Honeywell Aerospace Inc. (HONA) Earnings Call Transcript & Summary

All right. We'll kick it off. Thank you so much, everyone, for being here. For those on the webcast, I'm Sheila Kahyaoglu with the Jefferies Aerospace Defense and Airlines Equity Research team. We have the entire Honeywell Aerospace team here, but Jim Currier on stage, who's President and CEO; Josh Jepsen, who's CFO; Sean Meakim, who I won't forget Investor Relations; and Mike Ritzer, who is also on the IR team. Jim has a few slides for us, and then we'll go into Q&A. Thank you, Jim.

Thank you so much. Feels good to take an opportunity here in the first couple of minutes of our fireside chat. Just to give a little bit of background in context, particularly what's transpired here over the last month or so as we've been transitioning and obviously becoming an independent publicly traded company as of the 29th of June. So with that a little bit, I think a little bit of context, again, to kind of level set about Honeywell Aerospace for a moment. So as we've noted here, we are a critical mission system provider of high-value content across the entire aerospace and defense ecosystem, both in commercial and defense applications, whether that's commercial or transport, business aviation and/or defense, both domestically and internationally. Last year, over $17.5 billion in sales. We've secured over $105 billion worth of lifetime contract wins over the last couple of years. Backlog is sitting at over $18 billion, 90% of all the aircraft flying in the free world today have Honeywell content on board. The point being is that with the demand that we are seeing and the framework that is set up here, it really does create in combination with being a stand-alone, independent, totally focused on the A&D industry and what we do to support that going forward, a really compelling value proposition long term for all of our stakeholders. So the landscape and the framework is set up to be able to enable that to happen for us on a go-forward. And if you think a little bit about the demand aspect and where we're sitting here today, I mean, one of the things that we look at in terms of the value of a business and what brings a lot of intrinsic value is your demand that you are seeing across the industry. And we are seeing unprecedented demand for our products and our services and our technologies. And what I would make mention of is that we kind of look at this in terms of short cycle, long cycle orders, the order book itself, backlog is up over 9% year-on-year. Our book-to-bill is over 1.1 across the portfolio. We're not seeing any erosion to our demand going forward. So essentially, fundamentally the issue that we are experiencing and we've been very vocal about this, is our ability to execute out of the supply base to deliver on said demand. And essentially, it's just deferring the sales revenue for us because we're not seeing any erosion in terms of our products and our portfolios and the order book itself specifically. But then you have to kind of ask yourself, well, how did you end up in this position that you're in right now? And I tend to look at how Honeywell was operated in. Honeywell Aerospace was operated in as part of the conglomerate from 2010 to 2019. And we really maximized the supply base to be running at a highly efficient type of an operation going forward. And what does that mean? We moved away from multiple sources to single sources of supply. We got into a move where we were outsourcing a lot of the core competencies. And so therefore, the setup was such that we were very, very single sourced in many regards across the supply base. And in an environment that really demand was not very strong within the A&D community over that period of time. If you pivot to 2020 and above, you can see where the demand has increased substantially within the A&D industry. And that's not just across Commercial Air Transport. It's across business aviation, defense and space, again, the three end markets that we serve that are all growing exceptionally well. And then you think about where are we as part of that. We were obviously a single sourced, lacked vertical integration because of the outsourcing that we were doing, and also, there was limited investments that were made in terms of tooling and CapEx over that period of time. We were a little late. I'll be very honest with you, in pivoting the organization as part of the conglomerate to be able to capture that demand that we were seeing coming out of the pandemic. The point there being is that when I came in, in August of 2023, we pivoted that. We started investing very heavily back into the supply base. We put in over $1 billion into the supply base. Our situation at the time was constraints across the electronics portfolio, the mechanical portfolio. And what we see now is that our electronics portion of our business, which represents 40% of the portfolio has recovered. We're doing fine relative to that. Mechanical side, we fixed a lot of issues that existed there, and now we're focusing on the critical few that remain to go get addressed. And that sort of translates into the sort of a pseudo scorecard that we would share with you. Over 3,000 of our suppliers are actually performing exceptionally well. They're meeting our plan. They're growing year-on-year. We have no issues with them whatsoever. We're down to -- out of that 3,000. We're down to about 70 that we would categorize as either being critical and/or constrained. The definition between the two being as follows: critical are those suppliers that are not performing in terms of consistency in terms of their output and their deliveries to us. They have the capability to hit the output demand that is necessary, but they're just not doing it consistently. So they're on a watch list for us and have a lot of senior management engagement with them directly as a result. Of that 70, there's about 10 that we would call constrained suppliers within the supply base. These are the 10 that are not delivering to our plan, not growing year-on-year to the levels that are necessary and hence, become the bottleneck in the organization to be able to unlock fully our supply base. And they really fall under four specific commodity categories that we would look at. It's going to be either