Honeywell International Inc.

Thank you for standing by, and welcome to the Honeywell second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. Please be advised that today's call is being recorded. I would now like to hand the call over to Sean Mecham, Vice President of Investor Relations. Please go ahead.

Thank you, Liz.

Good morning and welcome to Honeywell's second quarter 2023 earnings conference call. On the call with me today are Chief Executive Officer Vimal Kapoor, Senior Vice President and Chief Financial Officer Greg Lewis, and Senior Vice President and General Counsel Ann Matts. This webcast and the presentation materials, including non-GAAP reconciliations, are available on our investor relations website. From time to time, we will post new information that may be of interest or material to our investors on this website. Our discussion today includes forward-looking statements that are based on our best view of the world and of our businesses as we see them today and are subject to risks and uncertainties, including the ones described in our SEC filings. This morning, we will review our financial results for the second quarter, share our guidance for the third quarter, and provide an update to our full year 2023 outlook. As always, we'll leave time for your questions at the end. With that, I'll turn the call over to CEO, then we'll conform.

Thank you, Sean, and good morning, everyone. Let's begin on slide two. The second quarter was another strong one for Honeywell. We met or exceeded our commitments as our rigorous operating principles enabled us to navigate a challenging backdrop. We grew our adjusted earnings per share 6% year-over-year to $2.23 or up 13%, excluding a 15-cent non-cash pension headwind. Second quarter organic sales were up 3% year-over-year, led by double-digit growth in commercial aerospace, process solutions, and UOP. Our aerospace business continues to perform at very high levels. The second quarter backlog grew to a new record of $30.5 billion, up 4% year-over-year, and 1% sequentially due to strength in aero, PMT, and HPT. Similar to last quarter, orders continue to grow double-digit organically in aero, For other segments, unfavorable comparison to last year's peak supply chain disruption led to a single-digit decline in orders for overall Honeywell. We remain confident in our 2023 outlook as recovering end markets and operational excellence continue to deliver resilient results despite macroeconomic uncertainty. Our segment margin expanded 150 basis points year-over-year, exceeding the high end of our guidance range by 20 basis points, led by expansion in SPS, HPT, and AERO. Our continued focus on commercial excellence and greater gains from productivity enabled us to remain ahead of our inflation curve. Free cash flow was $1.1 billion in second quarter, up 34% year-over-year, driven by strong net income and improved working capital in line with our expectations. Greg will walk you through the free cash flow drivers in more detail in a few minutes. We deployed $2.1 billion to dividends, M&A, share repurchases, and growth capex. including opportunistically repurchasing 2.4 million shares throughout the quarter, reducing our weighted average share count to 670 million. I'm pleased with the progress we made this quarter on our portfolio shaping priorities. We invested in multiple new technologies utilizing our robust M&A playbook, including completing the acquisition of Compressor Control Corporation for approximately $700 million. As always, we continue to execute on our proven value creation framework, which is underpinned by accelerator operating system. The operating system, along with ongoing growth in our key end markets and technologically differentiated portfolio of solution, is enabling us to navigate a challenging economic backdrop and deliver on our commitment again this quarter. Looking forward, I'm encouraged by the strength we are seeing in our long cycle aero and energy verticals and remain confident in our position to outperform. Next, let's turn to slide three to discuss the important leadership announcements. Last month, we announced that Jim Correa will be succeeding Mike Madsen as Honeywell Aerospace CEO. I want to congratulate Mike Madsen on his retirement and extend my sincere gratitude for 37 years he has given to Honeywell. Mike has been an extremely effective leader and change engineer in our company and the aero industry. He has a rich history of exceeding expectations as Aerospace won an unprecedented $35 billion in new business opportunities in these last two years. His leadership and commitment to customers, employees, and the community is unparalleled. During his tenure as Aero CEO, Mike navigated the business through unprecedented pandemic disruptions while growing the top line and expanding margins by over 200 basis points. Because of Mike's passion and dedication to the business, he helped set up Honeywell Aerospace to be even more successful in the years to come. We're excited about the next phase of growth in Honeywell's Aero business under Jim Correa's leadership. We are fortunate to have someone with this level of experience and tenure ready to take the helm, a true testament to Honeywell's bench trend and focus on succession planning. Jim has been with Honeywell Aero for 17 years, and prior to his current position, he had held multiple roles of increasing responsibility across function and geography, most recently as president of our electronic solutions business. The medium-term setup for Aero is the strongest it has ever been. Flight hours continue to be strong, including wide-body upside, which is now underway. We have diverse and optimized platform exposure, particularly in business aviation. In fact, over the last few months alone, we have won $3 billion in business to provide OEMs and airlines with our engines, Vs and brakes, APUs, and flight management system, along with associated aftermarket services. In addition, supply chains are gradually improving, and we have returned to growth in defense and space. This momentum points to a robust multi-year trajectory for the largest businesses in Honeywell portfolio. Let's turn to slide four to discuss our recent corporate development activity. I'm excited about our recent capital deployment announcement closing on our previously announced compressor-controlled corporation acquisition and adding two strategic assets that will drive enhanced innovation and strength our technology portfolio. This mix really exemplifies the type of deals that we look to generate on a consistent basis. Last month, we closed our acquisition of CCC, a leading provider of turbo-missionary control and optimization solution, deploying approximately $700 million in all cash transactions. CCC technologies, including control hardware, software, and services, bolster Honeywell's high-growth sustainability and digitization portfolio with new carbon capture control solutions. CCC integrates seamlessly to our process solutions business and provides meaningful revenue synergy potential with Honeywell Forge. We are excited to extend Honeywell's leadership in automation and help customers accelerate their energy transition with the completion of this acquisition. We also acquired SkedaFence, an Israel-based company that delivers operational technology, or OT, and Internet of Things, or IoT, cybersecurity solutions for monitoring large-scale networks. SkedaFence brings proven technologies in asset discovery, threat detection, and security governance, which are key to industrial and critical infrastructure cybersecurity program, into our SCE portfolio. The OT cybersecurity industry is expected to grow to greater than $10 billion in the next several years, and the SCADA Fence portfolio pairs seamlessly with Honeywell's cybersecurity business, providing an end-to-end enterprise solution that helps customers enhance enterprise resilience. In addition, we signed an agreement with Saab to acquire its heads-up display, or HUD, assets boasting Honeywell's comprehensive end-to-end avionics and safety offerings. We'll partner with Saab to develop and strengthen the HUD product line, which enables pilots increased situational awareness, specifically at night or in difficult weather conditions. Importantly, the HUDs will be integrated into Honeywell Anthem, our revolutionary integrated flight deck with an intuitive user interface and highly scalable design, in addition to Honeywell's Primus Epic flight deck and retrofit solutions. I'm excited about our new technologies and the adjacency we have unlocked through our recent M&A activity. We said before, and we have an active and robust pipeline, and this is further evidence that we are continuously enhancing our portfolio by investing in new opportunities. We look forward to continuing to deploy our capital in coming quarters to create more value for Honeywell shareholders. Now, let me turn it over to Greg on slide five to discuss our second quarter results in more detail, as well as provide our views on guidance.

