U.S. Markets closed

Honeywell International's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Call Start: 09:30

Call End: 10:30

Honeywell International Inc. (HON)

Q1 2014 Earnings Conference Call

April 17, 2014 9:30 a.m. ET


Elena Doom – Vice President of Investor Relations

David Cote – Chairman, Chief Executive Officer

Tom Szlosek – Chief Financial Officer, Senior Vice President


Jeff Sprague - Vertical Research Partners

Scott Davis – Barclays

Steven Winoker - Sanford Bernstein

Steve Tusa – JPMorgan

Nigel Coe - Morgan Stanley

Howard Rubel – Jefferies

Peter Arment - Sterne Agee

Shannon O'Callaghan – Nomura


Good day, ladies and gentlemen, and welcome to Honeywell's first quarter 2014 earnings conference call. At this time, all participants have been placed in a listen only mode and the floor will be open for your questions following the presentation. (Operator Instructions). As a reminder, this conference call is being recorded.

Now I would like to introduce your host for today's conference, Elena Doom, Vice President of Investor Relations.

Elena Doom

Thank you, Tony. Good morning and welcome to our first quarter 2014 earnings conference call. With me today are Chairman and CEO, Dave Cote and Senior Vice President and CFO, Tom Szlosek. This call and webcast including any non-GAAP reconciliations are available on our website at honeywell.com/investor.

Note that elements of today's presentation do contain forward-looking statements that are based on our best view of the world and of our businesses as we see them today. Those elements can change and we would ask that you interpret them in that light. We do identify the principal risks and uncertainties that affect our performance in our Form 10-K and other SEC filings.

This morning we will review our financial results for the first quarter and review our outlook for the second quarter and full year and finally we will save time for your questions.

So with that, I will turn the call over to Dave Cote.

David Cote

Thanks, Elena. Good morning, everyone. I'm sure you've seen by now, Honeywell delivered another good quarter to kick off 2014. EPS of $1.28 increased 10% year-over-year when normalizing for tax, so another quarter of double-digit EPS growth, with earnings coming in above the high-end of our guidance range. This was driven in large part by our strong execution and higher sales conversion, all while maintaining our seed planting investments in the future.

Our enablers and key process initiatives are driving meaningful results throughout the portfolio. An important driver of our productivity continues to be the savings we're seeing from previously funded restructuring actions. With that in mind, we've been able to proactively fund restructuring and other actions by fully deploying the approximate $0.10 gain from the sale of B/E Aerospace shares in the first quarter, just like we did in the fourth quarter of last year.

I'd also point out that the company funded an incremental $10 million of restructuring actions in the quarter from operations. So, in total, $0.11 of restructuring and other actions. The projects funded in the first quarter alone are estimated to yield full run rate savings of about $70 million over the next couple of years. We're being proactive about keeping that restructuring pipeline full and we think these actions position us well for further market expansion over the next five years.

Margin, EPS and cash flow were all strong in the quarter in spite of slightly slower top line growth, primarily related to timing in PMT and lower defense and space sales. Sales in the quarter of $9.7 billion were up 4% reported and 1% organic. However, if you exclude D&S where the headwinds are well known, organic sales for the total company were up about 3%.

We talked a lot about great positions in good industries and our diversity of opportunity which once again benefited us in the quarter. We saw a good momentum exiting the quarter in our short-cycle businesses, while our long-cycle businesses maintained healthy backlog. We're also seeing pockets of recovery in below peak end markets.

Transportation systems, for example, continues its healthy pace of recovery, and while weather may have been a factor in some areas, these challenges were mostly offset by weather related areas of opportunity. For example, ECC enjoyed strong double-digit sales growth in combustion and heating controls. The order momentum we're seeing out of our long cycle businesses and short cycle also positions us well for our expected acceleration of organic growth in the second quarter and second half of the year.

Geography is also part of our diversity of opportunity. In the U.S., we continue to see good growth excluding the D&S headwinds I mentioned. We're encouraged by continued stabilization in Europe and even more excited about the growth we saw in China, India and the Middle East. It's worth nothing that each of our SBGs grew double-digits organically in China in the quarter. So, both our short and long cycle businesses are delivering on our high growth reaching strategies.

Innovation and investments in new product and technologies are also driving value across the portfolio.

We unveiled the Honeywell User Experience or HUE back in March and we couldn't be more excited about what this will mean for Honeywell. We recently opened a HUE design studio in Shanghai with other design studios set to open globally.

