Honeywell International Inc. (HON) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Honeywell's fourth quarter 2013 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. I would now like to introduce your host for today's conference, Elena Doom, Vice President of Investor Relations.

Thank you, Zack. Welcome to Honeywell's fourth quarter 2013 earnings conference call. Here with me today are Chairman and CEO, Dave Cote and Senior Vice President and CFO, Dave Anderson. 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 fourth quarter and full year 2013, as well as share with you our guidance for the fourth and full year 2014. Finally as always, we will leave time for your questions. With that, I will turn the call over to Dave Cote.

Thanks, Elena. Good morning, everyone. As I am sure you have seen by now, Honeywell delivered another good quarter capping off a terrific 2013. We are benefiting from our diverse portfolio and that continued focus on new products and geographic expansion plus our ability to effectively manage and what continues to be slow growth macro environment. The importance of a balanced portfolio was evident last year as it helped us to offset some of the headwinds we faced in Defense and Space and Advanced Materials over the course of the year. Most importantly, the businesses, all executed very well, delivering margin expansion in every business last year As for the fourth quarter, it's very encouraging to see sales growth 8%, up 5% organically, with organic growth better than expected across all four businesses. We continue to drive margin expansion, up 50 basis points year-over-year, for an impressive 70 basis points when you exclude M&A, and we delivered pro forma earnings per share with all of $1.24, $0.02 above the high-end of our range, so we are starting this year with positive momentum struck by order rates continue to get better and there were pockets of acceleration in the commercial aftermarket ESS, Advanced Materials and Turbo, all suggesting a modest improvement in end market conditions overall. We are also seeing order momentum out of our long-cycle businesses, building on the robust backlog has positioned us well heading into this year, with ACS solutions orders up strong double digits, and our defense backlog up about 20% year-over-year due to strong international wins. We are also increasingly confident in our outlook because of the smart gain deployment actions we took in the fourth quarter. As you saw from our press release, we are able to proactively fund restructuring and other actions fully deploying…

Thanks, Dave. Good morning, everybody. Thanks for participating in this morning's call. Let me start on slide number 4, the 4Q13 results. As you can see from the numbers, we delivered at or above guidance on every metric in the quarter. Sales came in at $10.4 billion, above the high-end of our guidance range. They grew an impressive 8% on a reported basis, 5% on an organic basis. The strength we saw at the year-end was broad-based, as Dave said, with better than expected results really across each of the segments. We will take you through those details in just a moment. On a regional basis, organic sales were up 5% in the U.S., up 4% in Europe and we had organic growth of 13% in the fourth quarter in China. Segment profit growth and margin expansion were both strong. Segment profit increased 12%, margins expanded 50 basis points to 16.1%, and if you exclude M&A which of course was largely the impact of Intermec, segment margins expanded 70 basis points with growth in all four of the businesses. Productivity continues to be a key driver, of course, offsetting inflation and also offsetting the continued investments that we make for growth. When you move below the line, which we are going to detail further on the next slide, you will see that our gain from the B/E share was fully deployed through higher restructuring, environmental charges, as well as the recognized loss on the sale of Friction. Pro forma earnings per share, which excludes the impact of the fourth quarter mark-to-market adjustment, was $1.24, an increase of 13% on a year-over-year basis. Now, the fourth quarter reported EPS was $1.19, up $0.32 from last year which you will recall included roughly last year a $1 billion pretax mark-to-market. This year,…

Great. Zack, if you can open the line? We will take our first question?

The floor is now opened for questions. (Operator Instructions) Thank you. Our first question comes from Scott Davis with Barclays. Please go ahead.

Guys, one of the numbers that you gave China up, 13%, I think that's the best quarter you had China and gosh, I think it's been quite a while. I mean what, can you give us some granularity? I don't think many of your competitors are going to see anything close to that, so what's working for you in China and what's the visibility? I mean, is there a turn there in the businesses you are selling into or is this more a short-term?

Things feel pretty good for us in China, Scott. We did pretty well. If you take a look at the total year and the fourth quarter, and when we take a look at our short cycle order rates, they are also looking pretty robust and it's pretty much across the board, across all the businesses, and I really think it has a lot to do with the focus we have on becoming the Chinese competitor. This makes us a lot more local in everything we do and I think that's an economy that's going to continue to grow and grow for a long time, and we have just been working very hard at positioning ourselves there to be successful.