Thank you, Vimal, and good morning, everyone. We delivered another strong quarter in a very challenging operating environment. Second quarter sales grew 3% organically, led by double-digit organic sales growth in commercial aerospace, process solutions, and UOP, where demand strength continues to support Honeywell's short-term and long-term outlook. PMT grew at a robust 7% pace after four consecutive quarters of double-digit growth. Our long cycle warehouse automation business is around trough levels as expected, which led to overall volume decline of 1% for the quarter. However, excluding SPS, volumes were up 5% across the remainder of the portfolio. Our backlog remains at a record level, ending the second quarter at $30.5 billion, up 4% year over year, driven by strength and arrow in PMT. Supply chain constraints continue to moderate our overall growth rate, However, we continue to record sequential improvements in arrow output as expected and are reducing our past due backlog across our short cycle businesses. Our investments in Honeywell Digital have continued to yield commercial and operating benefits through surgical pricing actions, enabling us to expand segment margin by 150 basis points year over year to 22.4% and exceed the high end of our guidance by 20 basis points. Three out of four segments expanded margins in the quarter, each by more than 100 basis points, with SPS leading the way as expected. On cash, we generated $1.1 billion of free cash flow, up 34% year over year. This increase was driven by stronger net income, as well as improved working capital performance, with higher collections and good progress on inventory. where we have improved our demand planning and optimized our production and materials management using our improved end-to-end process and digitalization capabilities. Now let's spend a few minutes on the second quarter performance by business. Aerospace sales for the second quarter were up 16% organically, led by over 20% growth in commercial aviation. This marks the fourth consecutive quarter of double-digit aerospace organic sales growth, and over two years of double-digit growth for commercial aviation, supported by strong recovery in both flight hours and higher ship-set deliveries. Growth remained strongest in commercial aviation aftermarket, up over 25%, led by over 30% growth in air transport, as increased flight hours resulted in higher spare shipments and repair and overhaul activity. Commercial original equipment sales also increased double digits, driven by increased build rate. Defense and space grew for the second consecutive quarter as we were able to execute on our strong backlog and increase our sales volumes. The aero supply chain continued to make progressive improvements as better material availability enabled 20% year-over-year growth in original equipment and spare shipments again in Q2. Historically high past-due backlog increased again in the quarter as orders growth outpaced our backlog burndown. Segment margin in aerospace expanded 120 basis points year over year, to 27.7% due to commercial excellence and higher volume leverage partially offset by cost inflation. Performance materials and technology sales grew 7% organically in the second quarter, with double-digit growth for the third consecutive quarter in both HPS and UOP. Process solution sales grew 11% organically, driven by strength in our projects business and in lifecycle solutions and services. In UOP, sales also grew 11% organically, led by gas processing and refining catalyst shipments. Sustainable technology solutions within UOP had another standout quarter in Q2, with strong triple-digit orders growth and over 30% sales growth. In advanced materials, continued demand for fluorine products portfolio was offset by expected macro-driven softness in our electronics and chemicals business. leading to flat organic growth despite challenging year-over-year comps. Segment margin contracted 60 basis points to 21.7% as favorable price cost was more than offset by challenges in advanced materials, including lower volumes and the previously communicated disruption in one of our plants. Safety and productivity solution sales decreased 21% organically in the quarter. Sales declines are primarily driven by warehouse and workflow solutions and productivity solutions and services. While the projects portion of our Intelligrated business is around trough levels and the current low investment warehouse automation environment, the aftermarket services portion of the business continues to deliver solid double-digit growth. Sensing and safety technologies was flattish in the quarter, with ongoing strength in our industrial sensing product portfolio offset by modestly lower volumes and safety. Segment margin performance for SPS once again led Honeywell, expanding 410 basis points to 16.7% as a result of productivity actions and commercial excellence, partially offset by lower volume leverage and cost inflation. Honeywell building technology sales were flat year-over-year on an organic basis in the second quarter. Building solution sales grew 2% organically, despite expected year-over-year order softness, as we continued to execute on our robust backlog. with organic growth in our services business and no change year over year in projects. Turning to our products portfolio, we continue to see sequential improvements in the supply chain environment and we're burning down our past due backlog as expected. Building product sales decreased 1% organically as continued growth in our world-class fire products business was offset by declines in security and building management systems. Our continued commercial excellence and productivity actions have allowed us to once again mitigate the effects of elevated inflation, expanding HPT's segment margin by 200 basis points to 25.5%. Honeywell Connected Enterprises' strong software franchise continues to be accretive to overall Honeywell and a powerful differentiator. Overall double-digit organic growth was supported by strength in cyber, industrial, aircraft, and buildings. Double-digit orders growth in the quarter is supportive of continued strong performance for HCE. Overall, this was a great result for Honeywell. Our operational efforts enabled us to grow second quarter gap earnings per share 21% year over year to $2.22 and adjusted earnings per share 6% year over year to $2.23, despite a 15 cent headwind from lower non-cash income from our overfunded pension. From a year over year perspective, segment profit drove 21 cents of the improvement in earnings, the main driver of our EPS growth. A LOWER ADJUSTED EFFECTIVE TAX RATE CONTRIBUTED $0.06 OF IMPROVEMENT AND REDUCED SHARE COUNT ADDED AN ADDITIONAL $0.05. EXCLUDING THE PENSION HEADWIND, BELOW THE LINE AND OTHER CREATED A $0.04 YEAR OVER YEAR HEADWIND DUE TO HIGHER NET INTEREST EXPENSE FOR A TOTAL EPS EXCLUDING THE PENSION IMPACT OF $2.38 OF 13% YEAR OVER YEAR. A BRIDGE FOR ADJUSTED EPS FROM 2Q22 to 2Q23 can be found in the appendix of this presentation. Finally, as Vimal mentioned earlier, we continue to leverage our strong balance sheet, deploying $2.1 billion in the quarter, bringing the year-to-date total to $3.7 billion as we execute on our capital deployment strategy with meaningful portfolio updates. So overall, disciplined adherence to our best-in-class Honeywell value creation framework provided us with the operational agility to meet or exceed our guided financial metrics. Now let's turn to slide six to discuss our third quarter and full year outlook. While a number of challenges persist in the current environment, our rigorous operating principles enable us to increase our guided metrics for the full year. Our demand profile remains robust with record backlog levels, particularly in aerospace and PMT, and stabilized sequential short cycle order rates across much of the portfolio. For our Q3 sales guidance, we expect to