Johnson Controls International plc

Welcome to Johnson Control's fourth quarter 2020 earnings call. Your lines have been placed on listen only until the question and answer session. To ask a question, please press star 1 on your touchtone phone. This conference is being recorded. If you have any objections, please disconnect at this time. I will now turn the call over to Antonella Franzen, Vice President and Chief Investor Relations and Communications Officer.

Good morning, and thank you for joining our conference call to discuss Johnson Control's fourth 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. Joining me on the call today are Johnson Control's Chairman and Chief Executive Officer, George Oliver, our Vice Chairman and Chief Financial Officer, Brian Steeve, and our Chief Financial Officer-elect, Olivier Leonetti. Before we begin, I'd like to remind you that during the course of today's call, we will be providing certain forward-looking information. We ask that you review today's press release and read through the forward-looking cautionary informational statements that we've included there. In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items. In discussing our results during the call, references to adjusted earnings per share, EBIT A, EBIT, and free cash flow exclude restructuring and integration costs as well as other special items. These metrics are non-GAAP measures and are reconciled in the schedules attached to our press release and in the appendix to the presentation posted on our website. Additionally, all comparisons to the prior year are on a continuing ops basis. GAAP earnings per share from continuing operations attributable to Johnson Control's ordinary shareholders was $0.60 for the quarter and included a net charge of $0.17 related to special items, including year-end pension mark-to-market adjustments. Excluding these special items, non-GAAP adjusted diluted earnings per share from continuing operations was $0.76 compared to $0.78 in the prior year quarter. Now let me turn the call over to George.

Thanks, Antonella, and good morning, everyone. Thank you for joining us on today's calls. As the effects and impacts of COVID are still fresh in our minds, I hope you and your families are continuing to stay healthy and safe. Before we get started with the prepared remarks, I wanted to take the time to officially welcome Olivier to the team. Olivier is on the call today and will be actively participating in our guidance discussion and in Q&A. Many of you have already had the opportunity to speak with him briefly at a few of our investment conferences in early September. And if not, we look forward to speaking with many of you over the next several weeks. From my perspective, the transition couldn't be going any better, and it's clear to me that Olivier is already having a positive impact on the organization in his first 10 weeks. As we said at the time of his announcement, Olivier will formally assume the role of CFO immediately following the release of our 10-K in just a few days. I'd also like to take this opportunity to thank Brian for all of his contributions over the past several years. Brian has been an incredible partner and ally for me and, of course, played a vital role in the success of the merger integration over these last four plus years. I can't thank you enough for all that you've done. I think I speak for the whole team, Brian, in wishing you a long and happy retirement. With that, let's get started with a look back at our fiscal year on slide three. It likely goes without saying that 2020 is a year of unprecedented challenges. The experiences of this past year have tested the resilience, agility, and resolve of the entire organization and all of us as individuals. I'm incredibly proud of the way we came together as one team with an unwavering reliance on our core values and culture, which have underpinned every decision we made along the way. As we have said since the onset of the crisis, our goal as a company has been twofold. First and foremost, to protect the health and safety of our employees and their families, and second, to fulfill our customer promise by proactively developing and delivering solutions to ensure the continuous functionality of their critical infrastructure and essential facilities. Those two goals remain in place today. Improving the fundamentals of our business has been the foundation of our integration and transformation over these last few years, and the significant progress we have made was critical to our ability to navigate through the pandemic. From my perspective, we have continued to demonstrate strong execution and established a consistent pattern of achieving our commitments. In spite of the enormous amount of volatility in our markets this year, we continue to execute on our strategy. Although we had to pivot early in the year to mitigate the impact from COVID-19, we further strengthened our operating systems, continued to invest in our businesses, filled key leadership roles, and returned nearly $3 billion in capital to shareholders through share buybacks and dividends. We ended 2020 with arguably the healthiest balance sheet and strongest liquidity profile we've had since the merger. We opportunistically refinanced a significant portion of our debt at very attractive rates. It issued our first green bond, further underscoring our leadership in and commitment to sustainability. We have remained on offense throughout the course of this downturn, competitively positioning the company for the recovery as market conditions normalized. For example, we launched an impressive number of new products this year, including our expanded fleet of light commercial unitary HVAC systems. In addition, we completed a number of bolt-on acquisitions over the course of the year, including the remaining minority stake in Qualtis, a proven technology disruptor in the security products market, delivering cloud-based intrusion and smart building solutions, which further enhances our digital innovation capabilities. We also doubled down on service and on digitally connected systems and, of course, announced the launch of OpenBlue, all of which will form the axis of our growth strategy going forward. And finally, as we enter the next stage of the evolution of Johnson Controls, I couldn't be more excited about the opportunities in front of us as we turn our attention to accelerating growth and gaining share. I will come back later in the call to discuss this in more detail. Turning to slide four, I'll provide a quick summary of the financials for the quarter. We ended the year with positive momentum as general business activity and demand trends continue to improve sequentially across many parts of our portfolio. That said, while we are encouraged by the progress of the recovery to date, almost all of our businesses continue to experience material impacts from the pandemic. Overall, sales in the fourth quarter declined 6% organically, better than the 10% decline we were projecting coming into the quarter as our sales teams executed very well in the current environment. Global products showed the strongest sequential improvement, declining 3%, with sharp rebounds in many of our product lines, including our residential HVAC portfolio. Our field revenues declined 7% in aggregate as site access continued to improve, although discretionary spending remained somewhat more restrained. Service continued to outperform, showing more normal resiliency with sales down 3% in the quarter, led by the relative strength of our contractual service base. Install revenues declined 10%, but again, significantly improved compared to last quarter's 18% decline. We remained vigilant on our planned cost mitigation efforts in the quarter, holding our EBIT margin flat year-over-year at 12.9%, despite continued volume pressure, a direct result of strong execution, delivering best-in-class incrementals at 13%. Adjusted EPS came in at 76 cents, down 3% year-over-year, and we delivered on our cash commitment for the quarter, with strong free cash flow of $1 billion, bringing the full year to $1.9 billion, 115% conversion on adjusted net income. Turning to slide five. Let's look at our order trends for the quarter. Similar to last quarter, this chart highlights our monthly field orders on a trailing three-month basis through the end of September and excludes orders related to our global products business, as they tend to be book and ship. For the quarter overall, orders declined 7%, continuing to recover off the May lows, substantially better than the 16% decline we reported last quarter, and in line with our expectation for a mid- to high-single-digit decline. All three segments rebounded on a quarter-sequential basis. By platform, orders for our global applied HVAC install and service businesses improved to down a little less than 1%, led by positive growth in North America and APEC. Orders for our fire and security business remain challenged, including weakness in our retail business, However, these businesses have improved on a quarter-sequential basis. We continue to see uneven order patterns across many of our regions, and many countries across Europe are seeing renewed lockdowns and restrictions, and case rates in the U.S. are picking back up. So we continue to plan conservatively. With that, I will turn it over to Brian to discuss our performance in a little more detail.

