Q2 2022 Johnson Controls International PLC Earnings Call
Welcome to the Johnson controls second quarter 2022 earnings call.
Your lines have been placed on listen only until the question and answer session.
To ask a question. Please press star one on your telephone keypad.
This conference is being recorded if you have any objections. Please disconnect at this time.
I will now turn the call over to Ryan Edelman, Vice President Investor Relations.
Morning, and thank you for joining our conference call to discuss Johnson controls second quarter fiscal 2022 results.
Yes 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 Johnson controls Dot com.
Joining me on the call today are Johnson controls, Chairman and Chief Executive Officer, George Oliver and our Chief Financial Officer Olivier Leonetti.
As a reminder, before we begin during the course of today's call 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 EBITDA, and EBIT exclude restructuring as well as other special items. These metrics together with organic sales and free cash flow 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 with that I will turn the call over to Jordan.
Thanks, Ryan and good morning, everyone. Thank you for joining us on the call today.
To get started with a brief overview on slide three.
Our results in the second quarter reflects solid top line execution as we delivered strong sales orders and backlog growth in line with our expectations and at the high end of the guidance we provided.
Demand for digitally enabled equipment and services that solve for sustainability and energy efficiency remains robust and our sales teams are doing an outstanding job capitalizing on that demand.
The Reinvestments, we have made to develop industry, leading products and solutions are delivering results.
Digitization is at the center of our strategic vision for the company and we continue to advance those strategies every day.
Open Blue is accelerating the digital enablement of our solutions, allowing us to deliver increasingly differentiated offerings and capitalize on emerging secular trends.
We're also seeing the benefit of the discipline, we've instilled in our pricing capabilities over the last two plus years.
This realization continues to accelerate contributing nearly six points to overall organic revenue in the quarter.
You see that most clearly in our shorter cycle global products business, but it's also accelerating in our longer cycle oil field businesses.
We also continued to gain traction on our key vectors of growth.
Global efforts to Decarbonize economies and ensure the health of indoor environments are accelerating.
It's supported by the adoption of new policies by governments and industry associations.
At the same time, we continue to accelerate actions to optimize the efficiency of our cost structure and we remain on track to deliver $230 million in productivity savings this year.
We have deployed over $1 $5 billion in capital year to date, including over $1 billion in share repurchases and more than $400 million in cash dividends alright.
Alright, M&A pipeline continues to build with a number of active opportunities that would allow us to support our vectors of growth.
I'm incredibly proud of the progress we have made towards achieving our strategic objectives year to date.
As we have said in the past we truly believe we are among the best in class when it comes to the ability to deliver fully integrated solutions designed to address the challenges associated with the global secular trends developing across our industry.
We are operating in a very dynamic environment with heightened supply chain disruptions.
Second quarter profit underperformed relative to our expectations, while the anticipated supply chain improvement is happening it is happening at a slower pace.
Let's turn to slide four for more detail on what we're seeing in the North American segment.
Demand remains strong with orders up 13%, our backlog grew 14% to a record $6 $9 billion.
Just as in other parts of the organization, we are advancing our strategic priorities to accelerate growth by addressing this sustainability and healthy building needs of our customers.
Going into the quarter, we anticipated continued challenges related to supply chain disruptions and material availability.
What specifically inadequate supply of semiconductor chips and components, but controls products.
The margin underperformance relative to our expectations can largely be explained by the pace and mix of backlog conversion, resulting in lower absorption on our cost base.
As we described to you on our last call in any given quarter. We are typically executing on about 40000 projects across to install and service.
Each of these projects requires a significant amount of coordination.
In the current environment managing through our own material shortages. In addition to our suppliers and customers supply chain and labor constraints magnifies any slippage.
Additionally, given the pace of orders we have seen in the backlog we have been building we have maintained our investment in sales head count and service technicians.
With revenue conversion and mixed below our plan, we were not able to fully cover the higher cost of reinvestment in the quarter.
The last point I would make on this is on timing or.
Our initial forecast in late January assumed a modest recovery in supply chain conditions as we progressed through Q2.
Although there were some improvements in the quarter the recovery was slower to materialize, which coincided with the seasonal ramp into our peak season during the month of March.
Net net these two issues accounted for a $40 million profit impact in North America.
We expect a slower pace of improvement to continue throughout the second half, which is the primary contributor to our lower outlook for the year.
Despite these challenges we are confident the backlog is turning driving higher revenue growth with more accretive margins as we think ahead to 2023.
Please turn to slide five.
Opened blue remains the core of our strategy to digitize our portfolio to enable differentiated outcome based solutions.
During the quarter, we commercialized several several exciting new offerings, including the opening blue Gateway a cost effective easy to install device that will serve as a key enabler to accelerate the connection of our installed base.
Opened blue net zero advisor will be launching within the next several weeks it will help customers manage scope, one and two emissions in their journey to achieve net zero.
Lastly, opened blue connected controls will be the first full integration of open blue into our legacy medicines systems, which we believe will be a disruptive offering that will fundamentally change how building automation systems operate increasing the intelligence of building controls by infusing AI.
Importantly, this offering will allow us to extend our reach further into the mid market with a compelling plug and play solutions.
Let's turn to slide six.
We continue to make progress in the digital transformation of our service business leveraging open blue to further differentiate our capabilities.