be in the range of $9.1 to $9.3 billion, up 1% to 4% on an organic basis. We now expect full-year sales of $36.7 to $37.3 billion, which represents an increase of $200 million on the low end, incorporating our strong second quarter results. We're raising the low end of our organic growth range now 4% to 6%, and we continue to expect a greater balance of price and volume versus last year. We've upgraded our full-year expectations in PMP while softening our outlook for SPS to reflect our latest views on the end market speech. Moving to our segment margin guidance, we expect the third quarter to be in the range of 22.3% to 22.6%, resulting in year-over-year margin expansion of 50 to 80 basis points due to commercial excellence and productivity action. For full year 2023, we are upgrading our segment margin expectations by 10 basis points on low end to a new range of 22.4% to 22.6%, or 70 to 90 basis points of year-over-year expansion, driven by improvement in HPT, SPS, and P&T. Now let's take a moment to walk through the third quarter and full year expectations by business. Looking ahead for aerospace. We continue to be excited about demand across our end markets and expect sequential sales growth throughout the second half, supported by ongoing sequential factory output increases and strong orders. Commercial aftermarket, particularly in air transport, should lead growth in the aero portfolio as flight hours continue to recover and we see further recovery in the widebody market from increased international travel. On the commercial original equipment side, We expect build rate strength to drive volume progression in the second half. In defense and space, we expect sequential and year over year growth in the second half and continue to work through our robust backlog. As a result, we expect defense and space to grow at a mid single digit rate for the full year 2023. We continue to expect modest sequential improvement in the aerospace supply chain as growing commitments from our suppliers year-to-date, coupled with a second consecutive quarter of 20% output increases, give us continued confidence in our outlook. Given these factors, we still expect aero organic sales growth in the low double-digit range. For segment margin, we still expect aero to be flattish for the year as we see modest mixed pressure within our OE business, offsetting overall volume levels. In performance materials and technologies, encouraging fundamentals persist across our end markets, driving favorable growth. For the third quarter, we expect sales to increase year over year and sequentially, coupled with a seasonally strong fourth quarter. Growth will be led by smart energy, projects, and lifecycle solutions and services within process solutions, as the strength these businesses saw in the first half continues into the second half. In UOP, our growth outlook for the year is supported by robust demand for petrochemical and refining catalysts. The sustainability technology solutions business within UOP will also provide growth as we capitalize on legislation-backed demand. For advanced materials, we see ongoing demand for chlorine products, combined with improvements in electronic materials, supportive of sequential growth from the first half. Despite more challenging comps in the second half, these favorable market conditions and our strong execution give us confidence to upgrade our full-year sales growth expectations for PMP to high single digits compared to mid-single digits last quarter. For segment margin, we expect sequential improvement throughout the year, including robust expansion in the fourth quarter, resulting in modest year-over-year improvement for overall 2023. Looking ahead for safety and productivity solutions, our outlook continues to be impacted by the decline in CapEx for new warehouse capacity, However, our short cycle businesses appear to be stabilizing as we await a demand acceleration in the coming quarters. For the third quarter, we expect this to lead to organic sales decline, similar to Q2. However, we anticipate another quarter of strong growth in the aftermarket services portion of our Intelligrated business, and sensing and safety technologies should return to growth. With the SPS portfolio bouncing along the bottom of the cycle, we now expect full-year sales to be down low double digits in 2023. However, segment margin continues to be a bright spot for SPS as we implement productivity actions and drive operational improvements, and we still expect strong margin expansion for the full year. In building technologies, the macroeconomic environment remains challenging, so our team continues to execute well and burn down our past due backlog. For the third quarter, we expect sales to be relatively flat year over year as we continue to see more challenging comps and the timing of short cycle recovery remains uncertain. For the year, we still expect sales in our long cycle building solutions business to outgrow the more short cycle building products. Our institutional verticals, such as airports and education, will remain strong as we continue to see stimulus spend come through. The business is well aligned to energy efficiency and sustainability megatrends. Given these dynamics, we still expect HPT sales for the year to grow low single digits organically, we see potential for growth acceleration as we exit 23. for segment margins we now expect hbt to lead honeywell margin expansion as a result of strong inflation management and productivity actions turning to our other core guided metrics net below the line impact which is the difference between segment profit and income before tax is expected to be in the range of negative 120 million to negative 170 million dollars in the third quarter and negative 500 million to negative $625 million for the full year. This guidance includes a range of repositioning between $40 and $85 million in the quarter and $225 to $325 million for the year as we continue to fund attractive restructuring projects and properly position Honeywell for the future. We expect the adjusted effective tax rate to be roughly 23% in the third quarter two points higher than our full year guide of 21% and two points higher than 2Q, which is unchanged from our previous guide. That implies a lower 4Q rate due to the timing of discrete items. Importantly, this higher tax rate in Q3 reflects an approximately six cent headwind to EPS, but will be offset by a commensurate tailwind in 4Q, leaving the full year unchanged. we expect average share counts to be around 669 million shares in Q3 and 670 million shares for the full year. As a result of these inputs, our adjusted EPS guidance range is now between $2.15 to $2.25 for the third quarter, which would be down 4% to flat year over year. Excluding the pension headwinds, third quarter EPS growth would be up 2% to up 6%. For full-year EPS, we are increasing the midpoint of our guide, upgrading the low end of the range by 5 cents for a new range of $9.05 to $9.25, up 3% to 6%, reflecting our continued confidence that 2023 will be a solid growth year for Honeywell, despite the year-over-year pension headwinds. Excluding these headwinds, EPS growth would be 10% to 12% for the year. After a strong first half and continued progress on inventory and receivables management, we expect to meet our original free cash flow guidance of $3.9 to $4.3 billion in 2023 or $5.1 to $5.5 billion, excluding the net impact of settlements. So to wrap up, our original thesis for 23 remains intact. Robust backlog of $30 billion underpins our strength, our growth, though the timing of the short cycle recovery remains uncertain. We're encouraged by the strength of our portfolio and continue to execute on our rigorous operating playbook through a challenging backdrop to deliver outstanding results. Now let's turn to slide seven, and I'll hand the call back to Zimmel for some long-term comments.

