Carrier Global Corporation (NYSE:CARR) Q3 2023 Earnings Call Transcript

Carrier Global Corporation (NYSE:CARR) Q3 2023 Earnings Call Transcript October 26, 2023

Carrier Global Corporation beats earnings expectations. Reported EPS is $0.89, expectations were $0.79.

Operator: Good morning, and welcome to Carrier's Third Quarter 2023 Earnings Conference Call. I would like to introduce your host for today's conference, Sam Pearlstein, Vice President, Investor Relations. Please go ahead, sir.

Sam Pearlstein: Thank you, and good morning, and welcome to Carrier's Third Quarter 2023 Earnings Conference Call. With me here today are David Gitlin, Chairman and Chief Executive Officer; and Patrick Goris, Chief Financial Officer. We will be discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to GAAP figures in our earnings presentation, which is available to download from Carrier's website at ir.carrier.com. The company reminds listeners that the sales, earnings and cash flow expectations and any other forward-looking statements provided during the call are subject to risks and uncertainties.

A close-up of a cooling solution being tested in an electrical infrastructure.

Carrier's SEC filings including Forms 10-K, 10-Q and 8-K, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements. Once the call is open for questions, we ask that you limit yourself to one question and one follow-up to give everyone the opportunity to participate. With that, I'd like to turn the call over to our Chairman and CEO, Dave Gitlin.

David Gitlin: Thank you, Sam, and good morning, everyone. I am very proud of our team for delivering another strong quarter, enabling us to again increase our full year guidance. HVAC environment security sales were both up mid-single digits with the overall company delivering yet another quarter of double-digit aftermarket growth. Adjusted operating profit and adjusted EPS were both up over 20% year-over-year with adjusted operating margins up 240 basis points in the quarter. The HVAC and Fire & Security segments both delivered record adjusted operating margins in the quarter, approximately 21% and 18%, respectively. Free cash flow performance also continues to be strong, positioning us for some upside for our full year guidance.

Bottom line is we continue to perform while we transform, as you can see on Slide 3. We are a team that is very clear eyed about macro challenges. We are focused on controlling the controllables, driving operational excellence, being tenacious about customer centricity, out innovating our peers and consistently delivering on our commitments. With 2 months left in the year, we are confident that in 2023, we will deliver mid-single-digit organic growth, 15% adjusted EPS growth, margin expansion despite the negative impact from consolidating Toshiba Carrier and strong free cash flow. Not only are we poised to close out 2023 on a strong note, we have significantly matured our productivity processes. So we will enter 2024 with even more rigor and detailed plans around our cost reduction activities positioning us for further margin expansion next year and beyond.

We also have confidence in continued growth driven in part by our aftermarket and recurring revenue traction as you see on Slide 4. We're on track for 80,000 chillers under long-term agreements and 30,000 connected chillers by year-end. The attachment rate in Q3 was approximately 50%, nearly double pre-spin performance. Abound continues to gain market traction exemplified by new scale customers committing to our Abound Healthy Air Solution and Abound net zero management offerings in Q3. Additionally, we announced the launch of Lynx Logix, a new Software-as-a-Service application within our Lynx digital platform that helps predict and address supply chain disruption by automatically identifying trends, patterns and issues in distribution networks and transportation lines.

Customers clearly see the benefit of Lynx capabilities, and we now have over 100,000 paid Lynx subscriptions. Our playbook around digitally enabled life cycle recurring sales continues to yield encouraging results globally as we are well positioned for another year of double-digit growth in 2023 and beyond. Our other major growth theme is around driving differentiated solutions to ensure sustainability leadership. You see examples of that on Slide 5. We continue to introduce industry-leading products into the market that help our customers achieve their sustainability targets while decarbonizing the planet for generations to come. Carrier Transicold introduced a new optimal line refrigerated container unit, which offers best-in-class energy efficiency versus the competition and is approximately 15% more fuel efficient than our prior units.