We're on a path to drive higher attach rates on our installed base increased the level of connectivity of those assets and then as a result of differentiated service offerings drive higher revenue per customer and lower attrition rates.
This service growth flywheel is a clear algorithm that helps us achieve above market levels of growth expected to generate over $2 billion in sales through 2024.
Although we are still in the early stages of this process our core service business.
Augmented by early results from digital services performed well in the quarter.
Sales were up 8% overall with orders up 10%.
Our attach rate improved another 130 basis points in the quarter, bringing us to over 200 basis points year to date.
On track to achieve our four to 500 basis point target for the full year.
Digital services increased 7% in the quarter.
Turning now to slide seven.
The global commitment to Decarbonize economies continues to gain momentum both in the public and private sectors.
There was also increase recognition that economies cannot truly decarbonize without decarbonising buildings, which contribute 40% of the planet's greenhouse gas emissions.
Rising energy prices and the potential risk of supply shocks are forcing many governments to reconsider sources and uses of fuel.
The combination of higher energy prices and security risks are making paybacks much more attractive.
We continue to see policy moves and commitments from corporations that support the carbon reduction of buildings.
Our deep understanding of the building ecosystem uniquely positions us to capitalize on these trends.
During the quarter, we completed the full commercialization of our net zero capabilities.
Our performance infrastructure business has evolved into a global organization, we now referred to as sustainability infrastructure backed by decades of experience delivering guaranteed savings and an extensive network of subject matter experts.
The breadth of our installed base the depth of our field presence supported by an industry, leading portfolio of digital products and solutions.
As a holistic solution for customers to achieve net zero.
We continue to make progress year to date, our sustainability infrastructure business is booked over $450 million in orders in our <unk> pipeline now exceeds $7 billion.
Continuing with our vectors of growth on slide eight healthy buildings. We were encouraged by the recent initiative launched by the White House and the EPA.
Both customers and government agencies increasingly see the long term value of investing in improvements in building health and resiliency.
And it is not just focused on K through 12 nerd. It nor is it only related to Covid response.
We are strategically well positioned to capitalize on the adoption of healthy building trends.
We continue to develop and deploy new offerings with a focus on shifting the value proposition to longer term more strategic asset management.
During the quarter, our healthy buildings orders were up more than 30% to $150 million and our pipelines continue to build.
Finally on slide nine.
We continue to demonstrate our leadership in sustainability and ESG.
We are perhaps most proud of our owned Chief Sustainability Officer, Katie Mcginty recently being named as the top woman and sustainability in the corporate World.
To close out my prepared remarks, I remain extremely excited about the continued advancements we have made relative to our key growth vectors and I couldnt be more pleased with the way our teams are executing in such a difficult environment.
We remain laser focused on our strategic commitments and to delivering the outcomes our customers need on the path to a healthy and more sustainable future.
Although we are navigating through a more challenging environment with increased uncertainty regarding the macro backdrop I am confident in our path forward.
Momentum within our short cycle products business is solid.
Our backlog is strong and the margin profile is inflicting as we lap prior year order intake.
All of which sets us up well for 2023 and beyond.
With that I'm going to turn the call over to Olivier to walk you through the financial details in the quarter and update you on our outlook Olivier.
Thanks, Josh and good morning, everyone. Let me start with December you on slide 10.
Sales in the quarter were up 9% organically at the high end of our original guidance for high single digit growth with price contributing nearly six points above what we originally anticipated we saw strong performance across our short cycle global products to 40.
At 14%.
Our longest cycle business also performed well up 7% with solid growth in both service and install.
Segment, EBITDA increased 8% with margin down 10 basis points to 12, 6%, so the underlying volume leverage and dependency.
Ongoing SG&A and Cogs programs were offset by high inflation and supply chain related challenges as George discussed earlier.
Despite achieving over $300 million in price on the top line price cost was striking gets even a quarter and together with supply chain disruptions resulted in a 160 basis points margin headwinds.
EPS of <unk>, 63 increased 21% year over year benefiting from higher profitability as well as lower share count.
Free cash flow was down as the prior year benefited from lower working capital needs and Covid related benefits <unk>.
Turning to our EPS bridge on slide 11 of the whole operations contributed 10 this.
As the prior year, including a <unk> <unk> benefit from our Cogs and SG&A productivity programs.
And the line segment earnings ramp a net two cents tailwind year over year.
Excluding the extra headwinds from price cost and supply chain disruptions underlying incrementals in Q2 with approximately 76%.
Please turn to slide 12.
Orders for our field businesses increased 11% in aggregate with continued momentum on a two year stack basis service orders when led by high teens growth in our short term transactional business in store orders continued to rebound primarily driven by.
Demand call applied HVAC and controls systems.
<unk> grew 12% to $10 9 billion and $1 $2 billion increase versus the prior year and up.
$500 million sequentially.
Secured monitoring and backlog is up 80 basis points in the quarter, reflecting our pricing discipline and improving margin trend. We expect as these backdrop comes out later this year and into 'twenty two 'twenty three.
Let's discuss our segment results in more detail on slides 13 and 14.
Sales in North America were up 6% organically with broad based growth across the portfolio led primarily by strength in our applied business up low double digits.
Find security key grew low single digits.