I guess the natural follow-up to that is just that is this more of Honeywell specific or do you think that you are seeing actual turn in the overall industrial macro in China?

I guess, I would break it into the two pieces. I am not sure always how reliable all those statistics are when you see industrial production and that kind of thing out of China, so whether it's really good or really bad on the statistics. I think some of that was a bit of a grain of salt. Overall though, I would say we still see it growing, and within that we are growing better, so I think it's a combination of the two.

Fair enough. Then, you guys just talked a little bit about Turbo. It's always been a great business, and you have grown above market, I think something in the neighborhood of, call it, 7% or something over production vehicle numbers, but we will hit an inflection point here where you can outgrow those historic levels, just because the CAFÉ standards and such globally are all picking up to such aggressive numbers pretty quickly, can we start to think about Turbo as being a higher growth than 7% plus, you know, global SAAR or is this what you saw in the quarter more of a short-term temporary?

I am not sure what number I would put on the overall growth, Scott, but I would say as we said in last year's investor presentation, there is explosive growth possible in our Turbo business for a number of reasons. One is exactly what you said about the increasing standards around the world. The second is that a Turbo is one of the easiest, least, technologically difficult things for any OEM to do in order to achieve those standards. There is a lot of more complex stuff they can do, but Turbo, they are pretty well known, pretty well understood. I think that penetration rate is going to continue and we are uniquely advantaged within that space because we have a jet engine business, and that jet engine business allow just stuff like Material Science, Airflow Handling to be shared with the Turbocharger, because the Turbo is really just a small jet engine. So again I would say, it's the combination of the two. That market is going to continue to grow very well, but we will also grow very well within that market because of our capability.

That's fair enough. Okay, I will pass it off. Congrats on a good year, guys.

Thanks.

Thank you.

We will go next to Steven Winoker with Sanford Bernstein. Please go ahead.

Thanks. Good morning, Dave, Dave and Elena. Nice close to 2013.

Thank you.

Let me start with just the growth investments that you referenced in most of the business units. Can you give us any kind of - excluding the repositioning to see operating expense impact maybe in total or some sense for sizing how big they were this quarter?

I guess, I’ve got it off the top of my head. It's a decent size number.

If you look at it across the business, and here we are really talking about, Steve, obviously we are talking about growth investments and so you have to keep up that the investments part of that in quote, because it’s really P&L but it's really building for the future. So, it's a combination of R&D new product. The whole new product process, introduction process, CapEx, and the flow through of depreciation related to that CapEx, it's the expansion, feet on the street in terms of high growth region as well as just as you know, just the over continued investment we are making in terms of sales and marketing capabilities and engineering capabilities. It's about 50 basis points.

Okay.

When you think about the total of that.

Okay, that's helpful, and I suppose in March we will get more detail not just anecdotes around traction, I mean as you mentioned, you have been making these investments for years now on a relative performance versus direct competitors and peers. I think that would be helpful because it is often something we hear about. The second one is on the repositioning projects themselves, maybe give us a little sense for where you are directing us? I think it's no longer FrictionMaterials. Where is it going and what kind of things are you are you doing? Is it Intermec? Is it M&A oriented or where investors often wonder, is this the end of it for Honeywell from a repositioning standpoint, maybe give us a little flavor for what you are finding?

First I would say, if you noticed that it’s really spread across the businesses where we have done a lot of this. And the nice thing I like about it is, we still see lots of opportunity to be able to improve our operations. As you know, our margin rates are still lower than our, say high margin rate peers, and that's all upside for us as we continue to make the company more efficient. So the restructuring is pretty much spread amongst the businesses.