We're focused on how we can drive significant change and improve the experience for the user, installer and maintainer. With all that being said, we remain cautiously optimistic on the macro economy and with the strength in the first quarter, we're confident in our revised full year outlook for pro forma EPS, raising the low end by $0.05, making our new range $5.40 to $5.55, up 9% to 12% versus prior year.

Our outlook on free cash flow has also improved based on the strong performance we saw in the first quarter. As Tom will detail in a moment, we are now reporting free cash flow without adjustments for cash pension, NARCO payments and one-time items.

So, the guidance range remains the same, but it's reflective of the first quarter performance and importantly without adjustments. In summary, we've got a lot of momentum across the portfolio, which we highlighted in our March Investor Day, with roadmap for future growth and profitability as part of our new five-year target going out to 2018. Innovation and execution, our seed planting for the future, Great Positions in Good Industries, and the power of One Honeywell will continue to differentiate us, allowing us to deliver on these targets and continuing to outperform.

So with that I'll turn it over to Tom.

Tom Szlosek

Thanks, Dave and good morning. On Slide 4, let me walk you through the financial results for the first quarter. Sales of 9.7 billion were up approximately 4% on a reported basis and up 1% on an organic basis. The total sales are right in the middle range we communicated early March of 9.6 billion to 9.8 billion and the organic growth rate was slightly lower than expectation due to timing in aerospace and PMT.

As Dave mentioned, excluding defense and space, which is expected to stabilize this year, our organic sales were up 3%. Regionally organic sales were up 1% in the US and EMEA with Europe showing resilience, continued resilience despite some large customer project ramp downs. China grew 14% on an organic basis, with double digit organic growth in each of the business. As we will detail later, we are anticipating organic sales growth to accelerate as the year progresses.

Segment profit increased 6% in the quarter with margins expanding 30 basis points to 16.5% or up 50 basis points excluding the dilutive impact of M&A. We had guided to 30 to 50 basis points improvement in the margin rate excluding M&A, so the 50 basis points is on the high end of our expectation. We saw margin expansion three out of the four businesses, productivity continues to be a key driver across the portfolio, offsetting inflation and continued investments for growth.

In PMT we did experience some temporary margin contraction because of expected headwinds around unfavourable petrochemical catalyst shipment mix and pricing headwinds in R22 in resins and chemicals. Still PMT closed at 21% segment margin was our highest margin business in the quarter and we continue to have lot of confidence in our ability to expand margin going forward.

Below segment profit, I wanted to comment on two items, the first is the gains we experienced from the additional B/E Aero shares and second, the tax rate. On B/E Aero which I will further detail in a minute, the gain was more than offset than restructuring and other charges resulting in a $0.01 unfavorable impact on EPS. The B/E aero gain is not included in our operating margin but the restructuring and other charges are, so operating margins expanded 10 basis points in the quarter compared to the segment margin expansion of 30 basis points.

The tax rate of 26.6% was in line with expectation and represent a $0.06 headwind compared to 2013. Earnings per share of $1.28 was a penny higher than where we guided even after we funded incremental $0.01 of additional restructuring action. There are a couple of things to mention on free cash flow, first it was really strong, up 2.5 times 2013 amounts, the improvement came equally from better working capital performance and lower cash contribution to foreign pension plan.

Second, we are simplifying how we define free cash flow as Dave mentioned. It’s just free cash flow from operations – just cash flow from operation less capital expenditures, no more adjusting for pension or NARCO. We did this the same way for both 2013 and 2014 so the numbers are comparable and the growth is real.

Slide 5 provides a more detailed view of the gain deployment actions in the quarter. As you can see the $0.10 per share gain from the 1.5 million BE aero shares sold in the first quarter was exceeded by funding the restructuring actions and other proactive environmental remedy. So in total an $0.11 headwind to earnings from restructuring activities offset by the B/E aero gain of $0.10, so a net $0.01 headwind to earnings.

Restructuring -- repositioning and restructuring represent the majority of the gain deployment, just as you heard in January these actions are intended to proactively realign our businesses for growth and higher asset efficiency and will provide us with meaningful margin and earnings tailwind in future periods.

We’re expecting these projects to yield approximately $70 million of run rate savings in future years and each individual project has an excellent ROI. We will continue to maintain a steady pipeline of future projects to fund should the opportunity arise. This as you know continues to be a key element of Honeywell playbook as restructuring funds the exit cost requirements from our key process initiatives and integration activities.