Thanks, George, and good morning, everyone. So let's get started with our year-over-year EPS bridge on slide six. As you can see, operations net of mitigating actions was an 11-cent headwind. Despite continued volume pressure and some unfavorable mix, price-cost was again positive, and we achieved significant cost savings during the quarter. In total, Q4 benefited from approximately $200 million in mitigating cost actions in response to COVID-19. Ongoing synergy and productivity save was a 4 cent tailwind as anticipated, and net financing costs were a 2 cent headwind. Our lower share count, given the significant share repurchase activity over the past 12 months, benefited us 5 cents. Moving to our segment margin bridge on slide 7, as I mentioned, despite continued volume pressure across all four segments due to the pandemic, we did remain very disciplined on price in an increasingly competitive environment. As a result, we delivered another quarter of strong gross margin expansion of 70 basis points year-over-year to 34.3%. With a full quarter of run rate permanent cost savings in Q4 and the incremental benefits from our cost mitigation efforts, we were able to hold decremental margins to 20% at the segment EBITDA level and as planned, 13% of the consolidated EBIT level. Overall segment EBITDA margin declined 20 basis points on an organic basis to 15.6%. So let's turn to slide eight for a look at our segment results in more detail, and my comments will also focus on the segment and market performance that's included on slide nine. For North America, revenues declined 6%, with install down 9% and service down 3%. We saw strong retrofit activity, particularly from our enterprise customers requesting solutions to enhance the health and safety of their facilities. However, demand in our conventional install business related to new construction remains under pressure. Applied HVAC declined mid-single digits, and fire and security was down low double digits, while performance solutions grew low double digits in the quarter. Segment margin increased 50 basis points year over year to 15.4%, slightly ahead of our internal expectations, given better-than-expected top-line performance. Cost mitigation efforts and restructuring benefits, net of a mixed headwind, also benefited us in Q4. Overall, orders in North America declined 9%, with low single-digit growth in applied HVAC offset by softer orders in fire and security. Backlog of $5.9 billion was flat year over year. Moving to Amela, revenues declined 7%, with install down 11% and service down 3%. By end market, applied HVAC and fire and security both declined at high single-digit rates versus a high teens rate last quarter. Industrial refrigeration continues to outperform relative to the other end markets, declining only mid-single digits in the quarter. By geography, we saw continued challenges across most of the major regions. Europe declined mid-single digits, while the Middle East saw significant pressure down high teens in the quarter, with continued weakness in our HVAC business. Latin America was down high single digits. As expected, EBITDA margins improved sequentially, but declined 30 basis points year over year, as favorable mix, our cost mitigation efforts, and better fixed cost absorption weren't enough to offset the volume to leverage. Borders in Amelia declined 7% in the quarter, which strengthened our industrial refrigeration and security monitoring businesses more than offset by continued pressure in our HVAC business and to a lesser extent, fire and security. Amila's backlog of 1.6 billion was up 1% year over year. Moving to APAC, revenues were down 10% with install down 14 and service down 4. On a positive note, trying to continue to improve, down only 3% in Q4, with positive sequential revenue growth during the quarter. Across the rest of the APAC region, conditions do remain a bit fluid as it relates to COVID-19 and the steady pace of economic recovery that we've seen over the past several months may moderate from recent levels. EBITDA margins in APAC improved 50 basis points year over year to 14.7% as their favorable mix and the benefit of cost mitigation actions more than offset the volume decline. APAC orders increased 2% in Q4, with China orders up a strong 7%. Backlog of $1.7 billion grew 10% year over year. So let's move to global products, where total revenue declined 3% on an organic basis in the quarter. Residential was a clear standout, with strong growth across our HVAC and security product portfolios. North America Resi HVAC grew 31% in the quarter, driven by favorable weather, the release of pent-up demand, and our strong dealer conversion. We also continue to gain share, primarily in the air conditioning and heat pump categories, as a result of our new product launches earlier this year. As we transition to heating season, we continue to see unprecedented order momentum, with many of our channels restocking for upcoming service demand. In Asia Pacific, our Itachi residential revenues grew 5%, driven by strong double-digit growth in Taiwan, despite more challenging markets in Japan and India. Commercial HVAC markets remain under pressure, particularly light commercial unitary, as these products typically support verticals that are still struggling due to the pandemic. Sales in our North America light commercial business declined low double digits in the quarter. That being said, we continue to gain share in this market both for the quarter and on a trailing 12-month basis, and we are seeing good traction with our new choice and select rooftop platforms as well as our new channel program incentives aimed directly at converting replacement demand. The story for applied equipment in our indirect channel is very similar to Q3, with revenues down 9%, a strong chiller and air handling unit replacement in North America being offset by declines in APAC due to continued project delays and elevated channel inventories. Fire and security products decline mid-single digits, with security products benefiting from healthy building trends and strong growth in our intrusion business globally as we integrate QALSIS. EBIT margins declined 130 basis points year over year to 17.8% as positive price cost and the benefit of mediating cost actions was more than offset by the volume decline and related absorption as well as the negative mix. So let's turn to slide 10. Corporate expense was down significantly year over year to 58 million as we continue to benefit from cost mitigation actions, synergy and productivity save, and the ongoing cost reductions related to power solutions divestiture. As a reminder, we expect that our corporate expense will increase to a range of 300 to 330 million in fiscal 21, as some of the benefits from this year's temporary cost reductions begin to reinstate over the course of fiscal 21. Moving to our balance sheet on slide 11. During Q4, we made significant improvements to our balance sheet and liquidity profile. We took advantage of the favorable interest rate environment to refinance approximately $1.8 billion of our short-term debt, some of which was raised in April 2020, into longer-dated maturities at very attractive rates. This included the issuance of our first green bond, one of few industrial companies to do so, with a $625 million 10-year note that will be used to finance eligible green projects which further underscores our commitment to sustainability. Overall, our net debt leverage remains at a very strong 1.8 times, still well below our target range. As mentioned to you last quarter, given our strong balance sheet position and cash flow generation, we resumed our share repurchases in Q4, completing the remaining $750 million of the planned $2.2 billion for fiscal 2020. Moving to free cash flow on slide 12, we continue to see extremely strong cash flow performance across the company. Reported free cash flow in Q4 was $900 million, with adjusted free cash flow of $1 billion. For the full year, adjusted free cash flow was over $1.9 billion, representing conversion of 115%, well above the prior year, primarily due to aggressive management of CapEx, and COVID-related cash tax benefits. With that, I'll turn it over to George to provide you an update on our go-forward strategy.

