Honeywell International Inc. (HON) Earnings Call Transcript & Summary

It's my pleasure this morning to open with Darius Adamczyk, Chairman and CEO of Honeywell. I think we'll start with some questions from myself, and obviously, then I'll throw it open to anyone in the audience.

Maybe, Darius, thank you very much for coming. First question perhaps, Connected Enterprise is something that's been very core to what you've focused on since you became a Chief Executive. Maybe explain the concept of Honeywell Forge? How does that connect with the Connected Enterprise notion and give investors some sense of the size of your software business as it stands today.

Yes. So maybe if I start with your second question. Let's think of it -- so the total software business for Honeywell is roughly about $4 billion. What's within the scope of Honeywell Connected Enterprise is about $1.5 billion, and that's split roughly $1 billion of software and $0.5 billion of hardware that's associated with the software. The delta between the $4 billion and the $1.5 billion is really embedded software, where we sell -- that goes with the products, but we also sell enhancements, upgrades and so on. In terms of Forge, I mean what Forge is, is we really think about that as the IT stack. It's what enables our solutions to be built. And it's -- think about the whole structure between the edge and the cloud and the analytics. We call that whole thing a Forge. Now we don't want to call it a platform because a platform kind of has a connotation like it's a "solve all". That's not really what it is. It just enables a lot of our solutions, because we only participate in the end markets in which we play.

Yes. Understood. And I think one aspect that comes out of this, aside from just organic growth, you've talked about some savings that can come out from the enterprise as you push digital throughout Honeywell. Maybe give some update on that.

Yes. Now I would say our 2 other efforts, that being our ISC transformation and Honeywell Digital, I feel very, very comfortable. We estimate a roughly $0.5 billion in impact within a 3- to 4-year time frame from both those efforts. We're off to a very strong start, particularly in the ISC transformation. Things are going to accelerate in 2020. And we're already seeing some good benefits in our P&L coming through in '20, and then they'll accelerate in '21 and '22. And then Honeywell Digital, if you think about where we were versus where we're going, going from 150 ERP systems to 10, and we're going to get there by the end of next year, something like 1,500 websites down to -- ultimately, we want to get down to 40 Applications, we had well over 2,000, and we're going to get down to about 400. So you can see it's not just a lot of waste, but it also reduces risk and makes us much more of a contemporary company. All of that is underpinned by a data strategy because that's the foundational element, which is consistent data architectures, makeup, cleanup. So I'm pretty excited about what we're doing, and we're -- this is well past kind of the planning phase. We literally meet on this every single month to track progress and make sure that we're executing, and it's really the digitization of Honeywell internally. And I think some of the benefits, we haven't yet captured because until you really scope the given project, you really don't know. But I'm very comfortable with the initial sort of rough assessments that we made. And I would say the other thing, which is it's really showing up also in our cash performance, because if you take a look at our cash performance now, our cash generation is 50% more now than it was, call it, 3 years ago when we're a 20% bigger company due to the spins. So that's where it's really coming through. And our cash quality metrics now are, I'd say, tops amongst our peers. So I think that's what really we're the most proud of, is the kind of a cash-generating machine that Honeywell has become. And most of that is due to our efforts on the working capital. And we've substantially improved our working capital performance, and we still have more room for improvement.

On the free cash flow, I guess the supply chain moves will help with that around working capital management. Maybe talk a little bit about what Torsten has changed since he joined Honeywell a couple of years ago, and what sort of further improvements you could see to that cash flow coming in terms of, say, margins or conversion?

Yes. I think it's a few things. Kind of at -- obviously, the first thing is the footprint transformation because that's a big part of it. We had 300 facilities, and we think that we're not going to be needing anywhere close to that many, and we've reduced that last year already. Two is, planning rigor and discipline. That's really showing up in a lot of our inventory reductions, which finally showed up last year. But I would also tell you the rigor around general managers managing the balance sheet as aggressively as they do the P&L statement. Because, in Honeywell, I think most of everybody understands how to manage the P&L well and deliver results quarter after quarter, year after year. Our balance sheet is probably an area of bigger opportunity, and we've put a lot of internal processes ourselves as part of HOS goal to make sure that our general managers are spending as much time in managing their balance sheet and their cash performance as they are P&L performance. And I personally chair a meeting every Friday morning to actually -- that's all around cash and cash management.

If we look at the organic growth outlook, clearly, there's a lot of macro things moving around. But in terms of the self-help aspect of that growth, breakthrough initiatives are something you've talked about, Velocity Product Development, how are you gauging the success of those initiatives? How happy are you with where we are on their ramp-up?