A smaller portion of the gain was used to fund incremental environmental charges. This relates to certain remediation project that we believe seeking proactive remedies with the regulators will lead to lower expenses and more cost stability over the long term. Overall these actions position the company well for future earnings growth and as a reminder following the sale of 2.6 million B/E Aero shares in the fourth quarter of last year and the 1.5 million in the first quarter, we still have roughly 1.9 million shares remaining and continue to have a very favorable view of the company.

Now let’s take a look at the four business segments. Starting on Slide 6, aerospace sales were down 2% which is in line with our guidance. However excluding the impact of the expected defense and space decline, aero sales were up a solid 3%. Segment margin was up 30 basis points which was actually a bit better than our expectation.

From a sales perspective, commercial OE sales were up 1% reflecting strong air transport and business aircraft shipment. We had particularly strong 737 and 787 OE growth and broad strength across business aircraft portfolio. Regional jet sales were lower reflecting lower volume and free of charge shipment.

Commercial aftermarket sales were up 4% in the quarter with double-digits spares growth in both ATR and BGA, partially offset by lower R&O revenues, a reflection of fewer maintenance events and timing. The 14% spares growth was driven by the recovery in the US and China and we highlighted this as a challenge in the first quarter of 2013, as well by the continued robust RMU sale in BGA, RMU is repairs modifications and upgrade.

Defense and space sales were down 8% which we expect to be the low point from a sales perspective for the year, most of the decline was planned with known program ramp downs and anticipated lower government services and defense aftermarket revenue.

On segment profit, the aero team was able to more than offset the impact from the lower sales, to drive the segment margin up 30 basis points, through commercial excellence, productivity net of inflation and favorable aftermarket mix. On Page 7, we are looking at ACS prior to the shift of HPS to PMT. We expect to file an 8K in the second quarter to reflect this change and we will update our historical numbers. However we are perfectly clear when we shared the guidance for Q2 and the rest of the year which I will review in a few minutes, we will do that on the new reporting structure.

The ACS organic sales were up 2% and reported sales up 8% both in line with our expectations, the difference of course reflects the growth from M&A in particular Intermec and RAE Systems acquisition. Segment margin was up 40 basis points almost twice our expectation. ESS sales, so the products business, were up 2% with ECC and life safety showing particularly strong growth and more than offsetting the expected declines in scanning and mobility resulting from the ramp down of certain programs. Without this scanning and mobility dilution, ESS sales would have been up 5% with some favorable contribution from weather impacting ECC.

We experienced higher U.S. residential sales including on the retail side, modest improvements in Asia and Europe and continued HGR growth in China and India. The Intermec acquisition continues to go well. We're exceeding what were challenging expectations on the pace of integration and on performance.

Also the business continues to win a large number of orders that are expected to result in further 2014 growth. Process dilution sales were up 3% on an organic basis in the quarter, with continued good growth in high-margin areas like services and advanced solutions more than offsetting the impact of large project completions. Orders growth also continues to be healthy and backlog is growing, which Darius and the PMT team will see the benefit of in the future.

Building solutions sales were essentially flat on an organic basis. We are encouraged by our building solutions orders and the project backlog growth, both showing mid-single digit growth on an organic basis. And we're also experiencing similar growth in the services backlog, not a trend yet, but certainly encouraging development as we look for the rest of the year.

ACS margins expanded 40 basis points to 14.2% in the quarter and were up 70 basis points excluding dilutions from M&A. ACS continues to benefit from driving commercial excellence, volume leverage and productivity while at the same time investing for the future.

Moving to Page 8, Performance Materials and Technologies, PMT sales were up 2%, in line with our expectations and driven by 9% growth in UOP, offset by 4% declines in Advanced Materials. Although PMT margins contracted 100 basis points, the result was better than our expectations, and at 20.8% PMT was again our highest margin business in the quarter.

On sales, UOP experienced significant growth in catalyst volume and gas processing, offset by an unfavorable mix in catalyst shipments and lower process technology licensing sales, resulting from timing and challenging comps. As you know, we are in the midst of adding UOP capacity particularly on the catalyst side, which will help the business to better service $2.4 billion backlog.

Advanced Material sales were down 4%. We experienced volume increases in most of the Advanced Materials portfolio, despite the tempering effect of the difficult weather. However, this volume growth was more than offset by unfavorable pricing in fluorine products and resins and chemicals.