Thanks, Brian. Please turn to slide 13. As we've come to the end of our original four-year integration period, we are at a point now where the difficult work around our internal transformation, portfolio rationalization, and leadership changes is now largely complete. While there is always more work to do in an organization of this size, we are very excited about the growth opportunities in front of us. Our portfolio is very well aligned with the strong secular trends, including sustainability and energy efficiency, urbanization, and smarter and safer buildings and infrastructure. We are uniquely positioned to serve these trends with a holistic approach that leverages the most comprehensive product portfolio in the industry combined with the largest installed base, and brought us direct channel footprint to enable extensive go-to-market advantages. Our vision for this merger five years ago was to ultimately lead the evolution from managing traditional building systems to becoming an outcome-based solutions provider, supporting more intelligent, connected spaces and places. Given the improvement in our growth and operational fundamentals over the last few years, we are very well positioned to accelerate and leverage our unique competitive advantages. As I mentioned earlier, we have developed three growth priorities, all designed and calibrated around gaining share. Scaling open blue, accelerating new product introductions, and driving higher service attachment rates and sales growth. At the same time, in some respects enabled by these growth priorities, we will remain focused on driving improved margin performance attacking the cost structure with the same intensity we have over the last four years. With the steps we've taken to strengthen the balance sheet over the last two years, and the improvements we've made to our liquidity position and cash generation capabilities, we are now in a better position to pursue a more balanced but disciplined capital allocation plan. Please turn to slide 14. The launch of OpenBlue represents the next stage in our journey. Although it is still very early, we have achieved significant success in creating momentum with customers and partners. OpenBlue is immediately compelling to a wide variety of customers looking to connect, plan and manage space for enhanced security, sustainability and experiences. This platform addresses a series of solutions for a variety of environments. Worldwide, we saw engagement with a range of customers from one of the largest and most respected real estate developers in Asia to multiple sports venues across the world and everything in between. For example, let's look at universities. We began OpenBlue engagements at Stanford, Brown, Tulane, Kent State, University of Arkansas, and others. Our work with the National University of Singapore demonstrates our deep collaboration with Microsoft, creating a living laboratory for a new breed of customizable, contact-free applications built on Johnson Control's unifying digital technology suite, OpenBlue. From a technology perspective, I mentioned our collaboration with Microsoft. We've also begun new work with a portfolio of technology companies, including Accenture, Cisco, and Intel. OpenBlue is also fueling some of the most ambitious projects in the world, such as VIA and the next World Cup. Over the last several months, we have had numerous releases under OpenBlue. For example, in August, we launched our comprehensive suite of digital solutions under the OpenBlue Healthy Buildings label. Bringing together intelligent, connected hardware, software-based analytics and dashboards, as well as mobile applications aimed at accelerating building occupancy by instilling confidence and assisting in the management of COVID-19 risk. We remain focused on creating the world's best technologies and proud that we received over 600 patents and we earned the highly coveted ISA secure development lifecycle assurance certification, the highest standard in product security. Let's turn now to slide 15. As we have mentioned to many of you over the last few months, one of the biggest benefits of OpenBlue will be our ability to tailor our service offerings to individual customers based on their unique needs. This platform enhances lead generation, improves attachment rates, increases average revenue per user, and over time, should sustainably accelerate our service growth rate by two to three percentage points with a very attractive margin profile. In late September, we launched a new flexible tiered service offering powered by OpenBlue, which increases our capabilities around real-time remote service and monitoring, as well as predictive analytics. Lastly, turning to slide 16, demand for indoor air quality and healthy building solutions remain a key focus area, and we have seen significant uptick in interest from our customers since the beginning of the pandemic. For example, year-to-date sales of our Coke MERV 13 filters are up over 400% year-over-year. Our second half residential indoor air quality products were up 84% year over year. And in most cases, the revenue dollars for any one of these products individually are smaller, but in aggregate have been enough to partially offset some of the weakness we are seeing. In addition to some of our core offerings that have always served these markets, we have also rapidly innovated or redeveloped several new products for customized applications. I won't spend time on each one listed on this page, but this collection represents why we believe we are uniquely positioned to fulfill the different customer needs regarding healthy buildings. This focus on targeted innovation is one facet of our goal to accelerating new product introductions. Over the next three years, we expect to gain nice share and plan to launch over 150 new products in fiscal 21 alone. With that, I would now like to turn things over to Olivier to provide you with his initial impressions and our thoughts on fiscal 21.

