Honeywell International Inc. (HON) Q1 2020 Earnings Conference Call

Thank you Darius and good morning everyone. In the first quarter, organic sales declined by 4% as the effects of the pandemic spread across the globe, creating supply chain challenges and restricting access to customers' sites which constrained our ability to deliver, particularly in the last two to three weeks of the month. Aerospace sales were up 1% on an organic basis as demand for key U.S. Department of Defense programs and guidance and navigation systems in defense and space was partially offset by the steep reduction in flight hours and a slowdown in air transport OEM build rates, primarily from our previously communicated lower 737 MAX deliveries to Boeing. In commercial aerospace, safety and productivity solution sales were down 9% organically. Increased demand for respiratory personal protective equipment was more than offset by weakness in the short cycle part of the portfolio. Intelligrated sales were down about 12% due to the timing of several major systems projects as expected. As a reminder, Intelligrated organic growth in the first quarter of last year was approximately 50% due to strong major systems backlog conversion, aftermarket services and increased demand for voice solutions, which created a very tough comp for this quarter. Intelligrated backlog remains robust, approximately up 40% year-over-year, and as we discussed in our last call we expect it to re-accelerate in the second quarter. Honeywell Building Technology sales were down 6% on an organic basis, primarily driven by softness in building solutions projects and lower short cycle volumes in security and building management products. Finally, Performance Materials and Technologies was down 5%, negatively affected by the sharp decline in oil prices stemming from the OPEC Plus dispute and the COVID-19 related disruptions, with HPS down 6% and UOP down 2%. Continued illegal HFC imports into Europe and lower automotive refrigerant volumes and advanced materials also contributed to the sales decline. Despite these challenges, our productivity rigor combined with commercial excellence and swift cost actions drove segment margin expansion of 140 basis points, well above our original guidance of 20 to 50 basis points. We delivered earnings per share of $2.21, up 15% and well above the high end of our original guidance range of $2.02 to $2.07. Segment profit expansion drove $0.04 of earnings growth while a lower adjusted effective tax rate, primarily due to new India tax legislation, drove $0.13 of EPS improvement compared to last year. Even without the favorable tax impact, the first quarter EPS was $0.01 above the high end of our guidance and up 8% year-over-year. We generated $800 million of free cash flow, down 31% year-over-year, primarily driven by lower sales and slower collections particularly in late March. We continue to execute our capital deployment plans in the first quarter. We deployed over $600 million to dividends and $1.9 billion of share repurchases, substantially completing our full year 2020 share repurchase commitment. We also invested over $100 million on capital expenditures in the quarter, including investments that will enable us to produce millions more N95 masks to help the coronavirus relief effort. Overall, this was a very challenging quarter but we continue to execute and achieved or over-delivered on our segment profit margin expansion and EPS commitments. Now let's turn to Slide 5 to discuss our operations. Our portfolio is highly aligned to guidelines for essential and critical businesses around the world. Our teams have been working tirelessly to ensure that we are able to provide equipment and services to our customers in critical end markets globally, in compliance with government safety regulations. The spread of COVID-19 has created operational challenges for Honeywell, our suppliers and our customers as governments and companies implement measures to slow the spread of the pandemic and keep employees safe. These challenges included temporary site closures, staffing shortages, inability to access customer sites for service and project engineering, and transportation and logistics disruptions. The operational constraints change daily, however we have implemented rigorous business continuity processes to ensure they are proactively addressed and minimized to the extent possible. Though operational disruptions have clouded headwinds, our integrated supply chain teams' efforts under Torsten's leadership have been able to keep us running. After the outbreak in China, we set up a tactical operation center in January to monitor and manage global supply risk and establish processes to identify and assist suppliers in financial distress. We continue to monitor all suppliers to ensure they remain operational and we provide support to help them reopen when they experience temporary