Thank you, Greg. I'd like to take a minute to zoom out from the quarterly result to emphasize the long-term journey Honeywell is on. As you can see from the charts on the slide, Honeywell has made tremendous progress Whether it's accelerating organic growth, expanding gross margins and segment margin, or growing free cash flow, we have come a long way. But we are not close to done, and we have identified a critical lever that will enable us to reach even higher level of financial performance. We remain committed to our long-term growth algorithm that we discussed during our May Investor Day and during 2023 guidance, closely aligned with this framework. We carefully track our progression towards achieving our targets and remain confident in our ability to accelerate growth, achieve 25% segment margin, and expand gross margin to above 40%, and free cash flow margins to mid-teens and beyond. As I said in May, my priorities as CEO include accelerating organic growth and enhancing our innovation playbook, growing our sustainability and digitalization capability, and maintaining our leadership position in high-growth regions. I also plan to evolve the accelerating operating system to drive incremental value through business model optimization. Additionally, Honeywell has undergone substantial internal transformation, the result of which you can see in our top-line and bottom-line improvements over the last decade. I plan to further optimize the portfolio through strategic capital deployment and reduce exposure to non-core areas. Three Ds announced this quarter demonstrate the strength of our M&A pipeline and our commitment to deploy capital. I'm excited to lead the change for this next phase of transformation for Honeywell, and I'm confident in our ability to deliver superior returns for our shareholders. As we deploy our global design model across our portfolio, we are uncovering substantial opportunities to capture value, whether it is expanding margins, driving incremental sales growth, or generating more cash. and we will continue to update you as these efforts translate increasingly into enhanced financial performance. Now let's turn into slide eight, into closing part before we move into Q&A. Honeywell executed very well in what remains a very dynamic operating environment. We'll continue to effectively manage through ongoing external factors while delivering on our commitment by relying on our value creation framework. The macro economy remains challenging and the timing of a short cycle acceleration is uncertain. But with ongoing strength in our two biggest end markets, aerospace and energy, combined with operating rigor you have come to expect from Honeywell, we are confident in our ability to weather near-term challenges and meet our performance targets. Thank you all to our Honeywell colleagues who continue to enable us to outperform in any environment. With that, Sean, let's move to Q&A.