We do expect the pricing challenges to moderate in the second quarter and throughout the year, as we lap prior year declines. The decline in the segment margin was principally driven by unfavorable catalyst mix in UOP, the price raw challenges in Advanced Materials and contemporary spike in raw material costs due to weather, partially offset by productivity net of inflation.

On Slide 9, you can see transportation systems had a very strong quarter with sales up 9%, that's 7% without the benefit of foreign exchange and segment margin up 340 basis points. On the sale side, the increase was principally volume-related. We experienced strong turbo volume growth in our three biggest regions: Europe, North America and China.

The Europe growth was strong in both light and commercial vehicle segments. We continue to benefit from improving global industry macros on vehicle production, also from regulations and gas penetration. We continue to benefit from a strong win rate, with turbo unit sales from new product launches doubling from 2013 levels.

As the year progresses and we begin to lap stronger periods from 2013, we do expect some moderation in the growth rate.

The segment margin improvements to 15.5% reflects the strong productivity and volume leverage in turbo, and the benefits from restructuring and other operational improvement. We continue to work on the Friction Materials divestiture and expect a closure sometime in the second half of 2014.

I'm now on Page 10 with a preview of the second quarter. We're expecting sales of $10 billion to $10.2 billion which would be up between 3% and 5% on a reported basis or approximately 3% on an organic basis. We're using a euro rate of roughly 1.35 for the second quarter.

Segment margins are expected to be up in the range of 50 to 70 basis points, excluding the dilutive impact of M&A, EPS of $1.32 to $1.36 will be up 8% to 11% at our normalized 26.5% effective tax rate.

On the segment, aero sales growth is expected to be in between minus 1% and plus 1% in the quarter with low single-digit commercial growth offset by moderating Defense and Space declines.

On commercial OE, we're still seeing healthy demand for air transport deliveries which is helping offset the continued drag from lower regional aircraft sales. In commercial aftermarket, we're expecting ATR spares growth to be about in line with flight hours in the quarter, as well as continued BGA RMU strength. As for margins, we expect some headwinds primarily due to higher mechanical OE sales in both ATR and BGA and a higher proportion of ATR revenue in the quarter, resulting in flattish overall margin growth.

For ACS, as I indicated earlier, we're providing guidance based upon the new reporting structure. Sales are expected to be up between 8% and 10% or approximately 3% on an organic basis. The reported sales growth is largely driven by the Intermec acquisition and an acceleration of organic growth in ESS, particularly security and scanning and mobility, and also BSD.

Modest improvements in non-resi projects are expected to favorably impact ECC, life safety and security, and high-growth region sales look to continue their positive trend. The two consecutive quarters of long-cycle orders and backlog growth in building solutions is encouraging and should enable strong sales growth in the second half.

ACS margins are expected to be up again in the second quarter approximately 50 basis points or 100 basis points excluding the dilutive impact of M&A.

PMT, including process solutions in both years is expecting sales increase between 3% and 5% in the second quarter driven by double-digit increases in UOP and to low-to-mid-single-digit growth in HPS and Advanced Materials. In UOP, we foresee another strong quarter of increased catalyst and gas processing sales growth, while in Advanced Materials; we anticipate broad sales growth across the portfolio, including improved production levels in Resins & Chemicals and our normal seasonal ramp-up in fluorine products.

The PMT leadership is encouraged by the momentum in the orders and the backlog increases in HPS. PMT segment margins, however, are expected to be up slightly versus the prior year, based on the mix of shipments within UOP offset by moderating pricing pressures in Advanced Materials.

In transportation systems, the strong performance is expected to continue, although tampered slightly from Q1 by the more challenging comp. Sales look to grow between 5% and 7% driven by new platform launches, continued turbo gas penetration and flat or slightly better EU light vehicle production rate year-over-year.

Segment margins will be similar to first quarter levels and up approximately 200 basis points, primarily driven by higher volumes in turbo and continued productivity gains.

On Page 11, we're profiling the organic sales growth for the year. We're expecting full year growth of 3% on an organic basis, so there's some modest acceleration from the Q1 growth rate of 1%. We want to explain the key drivers.

The page shows the first half versus second half organic growth rates for 2013 as well as what we expect for 2014. The first thing to notice is that the first half growth for 2014 is stronger than 2013. We saw that in this first quarter as 1% organic growth although tepid was greater than the first quarter of 2013 where we saw a decline of 1%.

Second, the slope of the line is similar each year, 2013 we went from 0% in the first half to 3% in the second half, and 2014 we go from 2% in the first half, to an expected 4% in the second half.

