Carrier Global Corporation
Q2 2020 Earnings Call Transcript

Published: 30 Jul 2020

[Operator:]

Good morning and welcome to Carrier’s Second Quarter 2020 Earnings Conference Call. This call is being carried live on the internet and there is a presentation available to download from Carrier’s website at ir.carrier.com. I would like to introduce your host for today’s conference Sam Pearlstein, Vice President of Investor Relations. Please go ahead, sir.

[Sam Pearlstein:]

Thank you and good morning and welcome to Carrier’s second quarter 2020 earnings conference call. With me here today are David Gitlin, President and Chief Executive Officer; and Tim McLevish, Chief Financial Officer.

[Dave Gitlin:]

Thank you, Sam and good morning, everyone. Here’s the quick summary, the second quarter was better than we expected driven by our continued cost reduction actions, progress on our top line initiatives and improvement in the US in June. We are raising the low end of our prior outlook for sales, adjusted operating profit and cash flow, enabling us to add back some targeted growth investments that we had previously scaled back. Before we get into details on our Q2 results and the outlook for the rest of the year. Let me start with some context. Slide 2, shows the four priorities that we established at the outset of the COVID pandemic. Our team has continued to respond aggressively and effectively on all of them. It starts with protecting and supporting our people. Our operations and field teams have continued in the workplace with limited interruption and we have gone to great length to ensure a safe environment for our people. We have distributed 2.5 million masks. Instituted thermal screening for 100% of our employees at our scale locations and deployed Carrier’s healthy building program solution in our facilities to provide our people with as safe an environment as we possibly can. Our second priority has been to maintain business continuity to support our customers. While we experienced some short-term shutdowns by the end of the second quarter our factories and suppliers have resumed operations and we are now more than 95% of our production capacity availability.

[Tim McLevish:]

Thanks Dave. Good morning. Please turn to Slide 5. As Dave just mentioned April and May were right on track with our expectations. June however saw a significant pickup in activity in the US as the economy reopened. That led to a substantial improvement in demand in North America residential HVAC, residential fire and North America trailer. Due to the strong North America shipments in June sales of almost $4 billion for the quarter were better than we had anticipated. They were however still down 20% compared to last year due to the COVID related shutdowns. And we continue to expect that the Q2 year-on-year sales decline will be the low point for the year. GAAP operating was $442 million, adjusted operating profit of $476 million was down 42% from last year. The COVID related volume and factory inefficiency pressure were partially offset by our aggressive cost actions. Our decremental margin was 34%. Absence is one-time items, the decremental margins would have been closer to 30%. Our Q2, GAAP EPS was $0.30 and adjusted EPS was $0.33. Since we were not a public company last year, the year-over-year comparisons are not meaningful. Our free cash flow was considerably higher than our expectations. This is largely attributable to favorable earnings and timing benefits in working capital and also the timing of other payments. These results were higher than would normally be reflected in our seasonal pattern. So all things considered, our performance in the second quarter was better than we would have expected in a very difficult environment. Let now look at how the segments performed. Please turn to Slide 6. And note that the year-over-year number I’ll refer to on this slide are organic comparisons. The HVAC segment sales were down 15% from last year. Within the segment, North America residential sales were down 13% as mentioned earlier. The opening up of many states combined with a warmer weather led to a substantial pick up in the month of June.

[Dave Gitlin:]

Thanks Tim. We remain on track to navigating through this uncertain environment. We continue to focus on aggressive cost actions while driving key strategic initiatives. The quarter was better than we expected that enables us to increase the low end of our previous outlook while investing more in the second half to position us for growth in 2021 and 2022. Key trends around healthy, safe and sustainable building and cold chain solutions position Carrier well for sustained growth. We feel confident in our medium-term outlook of mid single digits sales growth, high single-digit EPS growth and cash flow equal to net income. With that, we’ll open this up for questions.

[Operator:]

and our first question comes from the line of Nigel Coe from Wolfe Research. Your line is now open.

