Earnings Call Transcript - JCI Q3 2025

Operator, Operator

Hello, everyone, and welcome to the Johnson Controls Q3 2025 Earnings Conference Call. My name is Nadia, and I'll be coordinating the call today. Operator Instructions. I will now hand the call over to Jim Lucas, Vice President, Investor Relations, to begin. Jim, please go ahead.

Jim Lucas, Vice President, Investor Relations

Good morning, and thank you for joining our conference call to discuss Johnson Controls Fiscal Third Quarter 2025 Results. Joining me on the call today are Johnson Controls Chief Executive Officer, Joakim Weidemanis; and Marc Vandiepenbeeck, our Chief Financial Officer. Before we begin, let me remind you that during our presentation today, we will make forward-looking statements that reflect our current views about our future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Please refer to our SEC filings for a list of these important risk factors that could cause actual results to differ from our predictions. We will also reference certain non-GAAP measures throughout today's presentation. Reconciliations of these non-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 Joakim.

Joakim Weidemanis, CEO

Thanks, Jim, and good morning, everyone. Thank you for joining us on today's call. This morning, we announced strong third quarter results, continuing the momentum we've sustained throughout the year. Organic sales grew 6%, segment margins expanded 20 basis points to 17.6% and adjusted EPS grew 11% and exceeded our guidance. Year-to-date, adjusted free cash flow has nearly doubled to $1.8 billion, and we are on track to deliver over 100% free cash flow conversion for the year. Orders grew 2%, led by strength in the Americas and offset by ongoing softness in China. Our backlog grew 11% to $14.6 billion and remains at record levels. We continue to see strength in demand for both our Systems and Service solutions. We are now building an even stronger foundation for long-term success by developing a business system focused on simplifying operations, accelerating growth and scaling our impact. This includes sharpening our focus on what matters most to customers and deploying Lean principles to tackle barriers to growth. We're raising our full year guidance, and Marc will give more details later in the call. I now have my first quarter under my belt, and tomorrow is my 140th day at a company celebrating 140 years of leadership. That is 140 years of winning with customers, driving innovation and supporting the advancement of human society with solutions for smart, productive, safe and sustainable buildings. After all, the advancement of science, education, health care and manufacturing occur in buildings. As we celebrate and reflect upon our history, we believe our best days are still ahead of us. Unlocking our potential depends on placing even greater emphasis on the customer. Our goal is to deliver consistent, predictable results over time and outperform our competition, enabling strong capital allocation and enhancing value for shareholders. Since joining Johnson Controls, I've had the opportunity to travel the globe, visiting our largest factories and spending time in the field with our customers and teams. I have visited well over 100 customers, all of our major innovation centers and walked more than 30 plants. I met with hundreds of our frontline colleagues in sales, service, R&D and manufacturing. These travels produced insights that will inform our future success as a company. First, we need to sharpen our focus on our customers while also staying ahead of the competition. Customer centricity will fuel accelerated growth by enabling us to win and retain customers more effectively through differentiated offerings and how we serve them. Second, it's essential that we enhance our investment in R&D to accelerate innovation. Our IP portfolio is strong with 8,200 patents and more on the way. Our products and solutions deliver results that resonate with our customers. While we possess considerable strengths, there remain opportunities to accelerate growth within our core domains by addressing gaps in our product portfolio. Third, our field position of 40,000 frontline colleagues has been and continues to be a competitive advantage. We see clear opportunities to better equip and support them, making it easier for them to deliver for our customers. By doing so, we can get more leverage from our team and expand capacity and productivity to drive stronger results. Given the importance of this effort, we recently appointed Chris Scalia as Executive Vice President and Chief Human Resources Officer. Chris brings a unique combination of people and culture strategy, operational excellence and a deep commitment to building high-performing teams. We're excited for Chris to hit the ground running; as we continue to transform Johnson Controls into a growth-focused, customer-centric powerhouse and a magnet for talent. As we look ahead to our ongoing transformation, developing a business system and embedding it in our cultural foundation is a