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

All right. Thanks, everybody. Welcome back. So like I said before, I'm Joshua Pokrzywinski, Morgan Stanley's electrical equipment multi-industry analyst. Joining us for the next fireside chat is George Koutsaftes, President and CEO of Honeywell Safety and Productivity Solutions business, as you will become very accustomed to shortly. Just as a reminder, if you have any questions about our research disclosures, please visit the research disclosure website or reach out to your Morgan Stanley salesperson. George, thanks for joining us. SPS, there's a lot going on right now. Certainly, the market is kind of a rich environment and a diverse mix of business. If you wouldn't mind, just kind of setting us up with some context for what you guys are doing in SPS and then what you're seeing out there in the market.

Great. Thanks, Josh, and a pleasure to be here. Good morning, everybody. Just by way of background, I've been with Honeywell for over 14 years now of [ serving ] the company, in this role for about 6 months, so still kind of learning the businesses. But I'm really excited about what I'm seeing in terms of our technologies, how they align with the macro growth trends of e-commerce, health care, sustainability. I'll talk a bit about that today. And we have a good organization, a world-class technology and people, an engaged, diverse workforce that's driving all this. So some key messages, Josh, I want to kind of get across. So first, as I mentioned, we're well aligned. Our portfolio is very well aligned to major growth macro trends due to rise in e-commerce, health care and the transition to new energy. The second key message is that while we're very excited about the long term, we're certainly seeing some near-term softness in the marketplace, in some of our fast-cycle parts of the portfolio, due to the rise, chronic rise, of inflation and also due to supply chain shortages. And we've taken actions to align our cost structure to some of those businesses where they see the softness. And we're also pivoting our commercial organization, just kind of representing the Honeywell agility that we have that's inherent in our culture and our DNA of how we pivot markets. The third point I want to bring across today is that we have a $3 billion addressable market opportunity, in addition to the things I'll be talking about today. Due to our software and solutions capability, leveraging a very large installed base, we're launching our connected worker and connected warehouse solutions that are going to drive productivity for our customers to the tune of over 20%. We'll talk more about that. And then -- and these are high recurring -- high-margin recurring revenue sort of sales that we're driving. And the last point is, as Honeywell and the culture of our company -- and so we're a corporation that drives margins in a very effective manner. And we're using the benefits of Honeywell Digital to make sure we have data liquidity in the organization, to be more insight and data-driven and making our decisions quickly. And also, we're using the Honeywell Accelerator operating system to drive supply chain transformation. All of these things are driving operating margin improvement. So we talked about aligning the macro trends, and we'll talk more about that in a few minutes, and you'll see all that in the chart. But the thing is, what ties us all together inside of SPS is 2 platforms of technology: sensing and software. If you remember anything about what we do that ties all this together, we're one of the world leaders in sensing technology and software development. Those 2 things combine that allow us to deliver leading solutions and warehouse automation, mobility solutions inside the warehouse, transportation, logistics, health care, as you see here on the board as well as our sustainable solutions. And we have a single go-to-market strategy with our key accounts to drive a bigger -- a larger discussion at the C-suite level to handle problems and discuss issues that the CEOs need to solve, which is around how they're going to digitize their company, how they're going to drive profitable productivity and how are they going to solve for sustainability. E-commerce is big for us. It's over a $40 billion addressable market for us. We have over a $10 billion installed base inside of our business today, of customers who adopted our warehouse solutions, our mobile computing solutions, that gives us the right to go and provide services of high-margin recurring revenue around connected software solutions. I mentioned our Connected Warehouse and Connected Worker. We're deploying those today. These opportunities and these solutions we're seeing deliver 20% productivity to our customers through the deployment of these opportunities. Also, we also have a big opportunity in robotics. We have launched a smart flexible depalletizer. This is enabled by advanced vision and machine learning capabilities that allows a customer to take their pallets, that can be mixed box-based pallets, depalletize it in an effective manner. And when you think about our customers who are struggling to get workers to show up every day, who are struggling to get productivity out of workers, this solution addresses this problem in a big way, and we've seen 30% to 40% productivity from our smart flexible de-palletizer. And we have more robotic solutions coming. Health and wellness, Josh, is something that we don't get enough promotion to inside this portfolio. Our sensing solutions are found in every day leading medical device applications, from infusion pumps, insulin pumps, dialysis machines, oxygen concentrators, ventilators and the list goes on. 70% of the top 25 medical device companies has specified Honeywell sensors inside of their portfolio. This is a big, growing part of our business. We've put out publicly that about 15% of our revenue is health care related. You should think about this part of the portfolio being about 1/3 of that with high double-digit growth rates going forward. And lastly is sustainability. Again, as the industry evolves towards needing to track methane emissions, carbon emissions and is developing new alternative energy sources, these are requiring the development of new production processes that need to be monitored from gas detection, which we're a leader in, and also need to be enabled through safe use of these materials. And one key example of that is EVs. EV batteries have a thermal runaway challenge that is a safety issue for drivers in the car. Current technology today is measuring the changing current in batteries. That changing current is an indicator, but it only gives a driver about 15 minutes advanced warning that they might have a fire in their battery. We're working with the industry to actually develop sensors that have much better, more sensitive early warning detection as our sensors are going to be able to drive that. So we're really excited about this. And the collective between -- our sustainability solutions, our solutions around health care and our solutions around e-commerce, collectively, are $60 billion of addressable market that we think long term will grow high single digit for us. So that's the story for us, Josh. And I think we're really excited about what we have as a business, positioning well with the macro trends, planning to grow high single digit in the long term. We're improving our margins by improving our mix, by launching new products that have higher margins, by launching solutions that are recurring revenue and also by improving our operating performance, all of which we think will lead us to deliver 18% to 20% operating income. So with that context setting, Josh, maybe we can kind of go [ to your questions ].

