Q1 2023 Johnson Controls International PLC Earnings Call
Come to Johnson controls first quarter 2023 earnings call. Your lines have been placed on listen only until the question and answer session.
To ask a question please.
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 turn the call over to Jim Lucas Vice President Investor Relations.
Good morning, and thank you for joining our conference call to discuss Johnson controls first quarter fiscal 2023 results. The press release and all related tables issued earlier this morning as well as the conference call Slide presentation can be found on the Investor Relations portion of our website at Johnson controls Dot 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 10-Q Form 10-K, 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 controls website, I will now turn the call over to George.
Thanks, Jim and good morning, everyone. Thank you for joining us on the call today.
Let's begin with slide three fiscal 2023 is off to a strong start with solid Q1 results are.
Our teams across the globe and executed well delivering strong financial performance for our shareholders.
Pushing the pace of innovation to provide our customers with the next phase of digital solutions across our vectors of growth.
During the quarter, we accelerated growth across our service based businesses drove higher margins and delivered profitability at the high end of our adjusted EPS guidance range.
Overall organic revenue grew at a healthy pace and our 11 $3 billion backlog remained resilient growing 11% year over year.
Our service strength was resilient remains a key competitive differentiator.
While order timing supply chain realization in China policies have impacted our global products and field install order flow during the quarter, we are seeing incremental improvements in order momentum heading into Q2.
As we mentioned over the last few quarters, we remain focused on the fundamentals of our business and improving our operational execution.
Our teams have done a great job advancing our initiatives to accelerate growth and optimize the efficiency of our cost structure.
During the quarter, we delivered $90 million and productivity cost savings and are on track to reach our $340 million savings target over the course of this fiscal year.
We are also committed to our prudent approach to capital allocation reinvesting in new products and technology to drive long term shareholder value, while continuing to return capital to our shareholders.
We recently announced our plans to enhance our growing industrial heat pump portfolio with the acquisition of hybrid energy.
Acquisitions are an integral part of our growth strategy and by investing in hybrids patented high temperature heat pump technology, we are continuing to strengthen our leading global product portfolio and provide our customers with the most efficient sustainable building solutions.
We are well positioned to capitalize on large growth opportunities across our dynamic product portfolio and field business.
Through our integrated domain expertise global coverage and scale, we are leading the way towards smart healthy and sustainable buildings for our customers.
While the global macroeconomic environment remains uncertain based on our strong start to Q1 and our expectations for the remainder of the year. We are raising the lower book end of our adjusted EPS guidance range for the year.
Now turning to slide four.
During the quarter, our open Blue platform continued to expand as we enhanced our capabilities leveraging the power of AI and providing customers with unique insights.
A good example is the deployment of open Blue enterprise manager at a leading tech manufacturer to help them meet their energy and sustainability goals.
In addition, we have recently installed opened blue companion at their facility to enhance employee productivity and space utilization.
From advancing predictive analytics to integrations at the edge, our full suite of solutions empowers our customers to meet their carbon emission goals and create a healthier more productive work space for their people.
To date, we have enhanced the existing connectivity of over 11000, Chillers through open blue representing a 79% increase year over year.
Moving on to slide five.
Our digital service journey has accelerated since we launched our innovative open blue platform in fiscal 2021.
At that time, we entered the first phase of our digital transformation with a focus on enhancing data mining capabilities.
Over fiscal 2022, we launched the open blue gateway, enabling data access at scale and increased connectivity across our growing installed base.
We are now positioned for the next phase of our journey as we standardized our field operations globally.
Linking the benefits of real time monitoring of connected devices to our extensive service network. We can provide our customers with faster response times, while optimizing the deployment of our global field service presence.
We are beginning to see the results of our digital offerings, enabling service growth.
During the first quarter service orders and revenue grew 10% year over year.
With continued growth we are in a great position to reach the goal we set out at our Investor day in fiscal 2021 to captured $2 billion in additional service revenue by 2024.
On to slide six with nearly 40% of the world's carbon emissions coming from commercial and industrial buildings. The goal of achieving net zero starts at the building level.
Through our Bath sustainable infrastructure partnership ecosystem, we play an integral role in helping our customers achieve these targets no matter, where they are in their de carbonization journey.
Starting with our established advisory services and goal setting partnerships with KPMG and Accenture, we help customers take the first step to accelerate and solve their decarbonization and efficiency goals.
We were also able to help fast track our customers net zero targets through carbon reduction services, collaborating with leading renewable energy supply and distributed energy providers.
With our comprehensive customer solutions and strategic partnerships, we are positioned to take full advantage of favorable regulatory tailwind and continued momentum.
During Q1, we realized over $200 million in.
Organic revenue growing over 20% year over year with orders over the last 12 months growing at 6%.
Turning to slide seven.
Healthy buildings opportunity remains attractive as our customers invest in indoor environmental quality improvements post COVID-19.
Solving for the indoor air quality and energy consumption challenges of hybrid work models is driving a compelling intersection of our healthy buildings and sustainability strategic growth vectors.
We are in a leadership position thanks to open Blue indoor air quality of the service, which continued to gain momentum in Q1.
As well as our leading <unk> and space management capabilities and open Blue Enterprise manager.
In our healthy buildings business trailing 12 month orders increased 11% year over year, and our pipeline of $1 $2 billion remained strong.
Looking forward, we expect continued growth momentum is the value of indoor environmental quality improvements delivers benefits for our customers.
Onto slide eight we are honored to be continually recognized for our dedicated sustainability efforts. Among other honorable recognitions to have Johnson controls leaders were ordered for their efforts.
<unk> sustainability officer, Katie Mcginty was named one of 2020 two's most influential women executives for sustainability leadership by Women, Inc magazine.
Our new resin indie President of Asia Pacific received the ESG exploration character award of the year from the 2022 ESG priority is 60 awards, but Jim Young I am proud of our team for leading by example, and executing on our values I.
I will now turn the call over to Olivier to go through the financial details of the quarter Olivier. Thanks, George and good morning, everyone. Let me start with <unk> on slide nine total sales grew 4% with organic sales, increasing 9% comprised of 10% price and a modest volume decline FX was a <unk>.
6% headwind during the quarter, we saw strong performance across our longer cycle businesses, which grew 10% in the quarter, our shorter cycle global products business grew seven 7% impacted by a slowdown in residential demand.
Adjusted segment, EBITDA increased 15% with margins expanding 140 basis points to 13, 7% positive price cost and improved productivity more than upset and favorable business mix adjusts.
Adjusted EPS of <unk> 67 was at the high end of our guidance and increased 24% year over year during the quarter, we absorbed an additional penny of FX headwinds versus the prior guide pre.
Free cash flow would tend to the normal seasonal pattern with a usage to start the year. In addition inventory levels were impacted by softness in residential as well as continued supply chain disruptions, which one improving impacted our ability to satisfy growing demand in commercial.
Turning to our EPS bridge on slide 10, although all operations contributed 19.
Versus the prior year, including an 11 cent benefit from our productivity programs for which we are on track to meet our targeted savings for the year.
In the quarter FX was a four cent Edwin below the line higher net financing charges and corporate expense were offset by a lower share count and favorable noncontrolling interest.
Please turn to slide 11 total orders for our field businesses increased 5% as George stated earlier orders in the quarter were affected by timing and Covid related impacts in China auto.
While the timing at the largest impact within our installed business, which grew 1% in the quarter.
We were encouraged by 10% order growth in our service business driven by double digit growth in both EMEA and APAC.
Beat backlog remains at record levels growing 11% to $11 $3 billion, the $800 million increase versus the prior year, what growing $250 million sequentially.
Our global products set party backlog grew more than 30% over the prior yet to two $8 billion.
Let's now discuss our segment results in more details on slides.
<unk> and 13th.
Sales in North America were up 10% organically with broad based growth across the portfolio our.
Our installed business grew 12% with low double digit growth in both retrofit and new construction.
Overall, HVAC and controls continues to gain momentum growing mid teens year over year, while financing <unk> increased high single digits.
Or the timing, mainly impacted North America as orders increased 6% with solid growth of 7% in our service business, New construction orders grew over 50% primarily niche back.
In aggregate fine and secrete fire and security orders grew low single digits total backlog ended the quarter at $7 $5 billion up 16% year over year.
Segment margins decreased 30 basis points year over year to 11, 3% as positive price cost and ongoing productivity benefits were offset by unfavorable project mix.
Sales in MELA grew 12% organically with strong performance in applied commercial HVAC and fire and security.
Our service based business was strong in the quarter growing mid teens year over year with recurring revenue contributing low double digit growth.
Orders were up 5% led by over 20% growth across our fire and security platforms, which was partially offset by declines in HVAC and industrial have coordination.
Backlog was up 5% year over year to $2 2 billion.
Segment, EBITDA margins declined 210 basis points to seven 7% as a result of and folk board mix and gene achieved price costs, which offset favorable volume leverage and the benefits of cost savings during the quarter.
Sales in Asia Pacific increased 7% driven by mid single digit growth in our commercial HVAC and controls platform.
<unk> performed well in the quarter growing low double digits benefiting from our shorter cycle transactional business, primarily in HVAC and controls.
<unk> grew 1% in the quarter impacted by Covid induced lockdowns.
As John as China continues to reopen we are encouraged with the momentum building within that region.
Orders declined 1% as low double digit growth in service was offset by a decline in HVAC and controls installation, while the horn and star orders declined 5% organically.
Backlog of $1 6 billion declined 1% year over year.
Segment, EBITDA margins increased 40 basis points to 10, 5% driven by positive price cost and productivity savings.
<unk> offset lower volumes and FX headwinds over the quarter.
Sales in our shorter cycle products business increased 7% in the quarter benefiting from strong price realization of 11% commercial HVAC product sales were up low double digits with strength in light commercial driven by over 20% growth in North America and Miller risks.
<unk>.
Applied HVAC sales were up low double digits with continued demand in Sheila within our data center end market.
Outside of North America, our global residential HVAC sales were up low single digits.
North America, Resi HVAC declined 20% as the overhaul market softened.
And we were challenged by unfavorable product mix in the channel.
Our HVAC business grew mid single digits led by more than 25 growth in applied with the MLR.
As well as strong demand from our a touchy commercial pump in EMEA.
Fire and security products grew high single digits in aggregate led by continued demand in North America and in the Middle East for our fire detection products.
<unk> margins expanded 580 basis points to 21, 3% driven by positive price cost and the benefit of productivity savings.
Turning to our balance sheet and cash flow on slide 14.
We ended Q1 with $1 $5 billion in available in available cash and net debt at two two times, which is which is within our target range of two to two and a half times.
Now, let's discuss our fiscal 'twenty three guidance on slide 15, we.
We were pleased with our start of the year and are encouraged by the continued strength and resilience in our order and backlog our backlog grew double digits and remains at record level.
We are providing Q2 organic sales guidance of approximately 10% growth, we surprise being the principal contributor.
Segment EBIT margin is expected to expand 100 to 110 basis points and adjusted EPS is an expected range of 72 cents to 74 cents, which represents year over year growth of 15% to 18%.
On a full year basis, we are raising the lower end of the wide range. We introduced two beginning of the year.
While we are encouraged with our strong start to the year and our current second quarter outlook. We continue to take a cautious outlook for the full year given the ongoing macroeconomic uncertainty.
Our full year adjusted EPS guidance range of $3 30 to $3 60.
Represent growth of 10% to 20%.
The top third of our EPS range signifies our base case scenario does account for normalized GDP growth continued growth vectors acceleration and co version of our existing backlog.
The low end of this range provides a bookend reflect reflecting a potential macro downside scenario, which accounts for potential degradation of global GDP that we believe would be upset by over <unk> <unk>.
Resident services and commercial market presence, along with additional cost mitigation actions.
On the top line, we anticipate high single digit to low double digit organic growth with price representing about 10%.
We anticipate segment EBIT a margin expansion of 90 to 120 basis points as we continued to execute our high yet booked margin backlog throughout the fiscal year.
Full year free cash flow conversion is expected to be between 80% to 90% operationally, we continue to improve our working capital management and expect further improvements from the gradual reduction of inventories as the supply chain normalizes.
As George mentioned, we are pleased with the strong start to the fiscal year.
What supply chain descriptions continued to impact our global products business, we see positive momentum in our field based services.
Cross sell of vectors of growth our pipeline remains robust and we are well positioned to capture secular tailwind, while continuing to improve our operational execution as we navigate through the first off of the fiscal year.
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Our first question is going to come from Nigel Coe.
From Wolfe Research Nigel your line is open.
Thanks, and good morning, everyone.
Good morning, Nigel, though hi, guys. So yeah, you mentioned fields.
Timing and fulfill the orders.
Coming in at plus 1%, so maybe continuing just double click on what's causing.
Some of the delays that perhaps you didn't expect that China, I think I understand but you know outside of China.
Yes, when you look at our field orders what is encouraging although the install was up 1% services was up over 10% in and we're very encouraged with the progress we're making there Nigel on the install side, it's mainly a couple of factors here that impacted us here in the quarter. It was the China.
Covid Lockdowns, we have incredible pipeline, but because of the disruption and ultimately the delay in getting those closed impacted us in the quarter and that's 1% to 2% and then in our project based business as we now drive our.
Vectors of growth around sustainability and healthy buildings as larger projects and a lot of these it's hard to predict the timing of the conversion and so that amounted to another roughly.
1% to 2% those are the key drivers.
As far as the orders field orders Nigel the backlog is up over 11%.
The pipeline continues to be strong double digits and our conversion.
So as we're now executing on the strategy. We are encouraged that our conversion is going to continue very strong here in Q2 and beyond for the year and then now the way that we've been set up here with the backlog.
<unk> up for the year.
It really does give us a lot of confidence in our ability to be able to deliver on the guide that we've provided for the full year.
Great. Thanks, and then my follow up questions on that.
The margin expansion for the full year.
You've raised the bottom end by 10 basis points I'm curious has the mix between the segments changed and I'm, referring here to the LCD. The strengths we saw NGO products the weakness we saw in EMEA.
M. A L. A so just wondering if the mix of that margin expansion has changed at all.
We're making tremendous progress on our margins and it's not all of this has been over the last couple of years on instilling a disciplined around price cost and the more important about the value propositions that we're bringing to the market with our vectors of growth and so we've got you see that not only in our shorter cycle business with our global products.
And the strength that we're having in margins as combined not only the value proposition, but now also the additional productivity that's playing through and the leverage that we're getting on that and so as we project. The current year, we're going to continue you're going to see momentum in margins.
Because the longer cycle business, we've got strong margins in backlog as we increase the velocity on the turn of these projects youre going to start to see much stronger margins come through on the rest of the year. So liberty and maybe you can comment on the segments are absolutely. So one clarifying point on the orders we expect as a.
As a an impact.
On orders due to the move of deal orders from Q1 to Q2 orders in the field to be high single digits in Q2 regarding demand chain.
We expect global product margin to remain strong for the rest of the year and we expect the field margin to turn positive in Q2.
Probably about 51 to 100 basis points at the segment EBIT, a level and increase day after significantly with a strong increase as we end the year Nigel in the field business.
Great. That's very helpful. Thank you.
Our next question comes from Joe Ritchie from Goldman Sachs. Joe Your line is open.
Thanks, Good morning, everyone.
Good morning, Joe.
Olivia I want to I wanted to pick up off that last point on field margins improving into you guys called out unfavorable mix, both in North America, and EMEA I want to understand that a little bit better and then specifically on North America. Yeah. I know that you guys saw the sequential improvement last quarter, but the <unk>.
Margin <unk>.
Down year over year for the last seven quarters. So just help us understand what's driving the confidence in those margins getting better from here and what was what was the issue with unfavorable mix that was coming through the field business this quarter.
So it would be from a project to.
Projects.
Makes or larger projects flowing through in the quarter. If you look at the at a high level and and we have discussed that job before we.
We have booked orders at <unk>.
Higher level of margin all through last year and those orders are now starting to flow through to the field business. So as I indicated to Nigel earlier, we expect the field margin to improve at a segment EBITDA level in Q2 by 50 to 100 basis points and keep inquiry.
Seeing there after that would include also our North America business the expectation for the margin increase in segment <unk> date level for North America. In Q2 is expected to increase to be of a full points.
So as we keep converting the backlog.
Which is at the higher margin as we keep delivering our productivity initiatives as we keep increasing the mix of our service business in our company, which was very strong in Q1. We expect this momentum to continues in Q2, you will see the field margin business to increase I would say.
Materially between Q1 and Q4 Joe.
Okay. That's good to hear and I know you don't.
Usually ask questions on North America resi business, because it's a small portion of the overall portfolio, but it was it was pretty interesting to see that business down 20% I think you guys called out product mix in the channel. So maybe provide a little bit more color with what's happening there because that seems to be a little bit lower than what we've seen a report.
So far from some of your peers.
Yeah, when you look at our North America.
Dr. <unk> business when you look at the overall.
Market is down.
In units.
And the teams now we were down more than that and it's really two big factors. Here. This is where we've had coming into the year. We still had continued supply chain disruptions. We also had the launch of our new products in 2023 product, while we work through that we worked through the supply chain.
Although we were down further in units.
We had strong pricing coming through we work with our distributors.
There is another key point to make on our field direct channel, which is a small portion of our distribution we were actually up 13%.
So that's similar to what others have seen on the distribution side, we've worked with our distributors and making sure that now as we have continued to improve our supply chain through the quarter.
That we're going to be positioned to be able to deliver on their expectations from a demand standpoint, as we now go through the rest of the year and so when you look at the rest of the year, we are projecting that the.
The market will be down high single digits and units will be continued strong pricing coming through.
We'll be in line with the with the industry and we believe that now with our recovery of the supply chain, we actually start to pick up some of the share that we had lost over the last year due to the supply chain.
Got it very helpful. Thank you.
Thank you Joe.
Our next question comes from Steve Tusa Jpmorgan, Steve Your line is open.
Hey, guys good morning.
Morning, Steve on a if I look at a roughly kind of the the 350 or so where.
Where consensus is.
It implies with using the midpoint of your guidance about.
You know.
$2.
$2.10 or so of earnings in the second half.
That's about a buck per quarter by my math.
Yeah.
What would you do you is that kind of the right type of seasonality would you expect fourth quarter to be.
Above third quarter, and how materially above maybe just give us a little bit of a little more color on how the third and the fourth quarters breakout EPS wise.
Yeah it'd be at the high level, Steve when we look at our build for the year. We were in a very different place this year than we were last.
No continued to accelerate our capacity expansion across our you know our product based businesses and we've seen a nice ramp for instance in our applied businesses in some cases, we're expanding capacity two or three times and we're starting to see that volume come through and then we have worked with our supply chain. So we're very much as.
<unk> now going into our seasonal ramp as well as the recovery of our backlog to be able to begin to accelerate here in Q2 and that will continue through the seasonality that we see in Q3 and Q4 and so we're in a very different place than we were a year ago and being able to execute on that ramp in them.
Very encouraged with the work that we've done, especially across our applied business where.
From a core strength that is our strength and we're beginning to see that pick up across the board. So Olivier I don't know if you got any additional no not not much more to add to backlog conversion now is going to have its full impact.
He will be very strong from Q2 onwards, the productivity initiatives are still well on track, we are deemed identifying new productivity initiatives or to the yeah. The backlog is very resilient our service makes us very strong accelerating significantly across the portfolio. So we.
See margin expansion.
Clearly in the second half Steve.
So like is it a buck the around the right number for <unk> and then it kind of steps up a bit from there or is it.
More fourth quarter weighted maybe just a little more precision to get people in line.
Roughly you are in the ballpark Steve Indeed.
Okay, and then one just one last one on on on non res activity.
You said that things are you know you expect things to pick up here. What are you seeing in January on that front I assume you are seeing some positive things and what's the latest outlook on how things trend in the back half of the calendar year.
As we look at our.
Our pipeline and we track our pipeline very closely especially as it relates to two all of the our growth vectors and then the overall general market. When you look at the Dodge number.
You know when you look at that growth we are lagging that.
We are seeing significant opportunity there as that plays through we are watching the Abi which is longer term.
You know from our projects that are coming to market. It did soften in November it did come back and stabilize in December .
And so for US it's and then when you look at our mix of our businesses with.
With the demand for our core applied business when we look at our our Chillers. When you look at industrial refrigeration you look at our data center.
<unk> across our supply.
Across the portfolio, we're seeing incredible demand and we're working to make sure that we're executing on the capacity expansions that we've made that we started over a year ago to be positioned to be able to to be able to support that demand and we're making good progress so from a non res as far as our mix and where we see.
Our strength to be we see continued very strong activity building on the put in the pipeline.
Great. Thanks, a lot.
Thank you.
Our next question comes from Julian Mitchell from Barclays.
Your line is open.
Hi, good morning.
Maybe I'd just wondering Julie good morning, I, just wanted to start off perhaps with the the inventory and the cash flow because I think the inventory was up.
You know about $400 million.
Sequentially and it seems like it's a mix of kind of.
Too much supply and too little demand in things like raising and then too much demand and too little supply in some other areas like commercial HVAC. So maybe just help us understand kind of what's going on in that inventory balance and then what does that mean for the pace at which free cash flow improved.
Over the balance of the year do you think free cash flow can be up year on year in the current second quarter or it's more of a sort of a second half recovery on cash.
So if you look at first of all default.
The full guide.
It's unchanged, 80% to 90% free cash flow for the full year. If you look at the seasonality of your question.
We believe we're going to go back to is to recall.
Free cash flow generation seasonality that means that we should be yet to date at the end of Q2 close to breakeven from a free cash flow standpoint, you can infer from that that we should be positive in Q4 in Q2 I'm sorry.
So breakeven yea to date at the end of Q2 posted <unk> in Q2, you're right inventory was the key via board explaining what happened in free cash flow in Q1, largely Josh covered that.
<unk> and some mismatch of inventory is what takes explaining this trend.
We believe that this is going to keep improving all through the year. We have detailed action in place and we believe that breaking event. After the first half is an achievable goal from a free cash flow standpoint, so Julian just to add to that as you look at our commercial applied business.
In many product lines, we're doubling in some cases tripling we're in the process of building up and being able to achieve that that output through the course of the year. So we're in a we're in a build and we're making good progress on the applied business. When you look at our total applied business with what we do externally as well as internally.
It's up very strong here in the in the first quarter and then the second is what Olivier said as we worked through the.
The residential disruption, it's really comes down to one plant on supporting our residential business with the disruption that we had are really coming into the quarter. We've worked through that and we're positioned to adjust given the mismatch. We had we've lined out with our distributors relative to what they expect and we have confidence that that's going to that's going to normal.
Lives here over the next quarter or two.
Thanks, very much and then I just wanted to circle back to the North America field business again.
You know because you've had the adding seven quarters now of down margins year on year. The Q1 margin was 200 points lower than it was two years ago.
And I think you'd mentioned mix as a headwind specifically in the first quarter, but clearly there's been issues.
Pre dating that pulling down the margin and it seems like it's taken.
Longer than you'd expected to get that North America field margin to turn a corner so yeah.
I think clearly the guide Embeds an improvement there you know getting to that dollar of EPS for example in Q3.
But maybe give us a bit more color on what you're doing kind of inside that organization to get the margins to turn around and how much of the improvement in margin is is that the internal self help us is getting some sort of macro or supplier burner.
Benefits.
And so let me let me touch touch on that and then I'll turn it over to Olivier when you look at the turn so what we've what we've booked over the last it's really been the last year or 15 months, what's been turning some of the the the longer cycle projects that are turning now and you look at what's going to turn second third and fourth quarter.
Much higher mix.
And relative to what the margin that we booked into the backlog and that margin is tied to much greater value propositions and then ultimately an installed base that's going to spin off service and so we're going through the last of the tail. There was prior to this inflationary period of projects that are that are still to come.
Went through but I have confidence that when we look at what we've been how we've been building. These projects costing and then ultimately executing youre going to start to see a nice pickup in margins and I think and then the other factor is that the velocity of our turn because of the improvement in the supply chain, you'll start to see much higher <unk>.
Activity because of the velocity of being able to turn these projects more consistently as we worked through the year. Those are the two big factors Olivier maybe you could comment on the on the margin rate I, absolutely saw as a byproduct of this dispute the backlog conversion, we would see as I indicated earlier it should get margin expansion.
I can go a bit more into the details of the numbers here. So poor being in Q2, we would expect segment AB Dave marching to increase close to a full points and today for Q3, we are planning actually close to a full point margin improvement in this business.
Not assuming not assuming a significant change in churn rates of the backdrop.
Great. Thank you.
Our next question comes from Scott Davis from Melius Research Scott Your line is open.
Hi, Good morning, George and Olivier and welcome Jim Thanks, Scott.
Two to the call and our world again here, but.
I think that the story really this cycle has been about pricing power in.
I'm kind of curious to see is demand kind of flattens out here.
Maybe some of the big Cobra drivers kind of anniversary how what's your confidence that price is something that you can continue to capture and I don't really mean in your backlog what's in the backlog is in the backlog I suppose but.
And forward contracts you can start to think about.
Back half of 'twenty, three and then to 24.
Yes, Scott.
We look at.
What we've done is we've been executing on the strategy that we outlined a couple of years back and where we are in that journey. It's really now capitalizing on a much bigger value proposition as we focus on our vectors of growth and that's not only in how we pulled together our combined capabilities within our products, but now with open blue and ultimately our career.
<unk> solutions that deliver on an outcome for our customers and the outcome is typically focused on energy reduction, obviously heightened indoor environmental quality and then ultimately leading to an autonomous building and as we focused on our core and then when you look at the contribution that our HVAC business has.
As to being able to achieve those outcomes. It is significant and so the value proposition comes with being able to create a solution that's very different than what it historically has been provided leveraging our technology and then being able to really leverage the core and how we ultimately deliver on that with the technology that we have in our products and so we're confident.
But when you look at how we're pricing today for the value proposition, we bring in the new products that we're bringing to market.
Our new product investment is up about 2025, 28% year on year, we've got the leading portfolio and heat pumps. He.
Pumps now today are going to be a big part of the solution and being able to reduce energy while we are.
Continuing to enhance the indoor air quality, and we have new heat pumps pretty much across the board, where where that technology is being applied across our entire portfolio from the most complex industrial applications with our chillers in an industrial refrigeration across to all of our commercial products rooftops as well as our are applied.
Air cooled chillers going into data centers, and then across our residential portfolio. So I'm confident that with the technology the value proposition and then our ability to fundamentally change how we serve our customers with solutions that focus on on outputs delivering for them, we're seeing significant momentum on that.
That's helpful George.
You break it certainly makes a ton of sense in HVAC. When when you think about fire and security how has that sales pitch kind of changed.
Over the last few years, I mean, I certainly understand the connected building, but how specifically has that value proposition I guess.
Which is so tangible in HVAC, but perhaps less so in fire and security and we can update us there. Thanks.
The way that we've leveraged our fire and security portfolio today, it's still very attractive its still 40% of our revenues its quota building systems on the digital side. They are critical systems to integrate with an overall smart building and because of the sensors that these systems to bring into the building very important for the data that we collect within open.
Blue and how we ultimately create a smart building. So it starts there now you would argue that it's more around the security systems. So whether it be access control intrusion or video those are very important sensors and systems that historically have been separate and apart, but then ultimately converge with R. R.
<unk> controls and the other digital systems within the building that with now with opened Blue We can bridge all of those systems into one solution into one dataset.
It starts there and then from a fire standpoint that when we install a fire system that the value proposition that we bring through service is significant and our ability to be able to connect and monitor and ultimately be very proactive in how we support our customers through service. So those are the two when you think about fire and security the Val.
<unk> proposition that it has into the solution set that we're building and ultimately differentiating the output. So we can create for the customers that we serve Scott.
Okay makes sense best of luck guys for 2023 I'll pass it on to Scott.
Our next question comes from Noah Kaye from Oppenheimer. Your line is open.
Good morning. Thanks.
Maybe circling back to supply chain health can you give us a little bit of better sense of what you saw across the business lines during the quarter, particularly in global products.
Maybe quantify any impact on how much revenue was pushed and then just your line of sight on the supply chain, helping that are improving pace of backlog conversion.
Yes.
Looking at our global products when you look at the impact that we had and I think the other.
Point to make here in our global products volume, we had a fire in a warehouse on within our fire suppression business.
<unk> the finished goods that we had stored and although we work to try to recover that in the quarter that impacted our growth rate.
At the product level about two or 3%.
So that is a big factor, we're going to we're going to recover that volume here.
Here in the second quarter.
Most of it in the second quarter, but maybe into the third quarter. So it's worthy to mention that the resi demand hit us for another roughly 1% to 2% and then when we look at China, and then the ability to be able to we're significantly ramping up our applied business. So when you look at our applied mix were up Doug.
Digit across the board and so we're confident that with the capacity expansion with the work that we've done with our supply base and making sure we have visibility to volumes as we ramp.
Like I said earlier and in some cases, we're doubling or tripling our volumes and our applied space. So yeah.
I am confident that although although and then when you look at our total product units were relatively flat because some of the units do go into our our direct channel solutions. So we're going to be ramping here, we're going to deliver.
The unit growth here as we as we position for Q2 that will continue to expand as we go through Q3 and Q4 those are the key factors.
That are have been impacting our ability to be able to turn.
Okay very helpful. And then just wanted to circle back to orders timing, maybe we can focus, particularly on sustainability, we look at the the pipeline growing up what was it 26%.
Versus the orders growth in the quarter.
We've obviously had a lot of significant relevant legislation and policy.
How much of this is that playing into the actual timing is our clients figure out the implications and are waiting for things like treasury guidance before more folks sign you know is there any kind of unexpected.
Air Pocket here or you know do you expect that conversion to significantly increase in the next quarter or two.
We're expecting that this is going to continue to significantly increase when you look at the IRI.
$369 billion in incentives over the next 10 years, and we believe and it's all focused on electrification, which we deliver through heat pumps.
It's focused on impact on grid capacity and generation, which we do incorporate renewable supply into our solutions.
Just the overall energy efficiency. This is right in our sweet spot and so we think the 369 actually multiplies by five to 10 times given the the amount of resource that will be put to work and being able to deliver on our customers' sustainability goals.
And so when you look at the pipeline that we're working to convert its well over $7 billion.
Last year that had ramped up to about $1 billion last year, we see that accelerating.
Over over over the course of the year. These are larger projects. So it's hard to predict the timing of conversion.
But our team so we've got the team on the field that would be the depth and expertise I think that fundamentally changes how we can go about serving our customers with the type of solutions that we're developing and all of that is delivered when you think about the optimal solution is not just the equipment because we have leadership equipment with developing.
Our leadership portfolio of heat pumps, but it's how the equipment comes together with our digital platform that ultimately delivers on our customers' expectations and that's what's going to I think differentiate us as we build not only build the pipeline, but begin to convert.
And capitalize on the opportunity ahead and just one last note in Europe is similar in Europe , I mean, we talk about the IRA, but we've been working very closely with the EU with a number of their their strategies. The green deal net zero by 2050, they've got the EU level legislation around they got climate law. They got.
And energy performance of buildings initiative, and then more recently it was the Repower EU.
Focusing on the independents from Russian fossil fuels all of these activities, we've been aligned working making sure. We're aligned so that we're going to be positioned to ultimately achieve the goals that they are setting out to achieve.
That's very helpful color and I'll correct myself that healthy buildings pipeline was up 26% and sustainability up 20%. So thank you for the color.
Okay Noah.
Our next question comes from Jeff Sprague from vertical research your line is open.
Hey, Thank you good morning, everyone.
Jeff I just wanted to actually come back I guess, a couple of topics that have already been addressed but just a really kind of clarify.
First just on the notion of margins improving on kind of acceleration of execution out of the backlog.
It doesn't seem like that's what you're guiding I don't know if you updated the volume forecast for the year, but I guess your guidance sort of assumes kind of little or no volume growth. So I guess the first question is is it that you expect acceleration to happen, but youre not quite willing to guide that way.
Or is there.
Some governing factor supply chain labor on the job sites that sort of thing that you're looking to get past first.
So if you look at the margin next generation, which is a byproduct of the backlog conversion as you said Jeff.
Jeff.
No, it's not really a viable associated with unit volumes. If you look at the field business.
Which is about 16 billion of whole venue for the enterprise. This is more and more of a business which is solution based.
What you need are less and less relevant measure.
So duchenne because we said services, we sell sustainability, we sell indoor air quality.
So the margin exploration is a byproduct of just the conversion and we are planning to your point for volume to be growing.
Low single digits about 2% for the back half of the yet.
And then a comment on that.
Comment on that just as we have instituted over the last two years the significant improvement in our ability to strategically price and then make sure that we're within that pricing, we're incorporating future inflation. So as were costing and these longer cycle projects, making sure we have the right cost and the right in terms of condition.