Thank you, George, and good morning, everyone. I'm pleased to be with you on the call today, and I'm thrilled to be part of the Johnson Controls team. I've been in the office for about 10 weeks now, and I fully immerse myself in learning the business, and with the help of Brian and the finance team, understanding the strengths and opportunities we have in front of us as an organization. I cannot thank Brian enough for his guidance and alliance through this transition. I thought I might quickly share with you my initial impressions and perspective before I get into our forward outlook. I've been asked by some of you why I was drawn to this role at Johnson Controls, and I will tell you There were a number of reasons. From a personal standpoint, how we do things is incredibly important to me. I wanted to be part of an organization where culture, diversity, and inclusion matters, where focus on the environment matters, where developing people and meritocracy matters. I'm impressed by what the team has achieved over the last three years, its strategic vision, and the operational discipline that has been established. I also recognize there is still work to be done, particularly around optimizing the cost structure of our business model. I am very positive about the growth opportunities of the end markets we serve, smart, safe, healthy buildings, and by our vision around services, digital, and product innovation. Finally, I'm excited about the ability we have to drive above-market growth with best-in-class margins. That seems like a natural point to transition to our outlook, starting on slide 17. I mentioned my optimism about our served markets, and I think this depiction of our business mix shows a very balanced revenue profile, roughly split one-third each for products, install, and service. We have one of the largest installed bases of buildings globally with an unmatched direct channel footprint, both of which we can leverage to generate very attractive service opportunities. As George mentioned, service powered by OpenBlue is expected to be an attractive vector of profitable growth for the company. Looking at our installation portfolio, we are roughly evenly split between construction and renovation retrofit. Although many parts of this business remain challenged by the effects of the ongoing pandemic, our portfolio of healthy building solutions and retrofit activity can moderate the weakness in new build. Product revenue at 35% represents those products sold through our indirect channels and will not include products and equipment installed through our direct channel. This is our short cycle business that is typically book and ship. Turning to slide 18, this slide provides our end market exposure as well as a few economic indicators on the fiscal year basis we utilize as an input to our planning process. Construction app look is a barometer for the new construction portion of our installation business in North America, which is about 15% of our total sales. GDP tends to be the barometer for service market growth. As the market forecasts indicate, the global macro environment remains uncertain. However, given the attractiveness of our portfolio and the elements of our go-forward growth strategy George discussed, we feel very confident that we are positioned to outgrow our end markets. Now, let's turn to slide 19 with our views of fiscal 21 and our Q1 guidance. Current forecast for market recovery suggests the stronger second half of the year. We will continue to manage costs over the course of the year, keeping tight controls on the amount and timing of temporary cost reversals as volumes continue to normalize. We also add the carryover benefits from the permanent cost actions we took in the back half, which will partially offset the return of temporary costs. This, along with our focus on higher margin revenue growth, is expected to result in ongoing EBIT margin expansion. Regardless of the presidential election outcome, we are very confident in our ability to maintain a 13.5% tax rate in fiscal 2021. Free cash flow on a reported basis will approximate 95% for the full year and should follow a fairly normal cadence, with the majority of our cash being generated in the back half, in line with our traditional cash flow seasonality. With the majority of the large cash adjustments now being behind us, we are transitioning to an unadjusted cash flow metric. As part of our disciplined capital allocation, we expect to deploy the remaining $1 billion of proceeds from the power solution cell to share repurchases. Now, for our Q1 guidance. We expect to start the year off with organic sales decline in the range of 5% to 7%. The continued focus on the cost side will allow us to expand our EBIT margin 20 to 40 basis points. And EPS should be in the range of 39 to 41 cents. For the whole, continued strong performance in a challenging environment. With that operator, we can open the line for questions.