Although we're up 13% with low teens growth in applied driven by continued equipment demand in the data center, K 12, and SaaS verticals.
Sustainability infrastructure orders were up mid teens, despite the strong double digit comparison as we booked another large energy services projects with the U S Public school system.
Alright, and security orders were up low double digits and backlog ended the quarter at $6 $9 billion.
Up 14% year over year.
When margin decreased 210 basis points to 10, 6% as volume leverage and cost savings were more than upset by 260 basis.
Headwinds from the pace and mix of backlog conversion and lower absorption as George described earlier.
In Mena, we saw continued strength in the core fire and security business, which grew at a high single digit rate in Q2.
This sure refrigeration grew high single digits, driven by the conversion of several large industrial heat pump projects.
Orders were up 8% led by low double digit growth in our core fire and secretive capsule backlog was up 9% to $2 $2 billion.
And the line margin performance was driven by volume leverage positive price cost and the benefit of cost savings offset by supply chain disruptions and lower equity income.
Sales in Asia Pacific were led by low double digit growth in applied HVAC.
China continued to outperform with revenue up nearly 20% led by strong double digit growth in industrial differentiation and mid teens growth in account.
Orders increased 8% with continued strength in applied driven primarily by continued momentum with the industrial vertical in China with a continued pipeline of Empress structure investment across key verticals like faithful Ken semi conductor etch.
<unk> centre as well as health care.
Backlog of $1 $8 billion was up 5% year over year.
The decline in margin was primarily primary leaders hilltop headwinds from price cost in hardware, both project and geographic mix.
Global products continued to perform well at 14% in Q2 with broad based strength across the portfolio led by mid teens growth across our HVAC equipment capsules.
Global residential HVAC sales were up 15% in aggregate North America, HVAC was up 27% benefiting from both higher growth in our equipment and pump business and strong price realizations.
Production in our new facility in Mexico continues to ramp and contributed meaningfully to premium growth in the quarter.
Outside of North America our.
E <unk> business grew low double digits led by strong double digit growth in Europe , driven by strong demand thoughtful our hitachi residential heat pumps.
Eight accuracy HVAC sales grew high single digits led by strong growth in India and Taiwan.
<unk> product sales were up high teens in aggregate with strength in light commercial driven by strong performance at Hitachi as well as 20% growth in North America, and more than 20% growth in via ACH.
Brian Security products grew low double digits in aggregate with strong demand across the entire portfolio.
Although not recall that in our Vishal fill order backlog.
Global products orders were up mid teens organically and our third party backlog exceeded $2 billion.
EBITDA margins expanded 170 basis points to 16, 1% as volume leverage.
<unk> income and the benefit of our productivity actions more than offset headwinds from price cost.
Turning to our balance sheet and cash flow on slide 16.
Our balance sheet remains in great shape shape we.
We ended Q2 with $1 $8 billion in available cash and net debt at two one times still at the low end of our target range of two to two five times.
Free cash flow was an outflow of $200 million in the quarter, driven primarily by higher year over year working capital requirements higher Capex and the absence of prior period tax credits and other COVID-19 related benefits.
Trade working capital as a percentage of sales declined 50 basis points to eight 6%.
For the first half we are fairly neutral on free cash flow, which brings us back in line with our normal first half second half seasonality.
We repurchased another 7 million shares for just of the carbon and $1 million in the second quarter, bringing us to just over $1 billion for the year.
Now, let's discuss our revised guidance on slide 16.
Underlying demand trends across most of our businesses continue to improve and I'm encouraged by the pace of order growth, we have seen year to date.
As George highlighted in his remarks, the ongoing supply chain challenges impacting the pace and mix of our backlog conversion in North America is driving a reduction in our outlook for the rest of the year.
As a result, we are revising our 48 adjusted EPS range to total long and 95.
We do not and <unk>.
Which represents 11% to 15%.
Growth year over year on the top line, we still expect to grow 8% to 10% organically price is now expected to contribute six to seven comes up an additional one to two points one achieved to our prior expectation fully offsetting additional inpatient.
On a full year, we still expect to be slightly positive on price cost.
Segment margin is now expected to come in flat to down 30 basis points, reflecting pressure related to related to additional price on the top line with minimal margin contribution and the mix impact associated with the supply chain disruptions in North America.
Combined these two factors reserves in a 80 basis point margin Edwin wall achieved to our prior guidance and now accounts for nearly a 150 basis points headwind versus the prior year.
As it relates to the ongoing lockdowns in China and the conflict in Ukraine, we are monitoring the developments daily from a planning standpoint, although it is difficult to precisely we have embedded some incremental contingency to account for the additional uncertainty surrounding this.
Supply chain for the bonds.
Yes.
This is reflected in our updated segment margin guidance for the year.
Full year free cash flow conversion is now expected to be about 90%.
As the inventory buildup in the first offer combined with slower backlog conversion creates nandy at $200 million Edwin to our prior guidance.
Turning to Q2 Q3.
We expect the headwinds related to supply chain to skew slightly more towards the third quarter, we <unk> expected to be in the range of 82 to 87.
Which assumes organic revenue.
Revenue growth up high single digits, and a segment margin decline of 80 to 100 basis points.
Although our expected backlog conversion rates are challenged near term due to supply chain issues I am confident in our long term outlook, we have strategically positioned the company to accelerate growth in line with competing secular trends impacting buildings for the next decade.
