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spk07: Good morning and welcome to the Johnson Control's fourth quarter 2023 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note today's event is being recorded. I would now like to turn the conference over to Jim Lucas, Vice President, Investor Relations. Please go ahead.
spk09: Good morning, and thank you for joining our conference call to discuss Johnson Control's fourth quarter fiscal 2023 results. The press release and all related tables that were 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 Controls Chairman and Chief Executive Officer, George Oliver, and Chief Financial Officer, Olivier Leonetti. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements. Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the control of Johnson Controls. These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to carefully review the risk factors and cautionary statements in our most recent Form 10Q, Form 10K, and today's release. We will also reference certain non-GAAP measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are contained in the schedules attached to our press release and in the appendix to this presentation, both of which can be found on the investor relations section of Johnson Control's website. I will now turn the call over to George.
spk10: Thanks, Jim, and good morning, everyone. Thank you for joining us on the call today. Before discussing our fourth quarter in fiscal 2023 results, I wanted to take a moment to thank all of our employees for their quick, agile response to the cyber incident beginning in the last week of September. Our teams responded quickly and worked diligently to minimize the impact from the incident. We greatly appreciate everyone's patience from customers to suppliers to shareholders as we work through our remediation efforts. We now have the incident behind us and our operations are back to normal. Now let's begin with slide three. We feel it is important to not lose sight of the strong year we had in fiscal 2023, regardless of the impact on our fourth quarter results from the cyber incident. For the full year, we grew sales organically 8%, expanded segment margins 80 basis points to 15%, and delivered adjusted EPS growth of 17%. We saw continued strength in our service business as our efforts in maximizing our large installed base are coming to fruition. In fact, we grew service 10% for the year with solid order momentum ending the fiscal year. Our total backlog grew 9% to $12.1 billion as demand remains strong across our commercial building solutions offerings. In fiscal 2023, we generated $1.8 billion in free cash flow, which represented 76% conversion. During the year, we returned $1.6 billion to shareholders via dividends and share repurchases. Our capital allocation strategy remains unchanged, targeting to return 100% of our free cash flow to shareholders through dividends and share repurchases. We have the highest conviction ever in our strategy to lead in building solutions and will continue to prioritize allocating capital accordingly toward that objective. Overall, we are pleased with our continued execution despite macro-driven headwinds over the fiscal year and believe that we are well-positioned heading into fiscal 2024 with our strong backlog and resilient service business. We are initiating guidance for fiscal 2024 for approximately mid-single-digit sales and adjusted EPS growth, respectively, and for a free cash flow conversion of approximately 85%. Olivier will provide additional color on the guides later in the call, but fiscal 2024 will show improvement following a seasonally slower first quarter. Now turning to slide four, demand for our building solutions is accelerating with our customers around the globe as we are developing applied solutions to deliver outcomes that save energy and reduce emissions while improving the overall occupant experience. We are able to achieve these outcomes not only through our leading domain expertise and applied HVAC and control solutions, but also through world-class fire detection and protection and smart security solutions enabled by an industry-leading digital platform, OpenBlue. All of our systems build on each other and are complementary components of our total solutions offerings. The journey starts with our customer as we design, digitize, and deploy solutions that achieve efficiency, sustainability, and decarbonization. This turnkey offering drives operations, service, and maintenance, which underpin our as-a-service offerings that make building smarter through our digital solutions. This helps our customers enable peak operating conditions, protect investments, and achieve the lowest lifecycle cost. Johnson Controls is unique with our value proposition to make buildings smarter through OpenBlue. Our comprehensive ecosystem of connected digital solutions for buildings can break down silos and connect building systems regardless of equipment OEM and make them interoperable to build resiliency and efficiency. We were honored recently to be ranked number two on the GuideHouse Insights Leaderboard in an assessment of leading energy service companies. The recognition underscores our commitment to excellence and sustainability on a global scale. It is a testament to our hard work and continued commitment to helping clients meet their sustainability goals. Moving on to slide five, fiscal 2023 saw continued strength in install orders, which creates a strong service opportunity over the life of the equipment. As we advance our digital strategy, including more than doubling our connected assets during the fiscal year, we are gathering more intelligence through data. This data allows us to better segment customer needs and create more proactive offerings across all of our domains, effectively utilizing our industry-leading service organization of over 20,000 professionals that make over 5.5 million visits annually. With our large installed base, improved operations, and strong pipeline, we see a long runway of continued growth for our service business. Turning to slide six, our value creation framework remains unchanged. We truly believe we are well positioned to drive continued growth, delivering solutions across sustainable and healthy buildings, while leveraging the increased adoption of OpenBlue to drive margin expansions. Our pipeline remains strong in our longer cycle building solutions business as we continue to realize top line growth. Our shorter cycle businesses and global products, primarily global residential HVAC and parts of fire and security, are stabilizing as the new fiscal year progresses. Converting our strong top line growth into improved margins and cash flow is our top priority. We are beginning to see our gross margins improve as supply chain disruptions continue to lessen. Within building solutions, we are also seeing stronger margins in our record backlog, and as service continues to accelerate, we should see favorable mix as well. Cash flow is a key area of focus for us. On the receivables front, we are making progress in improving the longer collection cycle historically associated with our install business. Inventories in our short cycle businesses continue to reduce as lead times normalize, and we are adding capacity to meet the strong demand in our applied HVAC business. As you can see, we are very excited about the opportunity ahead. I will now turn the call over to Olivier to go through the financial details of the quarter.
