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

Thanks. Good morning, everyone. My name is Peter Arment. I'm the Senior Aerospace Defense Analyst here at Baird. I am delighted to have Jim Currier, who's the President and CEO of Honeywell Aerospace, 17-year veteran for Honeywell, has really covered all aspects of Honeywell aerospace. He's been President of Electronic Solutions, President of the EMEA region in Aftermarket business. He's been Vice President of the Airlines in North America, VP of business development of engines, power systems and most recently, I think he led Honeywell Anthem cockpit program, which launched in May. So welcome.

Thank you.

Absolutely. So he's going to make a few opening comments, and then we'll jump into some Q&A.

Yes. So just a couple of things that I would say is coming into the role, I kind of think about Honeywell Aerospace, and I think of it upon three separate dimensions across the board. I mean how is the foundation of our business? How are you building the walls and the roof of our business? And do we have the operating system in place that kind of brings it all together to continue to create the value? And so I look at it on the left-hand side about the long-term tailwinds that we have. And I think about where we are in bizjet OEM growth that's happening in the market segment, air transport growth that's happening on the OE segment, where our products are positioned. Are they on the right platforms, going forward where this growth is materializing? So that foundation is very sound, coupled with the opportunities that exist in the defense and space realm as well and where we're positioned on F-35 and our navigational products. And so now then you pivot to the second part of the thesis, which is really around the future of aviation. Where are we investing? Where have we won on future programs that are going to materialize in the years to come? So I think about the Bell Valor program, where we have content on a lifetime value of almost $3 billion. Think about a new end market that's opening up in Advanced Air Mobility, which we are very, very excited about and where we have invested heavily and where we've secured substantial content, just now reaching $10 billion of lifetime value in terms of our products on multiple OEM platforms. And then the continued investment in our future. There isn't a single portion of our Honeywell portfolio, where we are not investing RD&E dollars for future development of technologies, advancement of the industry and positioning ourselves for the future as well. And so we actually invest somewhere between 5% to 8% of our total revenue is actually going into RD&E investment. And then you say, okay, well, the third piece of it is bringing it all together, right? Do you have an operating system that allows you to build from the foundation, put the walls and the roof on it in a way that allows you to expand and grow margins at the same time. And I would argue that we've got a best-in-class operating system across Honeywell, where we manage our cost, the way we manage our ISC transformation, the way we've digitalized the business, we get down to one fundamental ERP system that allows us to look at data on a real-time basis to make efficient decisions going forward. Again, that allows us through that operating system to build the foundation and build the roof and the walls on top of that. But it doesn't make any sense if you don't have an end market that supports what you're trying to do. And so even though we have the foundation in place, the roof and the walls and we've got the operating system, do you have an end market that supports that at the end of the day to enable that growth to occur? And if you look about across the board here, when we talk about ATR, flight hour growth is continuing, OEM production is continuing to grow at substantial amounts, business aviation, OE production rates are still at all-time highs. And the one thing I would say also is the Decoupled revenue, what we call Retrofit, Mods And Upgrades, right? So this is where you have to have an extensive installed base across the board to allow you to bring a Retrofit or a Mod or an Upgrade, enhanced features, enhanced functionality, enhanced value props for customers. And we actually have a situation here where we've grown that to well over $1 billion, and we continue to see double-digit CAGR growth in that particular realm. So if you take all of that combined with what I said before, and you can start to see how in those end markets, you can start to see mid-single-digit growth, high single-digit growth on a long-term horizon for aerospace. And then the last thing I would just make mention of is where we are investing. So I made mention a moment ago that there isn't a single portion of our portfolio where we are not currently investing and investing heavily. So we have four business units. We have our Electronic Solutions Business, Engines & Power Systems, Mechanical Systems and Components and Services in Connectivity, and every single one of those businesses are represented on this slide in terms of where we're investing, whether it's a Next-Gen Cockpit, alternative navigation technologies, where we're investing in the Next-GEN center line for business aviation, or Turboshaft for military applications. And all around the theme around sustainability, electrification, but that's what we're doing a lot in our Mechanical Services and Connectivity business as well.

