just touch on that specifically. What's really changed? Was that just some supply chain easing? What's enabled the better velocity in turning around the backlog in that business?
It's the turnaround of the backlog, which has explained what is happening in North America, which is explaining actually what is happening across the Building Solutions business. The timing of the phenomenon could be a bit different. The SG&A scaling could be a bit different. We discussed about that.
Mm-hmm.
What you see today is the byproduct of rich orders, which went backlogged, being now recognized in the P&L. We discussed that earlier. We're just at the start of now the realization of this rich margin backlog into the P&L.
Okay, great. That's great.
I go back, you know, how have we been able to do this? Functionalization is a theme at Johnson Controls. As we are developing one operating company model, functionalization is part of making this operating model very powerful. The functionalization is being also used in the pricing function, right? You have strong collaboration between the regions and the function. The functions is here to serve the region, but the functions is now elevated in term of know-how. That is also true in the way we price. There is a lot of value you can create if you have targeted pricing, including deploying some of the AI model you talked about earlier.
I'm going to ask another question and then turn it over to the audience to see if they have any questions. You mentioned price, and you mentioned the framework for this year has been, you know, double-digit growth, right? Organic growth. You achieved that in the first half of your fiscal year. Pricing is basically all of it, but you still have backlog that continues to grow. I would imagine you have some good volumes that are growing in your backlog as well. Maybe just kind of talk about, like, why 10% is the right framework for this year. You know, again, there's a lot of concern in the market right now regarding middle market lending, what that means for commercial construction. If you could weave in some comments on your thoughts there as well, that would be helpful.
When we think about the revenue, I mean, if you look at the macro, in the commercial markets, which is large, I mean, it's about 90% of our revenue. The commercial market units is strong. You see growth around the world of about 3% and not declining, right? We serve strong end markets. Stimulus is part of this supporting. Building back manufacturing in some regions of the world, including U.S., is part of the support of the market. Strong market, point number one. Point number two, we see our bid pipeline growing. We see our backlog growing and being very resilient. Nobody's trying to push this backlog. The opposite. They want the backlog to be realized soon.
You see at the macro level, the indicators are positive, and so a view on the revenue for the second half being what we guided. There is not a lot in the set of indicators showing us concern about the market and our ability to compete, the opposite.
I think this quarter you put up 3 points of volume.
Mm-hmm.
Correct. Assuming there isn't any downturn, is it fair to assume, based on what we know today, that we could get some volume growth or should get some volume growth?
We should, correct.
Okay. I'll turn it over to the audience, see if there's any questions, or of course, I'm happy to keep going. All right. We've got one right here.
You mentioned the service increments that come with that. Could you give us some KPIs around what you've connected so far? How, and you know, in practical terms, how is that manifesting itself in high service revenue? Can you give us some data around that?
We believe we will have connected in chillers, which is only part of the portfolio, right? We have a large coverage of the commercial footprint in HVAC. Chiller is only part of it. Only for chiller would be about 10% coverage of the potential by the end of the year. About 7% at the moment. You can see the potential. We want to connect chillers, but we want to connect all the commercial HVAC portfolio. We want to connect control. We do that at the end of the year and the rest of the fire and security portfolio. We're just at the start of this journey. The impact of digital in our service performance today is not material. The 10% is mainly due to a classic way of managing this business.
We have run A/B testing. We have deployed enough connected chillers today to understand the power. When we run an A/B testing on connected A, not connected B, we see better margin, better recurring revenue, higher level of customer retention, much lower cost to serve. We're now full steam. We understand the power of digital on services, and now we are in execution mode.
Other questions from the audience? All right. Oh, we've got one here on the right.
Can you talk a little bit about the potential for heat pumps? You know, what you offer, how do you see the market developing and what is the revenue opportunity for you?
Yeah. In the HVAC market, sustainability is a big theme. The regulator is driving that as well. The energy efficiencies you have through being into the sustainability business is big. Heat pump is a big part of it. We today have about close to 50% of the HVAC portfolio, which is enabled by a heat pump. We have a strong portfolio of heat pump from resi to commercial. A large part of the market share gain we have had in the quarter is also due to the strength of the portfolio. Heat pump is a big deal for all of us, for our peers and ourselves. We are deploying internal capital to keep our leading position in heat pump, and we're also looking at M&A, not doing something transformative to acquire IP in the e-pump category.
Heat pump is a big part of this business, no question, and part of the growth story, no question.
Olivier, maybe just to follow up there. If you're looking at potential M&A, and I heard not transformative, do you need to scale like a particular subsegment of heat pumps? Is it residential versus the commercial business? Like, where would you be looking to make that investment? You know, obviously, clearly, there was a big announcement for a large European residential heat pump player. I'm just curious, any color that you'd like to give on, like, where is the gap specifically within your own portfolio?
I wouldn't talk about gaps specifically, but I would say opportunities to be stronger, right? It's across the portfolio. There are pockets. Not every heat pump is the same. resi would be one we would target for sure. We look at heat pump technologies in the commercial space. Refrigerant is also part of what everybody's doing and what everybody's looking at, we're no exception to this.
