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

Good afternoon, everyone. This is Mark Bendza speaking. I'm Vice President of Investor Relations for Honeywell, and welcome to the third quarter installment of our Honeywell leadership webcast series. As a reminder, this conference is being recorded. [Operator Instructions] The purpose of these webcasts is to provide our investors with an opportunity to hear from a wide range of Honeywell leaders on special topics of timely interest. With me here today are Honeywell's Safety and Productivity Solutions President and CEO, John Waldron, who will highlight his vision and priorities for the SPS business; and Nigel Coe, Managing Director and Senior Analyst at Wolfe Research, who will lead the discussion on topics that are top of mind for investors. But before we begin the discussion, please note that today's webcast and presentation, including any non-GAAP reconciliations, are available on our website at www.honeywell.com/investor. Please also note that elements of our presentation 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 based on many factors, including changing economic and business conditions, and we ask that you interpret them in that light. We identify the principal risks and uncertainties that may affect our performance in our annual report on Form 10-K and other SEC filings. John, Nigel, thank you for being here today. Before we dive into Nigel's questions, John, let's take a few minutes upfront for you to outline your strategic priorities for the Safety and Productivity Solutions business. Over to you, John.

Thanks a lot, Mark, and thanks, Nigel, for being with us today. And I thought maybe before we get into the Q&A, I would just share a couple of slides just as a reminder of what we do at Safety and Productivity Solutions and what we've accomplished and where we're going. But before I do that, I want to maybe send a message out to all of the employees out there in Safety and Productivity Solutions who are doing such a terrific job helping us focus on our customers and helping us deliver. This has really been an incredible last 6 or 8 months at SPS. And it's really put a fine edge on what we do for our customers and brought us really close together with a lot of our major customers and even closer together with new customers. And our customers are having kind of the same basic challenges that many of us are. They're thinking a lot about their own safety, their health, and they're also thinking about how to continue to operate. They're thinking about how to be more productive, but they're also thinking about the future. And so that's really what we've wrapped our leadership team around, our leadership cadence and our priorities. So as a reminder, as you see on this slide, our business has 4 basic platforms: our warehouse automation business, otherwise known as Intelligrated, I'm sure we'll talk a bit about that; our Safety Solutions portfolio where we have a very broad set of offerings in personal protective equipment as well as gas detection and analysis; our Productivity Solutions portfolio, which includes mobile and barcode scanning, voice automation technologies and RFID; and our Sensing and Internet of Things business, which has been a really critical component of the business in this particular time. And as you can see in the bottom of this graph, we've got a very diverse exposure to end markets. And some of those end markets are doing extremely well and growing very quickly while others are a bit more challenged, but all in all, a very diverse set of markets that we're exposed to. So if you go to the next slide, it really shows, I think, what our priorities have been in the last 6 to 8 months here in 2020. We spend a lot of time thinking about protecting people and the workplace that they're a part of. As part of that, we've rapidly been expanding our capabilities in PP&E (sic) [ PPE ]. We've added our thermal imaging technology by way of our Rebellion acquisition and have been pivoting both of those into the health care space. We've been partnering with our partners at home and build -- or HPT here at Honeywell around healthier buildings and extending that into healthy stadiums, healthier universities and other settings where our technologies work together. We're delivering productivity outcomes right now for our customers. Some of our customers have never seen more demand in their businesses, and they're working to keep their employees safe and productive. We're helping them deploy new procedures, helping them keep their workforce at safe distance and in some cases, helping them operate their facilities remotely. And of course, we're focusing with our customers and partners to talk about the future. And in our portfolio, the future is all about e-commerce and its effect on many different end markets. We're investing in robotics and automation technologies, and our Intelligrated business continues to grow rapidly in delivering these outcomes to our customers. And in some instances, we're delivering complete turnkey solutions and micro-fulfillment. So these are exciting growth factors that we've been focused on over the last several months, and we're very pleased to turn in sales growth and margin expansion in the second quarter. So with that, I just want to pause and maybe bring Nigel in and see where we want to go with questions.

Yes. Thanks, John. Can you hear me okay?

Absolutely.

Good. Well, I managed to negotiate the mute button well, so that's a good start. So John, thanks for that. That was a great way to frame the discussion. So we've got about 25 minutes to sort of run through what I think is a business that maybe doesn't quite get the attention it deserves, has been built with a lot of acquisitions over the past decade. But we do think there's going to be a disproportionate amount of sales growth and earnings growth over the next 2 to 3 years. So obviously, the last jumping-off point we had for SPS was 2Q earnings. We saw extremely strong order growth at both Intelligrated and within your safety, PPE business. Maybe just bring us up to speed in terms of state of the union in terms of what you're seeing out there right now. And then maybe transition to what you see as your top priorities over the next 6 to 12 months.