Thank you, Vimal. Vimal, Greg, and Anne are now available to answer your questions. we ask that you please be mindful of others in the queue by only asking one question. Liz, please open the line for Q&A.

Our first question comes from the line of Andrew Obin with Bank of America. Andrew, your line is now open.

Yeah, can you hear me? Yep, good morning, Andrew. Yeah, good morning. Just a question on advanced materials. You know, it's a It's a good return business. When should we expect this business to return to growth? And also, you know, do you guys need to add capacity to grow this business? How strong the structural demand is? Thank you.

Yeah, thanks, Andrew. So I think the key is the comps of advanced materials to 2022. We grew more than 20% last year. So Combine that with some of the weaknesses we see in electronic materials size, we are having a moderate year for advanced materials this year. We do expect markets to turn better during second half and more importantly in 2024. To your question on capacity expansion, we remain very excited. In fact, in the next draft cycle, we expect more capital investment increase our capacity for advanced material for some of the existing offering and potentially some new offering. So overall, we remain very bullish on advanced materials portfolio.

Thank you.

Our next question comes from the line of Steve Tusa with J.P. Morgan.

Hey, good morning, guys. Good morning, Stephen. Um, the underlying, uh, I guess on the positive side, the very strong margin in aerospace, um, tough to kind of like cut through, you know, the OE incentives. Um, was there anything unusual there? Like where the OE incentives, I, you know, we just don't know the quarterly timing of those. I mean, I'm, I'm kind of getting to an underlying incremental of around like 40% for that business. If we adjust for some of these OE incentives, um, Can you just maybe talk about some of the moving parts there and whether I'm roughly right on the math?

Yeah, so the OE incentives, we haven't disclosed the exact amount of them, but the first half is going to be a little lighter than the second half in terms of those OE incentives. So that's why when we talk about the full year margins still being flattish, even though we had a pretty strong Q2, I think that's really what's going on in that regard.

Okay, and then just one last one on HBT. You know, that business just perhaps should be growing better in this environment. Even building solutions was kind of like, you know, weak, so there's really not a function of these. That really can't be a function of destocking. So maybe, you know, what are the moving parts there and why are you guys not keeping up with, you know, the other non-res players out there? Thanks.

Yeah, so Steve, we are conscious of our margin rates in HPT and make careful selection of our projects which have adequate margins and strong service days. So I think given that choice we make, you can see impact of that in margin expansion of building technologies, and that comes to a certain degree at the organic growth rate. So it's a choice to be made, and we want to deliver both in ideal work But we remain biased more towards growth in margin expansion versus the top-line growth. Great. Thanks a lot.

Our next question comes from the line of Sheila Kailu with Jefferies.

Good morning, guys, and thank you. I wanted to ask an aerospace-specific one, if that's okay. Last quarter, you raised your aerospace guide to upload double-digits. And I think the bulk of the raise had come from the OE side, which you guys are doing well in. But there's been a bunch of moving pieces this quarter with the max officially going to 38 per month yesterday. And then, of course, engine issues could force like a build, new build versus spares issue at Airbus on the A320. So kind of how are you thinking about the puts and takes for aerospace OE as we get into the second half following 15% growth in the first half?

So, Sheila, our deliveries for the year are pretty well aligned with all OEs, both on air transport as well as on the business jet side. We have our commits to all key OEMs for Q3, Q4, and our projections are based upon those commit rates. So I can't comment on their commitments to their customers, but we are pretty well aligned our commits to them. And our revenue growth and our volume growth is linked to that. And it's going to be pretty strong. I mean, we expect the momentum in aerospace not to change in 2023, or for that matter, even in 2024. Our backlog is extremely strong, and our supply chain continues to improve every quarter.

And the recent events have not changed their expectations of us to this stage.

Got it.

