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

Great. I think we'll get started. We're running a little late here, but it's just for those on the webcast. Thanks for joining the Wolfe Global Industrials and Transport Conference. My name is Nigel Coe. I cover the multi-industry sector here at Wolfe Research. I also cover Honeywell. And Honeywell is the next company on stage. And it's my pleasure to welcome Bill Hammoud, who's the President and CEO of Building Automation. And also in the crowd, we've got Josh Jernigan. So if you got any CFO -- the segments of any naughty questions on finance, we've got the CFO in the crowd as well. So Bill, do you want to make some opening remarks, and then we'll get into Q&A.

Yes. Sure. Thanks, Nigel. Good to see everybody here. Just a quick opening remarks. Strong business momentum. We've had back-to-back quarters with 8% growth. It really comes down to a couple of things. It's the strength of our customer relationships, especially as you think about closer to the customers in our regions as well as closer to our customers and select growth verticals, coupled with the R&D investment and the strong uptake and new product offerings. Obviously, this R&D investment will continue, specifically as we think about the investments we are making in the area of connected and software offerings something that will play quite nicely to our business model, which is 15% projects, 25% services and 60% products. We see further upside that this will create as well on our margin expansion journey. And lastly, with a couple of weeks away from the celebration of the full year of Access Solutions business being part of Honeywell Building Automation. And we're quite pleased with the first year. Everything is coming according to plan, financial and otherwise, in fact, slightly ahead, and we still see a lot of upside in that business as we look at our strategy for the next few years.

Right. So obviously, Vimal, your boss is talking about reinvestment, raising R&D, improved organic growth. And right on cue, your organic growth has been 8% for the last 2 quarters. So you're clearly ahead of the pack. Maybe just talk about what's driving the higher growth that we've seen in the last couple of quarters?

Yes, you're definitely seeing the big impact from the R&D investment. And across Honeywell, in Q1 , we've increased our investments by 50 bps as a percent of sales and certainly Building Automation is a part of that. So that uptake on the R&D investment and on the new launches, new product launches is definitely a big part of that growth algorithm as well as we've continued to define focus on the growth verticals. It takes the same amount of effort to win with a customer who's not growing as it does with the one who's growing. So as we get smarter about where do we see our growth globally as well within specific regions, that plays out to our growth algorithm.

Then when we double click into that 8%, solutions have been growing double digits for 2 or 3 quarters now. Products has gone from, I think, flat to negative to now mid-single digits. So maybe talk about solutions. What's driving that outsized -- particularly outsized growth in solutions because that's -- this is -- over time, it's been quite lumpy.

Yes. There's 2 elements for solutions. Within that 40% that makes up our solutions business, 25% is the services, 15% is the projects. On the project side, delivering consistent growth has to do with anticipating where the growth back is going and making sure that we go there. And this is all about where do we see which verticals and which regions, where do we see that investment happening and making sure that we do it. One of the advantages we have in Building Automation is that there's not really a country in which we operate in which we cannot scale because we're a truly global company. So if we anticipate growth somewhere, we're able to scale and make sure we're ready for that growth. On the services side, it's all about ensuring that the value of delivering and the way we deliver that value, that strong customer relationship translates into strong project to service conversion, and we're quite pleased on what we're seeing there as well as our software solutions to where now you're able to decouple ourselves from the natural investment cycles, investment cycles are either building a new building or they have a refurbishment plan coming up. But when we talk about decoupled growth, now we are able to create on the back of our connected and software offerings, an opportunity to go to the customer and say, you can do more with your asset base or you can run it more effectively or at lower cost by implementing the software solution. So now it's no longer tied to that natural investment cycle and the customer can create and justify ROI on its own.

Okay. Now you talked about the growth geographies and maybe some of the customer verticals. Maybe just make a bit more explicit in terms of where you see the growth verticals.

Globally, there's 3 verticals where we see cut across all of our regions as growth verticals. Data center, no surprise, hospitality, we see as a very growth -- a very strong growth vertical for us. as well as health care. And then within our regions, our regional teams will select based on where the investments are in the specific regions based on what they see. For example, no surprise in places like the Middle East, no strong investment in transportation in airports and stadiums. So I have teams there focus on that. In the U.S., you see strong investment around clean tech manufacturing, whether it's battery plants for semiconductor. So the combination of those 3 global growth verticals, along with specific ones that I called out by regional teams make up our growth equation.

Data center is obviously a very -- probably the highest growth vertical right now on the planet. Maybe just talk about your exposure to the data center, where you play? What kind of growth rates you're seeing? And is that impacting the growth you've seen overall?