That's perfect, yes. So maybe just starting off with kind of where we're at on the macro today, it's kind of a dynamic environment out there. I think there's this push and pull of certainly a lot of demand but supply chain holding it back, maybe some demand destruction in some instances. How do you see that playing across your business? Anything regionally that sticks out?

So the -- regionally, what we're seeing, the more acute right now is in China for us. So when you think about our fast-cycle businesses, we're thinking about businesses that have applications around use in the retail space, use in around the general industrial worker. And we're seeing, due to the COVID lockdowns, people aren't buying nearly as much in China. People aren't going to work as much as they would want to in China, and so we're seeing in China being a big issue. In Europe, we're seeing some softness, but it's in pockets, not in every market we see right now. But we certainly are being very cautious about what's going on there given what's going on in the energy situation and what impact that could have. But the order book for us right now in Europe is not showing any telltale sign that we're seeing major slowdowns. In the U.S., conversely, we are seeing a bit of a slower demand year-over-year. But again, not overly significant, but it certainly indicates to us that with inflation continuing, and the CPI print just came out yesterday, PPI print came out this morning, I think we just need to be cautious planners about how we think about the rest of '22 and into '23, which is why we took some of the actions we did.

Yes, that makes sense. On the U.S. piece of that, I mean, Intelligrated sort of weighs more heavily in that region. If I were to pull out Intelligrated, maybe some uniqueness in that market, is the rest of the business kind of looking more typical or maybe less volatile?

Yes. So first, let me comment on Intelligrated in particular, just to context that for the room. So when you think about top line revenue for our portfolio inside of 2022 and going to 2023, we're going to see revenue come down, largely driven by the deleveraging of warehouses not being built in the United States and rest of the world. So you're seeing a slowdown in greenfield builds and warehouses. And I'll talk in a moment why I think we're positioned well to take advantage of that situation. But from a top line revenue point of view, you're going to see that inside of our numbers. For the rest of the portfolio, things -- the -- we have close to $1 billion of business inside of our portfolio that's growing double digit year-over-year right now, and we expect that to continue. That's going to be offset by some other parts of our portfolio that are going to be exposed to the softness in the industrial market conditions that we see. So there'll be more kind of performing around the economic volatility of what we're seeing in the environment today. So when you net all that out, we're kind of looking at kind of flattish revenue, offset by the downstream of revenue that we're going to see in Intelligrated.