[Nigel Coe:]

I just wanted to kick off on the resi debt point. I think you said down 13% or 14% some in the quarter. You’re obviously all pretty much independent distribution so you’ve got the economic so, getting that Wasco had pre-significant inventory draw down. I’m just wondering if you got any intel on how the sell through look so we can sort of judge, how market share trended versus some of comps , that would be my first question.

[Dave Gitlin:]

Yes, we look at resi and like you said Nigel. We sell through distribution. So when you look at the shared number AHRI. You’re really comparing the sales from our distributors direct to the dealer network comparing to some of our competitors that shipped direct. What was very encouraging to us, is a few things coming out of the quarter. Number one, as I mentioned in the remarks June was the highest orders month that we’ve hand in our company’s history. It was plus 100% and a lot of that strength in orders has continued into July where resi orders in July have continued to be extremely strong north of 50% year-over-year. The inventory levels at our distributors ending last quarter were down about 25%. So we’re really - we started the quarter with low inventory levels at our distributors. We’ve done our best to reacted as very strong demand that we saw coming into July that’s continued into June that’s continued into July. So we feel pretty well set up for 3Q. The biggest we have right now is supporting that demand operationally with our logistics team.

[Nigel Coe:]

It’s a good problem have to, isn’t it? And then on your framework. Obviously, a little bit of a bump to the midpoint and I think -- of the prior framework call for mid-teens declined HVAC down 10% and then refrigeration down 20% and I’m sorry if I’m missed this. But how does that look right now, maybe in the second half of the year would be better sort of data points. How has that changed relative to what you saw back in early May?

[Tim McLevish:]

Nigel, this is Tim. I would say that I mean the same impact is hitting all of our businesses and roughly proportionally so. I would say that, the guidance we gave are overall for the company would be largely reflected by each of the business units. The one exception from an operating income standpoint would be our operating profit that we probably will have a bigger hit to profits for HVAC attributable to the decline in JV income and also that we probably have heavier investments of the $100 million incremental investment we talked about, this portion of share but will go into HVAC.

[Nigel Coe:]

But to be clear, the performance that translate in 2Q it doesn’t change your view, that’s going to be bit more of a good guide relative to the other segments.

[Tim McLevish:]

No, I’d say they’re going to be pretty proportional.

[Nigel Coe:]

Okay, thank you very much.

[Operator:]

Thank you. Our next question comes from the line of Julian Mitchell from Barclays. Your line is now open.

[Julian Mitchell:]

Maybe just first question around your overall perspectives on the non-residential markets across I suppose foreign security and HVAC in particular. But what are you expecting rather for the order intake there over the balance of the year? And maybe clarify for us, what proportion of your non-residential activities are tied to greenfield investments as opposed to replacements or aftermarket.

[Dave Gitlin:]

Okay, well. First Julian, just a reminder that when you look at our applied business. It’s about 70-30. We’re more heavily weighted towards OE versus service on the applied side. When we look at 2Q and then we’ll kind of look forward with you. We feel on the applied side that, we had strengthened in the US and China I think in terms of share. We felt positive. We had committed. Chris had committed to getting us to number one within five years which really looks at about 50 bps of improvement a year and we felt pretty positive about the share gains that we saw in the US and China. We lagged in Europe and we need to fix that and we will. But we felt positive about US and China on the OE side. Services is an area where when we look at it some of our peers had a quicker jump on that trend and we did, so we’re playing a little bit of a catch up there. There’s a lot of focus, a lot of momentum we’re putting the framework in place to really lean forward on services. But that scenario that there’s a huge opportunity ahead. When you look at some of the macro trends overall ABI, is a really good leading indicator of course, the architectural billing index. You want that north of 50, it had been north of 50 coming into March, April, May it dropped down into the 30s and then June it was back up to 40, so positive trend there and we’ll see if that bodes well as we look out six months. Light commercial was pretty rugged in April and May. It started to show better signs of progress a we’ve gotten into June and July. But that for us is 80-20 on replacement over OE. So we’re starting to see more activity in the light commercial space but some of those end markets remained challenged.