We continued to make good progress on our cost productivity programs and as backlog conversion normalized in 2023 machines I expect it to recover.
As on track for the fiscal 'twenty 'twenty four targets, we provided at our Investor Day last September we start operator, please open the line for questions.
Thank you.
And we will now start the question and answer session. If he would like to ask a question. Please first on mute your phone press star one and record your name and ask her name is necessary to introduce her question.
One moment for our first question please.
Also in the respective time, please limit your questions to one question and one follow up our first question comes from Nigel Coe of Wolfe Research. Your line is open Sir.
Thanks, Good morning, Thanks for the question.
Good morning.
Maybe just talk with Hyatt titles, maybe just talk about you know did you did you get a D commitments from suppliers.
Of course, some of this pressure in North America.
And then when did this start to really manifest was this more of a market issue or is that something that's developed through the quarter.
Yeah, what I would say Nigel as you know.
As we indicated on our prepared remarks, I'd start with the value proposition of our field based businesses, particularly in North America is resonating very well with our customers you saw our orders up 13% year on year, we're up 18% with a two year stack strong demand for the vectors of growth from a services and sustain.
The ability to endure environmental quality and that's in North America, but across the board, we're seeing significant pickup in our digital capabilities.
I think as you look at the quarter a combination of things that created the shortfall. We had recovery plans, we've been working with our with our chip manufacturers in semiconductor material suppliers for the last year and we've been working at the most senior levels myself personally involved with Ceos and understanding what their long term plans are.
Colleagues that align to supporting our growth and we've made a lot of progress and that includes also having to redesign chips in and ultimately making sure that we're gonna be positioned with a supply will occur and have much more resiliency in our plan going forward and so when we look at short term.
Certainly was the the plans that we have had have moved to the right.
They continue to improve but Nigel at the same time that we're ramping up with our seasonal build and so typically we're up usually 10% to 15% into March March as we plan for our third quarter and ultimately fourth quarter.
So that is ultimately what happened and so we werent able to to convert the backlog and a lot of this is our high margin mix as it relates to controls and the good news is when we look at our digital our orders the orders in our controls based businesses were up over 30% and so our backlogs are significantly up.
In spite of the supply chain, improving and so it did have a disproportionate impact on our revenue conversion in the field because of this high margin and when you think about products products multiply in the field. So not only once we deliver the product we get multiples of revenue for how we not only support our project, but more important.
How we complete the service and so it's about 40.
40% of our revenue does convert as we ramp, especially going into our peak season in the last month and that resulted in about an impact of 40 million in the quarter now as we have certainly we've been working this for the last year, we've gone back and making sure that as we understand now what is the commitment not only in an additional.
<unk>, but how we are positioned relative to their capacity I feel really good because our suppliers are totally committed and aligned with our growth strategy and so this will play out with a recovery in the second half and I think as I think about not only completing 22, but the setup we have for 'twenty three with the margin that we put in.
Backlog and were seeing that in our global products with the book and Bill business, we've seen tremendous agility relative to pricing and we've done the same in our field based businesses, although there's a little bit of a lag that we're gonna be set up for not only strong high digit high single digit pricing, but now with the revenue conversion as we get.
Into recovery in the fourth fourth quarter setting up for the first quarter you could you could assess that we have a $1 billion $1 billion to $2 billion of additional capacity to.
Take on the recovery when you look at our backlogs, we think we start to accelerate recovery as we get through fourth quarter and then ultimately set up the first half and 23. So that's what we've been experiencing has been a.
Full contact sport, everyone totally aligned working with our suppliers and making sure every step of the way we're positioned to deliver the growth and ultimately get to the volume growth and the returns that we've committed which I believe we're going to be in good shape to do over a long term plan.
Okay. Thanks George.
And just maybe just clarify did you say high single digit pricing in the backlog just want to clarify that point, but maybe 10 to Olivia so basically the 27 cents a revision to the midpoint guide 16th senses is kind of like coming out versus consensus of <unk> 11 cents and full Q I'm curious.
How much do you have baked in two three maybe four Q4, the China Lockdowns and weaker growth in China real estate.
Obviously, FX is a little bit of an impact, but I'm more curious on the north American impact how that's impacting the <unk> and do we have any spills forwards into 2023.
So if you look at today. The guide we are proposing for the second half of the yes. We are planning minimum amount of improvement we are ramping in the second half to the first half in volume.
If you disaggregate what is going on in the second half in our guide we expect to be price cost positive by about $50 million that we expect descriptions to still impact our business, we have factored about $100 million due to disruption.
Again, we are doing that in the abundance of caution obviously, we're not we're watching what's happening in Europe . We're also watching what is happening in China, but as we said earlier, we have build year on year.
$212 billion worth of backlog.
And we believe that we will have the manufacturing capacity and also supplies capacity.
And at the start of next year.
Too fluid the backlog after a very enhanced margin.
And as George indicated as well Nigel we couldnt be more pleased with how our value proposition is resonating as we.
With our customers. If you look at orders if you look at services sustainability.
Steve routing all the indicators are very positive.
Today.
Temporary conversion question that we have to face.
Okay. Thank you very much.
Thank you. The next question comes from Josh Poke Polinsky of Morgan Stanley . Your line is open.