Thank you so much. At this time, if you would like to ask a question, please press star 1 on your touch-tone phone. Please ensure that your line is unmuted. Please record your name and affiliation to be introduced. In respect of time, we ask you limit yourself to one question and one follow-up question. Our first question is from Dean Dre with RBC Capital Markets. Sir, your line is open.

Thank you. Good morning, everyone, and welcome, Olivier, and best of luck to Brian. Hey, just to start off on the forward look and guidance, and we suspect that a lot of companies are still going to keep the annual guidance suspended, but you've given us enough data points in the forward look on pre-cash flow and the conversion to back into an EPS number. Just want to make sure our math is right. We're getting a 245 to 250 range here. I just want to make – and that looks like a brackets consensus. I just want to make sure that math is right, and is it just the point of still heightened uncertainty that's keeping you from framing that guidance officially?

So let me give you a bit of colors before to answer specifically to your question. We are, as you sense from the call, very confident about the position of the company, and we believe we're going to be able to navigate – this uncertain environment as we did last year. Now, as you alluded to, at this point in time, there was a lot of uncertainty regarding what is happening in the pandemic. We have had, particularly over the last few weeks, additional lockdown and restrictions in Europe, and we have a second wave in the US. So in this context, we believe we have a solid plan. We have momentum building and will be agile. As you said, we have stressed, tested our plan, and we believe that despite the uncertain environment, we're going to be able to deliver a very good EBIT margin expansion and a strong cash flow performance. Now, let me answer to your question specifically. Based upon the current market trajectory, and all of that is still a bit known, where that will go, we were looking at organic revenue growth in the low to mid single-digit range. Our sales force today is targeting gross part of the market, focusing on indoor quality and healthy buildings, and in verticals such as data centers, warehouses, And as George indicated, we're investing heavily in new product launches. Now, if you look at your EPS range today, we believe it's not an unrealistic expectation.

Great. That's real helpful. And then on the – I really appreciate all the new color on OpenBlue. A number of your HVAC peers have started giving at least some framework on what the indoor air quality funnel might look like. I was hoping you could quantify for us. You gave a data point on the filtration orders being up, but can you give us a sense of what the funnel looks like? We're seeing a bit of the retrofit North America business starting to come through, but we're hoping you could frame for us that opportunity as it stands today.

Let me just kind of frame up what we're doing on indoor air quality, how important it is, and then I'll kind of frame up what we see here within the pipeline. So I would start by saying it's clear that this is front and center with all of our customer engagement. So with the education that has been had around air quality and the impact that that has in mitigating the impact of the virus, that's certainly front and center. Now, there's many critical elements to delivering clean air. It includes ventilation, filtration, disinfection, and then isolation. And it's also combined with sensors around temperature, humidity, occupancy, and ultimately ties to building controls. And so our clean air strategy has been focused on finding the right balance between air quality as well as energy efficiency. And it's based on science-backed recommendations on clean air delivery rate, which is ultimately clean air changes per hour. We're You know, we're performing a number of assessments and starting points to align our solutions and services to each customer application and ultimately their clean air delivery rate target. And we're not simply making product recommendations. And there's really no one better position now to be able to help our customers operate healthy, safe buildings. It really is built on the combination of our HVAC portfolio with our security and building software platforms that do uniquely enable us to provide more powerful solutions based on specific customer outcomes. Now, in addition to that, Dean, we've got over 16,000 service experts around the globe, which is the size and strength of our direct channel footprint, which we believe creates a significant competitive advantage. And so as we look at this today with all of this activity, right from assessments to deploying capabilities, we're looking at a pipeline of a couple of hundred million dollars for 2021. And now longer term, I think the focus on clean air and striking the right balance between proper ventilation, filtration, disinfection, and then energy efficiency will ultimately lead to increased service activity, you know, system replacements and other emerging solutions. So as we look out over a few years, we think clean air, the market itself is multi-billions of dollars in incremental markets. And now with that, you know, not only with our strong position, but we've been expanding our partnerships to be able to accelerate our penetration in our go-to-market. And that's with universities, that's partnering with technology companies that have additional capabilities that we can combine with ours that ultimately drive the highest disinfection solution. And then that combined with our attractive channel, we believe that we have a unique technology unique channel where we can get partners and ultimately bring the best solution to the market.