I think Dave just to add to that, and Steve, we talked about this. You are aware of this. I mean, the whole ideation, if you will, the development of projects and the pipeline of projects is something that we take very, very seriously, and it's something that's not a stop/start. This is a continual good process in terms of really looking for those opportunities to really set a new bar, if you will, in terms of the performance of the businesses. The other thing is, it's really consistent with, and we talked about, just a continued expansion and the growth of the global footprint of the company, really realizing the opportunity that exists in terms of the GDP, the GDP growth globally. So all of that functional transformation. It's amazing the things that we continue to do in terms of really a rethinking our model for support, both the service levels and the quality levels and the cost levels in FT. Just this past year I was working with Dave on the functions, it's amazing, the amount of things that you could consider to be still sort of breakthrough. Those all represent repositioning opportunities. We view that very, very positively, we are obviously strategic in our thinking and then very good we think in terms of execution by actually delivering on those results. We take that very seriously as well in terms of the ongoing tracking and management of these projects. It's something you ought to count on from us.

Right. In light of the volume growth that we are starting to talk about, I assume your capacity utilization levels are low enough at this point that there is not a lot of CapEx coming other than what we just talked about for UOP and specific projects on that front.

Yes. It's largely a PMT issue to your point, not much of an issue in the other businesses.

Okay. Great, and I will pass it on. thanks.

Okay.

We will go next to Steve Tusa with JPMorgan. Please go ahead.

Good morning. Maybe you program (Inaudible) say great quarter, so we are going to have to say it at every conference call here.

I don't mind.

On the fluorine side, you mentioned the incremental headwinds in the first quarter. I mean, it's a not a huge part of your business and I think pricing has stabilized there. In fact, I think one of your main competitors talked about raising price earlier this year. Maybe could you talk about, with the volatility and price there, or even though it's small, what kind of impact it's had on you in the last year and what kind of impact you think it's that's going to have and maybe qualify it in the first quarter and then am I right in kind of viewing the second half as there's a much easier kind of price comp on fluorine or does it get worse from here?

I obviously don't want to comment on anything anybody else is saying about it. I would say though that we did degradation in the course of last year, largely because non-patent related product and this is a game where you got to be able to have really unique stuff and that's the advantage we have. Once we are able to start producing that and introducing it, then we will be in that much better a shape. I don't know that we have actually set quarter-by-quarter how much it affects us, but we did feel and in fact last year I don't expect to see a huge decrement again this year.

Just to add to, Dave, to what you have said, and we referenced a meaningful headwind for us in the first quarter and it's measureable in terms of impact, so that is something that's going to moderate in terms of headwind in the first quarter. It happened to be paired timing-wise with also the headwind that we got out of UOP in terms of Parex shipments when we really had for the first quarter, where we really had just a rollout you recall first quarter 2013 By the way, that first quarter 2013, as I referenced when I went through my remarks, was also on top of a very strong first quarter '11 and in the first quarter '12. In 2014, we have a little bit of sort of the confluence of events with both, UOP fall into little bit in Resins and Chemicals and it is related to the phenomena, Steve, that you mentioned and then basically that moderates then over the course of 2014.

Is it a r22 or a 410a issue?

It's largely r22.

Okay, so this is really the volatility. I mean, you had a spike in the price, so that should normalize. Is it about like (Inaudible) third of the year-over-year comp to down 150 in margins?

In terms of headwind that we are going to have from PMT in the first quarter, due to phenomena I just mentioned. By the way, the other headwind we have as I talked about was ACS, which is well known in terms of the acquisition, in terms of margin rate. I am just talking margin rate. It's, say, about a third of the of impact in terms of the PMT phenomena.

Okay. That's great, and one last question before the March meeting here. I mean, you guys are kind of putting up the low double-digit, low-teens growth. I mean, you are kind managing a pretty well to that number. It seems like you guys are a little more optimistic on the economy, which would suggest that maybe at the end of the day that 12% to 13% consisting EPS growth is not really be that much of a standout outperformance. I mean, at what point do you kind of look out in a better economy see peers growing maybe 15% plus and think about maybe doing something a little more to get that growth rate up or do we still have kind of the mentality that look it is going to click away and do, we think, over a five-year period and above average type of growth rate? Is there any discussion as to that high level approach to the business model?