complex machining, castings, forgings and bearings. So you can see the pie chart on the right-hand side, what that represents is the amount of spend that we have within those commodities and the proportionate impact that those four commodity categories, therefore, then have within the portfolio. And this is where I personally am spending most of my time working directly with those most critically constrained suppliers visiting them face-to-face, at their sites, going through the issues, going through the problems, going through the action plans that are necessary to resolve what they are incurring and what they are exhibiting in terms of not demonstrating the performance that is required for the business and that includes a follow-up every single week sitting with them as we're trying to unlock that portion of the supply base. Then when you double-click a little bit into that. It's kind of get a better view of those four commodities and how they are performing relative to -- are they delivering to our plan and/or are they delivering to a growth algorithm associated with their particular business. And you'll see that the most constrained areas in the bearings at the moment, not delivering to plan, not delivering to the growth that is expected. We're seeing growth in castings and forgings, just not to the plan that is necessitated to drive the output that we are desiring across Honeywell Aerospace on a go-forward basis. And then similarly, in complex machining. Now what I would tell you is that you can look at that as you double-clicked into it, we really truly understand what are the critical root causes of the issues that these individual companies are experiencing, whether it's skilled labor, tooling, CapEx, just constrained supply as it may be. And we've got the action plans in place to go address those on an individual basis. And we'll talk a little bit about what we're doing relative to that as a point. So when we look at this particular chart, the point that I would make on this one here is that we truly now with the plans in place and the execution that we're seeing across these constrained providers, we're very confident in our ability to demonstrate improved output growth in 2027 and beyond going forward for us. We're building on the foundation of what we have done in terms of our investments from '23 to '25. We're doing additional investments in 2026. We're accelerating capital expenditures into 2026 for improvements on tooling and the like, which drives significant improvements on quality and yield for the products that are going through these particular factories and those continued investments that we will make in the coming years as well in driving the output growth of the business gives us that level of confidence that we have across the portfolio. And then ultimately, at the end, what matters are the proof points from all of the efforts we are embarking upon here. And again, this has been a journey that we've been on for some time. And I would give you three proof points around this. specifically around the four commodity categories that we are specifically referring to, bearings being one of those as an example. So what we have seen over the last 3 months in particular is that 35% of the total yearly output that is necessitated for us across our bearing portfolio for high-volume bearings that are proliferated across most of our products within Honeywell Aerospace, we have seen 35% of the yearly demand actually delivered in the last 3 months and primarily in the last 6 weeks, to be very honest with you. So what we're seeing is that second source of supply kicking in and now starting to deliver to our necessitated needs, and we're going to see the continued burn down of our past due that will continue to unlock revenue growth for us on a go-forward basis. You pivot to castings and forgings a little bit. The proof points around there is we are locking up additional capacity. We're providing long-term stable demand profiles to the supply base. We've invested in tooling that is coming online now that is improving quality and yield for those set products going forward, which gives you an immediate output and boost. And therefore, as we see the plans going forward, very confident as we look at the past due burn down that is occurring across that commodity group as well. And then lastly, the final proof point would be around complex machining. We have two very critical complex machining facilities within the supply base that are highly constrained, primarily from a skilled labor standpoint. And what we have done over the last 30 to 45 days that we've inserted dozens of our own skilled labor into those operations across the board as well as bringing in additional skilled labor outside of Honeywell and basically taking over some of those factories in terms of those operations that they have with our skilled labor in place. The result that we're seeing here over the last 30 days is about a 20% year-on-year improvement in output growth and the committed capital plans that we are seeing as well along with the burn down of past due across those particular suppliers as well. So we're definitely seeing the fruits of these efforts that we are embarking upon. And the last thing I would say is that for me and my management team, we know the impact that we have caused our investors as a result of adjusting our guide. We've taken the feedback very seriously. We've adjusted our operational plans going forward. And I will tell you, I'm very confident in what we're seeing in these early stages of the changes that we have been making and the details that we're digging into in terms of what we're going to be able to deliver in terms of improved output growth for 2027 and beyond.

Thank you, Jim. That was so comprehensive. Last time -- I have about 35 questions that all seem irrelevant given all the info you put out there. So I may change the questions I have set up here if that's okay. If you head-on address the elephant in the room. You had some really great color. As we think about the 70 critical or constrained suppliers, how are you managing them? Is there like a head of supply chain you've put in? Is it you and Josh just reaching out to them? How are you thinking about holding them accountable and what happens from there?