We also introduced a comprehensive new line of high and very high temperature heat pumps for use in industrial, commercial and health care buildings as well as district heating. These key pumps reduced both carbon emissions and energy costs up to 80% versus traditional gas boiler applications. Additionally, our new Zero GWP refrigerant air to water high-efficiency heat pump will nicely complement Viessmann's offerings in the European market. And on top of these new product introductions, our existing business continues to gain momentum as European commercial heat pump sales were up 70% in Q3 and are up 40% year-to-date. Thanks to our sustainability product and service offerings, we are well on our way to achieving our Scope 3 commitment of reducing our customers' greenhouse gas emissions by more than one gigaton by 2030, having achieved approximately 270 million metric tonnes of reduction since 2020.

We have and will continue to invest a disproportionate amount of our R&D in sustainability differentiation. We are pleased to have been recognized by Time Magazine, Newsweek and many others for our sustainability leadership. Excitingly, the combination with Viessmann Climate Solutions will further accelerate our mission of becoming the world leader in intelligent climate and energy solutions, as you see on Slide 6. Last month, we had the pleasure of hosting Max Viessmann, Chairman and CEO of the Viessmann Group, in our headquarters for a webcast event to discuss his views on the future combination, we are profoundly confident and excited in the value creation opportunities ahead of us. The trend towards heat pumps in Europe is unambiguous and will continue for many years to come.

Max confirmed that European decarbonization is a trend that is not changing and is well supported by government in Europe. While individual countries may adjust regulations and subsidy levels from year-to-year, we see a multiyear growth opportunity as those countries meet their commitments for emission reductions backed by EU and country-specific funding. Residential heat pump penetration in Europe is only about 8%, and 21 countries have subsidies to support 2030 and 2050 decarbonization goals. Viessmann Climate Solutions is also well positioned for continued share gains. Unlike some of its competitors, it has the advantage of providing solutions for all energy classes, heat pumps, gas boilers, hydrogen boilers while some of its competitors are pure-play heat pump or boiler providers.

It has a connected ecosystem of offerings for an electric home such as solar PV, batteries and a differentiated digital platform while also driving increased subscription sales. A good example is the Vitocal 250-A natural refrigerant air to water heat pump that won this year's award for the Best Heat Pump in Germany. Viessmann Climate Solution is soon introducing a 19 kilowatts of output version that will now give it access to over 90% of the single-family home heating market. Additionally, the brand-new Vitocal 250-A Pro also releasing in Q1, will offer heat pumps outputs of up to 40 kilowatts, ideal for multifamily and commercial buildings. And based on our experience with Toshiba Carrier and that acquisition and integration, which is going extremely well, we are certainly confident in the cost synergies and already see potential for revenue synergies, which go well beyond our deal model.

In short, Viessmann Climate Solutions is the most attractive business in the most attractive segment in our space, and we cannot wait to come together as one business, which is likely to close the first week of January 2024. Lastly, a brief update on our business exits on Slide 7. First, my thanks to our teams who are working quite literally around the clock and doing a superb job. We have many advisers, who together with our bankers, Goldman Sachs and JPMorgan on Fire & Security and Bank of America on Commercial Refrigeration, our focus on maximizing the net proceeds and speed while ensuring a clean exit of these businesses. We are progressing very well with the prospective buyers for security, commercial refrigeration and industrial buyers.

The interest level has been extremely high, and we expect to be able to announce signed agreements before the end of 1Q, hopefully sooner. The capital market transactions for the combined commercial and residential fire business is on track. These are superb assets with deeply committed and effective team members, and we remain very optimistic about the value that we will realize on these exits. With that, let me turn it over to Patrick. Patrick?