Sure. So a great way to frame it, by the way. So we did experience tremendous orders growth and record backlog at the end of second quarter overall and in both of those businesses. Largely, that has continued. We're continuing to see strong growth in both of those platforms and portfolios. And where some of our customers were kind of locked down in the second quarter, we've also seen some of them come back in other parts of the portfolio like productivity products and our gas and -- analysis business. So we've really been focused on expanding our capacity, expanding our output in those areas where, as we talked about, we've had record demand that's been put on the business while we have been pivoting some of our new product investment, new product innovation ideas toward the pandemic that's among us, new PP&E offerings, new technology in our mobile products to help them sense when they're too close together, for example, really helping our customers get more out of the technology that they have already purchased from us. So that's really what the current state of the union has been, which is rapidly expanding output, meeting that demand while we take stock of the markets that are still really challenged in some of our sensing portfolio and our gas business. And so leadership is really focused on remaining disciplined about investments and making sure that those are high-return investments, whether they be new product innovations or whether they be high-return CapEx investments and making sure that we get those out into the market on time or up and running on time.

Great. Obviously, Intelligrated, we've seen a lot of announcements on new warehouse capacity expansions from some of the REITs and, obviously, Amazon, et cetera. Is this purely an e-commerce story? Or are there some other drivers out there that you see? And I'm thinking here about maybe existing warehouse capacity being automated, for example. And how do we think about this extreme growth right now? Is this a pull forward? Or is it somewhat more sustainable?

Yes, great question. So the way we think about this is that it's a structural change in business commerce, whether that business is flowing ultimately to a consumer or ultimately to a business. It's not a temporary change. It's a structural change. And the global pandemic, we think, has accelerated the -- really the transition to this direct fulfillment mode. And it's largely to home right now because most people in the United States at least are still working from home and not working from the office. But we think there's going to be a hybrid work environment for quite some time. And the effects that that's having on this overall network of production, distribution and then fulfillment is having an impact at all levels of that value chain. So people in the manufacturing end are changing the way that they package product. They're changing the way and the options with which they create selection. In some cases, they're creating their own drop-ship capabilities. If it's in the distribution channel of these various markets, companies are engineering for throughput. They're engineering for more packages, smaller packages in many cases, but they're certainly engineering for a lot more items. And then on direct -- on the end of the marketplace, when you think about fulfillment, it's a lot about the marrying of those higher volumes of items and the delivery of them. And in all of those -- in all of that dynamic, everybody's competing for labor, and everybody's competing for volume. So productivity becomes the key. And so we're being asked to deliver more automation with less touches, solutions that require less human intervention. And to meet those needs, we're investing in technologies like robotics and machine vision, RFID, leveraging some of our productivity technologies, voice enablement and bringing those all together with our customers. And each customer has a slightly unique set of requirements. So it ends up becoming a very consultative discussion to ultimately help them reengineer their supply chain and their business footprint for the future.

That's a great point. So I guess if I kind of asked the question in a slightly different way, the orders you're seeing today, are they from customers -- traditional customers but they're ordering more? Or are you seeing some new customers that weren't necessarily investing a lot in their warehouse capacity and automation that are now in the market because of less touches and looking for more automation?

It's both, really. And especially early on in the second quarter, we had a lot of conversations with the existing customers, not knowing exactly what was going to be happening and how long the current environment would persist. As that has gone on, we've all seen and, I think, come to realize that this environment of the changed commerce economy isn't going away. It's probably here for a very long time and maybe forever. So that has really brought in a lot of new conversations, a lot of new players to our company, and we've really had conversations with people who we didn't know before. We've had conversations with people in the health care industry, for example, that are really thinking differently about their supply chain. We're having conversations with companies who have previously kind of been against or have not yet invested in a direct fulfillment e-commerce engine for their business. And they're realizing that that's really a need now, and so we're having conversations about that topic. But certainly, it's also the long-held relationships that we've had over many years of helping our customers meet the needs of the growth in their business. And so those conversations are a lot about new technologies. They're a lot about the future of labor in the industry and how we can work together to innovate around some of those challenges.

I see. Great. And then we think and others view this -- Intelligrated as a largely North American-centric business, and that certainly was the case when Honeywell acquired it. Just bring us up to speed in terms of where that's now gone in terms of globalization. And to what extent is the strength we're seeing today more global in nature?

