Honeywell International Inc (HON) — Q2 2020 Earnings Call Transcript

Thank you, Warren. Good morning, and welcome to Honeywell’s second quarter 2020 earnings conference call. On the call with me today are Chairman and CEO, Darius Adamczyk; and Senior Vice President and Chief Financial Officer, Greg Lewis. This call and webcast including any non-GAAP reconciliations are available on our website at www.honeywell.com/investor. Note that elements of this presentation contain forward-looking statements that are based on our best view of the world and of our businesses as we see them today. Those elements can change based on many factors, including changing economic and business conditions and we ask that you interpret them in that light. Unless otherwise noted, the cost action plans described herein are not final and may be modified or even abandoned at any time. No final decision will be taken with respect to such plans without prior satisfaction of any applicable requirements with respect to informing, consulting or negotiating with employees or their representatives. We identify the principal risks and uncertainties that may affect our performance in our Annual Report on Form 10-K and other SEC filings. This morning, we will review our financial results for the second quarter of 2020 and share our views on the third quarter of 2020. As always, we’ll leave time for your questions at the end. With that, I’ll turn the call over to Chairman and CEO, Darius Adamczyk.

Thank you, Mark, and good morning, everyone. Let’s begin on slide two. The second quarter was one of the most challenging quarters Honeywell has ever faced. The widespread repercussions of the COVID-19 pandemic and price volatility impacted many of our businesses and end markets. There are a number of factors beyond our control in the current environment. We were laser-focused on the drivers of value that we can control. In the second quarter, we made numerous investments in newly emerging growth opportunities. We aggressively managed cost to protect margins and we generated very strong cash flow. We delivered adjusted EPS of $1.26 in the quarter on sales that were down 18% organically, consistent with the greater than 15% organic sales decline we signalled in May. Our phase 1 cost plans delivered approximately $500 million of year-on-year benefits in the second quarter and we completed planning for a phase 2 plan. These actions helped us protect margins, limiting our decremental margins in the quarter to only 33%. In fact, we were actually able to expand segment margin in two of our four segments. Despite the challenging macro-economic conditions, we generated $1.3 billion of pre-tax flow driven by cost actions and customer collections resulting in adjusted free cash flow conversion of 140%. We prudently deployed approximately $900 million of cash primarily to dividends and CapEx investments. We committed approximately $250 million of incremental growth, capital expenditures compared to our previously allocated budget for new projects to accelerate our investments in safety products, Intelligrated, and other growth opportunities. These are high return investments expected to generate triple-digit IRRs. Let’s turn to slide three to discuss the work we’ve done to pivot our business given the current environment and emerging customer needs. I'm proud of the quick mobilization by employees throughout the company to rapidly innovate and provide solutions for both urgent and long-term customer needs. To address the urgent need for PPE, we are significantly growing our personal protective equipment business. We expanded facemask productions, specifically our N95 and equivalent mass production in Arizona, Rhode Island, the United Kingdom, India, the UAE, and China. In the U.K., we created a new manufacturing line capable of producing a significant amount of masks at our new site in Scotland, which will assist the U.K. government's response to the COVID-19 pandemic, as well as serve the European region. In addition to our expansions in the United States, India, and China capacity, we have added capacity in the UAE. We're a partner of Strata Manufacturing, a subsidiary of the Abu Dhabi state fund Mubadala Investment Company, to produce N95 masks. Beyond masks and other PPE, we’re innovating to provide creative solutions for new areas of customer demand. We recently announced our partnership with SAP to create a joint cloud-based solution to improve building performance, based on Honeywell Forge and the SAP Cloud Platform. Building owners often need to pull data from disparate sources that are not normalized, making it extremely difficult to determine the true efficiency and utilization of their portfolios. The Honeywell Forge and SAP Cloud for real estate solution will streamline and combine operational and business data enabling customers to benefit from building performance optimization, including reduced carbon footprint and lower energy costs as well as improved tenant experience. This will be especially useful as buildings come back online in the midst of the COVID-19 pandemic and economic crisis as building owners are expected to focus on key performance indicators tied to enhanced occupant safety, and reduced operating costs. We have also launched an integrated set of healthy building solutions to help building owners improve the health of their building environments, operate more cleanly and safely, comply with social distancing policies, and help reassure occupants that it is safe to return to the workplace. We are partnering with pharmaceutical and biotech customers in our Aclar Healthcare Packaging business to develop innovative packaging solutions for future COVID-19 therapies and vaccines. We have launched new bottles and vials called Aclar Edge that enable ultra-high moisture barrier without the limitations of glass. We've also launched a Honeywell ThermoRebellion temperature monitoring solution, which can be rapidly deployed at the entry of our factory, airport distribution center, stadium, or other commercial buildings to quickly and efficiently identify whether personnel exhibit an elevated temperature using advanced infrared imaging technology and artificial intelligence algorithms. In aerospace, we are helping to provide a safer and healthier travel experience with the ultraviolet cabin cleaning system. The Honeywell UV cabin system can treat an aircraft cabin in less than 10 minutes, for just a few dollars per flight for midsize to large airline fleets, significantly reducing certain viruses and bacteria on cabin surfaces. I am very proud of the part we are playing to keep people safe and healthy by providing new solutions for urgent customer needs. We remain committed to continuing Honeywell’s long legacy of innovation, and we are continuing to invest in our future in good times and bad. We also recently formed new business units dedicated to advancing our position in growing industries for sustainable energy and unmanned aerial systems. Our new sustainable technology solutions business in PMT will develop and commercialize new technologies that will help meet the growing demand for solutions that accelerate the path to a low carbon economy. This includes growth opportunities into plastic circular economy, energy storage, gas decarbonization, and renewable fuels. In aerospace, our new unmanned aerial systems business has continued to introduce new, innovative products for this exciting market, and recently conducted in-flight testing of sensors that will guide urban air mobility vehicles to land without pilot intervention. These are challenging times for all, and we are rapidly addressing our end market and customer needs through innovation and mobilization of resources across the organization. Finally, I'd like to make a few comments about our commitment to diversity, inclusion, and equality. Let me be clear, we’ll never tolerate racism at Honeywell, fully embracing the principles of diversity, inclusion, and equality, and treating all employees with the utmost respect are requirements for working here. In addition, we are committed to the following actions. We will continue to evolve our community relations programs and partnerships with key external organizations to promote diversity, equality, and opportunity for all. And we will intensify our focus on the recruiting, retention, and development of women, veterans, and minority groups. And we will continue to rigorously enforce our code of business conduct, which makes it explicit that there is zero tolerance specifically for racial discrimination. We recognize that these steps are a starting point, not an end, and we are committed to continuing to make progress. Now, let me turn it over to Greg on slide four, to discuss our second quarter results in more detail, as well as to provide our views on the third quarter.

