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

I'm Josh Pokrzywinski, Morgan Stanley's U.S. electrical equipment and multi-industry analyst. Thanks for joining us for the Life After COVID Thematic Conference. Before we get started here with Honeywell to touch on some of the changes in work from home and the office space and how those evolved, I do need to read a quick disclaimer. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that, we'll jump right into it. With me this morning, I have the President and CEO of Honeywell Building Technologies, Vimal Kapur, coming live from their headquarters. So actually back in the office, in the segment headquarters in Atlanta. Vimal, thanks for joining us. I understand, before we dive into some of the fireside discussion, you have some slides you want to run through. So take it away, and we'll jump in after that.

Yes. Thanks, Josh. Thanks for the opportunity. Yes, I have 3 slides. I think they're uploaded for those who could follow through. I'm not going to share them. Just want to give a little bit of an overview of our business. Our business, Building Technologies, automate buildings. We are a pure-play software and controls business. We don't do any equipment. We don't have any other associated stuff. It's purely controls business, spread all over the world, 70-plus countries and a very healthy mix of products and solutions. But 55% of our business is products; about 45% is solution. A big part of solution business is a very rich aftermarket, nearly 25%, and that's certainly helping us this year and the times to come. So last year, our revenue was $5.7 billion. Income was [ 20.4% ]. Clearly, this year, we have been hit like everybody else. We are trying to contain it to bare minimum. One of the highlights have been that we are trying to sustain our margin rates to prior year or slightly better. If you see our last 3 quarters, we have been able to sustain our margin rates here, which makes an important point that we are on path to our long-term margin commitment, which is 23% because even though our top line has shrunk, our margin rates haven't. And we continue to stay on the path to our 23% commitment, which we made during our November Investor Day, which we did last year. For our business, we really look at our 4 growth vectors: how we grow our core business, going to the market, how we expand using the power of connected, the data monetization. The third one we really look at is how we go to new adjacencies. And finally, we look at it, how we expand our margins. And I would say that playbook has changed a little bit, obviously, due to COVID. In the core side, we are focusing on some new verticals, which everybody will kind of appreciate, which have become more relevant today, like data centers, in particular, which has become in high demand. We're also looking at health care far more rigorously all over the world because there's a huge demand for building new hospitals, specifically in high-growth regions. In there, we also are looking in our connected side, much more focused on remote management. As a data point, our remote connections to our buildings, our ability to serve have gone 300%, 400% up. I mean all of a sudden, everybody is okay to do things remotely. As we are working from home, people have got very comfortable with that. The other tweak we have made in our strategy is bringing the whole concept of healthy buildings. We launched that in the month of May because air quality, all of a sudden, became pretty important. And that's become an important vector, and we'll talk more about it that -- how is that really adjusting ourselves. So if you go to the next slide, there's a little bit of color commentary on how the dynamics are emerging with COVID. And I'm sure we'll talk more about it. We really see the market split into the 3 broad buckets. The things which are not growing and probably will remain in a headwind for near term, which is commercial real estate, hospitality, some bit of education, retail, and we have obviously have a play in all of them. So certainly, that's a depressed market from a new construction perspective, less so from a retrofit or service standpoint. Then the second part of the business is where we see the growth, which is health care and data center and warehousing. Clearly, we are doing as much as possible to re-pivot our offering, reorganize our sales force around that. And the third part of the business, we see where is the government stimulus-driven business generation. It could be energy contracts in the government or it could be infrastructure, specifically in the high-growth regions. Governments continue to spend like in metro station or building new airports and stuff like that. So we're clearly focusing on that. So all in all, we kind of see that there is a good mix of good news, bad news. And we are really re-pivoting our business based upon these market dynamics, and the growth vectors really kind of stay on top of market available opportunities. And that really brings me to the last chart, which I have, on healthy buildings. This is something which started, as I said, in -- after the COVID. And we always manage the air quality in a building, but we never emphasized it. And I think after the COVID, it really became topical to really think about 3 things in context of any type of building, be it an office building, school, airport terminal, hospital. First is, how is the air quality? Can this be controlled? Can you manage it better? Second was, how do you maintain the safety? Because everybody wants to stay at a distance. People don't want to crowd themselves and stuff like that. How do you manage that? And third is, how do you share data of all this? I mean, how do you visualize things so that you know that this is going in? And we launched the new offering. I think the difference is that what we noticed was our customers were getting informed on many point solution that you can buy X, Y or Z. But there's no point solution. This can solve this issue. It's the comprehensiveness of the whole thing you have to do, and that's what really differentiated us with the market. And if you see our statistics here on the right of the chart, our pipeline in healthy building is greater than $500 million. We booked $80 million of orders since we launched it, almost 500 projects. So it's not one -- or it's not like we won 3 deals and we made this number. It's a lot of small transaction because all of these businesses' retrofits through our existing installed base. A lot of new products being launched, and it's spread over all the verticals. We see healthy building being deployed in schools, educational institutions, commercial building, hospital, manufacturing, government. So it's spread across the board. So we're pretty excited about that new growth vector which has come in. We think that healthier environment is here to stay probably for next several years. And there are headwinds, but this will certainly give us a tailwind here. So with that, I'm going to pass. I think I wanted to make just a couple of opening remarks to the conference. And Josh, over to you to give it a go.