Thank you very much. Our next question comes from a line of Julian Mitchell with Barclays.

Hi, good morning. Maybe just my question would be on SPS. Just wanted to try and understand how the sort of orders and backlog there is moving. I can imagine it's not moving well, and that's why the revenue guide has come down. But any finer points on the orders and backlogs? And I suppose in the conviction level around warehouse accelerating next year, if that's starting to get tested now because of the ongoing backlog pressure? And if we think about the shorter cycle businesses, how severe do you think the inventory depletion needs are in that business? And what does that mean for exit rates in SPS from this year on the top line?

Sure. So I would say if we take IGS first, you know, our order rates are down, you know, meaningfully as we've talked about, but when we look at the overall pipeline, we're starting to see the pipeline build back to a little bit better levels. That may not occur, you know, immediately, but we see there is a chance that we may be growing again in 2024 that will really be dictated by how the back half orders really come in. But we are starting to see a little bit more strength in the pipeline, which I think is a positive. As it relates to the short cycle businesses, what we talked about, it's down year on year because the first half of the year was particularly high. But we're seeing stabilization. The last two to three quarters have been either going up sequentially or staying roughly flat. So I think we've reached a stabilization point. on a short cycle, and as and when some of those markets begin to recover, then we'll see some growth. So as we think about SPS overall, I would expect it's going to grow in 2024. It's probably not going to be at the high end of our growth rate for our SPGs, but that's how we see it with the data that's coming through right now.

Thanks very much.

Our next question comes from Scott Davis with Milius Research.

Hey, good morning, everybody, and welcome, Vimal. A couple of small things here. One, I mean, you guys are spending a couple hundred million a year on quantum. Vimal, do you have kind of an evolved vision of where this business goes and how you can monetize it, when you can monetize it, if, you know, is it a you know, can the cash flow bleed go down, you know, a little bit over time or is there some kind of positive end game that you see here?

So Scott, I mean, we have publicly stated that we would like to monetize value of the quantum investment we have made in Continuum. And as the markets are more ready for IPO, which probably are here for a while, we are getting prepared for that. So we are doing everything towards that end game. and the strategy hasn't changed to create more value for our shareholders at appropriate time through an IPO for that business.

Okay, fair enough. And just quickly, just following up on Steve's question, I mean, I would have thought Forge for Buildings would have given you a little bit of a lift given the timing of when you rolled that out. You know, it... I understand project selectivity, but I would have thought that would have given you a little bit more of a tailwind into the quarter. Is there timing issues there, and those orders haven't really kicked in yet, and we'll see that later in the year, or is there other competitive dynamics?

Look, I mean, we are definitely seeing better bookings for forceful buildings, but one fact I would like to state is that business runs on a SaaS model, so even a large booking The revenue recognition process is different from traditional perpetual license-based model. So the revenue accretion is going to spread over multiple years for that. And we have consciously made that decision because rather than showing a short-term win, we are more biasing ourselves towards more recurring revenue model there, as I stated before. So that's why you see lesser impact. But we are scoring wins in force for buildings. And I continue to remain very bullish on that segment.

Okay, fair enough. Best of luck, Bimal.

Thank you, Scott.

Our next question comes from Nigel Coe with Wolf Research.

Thanks. Good morning. Thanks for the question. Just wanted to maybe just put a final point on Julian's question on SPS. So obviously encouraging signs of a bottoming process here, but it does feel like the guidance embeds uh flat to maybe maybe flattish plus or minus uh growth in fourth quarters just to make sure that's the case and you've got good lines out on that and maybe on hbt just just break down geographically what you're seeing uh versus you know north america europe and china and whether there's any um channel dynamics here we should uh think about as well so i'll start with hpd turn to grave for uh respond to sps question i think hpd uh from our uh

Geographic perspective, Europe continues to be where we want to have better outcome. I think that's a bit of a drag at this point. The strength is in high-growth regions. We see strength in Middle East, India, and China in buildings, and North America is more of, I would say, sequentially no change within the business. So that's kind of our overall dynamics. On the channel side, I mean, the channel demand will be determined by the end market demand. So it's a very short cycle business. So we don't see any dynamics of channels having less or more inventory in the HPT business. Maybe, Greg, you want to respond to SPS?

Yes. So SPS, it's likely to be down in the fourth quarter. So I would say it's not going to be flattish. It's going to be probably more like down. I think 3Q and 2Q are going to look pretty similar to one another, and then we'll get a little bit of a normal seasonal bump in the fourth quarter. So that's the way I would think about the progression for SPS top line overall.

Great. Thanks. Yep. Thanks, Pierre.

Our next question comes from the line of Jeffrey Sprague with Vertical Research Partners.

Hey, thank you. Good morning, everyone. I was going to ask a near-term question, but given your response about margins and HPT, I wonder if we could maybe just zoom out and just kind of think philosophically about kind of the trade-off between growth and margins, right? You know, we have seen situations in the past where companies with high margins get, for lack of a better term, a little bit trapped in wanting to maintain and grow the margins, right, and growth ends up suffering as a result. So could you, and you addressed this to some degree, obviously, when we were together in New York, but could you maybe elaborate a little bit more on your philosophy, you know, relative to managing those two metrics and how you make sure you don't hinder growth by overly focusing on margins?