Thank you, Darius and good morning everyone. As we highlighted in our May call, the second quarter presented significant challenges. However, we effectively managed with strong operational execution that our stakeholders have come to expect of us. For the second quarter, sales declined by 18% organically as the effects of the pandemic spread across the globe. Substantially lower sales volumes in our most challenged end markets in Aerospace and PMT drove 280 basis points of segment margin contraction, while we delivered strong sales and orders growth in both our warehouse automation and PPE businesses. Our phase 1 cost actions delivered approximately $500 million of year-on-year benefit in the quarter, which brought us to approximately $700 million of savings in the first half. We will discuss that later on in the presentation. We delivered adjusted earnings per share of $1.26, down 40% year-over-year as we funded over $250 million of repositioning in the quarter to drive cost savings in 2020 and into 2021. As we previewed in May, repositioning was significantly higher than the second quarter of last year, driving a $0.19 headwind below the line. A higher adjusted effective tax rate resulted in a $0.06 EPS headwind compared to last year, partially offset by $0.04 of EPS benefit due to lower share count. This quarter EPS is adjusted to exclude the favorable resolution of a foreign tax matter related to our spin-off transactions in 2018. So on a GAAP basis, our second quarter earnings per share is $1.53. You will find a bridge of our EPS in the appendix of this presentation. We generated $1.3 billion of free cash flow driven by strong customer collections, despite a difficult operating environment and our adjusted free cash flow conversion was 140%, up 40 points year-over-year. In terms of capital deployment, we paid out $650 million in dividends. We also invested over $225 million in capital expenditures in the quarter, up $56 million from the prior year. Our CapEx in the second quarter included the first tranches of investments that we are making to produce N95 masks to support the Coronavirus relief efforts. Overall, this was a very challenging quarter, but we continue to execute, managing costs and our cash flow with the discipline and rigor you can expect from Honeywell. Now let's turn to slide five and we can discuss our segment results. Starting with Aerospace, sales were down 27% on an organic basis as the steep reduction in flight hours lowered commercial aftermarket demand, and a slowdown in original equipment build rates in addition to the 737 MAX impact in air transport, impacted commercial OE more broadly. Our air transport aftermarket business was down 56% organically and our business aviation aftermarket business was down 50% organically in the quarter. The declines in commercial aerospace were partially offset by continued demand for U.S. government programs including the F-35, F-15, and the Orion space program driving 7% organic growth in a defensible space business. For the quarter, the defensive space backlog finished up double digits, giving us confidence we will continue to deliver growth in that business throughout the second half of the year. Aerospace segment margins contracted 510 basis points driven by lower commercial sales volume and business mix partially offset by cost actions to improve productivity. In Honeywell building technology, sales were down 17% organically, primarily driven by deferrals of product purchases and security, building management systems, and fire and softness in building solutions due to delays in the projects and energy businesses, some of which is a result of site access constraints due to shutdowns, particularly in India and the Middle East. Organic sales improved sequentially as the quarter progressed for the short cycle products businesses. HBT segment margin expanded 50 basis points in the second quarter, driven by commercial excellence and cost actions to improve productivity, which offset the impact of lower sales volumes. In Performance Materials and Technologies, sales were down 17% on an organic basis. Process solution sales were down 13% organically, driven by volume declines in products, including thermal solutions, smart energy, and field instruments. In UOP, sales were down 25% organically, driven by declines in gas processing, lower licensing, and lower catalyst shipments due to weakness in the oil and gas end market. As expected, we saw new orders decline significantly in the second half in the second quarter as COVID-19 and the oil price volatility led to lower bookings in HPS and UOP. However, we have not seen significant project cancellations to date. Organic sales in advanced materials were down 18% driven by lower automotive refrigerant volumes due to automotive plant closures, offsetting double-digit growth in packaging, composites, and electronic materials. Flooring product sales into the automotive end market improved sequentially by month throughout the quarter, as automotive plants began to reopen. PMT segment margins contracted 460 basis points in the second quarter, driven by the impact of lower sales volumes partially offset by actions to improve productivity. Finally, in safety and productivity solutions, sales were up 1% organically driven by more than 20% growth in Intelligrated and over 100% growth in the respiratory personal protective equipment space, particularly partially offset by weakness in Sensing and IoT portable gas sensing and productivity products. Orders