Got it. And if I could just double-click on one piece of the slide, the 18% to 20% long-term segment margin, there's a decent size gap to grow into that today. Can you think about what like the waterfall that gets you there from where we are today might look like, whether it's mix or price cost or restructuring or however you guys want to look at that?

So just even inside of 2022, when you look at the financials we have committed, from a top line point of view, we're going to see flattish revenue quarter-to-quarter sequentially. However, underneath that, we expect to deliver mid-teens operating margin inside of Q3 and higher-teens margin inside of Q4. Now that exit rate for the margins in Q4, I don't expect to see on a full year basis for 2023. But on the blend of all of that, we expect '22 to be better in terms of operating margin versus '21, and we are planning '23 to be better operating margin than '22. So the trajectory of margin improvement is there, and we're doing it because we're changing the mix of our business. Some of it's coming from the growth of the recurring revenue, higher-margin parts of the portfolio, in our software and our services. And the second is because we're operating around -- we're taking the appropriate productivity cost actions inside the portfolio, all of which are going to drive sustainable operating margin growth for us.

Got it. And I want to just focus for a bit, if we can, on Intelligrated. It's a big piece of the business. I think maybe unfairly, it's categorized as like all of what you do in SPS, which obviously that's not the case. But how do you see kind of the next few years playing out in Intelligrated? On one hand, you have kind of the market leader that is pulled back on spending with Amazon. But there's still a lot of old and efficient warehouses and a lot of folks that move boxes besides them like -- is this a market that can grow through Amazon pulling back over the medium term? Obviously, quarter-to-quarter could be a little different.

The way I would think about this, Josh is, as we get through '23, we're going to -- we'll see the slowdown play through. And as we exit '23, we expect to see some return to normalcy in terms of build-out rates. But one thing that's important to note is that while all that's happening, our customers still have existing warehouses for us to need to drive productivity through. And so what they're looking at is if they're not going to expand margins through growth, right, and profit through growth, they have to expand profit through productivity. And we're well positioned with our Connected Software solutions, our robotic solutions, to offer a suite of offerings to our customers, to make the existing assets they have more productive. We've had very engaging C-suite level discussions with our key customers in the market space, who may be delaying certain greenfield projects but are actually hiring us to do revamps in their facilities, hiring us to implement new software upgrades to give them better visibility towards the predictive and preventive analytics they need to get more productivity on other units.

How are you thinking about approaching that market as we transition from this kind of hyper growth we've been in the few -- last few years to maybe something a little bit more predictable? I think maybe the point I'm trying to make here is price sort of mattered very quickly overnight. I think one of your competitors in Europe preannounced overnight on the notion that maybe they were mispriced in some instances. Like, is this something where as the market becomes a little bit more definable or less hyper growth that you guys can be more selective or use some of those kind of Honeywell-wide pricing tools within this?

Yes. 100%, Josh. So when we look at what's happened over the last 12 months, we believe that what you're going to see out of Intelligrated is a much more pragmatic steady growth, high single digits, also with improving margins along the way because we're going to be pragmatic about the projects we're going to take on. We have a $10 billion installed base, I want to say it again, $10 billion, of customers who have adopted our equipment and our solutions, both through Intelligrated and through our mobility solutions business. And Intelligrated was delivering 20%-plus growth year-over-year to build that installed base. So while we don't expect that to repeat itself as the market normalizes, what we do expect to happen is we're going to be delivering for our investors a high single-digit kind of pragmatic steady growth that's going to be buffered by the fact that we're going to continue to grow our services portfolio, which we think is best-in-class in the industry and which, frankly, our customers need. They need to optimize the existing assets they have while they worry about building new assets.