Terrific. Well, let's jump right into, I think, some of that diversification.

Yes.

Because I think that's one of the things that stands out all the time is the diversification, not only by product but by end market, and allows you to kind of help you manage through the cycles and some of the investment opportunities. Maybe you could talk a little bit about that? How you think about the diversification through the cycle?

Yes. So I mentioned beforehand, the various products and portfolios that we have. So we do have a very broad portfolio. And I would say we're not an engine company. We're not an avionics company. We're not a mechanical actuation company or a service as a connectivity company. We are an Aerospace Technologies company at the end of the day. And it is representative of that broad breadth of products that we have. And then also the end markets that we serve relative to those, right, whether we're talking Commercial, Air Transport, Business Aviation, Defense, Domestic, International. So we play in all of those. And the part about it that really helps us from a market standpoint and resiliency is that we're not monolithically in a product, we're not monolithically in an end market segment. And if we think about what's happened over the last couple of years, back in 2020-ish, 2022 timeframe, when our commercial market was deteriorating, obviously due to COVID, it was our defense business that sort of propped us back up and kept us going in that regard. Here in 2023, it's our Commercial Market and our Defense markets are actually accelerating at the same time. So again, that diversification and not being tied to one particular end market segment really presents a lot of resilience for our portfolio.

And there is a way to think about it, that you think about kind of an installed base perspective? And kind of like across all kind of ages of a fleet, say, on air transport?

Correct. Correct. So whether we're talking about the older fleets of 737 Classics or A320 Classics into the new programs of MAX and NEOs, where we're thinking about in Business Aviation, where we're proliferated across Gulfstream platforms as well and the legacy platforms. And it's that installed base that you mentioned, that ties back to how we can continue to grow that business by doing the Retrofit, Mods and Upgrades that I mentioned a moment ago.

Right. Right. So let's talk about your cost structure. I mean you have like, I think, one of the industry-leading cost structures, because we can see it the way you -- in your margins. What are some of the key kind of areas of investments that you've made, I think that have helped drive that cost structure? And maybe we'll just start there.

So we have a very rigorous process around efficiency, productivity and cost management. And where we have invested heavily over the years has been in our IT infrastructure, getting back to that single source of truth of data that allows us to make these decisions that we make from a business perspective, the transformations we've made in our ISC organization, consolidating footprint, maximizing efficiency within that realm. Those have been some key areas of investment for us that have been able us to maintain our margins and actually grow them over the years.

Was there any structural takeout during COVID? I know that was a big focus for them, Greg and everyone right on down. I mean...

It is.

How about that?

So we definitely resized the business as a result of that. And it also causes us to think very differently about the business at that point in time. It was a significant event, clearly. And so we started thinking about, what do we stop doing? What do we start doing? And what do we continue to do? And if we continue to do it, how do we continue to do it in a much more efficient manner? So rightsizing the business, combining it with a completely different perspective in how we look at the business and how we operate the business, because over the years, you carry a lot of drag that came along with us. So we looked at it through a completely different filter going forward. And then now we've set ourselves up now so to have the volume leverage that we need going forward in a much more leaner organization to continue to propel that.

Was there like automation or things, investments that you put in that maybe could help just given the challenges with labor during that period?

We have, and we continue to invest very heavily in those areas. Because as you've noted, I mean, skilled labor within the marketplace today is one of the constraints that exist within the supply chain organization.

Right. Right. Let's talk about one of the exciting things. I think you've mentioned about the kind of the decoupling of revenue. I think you've -- on slide in the $1 billion kind of opportunity we think about, maybe walk us through some of the programs and technologies that are allowing you kind of look at that?