Patrick Goris: Thank you, Dave, and good morning, everyone. Please turn to Slide 8. Sales in the quarter were $5.7 billion with organic growth of 3%, a 1% tailwind from foreign currency translation and a 1% net contribution from acquisitions and divestitures. The latter was substantially all driven by one month of Toshiba Carrier before becoming organic at the beginning of August. Q3 adjusted operating profit of over $1 billion was up more than 20% compared to the prior year on 5% reported sales growth. Strong productivity and price cost helped us expand our adjusted operating margin by 240 basis points to 18.2%. That is despite a 30 basis point headwind related to the Toshiba Carrier consolidation. Reported earnings conversion was 65% in the quarter.

Core earnings conversion that is excluding acquisitions, divestitures and currency was far higher than that. Adjusted EPS of $0.89 is up 27% year-over-year and includes a tailwind from discrete tax items in the quarter. Free cash flow of about $950 million was up 35% compared to last year. Year-to-date, we have generated over $1.3 billion in free cash flow compared to about $400 million during the same period last year, reflecting improved working capital performance and higher earnings. Overall, a good quarter and better than we expected mainly as a result of better operating performance and the discrete tax items I mentioned earlier. Please turn to Slide 9. Q3 was another good quarter for HVAC. Organic sales were up 4%, driven by high single-digit growth in commercial HVAC, 30% growth in light commercial and double-digit growth in aftermarket.

North America residential HVAC sales were down low single digits in the quarter. Overall resi volume was down low double digits and revenues continued to benefit from price realization and positive mix from the 2023 year transition. Destocking is expected to continue in Q4, and we expect North America residential HVAC volumes to be down mid-teens for the full year. We expect field inventories to end 2023 also down mid-teens from the beginning of the year, which should position them at more appropriate levels heading into 2024. Offsetting lower expected residential volume in 2023, we now expect light commercial HVAC sales to be up about 30% versus about 20% in our prior guidance. Adjusted operating profit for the HVAC segment was up 33% compared to last year on 7% reported sales growth, driven by productivity and price costs.

Adjusted operating margin reached a record high and was up 410 basis points compared to last year despite a 50 basis point headwind from the consolidation of Toshiba Carrier. You will see in the 10-Q later today that there was a onetime $60 million tax benefit from a joint venture that is included in equity income, so that was more than offset by other discrete items in the segment. In short, excellent financial performance of this segment in the quarter. Moving to Slide 10 for Refrigeration. Reported sales were flat in the quarter with organic sales down 3%, offset by a 3% benefit from foreign currency translation. Within transport refrigeration, global truck and trailer sales were up high single digits driven mostly by over 20% growth in European truck and trailer.

Container continued to experience demand softness, however, and was down roughly 25% year-over-year. Commercial refrigeration sales were down about 10% in the quarter with orders for this business returned to year-over-year growth. Looking ahead to Q4, we expect the container business, commercial refrigeration and the entire Refrigeration segment to return to organic sales growth. Adjusted operating margin for this segment was down 80 basis points compared to last year, mainly due to the lower volume in container and commercial refrigeration, which more than offset the benefits from productivity and price costs in this segment. Moving on to Fire & Security on Slide 11. Just like HVAC, this segment had good financial performance in the quarter.

Reported sales were up 2%, with 6% organic sales growth and the 1% tailwind from foreign currency, partially offset by a 5% headwind from the KFI deconsolidation. Organic growth was broad-based with high single-digit growth in Industrial Fire & Security and mid-single-digit growth in commercial and residential fire combined. Adjusted operating profit was up 13% versus the prior year. Similar to HVAC, adjusted operating margins hit a record level and were up 170 basis points year-over-year, driven by volume, productivity and price costs. Turning to Slide 12. Total company orders were down a little less than 10% in the quarter, mostly due to the declines in the shorter cycle businesses. Overall HVAC orders were down about 10% in the quarter with expected declines in residential and light commercial HVAC.