Definitely impacting the growth. It still remains a smaller part of our business, but it's one that has been growing naturally as well as you know, I'd focus on it. So we see very strong double digits, north of teens, obviously. And our play there is a class all the control domains in which we operate. So our advanced detection 5 control system is the leading solution in data centers now. We've recently introduced a new control product. It's a PLC that sits between what we saw a sweet spot between the industrial PLCs and the traditional building controls, and that's starting to gain traction as a strong offering for that. And we'll continue to add in more specific offerings for data centers as we go.

Okay. That's great. R&D investments, how do you want to define it? Where has that been running in the past for your business? And I know Vimal is very keen to see you guys spending more, not just you, but across the portfolio, where do you see R&D going for Building Automation?

Definitely in line with what Vimal has been sharing about Honeywell. The 50 bps as a percent of sales increase we saw in Q1, across Honeywell, definitely Building Automation was a part of that. And there are different ways to create more capacity around R&D, pure dollar investment like we just talked about is one of those. The other one is around the productivity of your R&D resources. As we sit in this loom today about a year ago, we have rolled out to our software developers, AI tools that will make a proposal to the software engineers to say, use this line of code. And we track that every month, and we see continuous uptake of software developers taking more and more of what the AI tool is recommending to them. That by itself and a very short year has created a double-digit increase and productivity in our software engineers, even though we're investing more than that, our output is growing at a higher rate because of that productivity gain. And then the third leg of that stool is just a constant discipline on looking at every dollar that's being spent and asking yourself, is it being spent in the right place? Is it on the right path, the value proposition that we had as a hypothesis has proven to be holding through or do we need to make some tweaks on it. So these 3 things come together to give you stronger output on what you provide a new products that is measured not only by how much more dollars you're putting into it but by the results.

50 basis points, that's quite a big jump. I mean, obviously, quarter-by-quarter, it varies. But we're thinking about each year for the next 2 or 3 years, should -- is that 20 bps, 30 bps per annum?

Josh and I, we have a semi joke that we've done within Building Automation, with our teams. We always talk about we have no dollars to invest in fixed cost, but we have unlimited dollars to invest in growth. And I first started at Honeywell, I was much younger than now. It was 21 years ago. One thing that's true, we never have a problem coming up with new products because our engineers cannot do it. Our engineers can engineer and our software developers, they can engineer just about everything. Our challenge is making sure that we find a right differentiated value proposition for right customer. To the extent that we continue to challenge ourselves to find those ideas for investments, we're going to continue to invest.

Okay. Maybe a better way putting it would be vitality. Where is vitality today, where could that go? And what does the vitality mean in terms of growth pricing margin?

Yes. Vitality, it sits there around 25%, which if I look at it from a growth algorithm standpoint, it's something that we can measure. It's a few percentage points ahead of where it was historically. And in terms of the opportunity for margin expansion, and that's through probably across all of our automation business not just buildings. The value of the product that we sell to our customers, and I think about my system integrator customers. My portion of the overall spend is less than 20%. To the extent I'm able to tap into that other 80%, they don't spend with me to make it easier for them to implement something, to make it -- to give them the ability to execute more projects with the same labor pool. Now there's a very strong value unlock. And that is exactly what our connected and software solutions are doing. It's no longer just about the moat monitoring. It's about smarter commissioning. It's about over the lifetime of that asset, that asset being a little bit smarter and raising its hand when it sees a problem. So there's a very strong value unlock there that gets into the way that our customers delivered. The last thing I'll say about that, 10, 15 years ago, when you talked about, hey, I can do something remotely or less labor, the value equation was around, okay, cost me $50 an hour. How many hours do I save? That's the value. Today, when you talk to customers, and that's doing just about every company in which we operate, one of the top obstacles to growth is the availability of skilled labor. To the extent we're able to allow them to do it more quickly, all of a sudden that becomes part of our customers' own growth factor and there's a lot of value to unlock there and there's a lot of margin opportunities that come along with that.

Great. I definitely want to come back to software and IoT in a moment because I think that's very important. But thinking about the way that you've set up the year, you just put an 8% for 1Q. I think you're looking at maybe mid-single digits or maybe a bit below mid-single digits for 2Q and then mid-singles for the back half of the year. So what's driving that deceleration that you're seeing, especially in 2Q versus 1Q?