Yes. It's about what I expected. Not every one of them is taking off, but some of them have. For example, our industrial coatings business, which was a breakthrough about 3, 4 years ago, has now grown to be a $70 million, $80 million business. Another example, our play in some of the pharmaceutical areas is now $50 million, $60 million business, which was essentially 0. Some of them have not really achieved their objectives, but that's part of it. And what's different for this year is we're actually taking our breakthrough initiatives up to another level, even bigger. So what I've asked each of my CEOs to have is to have one major breakthrough for each of their businesses, and I have one, mine happens to be quantum computing, which we talked about before, whether it's renewables or sustainability for PMT, which I think is going to be a pretty exciting area for us. Number two, for HBT, it's going to be smart cities, which is evolving very quickly in places like India and Southeast Asia but actually not as fast in the U.S. So we think that that's a pretty big opportunity for us. In aero, it's UAMs. And in SPS, it's really the whole supply chain. Kind of think about it from seed to flower because we should be able to trace anything and everything we do with our presence in productivity products, warehousing and so on. So those are kind of bigger ideas, bigger bets. I don't think that they're going to be material kind of anywhere in the first -- next year or 2. But if any one of those takes off, that's a valuation-changing kind of an outcome. In addition, we're putting a great deal of focus in our NPD, and for the first time ever, we're doing something a little bit differently. Because it's not good enough just to say, "Okay. Every business has to have a robust NPI engine, and we measure things like vitality and so on, how much revenue we get from those kinds of things," but now we're literally assigning grades and scores to how good the pipeline is by business for each of the -- so our -- my CTO, Suresh, along with Jeff Kimbell, who is my CCO, they go through and actually examine every one of the pipelines for all our businesses and really provide ongoing feedback around the quality of that pipeline, because that's really the whole secret to organic growth, is to make sure that you have a robust NPI pipeline. And I feel comfortable that we -- all the business had a pipeline and they were innovating, but it never really felt like we had a good understanding of the quality of that pipeline. So we're going to be deep diving that for each of them. That's incremental to the major breakthroughs.

Got it. And you mentioned SPS a minute ago. That division has been at the center of some challenges, I suppose, the last 12 months or so. Maybe give us some context as to how surprised has Honeywell been or how surprised have you been by what's happened at SPS. And how confident are you that you'd get that sales uplift in the second half of this year?

Well, I would say surprises were in both directions. I would say, let's start with the positive. On the positive, I would have never dreamed that we would have bookings rates that exceed 100% in Intelligrated in Q4, booking rates that exceeded 30% in Q3. So that business is clearly winning in the marketplace. Warehouse automation is a huge area of growth and progress for us and have 100%. Certainly, that's going to return to aggressive. Now it is a little bit lumpy, and we saw some slowdown in orders in the first half of last year, but we never lost the order, so I wasn't particularly concerned. It just happened to come later in the year. So that business looks great. Productivity products, we've been very clear about that. But I'm also very encouraged by what I'm seeing, even what I saw in Q4 with growth again in our scanning portfolio. Mobility wasn't as robust, but we've normalized the stocking levels now and are pretty close to where we need to be. So I'm cautiously optimistic that's going to do well. And then when you look at industrial safety and our SIoT businesses, when we look at some of our short-cycle peers, the numbers that are posted there are very similar to the numbers they're posting -- so I mean I kind of wish they were better, but they're also not any different than what we see in a lot of short-cycle peers. And we do check that, so what our -- what did they post versus what did we post, and we're kind of at or slightly above the market rates.

And in productivity products, maybe give us some sense as to where inventories stand at your channel partners and also where we are on the new product rollout because I think that's been a big part of the turnaround ambition.

Yes. I think from a new products perspective, I think we're fine. I think it's less of a new product issue and much more of an inventory level issue, as I said at the end of Q4 this past year. And we have pretty good visibility of this. We were more or less at kind of normalized rates for the inventory levels. So I expect that business to show growth this year. This is not some structural issue where I think we're not going to grow for multiple years. So I expect the business to return to growth this year.

For the segment overall in SPS, you've had this high-teens, close to 20% operating margin ambition. Maybe just update us on how realistic it is to get there in the next several years and how you're weighing the estimates.