[Julian Mitchell:]

Thank you very much. And then maybe just a second question on the margin profile. I think Tim you talked about a one-timer perhaps weigh on decrementals. Maybe if you could just clarify sort of what you meant by that. And then also, as we look to the second half. It looks like the implied decremental margin is similar to what you had seen in Q2, just clarify that that’s the case and is the main driver a sort of narrower sales decline, but perhaps some of those more steps up investments as you look ahead.

[Tim McLevish:]

Yes, I think you’ve got it about right, Julian. So if you do the calculation and we come in about 34% decremental in Q2 and there’s about 1% of it is, the impact of the public company cost relative to the last year and the second one is really in accounting adjustment to our long-term liabilities, is about 3%. So that brings you back to kind of the targeted 30% that we usually expect to see. With respect to the second half, again if you do the calculations. I mean we would prefer not to -- for everybody to assume this we’ll be at the midpoint of each of the sales operating income etc. but if you did take that and you would calculate probably 45% decremental and about 10 percentage points of that is attributable to the investments. You recall. I mentioned in my prepared remarks that we really, if you think that we didn’t do much as we’re part of UTC in the first quarter. Second quarter, we were quite distracted by responding to the COVID crisis and our customers and keeping our employees safe, etc. that Dave mentioned. So we spent very lightly on those investments. So the majority of what we had said was $75 million now incremented by $25 million, so $100 million in the second half of the year is about 10 percentage points. And the remainder about 5% bring us down to that 30% range would be attributable to the public company cost that will step up in the second half of the year as we particularly exit a lot of the TSAs and so forth from United Technologies and digital spend etc.

[Julian Mitchell:]

Great, thank you.

[Operator:]

Thank you. Our next question comes from the line of Steve Tusa from JP Morgan. Your line is now open.

[Steve Tusa:]

100% increase is not that bad. Can you give us an idea of just regionally kind of the complexion of what you saw in residential? Were there any differences by region whether it’s shortages in certain areas - different types of behavior in different parts of the country as the heat came on here or obviously 100% everything was up a lot? Just kind of curious as to what you saw on the ground regionally, if there were any major differences?

[Dave Gitlin:]

Steve, the Northeast as the heat hit there, we did see a nice pick up there and including in the West and into the Midwest. The South and Southwest was strong, but it had been strong. So when you look at cooling degrees up 12% in June. It was pretty wide spread and I do think that areas that had been pretty well shutdown, there was some pent-up demand. So we did see a nice snap back in some of those regions that hadn’t been as strong as they had been in other parts. Mix, also although you didn’t ask. I’ll just mention that. On the product mix side, in the last call we said there was a bit of mixing down that we saw earlier on in April. But it kind of mixed back up to sort of normal levels on the side. So that was encouraging as well.

[Steve Tusa:]

And then price for that business in the quarter.

[Dave Gitlin:]

Yes. Look we had thought there’ll be a little bit of price tailwind. I mean it’s sort of flat to slightly up. But it’s - price is really neutral right now. Our biggest focus is honestly just supporting our customers. We really did not anticipate of course. It’s hard to anticipate orders being up 100%. But the tremendous order activity that we saw has been significant. We were little bit fortunate in the sense that, we had pre-provisioned some inventory and we really did it because we were worried that COVID could impact operations. So we used some of that inventory that we had pre-provisioned to help delivery. But the key right now is for our resi operations and our logistics to just keep supporting our customers.

[Steve Tusa:]

And are suppliers like Copeland kind of keeping up with you guys?

[Dave Gitlin:]

Yes, it’s not an operational issue. I mean we’re having through right now. If you look at both our facilities and our suppliers. Everyone’s all hands-on deck supporting the activity. In fact the biggest challenge we have right now is on the warehouse and logistic side. Getting supporting warehouse activity into the trucking, into our logistics channel is, the bigger challenge we have right now operationally just given the sudden spike in demand. But operationally, I’m pretty proud of our own team and our supplier partners. They’ve really stepped up.