Absolutely. So again, it builds off of the Installed Base that we have. These Retrofit, Mods and Upgrades, which enables the decoupled revenue to grow with double digit that we're talking about, can take on a hardware component associated with it, a software component associated with it, or a combination of the both. And think of it in terms of -- I'll pick an example of an avionics system that maybe onboard an aircraft. As we improve upon enabling features, functionalities, enhancing situational awareness within the cockpit, reducing crew interactions with the cockpit, to reduce pilot workload, all of that are software upgrades that are enabled upon the foundation of our hardware that's within that. So that's considered an upgrade as a result. So that would be one example. Connectivity solutions is another example, where they are either a solution to connect an aircraft to the satellite systems for communications on and off the aircraft or it could also be solutions whereby we're enhancing sustainability opportunities, flight efficiencies. So again, it's enabling software to be brought on to our existing hardware to drive features and functionality. So those are some examples of where we've done that with.

Software has been a big driver, I think, for a long time.

It has been.

It's been a big focus at Honeywell in general.

Absolutely.

I think almost half of your -- I think half of your engineers at Honeywell, corporate -- total company are software engineers.

That's true. That's true.

Same in aerospace. I mean, same thing. I mean has the business changed in avionics in the way kind of the software gets pushed out to the industry?

It is. It is definitely. I mean how we get the software on board the aircraft? How we maintain it on the aircraft? And what do we use all this data for that's being generated off of the aircraft, right? So how do we have preventative maintenance solutions that we can employ? Because all of this massive amount of data is very valuable in terms of how do you predict maintenance events that may occur and reduce downtime on aircraft. So being able to push the software onto the aircraft, but also taking that data coming off of the aircraft from the software that's been implemented has changed dramatically over the years.

How is the customer feedback from that? I think experience? Because I would think that having all that analysis push to them was very helpful for their own maintenance.

Absolutely. Absolutely. So it's all about reducing downtime, reducing AOG situations and maintaining aircraft operational. So being able to analytically predict when an event is going to happen on an aircraft, preposition hardware for that aircraft so that you can actually schedule the preventative maintenance to prevent that event from occurring has been exceptionally valuable, not just for air transport applications, but also for business aviation as well.

Same thing in business. Do they behave the same way?

They do behave the same way. I mean since we -- and since we have that hardware and that innate knowledge of the technology and the performance of those systems, we can run those algorithms behind the scene and accurately predict when an event is going to occur and what type of event you're going to have, or if a component on a particular system is going to fail and how it will fail.

Is there any opportunities in software for defense? Or is that more kind of more hardware-driven?

No, it's very similarly there as well in defense. And so when we talk about that decoupled revenue I mentioned a moment ago, some of the examples that I gave were very commercial-centric. But about 40-some-odd percent of all of that decoupled revenue is actually for the defense industry as well. And so we've got a lot of products that are currently in development and things that we have deployed, both software and hardware solutions that we considered to be a Retrofit, a Mod or an Upgrade that drives some of that decoupled revenue.

Terrific. You mentioned Urban Air Mobility and electrification. I think those are two of the sort of more exciting areas, future of aviation?

Yes.

Maybe you could describe a little bit some of the things you're excited about there?