spk01: Olivier? Thanks, George, and good morning, everyone. Let me start with the summary on slide seven. Total sales grew 3% to $6.9 billion, while organic sales increased 2% with another strong quarter from our service business, which grew 9% organically. The cyber incident was a 1% headwind in the quarter. Adjusted segment A was flat year over year with margins declining 50 basis points to 16%. Price cost was positive and we delivered strong productivity savings, achieving our $340 million target for the year. Turning to our EPS bridge on slide eight. Adjusted EPS of $1.05 increased 6% year over year and include a $0.04 headwind from the cyber incident. Operations contributed $0.03 of the growth in the quarter, benefiting from positive price cost and our ongoing SG&A and COGS actions. Below the line, we saw favorability from non-controlling interest and a lower share count. Let's now discuss our segment results in more detail on slides nine through 12. Beginning on slide 9, organic sales in our shorter cycle global products business, excluding the 2% headwind from the cyber incident, were flat year over year, with price offsetting a decline in volume. Global products saw continued strength in commercial HVAC, which grew high single digits after growing mid-teens in the comparable period one year ago. Demand remained strong, and our leading position in commercial HVAC was further extended in fiscal 2023. Supply and security declined low single digits as inventory further rebalanced as lead times improved materially year over year. Industrial refrigeration had another strong quarter, growing over 45%, driven by eMILA. Global residential decline high teens driven by a greater than 30% decline in North America and a high singular digit decline in rest of world. North America faced challenging year-over-year comparisons as we were still working out of a backlog from last fiscal year. In Europe, the heat pump market overhaul experienced lower growth than anticipated. As our book-to-bill business begins to normalize with improved lead times, our global products third-party backlog decreased 4% from the prior year to $2.5 billion and remained flat sequentially. Adjusted segment A margins declined 85 basis points against a tough comparison to 21% as continued weakness in global residential offset positive price cost and productivity savings. One of the biggest factor impacting our global products margin performance is due to lower absorption costs in global residential business. Moving to slide 11 to discuss our building solutions performance. Order momentum remains strong with 9% growth. Service orders grew 7% in the quarter and 11% for the full year as our transformation into a service-led organization gains momentum. Install orders increased 10% led by double-digit orders in North America and in ELA. Organic sales grew 5% driven by strong growth in service of 9%. Install grew 2% organically against a tough comparison. The cyber incident was a 1% headwind in the quarter. Adjusted segment EBITDA increased 5% while margins declined 10 basis points as a higher mix of equipment installations and weakness in China offset positive price cost and saving from productivity initiatives. Strong equipment sales are an important contributor to future higher margin recurring service revenue. Building solutions backlog remains at record levels, growing 9% to $12.1 billion. Service backlog increased 12% and installed backlog grew 8% year over year. Let's discuss the building solutions performance by region on slide 12. Orders in North America increased 8% with continued strength across our HVAC and controls platform, up over 20% year-over-year. Overall, there was robust demand in our office, data center, healthcare, government, and manufacturing sectors. Install orders increased 11% year over year with solid growth in new construction. Sales in North America were up 8% organically with broad-based growth across the portfolio. Our install business grew 9% with continued momentum in new construction, up 25% year over year. Organized sales in service grew 7% in the quarter and 8% for the full year, driven by strong performance across our shorter-term transactional business, which is the direct result of having a large customer base. Sales across our HVAC and controls platform grew high teens year over year, while fire and security was flat. Segment margins expanded 70 basis points year-over-year to 15.4%, driven by ongoing productivity benefits, the continued execution of higher margin backlog, and strength in our higher margin service business. Total backlog ended the quarter at $8.3 billion, up 10% year-over-year. In Mila, orders were up 16% with solid contributions of 16% growth from both surveyed and installed. Demand in commercial remained strong, growing 50% year over year, driven by HVAC and security. As the decarbonization efforts in Europe continue to gain momentum, our offerings in industrial refrigeration, and HVAC and controls increased orders by over 20% across the industrial sector. By region, all the growth was broad-based. Sales in Imila grew 3% organically, led by meeting growth in service with double-digit growth from both our recurring contracts and our shorter cycle transactional business. Applied commercial HVAC and fire and security grew low single digits within the quarter. Segment EBITDA margins declined 160 basis points to 7.8%, driven primarily by execution of lower margin jobs within the backlog. Backlog was up 10% year-over-year to $2.3 billion. In Asia-Pacific, orders grew 3% driven by double-digit growth in service with healthy growth across our HVAC and controls platform. Overall, we saw strong demand in the institutional sector growing over 30%. Sales in Asia Pacific declined 6% as the installation business was impacted primarily by weakness in China. Our service business continued a momentum of double-digit growth, increasing 11% in the quarter and 14% for the full year. Overall, fine security grew mid-single-digits, while HVAC and controls declined high single-digits. Segment EBITDA margins declined 50 basis points to 13.5% as weakness in China offset ongoing productivity savings and positive price cost. Backlog of $1.5 billion is flat year over year. Turning to our balance sheet and cash flow on slide 13, we ended the fourth quarter with approximately $800 million in available cash and net debt declined to 1.9 times, which is lower than our long-term target range of 2 to 2.5 times. As George mentioned, during 2023, we returned $1.6 billion to our shareholders via dividends and share repurchases. Our free cash flow conversion of 76% was better than our updated guidance. On the working capital front, our receivable collection has extended as our installation business, critical to generate our service business, has grown. We are making structural changes, such as more upfront payments, to improve our cash collection cycle in the installation business. While inventories remain elevated versus hysterical levels, primarily due to the challenges in our global residential businesses, we