closures. Today, well over 90% of our suppliers are operational. Our logistics team has been proactively securing transportation and freight modes to ensure transportation availability amid supply and demand imbalances. As it stands today, over 90% of our sites are operational globally. Approximately 15% of our sites are currently experiencing staffing constraints in select regions around the world, including sites in Mexico, Europe and Asia Pacific where governments have mandated up to 25% to 75% reductions in staffing. We are pleased with our progress in responding to these operational constraints and mitigating the impacts we experience. New headwinds arise every day but we continue to monitor our supply chain, work closely with our suppliers and respond swiftly when new challenges arise. Because of these actions, our global operations are running with limited but unpredictable disruptions or interruptions. These are some of the dynamics that are contributing to our challenge on predictability of our short-term financial outlook. Now let's turn to slide 6 and we'll discuss our segment outlook for the second quarter. As Darius said previously, the next few quarters are likely to be among the most unpredictable we have ever experienced and our visibility is limited under the current circumstances. Accordingly, we are suspending providing full financial guidance until the economic environment stabilizes and we can once again give reliable and comprehensive forecasts. We believe it is important that we provide a level of precision that is commensurate with our ability to forecast in the current environment, and therefore you'll see a different set of inputs versus our normal guidance. Starting with Aerospace, we expect more than a 50% decrease in global air transport flight hours and more than a 40% decrease in global business aviation flight hours in the second quarter based on industry sources, which will significantly impact our commercial aftermarket businesses. In addition, our commercial original equipment business will be impacted by the ongoing 737 MAX production delay, OEM furloughs and temporary shutdowns, and lower business jet demand due to the economic slowdown. However, government defense budgets remain intact and we expect continued growth in defense and space, though this will be more than offset by the broader end market challenges and significant demand reduction in the commercial aerospace segment. As a result, we expect aerospace sales to be down more than 25% compared to the second quarter of 2019. Moving to PMT, the dramatic volatility and decline in oil prices related to the OPEC Plus dispute, coupled with the COVID-19 related supply chain disruptions, has created a challenging environment. We are encouraged by the OPEC Plus production cut agreement and would hope for even broader action, however we need to see a sustained increase in demand to see a more meaningful impact in the marketplace. As we've said in the past, oil price volatility and sustained pressure on prices often leads to project delays and customer capex and opex budget cuts, which is what we are seeing today. We expect a steep decline in refining production in the second quarter and continued weakness in gas processing. The reduction of customer capex and opex budgets will create headwinds for our products businesses and process solutions in UOP, with declines in field services, equipment and catalyst shipments. Additionally, we anticipate new projects will push to the right, putting pressure on UOP licensing and engineering volumes in the near term. As we have discussed in the last two earnings calls, we entered 2020 with a healthy backlog of global mega projects in process solutions and we do expect to burn those down over the next few quarters, although we have not received any long cycle cancellations, we are expecting orders to decline significantly in the second quarter. In advanced materials, automotive plant closures will drive lower refrigerant volumes and a projected slowdown in global construction will further pressure sales. However, in specialty products we are encouraged by strong demand for healthcare packaging, armor and research chemical products. Altogether, we expect PMT sales to be down more than 15% compared to the second quarter of 2019. In HBT, we see the impact of the COVID-19 pandemic as potentially shorter term in nature. In the current environment, non-residential projects in multiple verticals have paused and customers are deferring non-essential spending, impacting the timing of long cycle building solutions projects and delaying purchase of security, building management and fire products. Lower building occupancy and temporary disruptions to site access are driving delayed timing of certain building solution services. However, we believe these are largely short-term timing effects and we continue to see underlying demand, particularly in