Hi, good morning, guys.
Good morning, Josh.
Alright.
I want to follow up on that last point that I think Olivier you made on the margins when this stuff exits the backlog and ultimately supply chain improve that there should be healthy I guess, if some of the issue is that the.
The the field force is sort of under utilized when you can't get this product I mean isn't there sort of kind of a bandwidth on how much they are able to do on the other side I'm just trying to think through like should we expect above normal incremental margins on the way out or is it just sort of simple as you can only install stuff so fast in the field.
<unk> can only be kind of sell productive with a number of hours in the day.
Yes, so if you look at.
You're absolutely right. So we expect largely that the backlog issues will normalize in the first half of the year.
If you look at today, the margin at which we price.
Orders today, we're pricing in anticipation of inflation and we're pricing today high single digits. So we believe we are going to are very healthy.
Set of revenue based upon the orders we book now in those we flow at the start of the yes, we have the capacity and we believe we're going to we'll be well positioned from a margin standpoint. In addition, and I know we spend a lot of time on the Oxford business fall for good reasons, our global product Division is real.
Outperforming.
Strong revenue growth and strong.
For feeds rate improvement so again very pleased with the value proposition of our company, Josh and we believe second half.
First half of next year, we will see significant margin improve.
Improvement going on.
Got it that's helpful and then just.
Joe I'll, just add that because I think it's important to understand the pricing dynamic as Olivier said with the the book and Bill business, we've been in very.
Very agile as I said with the pricing and we're getting on.
The 14% growth above 10% pricing that's embedded in that as the inflation began to accelerate last year. We began to two then as on a forward looking basis within our appeal based business to be able to to forward look much higher levels of inflation. So we've been putting into backlog over the last number of quarters much.
Much higher.
Anticipated inflation, so what you're seeing in converting now of projects up prior to prior to last year early last year that are still converting but would be with what we've been putting into the backlog is is price much differently and that becomes to be a higher mix as we get through the second half.
And then more important as we look at our turn in the backlog going into 'twenty, three that's where I said that we have we're positioned for for high single digit conversion relative to the price thats in backlog. So that is the work that we've been doing over the last it's really been the last two years with with the work that we've done around pricing, but we're very confident that with the.
Fundamentals, we have in place and its demonstrated in our product businesses that we're getting great traction with the initiatives that we have in place.
Got it that's helpful. And then just on digital services I saw the 7% growth.
Is there something I'm missing in Kennedy the base that that's also a I would've thought things like open blue and some of the newer kind of digital offerings would've been growing a bit faster or is there. Some legacy stuff that is maybe a bit slower or being made obsolete by by open glue that.
And kind of altering that base.
No I think when you when you George when you think about our open blue it's really digitalized all that we do it's strengthening our products and it's fundamentally becoming embedded in all of our services. So when you look at open blue. It's the connectivity. So it's the ability to be able to connect and then with that connectivity where increase.
Our attach rate.
Contracts long term contracts. It allows us then to with these new service offerings, leveraging the data and the AI that we're applying to the data that fundamentally differentiate the service offering so that the incremental revenue per customer and then with the connectivity it allows us to be able to.
Can we reduce attrition and that's when you factor in all that the digital does it contribute to that high single digit service growth that we're committed to achieve and we're making great progress like when you look at the the new the new services that we've launched here in the last just the last.
Last quarter, you know whether it be the connected our new gateway that is going to be fundamental to all of the assets that we have in the installed base and how we get them connected and then now we're launching our advisory services Energy Advisory services and associated services. So there's a lot of it's now IAA Q as part of our.
Healthy buildings.
Service is the enabler now of those additional services with that connectivity that ultimately drives the revenue per per customer and the revenue per customer price as well as additional additional service is significantly growing.
I appreciate the color there thanks, so much.
Yes, maybe.
I'll commend Josh this is important most of those capabilities and thought we believe are unique in the market. When you speak about open loop getaway.
Which is easy way to connect or devices in the <unk>. If you speak about also opened blue connected with Pms, which allows you to control <unk> remotely that's unique in the market and our edge capability to D and now implementation to our ecosystem Mark.
One those are unique capabilities, we believe game changing for the building.
Business those are also new.
So we.
We will start to see more of an inflection point for us when Josh.
I appreciate that that's helpful context. Thank you.
Thank you. The next question will come from Steve Tusa of Jpmorgan. Your line is open Sir.
Hey, guys good morning.
Hey, good morning, Steve.
Olivier maybe just a couple of things on the numbers first of all on the quarter can you just maybe give a little more context around you know maybe a couple of examples that you.
You know had amongst the larger impacts on on the AR on the margin in the quarter just from a you know fundamental on the ground perspective, just to give us a better picture of what's actually going on and what the headwinds are and are you I assume you're reviewing your just kind of like discrete headwinds you're not you're not covering your.
Fixed costs. So they should kind of reverse next year and then number two you mentioned that you do have some contingency built in to the second half of the year, maybe could you give us some more precise financials around you know what normal what normally would have happened and then what you're what you're assuming.
Most companies are assuming some improvement.
In in supply in the second half, you're kind of saying that youre not assuming much at all maybe just clarify with with the with some financial details to help us understand how the comps work into next year.
Absolutely Steve not to talk to you. Let me give you. An example on North American I E.