saw overhaul inventories improve five days sequentially in the fourth quarter. We anticipate further improvement entering fiscal 2024. we have the fundamentals in place to be a 100% cash conversion company over time. However, continued growth investments and some further restructuring in fiscal 2024 will be headwinds in the fiscal year. Now let's discuss our first quarter and fiscal 2024 guidance on slide 14. We're entering fiscal year 2024 with a backlog at historical levels, strong momentum in our industry-leading service business, and broad-based demand across end markets. We're introducing first quarter sales guidance of approximately flat year over year as we return to normalized seasonality. Our forecast includes a roughly 1% headwind from the cyber incident, as well as continued weakness anticipated in China. We expect building solutions momentum to continue, led by our resilient service business. Global products faces a tough year-over-year comparison as we were working through elevated backlogs in the comparable quarter last year, especially in residential HVAC and certain far-end security and direct channels. For the first quarter, we expect segment EBITDA margin to be approximately 13% and adjusted EPS to be in the range of 48 to 50 cents. We're expecting a slower start of the year as we return to more normalized seasonality, incur the negative impact from the cyber incident, and anticipate continued weakness in China. For the full year, we anticipate global products to stabilize in the second half of 2024 as backlog continues to normalize and building solutions converts its higher margin backlog. We expect organic cells to grow approximately mid-single digits with building solutions leading the growth, particularly in service. Segment EBITDA margins are expected to expand approximately 25 basis points or greater as price cost remains positive and makes improve throughout the year. Adjusted EPS should be in the range of approximately $3.65 to $3.80, representing growth of 4% to 9% year-over-year. For the first quarter, we anticipate our normal seasonal cash usage with incremental impact from the cyber incident. We expect free cash flow conversion to be 85% for the full year. Our results and guidance reflect great progress advancing our service strategy enabled by digital, momentum in our commercial products offering, and we enter fiscal 2024 with strong order momentum and record backlog in our longer cycle building solutions business. With that, operator, open up the lines for questions.
spk07: Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you're using a speakerphone, we ask that you please pick up your handset before pressing the keys. To answer your question, please press star then 2. In respect of time, we ask you to limit yourself to one question and one follow-up question. At this time, we will pause momentarily to assemble our roster. And today's first question comes from Jeff Sprague with Vertical Research. Please go ahead.
spk02: Hey, thank you. Good morning, everyone. Maybe we could just touch on cash flow a bit more. You know, A, how much kind of recovery, you know, from the cyber incident do you kind of expect embedded in this 85% in 2024? And then also, it seems peculiar, Olivier, your net financial charges are going up to $420 million per year guide versus $280 last year. Is there something going on in the factoring or something else in kind of the capital structure that would explain that sort of delta year over year?
spk01: Thank you for your question, Jeff. Regarding the free cash flow, we had an impact in the first quarter, which we believe will be about $200 million. If you look at the guide for 24 at 85%, That includes two elements. One, some restructuring and also some investments in CapEx to support the strong demand in our applied business. George mentioned that in his opening remarks. If you look at the levers of improvement for free cash flow, we see one, inventory reducing as we reduce our inventory in resi. Two, in receivables, we believe we're going to be able to demand more upfront payments as our lead time have improved. And also, we have implemented our supplier financing program across the network, and that will help further improve GPO. To go back to your net financing charge is the byproduct of higher interest rate. We are going to refinance some debt. We have some commercial papers as well, which have been to be priced at the current higher interest rate. Factoring is a small proportion of the cost.
spk02: And then separately, Could you just address, I mean, orders obviously looked pretty solid in the quarter. Was there any impact from the cyber and the ability to kind of book orders, either as you ended the September quarter or as you've entered this particular quarter? Maybe just give us a little bit more color on what the challenges were in the business as you worked your way through this.
spk10: Yeah, so when we look at our orders, Jeff, you know, obviously they continue very strong. And I think we're seeing strong growth in office data centers, healthcare, state and local government, education. We do see manufacturing industrial bookings continue at an elevated level after a strong growth in construction starts. It is focused on the EV and semiconductor manufacturing. And then when we look at our pipeline, it's very strong. And a lot of that pipeline is focused in these key verticals. I would say from a booking standpoint, we were tracking prior to the cyber incident a little bit better. And then with the outage, you know, I think we're somewhat slowed a bit in that last week. But I think as we look at, you know, first quarter and for the year with the pipeline that we have, we're going to see continued strong water growth. And I think when you look at our, you know, mainly around, you know, the commercial HVAC trends. Um, it's clear that we're, we're gaining share pretty much across all of the industries that's creating, you know, significant equipment sales into our building solutions business, which is creating a really nice installed base that we're now capitalizing on, on the service opportunity in building solutions. Our applied orders were up, uh, about 20%. And then, um, You know, in the ducting space, when you take out resi, our commercial ducted was up over 50%. So, you know, our portfolio of commercial HVAC is playing out strong. And that ultimately is what's driving, you know, the installed base within our commercial, you know, within the commercial building solutions business.
spk07: Thank you. And our next question today comes from Joe Ritchie at Goldman Sachs. Please go ahead.
spk04: Thanks. Good morning, everyone. Morning. Hey, guys. Can we start on just the mix impact this quarter? I was a little surprised to see the business solutions business see a $100 million impact from mix, and also because it seems like your service business has farly exceeded growth versus install this quarter. So what exactly is going on within business solutions that's driving negative mix? And is that expected to reverse in 2024?
spk01: So if you look at the equipment sales today, particularly in the high end of our market, we are gaining share. This is a strong part of the market. This business is very attractive for us because for $1 of hardware, we typically generate over the life cycle of the equipment another $9 of solutions, including hardware. $4 of services. And you saw also Joe in services today, we clearly have momentum. Services is growing fast, enabled by digital. And as a reminder, services is twice the profit of the average of the company. So this mix is based upon equipment sales. which would generate attractive profit with the service annuity and solution annuity.
spk04: Okay. Got it. Understood. And I guess maybe my one follow-on question then would be on 1Q. And so to look, it's December 12th. We're clearly, you know, well into the quarter. You've given a fairly, you know, narrow range for the first quarter. I guess I'm just trying to understand two things. Number one... confidence that that will be the range when you report results. And then secondly, just any help that you can give on the bridge, because even if you adjust for the insurance settlement from last year, it seems like a relatively large decline in the first quarter, despite flat organic sales expected this year.
spk01: So if you look at Q1, we see a strong order momentum continuing. If you look at, of course, the confidence, we have now a few days to go before the end of the quarter. So that by itself answer to the question. If you look at what is happening in Q1, we have strong momentum in our building solution business. Service solution powered by digital is going fast. We see weaknesses in our global products division, particularly as it comes from resi. We have some impact also in China. Also, we have the impact of cyber, which is about 1% of the top line, and it's difficult to dimensionalize exactly about 2 cents of EPS. And last but not least, GP now is going through a more normalized seasonality after a few years of supply chain impact.
spk07: Thank you. And our next question today comes from Scott Davis at Milius Research. Please go ahead.
spk05: Hey, good morning, guys.
spk01: Good morning.
spk05: Can you guys give us kind of help us understand the materiality of data centers? It seems obviously really bullish commentary. We've heard from many folks and don't always think about JCI and the data center business, but certainly you guys have a meaningful presence. So can you help size that for us?
spk10: Yeah, Scott, let me take that one. When you look at, you know, as we look at data centers, we've been obviously reinvesting in all of our applied product to have the full portfolio to be able to capitalize on what we see to be incredible growth here over the decade. And so when you look at a typical data centers, let's take 100 megawatt data center, that requires roughly about 30,000 tons of cooling. That can be served right now. The big trend is air-cooled chillers. We're the leader in the space with the investments that we've made in being able to deliver on those capabilities. And that's where we're seeing significant growth in serving that set of customers. And so it can either be air-cooled or water-cooled. Of course, water-cooled, we're in a strong position. So roughly about 30,000 tons of cooling So when you look at the market in 24, we're projecting somewhere 15 to 20 gigawatts, which will amount to about five tons of cooling needs. Now, because of our position with our strong portfolio of the full technology to serve these, we believe we're positioned to get, you know, let's say half of that volume going forward, which the overall volume would be greater than $2 billion. And so for us, this has been a position of incredible strength. A lot of that is because of our multi-generational developments we've made at our engineering center. Just a comment on that. Just in the last 90 days, we've had customers representing over 20% of the US GDP at our technology center. Because as we're laying out long-term plans with our customers, we're making sure we're positioned with the applications that ultimately achieve their needs. And so It is a very attractive space for us, Scott. And then from a service standpoint, once we get that unit installed, we're getting very strong service growth on top of that, which will then be over the lifecycle of that installation.
spk05: That's helpful, George. And when you think about putting, you know, servicing an AI kind of heat-intensive data center, Is that higher margin? A is a higher margin, but B is a higher margin. If it is, is it higher margin because of the complexity or because of just the scale that you're just getting so much more content into that facility?
spk10: Yeah, I think it's both. I mean, the criticality of the applications that we provide and then the ability to be able to operate within those conditions and then from a data standpoint, making sure that we're We're secure relative to what we do and how we manage the data that ultimately delivers the outcomes that we can deliver. You know, certainly the work that we've done around OpenBlue and the cloud-based technology there, none of that was not interrupted at all with our cyber incident. So a lot of that is we believe it's high margin service opportunity, not only at the equipment level, but then with the use of all of the data to enhance how that equipment is actually operated in their environments.
spk07: Thank you. And our next question today comes from Steve Toussaint with JP Morgan. Please go ahead.
spk06: Hi, good morning.
spk01: Morning, Steve.
spk06: Can you spread a little bit more detail around the impact from the cyber attack? I mean, I think you said $0.04 in the fourth quarter, but it was kind of late in the fourth quarter. And then in particular, which businesses it impacted, just kind of the mechanics of the thing. And then just clarify what you're saying in the first quarter. I think you said $200 million in cash, but then – two cents of earnings I might have missed. I'm not sure I can reconcile all those numbers, so maybe just a little more mechanical detail on the impact of the cyber attack.
spk01: Let me give you some of the numbers. In Q4, we believe that the impact on the top line was about 1%. It will be the same in Q1. What you have going on, Steve, I will go to DPS impact in a second, is what you lose in Q4, you recover some of it in Q1, right? That's why you have those numbers going on. So 1% in revenue. in Q4 and in Q1. The EPS impact in Q4 is about $0.04 and the impact in Q1 about $0.02. What is mainly impacted is everything which is short cycle. If you need to satisfy a demand for something that you need to have in inventory, if you don't have it, you lose it. That's where the impact will be. My 200 million impact in cash is lower collection in the first quarter because we're not able to bill immediately as we could not bill immediately then that has delayed collection. That's the 200 million, Steve.
spk10: Steve, just when you look at the overall event, it did create significant distraction internally. It wasn't one or two days. It actually was about three weeks which was the better part of October. So while we're able to quantify some of the impact, I think it's harder to put a number to the overall impact in October. Although we maintained operations, we weren't necessarily operating at full efficiency. But I would tell you the way that our teams have responded and actually got back to operations has been remarkable. And so I do believe Just from an overall momentum standpoint, we lost a little bit of momentum in October, but I can tell you in November and December, we've gained that back.
spk01: Steve, a final detail. We have substantial insurance coverage and a large proportion of our costs, including business description, will be covered by insurance.
spk06: Okay. And so I guess I'm just struggling to see how you get from like 50 cents in the first quarter, which seems like an operating base to, you know, I don't know, 375 for the year. That just seems like a pretty steep hill. And I mean, are you, I know you're probably assuming that, you know, the comps maybe get a little bit easier in some of the products businesses, but I mean, are you assuming like recovery, true kind of economic underlying recovery in some of those short cycle businesses for the back half of the year?
spk01: So what we see happening is earning growth to return doing Q2. What we see today is momentum in our building solution business. We talked about that at length. Equipment services enabled by digital are resonating with our customers. We see GP stabilizing in Q2 and more normalized growth in the second half for our global product division. If you look at the theme for the year, commercial strength, service strength, with service expected to grow high single digits plus in the year.
spk07: Thank you. And our next question today comes from Julian Mitchell with Barclays. Please go ahead.
spk16: Hi, good morning. I just wanted to... understand some of the free cash flow moving parts again, maybe as we talk just dollars year on year is the easiest thing for 2024. So I think you're guiding about $100 million of net income growth, about $300 million of free cash flow growth in 2024. So just trying to understand that extra kind of $200 million in the free cash How much of that is sort of capex maybe coming down or working capital coming down substantially? I'm just trying to understand as well, what's the full year impact of cyber in the free cash year on year? And if there's anything to be aware of on factoring, I know you mentioned supply chain finance. Thank you.
spk01: So if you look at the key driver of free cash flow, they're going to be around working capital, mainly in inventory. If you look at our level of inventory, we are going to close the year at about 54 days of inventory. We used to be, before those supply chain events, at about 45. A day of inventory is worth about... you know, quite a lot in terms of free cash flow. So inventory is going to be a key variable. Receivables also will be unchecked to declining as we are improving the way we manage that particular balance sheet line. Some of that will include upfront payments as our Cycle has been improving to satisfy demand. We're able to demand for acceleration of products. We're able to demand more upfront payment. And the final one would be supply chain financing, which we're now deploying across the world. Factoring would be flat year on year.
spk16: Thanks, Olivier. And the cyber 200 million free cash headwind in Q1, is that like a headwind of 200 for the year as a whole, or are you assuming you recapture most of that in cash flow in the balance of the year?
spk01: It would be timing-related. We'll catch that up in the second quarter.
spk16: And then my follow-up question would just be on the pace of the EPS recovery through the year. Historically, I think Q2 is about 19% or so of full year earnings. Is that roughly what we should expect for 2024 in terms of the seasonality?
spk01: We are going to go through a more normalized seasonality in terms of EPS performance as now the supply chain is going back to what we had pre-COVID. If you look at the themes for EPS, earning growth expected in Q2, momentum in building solutions I've indicated, GP stabilizing in Q2, and then going to an increase in profit contribution in the second half. Those would be the theme for the flow of EPS across the year.
spk07: Thank you. And our next question today comes from Nigel Coe with Wolf Research. Please go ahead.
spk11: Thanks. Good morning, everyone. Good morning. I know we've danced around this a fair amount here, but on the 1Q guide, Olivia, I really struggled to get down to that range, you know, dialing in flat sales and the 13% second EBITDA margin. So is there anything below the line from corporate timing, the interest or anything else Anything below the line you need to think about there, just any help there would be helpful. And then on the free cash flow, the restructuring, I'm not sure if you did quantify that to Julian's question, but what sort of payback are we seeing on this restructuring action? Where should we dial in for structural cost savings in 2024?
spk01: So if you look, let me start with the end. On free cash flow, we're going to have an impact of about 10 points of conversion to two elements. One is higher capex actually due to the demand we have mainly in the data center. That's about three points of conversion. And restructuring, we expect to have seven points of conversion due to restructuring. The impact, the payback of those restructuring actions is about a year. or below that. And we have quite a few projects to improve the profitability of our enterprise. On Q1, I go back to what I indicated earlier in the Q&A session. Momentum in building solutions, that's what we see in Q1. weakness in global product due to the RISI demand, some more normalized comp as the supply chain is normalizing for our global product division, and then, of course, the impact of cyber.
spk11: Okay. And just on the CapEx, it just seems like it's a $60 million increase. I just want to just verify that. But maybe I could talk, can we just dig into the EMEA LA segment You know, the margins have been struggling for so long now. And, you know, we've got inflation growth in orders and backlog, but inflation is down 5% this quarter. So I'm just wondering if you could just maybe talk about, you know, what the problems are in that region and what some of the fixes are.
spk01: So we see no structural reasons for the Milan margin to be double digits. And we expect margin to turn positive in Q2. Clearly, we have work to do in the region. The margin profile of the region is mainly due to the realization of lower margin orders into the revenue. We see that turning the other way, so turning positive in Q2, Nigel.