Great. I appreciate all that, Carla, and best of luck to everyone.

Thank you for your question. Our next question is from Jeff Sprague with Vertical Research. Your line is open, sir.

Thank you. Good morning, everyone, and best of luck, Brian. Two for me. First, George, and this maybe picks up a little bit on what you were talking about, but You know, you were kind of talking about OpenBlue adding one to two points to your sales growth, and now you're saying two to three. You know, your confidence level is clear in your voice this morning, but interesting that you're already thinking a higher number before, you know, we're too far into this. So I just wonder if you could elaborate a little bit more on your thinking around that incremental growth rate and how the customer conversations are going.

Yeah, let me start, Jeff, by talking about the strength of our OpenBlue platform. And so for everyone on the call, it is a complete suite of connected solutions that enables the delivery of more impactful sustainability, new occupant experiences, and enhanced safety and security that does combine with our longstanding expertise in buildings with cutting-edge technology. And it does enable us, along with our customers and partners, to fundamentally transform how spaces and places are experienced, and that are ultimately safe and protected. So what it does, it combines everything that we do in a building, and through leveraging connectivity and data, allows us to be able to create new outcomes. And we truly do believe that this differentiates what we do through our direct channel footprint with this significant installed base of equipment and service that we have today, that we can actually amplify this now with digital solutions. So let me talk a little bit about the progress we've made. In the last 90 days, as I said in my prepared remarks, we've had significant engagement, customer engagement, right from the start. And we've kept the momentum going with the release of several new solutions, including OpenBlue Workplace, new tiered flexible service offerings under OpenBlue, OpenBlue Enterprise. And there's many, many more coming over the next several months, including five that are planned in the first quarter. Now, let me move to customers. You know, when you look at the customer wins, We're very excited. I mean, the one example I talked about was one of the largest real estate developers in Asia who is a leader in facility management. They ultimately selected our OpenBlue Enterprise Manager solution, which is a software solution that helps customers manage large portfolios of properties. They've now deployed that across 42 of their buildings in Singapore. So we're embedding OpenBlue in everything we do and the enhancements we're making to our go-to-market strategy. We've already built, when you look at the pipeline that now OpenBlue is connected to, so our multi-year pipeline, it's well over a billion dollars of opportunity when you take what OpenBlue does, not only as a standalone, but how that combines with our core capabilities in how we go to market. And then, like I said, we've supported that with partnerships with Microsoft, Accenture, Cisco, and Intel. And when you look at these partnerships, they're integral, I would say, on many levels. to ultimately deliver a complete outcome-based solution that our customers are asking for. And we believe that we have a lot to offer as a partner.

Thanks for that. And just on the cost headwinds and tailwinds, you gave a very explicit table and chart on the Q3 call. I'm wondering if all those numbers are basically the same, the $240 million to $260 million tail on permanent and kind of what you gave us on the temporary, and I guess whether the answer is yes or no. Can you give us a little bit of color on, you know, how these kind of feather in and out over the course of this year? Thank you.

So, Jeff, before I answer to the specific of your questions, we have said that in the past, but we want to repeat it because it's very important. We believe we have the opportunity to improve the return on sales of our business going forward. And we believe we have opportunities in both growth margin and OPEX management. And if you look at the prepared remark from Brian, improving the margin rate by about one full point year on year last year, despite the environment, was remarkable. So that says a lot about the execution discipline of the company. And we believe we have said that and we have done some modeling lately. We believe that a 30% incremental is an achievable goal. and required goal for the company. Now to answer specifically to your question, the net 40 million that Brian mentioned before is still valid. We would expect those costs to come back mainly the second half of the year. So we believe that it's the best way to plan for those costs. However, we're still looking at levers to mitigate those costs to come back in the second half but it's too early for us to commit, Jeff, at this stage.

Thank you for that. I'll pass it on.

Thank you so much for your question. Our next question is from Nigel Coe with Wolf Research. Your line is open, sir.

Oh, thanks. Good morning. I just wanted to come on the back of Jeff's question there. So the, obviously, the temporary costs coming in towards the back end of the year, The structural costs, is that more linear through the year? Are we seeing some of those coming through in the 1Q guide?

So at the moment, for the first half of the year, we have a net benefit to the P&L when you look, Nigel, at the permanent and temporary costs coming back. And the headwind will come in the second half and more in the Q3 fiscal quarter, Nigel.

Great, thank you. And then, obviously, the service kind of acceleration is really encouraging, and also the billion-dollar pipeline. Has that billion-dollar funnel, has that been built since you sort of self-launched OpenBlue, I think in mid-2000s, I can't exactly remember the date, but I think in the last several months, has that all been built in that time frame? And do you have any indication on sort of the timeline to the service revenue accelerations?