So every single leader of my management team owns a certain subset of these suppliers. So even my business leaders, my presidents and CEOs of the three businesses with Honeywell Aerospace, if there is a supplier, that is constrained that is impacting their business directly, they own that supply base. So it's a combination of Kathy, who owns the entire supply chain organization. But across the management team, and this is the reflection and understanding of the criticality of this singular issue that is affecting our ability to grow at levels that we desire to grow at and expect to grow at, they are all intimately engaged to the point that every single day, 7 days a week, there's a sunrise meeting that looks at the tactical execution of the business and then a sunset meeting, which is focused on the strategic aspects of how we're going to continue to unlock the supply base. For me personally, I am literally flying to every single one of these suppliers and spending time with the CEOs and owners of those businesses, looking at the details of their plan, challenging the details of their plan and then coming away with a high level of confidence that we do have the right actions. And some of that is actually self-reflecting a little bit as well as an organization. We have not been the best customer to our suppliers over the years. And so it's truly developing a framework and a partnership with our suppliers, where we have misstepped that are impacting them and addressing those real time for them as well.

Maybe a follow-up on that. How do we think about what's required whether you have to invest in them with like your employee base being at their sites and helping them manage or investing in them from a working capital perspective? How do you think about that?

We actually address all facets of that depending upon where the root cause of the issue is. So if it's a tooling issue, we'll go in and we'll fund the tooling to drive improved quality improved yield and/or an additional sets of tools that as a tool wears down, you have resiliency of a new tool coming in place. With this capital expansion requirements necessary as well if there's an unwillingness on their part or affordability on their part to be able to do that, we will do the capital expansion projects for them as well. And also it means inserting the skilled labor. And not just touch labor, it's how do you run your factories more efficiently? How do you run your factories with higher productivity to drive more output as well? Then the receptiveness that we're seeing from the supply base to all of these things that we are doing is truly being demonstrative of the partnership that we are developing with them as a result of embarking upon this endeavor, and they've been very receptive to this, ultimately, and that we're seeing the benefits of that playing out. So whether it's CapEx needs, people needs, skill set needs, factory productivity needs across the board, additional tooling. And by the way, it's also looking inside our own four walls as well because as the supply base continues to expand and drive growth, we're staying ahead of that with our own four walls and investing as necessary to ensure that we don't become a bottleneck with our own four walls as well. So we look at that entire end-to-end value chain.

Maybe if you don't mind, can I go back to that slide where you mentioned the 10 critical suppliers or the constrained suppliers how do you think about what the size of them are, how you match them? If you could dive a little bit more into those buckets, if you don't mind.

Yes. I mean so the size of them will vary. If you're talking about a complex machining operation, you think about how Honeywell Aerospace maximize the efficiency of the supply base, we actually have a tremendous amount of small suppliers in the complex machining part of the portfolio, family-owned business, 50-person operation, 100-person operation. So it's a very different level of engagement in terms of how we have it with them. That's direct one-on-one where they have the needs going forward where, again, it's primarily skilled labor and tool sets that are necessary for them. If you start moving up that value chain a little bit into like bearings as an example, there's kind of a bifurcation in terms of the supply base that we work with in bearings. Some of them are smaller operations, some of them are much larger that we brought on board. And so we're seeing that investment that they're doing on without us necessitating to do that and setting up dedicated production lines for Honeywell Aerospace products within their facilities as well. And then as you move into castings and forgings, it's highly concentrated amongst a top four or five casting and forging providers. And again, it's working directly with them and understanding where the capacity constraints are and how we can help unlock them as well.

Just on that last bucket, obviously, news in the last 10 days from both SpaceX and GE buying CPP. How do you think about the castings and forgings market and how you're watching that, maybe a little bit more closely.

So we've always watched it very closely in terms of what's happening in terms of vertical integration and the like. This latest acquisition announcement regarding GE and CPP. The one thing that I would tell you is where our business is with CPP today does not overlap anything that GE does with them as well. So we're kind of separated in that context. And the investments that we're making into CPP to drive more output across the board, again, tooling and the like and improvements on yield and quality. I don't see the impact or the concern, although we stay very close to what's transpiring there. and we look at our long-term contracts that we have with CPP in place. I'm convinced that as that transaction goes through, that GE acquiring CPP is going to be a great benefit to the industry and to ourselves.