Well, I would say, Steve, there is always obviously a big difference between actual and forecast. And when you are trying to forecast out for five years, its one thing to just put a really bullish economic scenario behind it, it is another to say, okay we want to make sure that we can do whatever it is that we say that we are going to do. I would rely though that, if we take a look at how we done on actual, historically we have always done very well when it came to actual, especially worse is our forecast. If we say, okay we have got plan to grow a certain percent over the next five years and the economy is significantly better than what we expected, that certainly won't be holding ourselves to that as a maximum, rather we are going to continue to be focused on how do we outperform our peers every quarter, every year, just like we have in the past. So I wouldn't get too hung up on a forecast that how bullish is the macro forecast for the economy. I am certainly hopeful that it ends up better than what I tend to think it is going to be but it is showing signs of some life now. I don't know that we are going to see a really robust economy over the next five years but you just don't know. No matter what happens, it will be our intent to outperform on the actual.

Okay. Thanks a lot.

You are welcome.

We will go next to Jeff Sprague with Vertical Research. Please go ahead.

Thank you. Good morning, everyone.

Hi, Jeff.

Hi, Dave. One way to get at that question is that it kind of looks like the cabbage path is really slowing up.

Well, we have done a lot of seed planting. There is a lot cabbage to be picked up. I agree with you.

So, I mean, obviously you are not going to announce deals here today or anything but how active is the M&A pipeline and where is your head on share repurchase? Obviously you have got the $5 billion authorization you put out there. Its not clear that you are going to really aggressively move against that though.

Well, I think hacking back to the comment Dave just made on restructuring and how we keep a pretty full pipeline. We do the same thing when it comes to M&A, looking at what's available, what's possible, how do we continue to do what we call our milk runs, and just calling on companies and heard me liken it to being at a retail business where you sit there and from 10:00 to 2:00, nobody shows up and then at 2:00 for some reason seven people come it at the same time and you wonder why it wasn't spread out during the day. Well. the same thing happens with M&A deals. Sometimes they come in a bunch like they did nine, ten months ago and sometimes you go a year-and-half without much happening. So its tough to predict. So if you are focused on making smart deals like we continue to do, then it is probably going to keep coming in bunches, because I never say, okay, we have got to deploy $2 billion a year or anything like that. I want to make sure that we continue to say, stay smart about this. That being said, there is just a whole lot of opportunity for us when it comes to M&A. It's a big world out there and we look at the possibilities for great positions in good industries, building off the portfolio we have. There's still a lot of good stuff out there. So we are going to continue looking. When it comes to repurchases, I want that in our quiver as the things that we could be doing. We are going to continue to at least hold share count flat. Its my intent to do that. So. I want to make sure that we are a little more opportunistic when it comes to it. I am always fearful of falling into that 80% that buys at the wrong time and I would like make sure that we fall into the 20% that looks like, wow, that was a really smart thing to do. I think timing does make a difference there and we will continue to think about it that way. So I still see a lot of M&A potential and I think we have proven over the years that we are reasonably good at it.

Okay, another thing to add. If you just look at 2013 and this is another, I think, kudos for the company, you look at 2013, we had $1.1 billion in terms of share buyback. Te had roughly the same number in terms of M&A. Dividend, we paid out $1.4 billion rounds. $1.375 billion roughly, $1.4 billion. This is very strong performance and I think if you look at the track record of Honeywell, what we have been able to deliver, not only operationally but in terms of, as Dave said, smart capital deployment. Smart deals we thought. If you go back to 2005 Nomar transaction, the UOP transaction, go forward in terms of what we have done in terms of building on a position in gas detection, our safety products business. The growth now and AIDC Scanning and Mobility. These are all very, very smart adds that lend themselves to further both, organic and inorganic growth. Thomas Russell add to UOP. As Dave said, the pipeline is rich. There is always the distance between the cup and the lip. In M&A, it's very tough to move from concept to actually close, but what we have done has been very successful and the track record is well balanced in our capital deployment. 50% of our cash over the last 10 years deployed to build the business into CapEx or M&A, 50% back to shareholders either in the form of dividend or share buyback, so we are just going to continue to be smart about it. We think that disciplined approach pays out over time together with the operating discipline and the operating performance.

Jeff, I like everything that Dave just said with one exception I might modify and correct his pronunciation of the word smart.

Interesting.