in SPS were up approximately 90% in the second quarter, led by record high bookings of $1.2 billion in Intelligrated, up 300% year-over-year, and over $650 million of bookings in personal protective equipment, positioning SPS well for the second half of the year and into 2021. SPS segment margin expanded 150 basis points in the quarter, driven by productivity including cost actions net of inflation and commercial excellence. So overall, we finished the challenging quarter with significant top-line impact from the COVID-19 pandemic. However, we grew in several businesses including defense, Intelligrated, and PPE, and due to prudent cost management and commercial excellence, we were able to limit decremental margins to 33% overall and expand margins in HBT and SPS. Now, let's turn to slide six to discuss our cost management actions in more detail. We previously announced our phase one cost reduction efforts which we rapidly started implementing in the first quarter. This included curtailment of discretionary expenses, cancellation of 2020 merit increases across the enterprise, reduced executive and board pay, reduced work schedules, and a first phase of targeted permanent census reductions. During the quarter, we completed preparation of a second phase of actions to expand permanent census reductions, which we also began executing in June. The result is that we reduced fixed costs by approximately $700 million year-over-year in the first half, which is pushing us toward the high end of our original phase one target range of $1.1 billion to $1.3 billion. The phase 2 actions are expected to deliver approximately $200 million of 2020 benefit, so the combination of phase 1 and phase 2 is expected to reduce costs by $1.4 billion to $1.6 billion in 2020. Our aggressive deployment of repositioning funds $250 million in the quarter and $325 million in the first half is serving us well. I do expect our fixed costs to be pressured sequentially in the third quarter as the permanent reductions begin to replace the benefits of the more temporary actions. Now let's turn to slide seven and discuss our balance sheet and liquidity. We exited the first quarter in an incredibly strong position on the balance sheet, and we took additional actions during the quarter to further bolster our financial flexibility. In the second quarter, we issued $3 billion in long-term debt instruments with maturities in 2025, 2030, and 2050, replacing a portion of the term loan financing, which we reduced from $6 billion to $3 billion. We fully drew down on the remaining term loan so as to access the liquidity of $6 billion that we had highlighted previously. As a result, we ended the quarter with $15.1 billion of cash and short-term investments on the balance sheet, and a net debt-to-EBITDA ratio below 1 to $15 billion of cash and short-term investments compared to only $3.5 billion of commercial paper and $800 million of long-term debt coming due within the next year. As you'll recall, we substantially completed our 2020 share repurchase commitment in the first quarter, and we were focused on liquidity preservation in the second quarter. We deployed $650 million to dividends and approximately $225 million to CapEx in the quarter. While being prudent on CapEx overall, we will continue to fund growth investments in the second half, and we expect full year CapEx to be approximately $900 million, including the additional growth capital Darius mentioned earlier. We are committed to holding share count approximately flat with the second quarter for the remainder of the year at a minimum. We are open to deploying capital to share repurchases and M&A investments in the second half of the year if attractive opportunities become available. On the topic of M&A, we are pleased to welcome Emily McNeil to Honeywell this quarter as our new senior vice president of corporate development and Global Head of M&A who will be responsible for maintaining and building our robust pipeline of acquisition opportunities that are strategically well-positioned to accelerate Honeywell growth. We are very excited to have Emily on board. Now let's turn to slide eight to discuss our segment outlook for the quarter. The next few quarters will continue to be unpredictable and our visibility has limits under the current circumstances. Accordingly, we are continuing the suspension of full year guidance until the economic environment stabilizes. And we can once again give reliable and comprehensive forecasts. We believe it's important that we provide a level of precision that is commensurate with our ability to forecast in the current environment, and therefore we will provide the same set of inputs that we provided in May. We are closely watching several key drivers of uncertainty in the third quarter. First and foremost, the severity of increasing COVID infections and the potential for additional lockdowns is still very fluid and could have significant impacts on the macroeconomic environment. The support provided by the fiscal stimulus programs deployed in the second quarter by governments globally will diminish in the third quarter, and additional stimulus is uncertain, particularly in the U.S., which complicates the visibility through economic stability. The geopolitical environment and traceability also continue to be a wild card. From an end market perspective, the dynamics in the air travel industry, including flight hours, retirements, and used serviceable materials, as well as oil price volatility and CapEx and OpEx budgets which affect our PMP business are not stable yet at this point. With that said, the impact on customer solvency and aging receivables remains a question mark as well and a potential future risk that we're monitoring. Together these drivers are difficult to predict and set the stage for challenging quarters ahead. So as best we see it, starting with aerospace, we expect global flight hours to remain far below pre-COVID-19 levels, which will significantly impact our commercial aftermarket business. We do expect air transport flight hours to begin recovering from second quarter lows. Those sequential improvements in commercial aftermarket sales due to flight hour improvements may be offset by the impact of used serviceable materials, and rotation of fleets. Our commercial, original equipment business will continue to be impacted by lower air transport, OEM build rates and lower business jet demand due to the economic slowdown. We are anticipating that government defense budgets will remain intact, and we expect continued growth in defense and space. In combination, we expect aerospace sales once again to be down more than 25% compared to the third quarter of 2019. Moving to PMT, a combination of volatility in oil prices, coupled with the uncertainty stemming from the global pandemic has continued to put pressure on our businesses linked to oil and gas. We've seen a continued reduction in customer CapEx and OpEx budgets as well as project delays and site access constraints, which are impacting the engineering and licensing business in UOP and orders and projects in automation solutions in HPS. We also expect ongoing headwinds for our products, businesses and process solutions causing declines in field services. As we have previously discussed, we entered 2020 with a healthy backlog of global mega projects in HPS, which was still up over 80% year-over-year for the second quarter. And we expect these projects to continue to convert for the next few quarters. Access to customer sites will likely remain impeded, especially in high growth regions, including India and the Middle East. In UOP, we expect continued weakness in gas processing and lower shipment due to lower production and refining volumes. Additionally, we anticipate new products will continue to push to the right, and progress on current contracts may be delayed, resulting in continued pressure on UOP, licensing and engineering. Within advanced materials, we expect that automotive refrigerant volumes will continue to recover as auto OEM plants increase production and capacity levels. In Specialty products, we expect strong demand for healthcare packaging and electronic materials. Altogether, we expect PMT sales to be down more than 10% compared to the third quarter of 2019, driven principally by the volatility in the oil and gas markets. In HBT, while we do expect access to customer sites to improve in some regions in the third quarter, the current environment of non-residential product projects in multiple verticals have paused, and customers are deferring non-essential spending, impacting the timing of long cycle building solutions projects, and delaying purchases of security, building management, and fire products. We expect these dynamics to continue in the third quarter but to improve sequentially. In addition, Darius mentioned our new healthy building solutions and our partnership with SAP for buildings, which we see as emerging growth opportunities. We expect HBT sales to be down more than 10% compared to the third quarter of 2019. And finally in SPS, the surge in e-commerce as governments enact social distancing requirements has strengthened demand for our warehouse automation business, and support continued conversion of our robust Intelligrated backlog. Our Intelligrated orders were up over 300% in the quarter to $1.2 billion, driven by major systems bookings and Intelligrated backlog remains very strong, up 140% year-over-year to $2.1 billion. So we expect this business to perform well for the remainder of the year. We are also continuing to see record level demand for respiratory masks and other personal protective equipment. PPE orders were up triple digits for the second consecutive quarter, strengthening the respiratory, head, eye, face, gloves and clothing categories. Our personal protective equipment backlog is now also at triple digits and our total SPS backlog is at an all-time high. The macro conditions continue to put pressure on other SPS businesses including sensing and IoT, gas sensing and productivity products where we expect to see declines in the third quarter. Overall, we expect sales in SPS to grow single digits compared to the third quarter of 2019, less than 7% overall, a very good result. So while there are signs of stabilization in the macro economy, key end markets remain challenged and economic conditions fluid. We have both opportunities and challenges in the portfolio, but on balance, we expect sales for the company to be down again more than 15% versus the prior year. We expect between $125 million and $175 million of additional repositioning charges in the third quarter to fund our cost programs. This increase in repositioning in the second and third quarters will drive higher repositioning cash outflows in the second half of the year, putting pressure on our free cash flow. Additional details for our tax rate, share count, and below the line expenses are included in the appendix. With that, I'd like to turn the call back to Darius.