You mentioned $1 billion of investments since you took over in August '23. How do we think about what that investment was spent on? And how do you think about it going forward?

Yes. So on a go-forward basis, I would tell you it's going to be equal in dollar amount, probably over the next couple of years, but on an accelerated time line. So we're moving some of those investments forward into 2026 and from '28 into 2027 as we continue along that journey. The $1 billion that has been done thus far has covered across the portfolio completely, whether it's in the electronics portion of the business or the mechanical portion of the business has been within our own four walls of expansion that we have done. I think we had announced a year or 2 ago about expanding our production capabilities in our electronics business by putting a dedicated circuit card assembly line in our Olathe facility for $100 million as part of that investment that we've done to again, to kind of in-source some of that work going forward. So it has been within and it has been external as well. I would say it's probably more of a 70% of that has gone externally then 30% of it has been internal investments that we've done to continue to drive capacity ability.

We're halfway through the fireside, so I'll get to my first original question. I guess how do we think about the 6% to 8% framework you laid out in the different buckets as we think about commercial OE, aftermarket and defense.

Yes. So I'll break apart those three end market segments for a moment. So I think about commercial aftermarket. I think it's important to also realize on our commercial aftermarket business, 60% of that business is Commercial Air Transport, 40% of that business is business aviation. And what we are seeing is still strong, resilient demand for flight hour traffic across those portfolios and for where we're positioned with our products and so we're seeing that continued growth that is occurring there as well and particularly in business aviation, where the certain segments of business aviation that are growing significantly are in that super midsized category all the way up to ultra long range. And that's the sweet spot for which were Honeywell Aerospace plays with our products and technologies, whether it's engines, APUs or avionic systems as well. You pivot over to the commercial OEM market for a second. I mean it's very clear and well understood that both in commercial transport and in Commercial Business Aviation, there are record backlog level at all of the OEMs in both of those end market segments within commercial OE. You're seeing the ramps that are occurring across the board. What I would tell you relative to that is obviously, where you are standard equipment on board an aircraft, you will rise with that production ramp, but there's also selectables that occur on those platforms, and that becomes a differentiator for you in terms of can you grow faster than how that production rate is growing and selectables being things like on commercial or transport auxiliary power units and avionics systems as an example of products within Honeywell Aerospace. Again, the backlog that we're seeing in the high growth and business aviation, again, in those market segments is a strong tailwind for us going forward. And if you pivot to defense for a moment, clearly, the high-growth areas of defense that are occurring, whether it's production, fighter aircraft production, missiles, munitions, rearmament, sustainment, electronic warfare capabilities, all places where Honeywell Aerospace plays considerably are all growing substantially given budget increases that are happening not just domestically, but internationally as well. And so we see the tailwinds of that demand remaining very strong and remaining strong for years to come.

You mentioned that you became a stand-alone company on June 29. How do we think about the supply chain from 2010 to 2019 was very different in how it was managed. How else is Honeywell as a stand-alone company different today versus 3 months ago?

It's a very good question. So not being part of the conglomerate. It allows us to be hyper focused on everything that we do is specifically for the Honeywell Aerospace business as a pure-play company going forward. So whether it is the management team, the strategy, the incentives for our team on a go-forward basis, it's all built around what is necessitated to drive the growth of the business and for the betterment of Honeywell Aerospace without having to consider all of the other businesses within Honeywell. The other added dimension is that with that laser focus and a laser focus on strategy and execution and a singular operating system that is purpose-built for Honeywell Aerospace instead of being purpose-built for a conglomerate. The speed at which we can make decisions is accelerated as being a stand-alone and being very focused on the business itself. When it comes to making decisions on CapEx, when we decide, you know what, we're going to accelerate $50 million of CapEx from '27 into '26 to drive the business. We make those decisions very quickly. Everyone on the management team is a very exceptional and experienced. They understand the market, they understand the business. They understand the dynamics, the revenue models, business models. So those decisions happen at a cadence and at a speed that never could have happened as part of the conglomerate going forward. So those are two very, very unique differences happening. And then the third element would be the Board. It's a purpose-built board that is built for the needs of Honeywell Aerospace, not for the needs of a conglomerate with multiple businesses within.

Yes. Maybe I'll follow up to that later if I have time, but I don't think I will. Maybe two more on top line, and I'll go back to supply chain. How do we think about your top line growth in commercial OE as you mentioned, lots of selectable products, whether it's APUs and avionics that your market share is pretty high there. You had the 800 aircraft, A320 order, the IndiGo win. How do we think about your commercial OE outlook as you try to balance that with supply chain at the same time?