I think I would learn that through for all these years.

Smart in China.

Thanks, Jeff.

Dave, I also just asked that question on the context of situation what it looks like you maybe could be net cash by the end of the year. You are going out a new five-year target right, I doubt if you are modeling the recession. Perhaps, you are, but if you are going to grow earnings 10%, 12%, 13% in next five years, that's going to be a (Inaudible).

Jeff, I am well aware of the cash that we have on the balance sheet.

Then just finally, Dave Anderson, said each asking you would lay out target for more profitable growth, so currently is you are going to project higher (Inaudible) are there any particular areas that actually standout as being on target form the margin standpoint?

I think, Dave, really it's across.

Yes. We see upside, maybe it should be one of the businesses, Jeff.

The pattern of that, Jeff, will vary just as the pattern varies by quarter in 2014, vary by business, by year based up on their individual growth outlooks, if you will to make up the long cycle short cycle, all of those factors are going to influence, but when you look at the overall five-year numbers as Dave said, we think are very positive for all the businesses.

By the way, Jeff, just a compliment for you, we were really amused by your phrase. A pretty typical street forecasting, well done.

Yes. It's 23% every year, right? Have a good day. Talk to you later.

Nice. Thank you.

We will go to Howard Rubel with Jefferies. Please go ahead.

Good morning. Thank you very much. A couple of things. One is, on Thomas Russell. It looks like the numbers were sequentially about the same and how is it doing? Can you kind of provide an update for us, please?

On Thomas Russell? It's doing well.

I would say between their capability and ours, extremely complimentary in market, technology and sales outreach and even manufacturing, so quite good.

Year-over-year or you are still lacking high, what I would call a 10%, 30% growth rate?

I don't that we disclose it.

No. I think, you can comment though. It's not that level hard.

You can see part of it below the line, Dave, so that's why -

Fully integrated in (Inaudible)…

All right. I will leave that.

You are correct. It's doing well.

Then in terms of Aerospace, new products, I think that there has been a number of them in terms of synthetic vision and in terms of some other things in term of integrating the cockpit. Mike, you talked about them and sort of what's your finding as you (Inaudible)?

I am not sure what you are looking for specifically there, Howard, but yes. We do have a pile of new products coming out of the Aero business, some of which they have talked about, some of which they haven't and so far so good, things are going well.

And one of course is all the connectivity things that you have got, (inaudible), maybe you can provide an update on some of that. That's where I was going, though.

Okay. Well, you can expect us to talk more about that on Investor Day, because you are correct. We think that's the place that we excel and we see continuing to increase.

Oaky. Thank you very much.

You are welcome, Howard.

We have time for one more question.

We will take our last question from John Inch with Deutsche Bank. Please go ahead.

Thank you. Good morning, everyone.

Hi, John.

Commercial aftermarket, just wondering what the trend and cadence of the business is. You had pretty robust results and from competitors and chatter about some inventory restock and you guys are going to be rolling into, you actually have these in your compares this quarters. You seem to have easier compares on the segment. As the course of the year unfolds, why don't you talk to the compares towards what is the cadence of that business.

I assume you are talking about Aero, John?

Yes, I am sorry, commercial aerospace aftermarket.

We think that's something that starts to get a little bit better this year than it was last year overall.

Specifically, John, to put some perspective on it, we had something shifting, numbers. If you look back at the fourth quarter of 2012. We did start to see the impact of aircraft dismantling and asset pooling and that really pulled down in the developed economies, their spare sales. For example, U.S. spares in the fourth quarter of 2012 were down over 20%. Obviously this is partially offset by what we talked about a year ago, a bit of a pull-forward in buying behavior out of China. So in the fourth quarter of 2012, our China spares were up over 40%. So now, if we fast forward to 2013, in the fourth quarter we did see a return of more normal buying behavior across almost all of the geographies but in particular, you see the U.S. rebounding nicely, up over 20%, while China spare sales increased sequentially, though they are still facing that difficult comp and I think about 10% within the quarter. So moving forward to 2014, we do expect the ATR aftermarket there to grow in the first quarter in excess of flight hours as a result of the easier comp and obviously more normal buying behavior.