Perfect. Thanks, Vimal. That was a helpful overview.

Maybe just before we dive into it because you used a lot of points in some of those opening remarks that I think are interesting and worth diving into. From folks who are on the line who may not be as familiar with some of the specifics in Honeywell, obviously know the name, but can you break down the HBT segment a little bit in terms of kind of the big categories, fire and security, building controls, some of the ways people can kind of conceptualize the product sets there?

Sure. So we are organized into products and solutions. So products means we'll sell our products in fire, security, building management system through channels, which could be 1-step channel or 2-step channels. That's 55% of our business under a normal year; this year, maybe a couple of points here and there. And then 45% of business is where we actually do a project directly with the customer using the products, which the product businesses make. Project business has no product of their own. They just use internal products. And then we create the installed base, and we monetize the installed base through aftermarket. So that's kind of a broad spread of the business, about 55% products, 45% solutions. And within the solution, the aftermarket is about 25%. So 25% in -- out of that 45%, 20% on new projects, and 25% is recurring aftermarket services. So that's the broad split of the business. The business is very, very global. We are equally strongly present in Europe, China, Middle East, India, ASEAN, Pacific, Mexico. So this is truly global business, not really centricity on one particular geography, which also gives us certain optionality as things go up and down, specifically in these times.

Got it. That's helpful. So just to pick up one of the bigger talking points, I think, in the sector right now when we discuss the return to the office or just commercial buildings, in general, is indoor air quality. I think one of your occasionally competitors, occasionally partners out there size the market at $10 billion. And I think what has really become apparent out there over the past few months is that this started off as, hey, everyone needs to go out and buy better filters or something like that or how much UV light can you pour through your system. And I think we're all growing to appreciate, especially folks who are close to the space, so this is more about being able to get the fresh air exchange right, get all the other kind of knock-on effects of having something like a tighter filter. So you create a lot of these downstream problems as a function of trying to solve for cleaner air. How would you contextualize maybe Honeywell's TAM to the extent that you guys have been able to identify it? The pipeline looks very vigorous relative to somewhat -- some of the other folks have said. And then I guess within that TAM, where are your best opportunities, understanding that everyone in the building space kind of plays in a different zone?