So that's a massive installed base for what's a pretty young business in the Honeywell portfolio, at least relative to some of the other things that are 100 years old. How do you think about sort of the strategic optionality that gives you? Like, should you consolidate the market amongst other integrators? Are there component suppliers that you're specifying in today that, if you own them, you could specify them 100% of the time and kind of capture those product gross margins rather than the integrator margin? Like, how do you think of what that installed base affords you in terms of kind of strategic optionality?

Yes. So I think you're really kind of asking some -- an M&A question behind that, right, in terms of the...

Maybe, yes. Like it, just -- does that give you an entitlement to do more than you're doing today?

Well, it certainly does. I mean it opens the door to have richer conversations with our customers to have technology road map discussions, growth road map discussions with our -- with the CEOs of these customers and their executive team. That's what it does for us. And what it allows us to do is to learn even more about the challenges they have around worker availability, the digital journey that they need to go on and how we can get them there. This is not an easy challenge for them to solve for. Many of our customers are basically data poor in terms of how they capture their data and how they use it. And what we're finding is that what they need is someone like us that can walk in and provide them a bespoke solution of software and equipment and mobile devices that can communicate across the platform, given the control tower visibility on how said warehouse is performing, how a worker's performing, and how they can dial in those constraints or release some of those constraints to get more productivity. So we think this $10 billion installed base gives us the right to kind of go and open up this dialogue. And then when we find that there's opportunities for either specialized solutions or specialized equipment, we'll -- we've done partnerships with companies, and we'll look to kind of expand the portfolio appropriately as we need to.

Is there an M&A agenda that bolts on to that?

There certainly is. And it's -- we have an M&A agenda across the portfolio that's focused around adding robotic capability that would be additive to our technology core set. It'd be adding also sensing capability. Remember, sensing is a platform, folks, for this business. So adding sensing capability that either will add to our technology set or get us deeper into a market that we find highly attractive already.

Where is that line between sort of the Connected Warehouse between -- versus just connected manufacturing? I mean material handling is sort of a concept or domain in a lot of different avenues. Like, does this give you a toehold to go more into the manufacturing environment? And if it does, I guess, why stop at the warehouse?

Yes. So it depends on the throughput that a manufacturer needs to the warehouse. So we're in warehouses -- we're in manufacturing warehouses today with our mobile solutions. So they're using our wearable scanners, handheld scanners, mobile computing devices, to move product around the warehouse from a manufacturing context. That's already happening today. The step change, I think you're asking about is, where is that dividing line where said manufacturing warehouse would need to automate conveyance and handling of stuff going through the warehouse. And frankly, we're not sure that there's a business case for that for manufacturing warehouses. But what there's a business case for is infusing robotics at select locations to give more automation to them to move stuff around the warehouse.

And does software play kind of a similar role in that?

Indeed. It plays an important role because, at the end of the day, the warehouse manager needs to see both -- they have productivity goals, how much stuff they're moving in and out of that warehouse on a daily basis. And they need to know which assets are performing or underperforming relative to those metrics. They need to know which workers are performing or underperforming to those metrics. They also need to know how far is my worker walking today? Are they walking a mile, 2 miles, 3 miles? Can I make that less to make them more effective? So this is information that our software can help them tabulate and understand to get predictive outputs to what they could be doing to manage their people and their assets.

How's the overall software content in your business maybe versus the rest of Honeywell? Like, does it outpunch its weight? Or is it smaller, just the nature of the product set?

It's smaller today relative to the product set. But we've really kind of accelerated our investment in the software solutions I spoke of. And our Connected Warehouse solution, we've had out in beta for a couple of years, and now it's going live. And so we're pretty excited about that opportunity. And we're excited about the feedback that our customers are giving to us about that.

Got it. I want to zoom in on a couple of businesses that seem to have stood out lately. First, you've talked about advanced sensing technologies a few times now. I think the last several quarters have had some pretty strong growth. What's different and changing there? I mean, it feels like this business kind of caught a little bit on fire and maybe a little bit out of thin air. Like, is it an end market? Is it a new product set? Like, what's driving that?