That's a great question. As we've talked about for quite some time, we have been investing to globalize this business. And it really starts with the product set because we have to have a global product set that's capable of meeting the needs in those markets. And then it's next to the supply chain. You really have to be able to locally source and manufacture and create a service chain to support customers that put these solutions in and use them for many, many years. And so that has been underway and is in a pretty advanced state now. We're really primarily focused on 3 markets for that international expansion right now: Europe, China and India. And those 3 markets are big market opportunities for us. I'd say fairly advanced as it pertains to automation and commerce. India perhaps may be behind the other 2 in terms of automation as a component of the overall supply chain setup, but we think that's going to change. We think that's a big opportunity. So it's growing. We're winning business in those marketplaces. We're deploying projects now in all 3 of those regions. But as an overall kind of dollar value percentage of the total, it's still quite small. So we think there's still a lot of runway out there for us to grow internationally.

Obviously, Europe, China and India in terms of -- a decent part of the globe. Do you have any near-term targets for -- in terms of international mix of sales over the next, call it, 3 years?

We haven't really set any targets for that at the moment, Nigel. We'd like the international business to be substantial. We think it could be 25% to 30% of the total in the next 3 to 4 years. But largely, that depends on continued execution and making sure that we deliver the customers' needs. It also depends on the denominator, how fast the North American business continues to grow.

Yes, that would be a good problem to have though, wouldn't it? What does this mean -- so again, there's more to your business than Intelligrated. I do want to move on in a second, but what does this big surge in orders imply for the sourcing and capacity requirements? Are we going to see a ramp-up in CapEx for Intelligrated?

Well, we are investing now and expanding our manufacturing and assembly capability. We've nearly tripled the business since we bought it. So we've gone through this cycle once, and we know what it takes to expand both the manufacturing output as well as the project management and installation output in the business. And so we're at that again and underway. We don't expect it to be a huge drain on CapEx. It's not a particularly CapEx-intensive part of the business at the moment. So we think we've got that well under control, and we've got to continue to put in the extra capacity that we need.

Great. And then switching over to safety, PPE. This is another area where you've been investing CapEx to ramp up capacity on the N95 masks. You, I think, booked $650 million of orders in 2Q. Number one, just give us an update on the status of the capacity ramps that you've highlighted in your prepared remarks. And then what is the -- what do the bookings tell us about how this business is going to ramp or likely ramp in the next 12 months?

Sure. So we have continued to expand capacity, and we haven't given out specific numbers publicly, but we are going to be well in excess of 25x output by the end of the year than when we started the year. And we've opened a number of new facilities around the world in partnerships with the local markets. And I think as we've also described before, we're trying to do this in a smart way, where we're partnering with customers and some of the distribution companies in these markets to make sure we have long-standing commitments for that demand as we put in the supply. And so far, that's going quite well. Q3 continues to trend well in that regard, and we think there's still more opportunity out there. Our capacity ramp-ups are going well. In all cases like this, where you're [ opening ] multiple factories in record time and putting in complex processes with automated machines, our teams are managing through the challenges and, frankly, doing a terrific job managing a very complex and difficult set of inputs and dynamics. In terms of the long-term kind of nature of this market, we've done some modeling on this. We've done a lot of research. We think that the market for N95s in particular but health and hygiene more generally has changed pretty fundamentally. And we think that there is a long-term durable demand here for what we're doing. We're working with the end users and the end organizations in these markets directly. And we think that this is going to be a good business for us.

So it sounds like you're reasonably confident that the demand is going to persist once we, God willing, get a vaccine and then move into a post-COVID world. So it sounds like you're confident that this doesn't become stranded capacity.

Yes. That's certainly our expectation. I mean we think -- no one has a crystal ball here, Nigel, obviously, but I mean, there are many -- there's a lot of really good work being done in the vaccine space. And I'm sure you've done research on this as well. But even if the stage 3 trials go well and the vaccines are distributed as planned later this year and early next, it's not going to be a magic bullet that immediately eradicates the COVID-19 virus from the globe. And things like this are now a heightened risk in everyone's mind. And I think that reality is going to live with us for quite some time.

Great. Fantastic. And then maybe one more here before we move on to productivity products. Darius and Greg talked about the $250 million of CapEx investment this year with a 100% IRR or triple-digit IRR. To what degree is that being driven by the CapEx that you're investing in SPS?

Well, what I'd say is that we are getting our fair share of that CapEx for sure, and we are spending an elevated level of CapEx for our business and for the PP&E business in particular. And we expect to be largely finished with that investment stream around the end of the year through the first quarter for sure. So we're satisfied with the opportunities that we've had to invest, and we will continue to be flexible. Obviously, if there are more high-return opportunities that we see ahead of us, then we'll capitalize on those and invest again. But we're definitely getting our share of that and putting it to good work.