Yes. We have, Josh, really looked at it as an opportunity to go to our installed base and really position this new offering. And when I say an installed base, I always look at an installed base for what we created. All our customers may have some competition system which are co-located. So probably say majority is Honeywell, and there's a little bit of competition A or B. So I would say that if I have to size the market, I see this layering in on our aftermarket because if our aftermarket business is 25%, how do I leverage this growth vector to really grow that business much rapidly? Because it's much easier to go to my existing customer and talk about optionality they have or the action they have to take. So we have really not sized it in terms of absolute TAM, but we have sized it in form of that how this becomes the growth vector for all the installed base we have, not only we created directly with ourselves, but what our channel partners created because that's an equally big opportunity. And we are, from an offering perspective, we are creating new offering to really monetize that opportunity. So we have created new sensors, which we launched very recently because traditionally, sensors did not do a very good job to measure suspended particles. Because the trick here is you want to measure suspended particle in the air because it's a suspended particle, which carries anything, right? I mean just imagine that's going to carry virus or bacteria, and it can reach from here to there. How do you eliminate that? That's a problem. Like how do you minimize it to a point? So we created new sensors. We have launched them. We have deployed them. Obviously, we talked about we changed the way we do controls, ventilation, number of air changes. By the way, there's a dynamic algorithm we are building using machine learning there because it cannot be static, even that has to change. So that's going to differentiate us over the competition. And finally, on the filtration side, we have brought in new technologies by which you use methods by which you do filtration without energy loss. Because the challenge is everybody talks about HEPA filters. Those are not energy efficient. So you have to solve the problem without impacting other KPI. You can't say, okay, sorry, we just spoiled your energy efficiency while we solve this problem. So all in all, our content has increased. So think about this business as a retrofit business for us. We go to a customer. We have a very simple audit process that can be done in less than a week that kind of says that here are the standards and here are your gaps to the standard. And if you want to fill the gap, here are the things you have to do, which can take 6 weeks to 8 weeks. So we give our products or software. Now the key differentiator we have also had brought in is a visibility through a dashboard. We have introduced Healthy Building Index, HBI, so that you really can dynamically see that if your score should be 100 based upon the intervention you do, where do you stand? 80? 75? And we dynamically visualize it. Now why that's important is humans want to see what's done. Imagine you come to an office and somebody said, oh, you've taken a lot of actions. You say, okay, how do I know? How do I believe it -- believe you? So the dashboard is a mechanism to visualize it that links to Forge. So that's where Forge comes in. So I think all in all, we have added new content going after our installed base. And as I gave you some statistics, we won almost 500 deals over the last 6 months. So think of this as a lot of retrofit migrations business. I mean, if the market or a competition claims it's billions of dollars, we'll take it. I think we definitely have an advantage compared to our peer group because at the heart of it, this is a controls problem. And it's not -- so I feel pretty good about where we are on this growth vector.

Got it. That's helpful. And I guess within that, maybe help us to understand some of the other areas that customers are wanting to talk about in addition to indoor air quality because it's probably comprehensive, right?

Yes.

I mean I know that the few times I've been in the office since COVID, you have the temperature screening in the lobby. There's an iPad system kind of set up, presumably some sort of tie-in to things like fire and security and employee tracking. Yes, there's a lot of systems that get brought in that get pulled in to Honeywell's domain expertise. What are the other kind of big areas?

So security is a big area, Josh, as you guessed rightly. So the simplest thing is that we can all imagine that somebody is standing outside and taking a temperature. Probably right thing to do, but most ineffective because by measuring temperature, the question is, if somebody has a temperature, what do you want to do now? That's a bigger question. And you have to develop a policy. So essentially, we have an integrated -- we have evolved an integrated security system, which ties on these new thermal cameras. We introduced thermal cameras that tie into access control systems. So simple logic is if Vimal comes to the office and have temperature, Mike says control card won't work. It's -- you swipe it, it says here, sorry, you can't go in. So simple things like that. We also have put in new software techniques to measure social distancing so that we could print report people where they're crowding. We also have ability to detect measuring wearing PPE or not. Then other things we have introduced is things like counting people in conference rooms so that you can alert that if conference room is supposed to have 4 people, there are 7 people sitting. So our security system has been added with many functionalities on core, what we have. And pretty much all the deals we do, it's a combination of both. It's air quality and security going together. And the third thing we are seeing is customers' willingness to adopt remote management of the building because buildings are closed, you still need to do certain actions to keep them running. And we have been able to do that remotely. It means we have capability through our IoT platform. We can perform a lot of basic operation of the building. So I think all those are the fundamental shifts which have happened over the last 6 months: a focus on air quality, focus on safety and focus on remote management. All have become a new growth vectors. These are new revenue streams for us. We are hoping now they are scaling at a pace that they offset some of the contraction we will see in the new construction for the near term. That's kind of the focus we have right now to balance the 2 sites.