[Steve Tusa:]

And then one last one, are you re-evaluating it all in your portfolio analysis? The value of the more security type assets on the commercial side with this pandemic I know that you know some have gone after integrated buildings as a strategy. I think you guys were I feel like you guys were kind of still making that decision around what you kind of wanted to do with portfolio. Does this change it all that portfolio analysis when it comes to keeping that kind of content and that channel outside of HVAC with the security stuff?

[Dave Gitlin:]

Steve, we said that we would put every part of the portfolio through a very rigorous and clinical set of lenses. And if you look at the fire and security portfolio. It’s really 60% products and 40% is that Chubb business, which is that field and installation business. The field and installation business is pretty agnostic. It doesn’t pull through products so that gets a different assessment. The products piece that 60% of the business. What we’re finding is there’s tremendous synergy on a product side between that and our healthy building initiative. We’re seeing it with some of our touchless offerings. We’re seeing it even last night we announced this partnership with FLIR, where we’re going to be reselling their thermal imaging camera capabilities and we’re going to integrate into the BlueDiamond app. So when you look at a holistic set of one stop shop ecosystem of healthy buildings. The fire and security product portfolio fits very, very well and we see that in terms of real application. Normally, we would measure CO2 levels and then adjust the ventilation. But you can use the fire and security contact tracing to anticipate CO2 level rises and get into artificial intelligence and then use that to pre-ventilate. So there’s some really interesting parts of that portfolio and some synergies that seemed to fit quite well.

[Steve Tusa:]

Got it. Thanks a lot.

[Operator:]

Thank you. Our next question comes from the line of Jeff Sprague from Vertical Research. Your line is now open.

[Jeff Sprague:]

Maybe just a pickup on Chubb there for a second. Fully understand what you said about kind of nature of it. But in essence it’s also kind of an important customer touch point, isn’t it? If you kind of look back maybe wish you had more distribution on the HVAC side and alike. Is there something more creative to do with that field force than what’s been done historically?

[Dave Gitlin:]

Yes, look Chubb is a very solid business. And the interesting thing about Chubb is there’s tremendous room for improvement in growth. It’s no secret that UTC had, had it on the market and decided to take it off at the end of 2018. And that’s been an obvious area that we’d assess. There’s sort of two aspects to the assessment, does it strategically fit and if it does not, when is the right time that you would look at divesting it? We’re in the first phase of really assessing that right now and Chubb was hit very hard because it’s very European centric. So if you look at 2Q, I think Chubb was down around 25%. So we really have our work to do in the second half to get the EBITDA and the performance up to levels that we would expect of the business. And then we’ll asses the kind of question that you’ve asked, does it fit from a distribution and touch point with customers or is it worth more in the hands of others and our focus right now is just on improving the performance for our customers and for ourselves.

[Jeff Sprague:]

And maybe second sort of related question, you also have other assets that maybe you could deem non-core, not the size of Chubb. Things like if I’m pronouncing that correctly and other things. What is your thought on monetizing some of the stuff and how it actually fits in your portfolio going forward?

[Dave Gitlin:]

Yes, we’ve said that not only for every part of our product and service portfolio. but including our JVs you mentioned where we do have a stake in European distributor of refrigeration other equipment and it’s a 37% stake and we said that, we would assess every aspect of our portfolio including the JVs and we will decide, is it worth more to us to continue to invest in those or is it worth more to monetize those and we’ll make those decisions as we go forward.

[Jeff Sprague:]

Great. Thanks for the color.

[Operator:]

Thank you. Our next question comes from the line of Gautam Khanna from Cowen. Your line is now open.

[Gautam Khanna:]

Thanks for the great detail. So I had two questions. First just on the resi HVAC side, can you speak to any trends on mix and are you seeing patchwork repairs relative to system replacements? Any sort of trade down or what you would expect to be a trade down given the consumer is under some pressure or we’re just seeing the opposite right now?