It's both, Josh. It's the end markets that we decided to focus on, which is health care and sustainability. Both of those businesses inside of the sensing portfolio are growing very nicely at a double-digit growth rate. And we don't expect that to slow down in the next year or 2 during our forecast period. And the reason is because we've been able -- we're experts in sensing. We've been able to design our sensors to perform well in these critical care medical environment. And the demand for these products, the end products, are going to continue, right? You have the secular growth trends around tailored medicines and tailored solutions, the secular growth trend around the need for smart solutions, right? Hospitals are generally inefficient. We all have been in hospitals -- in and out of hospitals periodically through our lifetime. You go in a hospital today, it's amazing how data poor they still are at the nurse practitioner level, right? And we're running studies today at hospitals to actually look at the workflow of nurses and medical practitioners, to how to connect the data that's coming out of those medical devices I spoke of earlier, whether it's an infusion pump, an oxygen concentrator, how to connect that data to the nurse's handheld scanner or mobile computer, how that connects to their enterprise system and allows the manager of the floor, the manager of the hospital, to actually have insight towards productivity and patient outcomes they didn't have before. So we're really excited about what the sensing business can do. And on the sustainability side, we're specified in EVs today. And as I mentioned earlier, that's going to grow even further based upon the advanced technology work we're going to do to help the industry get to a much safer place.

And then you mentioned health care, and that was going to be my second kind of area of focus. But maybe since you've covered a little bit of it already, do you have the pieces you need in health care to go forward? I think when a lot of people think of Honeywell, they think more of the safety than the health piece of it, just kind of given the legacy positions. So do you have like the raw material in the portfolio? Or is that still need to be developed?

There's a few areas -- when we talked about M&A earlier, there's a few areas in our sensing portfolio that I think we could still stand at in terms of competency set that would help round out our portfolio to make us just about a full-service provider to our health care customers, to solve whatever design needs they have inside whatever medical device they're developing. And so that's an important aspect of what we're going to be focusing on.

The -- there's a lot of -- you've spent a lot of time talking about kind of the rich opportunities out there across some of these markets that are pretty different. How do you attack that commercially? Like, is there a channel in place in -- across these markets to be able to reach that customer? Or are there a lot of products that you guys are developing, and some engineers are really excited about but like he can't touch that customer and explain it to them as well as he should?

Certainly. As you -- as any business goes into a new market that you haven't been in before, you're going to have to deal with building up competency in your marketing team, in your sales team, about how to sell to that end market space, what the value propositions ought to look like. But we've been investing in that for years already in health care. The thing we don't have, we're not clinicians, right? So we're not going to go predict what a 510(k) approval outcome will look like for a medical device company, although we're an input to that, right? So having knowledge of that is important, having knowledge of what risks our customers are going to engage in to risk mitigate that in terms of our design is important. And that's the skill set we've been bringing into our team, is bringing some more, what I call, medical practitioner -- regulatory practitioner is probably better said -- into our portfolio. But we've built a team of sales and marketing people that come from an industry that know how to sell to that end segment.

Got it. One final question for me, then I want to open up to the room. Supply chain clearly still very much in focus. I think there's some signs that maybe there's a thaw going on. But how do you see that within your business? And any sort of broader commentary on how you think that's sort of playing out across the rest of Honeywell, to the extent you can speak to, would be great.