Yes. So we are -- we've gone very, very heavily into what we think is going to be a very strong emerging market in Advanced Air Mobility, Urban Air Mobility. So much so that about 3.5-years ago, we actually established a business unit within Aerospace that was solely dedicated to that end market. And so if you think about it, we normally are structured around our products that support multiple end-markets. But this is one very unique one that could have multiple technologies that can come into play, and it was a very emerging end-market. So we established that business unit. And in that 3.5-year timeframe, we've developing technology and securing business to the point of what I mentioned a moment ago, roughly $10 billion of value, contractual value into that market that we've been able to secure very successfully. And so then the technologies that we're developing there are fully integrated technology. So we're talking either a new cockpit system, Compact Fly-By-Wire System, Mechanical Actuation, Electric Propulsion Systems, Hybrid Electric Propulsion Systems. So all of that has been enabled through a lot of the technology that's being developed in that space. But I think the important thing to say also about that space is that those technologies that we're developing is not bespoke for that end-market segment. So we're taking a lot of that technology back into what I would call traditional aerospace end-markets as well. So it's become an enabler, as sort of a tip of a spear in terms of developing some of those -- feeds back into the traditional, what we would call traditional aerospace market. And again, I think for us, it's not a question of if that market segment will materialize, it's more of a question of when. And the value that we bring from fully integrated systems has been recognized. Again, not being bespoke to an industry, we're not bespoke to an OEM in that end-market segment, that's point. And if you think about the maturation that's happened in that end market, it's gone from paper designs to now actual hardware companies are flying subscale prototypes, full-scale prototypes. Companies have gone public in that realm. So it is an evolving market segment. That is not a question of if it will happen, it's just a question of when it will happen. And when it does happen, it will have a tail with it, there will be some evolutionary growth that comes along with it.

So you're not waiting on sort of this certification timeline because you said it's kind of feeding back in?

Right.

Do you have an example of that or like one of the technologies that kind of is feeding back in an opportunity?

Yes. So one of the technologies that we use that kind of really drove as a catalyst for accelerating development is what I would call our Honeywell Anthem system. So our Next-Gen aviation cockpit, integrated cockpit that we're deploying. Some of the first opportunities that were enabled were in that AAM market space, but that has direct applicability to every end market that we're talking in, whether it's going to be business aviation, Helos, general aviation, defense or transport, it all plays back into that. And what we've seen is the successes of developing that in an accelerated manner in the AAM segment. Now has parlayed itself very nicely into the other markets as well. So it's bringing that technology back.

Maybe just for a moment, talk about Anthem. Just because you led the development, how are things progressing there?

It's progressing quite well. And it's exactly where we expected it would have been at this point in time in the development cycle. The amount of interest has been phenomenal for that particular program. It really is a leap forward in technology and a leap forward in capability, features and functionality, and it will change the way we operate aircraft going forward. It's a very simplified user interface. Someone who is not a pilot can literally get into our simulator. And within about 1 hour to 1.5 hours, feel very, very comfortable flying the aircraft. That intuitive user interface is so simplistic. And the way we connect that cockpit off the aircraft as well makes it a very unique scenario for us. So we're exceptionally excited about that platform.

So do you see this kind of rolling out the same way you've done in the past with other kind of platforms on your avionics platform?

I do, I do. I mean if you think about the predecessor to what will be Honeywell Anthem, when enters the market is what we call our Epic system, which has been incredibly successful over the years. There's over 7,000 Epic cockpits that are operating within the world today, in which we build upon those RMUs, as I mentioned a moment ago. So taking that leap of faith and going into a brand-new Next-Gen avionic system is literally our vision of what we think the future needs to look like and then putting it into that new cockpit. And we expect it to be just as successful or more successful in what we're seeing with our Epic systems.

And just one final thought on Urban Air Mobility. Have you thought about just how you think about the FAA and some other looking at certification? Because we've always thought it's going to be longer than on that process, but maybe just get your updated thoughts on that?

Yes. So we work very closely with the regulators in this space, whether it's the FAA and/or EASA. In short, we're still trying craft and shape how you could go about and certify these aircraft. I will tell you EASA is a little ahead of where FAA is in terms of how they're viewing, how to certify some of these aircraft platforms. And so we work very, very closely with the regulators and actually with legislatures as well, as they're establishing funding for the FAA in terms of how to go off and certify these platforms going forward. So yes, there's still a lot of work that is required there, but I definitely feel we're on that journey, and the FAA and the regulators are on that journey because they recognize the importance that this end-market segment will bring to the industry. And not only from a new end-market that's opening, but the whole sustainability aspect of what Urban Air Mobility or Advanced Air Mobility can bring, not only to commercial applications, but defense applications is very valuable and they recognize that.