If you look at our North America cheese business, which is our more sophisticated.
Business.
The value proposition of what we do is resonating in the market and Thats important I will answer to your question precisely basically look at the underlying trends order growth, 13% 18 on a two year stack backlog growth, 40% services grew 7% sustainability infrastructure.
To your stacks, 60% SD building orders growth, 85%, we are tremendous demand for our North America business.
The challenge today is a short term conversion, let me give you an example.
Email semi cap, we need to orchestrate our own supply chain.
One of our partners and the wonderful customers.
And D issues.
Issues, we're all facing in industrial world are being amplified in dis sophisticated business. So thats what is happening and as John has indicated it's mainly due to controls and four.
I want to know what the new which controls do you have a tremendous impact on.
So torn.
The new four four months number of accounts to your question will that with that next year <unk>, yes.
We expect today.
If you look at in aggregate for the company to some of the headwinds.
Im going to be about 160 basis points from our company for the full year.
If you look at the underlying margin increasing by more than 100 basis points team and we expect that to be flowing.
Flow into next year. So that's the first part of your question on the second part of your question. We are being prudent we are September year end company. So we'll have less time to see what's happening for example in Europe or in China, which is largely today.
Some parts of the operation in Lockdown, we are planning as I indicated.
More disruptions in the second half.
Asset about one of the median of disruption that's prudent.
We believe we have factored the reach the risks in the appropriate manner and we see some positive price cost.
So prudent approach to supply chain and we expect first half of next year to be a very positive start for us as we convert backlog at a very high margin.
Right. So so so when you guys guide next year.
We'll assume that you know for lack of a better term the comp is very easy so that you'll be guiding to above average or above what you would have expected incremental margins and you know the earnings kind of flow through next year as opposed to this year. So when you guide that would be the case all else equal correct.
That's absolutely the case.
If you look at all the indicators today, Steve regarding amped up the our business is actually very strong and the margin rates should increase significantly next year.
<unk> no question.
Thanks, a lot David I think its important Steve is important to note that when you look at our backlogs both in our book to Bill were up significantly year on year is still and that's continuing to build and then our field based businesses were up significantly and so we're working this such that with the recovery as we see.
Going through the peak in the third quarter and then we begin to recover we have wanted to we believe in the beginning of the fourth quarter first half of next year with the commitments, we're getting on supply right now that that's the capacity that we have to really begin to accelerate the recovery with the backlog, we built and the demand continues to be very.
Especially as it relates to our digital digital components and that's a reflection of the work we're doing with opened blue and across our digital platform. So I think we have confidence at this stage that we went into the year, we should have a real good tailwind with the margin and backlog and then the ability to be able to convert with an improved supply chain.
Great. Thanks, guys.
Thank you. The next question comes from Gautam Khanna of Cowen. Your line is open Sir.
Yeah. Thank you guys.
Olivia just to.
Clarify your answer to Steve's question, just now I want to ask is the if you were to take the sum of fiscal 'twenty, three and fiscal 'twenty two.
Before we walked into today.
Do you still think the sum of the two is gonna be equal I mean in other words. These are.
Full catch up in 'twenty.
23 numbers.
It actually go up from where we were was there was a catch up.
<unk>.
I just wanted to be clearer should we take down it's kind of a forward curve in entirety.
Absolutely the math is correct.
If you take the sum of the two years.
We would be able to recover.
The margin rate and again, if you look at the topline today and indicators we have in timber orders enough that would comes out we feel very positive about topline and margin improvements when you take those those two years together correct.
Okay.
Thank God to move in the short term just got them a point on that is with the with the supply chain because a lot of a lot of this is really impacting our digital mix and the recovery of we've got commitments now in the recovery of the microchips in semiconductors. They are weighted to the first half of 'twenty three but some continue through.
So it's tied to both the the supply with the ability to be able to get the leverage with the mix and the completion of the project and services, we're completing but that would be as you model as we as we begin to think about 'twenty three.
That's ultimately what our goal is.
Okay I appreciate that.
And maybe related to that.
Do these delays have any.
<unk> impact on incoming orders.
I'm curious like pulse.
Customers, saying hey.
If you can get it to me and with conviction in nine months, we'll close the order now, but if you can't we're going to look at it.
Hold off I'm, just curious if youre seeing any.
Dampening impact on <unk>.
On orders given the spill at what times.
What I would say, it's the opposite right right now our demand and of course, where we're not over committing based on what we're learning relative to our ability to convert but I would tell you that that with the strategies that we've been executing services digital.
Is this a trend on de carbonization healthy buildings ultimately automated buildings.
We're operating at a much higher level within our customers. Because these are now problems at the C suite or where the CEO is focused on.
So even even in the environment, we're in and with the economic environment that the demand is still coming in strong and so we feel that the way that we're committing in the way that we're booking the business is is ultimately in line with what we can achieve and what our customers are demanding so at this stage.
We have seen very very little or none relatively low cancellations and when you look at our so you look at our short cycle business.
As I said, our short cycle business, our backlog is significantly up year on year, and that's after a quarter delivering 14% growth in.
In the quarter, we had actually revenue orders that exceeded that in the quarter and then when you look at our field based businesses. These are longer cycle projects that are typically financed and were working upfront with owners and developers, especially now with open blue where this becomes a fundamental to their infrastructure the digital infrastructure.