fire and security products and our services where orders grew in the first quarter. So building technologies may begin to stabilize as businesses begin to reopen. We expect HBT sales to be down more than 10% compared to the second quarter of 2019. Finally in SPS, the surge in e-commerce as government and other social distancing requirements have created more demand for our warehouse automation business and supports continued conversion of our robust Intelligrated backlog. In the second quarter, we will see growth from the major systems projects that we booked last year. Our Intelligrated backlog remains strong, up approximately 40% year-over-year, and we expect this business to perform well for the remainder of the year. However, the macro conditions are resulting in headwinds in our short cycle SPS businesses, including productivity products, gas sensing and retail. Weakness in aerospace, heavy equipment and automotive end markets is also resulting in headwinds in the Sensing and IoT business, which will partially be offset by increased demand for sensors in medical ventilators and respiratory equipment. Finally, we are of course seeing record level demand for respiratory masks and other personal protective equipment and we expect that demand to continue for the foreseeable future. Mask production at our Smithfield, Rhode Island facility is already online and our Phoenix facility is expected to come online in the second quarter. PPE orders were up triple digits in the first quarter with strength in respiratory, eyewear, face, gloves and clothing categories. Our personal protective equipment backlog is now up triple digits in the second quarter. However, we expect the macro and short cycle headwinds to more than offset the growth in PPE and Intelligrated. We expect SPS sales to be down more than 5% compared to the second quarter of 2019. So while our diverse portfolio is resilient, the combined impacts of the COVID-19 pandemic and the OPEC Plus dispute are meaningful across the global economy. While we have rigorous measures in place to manage our operational risks and the continuity of our operations, as well as those of our customers and suppliers, continues to change daily as the impacts of the health crisis continue to unfold and evolve. As a result, we expect a very challenging second quarter with sales expected to be down more than 15% for the company versus the prior year. Now let's move on to slide 7 and discuss our balance sheet and liquidity. Our strong balance sheet provides a stable foundation as well as opportunity for our company during challenging times such as these. We have maintained a premium credit rating for over 25 years, which has been a long-term competitive advantage for us, especially during difficult times like the downturn in 2008 and 2009 and again today. It reflects many years of responsible capital management, good stewardship of our pension plans, and an emphasis on prudent leverage and significant liquidity. We exited 2019 in an incredibly strong position and we took additional actions during the first quarter to further bolster our financial flexibility as a precaution in these unpredictable times. As discussed in our outlook, we further derisked our pension plan by increasing the plan's asset allocation to 60% fixed income in the first quarter, which has proved to be prudent as our pension plan remained overfunded at the end of the quarter and requires no additional funding even with the tremendous volatility in the capital markets. We also refinanced a billion euros of February maturities with a euro bond offering maturing in 2024 and 2032. We have no remaining bond maturities coming due in 2020 and only $800 million of bond maturities coming due within the next year. Most recently, we announced a $6 billion two-year delayed draw term loan agreement which, combined with our pre-existing $5.5 billion of undrawn revolving credit facilities, brings our total undrawn sources of liquidity to $11.5 billion. As of the end of the first quarter, we had $8.8 billion of cash and short-term investments on the balance sheet and a net debt to EBITDA ratio well below 1. All together, we have over $20 billion of cash, short-term investments and undrawn sources of liquidity readily available, compared to only $800 million of long-term debt maturities and $3.5 billion of commercial paper coming due within the next year. As you can see on the slide, our balance sheet and liquidity profile is significantly stronger than it was heading into the 2008-2009 downturn when we were more levered, had less than $6 billion of undrawn liquidity, and our pension was severely underfunded. We will focus on preservation of liquidity during the second quarter and expect to enter the third quarter with significant capital deployment options should we have greater clarity on economic conditions. With that, I'd like to turn the call back over to Darius.