spk07: Thank you. And our next question today comes from Andy Kaplowitz with Citigroup. Please go ahead.
spk00: Hey, good morning, everyone. Good morning. So your orders accelerated slightly, actually, in Q4. It's up 9%, I think, for building solutions led by North America. And I know you talked about the strength already and applied in markets such as data centers. But as you know, some leading indicators in non-res have been a little weaker. So do you see order growth holding up here across your businesses throughout FY24? And do you see your backlog staying around that $12.1 billion number for your long-cycle businesses in 2024? I think any incremental color would be helpful.
spk10: Yeah, I do, Andy. And when we look at, you know, we've got a pretty robust tracking across all of the critical markets across the regions. And we're tracking not only lead generation to conversion to where we're positioning to deploy our resources and differentiate and ultimately win. So the pipeline generation continue to be very strong. And it's in line with what I previously discussed as far as the segments that are driving that. And I think as we look at our service business, that's when you think about new projects and new opportunities to build install. So that has been very strong. And what we're also seeing is that on the service side, with the work that we've been doing with not only going back into the install base, getting connectivity, getting use of the data, and then bringing forward new value propositions, we're seeing significant pickup in our PSAs and being able to get longer term contracts and build the base there. So in spite of, you know, when you look, when you segment our building solutions, whether it be installed, still strong, and then our ability to be able to, even in an economic decline, we should, with the value proposition that we're bringing to our customers within service, I believe that that's going to continue to hold up. And so right now there's no, even though we look at the same metrics you look at, you know, Dodge starts and ABI and all of the key metrics being a little bit weaker and At the end of the day, with the way that we prioritized our growth and how we're deploying our resources, we're positioned to capitalize on where the growth will occur.
spk00: It's very helpful. And then maybe you could give us just a little more color on your expectations for global products. Do you see global residential markets, for instance, turning positive in the second half? And as the greater segment turns, how are you thinking about the European heat pump market? I think you mentioned you know, GP stabilizing overall in the second half, but maybe you can talk about your confidence level that destocking ends in the second quarter, as you guys mentioned.
spk10: Let's start with the resi. You know, as we look at the U.S. resi market, obviously there was challenges that set up for resi in 2023, both in units as well as overall sales, you know, with the recession. I think when we look at the reason for that, it's higher cost equipment, it's weaker equipment, you know, consumer spending. It's now people going back to work and reducing their home improvement spending. So a lot of contributors to that. I do believe that as we look at the transition here with the refrigerant changes, we get into more stabilization where, you know, although there'll be less units, certainly with the new refrigerant launches, you know, that's going to demand more price because of the refrigerant. And so on a sales basis, I think we're extremely well positioned now to be able to deliver our portfolio of refrigerant changes in time for the implementation on January 1st. We have pulled ahead our new product introductions by as much as two or three months to ensure that we're giving our distributors enough time to rebalance their inventory and ultimately restock with the new 454B refrigerant products. And again, we're working with all of our constituents right from the suppliers to our distributors to partners to make sure we have a smooth transition. So we do believe it normalizes and somewhat stabilizes going forward. And that's on the resi in North America. Your question around heat pumps, I think we believe across our portfolio that creates an incredible opportunity for us. We believe it's about a $100 billion market that's growing mid single digits. And today we assess our portfolio as about a third of our sales within HVAC are heat pumps. And I do believe, although we've seen a pullback in Europe, and it's mainly around our JCH product that we were planning for a pretty significant pickup here, 23, which ultimately didn't materialize. that maybe that's just kind of pushed to the right a bit as some of the countries in Europe have pushed forward the implementation date and the like. And then as a result, I think consumers have pulled back and not ultimately capitalizing on the efficiency that the heat pumps represent to them. And so we're watching that closely, but I do believe that over the next, you know, maybe it's 18, 24 months, that'll come back and come back pretty strong. And then on the commercial side, pretty much globally, You know, we do have a leading portfolio. We're understanding now with the focus on decarbonization and sustainability that we are uniquely positioned with low GWP refrigerants across our portfolio. And we're positioned to now capitalize on that being a significant strength as we're, you know, capitalizing on some of the key markets globally. So that's kind of an assessment as I think about where we are with heat pumps.
spk07: Thank you. And our next question today comes from Noah Kay with Oppenheimer. Please go ahead.
spk12: Good morning. Thanks for taking the questions. And it's really actually building on one of Nigel's earlier ones around restructuring and more broadly productivity gains. You know, you've got the $340 million of productivity savings for 2023. Is it time for kind of an updated medium-term target around productivity? And what do you see as the path forward to drive a stronger margin profile for the business and how much does productivity play into that?
spk01: So we believe, Noah, that fundamentally we have the ability to be a 30% incremental company. We will achieve improvement in margin through two levers. One, gross margin as we improve our mix, as we improve our operations. And the second lever is going to be through OPEX as we keep standardizing and centralizing our operations. And we have, as we see, a strong portfolio of ideas and projects to improve the profitability of our enterprise. As I indicated earlier, typically those projects have below one year payback. We don't think we need to update today our productivity programs. I think you will see that being embedded in the guide, Noah.
spk10: Noah, just a comment on that. As we have been able to strengthen our operating system globally, it hasn't identified significant opportunities continuing so that we can capitalize on and ultimately continue to expand margins going forward to be able to get incrementals 30% plus.