Within the building.
As we sit here today and I think.
Even if we were to get into a slowdown given the importance of what we do and how we're deploying our capabilities, it's still going to be high demand.
Thank you I appreciate it guys.
Thank you. The next question comes from Scott Davis of Melleous Research. Your line is open Sir.
Good morning. Thank you good morning, everybody.
Good morning, Scott.
The $500 million of that was released by the White House.
Does that have to be spend are there any terms around that does that have to get spent in the next year or does it have to get spent on filtration versus just.
Can it be just basically upgrading chillers I mean any color on that'd be helpful. George.
So the color on that Scott is that we've been actively involved in all of these bills that have been tied to our industry with Katie Mcginty myself, we've been very actively involved not only in the U S but across the globe.
With each of the governments and helping to define how they deploy these resources to get the biggest to get the biggest impact and so we have been very active like for instance, with heat pumps and the opportunity to get a three to one benefit by deploying heat pumps in and replacing some of the boilers in an older equipment and upgrade.
With heat pumps, you get significant.
Significant reduction of energy required.
Ultimately with that capability and then you get a good payback just purely with the economics and so there is a high mix of that that is tied to all that we do it's only HVAC, but it's it's with the digital capabilities that enable us to be able to significantly enhance energy reduction upgrade the indoor air quality all of that together.
Scott So it's not broken down into any one domain is more in line with what is the output that they're trying to achieve and the two outputs are getting to a higher standard of indoor air quality, while at the same time, we're reducing energy not only here in the U S.
Actually, whereas we work with the European governments harder they quickly deploy heat pumps to ultimately put into distribute district heating and cooling and and other applications that can significantly reduced demand, but a lot of that is because we've been actively involved in defining all those resources should be applied.
Okay, that's really helpful and then.
Net zero adviser.
Does that actually do or are you just are you basically cataloging.
Energy consumption and carbon or are you actually advising on how to improve it or what.
Which I think was part of the original open Blue also perhaps but maybe you can clarify a little bit that would be helpful. Thanks.
Yeah, I mean, the whole idea of open Blue advisor is really making a building of economists and Hugh you can take all of the data in a building and then with AI and <unk> and.
In other applications you can then understand what is the best way to optimize the building and so not only taking what the energy what the current energy being consumed but then how do you then advised based on what entitlement as to how you get to to the most optimized.
Energy usage within the building and it takes into account all the factors of a building so not only the HVAC equipment, but but presence in and a lot of the other factors that ultimately really helped contribute to how you get to that best outcome and so it's really think about it Scott is taking all of the intelligence of our.
Building being able to put it into one platform apply AI and then being able to work with our customers to define what the best solution is to be able to achieve their net zero commitments that have been made and this ties well with our net zero building offerings. When we go in we can do a full offer.
Where we upgrade equipment, we deployed digital we can taken as built building and when you. When you look out towards 2050, it with all of these commitments to get to net zero, 70% of the building stock today will still be in operations and so we're seeing high demand to go in and ultimately upgrade.
Deploy digital <unk>.
Consume the data apply AI and then ultimately advise what the best solution is to get to the energy commitments that they've made so that's in essence, what we're doing.
Very cool well best of luck George Thank you for this I'll pass it on.
Thanks Scott.
Thank you. The next question comes from Julian Mitchell of Barclays. Your line is open.
Hi, good morning.
Maybe just wanted to circle back on that point around contingency in that second half margin guide because it looks as if I think you you need a sort of 40% plus sequential operating leverage.
In the sort of second half operating profit versus first half.
And that's not on the face of it it doesn't look that different from what J C. I did historically.
Post the power exit so I just wanted to check is that math roughly right and is it right that you're assuming operating leverage not that different from previous years in the second half.
That's correct Julien.
What we I didn't see pay to duration of Lee was to be able to beat those seasonal trends.
And we had expected that we would <unk> the key to flow some of the increased backlog we add for the reasons we are presenting today.
Increased conversion of backlog would be delayed by two quarters.
I see but you think in a normal seasonal trend is still possible or probable even with all of the supply chain constraints.
Absolutely correct.
<unk> increased in the normal flow is not happening, but we believe today that we would be able to meet the Easter recorded this in our trends.
Thank you and then maybe following up on North America field specifically.
That's a business that of the four segments that has the highest margin ramp dialed into the medium term plan. So its its clearly crucial Fred just in terms of that rate of change, but also the scale of the business today.
I think the margins there have been down year on year kind of a full quarters in a row now you know before it was temporary costs that were the issue now it's inflation and supply chain.
So I guess, maybe give us an update on the confidence in the state of that business in aggregate on the margin plan and then what should we expect there for that second half margin improvement in North America field, specifically, so sort of a second half question on North America Field, and then also just taking a step back.
Given the margins are down four quarters straight what's the conviction on that plan.
So if you look at today, the North America business. This is the one which is the most sophisticated and difficult to for you and if you look at today.
Demand signals.
And we have we put together a slide on this in our.
A slide deck audience.
Indicators are actually resonating well with our customers said, they sustainability and stability.
Due to the complexity of the north Tamarine cash supply chain, we are seeing more headwinds that we have elsewhere in the portfolio.
Net of those the underlying margin in North America is actually improving and we feel confident that this business will add.