[Dave Gitlin:]

Yes, Gautam we’re not seeing any mix down and we’re not seeing customers favoring parts over full replacement. So we had been concerned about that. We’ve been watching it closely and we haven’t seen that materialize. I think that we’re seeing a very positive combination of a lot of forces that is driving a lot of near-term activity. People are spending more time at home. They’re not eating out. They’re not traveling as much. So there’s a lot of consumer spend on the home itself and I think that’s helping. Of course the weather was some nice tailwind. I think our distributors were a bit under provisioned coming in so we’re catching up with that. So there’s a lot of forces in play to drive some very strong order demand. But we’re not seeing a pickup in parts or mixing down.

[Gautam Khanna:]

Okay and just as a follow-up on the indoor air quality assessments that you’re going to do for the commercial customers. How should we think about when these manifest in orders? Some of the solutions that you’re now offering is this - I mean its early days but do you anticipate that we’ll start to see meaningful bookings on this front in the second half of this year or is it more of a first half type of opportunity of next year?

[Dave Gitlin:]

This is thematic and we’re at the early stages. But it’s something that we would continue to anticipate would accelerate significantly as we go forward. We were seeing orders in 2Q on some of our - we introduced it as OptiClean, HEPA filter. The air scrubber machine and we’ve seen very solid order activity. Whether it’s a dentist office adding on or K-12 we’ve seen very strong demand there. We’ve seen it where we even thought chillers and some of the building operators have come back and said, can I upgrade the filtration system. So we would put that in a healthy building category. And we think that this is a trend that will withstand the test of time. So even post vaccine, whenever that comes. There’s society shining a light on the criticality of the health and safety of indoor air environments. And the nice thing about Carrier’s that we have a one stop shop ecosystem where we can address all vectors of what would create a healthy indoor environment. So we’re in early stages. I would call the first phase of what we’ve done is taken our core offerings and put those together for our vertical customers in a stop shop approach. Phase two, what you saw with FLIR last night is we’re starting to add partners and fill other gaps into the ecosystem. So Carrier does become the go-to place for healthy and safe indoor environments.

[Gautam Khanna:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Deane Dray from RBC Capital Markets. Your line is now open.

[Deane Dray:]

I’d like to stay with this indoor air quality theme and just the idea of how does the market develop. We understand holistically why there is a need. But do you expect this to be regulatory driven building codes or will it start from just building-by-building engineers deciding this is what they need?

[Dave Gitlin:]

I think the answer is yes. I think it’s going to be a combination of code driven and customer-by-customer. I think what you’re seeing is a lot of verticals looking to give their customer’s confidence in coming back into these public environments. So whether it’s university or K-12 or other schools globally. They’re stepping up and asking the right questions about what changes do I need to make and you’re seeing it for commercial office buildings. You’re seeing it for hospitals and airports. So I think there’s an element of individual customer demand state-by-state, country-by-country. But you’re also seeing some of the regulatory bodies and it could be an organization like ASHRAE coming forward with specific standards that, I know us and our competitors would all support. So I think that there will be a balance between customer demand and the regulatory piece. But I can tell you that the amount of activity and questions and quoting that we’re doing is really picking up in a positive way.

[Deane Dray:]

That’s great to hear. Can you spend a moment talking about how you’re differentiating competitively in terms your go-to-market? Again on this indoor air quality. You mentioned the OptiClean, the filter. Are you looking at UV as a potential add on? And talk about the monitoring capability beyond just CO2?