Yes. I think that a little bit of the challenge is going to be due to the Intelligrated business, frankly. But it's good news rather than bad. And I think it's really important that our investors understand it, which is we're very much in the greenfield build-out phase of warehouse automation. And as you can imagine, there are 2 components to the business, one being -- well, 3 components: warehouse automation, the projects; our service business that comes after you put it in the warehouse; and our software business, which is just now taking off and growing. The business that's going to dominate for the next few years is going to be the projects business because we're in a build-out phase and it's just much bigger than the service component or the software component. However, the service business is growing at a rate of over 20% per year, and the software business is something similar. Now they're a lot smaller than the projects business today, and that's why the math will still be dilutive to the overall margin rate. But as I explained, this business is similar components to our Process Solutions business, which is kind of back -- if we go back into the '80s where a lot of the automation was still being put into refineries and petrochemical plants, et cetera, it was primarily a projects business. So what will happen a bit later on, and let's call it more than 3 years out, probably the rate of growth is going to slow from a double-digit growth to, let's call it, mid- to high single-digit growth rate, but the profitability is going to improve because it's going to be made up of much more of the services business and the software business. So that's kind of how that dynamic is going to work. In terms of the other businesses, that profitability is relatively stable. Obviously, with productivity products that was depressed given the volume leverage, but we expect that to recover as the volume does.

Now switching tack maybe to what's happening in China right now. Maybe just help us understand where Honeywell is in terms of its supply chains, how much your local production sites' ramp can backup .

Yes. China is at the forefront of our thinking right now. I guess I would say, right now, and I emphasize the word right now, probably for us, the good news outweighs the bad. We have about 21 facilities in China. We had all but 4 start up last week, Monday, so they've been operating. The other 4 that didn't start up did start up during the week. So we actually have permission now to operate all our facilities in China, so all 21 are up and running. So that's the good news. The other piece of good news is because they were going to take a week off anyway for Chinese New Year but then ended up doing an extra week because of coronavirus, we had plenty of inventory to actually produce. Our production rates for next -- for last week were actually quite good. They were, what I'd call, very much near norm. That's the good news. The unknown that we still don't know is the supply chain that's kind of downstream from us. Some of those are smaller suppliers. Some of them are still not operating. And we know -- we have about 36 critical suppliers. About 60% of those have now started up roughly. And we're watching our inventory levels to make sure we just don't run out of raw materials. So that's the big unknown. And the other thing that that's, I think, pretty obvious is that China is going to be slow this quarter. I mean the country has been shut down more or less for a number of weeks. We don't -- I think we expected that -- I don't know if it's going to be worse than we expected or better than expected because I don't know if March is going to be a big spring back when the country comes back and generates huge demand or whether it will kind of slowly recover back to normal. That's too difficult for us to predict. So we're -- it's kind of too early to tell exactly how this is going to evolve because we had some good things happen and some things that we're still concerned about. So it's still very much an evolving situation. But I think the key thing to remember here is that for long-term holders, I mean this is a transitory environment. I mean I don't anticipate this as some long-term structural issue in China that's going to change the Chinese economy. I mean if you look at SARS, what happened during that period, yes, you saw a pretty decent hit in 1 quarter, less so in Q2 -- the second quarter, and then by the time you got 3 and 4 quarters out, things were kind of more or less back to normal. So yes, it's a concern and certainly a concern to us as Honeywell, but I don't think it's a structural concern that I would be too worried about for the long term.

Maybe switching to the portfolio. It's been sort of 18 months now almost since the spin-outs. You undertook the 2 spin-outs in 2018. Maybe give us some understanding of that portfolio review that led to those was -- over 2 years ago now. So how have your thoughts on the portfolio evolved from that point up until today? And are you sort of looking at the portfolio again with a fresh pair of eyes right now?

Yes. Oh, no, we always do. So I can tell you this is a continuous process. And as I stated, when we did the first 2 spins, there's probably more things that we need to do. They're not -- it's unlikely that they'll be as substantial as the 2 spins that we completed, but there are some things that may or may not be Honeywell businesses. So I think that there will be still some more minor changes from a minor -- from a minus perspective or reductions in the portfolio. And then on the M&A side, I mean, it's been -- we've been a little bit disappointed in the kind of fever pitch that we see in the M&A environment. And we continue to do what we always do, which is we're a cautious buyer. We're prudent with not really -- what I view as my money or Honeywell's money but our investors' money, so we want to make sure that we acquire things that are at valuations that we can generate attractive returns. I mean the days of buying good businesses at 10 or 11x are -- that's -- those are over, at least unless we have another recession. So it's a bit disappointing because the multiples have moved up to, we think, even maybe 3 points up in the last 3 or 4 years. That's sort of the rough math that we came up with. So it's just going to cost more to acquire decent assets, and that's the reality of today's M&A environment.