Okay.
Again, part of the sustainability vector of growth.
Yeah. Since we're on the M&A discussion.
Right.
You know, there's a big fire and security asset that is, you know, coming to market one way, shape, or another. obviously, you already have a scaled fire and security business, but there's always opportunities for synergies. what is your kind of like ambition? You know, would you would a large fire and security business be something that would be of interest to you?
The answer is no. We are very interested in fire security, though. We all have a different set of facts. When you have a Building Solutions business, when you want to develop a service business at the back of digital, when you want to offer a solution, you want fire security in the portfolio. You want to have it because it gives you a lot of insight about what is happening in the building.
Sure.
On top of that, for us, fire and security is a growing part of the business. It's been growing nicely in the quarter. It's number two in the top of the margin pyramid. Number one is parts, number two is fire security. We like fire security for all those reasons. Do we need to buy something large? No. Nor do we want to. Do we look at this business? Again, where we want to invest, we have a large portfolio, we want to buy an IP and leverage it through the rest of the portfolio. Small tuck-in will be part of the target, not something large.
That's helpful to hear. You mentioned earlier that, and I'm paraphrasing, that you'd only really want the installation work if you can get the service work.
Correct.
as well. I'm curious, though, how important is it to have the installation business? Clearly, you like the service business, but how important is it to have the installation business? This will also create a lot of complexity for your organization.
It does.
I'm just curious, like, how do you think about the installation business longer term? I know, is it scaled the right way? Is it like, are there opportunities to potentially basically have addition by subtraction with that business?
Yeah. It's a great question. We know that installation drives customer intimacy. We know that customer intimacy drives services. We have demonstrated this. If you look, by the way, as a fact, our service business on the like-for-like basis, you exclude parts, you exclude retrofit. Our service business does not include parts, does not include retrofit. Okay. If you look at our service business today, it's much stronger than what our peers have, again, because of difference in business model, and the difference is due to the install and the field presence. I go back to the install. Having said that, we believe that we can optimize the install business. We select the one only driving services, point number one. Point number two, you could optimize the way you run an installation business. We have created, two quarters ago, a field operation business across the planet.
As you run manufacturing across the planet, we run now field operations across the planet to optimize it, standardize it, be very good at doing it. As a result, you will see the install business to be very targeted and increase in margin because of the operations being run better.
You're willing to sacrifice some growth then, too, in the install business.
Correct.
Okay. Great. I'll turn it back to the audience, see if there's any other questions. Again, I can keep going, but if there's any other questions, maybe one last one. All right, great. Let's keep going. Global Products margins, phenomenal story, right? Less complexity in the business. Margins have expanded a lot over the last several years. What's left in this business? I know that you've given us the target now, 30% incremental margins going forward longer term. How do you think about this business specifically, and are you continuing to expand your external distribution channel?
We're always looking at our distribution channel. There is more we can do on the go-to-market. If you look at the Global Products division has been doing a great job. As the lead time are now starting to be very competitive, you see our ability to then have a better velocity. The product portfolio is very strong. Heat pump, new refrigerant, lower cost to serve, lower cost to service. We're doing a great job here. The excitement behind Global Products is the portfolio. Very diverse, rich in margin, very strong in sustainability, the ability to run manufacturing and operations better. Those two should allow us to gain shares, as we have had, then improve the profit of the revenue as well.
We feel very excited by the potential of this business as well, knowing that the Building Solutions business should have more margin headwinds. headrooms, not headwinds going forward.
Great. We've gotten this entire conversation without discussing OpenBlue. I know that we have talked about it around the surfaces, but maybe just one last question then from me. Yeah, you rolled it out a couple years ago. I'm just curious, like, how has the progress been? How has been the customer receptivity? Do you see it? Has it been the differentiator that you expected it to be? Maybe to this person's question from earlier, what are the right KPIs that you're looking at?
Yeah
... for OpenBlue?
We are two years into this journey, and I would characterize the journey as having 3 Phases. We created OpenBlue about three years ago. George, our CEO and Chairman, announced it about three years ago. You create it, you create a capability. About now one year ago, we created ease to connect to OpenBlue. Smart devices to connect at a lower cost point, your equipment. We are one year into this. Now we can start to aggregate data. That's Phase 3. Created OpenBlue, created ease to connect, now starting to connect and aggregate. We're at the start of this journey. It's a part of us disrupting the service business, which is large and profitable. It's part of us realizing the vision we have for the Building Solutions business.
OpenBlue is going to be part of really making the Building Solutions business the business it should be, adding the extent the headrooms it has from a margin standpoint. Very pleased. We're learning. We're trying to be very agile in the way we are running this. AI is going to help to augment this, but we are very excited. Again, when you look at how we go to market relative to our peers, it's a unique asset we have built.
Fantastic. Olivier, on that note, great to see you.
Thank you.
Thank you for coming.
It was long overdue.
Yeah. Enjoyed it.
Thank you.