Let me go back, Nigel, to the pipeline. That pipeline is when we do, as we're doing installs and now taking our digital capabilities with OpenBlue and combining that with our core capabilities and ultimately then deploying that as a solution. So that isn't just service. That is ultimately creating a much bigger install base with our digital capabilities that will then spin off services from that. So that's what I talked about there with the DigitalBlue As far as the services, you know, what we get with OpenBlue, you know, it allows us to be able to not only differentiate the core of what we do with our services, making everything connected, utilizing data to optimize our delivery of service, and then adding new services on top of that. And that's what OpenBlue allows us to do. It enhances our ability to be able to immediately attach service contracts, and we're starting to see a nice pickup in our contractual services, and that will continue to improve as we go forward. And then from a revenue per customer standpoint, it ultimately allows us to now build on top of that base of service new capabilities and be able to deliver enhanced value, which ultimately then we get paid for. And so it's really a combination of not only expanding our installed base with OpenBlue, but then being able to mine that installed base with additional services on a recurring basis.

Thanks, George. Just to clarify, the funnel, though, has been built this year, correct?

Yeah, the funnel, I mean, when we look at our pipeline, what we've done, Nigel, is take everything that we do with how we go to market. OpenBlue now becomes part of what we offer and how we differentiate not only the solutions that we go to market with and install, but also the capabilities that we deploy to be able to attach service and then perform the service over the life cycle of that installation.

Okay, I'll leave it at that. Thanks, Drew.

Thank you for your question. Our next question is from Steve Tusa with J.P. Morgan. Your line is open, sir.

Hey, guys. Good morning. Good morning. Just curious, how much does the, you know, one of the big differentiators versus you guys and your, you know, HVAC equipment peers at least is, you know, your control system, you know, the kind of Metasys platform. Maybe that brand's changed. But how much of a differentiator is, you know, having that, you know, controls legacy, if you will, you know, the building controls legacy over and above the kind of HVAC and fire and security?

Yes, Steve. Let me just start by talking about commercial HVAC and the importance of not only the equipment but also the digital capabilities. You know, when we look at these markets, they're very attractive with long-term secular drivers that ultimately align with our core capabilities in both equipment as well as digital. And the secular trends of energy efficiency and sustainability enabling us to be able to now mine a much larger installed base with the connectivity with our digital offerings. And then the ability now, as we discussed previously with Nigel, which opens up an opportunity for us to be able to build on additional services. And then ultimately capitalizing on the emerging trend with indoor air quality and healthy buildings. So all of these trends, the ability to be able to take a holistic solution with our equipment plus our digital platforms, which from a building system standpoint, it is Metasys, and then being able to connect every other device and every other system within a building is what uniquely positions us to be able to bring the most, you know, the best solution, the most efficient solution, and ultimately delivering on the customer's priorities. And when I look at what we do, you know, we're very well positioned with that combination of not only leadership products that we've been reinvesting in, but also now industry-leading controls, embedded software, with also our digital offerings and building automation software that all complement the core. So although we push intelligence to the edge, the ability to be able to take that intelligence within one platform and to be able to create new outcomes is a competitive advantage. And we're going to be continuing to not only differentiate what we install, but also how we go about capitalizing on the service opportunity, which is what contributes to being able to accelerate our service growth on a go-forward basis.

Right. So said differently, the control system is key. And then just one – Maybe, correct me if I'm wrong. Just one other nitpicky one. You guys bought in a JV, I think, at least on the cash flow statement. It suggests you guys had some activities there. Were there any P&L impacts on that? Sometimes companies that we cover buy in JVs and they book a gain on their ownership. Any impact on the P&L from that front?

Steve, that was related to the buyout of Qolsys. We had a majority interest in Qolsys already, and we bought out during the quarter the remaining 42% of those shares. So the activity that you're referring to was an entity that we historically have consolidated. So there was no unique P&L and Q4 related to that.

Great. Thanks, guys. Thanks, Steve.

Thank you. Thank you for your question. Our next question comes from Gautam Khanna with Cohen. Your line is open.

Thank you. Congrats, Brian and Olivier. Thank you. I had a couple questions, George. Maybe if you could elaborate on the IAQ opportunity. Carrier had talked about it at like $9 to $10 billion in aggregate. I wondered if you would agree with that assessment. Secondly, Maybe if you can talk about whether you think IAQ sort of becomes a table stakes for some of these commercial building operators, because it seems like there is a conflict between energy draw going up when you utilize some of these solutions and, you know, what has been the compelling case to renew applied systems, which is, you know, the energy consumption drops with the new technology. You know, just how you kind of frame that. Do you think it's table stakes? Do you think it's kind of a short-term solution? blip while we have COVID and then maybe we'll revert back or just your opinion on that topic.

Yeah, so when we talk about indoor air quality, as far as the market, so you've seen numbers from Navigant where there's like a trillion seven of square footage and about a quarter of that is ultimately non-resi space and then within that today's level of air purification is well below what would be now in this environment perceived as being acceptable. And so as I talked about the key elements of being able to provide, you know, the right solution, it does include multiple domains or multiple capabilities, whether it be maintaining or maximizing the ventilation, bringing the highest level of filtration. So it might be today MERV 8 and moving towards MERV 13. It includes deploying potential disinfection technologies. And then like in a healthcare, it's isolation. And so what we do is be able to not only provide the best solution that ultimately delivers what we call the clean air delivery rate, which is clean air changes per hour with a level of purification, but also making sure that we're doing that and optimizing the energy required to ultimately perform and deliver on that outcome. And so we are working feverishly here, not only in how we deploy these multiple capabilities, but how we optimize those with our building controls and ultimately bring in the best solution at the least amount of energy required. We believe that there's optimization that can be had where you can get to a much higher standard while you're still delivering on the sustainability goals of our customers. And that's what we're ultimately focused on doing with the technology developments that we have underway.