And that obviously pertains to prospectively better margins in the second as the year unfolds, if I am reading that right.

I think that's fine.

Okay.

And maybe a way to summarize all of that is to say that the guidance is the same which is, we are looking at mid single digit growth in the commercial aftermarket for aerospace in 2014.

For the year.

Can I ask you about transportation. I think European light vehicle in the first quarter was down in terms of production, down double-digit. Why is the number, I realize it's a little bit of currency headwind, but given the strength of transportation in the fourth quarter, the momentum you seem to have, why is your guide still where it is? Why 3% to 5%? Why isn't it up a little bit higher for '14?

You are talking about TS in total?

Yes. Correct.

I guess, it's the moderating effect of friction plus there is, let's say, a conservatism on our part when it comes to what's going to happen in Europe. So we think its bottomed at this point and that's why we are starting to see increases as new launches more than offset the slight declines but its just more a case of just wanting to not get too far off on this one.

Currency also has a big impact there, but the assumption that we make, when using, as you recall, John, we are using a 1.30 Euro to Dollars. So that has a little bit of a headwind effect to TS. It's largely non-U.S., today, business. So that does have an influence as well.

Well, is there any sort of rate to your assumption that perhaps maybe the rebound you are seeing light vehicle consumption in Europe is perhaps little bit short-term duration or is there something else? I am just trying to, is this anything more than conservatism, I guess is what I am going after?

Well, John, I would point out that, in the fourth quarter, we did see very strong buying behavior in China. Dave referenced this in his opening comments. So there is some free buy ahead of some potential regulation changes on emission that certainly bode very well for the TS sales in China in the quarter. So we are not anticipating that that will repeat.

Okay.

And I am also hopeful that its conservatism on our part.

I get it. I am just making sure there is nothing else in the mix that has (inaudible).

There is nothing bad.

Just one more quick one then. It's a little bit of back to the M&A question. Dave Anderson had set a $1 billion placeholder for this year, and you kind it kind of make sense as a placeholder. I just want to know, Dave Cote, how are you thinking about perhaps the prospects given the strength of your balance sheet toward - if the opportunity came along doing say a mid-year deal in ACS or something that could sort of build up the success of Intermec and some of these other deals have done or do you really sort of see '14 at this juncture still kind of a pretty much a bolt-on year?

John, I would go back to what I said earlier. It's tough to know. We look at small stuff, we look at the bigger stuff and you just never know when something is all of a sudden become actionable and I don't want to ever commit certain amount every year, because it's not necessarily the way deals come in, but I could tell you we are very interested in M&A, because I think we have proven we are good at it. Where, it's focused on doing a good job with it today as we were 10 years ago, because it's not an area where we ever want to make a mistake, so who knows? I would just say that I have a predilection for doing M&A, because I think we are good at it and it's a way for us to really add value.

I understand, but, Dave, would you prefer to do a bigger deal if the opportunity arose because of the success you have had or do you think the smaller bolt-on framework is really still the playbook we should think about?

I guess it depends on how we define bigger deal, because I am not favoring one or the other. At the end of the day, I just want to do good deals and I would rather do 10 $200 million really good deals than to do a $2 billion average deal. By the same token, if there is a $2 billion, really good deal. I am certainly not going to sit here going well, that's too big. I don't want to do that, so it's got to be on a case-by-case basis. The thing I can promise you is, no matter how this ends up evolving or developing, I will be able to make a strong case to you on why we can make good money on this focused on cost synergies, not counting on sales synergies and it will be a great position in a good industry.

Thanks very much. See you in March.

All right, Dave. Do you have any final comments?

Of course. We certainly like what we have accomplished, and not just in this quarter, of course. While that does feel good, what feels even better is what we can see coming as we continue to outperform. I got to say it's been very fulfilling to complete our first five-year plan with panache even in a weaker than expected macro economy. That being said, as I say a lot and my team has heard me say a lot, yesterday's press clippings wrap today's fish. We intend to continue outperforming for a long time and the seed planting that we have done for several years now puts us in a great position to make that happen. We continue to look forward and we look forward to sharing our next five-year plan with you at our March Investor Day. Thanks for listening.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time. Have a wonderful day.