<unk> and the like that has significantly improved and so when we look at what's going to turn the next three quarters a high percentage of the projects that are going to turn or in backlog and the margin is.
As we have been working through the older backlog that was that was priced prior to the inflationary period that is becoming less and less and so we're confident that watson in the in the in the margin in backlog is a significant step up and now it is just our ability to be able to minimize disruption give more precise.
Two the material flows that support these projects and by doing so we accelerate the velocity of the turn and what that does it gives us higher productivity and then also from an inventory standpoint, our ability to be able to recognize revenue with the execution on a shorter cycle. So that's a big that's a big element.
And so I think we're cautious relative to the continued improvement that we're seeing in those factors, but we're confident that the margins that have been booked are going to turn and turn to be significantly improved over the course of the year.
No.
Thanks for that and that partially addressed this my second question, but I did want to come back to kind of projects and mix. So.
You pointed to kind of large projects being mix negative in the quarter and I think a lot of the kind of open blue healthy buildings.
<unk> Air.
But inherently often be larger projects as is it an issue that the stuff that's coming through the backlog is also let's just say maybe it wasn't priced appropriately for the inflation that was coming but also just inherently.
We had.
Less of the newer stuff embedded in it really want to kind of understand if we're waiting on big projects to come through that in fact, when we convert them.
They're margin accretive to the equation.
No I mean, it's actually the opposite Jeff when you look at our core as we have focused our field based business on our strategy to really differentiate and capitalize on the on the growth vectors, which is ultimately.
The energy reduction the healthy environment.
And then overall automation building, making sure that everything we do is deploying our core core capability core technology getting it connected and then ultimately converting it to a service.
By doing so it has refocused the.
The business so that we're the value proposition is greater.
With what we do and taking out a lot of the historical contracting that we might have done that ultimately was low margin and didn't convert to services. There's a much higher focus on leveraging our core obviously leveraging digital and then ultimately delivering on outcomes that historically had been achieved and so I think from that standpoint.
When you look at our applied.
<unk> business, where.
We're up.
Double digit with the applied products flowing into our channel, which ultimately is helping us create a bigger installed base. It's also getting the connectivity to that base, which then drives us to be able to create new value propositions with the data that ultimately we use from from that installed base.
Great. Thanks for the color I appreciate it.
Jeff.
Our next question comes from Nicole <unk> from Deutsche Bank. Your line is open.
Thanks for taking my question good morning, guys.
Good morning.
I just kind of wanted to pick off where Jeff just left off because I'm not sure I'm totally getting at.
I mean, if we think about it it seems like unfavorable mix was the cause of the weaker margins in the field business this quarter, but it seems like you do you have confidence that that unfavorable excellent not be a factor throughout the rest of the year. So I guess what is the risk that larger project.
Larger projects come through again greater than you expected in the second quarter to the fourth quarter driving that unfavorable mix again, that's the piece that I'm just not getting thank you.
Yes, its simple simple fundamental as we track.
How we book and what was.
Booked from a cost standpoint in and how does that tie to the the value proposition and then how it turns and so Nicole when we talk about mix on a forward looking basis you have a much every quarter you have less of the older projects that maybe didn't incorporate the higher inflationary rates that we now have experienced over the last.
18 months or so and so when we talk about mix as part of that as well as our ability to be able to then everything we've been booking from a strategy standpoint is more aligned to how we create.
<unk> base and ultimately get a recurring revenue from that installed base with service and that is when we talk about on a go forward basis that will continues to improve recognizing that we still have projects that we'll be turning that.
That didn't necessarily have that factored in.
Okay. Thanks, George that's really helpful clarification.
And then the second thing I just wanted to hit on is the gross sorry.
Sorry, the global products margins have been really impressive and I think a big driver of upside are offset to sales weakness for several quarters now I guess like what's the confidence that you can continue to improve global products margins from here at some point do you kind of see somewhat of a margin ceiling. Thanks.
Yes, if you look at today. So we believe we're going to be able to maintain the margin Ingrid about product and keep improving the margin in the field I know Nicole just to go back to your prior question on mix.
Backlog conversion is the big viable for mix improvement more than anything else and we have a high confidence in that now happening with no improvement in lead time.
Going back to your global Marching question, you'll go back to what George.
George has indicated.
We are mainly exposed to the commercial market today in global products receive a small proportion of our portfolio and in global products. We are investing heavily in important if you look at the new product introductions today, 90% of them are very strong eat pump capabilities, we bought a small asset or so in the quarter.
With IP need pumps. So we believe that the channel the strength of the portfolio is going to keep allowing us to maintain a strong margin in global products.
And there was no if you look at the macro and Nicole today from a commercial standpoint is still strong for commercial.
Thanks Olivier.
Our next question comes from Josh <unk> from Morgan Stanley .
Your line is now.
Hi, good morning, guys.
Morning, Josh follow up yes. Good morning, So just a follow up on the IRI.
Wondering if that is something that you guys expect to start booking this year and if we really don't expect to see any sort of shipments until 'twenty. Four is that is that sort of the way you guys are thinking about the timing looking start this year and maybe start to see the revenue benefit next year.
Yeah, I mean, we're obviously, we're already working with customers and working through what the what this means and how they go about it in <unk>.
And I think that we're obviously part of that is.
As Bill was formed and so we're definitely going to start to see some momentum here on the on the order side and then depending on the timing how that flows through the year and into next will continue to keep you updated but that this is ultimately helping to build the pipeline that we have.
And the confidence that we havent being able to.