Sure. Well, the 2 things that we see as supply constraints is major themes or major categories, one no surprise -- both by no surprise to you, semiconductors and labor. On the semiconductor side, we are the single largest consumer in Honeywell from a business unit point of view of semiconductors. And what I can tell you is that from when the year opened to where we are now, we still have constraints. We're still managing the fact that we have less supply of semiconductors than we have demand for. However, that gap has narrowed over time. And we've done a couple of things internally to kind of help make that happen. One is we actually engaged with our semiconductor suppliers in strategic discussions we didn't have with them before. The thing that the whole industry missed, not just -- everybody missed, was the fact that the industry, while they're expanding capacity on the newer technology nanometer nodes, they weren't focused on, well, how much capacity is being added for 90 nanometers and 100 nanometers, right? So that's what everybody missed last year, right? We figured that out. We started engaging and discussing with our suppliers about when will they add capacity on said nanometer and how does that align with our platform. What we found was that we had opportunities to switch some of our products to a platform that was an older node, that they were expanding capacity for, that we can actually draft into and get more supply. So we did that. We've also been able to more actively redesign our products for other chip suppliers on the same nanometer nodes. So those 2 things gave us near-term benefit that allowed us to kind of dwindle that supply risk down a bit. And that playbook is being deployed across Honeywell. We just happen to be the leading because we're the largest consumer of it across the company. The second thing is on labor. And we're seeing in a couple -- play out in a couple of ways. One is the availability of labor in certain regions around the world for our manufacturing plants is less predictable, so we constantly are fighting the fact that we have to hire new labor for labor that's leaving. But also on our contract installers, so we hire a large base of contract installers in our Intelligrated business to do installations. We've seen a number of decommits from our contract installers because they're struggling to keep labor on site in a pragmatic manner. So we're managing that by qualifying new installers just like we're qualifying new suppliers. And it's also affecting our Tier 3 and Tier 4 suppliers, the smaller ones. So we have suppliers in our supply base that are $50 million, $100 million companies, not large companies but companies that might struggle to hire workers, and we see that pop up periodically in our supply chain. We work with them to help either qualify a different product they might have that we can substitute inside of our own product or we'll go find another supplier. And we're constantly working that playbook.

Excellent. I think we have time for one question in the room if anyone wants to be the taker on that.

So the question is more a 20,000-foot question, when you think about your assets in China. Obviously, a lot of conversations, a lot of activity, back and forth in China and the U.S. And I don't want to [ fill the conversation ] on this question. But when you think about ESG and you think about investors looking for -- thinking about [indiscernible] capital in China, sales in China, like, first of all, [indiscernible] is more kind of an [ area of angst ] for investors? And how are you, if at all, [ managing and ] thinking about that given that you may have investment companies saying, look, we don't want you doing this in China the way you're doing it. The fact of the matter is that potentially [indiscernible] report from the government is maybe not acting in a way that's appropriate from an ESG perspective. How do you explore that circle such that you have a lot of business there [ and happenings ]? But I do think that ESGs are more focused on companies saying, look, you can't have the full equipment. So a 20,000-foot question, a longer-term questions, but I do think [ this doesn't matter ] to the company [ like some of the ] other companies that has [ the main thing ] happen in China?

Sure. Well, it's a much larger question than just my business unit. But what I can tell you about my business unit is that we're going to make very clinical decisions based upon making sure we comply with all rules and regulations across the globe, including inside of China and outside of China, number one. Number two, we're going to ensure also that we're never overexposed too much to one region, one supply base. And so to the extent we feel like we're overexposed in one region versus another, we're going to diversify, and that is something that we have to do. The hypothetical question is hard for me to kind of answer in terms of what if somebody says you shouldn't do business in China, I don't know. I don't know how to answer that question, to be honest with you. But look, China is a big market. We pride ourselves in Honeywell that we've built a China, for China strategy that has been successful in the region. And we know how to develop products that are designed to fit for the consumer needs or the industrial needs in that region. And we've been successful growing our markets there. And we've also been successful in developing products inside of China for the rest of the world as well. So I think we have to be very -- just going to take a cautious view on our position, always look ahead to see where we have diversification risks, try to mitigate those diversification risks. And to me, that's good business practice. And that's probably the best way I can answer that question.

Perfect. I see we're out of time. So George, I appreciate you making the time and joining us. And we'll leave it there.

All right. Thanks, Josh, appreciate it.

Thank you.