Terrific. So we've talked about your Installed Base, your kind of your exposure across the board, some of the decoupled revenue opportunities. Maybe let's switch to kind of the state of the market. How you're seeing the air transport market and bizjet market today? It feels like we're back on just about all levels, or 2019 levels on traffic. How are you guys seeing it?

Yes. So I'll bifurcate it to air transport versus BGA for a moment. So yes, the air transport market has recovered and recovered nicely. There are areas, however, within the industry globally where it has not recovered to pre-COVID levels. I'll pick China as an example, right? So domestically, within China, yes, the growth has been substantial over the last year as they've opened up some of the travel restrictions, but still regionally within Asia, and then transpacific travel back and forth from the EU exactly. The international travel back and forth is still very, very suppressed compared to where it was in pre-COVID. So there's tremendous opportunity still for the air transport market to grow in those areas. And for us, we view that as a tremendous value and growth opportunity for Honeywell because if we think about our content on a narrow-body versus a wide-body and what we receive in terms of revenue for every flight hour that occurs, it's about a 3:1 ratio. So for every flight hour on a wide-body aircraft is, say, $3. And for every hour on a narrow-body is $1. So that opportunity continue to grow, represents opportunity for us as well. And I think the other thing that I would say in the air transport market that we all need to pay a lot of attention to is what's happening in India as well, right?

Yes.

I mean so you've got two major airlines there that have ordered well over 1,000 aircraft. The Indian government is investing substantial amounts of money into the infrastructure...

Finally, India's time.

Finally. It's finally going to be India's time. And they will rapidly get to the point where they will be the third largest air transport market segment in the world. And if you pivot to BGA for a moment, yes, there was a massive, massive rise in flight hours coming out of COVID. I think that has normalized. And we're seeing more of a normalization of what we see in terms of growth going forward. So there was a hyper increase, a major adjustment, and now I think we're back into that realm we're going to see normal, where we see typical pre-COVID levels. And they are, right now, they're flying at about 10% to 11% more so than what they had pre-COVID. So that will continue to grow going forward.

And the good news there is the industry was massively oversupplied in '08, '09, kind of all those deliveries, but then it went through a decade of leaning out.

Correct.

And so now you have this aging fleet, which I think has got to be great for you when you think about kind of that opportunities on the aftermarket.

Absolutely. Absolutely. It helps support us in that opportunity space as well.

Got it. How do we think about just the replenishment cycle when you look at like the aircraft fleet in terms of how quickly they do upgrades in air transport? Is that still an opportunity when you think about, is it just driven by utilization? How do you...

No, I do. I do believe that. I mean so if you think about the number of OE aircraft that are being delivered, right? I mean all the major OEMs in that space are ramping up their deliveries into that end market segment. But there is still a lot of demand that exists out there today.

Right.

And so we don't see a significant decline or a significant advancement, I should say, in terms of retirements of aircraft, parking of aircraft. We're in that cycle whereby to continue to push those aircraft into the market, the demand is there to support it, and we don't see that decline happening in terms of retirements and/or parking of aircraft class.

Sort of what's happening on both fronts for you, OE is continuing to ramp and then the utilizations are happening on...

Still happening as well on the aftermarket.

Yes. So you've got that balanced. Let's switch over to defense. So it's a big market for Honeywell. I don't think a lot of people -- and then also International.

Correct.

Maybe just give us your thoughts on how things look there in the short-term and maybe medium-term?

Yes. We're really excited about the growth opportunities that exist in Defense for us right now. This is like our fifth quarter of our book-to-bill being greater to 1. We'll be...

30% growth in orders, I think?

30% growth on orders has happened as well. Exactly. And also, if we think about it, we'll be double-digit growth this year in 2023 relative to defense and space. And a big part of that is, yes, there's substantial demand that's entering the ecosystem and the value chain as a result of what's been happening geopolitically around the world, but there's also an unlock that's happening in the supply base as well. That's enabling us and others to be able to fulfill that demand going forward.