spk12: payback that we're getting on the work that we're doing is within the within a year yep appreciated it may be a little bit surprised positively I would say that the cyber incident didn't more significantly impact the service business one can you can explain why that was the case and to just just talk about how you know the the service and install operations you know, performed during this challenging period for, you know, IT infrastructure for the company?
spk10: No, let me just comment on the cyber incident as a whole. You know, what we learned is we're not alone, and this is a more common phenomenon across companies like ours. It certainly was unfortunate, but what I would tell you, there was incredible, remarkable work by our team with our business continuity plans. And so as we were impacted, our teams really responded well, staying focused on customers, continuing to work and maintain operations with incredible speed and focus. And so with that, we were obviously very proactive in how we've communicated with suppliers, customers, employees to maintain our operations. So that is the foundation of what we were able to accomplish. What I would say is, is that the agility that we saw and the ability to be able to, where we did have some compromise, be able to get the proper set of data and make sure that we're continuing to serve across the board. We're able to maintain that and stay focused on what matters, which is ultimately delivering for our customers. So even though we had a little bit of disruption in the month of October, which we talked a little bit about earlier, I believe that the work that we've done really has positioned us strong going forward. And we've seen that momentum come back in November and December.
spk07: Thank you. And our next question today comes from Joe O'Dea with Wells Fargo. Please go ahead.
spk13: Hi. Good morning. Good morning. First question I just wanted to ask on channel inventory trends. I think that first emerged as a headwind in the third quarter. I believe you expected to see a more meaningful headwind in the fourth quarter. And so can you size what you believe you saw in the fourth quarter and then within the guide, what type of headwind would be embedded in sort of first quarter or even second quarter of 24?
spk10: When you look at our global product book to build businesses that really depend on channel, starting with Resi, certainly we saw a pullback in Resi and that was obviously more so in the U.S. versus globally, but overall there was a decline within resi. So we've been working to offset, you know, obviously offset the inventory and get positioned for what we believe the new demand to be. And I think as you look at the book to bill, it's getting more normalized relative to, you know, on a go forward basis that we've seen the adjustment When we look, when we track our inventories, I think we're back to where we were historically relative to what's in the channel with our distributors. And so I'm somewhat optimistic that that's stabilizing going forward. When you look at the rest of our book to build businesses, and it's mainly you know, around fire and security controls, the same holds true there. So we think that we're through most of the headwind with the adjustment of inventory in the channel. We've also adjusted our inventory in line with what we believe the forward-looking demand to be. And so it's important that we're positioned to be able to support that demand on a real-time basis, which we are. And as we go through reviews, business by business, looking at what is actually happening, we are encouraged that now We're seeing orders across the board starting to build back our backlog so that we can be positioned here through the course of 24 to continue to build, you know, build on the revenue base on a go forward basis. So, I mean, we're somewhat optimistic and I feel that we've, you know, the headwind that we saw in the, you know, second, third, fourth quarter, you know, some of that's now is normalizing and we're back to seeing growth.
spk13: And then just wanted to understand kind of project activity in the market. I think 2023 would have seen still a lot of constraints as it relates to labor availability for projects, supply chain availability. What you're seeing on that front, kind of the smoothness of operating of projects at this point, whether labor still remains a constraint. And then just related, I mean, office strength does come across as a bit of a surprise. And so any additional color on kind of what you're seeing in North America office, anything that you're doing where you think you might be driving share gains there?
spk10: Yeah, I'll talk a little bit about operations. When you look at our building solutions across the globe, certainly there was significant disruption where from a cycle time standpoint, some of our projects got extended a month or two. As we look at where we are today, we're back to almost where we were. And what we're believing now is our operational operations or the operating system that we've deployed, we can create now cycle time as a competitive advantage and being able to respond with the improvements that we've made within our supply chain and within our factories and ultimately within the field and how we execute on projects. So I'm very confident now that that's gonna be a critical strength of ours. Your question relative to resources, we have been very attractive in being able to recruit labor pretty much across the globe and have not been constrained by labor across both our project-based business as well as our service business. And then in our critical factories, we've been able to recruit, retain, and develop the talent that's ultimately going to be critical to delivering on our capabilities. So that feels very good. As it relates to commercial buildings, even though there's a thought that maybe buildings, there's going to be a pullback, the work that we're doing within buildings is differentiating. And so as we go into a building now, especially with the focus on energy savings and decarbonization, there's no company that's consuming as much data as we are within the building. And so because of that, we can actually do upgrades and deploy new technologies and utilize our data platform, consume all of the data within the building, and in many cases, get a payback on what we do within the building. And so that is our focus. And now with building standards being implemented in many jurisdictions, not only here in North America, but across the globe, we believe that that really presents a big opportunity for us in that space, especially with the focus on energy and decarbonization.
spk07: Thank you. And our next question today comes from Dean Dre with RBC Capital Markets. Please go ahead.
spk03: Thank you. Good morning, everyone. Just wanted to follow up on the potential timing of the insurance recovery, the business interruption insurance. Would that be a fiscal 24 event? And is that embedded in your guidance?
spk01: The timing would be at 24 events. Some elements of our cost will actually be reimbursed, we believe, in Q1. That's the goal. So we depend when the costs are incurred and when we are able to prepare our claims. So some of it will come in Q1, certainly in this year.
spk03: Okay. Well, if you get that in the first quarter, that's pretty fast. So that's impressive.
spk01: And then...