Yes. On the one hand, you've got things that are under our control, a strong conviction and what we've done to focus our teams on the high-growth verticals, these strong uptake that we're seeing from our customers and our new products. Things that are at our control that had strong momentum for us. On the other side, you've got things we cannot control the entire uncertainty around tariffs. So I'd like to think what we've looked at right now is a pragmatic approach that takes all of these factors into play and that's what's creating our guide.

Okay. From what you can see, I mean, are tariffs driving any unusual behavior? I mean you do sell through independent channels, contractors. Is that driving any unusual that you can say?

We are staying super close to our customers. It's a time of uncertainty. I think at the beginning, there was a lot of fear of that uncertainty. As things have settled down a little bit, even though we talk about a 90-day pause, I think there's a natural optimism that, that 90-day pause would translate into a more permanent pause. But at the same time, especially some of our bigger customers they are looking at that and saying, okay, we have to see what happens and how that's going to impact that overall ecosystem.

[indiscernible] what we're hearing elsewhere by the way. There's also been a fair amount of concern around nonres construction in general, especially some of the larger projects might get pushed given the macro uncertainty. Have you seen anything like that across your end markets?

On the larger projects, especially when you think about critical projects such as data centers and some other critical infrastructure. Those are bigger investments that people make longer cycle, less have a concern around that. Maybe some of the smaller projects on the one side, somebody may accelerate it to get ahead of the tariffs or maybe pause a little bit. I will have to say, though, past the 90 days of some of what we talked about in early April comes to fruition, that's going to cause everybody to rethink what they're going to do even long-term projects.

Great. And then just maybe just one more on this topic. Obviously, we've got the U.S. mega projects. Eaton talks about $1.7 trillion of projects out there in the pipeline. What sort of -- when you look at this funnel, I mean, what does that mean for Honeywell in terms of content, in terms of opportunity?

Yes. I mean you look at our funnel for a long cycle business, it definitely supports what we've laid out there. The goal for building automation to be in the mid- to high single digits. We see that playing out quite nicely for us.

So Access Solutions turns organic in...

June. First week of June.

Okay, 2 weeks. Maybe just recap on what the first year of ownership of the assets, would it be done to it? I know there was a very strong revenue synergy opportunity globalizing that business. Maybe just recap us on 2 of the 3 major things that have happened since you've owned [indiscernible]

I'll start with the revenue synergies one. Historically, that business prior to becoming a part of Honeywell was primarily North American business. The 70%, 80% of it was North America. You look at Building Automation, about 1/3 of our business is U.S., 2/3 is outside the U.S., hundreds of salespeople trained on it lot of excitement and a lot of strong uptake from our salespeople as well as our customers that are driving our sales synergies to be ahead of where we had committed to when we looked at making the acquisition. Beyond that, we've shifted a lot of investment into Access Solutions on the R&D front. We see that, that customer set is probably the most forward thinking in terms of thinking about the connected journey to be through cloud-native journey. So we've put a lot of investments since we've acquired the business into that area. And we see possibilities on the architecture which will play out in buildings as well as industrial, that's smart edge to cloud piece. It will probably happen first, now but will happen first in the security and access solutions space, and we've been putting a lot of work into that area.

Okay. I think when you acquired that business, I think the margins were in the high 30s, 40% maybe, is that because there was underinvestment in that business and you have to then raise that NPI spend and R&D or is that just the nature of the business. This is a very high-margin business?

We definitely see opportunities to invest organically and inorganically into that business, and we have been doing it and that's reflected whatever the impact of that has already reflected in our results. The true margin on that is the value creation that, that business does. The scalability of the [indiscernible] solution as an Access Solution for a large enterprise. No one in the world can come anywhere near it. The piece for that, how do we sustain the growth of such a high growth, high-margin business. And this is where all of our investments are coming into make it more fully integrated security as well as Access Solutions platform and continue to make sure that we leverage the scalability and make it more scalable as a cloud-native solution.

Okay. What are the barriers to taking the Access Solutions business to Europe and Asia? Are there any barriers? I mean are there any coding differences that we should be aware of.

We are -- there will be some in there, but nothing major. It's nowhere near what we've seen in our fire business where you have most strict codes from region to region. We're seeing the uptick there. We're already seeing that start to manifest itself and our sales synergy, it's part of our 2025 growth algorithm.

Of course, Access becomes organic in the second half of the year. Is that going to be helpful or hurtful?

It's at least as good, if not better.

That's good. Great. Maybe switching to -- let us touch on the importance of having the solutions, which is design, install, servicing and the product side as well? How much synergy is there between the 2 sides of the -- of your business?

Our solutions are built on the technology capabilities of our private business. One thing that we're talking about earlier today, we sell a lot of products to our solutions business. And our bias is we take the projects that have heavier first-party content for a number of reasons, not the least of which the strength of the value proposition. So it builds on that. The other thing that it does more strategically is that -- it creates a stronger connection between us and the customers. The days of developing something on that and putting it out there are long gone. We can do it, but it doesn't mean you're going to be successful. So the concept of co-creation is a very prevalent one, one that Vimal talks about the across entire business and that we're all quite keen on. So that direct connection allows us to dive co-creation and 2 distinct but very valuable vectors of value creation. One around the value of that solution to the end user and the other one, working with our system integrators as well as our own technicians to say, how do we make that solution easier to install, how to make it easier to commission easier to service. To give you an idea, a couple of years ago, to walk into a building and provide a connected solution would have taken us days. The offerings we just launched now when we're launching with our channel partners, has taken hours. We put the target out there, we said it should be less than a day, it should be 10 hours. That was my own target. And every once in a while, and my team is more ambitious than me, and I'm glad for that. In some cases, they're doing in less than 5 hours.

Okay. And when you're integrating third-party content, so one of your competitors theory, why is that? Is that because they've been specified by the, I don't know, the build owner or the general contractor or the E&C or is it large because you don't actually have that product set?

It's a small of the latter. Sell them, if ever, and some projects depending on the size, Josh and I get to see them and with the official approvals on them. And that's one of the things that is part of our teams' standard work. They look at all the product and software content. And we check the box. Is there something we can provide. Yes, and no, and if we can, then the better will be coming from us. And that, by the way, has played out quite nicely for the [indiscernible] offering from the Access Solutions acquisition because now all of a sudden, we're able to create more capability that goes into a projects business. So it ends up being stuff that we just don't have in our portfolio that we integrate, let's say, third-party.

Any questions from the audience before we move on. Okay. Great. Margins. So I do want to touch on margins. I believe last year, you reported 25% unchanged, 25.7% margin. This year, I think we're in the 26.2%, 26.3%, maybe 26.5% zone. Your long-term target, I believe, is 29% That's what it was last time we heard publicly. But what are the stepping stones to a higher margin for BA?

Two pieces. One around the execution, one around the strategy. On the execution side, and this is something that's well ingrained in our DNA and we do well. The combination of investment plus pricing has to be greater than inflation plus -- productivity plus pricing has been greater than inflation plus investment. And that algorithm has been there and continues to be part of our margin expansion algorithm, and we saw very nice margin expansion in the first quarter. The other piece of it more strategically is around some of the stuff we talked about earlier. How do we continue to drive within our mix, one of these solutions that get at how our customers do their jobs. So it creates more value for them so that there's an opportunity there for us to sell more of these software connected solutions that drive higher margins.

Yes. Pricing and costs. Let's talk about tariffs. I mean, obviously, there's been a lot of news on tariffs, China, tariffs will come back. How is the whole sort of supply chain tariff situation, pricing negotiations, how has that changed the business for you in the last 2 or 3 months.

Yes. I'll start by saying, I mean, we have a natural obligation to minimize the impact of tariffs for us and for our customers and connection. There's a very strong relationship and joint success between us and our customers, especially on the system integration side. Within Building Automation, we have the benefit of after 2018, after COVID, we put a lot of investment in not only looking at how we consolidate our [indiscernible] but also how do you make regions more independent. So if I look at our regions, they are more than 80% local for local. That automatically gives us an inherent advantage in terms of dealing with it better. And in the instances where we have to make different choices, we're able to execute on those choices in weeks as opposed to months. Our approach thus is that our customers see that goodness. And they see that's have an impact as it relates to tariffs from us as they do from our competition. And that is indeed the case as we sit here in this room. We have to continue watching to make sure that it's a dynamic environment and yes, that's a right thing to do that.

So you mentioned software a number of times now. So I'm guessing you're itching to talk about software. Look, we've heard a number of your competitors have made big splashy announcements around IoT. And then we hear nothing else. Maybe just talk about where Forge is right now penetrated within the build automation business and some of the success stories you've had and where do you see the potential of software going forward?

Yes. It's -- you said it very well, Nigel. Probably if I think back 7, 8 years ago, everybody had a big splashy announcement including us. And as it turned out the journey to have those patients materialize where more arduous than anybody expected, including ourselves. The difference is we stuck with it. And the difference is when I look across our automation business and Industrial Automation and Building Automation, those same enabling those building blocks apply equally as well across the business. So give us more staying power in terms of that Forge ecosystem and developing it and the applicability of that ecosystem across the board. I'll point out to a couple of things. One is when you look at organic homegrown software solutions that were not acquired, we probably have within Honeywell, the more successful, one of the most, if not the most successful businesses that was built from zero to being a scaled business around our Forge connected life safety software offering. And the big lesson learned from us there, the success of that scaling came about from our ability to extend that to our channel partners. That model works, you come up with the right value proposition, the right offering, the ability of our channel partners to scale magnitude and speed-wise far exceeds any one company, us as well as any of our big competitors to do it. We're applying that same concept across rest of 4 software offering. And in fact, just as we sit here in this phone for the last several weeks, we've gone out to the regions, different countries within the world, rather than own salespeople as well as our customers, and we explain them on these new products. To do that, though, we took great care and made a very big investment in saying, it's not enough for the solution to be sexy and attractive to the end user, it has to become easier to implement. Easier to implement, we talked about earlier ago from days to hours. But just how do you transact. A lot of our customers are not accustomed to a recurring revenue model. We created that entire ecosystem from the business, commercial, administrative all the way to the offering itself and how you implement it and how you keep an eye on it to bring that success to our channel partners and as an association, we'll be able to scale that. What I just described now in terms of opening it up to the broader channel partner community. That's probably something unique for Honeywell in this industry that no one else has done.

Just to be clear, you're selling Forge solutions by our channel partners.

Indeed, we just started that now.

Maybe just help us out in terms of how big is Forge, the software IoT platform with BA.

Yes. Overall, for Honeywell, we talked about connected enterprise business being $2 billion. And a lot of that sit in IA and BA. So that kind of gives you an idea of the scale of what it is.

Yes. And then I think you hinted as well, automation within the building doesn't necessarily -- it's not radically different from automation and industrial environments or automation in the process plant, et cetera. So from your perspective, how much overlap is there? When we think about the new Honeywell, the Honeywell Automation RemainCo business, how much technology overlap is -- will there be across the remaining businesses?

When I think about the Forge ecosystem and the building blocks of that 100% applicable. In fact, when I look at the even the big software integration platforms and buildings we have something called enterprise building integrator, EBI, which is the backbone of what we do in the solution space. That is the exact same platform that we use on the Industrial Automation side. We call it Experion, just twin sister or whatever you want to call it, same backbone. So very relevant, just that last mile, if you will, of how you customize it and configure it to that specific customer?

And then just my final question. There's a big debate on Wall Street about what kind of growth fire and security businesses are, right, going forward? Are these low-growth businesses? We've seen carriers selling the F&S business, we've seen Stanley had a niche business, Ingersoll Rand back in the day as well. From what I can see, only yourself and JCI really has an end-to-end capability from soup to nuts, basically from front end to back end. Is that the right answer that you have to be a scale player in this business or are there other reasons?

Yes. Two parts to that. Just if I talk about fire and security to start, probably security is one of the biggest in the control domain, the building control domain and it probably has the biggest upside of growth, especially as people wanting to go people no longer want the responsibility and the burden of maintaining on-prem solutions. And the security space is probably the first one that's going to go full cloud native that look to us and our ecosystem partners to say, it's your responsibility to patch and maintain and upgrade and make sure that everything is safe. That's going to create its own growth trajectory. On the fire side, it's a highly regulated business. And a lot of companies and they're pretty good at it, they say, those are the placement cycle, you must follow that replacement cycle, you don't have a choice. Add to that, what we've done in Honeywell on the connected life safety, for example. I don't need connected life safety to run this fire system. But boy, that's stronger, quicker transmission of the fire signal to the first responders coupled with the fact that the system integrator and maintaining it can do a lot of that stuff remotely, that creates own growth vector. And then come specifically to your question about some of our peers and obviously, everybody can talk to the strategy better, you see a lot of people going for pure-play pieces. Even some of the names that you mentioned that play in multiple domains, control domains, they've -- one of the bigger parts of the business around that appliance, which is an HVAC appliance. And building automation, there's no appliance. We are appliance agnostic Our pedigree, our DNA, our differentiated value proposition has for decades come from that controls domain. That's through a class, all of our automation business. So what may be HVAC as a pure play for somebody because that's where pedigree is for us, our pure play is controlled. And how do you evolve that into analytics how do you evolve that into more AI? How do you evolve that into a journey towards through the autonomous factory and a truly autonomous building.

Great answer. That's a great discussion. Unfortunately, we're out of time. So thank you very much.