critical step in driving long-term success, one that requires dedicated effort, discipline and patience. My deep experience with proven business systems, combined with spending meaningful time at Gamba has helped us shape a clear vision for what this could look like at Johnson Controls. This business system is how we will win and run the company. It will be anchored in proven methodologies like 80/20 and Lean and augmented by digitization and AI. First, 80/20 is a powerful operating model that sharpens our focus, cutting through complexity so we can concentrate our energy on what matters most to our customers. We simplify. Then adopting principles of Lean. We convert this focus into action with a strong orientation on what matters most to our customers. We eliminate waste, streamline workflows and accelerate processes to drive speed and efficiency across the organization to better serve customers and increase our competitiveness. We accelerate. And throughout the process, we embed digitization and AI as core enablers in our process improvement. This augments our focus and speed with smarter systems and the ability to scale impact for our customers and our people. We scale. So simplify, accelerate, scale. While we've made progress over the last several quarters, we know that with a strong business system in place, we can accelerate and improve our results over time. We will solve customer problems faster and more effectively by empowering our people. It will become our way of life at Johnson Controls. Our efforts are already underway. Since the last earnings call, we have identified a number of growth blockers, and we are actively addressing them. In general, the growth blockers center around the speed of execution and more effectively and efficiently leveraging our existing capabilities in the field and beyond. To ensure speed in decision-making and implementation, it is important to identify the root cause of these growth blockers and develop countermeasures that we can then implement into consistent, repeatable processes. We have started with a narrow focus to deliver results quickly, and then we will scale more broadly. I can give you two early examples of progress. The first example is in our conventional HVAC business, where we're creating value for our customers and our frontline colleagues who serve them. Our objective is to substantially increase the amount of time our sales teams can dedicate to engaging with customers by streamlining internal processes and eliminating waste that does not contribute direct value to the customer experience. Over the last four weeks, this team has identified specific countermeasures to double time with customers for our sellers. This will unlock opportunities to better leverage our enviable field position. Another focus area is improving lead times for our key chillers in North America, where we continue to see dynamic growth in the fast-expanding data center vertical. We have an opportunity to cut lead times in half, which will both improve our competitiveness and create additional manufacturing capacity. As we deliver substantial improvements around the growth blockers we have identified, we can replicate these successes and deploy across our global portfolio. With momentum building, our executive team has been trained on the core foundations of our future business system, and each of them has participated in at least one kaizen. After countless kaizens throughout my career, I participated in my first Johnson Controls kaizen a couple of weeks ago. Over the next few months, we will train our top 200 leaders and ensure their participation in kaizens and our program overall. As we begin to see tangible results from these early initiatives, we will expand engagement and training across the organization. While we have many opportunities to drive growth through operational improvement and ultimately more consistent predictable results, we're also continuously evaluating and refining our strategy. This has started with a fresh objective view of all our business lines and solutions. Looking ahead, we will evaluate our portfolio and make strategic decisions to ensure sustainable growth through targeted acquisitions or thoughtful exits. As we move forward, our focus will progress to a comprehensive review of our operations, including our manufacturing and back-office networks to further unlock productivity and capacity. In summary, we believe there are clear opportunities to optimize our portfolio, footprint, cost structure and the way we work going forward. This is an ongoing process with continued focus on delivering shareholder value. It has been a productive four months since I've started at Johnson Controls. My excitement continues to build as we become more intensely focused on the customer, the people on the front lines who serve them every day and drive adoption of our future business system. I look forward to the journey ahead as we work together to deliver even greater value for our customers, team members and shareholders. With that, I will now turn it over to Marc.