Jeff, our business model in HPT is combination of serving the market both through direct and channel. So we have to make choice what business we want to serve direct and what business we want to serve through channels. And in direct, we want to pick projects which have a strong first-party content and aftermarket services. So given that algorithm, we make choices with that rule. And we are sensitive to drive top line growth, but we are not going to compromise to book projects which are lower margins and show shiny top line growth without any margin expansion. That has been our principles. And the reason we are quite determined on the principle is it takes one bad project to deteriorate the entire business and the portfolio. So we remain committed to that model. I'm not suggesting that we will not see growth in building technologies. I do believe that as energy efficiency becomes more prominent across the board, our energy business there will do well, and we will deliver more growth in the project side of the house, too. But that remains our overarching goal.

Yeah, thank you. I sort of meant the question on a total Honeywell basis also, though.

Okay. On total Honeywell basis, I mean, organic growth on the top end of our range is my biggest priority. I stated that in Investor Day. If something I want to make my contribution in my tenure is how we grow at a higher rate. Now, we are having favorable macros in two of our biggest SPGs, both in Aero and PMT. So on the strength of that, and if we couple that with the right new products, I see no reason that we should be delivering our growth in upper end of our four to seven algorithms. And that's what I work on every day and continue to drive our new product execution and then M&A accelerating our overall growth algorithm. You know, that remains my top commitment.

Thank you for the perspective.

Our next question comes from the line of Josh Pokrowinski with Morgan Stanley.

Hi, good morning. Hey, Josh. Hey, so just want to maybe flip around the HBT question from the other perspective on PMT. I mean, you're seeing some of the bulk chemical guys go through destocking. I think traditional oil spending has been okay, but maybe not as strong as what you guys are seeing and some of the other process guys are seeing. I guess just how much are we getting away from kind of traditional oil versus either some of these mega projects or energy transition? Like, is this business really transcending its roots of, you know, even kind of five, six, seven years ago?

Sure. So, Josh, if I look at each of the three segments, our automation business process solution has increasingly reduced its dependence on oil and gas. It has diversified very well in other end markets. energy storage, you know, the gigafactory, metals and mining, et cetera. So we can see that in the growth rate of revenue generation for process solution, and we remain very bullish on that business for 2023 and 2024. The UOP segment, our strategy has been to grow our business into sustainable technologies, renewable fuels, clean hydrogen, carbon capture, And we see pretty strong bookings in our sustainable technologies business. Just as a data point, now we have licensed 40 renewable fuel projects till Q3, and on a path to be 50 by, I would say, Q1 of 2024, which I mentioned in a couple of earlier investor meetings. So UOP business is becoming also less linked to traditional refining petrochemicals, but fast moving towards renewable technologies. And in advanced materials, our business is very specialty chemicals, solstice product line continues to grow. We see some pressure in electronic materials, which is reflected in our overall growth rate. But we do expect that to turn back into normalcy in 2024. So overall, the extremely positive outcome and bullish view on PMT. for second half of 2023 and 2024. The booking rate remains strong. Backlog is very strong. New innovation pipeline is very, very strong. So all good news there. Understood.

Our next question comes from Joe Ritchie with Goldman Sachs.

Thanks. Good morning, guys. Good morning. And so just two quick ones. I guess just on SPS, we've talked a little bit about the growth dynamics for the year. I'm just curious how the reduction in the short cycle businesses is perhaps impacting margins for the second half of the year. And then the other question is really around the defense business. It's nice to see the inflection there. I'm just curious, at what point do you really start to see an acceleration in defense growth, just given what you know about your production schedules?

So the way we have guided it, we are, you know, short cycle orders have stabilized and we're expecting similar trend over the next few months and our guide is based upon that. We are expecting stronger performance in warehouse automation orders because our pipeline has become better, but that will really strengthen our 2024 position given the long cycle nature of the business. And that's our forecast right now, and we'll continue to update you if things change.

Yeah, and I would just say, Joe, that the teams have resized their cost envelope to the current reality. And as and when the short cycle businesses reaccelerate, you know, you can imagine those are very high margin at the VCM level, and that will create a lot of acceleration from a margin rate standpoint. So, you know, the margin rates that we're going to be printing now are going to be within a tighter band until we see that acceleration come, but their business is poised for it. And we'll see, is that going to be Q4? Is it going to be Q1? you know, remains to be seen, but we've sized the business properly, and there's going to be fairly substantial leverage opportunities, you know, when that acceleration happens.

And then he had a question on defense, and we could see an acceleration in demand there.

Yeah, so in defense, our bookings remain very, very strong. So we are working our supply chain constraints there, and we do expect our delivery performance to be better in second half versus first half. So we had low single digits in the first half of the year. We expect the year to finish more in the mid-single digits for the defense business.

And from here, though, you know, we've passed probably the comps where, you know, small increments are going to create, you know, meaningful growth from a percentage basis. So it should be all, you know, accretive from this point on.