Thirdly, the notations on the top of the 2014 bar show the expected organic growth rate excluding Defense and Space which would be roughly 3% in the first half of 2014 accelerating to approximately 4% in the second half of the year.

That happens because of the factors mentioned on the right side of the page. In Aero, Defense and Space declined significantly moderate. Also commercial OE is expected to improve slightly largely driven by the absence of the prior year's large fourth quarter BGA OE payment.

In ACS, we anticipate scanning and mobility returning to growth after lapping the program wind downs I discussed earlier and also layering on new business wins. The macro environment is also expected to modestly improve which continues residential strength and improving non-residential markets benefiting ESS. And as highlighted earlier in the last couple of quarters, have seen a nice lift in building solutions backlog, which is expected to result in stronger sales growth rate in the second half.

In PMT, the pick-up in the second half was driven primarily by better Process Solutions and Advanced Materials growth, partially offset by tougher comps in UOP. UOP organic sales grew 17% in the fourth quarter of 2013.

The Process Solutions backlog of projects and services continues to grow nicely, which like Building Solutions is expected to result in better second half sales growth. And as mentioned earlier, Advanced Materials pricing headwinds are expected to moderate in the second quarter and back half of the year, and we are also expecting a boost from higher volumes and higher sulfate [ph] sales in fluorine products.

Finally in Transportation, while the outlook remains very strong, the comps become gradually more challenging as we progress through the year. So, while we're expecting the growth in the second half in TS, it's expected to be at a slower pace than the first.

I'm now on Slide 12, where we provide an outlook of segment performance for the year. Again, this guidance reflects the realignment of our Process Solutions business in the PMT from ACS. So, let me explain the set-up here. The left-hand side of the slide represents the guidance we provided in March and it's based on the old reporting structure.

The right half reflects our current guidance. On a total Honeywell-basis, if you look at the bottom-line, the segment guidance for the year is not changed. However, there are some minor changes to the segment that you should be aware of. Aerospace sales remain roughly in-line with the guidance, but reflecting the slower R&O growth in the first quarter, and slightly lower margins impacted by volume leverage on that lower sales growth.

ACS and PMT now reflect a shift of Process Solutions for the full year. Organic sales are expected to improve in the second half of the year from both businesses. We have also provided updated margins profile which show continued expansion in both ACS and PMT. The Transportation System guidance reflects the first quarter top line strength and strong margin expansion. We're now expecting TS margins to approximate 15% or more in 2014. So small puts and takes, but as I said, no change to total Honeywell sales and margin outlook.

Moving to Slide 13, we have an update on our full year guidance, which is very similar to what we shared at the March Investor Day except for two things. One, we're raising our full year pro forma EPS guidance at the low end by $0.05 resulting in a new range of $5.40 to $5.55, which is up 9% to 12% versus 2013. This reflects our first quarter performance and the confidence we have in our outlook.

Second, we're raising our free cash flow guidance by approximately $300 million to reflect the strength we saw in working capital in the first quarter, and lower foreign cash pension contribution. To be clear, the $3.8 billion to $4 billion range looks the same as what we showed you previously in March, but that range was based on the prior definition of free cash flow, which excluded several non-operating items.

So with those changes, we continue to expect sales in the range of $40.3 billion to $40.7 billion, which is up 3% to 4% on a reported basis and 3% on an organic basis. Our sales range reflect euro at $1.30 for the second half of the year, so a little bit of headwind there.

We also continue to expect segment margins between 16.6% and 16.9% which will be up 30 to 60 basis points from 2013 or 50 to 80 basis points excluding the M&A impact. So, as Dave said earlier, still a very balanced outlook for the year but taking into account the good start we saw in the first quarter.

On Page 14, I have a brief wrap-up. In markets that continue to be somewhat challenged, we're off to another good start to the year. We exceeded our expectations on most fronts including margins, earnings and free cash flow while at the same time continuing to invest for future growth and productivity. We raised our earnings and cash guidance to reflect a strong first quarter as well as our expectations for growth acceleration in the second half. We intend to continue our outperformance by leveraging our balanced portfolio, which as you know is strategically aligned with the favorable macro trend. These include energy efficiency, clean energy generation, safety and security, and urbanization combined with a growing middle class and customer productivity all of which remain intact.

So, with that Elena let's go to Q&A.

Elena Doom

Thanks Tom. Tony, we will now open up the line for our first question.

Earnings Call Part 2: