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

Good morning, everyone. My name is Peter Arment, I am senior aerospace defense analyst here at Baird. Thanks for joining us today. With us, we have Honeywell International. And with us from Honeywell, we have Jim Currier, President and CEO of Honeywell Aerospace. Jim has served as President and CEO of Honeywell Aerospace Technologies since August '23, previously spent two decades in a ton of senior roles across the globe with Honeywell, President of the Electronic Solutions business, President with company's Aftermarket Organization across Europe, Middle East, Africa and India, Vice President of the Airlines, North America, and last week, Honeywell announced that he will lead the Aerospace -- Honeywell Aerospace as President and CEO following the planned spin-off as an independent publicly traded company in the second half of '26. So congrats on that. That's fantastic, and welcome, Jim.

Maybe we'll just start with that spin-off. You've announced that that's on track for the second half of '26. And it's going to be positioned as one of the largest pure-play aerospace suppliers out there, which is very exciting. Maybe can you share just kind of your vision, how you view it as a stand-alone company and any strategic advantage you expect to unlock post the spin-off?

Yes, absolutely. I think a couple of things I would say is, first and foremost, I truly feel Honeywell Aerospace is exceptionally well prepared for all the new opportunities that are going to be presented to us in a post spin state as a pure-play stand-alone. We have an exceptionally talented and experienced leadership team. We're going to have an investment grade balance sheet as well that's going to afford us a lot of opportunities going forward. I think as well as the announcement that came out last week about me, we also announced that Craig Arnold is going to be our Chairman of Honeywell Aerospace, and there could not be a greater leader. He partnered up with me to be able to drive the business into the next decade and beyond going forward. I think when I think about the benefits afforded to us by the separation, I think along two parallels. One, first and foremost is just being able to be exceptionally focused, laser-focused on just the business itself strategically and from a tactical perspective. We're going to be able to not to worry about any other activities occurring outside of aerospace as being a part of Honeywell. Everything we do, every decision we make will be foundationally rooted in driving the aerospace business for Honeywell going forward. And then there's a second element, which is financial flexibility right? We'll have all the decisions around capital allocation, will reside within Honeywell Aerospace and the leadership team. There'll be no more sort of competing for capital across the rest of Honeywell, whether that's capital for allocation purposes and factories, capacity expansion or that's capital for M&A activity as well. So again, all that flexibility driven by a complete element of being laser-focused on the business, I think, is a great benefit afforded to us by the separation and by the spin. And that ultimately underlies the underpinnings that allows us to actually accelerate and become more amplified as a pure play and really driving the most technologically advanced innovative solutions for our industry, solving exceptionally complex problems that exist today, which is where we currently play. The investments that we make on new technologies, new products, and new services, again, all of that underpinned by the benefits afforded to us by the separation.

Got it. Yes. That's terrific. Well, maybe let's start with a little bit of a high level for the audience. Maybe describe how you view kind of the portfolio when you think about it, it's so diversified, whether it's by product or by market. And you've been able to -- and that has allowed you to really manage the cycle across, take advantage of some opportunities, maybe describe that for the audience, the portfolio.

It is a broader portfolio, to your point, as you mentioned, among products and end markets that we serve. So I'll touch on the end markets for a moment. Currently today, we provide products, technologies and solutions that support either commercial air transport, business aviation or defense aerospace. That ability to service multiple end markets typically provides currently today, all end markets [Audio Gap] we are essentially nose to tail on an aircraft. We are divided out amongst three strategic business units, electronics solutions, digital power systems, radar control systems business and within each of those electronics solutions as an example you can think of so avionics, flight management systems, flight control systems, surveillance, radar systems, flight controls. Moving to the engine, and the power system business, you can have business jet engines, military engines, APUs across multiple end market segments, electric power distribution systems as well, electric power generation. And then you move into the control systems portion of the portfolio, anything around environmental control, cabin pressurization, thermal control, friction control with our wheels and brake systems, fuel control systems on commercial engine aircraft going forward. So again, when you think about the breadth of that portfolio, it is nose to tail. And again, it's multiple end markets that we serve as a result. And I think that provides a really interesting backdrop to enable us to be very resilient and also very to be able to drive the growth of this business.

Yes. So it is incredibly diversified and obviously, provides a lot of visibility too. I was also, I think, also considering kind of an industry-leading cost structure when we think about your portfolio. What are some of the key investments that have enabled this and how do you think about that?

I think the underpinning of our margin performance that we have seen over the years is really foundationally built upon our operating system that we have. It is a cohesive, fully integrated operating system, not only within the businesses, but within the functions as well, and that operating system is underpinned around productivity, efficiency, resilience and margin expansion. So that has been an enabler for us to drive the margin performance that we've seen over the years. One point of clarification is we've done that not at the expense of under-investing in new products and new technologies. If you look at as a percent of revenue of what we invest in new products and new technologies, it is at or above where our peer set is today in the aerospace industry. Now what I will tell you though is that over the last couple of years under my tenure here from the last 2-plus years or so, I have been very, very dedicated and diligent around investments to set the company up and sustain a 10-year-plus growth profile. So that could have been investments that we were making in the supply chain, that we're making in new products and new technologies that I mentioned a moment ago. But that really is the setup for the complete 10-year sustained growth trajectory. And with that over the last couple of years, the margins have been a little bumpy as a result of those investments that I'm making. But I would tell you, I think we really kind of hit the floor in Q2 as a result of that. And now you saw from our performance in Q3, some margin expansion largely attributable to volume leverage that we're getting as well and through the investments that we've been able to make to drive the volume output of the factories. But it's also going to be a tailwind for us going forward through these investments, right? We've got integration activities and costs that will be falling off the books going forward. The volume leverage that I described a moment ago as well, the continued efficiencies on the operating system that we have across Honeywell Aerospace. And then also as you think midterm horizon, as we have a lot of our long-term agreements that we have in place, there will be pricing opportunities that will present themselves. So I think you'll continue to see this margin progression increasing throughout Q4 through 2026 and beyond.

Was there any structural cost takeouts kind of with COVID or anything along those lines that you kind of were able to address?

We did adjust the business as a result of the COVID impact that happened. We looked at areas whereby customer interactions, customer-facing, supply chain challenges that we had or supply chain enabling activity that was occurring. So there was some cost takeout that was made as a result of doing that. But we reinvested back into all of that ultimately to give us the supply chain resilience that we need going forward.

Okay. That's helpful. Let's switch and talk a little bit about the aircraft market. I think you guys again have a very good insight into both air transport and business aviation. What's your view of where we are? And I think we all kind of accept that maybe we should be entering a more normalized environment because we've had such a snapback post COVID. But how are you viewing the kind of the market?

So I look at it from two different end markets that we serve, business jet and then commercial and transport. If I focus on the business jet aspect just for a moment here. Clearly, coming out of COVID, there was a massive snapback in terms of flight hour growth in the business jet market. It got to a point where it was about 20% above what it was pre-pandemic levels. We saw a little bit of a regression to that, normalized going forward. And I think that's going to be steady state going forward, like low single digits in business jet going forward, again, consistently with what we've seen recently and consistently going forward. But I'll tell you on the air transport market, I still think there's opportunities for continued growth there. I think it's stronger than what we're seeing in business jet as an example. The point there being is that in the U.S., we've largely recovered to pre-pandemic levels, but we are still considering to see a lot of growth in Europe, Middle East, India, the Asia Pacific region in air transport, and those will continue to be growth drivers for us as an enablement for our growth going forward. But the one thing that I would say about flight hours and coupling flight hours to revenue, right? That's a direct almost a one-to-one correlation. The more you fly, the more you repair, the more you overhaul. And so you can see a growth calculation associated with that. We've been very fortuitous in that we actually able to outgrow what the aftermarket is doing in terms of flight hours. And what we've done there is through a substantial amount of investment that we've made in what we call retrofit mods and upgrades. These are products and services where we are upgrading the aircraft with latest features, latest functions, latest capabilities, safety enhancements as an example. And that becomes what we call decoupled growth. It's not tied to the flight hours. It's just providing value-added offerings, value that's perceived by operators of aircraft to drive this additional growth. And that's become a huge growth enabler for us that allows us to outgrow the aftermarket. The revenue associated with that is about 10% of the total portfolio. We've been on this trajectory for quite some time. The growth that we've seen there over the last 3 years has been about 20%, 10% year-on-year is what we've been seeing going forward. So that is truly that enabler that you have your coupled growth that happens in the aftermarket tied to flight hours. And through our investments in new products and new technologies and value-added offerings, we are able to sell those products and create a decoupled revenue profile or a decoupled revenue stream that allows us then to outgrow the aftermarket.

When thinking about aftermarket, I remember years ago that you guys always kind of highlight how many software engineers that you have and how that allows you to kind of address there's additional services that can be done. Have you seen any pickup there regarding when you think about software and impacting your business?

We have. I mean we have roughly across our organization about 11,000 engineers. The majority of them are software engineers. That is really where a lot of the value-added offerings come, particularly when you think about integrated cockpits. So the thing to remember is that when you introduce a product for the first time onto a platform, that aircraft is going to fly for 20 to 30 years or more. And it's constantly going to be evolving and needing new technologies, new safety standards, new mandates that are coming in. And having that footprint or that real estate on the aircraft with the breadth of the portfolio that we have nose to tail, 90% of the aircraft flying in the free world today have Honeywell content on board. It's a very fertile ground for these RMUs, and many of them are software upgrades to bring those features and functions into the cockpit driven by reliability, safety and other value-added features.

Yes. So I was going to ask about it later, but the supply chain is kind of a critical focus. So -- and it's related to this business because we've seen a lot of -- there's going to be a lot of pressure on the OE production ramp going forward just because of where both OEMs, Boeing and Airbus want to go. How are you thinking about the supply chain health and your ability to kind of support what's going on?

So when I look at the supply chain, given the breadth of the portfolio that we have, I tend to bifurcate it. I look at the electronics portion of the industrial supply base and the mechanical portion of the industrial supply base. And the reason why I do that is that the underlying issues that existed across our industry in terms of capacity or the lack thereof to supply or to support the demand that is necessary is very different between both of those industrial supply chain segments. The electronics portion has recovered very well across our portfolio. I would indicate that it's fully recovered, to be honest with you. The mechanical side, although it has progressively gotten much better, there are still pockets of continued constraint that exists. And you can kind of think about forgings, castings, complex machining operations, outside special processing that's required of these parts for our aerospace industry. And a big difference in the mechanical space is that it's a very fragmented industrial supply base. You have a lot of small family-owned businesses that are in that sector doing the machining that came under a lot of financial pressure during COVID and coming out of COVID. So what we've done, so it's gotten much better. We've seen now 13 quarters for Honeywell Aerospace of double-digit volume output from our factories, and it's largely attributable to a lot of the investment that we've been making. Since 2021, we've invested over $1 billion into the supply base. Now that could be from workforce needs and expansion required, capacity expansion, test equipment, capital equipment, in-sourcing to provide additional capacity, outsourcing or finding alternate sources, I should say, to find additional capacity to support the demand coming into the industry. And a lot of that, quite frankly, was done directly into those fragmented suppliers. They didn't have the ability to buy capital. They didn't have the ability to buy the necessary test equipment or the equipment to manufacture parts at scale that is necessary. We went in and bought those on their behalf to be able to, again, drive capacity to be able to supply what we need in terms of the demand that's required.

Can you talk a little bit about your visibility into that supply base because it seems like you guys really have made a lot of -- stepped up and made a lot of investments there so you can see down into those levels. Can you talk a little bit about that?

Yes. I mean, so the visibility has greatly amplified over the last couple of years and largely as a result of the direct investments. The other part that I would say where we've invested is that we have embedded hundreds of people from our organization within Honeywell Aero into suppliers. And so you do get that direct visibility. And one of the things that we had noticed as going through that process is that due to some of these smaller shops that have been a little cash strapped, they weren't placing orders for the material, right? And so they were managing their cash flow. Well, unless you had boots on ground in those factories, in those offices and with the leadership and owners of those factories, you would have had that visibility. So now we've had that. And so we've been actually now driving cash, buying the castings, buying the forgings. And so that visibility has greatly increased for us across the board. But again, there's still some of those pockets, right? I mean there's still much in the way of opportunity for improvement going forward. But again, that's sort of a pan-aero industry-wide issue that I think collectively, we've all been addressing.

Got it. Yes, that's helpful because I mean, it's been -- I think that's been the -- we all kind of understand where the OEM volumes are going, but we -- it's been the supply chain hiccups that I think surprised people. Let's switch over to defense a little bit. It's a huge end market for you. Maybe you could talk about how you're viewing defense in the short and maybe medium term.

Yes. I mean so I mean, when we talked about the breadth of that portfolio, one thing I didn't mention was how our revenue is split between commercial and defense. So 60% of our business is commercial, 40% of our business is defense. And if you think about the defense portion of our portfolio, 75% of the revenue within defense itself in that end market segment is domestic defense and 25% of it is international defense. And to clarify, because I get asked this question a lot. When I get asked about international defense, people assume that it's foreign military sales, FMS sales that we're doing. That is not the case that when I talk about Honeywell Aerospace's international defense business. We treat FMS sales as a domestic sale because the end use of said product is unknown necessarily. So we treat that as a domestic sale. So when I think of 25% pure international as part of our defense portfolio, that is direct sales to governments, ministries of defense and international primes, right? And so that is -- and that is the high-growth area for us. And so when you think about the domestic and the international market segments, you're seeing a lot of investment happening here with this administration and the opportunities that's going to present to us and where we're well positioned on the platforms where the investments are occurring. Golden Dome would be one example amongst many. And the second element is internationally. You see continued emphasis and focus on increasing budgets within NATO, increasing budgets within the Indo-Pacific region as well, for which we're well positioned with our products and our technologies. And so we will capitalize on that going forward for us, and we see that as a substantial growth driver for our business. And the thing that I would say is how we're capitalizing on, particularly in the international market segments where there's a substantial amount of investment that's coming forth through governments and through NATO and the like is out of those 11,000 engineers that I mentioned a moment ago, about 1,000 of them are based in Europe. And they're doing nothing but developing non-ITAR technologies to support the international defense industry and not just for Europe, is to be able to take those products internationally and abroad. And we saw that shift that was happening years ago in the international defense market and domestic. And we've kind of shifted our strategy and our approach to make sure that we were developing non-ITAR technologies and capability in the region. And one of the underpinnings of what we did relative to that was an acquisition of a company called Civitanavi in Italy, provides inertial navigational units for us, high-performing, low-cost, non-ITAR, smaller company. We provide them the scale to bring those products onto the international stage that is necessary as well as they have a manufacturing capability there in Italy as well. So no longer are we just designing products in Europe for European defense application, but now we're going to be manufacturing products as well in region to support the growth that's happening there.

Yes. You're seeing that the NATO uplift in spending or the planned uplift in spending, they're kind of looking for that indigenous capability and you guys seem like well positioned there.

Correct. Correct. We've been investing and focusing on that area for that indigenous capability.

You mentioned Golden Dome. Could you just highlight how you think about Golden Dome for Honeywell?

Golden Dome for me is just -- it's a constellation of products and technologies and services that all must interact with one another to provide the protections that are necessary and as dictated by the Golden Dome. So you can think about missile technology and the like as being a part of that. Most of our navigational products that we provide, electromechanical actuation systems to steer many of these missile systems is where we have a strong, strong presence as a result of Golden Dome and the continued investments that are happening there and elsewhere around the world for that matter. So most of these systems have our inertial navigational systems on board. Most of them have all the resilient navigation systems on board as well. If we think about another company that we acquired last year, which was CAES, they have tremendous technologies and capabilities in terms of electronic warfare, so anti-jamming of systems on board either our aircraft and/or onboard our missile systems. So now you've got anti-jamming capabilities that we provide on the missile systems in support of Golden dome, our navigational products on these missile systems to support activities on Golden Dome and electromechanical actuation systems as well for steering capabilities on these systems.

So when we think about international, you mentioned the 25%. So is it -- we should think of that as more of a direct commercial sale versus kind of how we're thinking about kind of a margin opportunity?

Yes, exactly. And it's a good point that you bring that up. It is a direct commercial sale. And so with that, it brings margins that are very accretive compared to our typical defense portion of our portfolio. And again, that's part of what we also do even within our industrial needs here in the U.S. We develop commercial and we sell commercial pricing as a result of developing on our own dime, and that helps us to drive additional margin capability within our Defense & Space business.

So you've mentioned the M&A that you did in the last year or so and that was new for a while. We hadn't seen Honeywell Aerospace kind of lean in on the M&A front. Maybe just can you talk about -- you mentioned the attractiveness of those businesses, but how the integration has gone? And then how you're thinking about M&A going forward?

Yes. I mean, so the integrations have gone exceptionally well. We've just passed the 1-year mark on both of those companies that we acquired. I could not be any more pleased with how the integration has progressed. And in fact, the performance out of those businesses as expected and through the synergies that we were bringing as part of combining those businesses within Honeywell Aerospace have actually exceeded our expectations from a TVA perspective. So we're very pleased with how that has progressed. And you're right, we hadn't done much M&A, at least not to that scale historically over the years, and it kind of goes back to one of my earlier points that I made, which is, there's a lot of competition for capital within Honeywell International. There's a lot of competition for dollars to do M&A activity as well, which now, as I mentioned, is one of the benefits of the separation that we can kind of control that. We're not competing in that regard. It is foundational to our growth strategy going forward, I will tell you. I look at the business and I look at growing a business in 3 ways. You can do it organically, inorganically, partnerships or JVs. Those really are the 3 principles to be able to drive the growth of the organization. We've done an incredible job on the organic side. We're now dipping our toe back into the water on the M&A side, and I think we've been able to prove that we have a right to acquire companies because that integration has gone well and the financial performance is exceeding expectations, and we've got a very deep pipeline of other properties that we're very interested in as we go forward. So it will be a critical third leg of the stool, so to speak, in terms of our growth strategy to continue doing and exercising the M&A muscle.

That's great. That's great to hear. Backlog, I think it's a massive backlog, $39 billion, I think, last time, and you had strong book-to-bill. How are you thinking about just kind of the overall -- the visibility, how that rolls off as we think about the kind of the environment with the backlog?

Yes. I mean -- so you're right. I mean the backlog is at an all-time high for us at Honeywell Aerospace, book-to-bill of about 1.2. We've had consecutive quarters of double-digit order growth as a result as well. So there's a very, very strong underpinning that's driving our growth going forward as long as we continue to unlock the supply chain to enable that to materialize and which we will continue to do and continue to invest because that is foundational things we're going to be doing. What I will tell you is on the longer-term horizon, we have very good visibility in what's happening on the OEM front for commercial air transport. We also have tremendous visibility of what's happening in the business aviation side of the equation as well with the partners that we work with at the OEMs. And we're getting that visibility much deeper through the funding that is occurring both domestically and internationally for our defense programs. So we will start to continue to see that. Now eventually, at some point in time, things do need to normalize, right? I mean like I mentioned earlier, we've never seen -- I've never seen in almost 3 decades in the aerospace industry, I've never seen where all 3 of the end markets that we serve have been doing so well and growing. You're starting to see a little bit of a normalization on BGA. I think there's still tremendous opportunity in ATR in the air transport sector. And again, with the ongoing conflicts, the need to restockpile the munitions that have been used and/or have not been invested in over the last decade, I continue to see defense being a strong growth driver for us.

Yes. You guys are incredibly well positioned across the board. One last, just in the last minute or so, and it's not volume yet, but there's investment going on in air mobility and electrification and things are going on there. How are you seeing that evolve? Obviously, I think the -- we all know the critical hurdle is always certification and those always kind of move to the right, and particularly with the FAA today, there's obviously a go-slow approach, but how are you viewing -- how Honeywell is supporting that market?

Yes. So I think I have to start at the root of when we really got actively engaged in this a little bit because it will kind of explain where we see the industry today. So about 5 years ago, we stood up a stand-alone business within Honeywell Aerospace that was only focused on the advanced air mobility market segment. We recognize that there are many nuances associated with that segment, nontraditional players, a lot of entrants, a lot of disruptors, a lot of entrepreneurial ideation going on and a need to move at speed. So we created this business, isolated. We called it a greenhouse, and all they did was focus on that aspect of the portfolio, and I think we've been highly successful in that regard. We've secured many positions on multiple platforms, but we also knew very, very much in the onset that there's too many players. There will be a consolidation that will happen across the industry and some will rise to the top as a result of that. So we knew that. But what we did is from an investment profile, we took advantage of the fact that there was so much investment that was occurring in that space that we actually ended up using a lot of those investment dollars that were coming in from customer funding to actually accelerate development of some of our franchise portfolio. Think about our Honeywell Anthem integrated cockpit, think about our Honeywell Assure electromechanical actuation systems and ATTUNE for vapor cycle cooling systems. All of those large -- by and large, were funded coming out of that because what we do from an RD&E standpoint is we don't develop anything that is bespoke for a platform or for an end market. So even though we were tip of the spear in those developments with customer funding on those products that I mentioned a moment ago, we have secured positions with those products across traditional end market segments, whether it's commercial air transport, business and defense. And so that has been a great enabler for us to maximize the efficiency of our RD&E dollars. Now going back to the market for a second. I mean that market will certify. Those products will certify. LA 2028 is sort of a stake in the ground that our administration has put in, in terms of wanting to demonstrate the capability on a global stage in terms of U.S. technology and the like around the specific end market segment. So it will happen. These products will get certified, which is good, and I would say that the question really becomes the adoption, the ramp of said adoption, and we would expect that to happen sometime within the mid-2030s time frame where you start to see things at volume that then become meaningful to the business portfolio.

Terrific. Well, let's wrap there. We're out of time. Jim, thank you so much. Again, appreciate the support to the conference.

Really appreciate it.

Thank you. Thank you.