Turn when not only book, but then turn sustainable solutions and it's across all of our portfolio right from residential incentives right up through some of the more complex offerings that we have.
And Josh this is where the field presents is very important we have today, a feed presents allowing us to advise our customers.
How to best leverage the benefits of D. A.
Got it and then just on maybe.
A little deeper trip into the weeds on the IRA I think there's like $5 a square foot and commercial energy retrofit incentives. My understanding is some of the stuff like open blue is significantly below that per square foot.
Yes.
Sort of like a lay up for customers what would hold them back if anything or is it just the industry yourselves included can only installed product so fast.
Yeah, I mean, it's just purely.
As a as an educational element that we're working through and understanding what it is and then what we can do and how we can go about solving the problem and being able to capitalize on the incentives and like to your point.
The the value proposition that we bring with the output that we can create again.
It becomes very attractive for the customers. So it isn't a matter of them that I think that they're going to ultimately proceed is more just the timing of going through that initial upfront process and getting getting it defined and then ultimately being able to execute but we're confident Josh would be the solution set that we built that we're gonna be.
Well positioned to be able to capitalize on the dollars that come come into the market as a result of that.
And some of it is when you look at customers. It's also changing how they're thinking about whether it be capital or Opex and how these business models are configured and then.
They match that too to the benefits that they see so.
Working through that and we've got a team that's working directly with our customer base in and sorting that out, but we're going to start to see momentum that on that both in the orders and then our ability to be able to convert.
Alright, Thanks, I'll leave it there.
Sure Josh.
Our last question, we have Gautam Khanna.
Color from Cowen.
Your line is open.
Hey, good morning, guys.
Good morning, good morning.
Was wondering if you could talk about any differences you are seeing in the forward pipeline order pipeline between fire and security.
The applied HVAC market I remember back when you had your Investor day.
Those markets would go away.
Similar rate and is that consistent with what youre seeing today.
Yes, so on the fire and security we are seeing strength in the with the Dodge construction and the and the activity coming through and we're positioned well on that.
On the more of the retrofit side.
We thrive and from a service standpoint, and how we upgrade and ultimately reconfigure indoor space and the like and we're seeing a lot of that given the hybrid work and help people who are coming back to work and so that is those are the factors that drive fire and security were up.
Both orders and revenue up close to double digit and both are typically a little bit lower growth rate than what we see in HVAC.
And then HVAC is really being driven by what we've discussed frequently hear during today's call around you know the value proposition not only with the efficiency that we bring within the new equipment, but.
The deployment of heat pumps for instance.
We're in a situation, where we've improved our technology with the temperatures that we can generate when you take a chiller and convert to a heat pump and then be able to replace a boiler.
Significantly reduces the carbon footprint for our customers at the same time, you're getting three to five times the efficiency out of the unit and so you get a tremendous payback and so it's through these models got them that as we begin to unleash what we believe to be a very attractive market and it does play to our stretch.
That is going to be a different demand.
Cycle than what historically, we've seen an HVAC one statistic goddamn to complement what Charles has indicated our adjusted pipeline growth today is in the mid teens, just reflecting what draws as indicated.
Okay, and then could you comment on your updated expectations for.
Commodity inflation or deflation I should say this year.
<unk>.
And then if you could just also comment on lead times that you guys are quoting.
In the applied commercial HVAC space. Thank you.
Yes, so on the on the inflation as it relates to commodities, we're watching that closely certainly some of that has moderated.
But as they've moderated other costs have continued to increase so that's something we're watching closely.
Certainly want to make sure that we stay disciplined.
With the impact that that might have I think whats important to us now is that the business.
The business proposition here is that we're creating value unnecessarily tied to purely price cost.
Is.
Historically, we would have done so I think that's one one factor and then the second on the would be the second was on the applied.
The lead time commit to the lead times as a result of the strong demand you're going to realize gautam that as as we've gone through the last year, we've had significant pickup in our backlog around applied and so on a go forward basis. It's important that we get we've been building our capacity, we're expanding a number of our plants.
Whether it be water cooled chillers are air cooled chillers are industrial refrigeration our data centers.
Data Center solutions, we're significantly increasing our capacity as we've been ramping up and we've been doing this in line with the supply chain recovery that we've been executing on and so once with this backlog.
We're trying to address the backlog so that we can open up capacity with shorter lead times to now be able to capitalize on what we see to be very strong demand going forward. So the lead times are being reduced there not to where we'd like them to be but with the additional capacity, we're putting online as we go through the year, we're going to be positioned very competitive.
Really from a lead time to be able to respond ultimately and support the customer demand that we see.
Okay.
Can you give us what the lead times are today.
Nine to 12 months.
They vary so it's hard to state any one depending on the right from the residential to the large commercial you know, but we've been reducing them significantly here over the last six months. We are now with the additional capacity coming on board I would tell you our volumes and our applied business.
A run rate basis, with our Chillers and then our.
Water cooled chillers in our air cooled Chillers were looking at volumes on a run rate basis that are going to be two to three times.
And so as we're putting those.
Capacity in place it does gives us an opportunity on a forward looking basis to reduce the lead times that we're quoting to our to our customers.
Thanks, guys.
Thanks, Bob.
That was our final question today I will now turn the call back over to <unk>.
Yeah, and I'd like to thank everyone. Once again for joining us on today's call. As we have discussed we have a very strong start to the fiscal year I'm very confident in our ability to execute and continue the momentum in the coming quarters as we start to really step up into the next phase of our digital transformation journey.
And with that look forward to seeing many of you over the conferences over the next couple of next month or so and with that operator that concludes our call.
That concludes the call. Thank you for participating you may disconnect at this time.