[Dave Gitlin:]

I think what really differentiates Carrier is the holistic capabilities that we have. So obviously we have all aspects of HVAC. Within HVAC and indoor air quality. We have a multi-prong approach to filtration. So yes, for homes we use electrostatic filters. We have HEPA filters, we’re using bipolar ionization and we have capabilities around UVC. So we have a pretty comprehensive portfolio when it comes to filtration. But the same comes with our ability to do customized ventilation approaches because it is very application specific. And the same with controlling humidity levels. Then you get into the controls and we have our ALC business that has controls capability. And then when you integrate all of the HVAC and sensing and controls capability that we have there with our fire and security portfolio and then you can make it a one stop shop for customers through a natural interface point. Whereas you picture walking into a restaurant and you look at a computer screen, it can give you a red, yellow, green and all aspects of that healthy and safe indoor environment. So we can provide the controls, we can provide the user interface experience for our customers whether it’s through the controlled system or an overlay-controlled system. We have the ability to connect the dots. I think in a fairly unique way for our customers.

[Deane Dray:]

That’s real helpful color. Thank you.

[Sam Pearlstein:]

Can we just go to one last question, Gigi?

[Operator:]

Of course. Thank you. Our next question comes from the line of Vlad from Citigroup. Your line is now open.

[Unidentified Participant:]

Maybe just one more follow-up on the healthy buildings and indoor air quality. Maybe it should be obvious but you mentioned that you are implementing this in your own facilities. So can you talk about as you begun to roll this out in your facilities what you started to learn about the ease or difficulty of implementing some of these measures and what the employee response has been in terms of the feedback or feeling of the security in the facilities as these measures have come out?

[Dave Gitlin:]

Yes that’s the beauty of - even the building that we’re doing this call from today is our Center for Intelligent Buildings here in Palm Beach Gardens in Florida and this is basically a showcase of our capabilities and it’s also kind of an existing lab we have to make it the best in class building for healthy and safe indoor environment. So for example, we have significantly more ambient air in this facility than most commercial buildings. We have a designated outdoor air system. So we continue to leverage that to maximize the amount of ambient air. When COVID hit, we started to use more bipolar ionization. We have a relationship with a company called GPS. So we implemented their capabilities in our filtration system there. It’s combined with a HEPA filter as well. So we’ve been using this building to really validate a lot of our apps. So we have our BlueDiamond app that’s part of our LenelS2 business. And what we’re hearing from our employees in this building because right now for office employees at Carrier. It’s still voluntary whether to come back to the office. But we’re seeing an uptick in people coming back to the office because they know we’re investing in the health and safety of the indoor environment. They see it when they get their temperature taken when they come in the morning. They can see it through their app interfaces. So it’s really having a direct correlation to employees coming back in the investments that we’re making.

[Unidentified Participant:]

That’s great to hear and then maybe just a last follow-up from me. You had mentioned earlier in the call, a back-office review that was underway with a look to go to more of a shared services model overtime. Can you just clarify whether that cost potential savings from that - would that be all under what you’ve anticipated under the Carrier 600 umbrella or is that sort of new initiative that can be incremental savings overtime.

[Tim McLevish:]

Well this is Tim. It’s an initiative that we had envisioned for since kind of the inception. It is part of the Carrier 600, we carved out about $100 million of the Carrier 600, that what we call the G&A savings. And we’re setting up what we call - it’s a GBS, it’s a Global Business Services center and we will centralize a lot of the back-office activity. We’re starting with the cash application. We’re starting with accounts payable. We’re starting with some of the accounting back office routine activity. We call it in the reporting of accounting and we’re setting up facilities and probably three or four places around the world. We have one in Prague today. We’re going to set one up in India. We have one in the United States. We’ll put another one down in Mexico and we anticipate it’s a labor arbitrage of the cost structure, but it’s also an efficiency. We’ll employee state-of-the-art tools, to reduce cost and yes, that is part of the Carrier 600 and is well underway. I won’t say that to-date we have realized the savings. We’re still in the process of the setting it up. But you’ll see them soon.

[Unidentified Participant:]

Great. Thank you.

[Operator:]

Thank you. At this time, I’m showing no further questions. I would like to turn the call back over to Dave for closing remarks.

[Dave Gitlin:]

Okay, thank you. And thanks everyone for joining us always. Sam is available for follow-up questions. We look forward to speaking with many of you in the coming months and thank you for your time today.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.