And also I should also mention we see, you know, longer term for the defense business pretty strong demand outside the United States. As we can all imagine, the recent war in Ukraine has created more higher budgets by different governments, and we clearly see those signals coming to us in terms of demand from NATO countries, other friendly countries, and that will play out even more stronger for the defense business in the times to come.

Great. Thank you.

Our next question comes from the line of Dean Dre with RBC Capital Markets.

Thank you. Good morning, everyone. Good morning. Hey, just want to circle back on SPS if we could. On warehouse automation, what are you seeing in the pipeline that suggests a bottoming? And then a related question is, can you give us any sense of when you'll hit this targeted critical mass of installations that will drive that flywheel of attractive aftermarket? How close are you to that? What kind of time frame?

So the pipeline is growing very nicely, and that gives us a little bit more optimism on better orders performance for the business in the second half of the year. And the part of the pipeline growth is driven by much more diversified end markets we serve now. So we are not limited to e-commerce. We are diversified into retail, into fashion, into logistics. So that wider coverage is giving us – better pipeline and, you know, we are anticipating good progress in the orders in the second half of the year. On the aftermarket flywheel, I would say it's been working now. We are growing double digits in aftermarket in 2023 and will cross our aftermarket business more than half a billion dollars in bookings and pretty much nearly the same revenue for the year. And we don't expect the momentum to stop. That's our strength. Honeywell has a strong playbook on how to drive aftermarket services, and that's a value we'll continue to add into the business. And our strength in that business in 2024, therefore we anticipate low to moderate growth, but very strong margin expansion because we continue to build more business with more first-party content. and very strong aftermarket. And we've coupled the two together. We do expect pretty healthy margin growth in warehouse automation business in 2024.

Yes, I mean, that business was around $200 million of the total in 2018. By 2022, it doubled to roughly $400 million. As Vimal said, this year it's going to be over $500 million.

Aftermarket business.

So that aftermarket is happening.

Great. Thank you. You're welcome.

Our next question comes from the line of Nicole DeBlaise with Deutsche Bank. Yeah, thanks, guys.

Good morning.

Good morning.

Just maybe on PMT, if you guys could talk a little bit more about the order activity you saw within UOP and HPS in the quarter, and then on the margins, you talked about the challenges in advanced materials. I guess, how does that kind of phase through the second half of the year? Thank you.

So orders remain pretty strong in first half for UOP and HPS. And we expect to finish here strong in both the businesses, I would say, high single-digit orders growth in both UOP and HPS. And I explained the rationale of it. In HPS, it's more diversified end markets and our strength of our aftermarket business there. And in UOP, it is diversifying to renewable technologies. And as they become more and more important part of our portfolio, it continues to grow the business. And UOP, the catalyst business, continues to have a lot of strength in both refining and petrochemical catalysts. Advanced materials, as I mentioned, 2022 was an outstanding year. 20% plus growth, so our comps year on year are tough. The margin rates are driven by some of the plant shutdown, which we had announced earlier, so that certainly put pressure on our cost positions. And then some contraction in electronic materials business, which is depressing our margins. But overall, it's still highest margin business in the PMT portfolio. And as mentioned before, with the potential capacity expansion coming in years to come, this business is poised to perform very well in our portfolio.

Yeah, Nicole, if you think about this year, we're literally going to progress each and every quarter sequentially a little bit better. You know, we picked up about 110 basis points sequentially from 1Q to 2Q. We expect, you know, some additional sequential improvement in Q3 and then again in Q4. So, you know, I think as we get to the end of the year, it'll look like modest year over year for the full year, but it's going to be a nice sequential step up quarter to quarter to quarter.

Thanks, guys.

Thank you.

Liz, I think we have time for one more question.

This question comes from the line of Andrew Kaplowitz with Citigroup.

Good morning, everyone. Hey Andrew. Daniel, could you talk about the stepped up level of acquisitions you did in the quarter? Would you expect that kind of activity to continue over the next few quarters? Have you changed any of your methods for assessing potential acquisitions? I think, you know, given the investor that you probably didn't, but could you talk about the pipeline of opportunities going forward?

Look, Andrew, the pipeline remains extremely strong. We are actively working more outbound activities in M&A and remain very optimistic if we can get the deals done at the right price. Because one thing we're not going to compromise is our deal metrics. We want to stay disciplined to create shareholder value. But at the same time, our number of opportunities in the play are at a much higher elevated level compared to, you know, this time in the past. So, Anne, if you want to add any comment from your perspective.

Yeah, I would just add the pipeline is growing. It's rich. We feel good as a strategic acquirer. We maintain the view that it's a hospitable environment for strategic acquirers, while the private equity community still is having a harder time financing. So it's a good time for us to be a buyer, and we expect that environment to continue into 2024 and beyond. Thank you. Thank you.

Thank you. I'd now like to turn the call back over to Vimal Kapoor for closing remarks.

Thank you. Our value creation framework is working. We are deploying our rigorous operating playbook to navigate near-term uncertainty. Honeywell remains well positioned to outperform in any environment as we capitalize on recovering end markets combined with solid operational executions. Thank you all our Honeywell colleagues who continue to drive differentiated performance for all our customers and shareholders. Thank you for listening, and please stay safe and healthy.

This concludes today's conference call. Thank you for participating. You may now disconnect.