spk03: Just a second question on China. Just it was called out several times as being a source of weakness, especially in building solutions. Any color there, just in terms of at the margin, what might be changing?
spk10: So, you know, as they went through different phases of COVID, we saw, you know, a pickup last year and capitalized on that opportunity. You know, we believe that we built a leading position in the higher end of the commercial market there. and have a very large installed base that we're capitalizing on to be able to build our service business. We are concerned that the macro environment has continued to deteriorate, leading to concerns of the overall slowdown now accelerating. I think when we look at these macro trends not only working against us but our competitors, and as we have now studied the markets and looking at verticals or looking at the overall region, we are planning prudently for continued pressure in China. So we hope we're a bit wrong and maybe it comes back a little bit stronger than we suspect right now, but that's really what's embedded in our guide. Thank you.
spk07: And our next question today comes from Andrew Oatman with Bank of America. Please go ahead.
spk15: Yes, guys. Good morning. Morning, Andrew. Can I just think, you know, it seems that JCI is facing, you know, as we look, more growth, more investment, more inflation, so more capex, more working capital. So how do we think about this 100% cash conversion target going forward that we are in a more growthy and more inflationary environment, right? How do you balance growth and growth opportunities and investment opportunities versus cash conversion?
spk01: So if you look at what we said in our prepared remarks, we believe that the fundamentals to allow our company to be a 100 free cash flow company over time are there. Today, to your point, we are investing in some parts of the business to support the strong growth in high-end HVAC. We believe that the level of CapEx at this level will be what we need to support the growth we see in the coming few years. The big levers of improvement in free cash flow are going to be around working capital. I mentioned inventory. Just a day of inventory is worth about 50 million of cash. And if you look at where we are at the end of FY23, at about 54 days of inventory, we used to be at 45 days of inventory. You can do the math. There was a big gap. level of cash flow trapped in inventory. We are at it. Inventory are declining, as we put in our prepared remarks. We see also the ability to reduce the collection cycle. As our lead times are improving, we're going to be able to collect faster. And we are now, because of the value proposition of our offering, we're able also to demand some prepayments. So those are the levers. I mentioned supply chain financing as well. So that's basically, Andrew, what is explaining the view on free cash flow and the path to be over time a 100% free cash flow conversion company.
spk15: Gotcha. And I just clarify if I got it wrong. I think you had 220 million in impairments and restructuring charges. Were there incremental impairments in that number? And if yes, what were they?
spk01: Go again. We had impairment charges, correct. Go again on the second part of your question. What assets do we impair? So we had, first of all, some open blue assets associated with the FM system acquisition. Some of those assets are part of the FM portfolio. They are better. So we're going to discontinue what we have in open blue. We had an impairment associated with a business we have in Argentina. This business is impacted by high hyperinflation. and also we had some restructuring charges. Those are the three key levers.
spk07: Thank you. And our next question today comes from Brett Lindsay with Mizuho Americas. Please go ahead.
spk14: Hey, good morning. Thanks. Just wanted to come back to price-cost. You said positive for 24. Could you just discuss the pricing component within that framework, and how are you thinking about incremental price actions this year? I'm just curious about Did the cyber disruptions in any way limit your ability to capture price ask? Any color there?
spk01: So on price cost today, we see price cost to be positive. We believe we're going to be able to keep the level of pricing we saw in the second half of the year.
spk10: And when you project the full year, you know, we still see strong, you know, with the value propositions that we're bringing to our customers in building solutions, strong value propositions that we're pricing to and with the differentiation that we bring with our digital content that really drives a margin. And then on the product side, you know, we continue to have record launches of new product introductions, which ultimately we price to the value that we bring to the market. So we're still seeing strong pricing across the portfolios.
spk14: Okay, great. Thanks for that. And then just quick follow-up on the capacity expansion. Encouraging to hear, I guess maybe just a little bit more context, is it just simply targeted on data center? Are there other geographies? And is there any way to size what that investment was?
spk10: Yeah, there was a big segment here that's targeted on data centers because of the position that we have and the strength that we have. have earned with the products that we're bringing into that segment. So as I talked with Scott earlier, you know, we see a significant demand here over the next multiple years that we're positioned now to capitalize on in line with the customer relationships that we have. So that's going to continue. But when you look at applied, when you look at our overall commercial HVAC business, you know, when we, What's happened is across the board with the secular trends around decarbonization, sustainability, efficiency, we are uniquely positioned with our technology and the way that we develop technology. We engineer and design right from the compressor to the end market, making sure that our equipment is optimized for the application that we provide. As a result of that, that has... broad base positioned us to be able to now capitalize on these secular trends broad base, not just within data centers, but across many of the other verticals. And so as we think about the work that we've done to reinvest over the last three or four years in the position that we have, we have a very strong position across our applied portfolio that I believe beyond, well above the economic growth that we're gonna now be able to capitalize on because of that increased demand. So it's pretty broad based.
spk07: Thank you. This concludes our question and answer session. I'd like to turn the conference back over to George Oliver for any closing remarks.
spk10: Thank you all for your continued interest in supporting John's Controls. As we stand here today, we are set up for success through our strong foundation as we continue to build on opportunities to enhance our business from our margin profile, free cash flow generation, and growth through the digitization of our service offering. It is all about execution as we look ahead. I am confident in our global team's ability to deliver value and results for our customers and shareholders as we enter fiscal year 2024. So with that, operator, that concludes our call today.
spk07: Thank you. This concludes today's conference call, and we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.
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