Thank you.

Thank you for your question. Our next question is from Nicole DeBlaise with Deutsche Bank. Your line is open, ma'am.

Yeah, thanks. Good morning, guys.

Good morning.

I just wanted to focus a little bit on the first quarter guidance. Looks like you guys are kind of projecting organic revenue decline similar to what you saw in 4Q. I'm just curious if that reflects kind of stabilization in organic trends throughout the quarter or if you did see improvement into, you know, the later parts of the quarter and into October.

So, Nicole, we are seeing today, you're right, a gradual improvement in our business environment, both for our field business and our global product segment. So if you look at our order book, and I'm not talking about revenue for now. We'll give you the specificities in a second. An order book is more representative of the current velocity of the business. We see Q1 as being an improvement over Q4. So if you look at our field business specifically, we are seeing in Q1 all the velocity for our field business being sequentially better by one of two points. relative to Q4. And what you see is you have our install business, which is booked now, but the orders were recorded about two quarters ago, give or take. So you see this install business, because of this lag in the quarter, being still down. And you see, as George mentioned, an acceleration of our service business, which is largely because of setting what is happening in install. So that's for our field business. If you look at our global products, again, we see today that we are gaining shares in the product we sell. And we're experiencing, because of our product portfolio, the impact of the delay in commercial HVAC and fire and security businesses. And as we move into Q1, we see today a slightly larger revenue decline relative to Q4. And what is happening, and you saw that in our opening remarks, Nicole, Q4 was very strong and largely, not largely, but in part due to the demand we satisfied in Q4 due to the depressed Q3 we had. So if you look at the two-year stack, Q1, financial year 21, will be similar to Q4. So overall, an environment from a revenue standpoint which is comparable to Q4 and we believe it's a prudent approach despite an improvement in the level of order velocity. But as you saw in our guide, we believe we need to be able nevertheless to protect the bottom line due to our cautious cost mitigation activities.

Got it. Thanks, Libby. That's really helpful. And then maybe just a follow-up also on the first quarter. When we think about the 20 to 40 bps of expected margin improvement, can you just talk about any divergences between the segments? I know global products face some unique challenges this quarter. Does that continue into the first quarter? And anything on the field businesses that we should make sure we think about?

We believe that without going into too much details, we will see some negative impact on our global product business for two reasons. One, absorption of fixed costs and two, product mix. And our field business is keeping its momentum from a margin improvement standpoint.

Got it. Thank you. I'll pass it on.

Thank you, Nicole.

Thank you. Thank you for your question. Our last question will come from Scott Davis with Milius Research. Mr. Davis, your line is open.

Hey, good morning, everybody.

Hey, Scott.

Good morning. A couple questions, but first just is George's M&A still on the table as a possibility in 2021?

Yeah, I mean, absolutely. We're going to be very disciplined, but certainly as we look at our capabilities and as we look to enhance some of our positions in technology, and as we build out OpenBlue, there's certainly going to be opportunities that we're going to pursue and have been pursuing. We've done some in the past year. We've done some bolt-ons. We completed the acquisition of Qolsys, which has helped us from an interactive standpoint, technology capability that we're now leveraging more broadly. So, yeah, that's going to be, you know, as we think about growth, it's part of our capital deployment.

Okay. And then on OpenBlue, George, and I know there's been a ton of questions, but just to clarify, when you do an install, I imagine there's a fair amount of upfront customization. And do you charge for that, or is that part of kind of the, you know, the SaaS pricing you expect, you know, over time to have, you know, perhaps a break-even period and then, you know, a more profitable period after that? Is that a way to think about it?

Yeah, so, Scott, when you think about our install business today, it is an applied – business where we apply engineering, we configure solutions, we deploy those solutions with install, and then ultimately we look to attach and get the lifecycle service. And so today, in many ways, we do incur a lot of engineering up front before we ultimately get a contract, and then we take the contract and continue to pursue that. What OpenBlue does for us, it really changes the level of engagement with our customers, where now with OpenBlue we can significantly change the outcomes that we can produce with the installations or solutions that we propose. And then with that, that is incremental to what we historically would have done and certainly get paid for that up front with the ability now to be able to attach recurring revenue, you know, onto that service on a go-forward basis. And so that's why when I say when we look at our pipeline of projects, and we begin to deploy OpenBlue with those projects. It truly does differentiate how we can go to market and ultimately create outcomes that historically we haven't been able to achieve.

That's helpful. Thanks. Good luck, guys. Thank you.

Thank you, Scott.

Thank you for your question. I will now turn conference back over to George for some closing remarks.

Yeah, just to wrap up here, I want to thank everyone again for joining our call this morning. I'm incredibly proud of how our teams responded in a time of global pandemic and the progress that we've made as an organization, and I'm extremely pleased with our continued strong performance and very excited about the future opportunities which we discussed today. I hope that you and your families remain safe, and I look forward to speaking with many of you soon. So, operator, that concludes our call.

This does conclude today's conference call. We thank you all for participating. You may now disconnect and have a great rest of your day.