Yes, couple that. I mean in terms of Q2, I think we expect our worst decremental for the year in Q2. Obviously, we're in the middle of some cost actions that we expect to be the most depressed from a GDP perspective or sort of underlying assumptions here, and I emphasize the word assumptions, is that GDP Q2 will be the worst, improving Q3 and improving Q4. So obviously our margins will kind of follow that trend. Q2 will be the bottom, we expect some level of improvement in Q3 and further in Q4. That's sort of the overall trend. We can't give a level of precision on this because obviously some of the cost actions, timing of that, is still a little bit not totally within our control. But we're taking aggressive action with the Phase 1 that was discussed, but we're also looking at Phase 2 which is going to be finalized and deployed within the next 60 days for sure.

Well, clearly our Q2 decrementals will be worse. I mean that's you know, and then they'll start improving. I don't know that I can give you any more precision than that. I mean, it's essentially providing guidance, right? And then just on the buyback, you guys talked about completing your 2020 program but obviously your balance sheet is in good shape. I don't know where you bought back the stock this quarter, but do you have capacity and are you willing that as you get better visibility on the second half that you could be opportunistic in the event things pull back again?

Sure, so just a couple things. Number one, the $1.1 to $1.3 billion, about $200 million of that is carryover restructuring from the prior year, so it's not 100% incremental. And your guidance, we guided a pretty sizable repositioning capacity as we always do because we're always building pipeline around repositioning. That's been one of the things that continues to feed our productivity delivery over many years. So what you're seeing here is we've accelerated a substantial amount of that into the first quarter and the second quarter mainly to drive direct and indirect cost reductions to combat this situation. So that capacity has always been there to deal with the pipeline as it gets created; we've just now deployed it or are about to deploy it into some very specific things around direct and indirect cost reductions in the near term. And then maybe just one other thing to add to that is a portion of that cost saving is also in indirect cost because we think about 2021. Obviously as you reduce your indirect cost that doesn't require much of any restructuring, so we don't anticipate going back to 2019 indirect spending levels in 2021. That's probably not realistic. So part of that savings that we'll see is going to live through in 2021. It's going to be somewhere between what we're going to come back in 2020 and what it was in 2019. So part of that is going to be a carryover.

Yeah, I would say from an aftermarket perspective, it's definitely accelerated in the last six weeks for sure. At the end of March in particular, we started to see some pretty substantial slowdown. So when we think about it in the second quarter, we're going to have some substantial reductions, probably greater than the flight hour reductions that I mentioned earlier. So probably greater than 50% types of aftermarket down, and in any ATR segment in particular.

Yes, so I can tell you that we are in active dialogue with our customer base and particularly in those two segments as you mentioned because they are hurting. So customers are coming back to us and talking with us about ways we can work together to ensure that they are able to navigate through this environment. So we're going through what you would expect a disciplined company to do. We're doing not only direct dialogue with some of those larger customers but we're also doing a substantially deeper credit risk assessment on our whole portfolio. In cases where we need to do things like pay before shipments or require cash before orders are taken, we're doing it. But that's a nuanced strategy because you've got to be considered about the strategic customers that you're dealing with. So it's an ongoing activity. I will tell you that it has the senior-most leadership attention. These are not decisions being taken at low levels of the organization. Each of the SBG presidents and CFOs, and Darius and myself, are having direct dialogue on some of these larger customers in particular. So it's going to be a challenge. There's no doubt about it. I don't think we've seen the impact in the markets yet of what could happen from solvency risk standpoint, and I think that's yet to play out. But we're taking appropriate actions as you would expect to manage through that.

The two biggest areas we're focusing on, as you can imagine, are inventory and receivables. So we've got a full-court press on with our receivables teams and the SBGs as I mentioned to make sure that our collections activities are robust. And then Torsten and his team, as Darius highlighted, have instituted a weekly executive S&OP all the way to the Honeywell level. That's going to be a big focus for us. I'll let maybe Torsten say a few words about what we're doing there.

One other thing, Nigel. I will tell you that we are not planning on cutting growth capex. We're in a strong cash position. Those projects are high-return projects. I'm not planning on sacrificing the future just to cut back on capex, and I think that's probably something that we're going to continue to fund.

Actually, it's really hard to parse it and be able to say for sure. We think we probably lost two to three points of growth in the first quarter due to some of these issues. To be honest, it's not like I know what they're going to be until people movement becomes freer. We're going to struggle with service and project execution in the solutions businesses while social distancing norms become clear in the factories. That's going to have an influence over capacity and attendance and so on. But it's near impossible for us to put a number on that, which is partly why we shared the greater-than type of a number as opposed to some level of precision, because it's changing almost daily and it's different in every region of the country. It's going to be different in certain states in the U.S. I wish I could provide something more precise, but frankly that's part of the reason why our level of visibility is precluding us from giving precise guidance.

Well, I think there's just a lead-lag effect. There's clearly a correlation in the aftermarket to flight hours flown, particularly on the Air Transport side. There's probably a little bit of a delay in terms of a recurrence and growth in flight hours and that being exhibited in aftermarket consumption. But other than that, I think the correlation is generally there. As you see flight hours return, whether in the business segment or air transport, you should start to see aftermarket return, probably with some lagging effects.