Marc Vandiepenbeeck, CFO

Thanks, Joakim, and good morning, everyone. Turning to Slide 6. We delivered strong results in the fiscal third quarter. While the broader environment remains uncertain, our execution continued to drive meaningful results. Our focus on operational efficiency is helping us to deliver for our customers and reinforce our competitive edge. Our team is committed to generating consistent long-term value for our shareholders. In the quarter, organic revenue grew 6%, and segment margin expanded 20 basis points to 17.6% as we proactively mitigated the impact of tariffs through strategic sourcing and cost management initiatives. Adjusted EPS of $1.05 was up 11% year-over-year and exceeded the high end of our guidance range. On the balance sheet, we ended the third quarter with approximately $700 million in available cash. Compared to last year, net debt declined to 2.5x, which is within our long-term target range of 2 to 2.5x. Year-to-date, adjusted free cash flow improved approximately $900 million year-over-year to $1.8 billion. This strong performance driven by improved cash conversion reflects our disciplined financial management and consistent operational execution. Let's now discuss our segment results in more details on Slide 7 and 8. Orders in the quarter grew 2% as growth in Americas was muted by softness in China. Customer engagement remains strong, and we continue to see healthy activity across our pipeline. Additionally, the mix of orders is shifting toward higher-margin solutions, reinforcing our long-term growth and profitability outlook. Geographically, orders in Americas increased 5%, with mid-single-digit growth in Systems. In EMEA, orders were up 2% against a tough comparison, with 6% growth in Service offsetting a 1% decline in Systems. In APAC, orders were down 8% as the decline in System more than offset double-digit growth in Service. At an enterprise level, organic sales growth was led by solid mid-single-digit growth in both System and Service. Sales in Americas were up 7% organically with continued strength in both HVAC and Controls. In EMEA, organic sales grew 4%, led by 8% growth in Service. In APAC, sales grew 6% organically with strong double-digit growth from our resilient Service business. We continue to maintain healthy margin through disciplined cost management and strategic pricing, ensuring profitability even in a dynamic market environment. Operationally, we have driven greater efficiency across our core processes, while improvement in our service mix has allowed us to prioritize higher value offerings that enhance customer satisfaction and support long-term profitable growth. By region, EMEA adjusted segment EBITA margin expanded 100 basis points to 14.1%, driven by improved productivity and the positive mix of Service growth. In APAC, adjusted margins expanded 70 basis points to 19.4% as productivity continued to improve. In America, adjusted margin improved 10 basis points to 18.5% as System growth outpaced Service growth. Our backlog remains at record levels, growing 11% to $14.6 billion. System backlog grew 11%, and Service backlog grew 8%. Let's now discuss our fiscal fourth quarter and full year guidance on Slide 9. As we enter the fourth quarter, we are building on strong momentum, driven by enhanced operational efficiencies and a backlog that remains at historical high levels. We anticipate organic sales growth of low single digits, adjusted segment EBITA margin of approximately 18.6% and adjusted EPS in the range of $1.14 to $1.17. As a reminder, we have a challenging comparison due to a large one-time project we successfully executed last year. Based on strong execution and consistent performance, we are reaffirming our full-year guidance for mid-single-digit organic sales growth and approximately 90 basis points of adjusted segment EBITA margin expansion. Additionally, we are raising our outlook for adjusted EPS and free cash flow conversion. We now expect adjusted EPS in the range of $3.65 to $3.68 per share, representing 14% to 15% growth. Building on our strengthened working capital position, year-to-date free cash flow performance reflects solid execution and financial discipline. As a result, we now anticipate achieving free cash flow conversion of greater than 100% for the full year. We continue to target returning 100% of our free cash flow to shareholders through dividends and share repurchases. Finally, we expect the sale of our Residential and Light Commercial HVAC business to Bosch to close in our fiscal fourth quarter. While we anticipate returning the majority of the net proceeds to our shareholders through share repurchases, the impact on this year's share count is expected to be minimal, with the benefit primarily accruing in the next fiscal year.

Operator, Operator

Operator, we are now ready for questions.

Amit Mehrotra, Analyst

Joakim, I guess, as you approach five months on the job, I know that's not a long time, but I guess it would just be helpful nonetheless to understand your initial observations. What are some of the KPIs you're focused on to make sure the global organization is moving in the right direction? And importantly, how quickly do you think we can see some of the tangible progress on the return profile of the business?

Joakim Weidemanis, CEO

Yes, Amit, four months in, I have visited many places around the world, met with over 100 customers, toured more than 30 plants, and collaborated with colleagues at all of our innovation centers. I feel I have a strong understanding of the opportunities ahead. First and foremost, we must enhance our focus on the customer across all levels and functions of our company, which is a crucial foundation. I also see potential for growth through innovation and increased investments in R&D, which I will explain how we plan to fund. We have a strong position with 40,000 colleagues in the field, a capability developed over decades that is hard to duplicate. However, we need to find ways to accelerate improvements within the company that are valued by customers, allowing us to invest more in areas like innovation. That's why I mentioned a new business system that we are starting to implement. I provided two examples: one focused on commercial growth and one on operational efficiency, both aimed at cost reduction and growth. In our HVAC conventional business in North America, we have a team currently working on their fourth kaizen aimed at doubling the selling time for our sellers by eliminating waste from processes. I am very enthusiastic about the potential this holds. On the operations side, I shared an example where we are working to halve our lead times and are currently in our third kaizen for that initiative. I attended one of those kaizens recently. Halving lead times helps reduce costs and the amount of working capital tied up. This effort will provide benefits beyond just lead time reduction and will enhance our competitiveness. We are starting with product lines focused on the data center market, where demand remains high, and our ability to deliver faster than competitors is key to our advantage. We are beginning with a narrow focus to engage and train the organization, and then we will expand this approach over time. There are plenty of opportunities in these areas, and I am very excited about what lies ahead.

Scott Davis, Analyst

Appreciate the color on that question. I'm kind of going to go a slightly different direction. You've had 140 days. Maybe that's not enough time to answer this, perhaps. But do you have a better sense, Joakim, now of how you can accelerate growth in Fire & Security and how that business really leverages off of each other? I think historically, it's always been a question mark of whether they fit or not, but I think investors at this point are pretty open-minded on hearing your view.

Joakim Weidemanis, CEO

Thank you for the question, Scott. As we discussed previously, I view these as distinct businesses catering to a similar customer base but targeting different personas at various stages. This does not imply that they lack potential; they certainly have opportunities for growth. Many of the new business system examples I shared focus on HVAC & Controls, which we believe inherently have higher growth prospects, but there are also growth opportunities in Fire & Security. We will gradually implement the approaches I mentioned into those businesses, as we believe they have good potential for performance improvement over time. We are taking an objective look at our portfolio and are currently two months into a thorough strategic review of our businesses, assessing where we are now and our aspirations for the future. I am closely collaborating with the Board, as these discussions cannot be concluded in a single meeting. In the upcoming months, together with the Board, we will begin to outline what the future portfolio will look like.

Jeff Sprague, Analyst

Wondering if we could shift to free cash flow. Marc, nice to see the bump here this morning. Maybe could you address, and certainly Joakim, love to hear your thoughts on this also, but where the most significant opportunities are on the free cash flow side? Should we view this 100% plus sort of a catch-up on low-hanging fruit? Or is your confidence level that the company can kind of consistently be in that 100% range rising here?

Marc Vandiepenbeeck, CFO

For sure. Yes, thanks for the comments. We had a strong start to the year in cash flow, and we've continued that momentum. I think the progress we've made this year has a lot to do with our accounts receivable, our collection management, and everything goes from managing orders and managing customers through that experience. That has allowed us to continuously improve the conversion throughout the year and has allowed us to get to that 100-plus percent conversion. Almost $1 billion of improvement year-on-year is a good feat, but it doesn't mean that we are done and that's all of the benefits we are going to see. We still have those fundamental structural headwinds we've talked about of our effective tax rate being slightly different than the cash tax rate, and we still have slightly elevated CapEx, but those two things over time will die down. There are a lot of opportunities that are going to come from our Lean efforts and Lean transformation. If you think about when we start that flywheel around that Lean transformation, the need for facilities will reduce over time, which will reduce CapEx, which will reduce inventory. Our ability to increase cycle time and improve customer centricity will also drive ultimately better outputs from an inventory standpoint. We think that's where, moving forward, the larger opportunity is, but there's still progress to be made on every aspect of the fundamentals of our free cash flow conversion.

Joakim Weidemanis, CEO

Yes, I mean, I'll second that. The lead time reduction example I gave, in principle, that means that we'll be able to get a lot more output from that facility without adding additional physical asset space. That decouples the capital expenditures we need for our growth. We're also going to, at the same time, because with the approaches we're applying there, decouple the addition of inventory dollars for the growth dollars that we have. That lead time reduction initiative is what that's about. We've started narrow, and we'll go broader over time. We also have a work stream in our second kaizen, where we're looking at how we're performing on billing, how fast do we bill, how accurate is our billing and, therefore, what is sort of the first pass yield on customers paying invoices. Every company in this world is not perfect on invoicing; there are sometimes misses. If you have a couple of percent of invoicing errors that you need to redo versus less than 1%, that not only impacts customer satisfaction, but of course, also your cash flow. We've seen some good opportunities in that area, too. Those themes give me confidence that we're going to be able to maintain the cash conversion that we've seen so far this year.

Nigel Coe, Analyst

Just want to follow up on that last point. I mean, I don't want to sound greedy, but with the intangible amortization, is there a pathway to maybe being above 100% free cash conversion based on the current reporting structure? And then, maybe if we could maybe go back to the portfolio, very clear messaging there. Are we still in the zone of 5% to 10% of the current portfolio being, I guess, with a question mark over its strategic importance?

Marc Vandiepenbeeck, CFO

Yes, Nigel, I understand the question on above 100%. I think it's a little early for us to commit. What I can tell you is that, historically, we've said the algorithm was 85%, 90-plus percent. I think we are comfortable that we'll be able to deliver solidly in the 90s in terms of conversion. Over time, as we see the improvement on the Lean transformation yielding the results, we could raise from there. But at this stage, it's a little too early. On the portfolio, I would say the immediate actions we are taking on some of the assets that we believe are non-core. It's still within that 10%, 15% range. Now there's a broader amount of work that's being done; Joakim alluded to that earlier. That could be greater than the 10% over time as we validate our strategic vision with the Board and decide where we can focus and orient the company to be successful and grow faster.

Steve Tusa, Analyst

Can you provide some insight on the order number being a bit lighter than expected? How do you see that trend moving into the fourth quarter? Additionally, when can we expect a longer-term outlook on how these actions will impact finances?

Joakim Weidemanis, CEO

Very good. Yes. Orders in Americas were strong. EMEA, in my view, was better than perhaps what the number appears to be because of the comparison. There is ongoing softness in China. As you would expect, we've continued to dig deep into leading indicators, our pipelines and so on. My conclusion is that our core vertical markets remain healthy. It's not just in our health care and data center verticals. But overall, there's no change. I feel good about our pipelines. On China, which we've talked about before as bouncing around the bottom, we've continued to be diligent there around going after higher-margin Systems orders and prioritizing our Service business. We had healthy growth on the Service side. China is maybe a longer discussion, but I was there recently. One tidbit is that market is gradually turning into a more mature market in the sense that the retrofit part of the market continues to steadily increase, which is different than a number of years ago when it was a new construction market. It starting to look a little bit more like some of our Western markets. In the near term, new builds in China is a challenging space to be, so we need to be very mindful about what we choose to go after there and protect and manage our margins.

Joe Ritchie, Analyst

So with the quarter ending with record backlog, Joakim, I'm curious if you could provide us with an initial framework for 2026. Additionally, regarding Steve's question on long-term targets, are you considering an Investor Day next year?

Joakim Weidemanis, CEO

Yes, I appreciate your question, and I apologize for not addressing it earlier. I will ensure we cover that next time. We are currently working on 2026. I've been here for 140 days now, so I want to make sure I do a thorough job alongside Marc. Perhaps, Marc, you could provide an update on our progress.

Marc Vandiepenbeeck, CFO

Yes. We are on the finalization of our internal plan for '26. It's a bit early for us to comment on this. But I think, overall, the long-term algorithm we've been talking about, as a reminder, mid-single-digit top line growth, looking for well over 25% incrementals and then double-digit EPS growth remains the basis for now. As we implement the new business system, it's hard to imagine not having better incrementals over time, and understanding how that will influence the ultimate long-term algorithm. I think we'll be better positioned to give you a view on that as we close the year and release the fourth quarter and start talking guidance for '26 and give you a better view. As far as Investor Day, we really want to go through that deep understanding of our strategic orientation before we take people deeper into what the new JCI may look like and what it would mean long term from an investment thesis. So give us a little bit of time there to get through that and sharpen our pencil on the strategic view.

Joakim Weidemanis, CEO

Yes. Regarding the guidance, the two examples I've mentioned illustrate how we are implementing our new business system. To reinforce what Marc said, the commercial example I provided, which focuses on increasing the selling time for our sales team, is about separating the required investment in field personnel from past algorithms. The operations example I gave is about separating capital expenditures, inventory, and costs to also foster the growth we aim for from a cost perspective.

Nicole DeBlase, Analyst

Just wanted to ask something a bit short term in nature. I think, typically, if we look at EPS seasonality throughout the year, you've historically tended to see a low teens percentage increase in Q4 relative to Q3. The guidance this year implies something a bit lower than that. So I just want to understand, Marc, if you could kind of help with any major puts and takes between Q3 and Q4 that we should be considering.

Marc Vandiepenbeeck, CFO

Yes, nothing in particular. There are two dynamics that are happening at the same time. There’s a bit of uncertainty on what tariffs will do on the bottom line. So far, we've executed very well, but we've taken a more conservative view into the fourth quarter. You got to remember, with the extraction of our Residential and Light Commercial business, which was more transactional shorter-cycle business, we are now a little bit of a longer cycle company. The variation you see quarter-over-quarter is a little bit less seasonal. The fourth quarter, particularly in our HVAC & Controls business, is generally a very healthy quarter from growth and consequently the absorption of our field team simply because of the weather in the Northern Hemisphere. It will naturally provide better tailwinds overall, but nothing vastly different if you look at the enterprise from a continued basis standpoint.

Joseph O'Dea, Analyst

Marc, in reference to your comment around just the comment around the algorithm and well over 25% incrementals, can you touch on restructuring and the program that was announced last fall? Of the $500 million, what savings do you anticipate achieving this year, just kind of broad strokes what the setup would be for what you can achieve next year? And then separately and with some of the legislative developments, just anything on tax. I think you've previously outlined that, that could be up 400 to 500 bps year-over-year as we go into next year, but not sure of any recent developments there.

Marc Vandiepenbeeck, CFO

On restructuring, we've spent slightly over what we anticipated and achieved approximately dollar-for-dollar savings. This is part of our margin improvement as we reduce stranded costs linked to the Residential and Light Commercial sale throughout the year, even before the transaction's closure. We believe we can continue to aim for that $400 million target to realize the full $100 million benefit by the end of '26. We will need to consider how we manage our restructuring efforts and whether to extend the program to maximize returns from those initiatives. Regarding taxes, there are minor changes that will necessitate specific planning on our part. However, the rate headwind I mentioned earlier of 400 to 500 basis points on a projected 12% effective tax rate in '25 will persist, mainly due to the global minimum tax impacting our rate. Interestingly, this situation does not significantly alter the cash tax rate for '26, which is somewhat favorable for free cash flow conversion as our cash tax rate is expected to remain in the low 20s or high teens, depending on various actions we might take.

Andrew Obin, Analyst

Just a question going back to Americas orders. Could you disaggregate the orders between Fire & Security, Commercial HVAC? Specifically, what are you seeing on data centers? You have such a strong market share globally in the market. Given the overall strength, I would echo the sentiment that I would have expected a little bit more growth. But maybe just give us a sense of what's happening. Are there any specific push outs, but by verticals in Americas?

Joakim Weidemanis, CEO

Yes. Thanks, Andrew. Data centers continue to be very healthy and it's about 10% of our sales today, growing very nicely. There’s a reason why we decided to deploy the initial stages of our business system focused on the operations, manufacturing side of things to cut lead times for a data center product line. We see that continuing here over time. We're doing well with both hyperscalers and colos. We could have a more detailed discussion at another point in time. That says it for the HVAC and Applied side of our business. In general, it's doing very well. The example I gave on Commercial, where we're deploying the business system is in HVAC and Applied outside of data centers. We're already growing at a very healthy rate. Fire & Security is growing, but at a lower rate than HVAC. That's more in the low single digits. We see plenty of opportunity to apply the principles of what we're doing on the HVAC sales side in those businesses as well. We chose to start in HVAC because in the short term we think there's a bigger opportunity there. So Applied HVAC and data center heavy is the story here. The other businesses are still growing, but at low single digits.

Christopher M. Snyder, Analyst

If we look at JCI's Service business, it's had really good top line growth over the long term. But if we look back at history, is there any color you could provide as to how margins have expanded or the business has kind of driven operating leverage over the last few to several years?

Joakim Weidemanis, CEO

I think the answer to that is not enough operating leverage, and that is now an opportunity for us. I think there are, from my travels, two reasons for that. Just like we advanced on the HVAC sales side by applying Lean principles, we're able to remove waste in our internal processes and help accelerate the sales process. I think we have the same opportunity in Service, allowing us to gradually break the back off the connection between Service growth and adding Service cost. I see good opportunity in that. That's a body of work that we're going to be launching over the next quarter here. Then, I think in a couple of our businesses, the way we productize Services, we have an opportunity to add more differentiated Service products to our portfolio. Perhaps, I can come back to that at some point in time in the future. When I talked about wanting to increase investments in innovation, I'm not only talking about investments in Systems, but also in Service products. Some Service products might require tweaks and changes, and additions to our Systems on the installed base as well as new products. There are also innovation opportunities in how you digitize services to deliver, if I could call them, more outcome-oriented Service products to customers versus more break-fix-oriented Services. I see good opportunities, both operationally and from a product and differentiation standpoint, and being able to both continue the Service growth and, as I said, break the back off the costs so that margins can improve over time.

Julian Mitchell, Analyst

Just wanted to ask about operating margins and a couple of different questions on it. I think, first off, the OE mix is fairly muted year-on-year in the second half of this fiscal year. Understand that tariffs are weighing. But is the construct that sort of those related headwinds last through the first half of next fiscal year and then you get a larger jump in the back half as that tariff headwind eases? Beyond the next 12 months, I guess I was intrigued, Joakim, that you sounded relatively muted on the margin potential in Fire & Security. Perhaps, the growth outlook as well. I wondered if that's around JCI's positioning or something about market share because certainly there are some peers like Honeywell or Allegion who are putting up pretty decent numbers in various parts of F&S.

Joakim Weidemanis, CEO

Yes, thanks. I'll let Marc take the first half of the question, and then I'll add on.

Marc Vandiepenbeeck, CFO

Right. Yes, on the OE mix, you're right. Part of it on the rate standpoint is clearly the tariff, where we've been able to recover the vast majority of that headwind, not always being able to consistently drive margin on that recovery. Some markets have more pricing power, and we have been able to recover with margins. Other markets, given the size of the tariff impact, it was a little more difficult to justify to the end customer the need to receive margin on that. You got to remember there's a lot of stranded costs in our SG&A associated with the continued discontinued operation, the Residential and Light Commercial. There is a lot of work underway and progress being made to take that cost out. But that's muted a bit our ability to expand margin beyond the expectation. Moving forward, we have opportunity. I'll pass it on to Joakim on the Fire & Security margin opportunity.

Joakim Weidemanis, CEO

Yes. If we start with Fire, and since you mentioned Honeywell, they've done a very nice job on their product portfolio over many years. So when I mentioned we have some product gaps in our portfolio, I was thinking about fire detection as one example. We play a little on the premium or more sophisticated system side of the market. We have opportunities to go beyond that over time. On the Security side, it's a market that consists of many different kinds of solutions. We need to be careful with comparing companies like apples to apples or oranges. Remember, I used to be on the Board of Assa Abloy, Allegion's biggest competitor, so I've seen that from many different angles. Regarding Security side, like fire detection, there are some product gaps we have opportunities around. On the Service side of things, I've previously mentioned there is good opportunities to work again to break the back off the Service growth and the Service margins by applying Lean principles and how we operate in the field to provide the services. I also think there are some opportunities in productization of services that could drive greater differentiation. So I see those opportunities. We do see that the opportunity in HVAC and Controls has higher growth and margin opportunities over time as well. It doesn't mean the other two are less valuable businesses. I think we can operate those better over time versus how we have in the past. We are working diligently on the strategic review of the portfolio, and once we have conclusions, we will let you know.

Andrew Kaplowitz, Analyst

Just wanted to follow up on that line of conversation a little bit. You've had recent strong margin improvement, I think, in your other segments outside of the Americas. As we think about the Americas going into '26, obviously, you have a mix component. We've talked about tariffs, and you just talked about Service. Can you improve the margin there as you go into '26? Is there anything in the competitive environment that may be holding you back? I know you've shown good improvement in Europe pretty quickly. Can you do that in the Americas as well?

Joakim Weidemanis, CEO

I can start with a long-term perspective that we've touched on in previous calls. I maintain my belief from our last discussion, which is that there is no reason for our margins to fall below those of our direct competitors over time. This isn't just a one-year or five-year consideration; I think we can aim for greater achievements in the long term. How do we achieve this? I provided some examples in my prepared remarks on how we plan to implement a business system to support this goal. The examples I shared were focused on North America, but we intend to expand this approach to other regions over time. Therefore, I believe there are ongoing opportunities to improve margins in all regions.

Marc Vandiepenbeeck, CFO

Yes, and in the short term, you mentioned the system that continues to update service. Our Service business being overall a higher margin business will taper a little the mix headwind you were talking about. This quarter, we had a year-on-year M&A headwind of about 20 basis points that didn't help. From a growth in productivity perspective, if you exclude tariffs, we had solid improvement in that margin line. In the short term, it's more muted. As we get through those tariff changes and the M&A behind us, and the mix balances out to a more balanced 50-50 between Service and System, I believe we have some tailwinds here for the Americas from a margin standpoint.

Deane Dray, Analyst

I wanted to circle back on free cash flow, if we could. It wasn't very long ago where JCI was struggling at that 80% conversion with tempered expectations on where and how it would be improved. It really does feel like you've turned a corner here. Can you give us a sense of the sustainability above to be in and around 100%? Just remind me, did the sale of Resi provide any structural lift to the cash conversion cycle?

Marc Vandiepenbeeck, CFO

Let me start with that last one. Resi was actually a headwind. It was a higher cash flow converter because of the JV structure we had within that business. So that put about a 5% to 10% headwind to our overall enterprise conversion. In terms of sustainability, to give you a sense of the two different, we've fundamentally changed a lot of processes internally: how we bill, how we onboard suppliers, how we manage our inventory. We've been more meticulous about where we deploy CapEx and the pace at which we deploy those capital expenditures. When you combine all of that together, it provides a solid foundation to perform in the 90s or 95-plus, I would say, from a free cash flow conversion. I don't think any of those fundamentals are at risk to go backward. Quite the opposite. As we improve, they provide short-term tailwinds. I'm confident we are going to be able to hit that 95-plus percentage. Over time, as we progress on Lean, as I mentioned before, that flywheel starts to provide additional tailwind. I think we will be more comfortable talking about 100 or 100-plus. But at this stage, I'll stick to 95.

Joakim Weidemanis, CEO

Yes, and we're early in the journey on inventory improvement. So over time, we're going to go make some progress there. Well, thank you all for your questions. We have an exciting future ahead of us here at Johnson Controls. We have a lot of work underway, as you heard, and many opportunities to unlock. With a culture centered around our growth business system, I'm confident that our increased focus on our customers will allow us to continue to win with them. I'd like to take a moment to thank our 100,000 team members around the world. You are the foundation of our company, and I'm confident for what the future has in store. I look forward to continuing my conversations with all of our stakeholders. Thank you. Thank you all.

Operator, Operator

This now concludes today's call. Thank you all for joining. You may now disconnect your lines.