Commercial HVAC orders were flat against a difficult comp. Last year, orders were up 15% to 20%, and the backlog remains robust, up over 40% on a 2-year stack and extends well into next year. Refrigeration orders were down approximately 15% to 20% in the quarter, largely driven by Transport. Very strong orders growth in international truck and trailer, up 60% year-over-year, was more than offset by over 50% order decline in North American truck and trailer. For North America truck and trailer, we opened the 2024 order book in Q2 of this year. For 2023, we opened the order book in Q3 of last year. On a year-to-date basis, North America truck and trailer orders are up low-single digits, which is probably more indicative of underlying demand. Commercial refrigeration and container orders in October give us confidence in the Refrigeration segment's returned to organic growth in Q4.

Orders in Fire & Security were up around 5% with particularly strong growth in industrial fire. We believe that lead times for the majority of our shorter-cycle businesses across our 3 segments have normalized with backlogs close to more typical levels. Our longer-cycle backlog continues to grow year-over-year. Now moving on to guidance on Slide 13. We expect full year sales to come in around $22.1 billion to $22.2 billion, including mid-single-digits organic sales growth. We are raising our full year adjusted operating margin guidance to about 14.5%, driven by strong year-to-date performance. Within the segment, we are increasing our full year HVAC adjusted operating margin guidance to about 16.5% while maintaining our Fire & Security guidance at 15.5%.

Refrigeration full year adjusted operating margin is impacted by lower volume in container and commercial refrigeration and as a result, will likely end up a little lower than 13%. We are increasing our full year adjusted EPS guidance by $0.10 compared to our prior midpoint to about $2.70. We have included a 2023 guide-to-guide adjusted EPS bridge in the appendix for your reference. In essence, improved operational performance drives about half the increase. The balance is mostly driven by a lower expected adjusted tax rate. Our full year adjusted effective tax rate is now expected to be between 21.5% and 22% compared to our prior guidance of about 23%. As for free cash flow, we now expect to generate slightly more than $1.9 billion in 2023.

Before I turn it back over to Dave, let me give you a couple of updates. You may recall that we will be funding the Viessmann acquisition through a combination of equity, cash on hand and debt. The latter will be a mix of term loans and long-term debt. We previously shared that we hedged the cash portion of the consideration against currency trend. In the third quarter, we entered into a number of interest rate marks to mitigate interest rate exposure on the expected issuance of debt with maturities 10 years and beyond. As a result, we do not expect a significant change in our cost of financing for Viessmann compared to our original business case. We expect to be in the market for the bond offerings in Q4 in advance of an early January close.

As we communicated previously, we will be very focused on deleveraging post-acquisition, and we'll use free cash flow and proceeds from the business exits to do so. We continue to expect to return through share repurchases as soon as our net leverage returns to about 2x. One last topic. I'd like to share our current thoughts on how we will provide 2024 guidance in February, given the acquisition and the 4 business exits transaction. We currently expect that our 2024 guidance will include a full year of Viessmann Climate Solutions. The exact timing and the proceeds of the business exits are, of course, not known as of today. For context, there are specific rules that determine when a business can be treated as discontinued operations in the financial statements, and it is our current assessment that the Fire & Security businesses being exited will likely not qualify as disc ops for reporting purposes until all of these transactions have been executed.

We do not expect commercial refrigeration to qualify for disc op. Therefore, we intend to provide guidance consistent with how actual results will be reported. This means that we will include the earnings of the businesses to be exited into our 2024 guidance. We will then adjust guidance as needed for the exact timing of the exits and the use of the proceeds. By the time we provide guidance in February, we expect to have a better sense of timing and proceeds with several of the business exits. With that, I'll turn it back over to you, Dave.

David Gitlin: Well, thank you, Patrick. In closing, Carrier continues performing while transforming. We had another strong quarter. And more importantly, we again increased our outlook for 2023 with mid-single-digit organic growth, margin expansion, double-digit adjusted EPS growth and strong free cash flow performance, all broadly in line with the value creation framework that we shared with you at our latest Investor Day. So with just a couple of months more to go in 2023, we are, of course, already looking ahead to 2024 with continued confidence in strong top and bottom line growth and cash conversion. With that, we'll open this up for questions.

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