Margin at the.
The bottom line to fall below our company all of those issues today.
Hyde and temporary.
Julien.
And as the operating leverage in North America failed in the back half is that sort of 40% as well half on half.
So about that amount.
Perfect. Thank you.
Brad will take one more question.
Sir Your final question will come from Nicole to place of Deutsche Bank. Your line is open.
Yes, thanks, good morning.
Good morning, Nicole.
I appreciate you guys squeezing me in.
So I guess, maybe just starting with a little bit more explicit detail around what's going on in China. Because you guys just describe what's yours.
Maybe you could give us comfort in what's embedded from Sierra like what Youre looking for in the back half and the Asia Pacific.
Yeah, what we're seeing.
I would say is the order trends when you look at all of Asia Pac because that's how we report the order trends continue to stabilize and they've been pressured over the last year outside of China, but those economies are coming back as they exit COVID-19 and are actually doing very well.
You see your order momentum in northeast and Southeast Asia are very solid mostly in Japan and India.
India is doing very well, we're up almost 30% there's lots of infrastructure investment and when you look at you asked specifically on China, we're seeing good demand in China HVAC.
Led by strong industrial vertical and work with our industrial refrigeration supporting petrochemical and downstream and then when you look at orders in the quarter were up 6%, but that was to a 39% prior year compare and so when you look when you look at the environment that's.
Now from a commercial standpoint, we're actually doing very well now when you look at your question relative to the current environment.
We have began to see impacts in March both in China and Hong Kong.
Our headquarters in Shanghai in two of our plants and I'll talk about those two.
Have been into some some amount of shutdown locked down, but we are back and operating today in both plants. So we have a wuxi plant, which is chillers and that's are not only supporting China, but also other parts of the world and we have wuhu, which is R. J C H factory.
An interesting during the shutdown we had many of our employees actually stay in the plant live in the plant and ultra ultimately continue to create output, but that was to a much lower low volume. Both now have been reopened and are operational but not quite to where we need to be so that's some of the pressure that Olivier talked about now when you ask them.
Bout the China supply chain.
Since the pandemic, we've been doing really good work, our sourcing team and looking at all components that come out of that supply chain supporting the rest of the world and so as we look at the Lockdowns impacting other parts of our business is minimal at this stage. Although we're watching this closely the Shanghai Port is I think operating like.
At 40% capacity and making sure that with what is left that where we've got contingency with other supply, but I feel really good about that and so I think the concern Nicole short term is is are there going to be additional lockdowns with any additional spread of the virus and then continuing to make sure that we're getting the <unk>.
Supply for for anything that's left within the supply chain supporting the rest of our businesses, but overall I think we factored that into to the framework we provided.
Got it thanks, George and then.
I don't think we've talked about really each back today I know, it's a smaller business for you guys versus some of your competitors, but could you just talk a little bit about the order activity in that business. I mean, my understanding is that we've seen no orders turned negative year on year on tough comp.
You've seen that trend as well.
Yes, so it's.
For us, it's maybe a little bit different or North America. So when we look at resi globally. It's both ducked it in the U S and are inducted business with Hitachi and so we're up about 15% globally now when you look at North America. So we had sales up 27%.
But our backlog continues to grow and we're at a point Nicole that because where we are.
At our capacity, we're bringing on new new capacity as we speak in our Mexico facility were governed right now by being able to take orders.
Our capacity expansion and in Mexico, and so at this stage, it's hard to look at our orders because its book and bill in and where ultimately not taken orders that we can't support here.
I believe within the timeframe that theyre looking for delivery. So that's a little bit of a factor for us as far as on the auto side, but we still believe that on a run rate basis that the demand that we see coming in is still very strong to be able to support the distribution that ultimately we supply to and because of the investments that we've made.
And new products and now with the expansion of our capacity and distribution, we still feel really good about the prospects for that business now in the non in the resi and the non ducting.
That's performing very well, we're up 13% year on year.
And this has been driven by we've been strong in Asia Pac up high single digits, that's been driven by Taiwan, and India, and then Europe actually and this should be a big strength of ours going forward because of the heat pumps and the mix of heat pumps in our portfolio there that.
We were up 23% and our V. RF is up 53% and so incredible success, there with the adoption of <unk> and some of our new ear to water heat pump technology and so I think overall this is an important segment for us and we're making the investments and I think we're seeing the success with the investments were.
Thanks George.
Thanks Nicole.
So on that operator, and let me add a few comments here to close the call I want to thank everyone for joining us. This morning, I think overall executing extremely well on our strategic strategic initiatives ultimately that will position us to to accelerate profitable growth, we're positioning the company to capitalize on some.
MS trends here that are facing our industry for the next decade, plus and although we've had a short term supply chain disruptions and they remain a challenge I can tell you that our teams are executing well I'm personally involved on a regular basis and making sure every step of the way, where we're taking the actions required to ultimate.
We recover and I think with the strength of our orders and backlog provides us added confidence on our growth outlook going forward and of course, we always remain focused on although we've had some impact short term. We are very much committed to deliver results for our customers and ultimately the long term plan that we have.
Committed to our shareholders. So I look forward to speaking with many of you soon and over the next few days, an operator that would conclude our call today.
Thank you all for your participation on today's conference call at this time all parties may disconnect.