Yes. A lot of people have a misperception about defense margins, but your international margins are -- a lot of that's done on kind of commercial terms. Maybe you could talk a little bit about that if it's favorable from your perspective?

Yes. I mean -- so if I look at the defense business for Honeywell, about 75% of it is domestic and about 25% of it is international. And although we don't talk in terms of margins at that level, what I could say is that you could expect it to be at the levels of what we see and what we demonstrated at the aero level, and that overall, it's accretive to Honeywell.

Terrific. Well, that leads us right into a margin discussion in the last few minutes anyway. I guess you have the industry-leading margins. I mean it's terrific. I think 27% is kind of the operating margin number roughly this year. Maybe just talk about just kind of how you see that going forward? I know there's a balance between OE and aftermarket and defense, how that all kind of makes us together?

Yes. So I mean we've done a substantial amount of investments in our IT infrastructure, digitalization across the board, technology differentiation. And over the last 10 or so years, maybe a little bit less than that, we have grown from sub-20s to where we're sitting today around 27%, 27%-plus. What I would tell you, though, is that we're not tapped out by any stretch of the imagination. I mentioned earlier about how we revisited what the business needed to look like when we went through COVID through a completely different lens, maintaining some of that diligence around efficiency and productivity. And yes, there isn't a heavy OE mix cycle that we're going through right now that I've talked about. I would expect us to be flattish in the 2024 timeframe.

On the margin rate side?

Yes, on the margin rate side. Yes. And -- but I see no reason why, and we've got the algorithms in place and the path on how we can get to 29-plus percent margin over a longer-term horizon.

On whole dollar EBIT is still growing because you've got all this growth? And still when we think about it, it's a core focus on that?

Yes, That's correct.

One of the things that's also -- well we only have 2-minutes left, let's just finish on a brighter note. I mean the supply chain was probably a real challenge in the last 3-years has gotten a little better. Maybe you could talk a little bit about that and just how you're thinking about that?

Yes. So we have not been able to unlock some of that powder keg within the supply base that exists today. There's still a lot more work that's required there. I would say one of the areas whereby there's still capacity constraint that exists is in the skilled labor area. But we've continued to invest, not only internally within our own factories, increasing census in terms of direct and indirect headcount, touch labor for the direct to drive capacity increase, but also investing very heavily into our supply base as well, from a capitalization standpoint, driving capacity ability there, tooling, fixturing, automation as well. So yes, we've been able to unlock some of that, which has enabled us to drive some of the growth opportunity that we've been identifying here, particularly in the defense space, but there's a lot more work required there. And we're still fully committed to continue to invest into that supply base going forward.

So just lastly, when you came into '23, and now we're going to be going into '24, maybe just as a wrap-up comment, what you're excited about? And kind of what has changed maybe that was maybe you thought differently in '23 and now going into '24?

I'd say a couple of things, right? Usually, in this industry, you'll have a commercial market that is accelerating, and maybe defense will be depressed or vice versa. You've got all three end markets that are really accelerating and growing nicely. You add in a fourth end market, which I would call the AAM, a new segment that's also growing, right, a little bit more on a longer-term horizon. So that element for me is very exciting. I think about where we're continuing to invest in new technologies is very exciting as well to enable the future that we anticipate aerospace will lean to, and then the continued unlocking of the supply base. So when we started 2023, yes, we had been investing for a few years to try to drive more output from the factories, not only from ours, but you're talking 2, 3, 4 tiers down in the supply base. That's where a lot of the investment was going into. And it's a massive machine. That ecosystem is huge. And so it takes time to come out of that. And so at the start of 2023, we would ask, what you were seeing was going to happen was some unlock. Did we see it? Yes. We're starting to see the fruits of those endeavors that we've made and then obviously, now growing it from there going forward in terms of what we anticipate in '24.

Terrific. Jim, thank you so much. Thank you, everyone, for joining us. Thank you so much.

Thank you. Thank you, Peter.