Thank you, Greg. Let's wrap up on slide nine. As we expected, this quarter proved to be very difficult, but we effectively managed to the challenges with strong operational execution and cash generation. We remain cautious heading into the second half of the year, as there are still many unknowns. However, our diversified portfolio and significant balance sheet strength will continue to provide resilience in these uncertain times. We acted quickly and responsibly to make structural changes to our cost base during the quarter. We funded over $250 million in repositioning and we identified significant additional actions to align our cost base with the current environment in 2020 and 2021. Despite the challenging times, we are delivering growth in several parts of the portfolio, particularly in Defense, Intelligrated, and Personal Protective Equipment. We're also investing in growth opportunities and working hard to provide innovative solutions for emerging customer needs. I am proud of everyone at Honeywell who is working hard to adapt and deliver in this challenging environment. I'm confident we will emerge from this crisis even stronger than ever. With that Mark, let’s move to Q&A.

Thank you, Darius. Darius and Greg are now available to answer your questions. Lauren, please open the line for Q&A.

Thank you. Good morning everyone. Two from me, if I could. Very clear on the cost out what you expect to deliver in 2020. Darius or Greg, though, given that some of this stuff is kind of in flight over the course of the year here, I just wonder if you could give us a little bit of feel of kind of what the carryover positive effects of this phase 1 and phase 2 would be, as we look into next year?

Yes, well, I think we sort of provide some guidance on that in the 60% to 70%. Because I think you have really three buckets of cost that we think about, which is purely temporary and think about those as furloughs, which obviously are going to come back. The second bucket is what I call semi-permanent, those are some of that indirect cost base, which obviously are impacted, which they're not permanent in nature, but we think some of those are going to carry over into 2021. And obviously, permanent reductions, so the 60 to 70 is a pretty good guide around that includes primarily the permanent reductions, and then some portion of the semi-permanent because obviously, on the indirect cost, we're not going to be as low as we were in 2020. But we're also not going to get back to 2019 levels. So we kind of have, think about a 50:50 or something in that kind of a split that we approximate. That's sort of the rough guide, how to think about that. I don’t know Greg, if you want.

No, that’s right. And again, at the midpoint of our 14 to 16, you can kind of use the one five number, extrapolate that 60% to 70% from there.

I think the only unknown is the timing, as it isn't perfectly predictable for the permanent changes. Some may happen sooner and some may take longer. So the timing aspect is somewhat unpredictable, but I wouldn't expect it to slide more than about a quarter.

Yes. And that'll become much clearer, 90 days from now, as we get through the third quarter.

And second question, just again trying to get a sense of what the future holds. And I totally respect you don't want to kind of give really explicit guidance yet, but the framework here certainly helps. You gave us SPS orders, could you give us orders for the other two segments in the quarter? So we have kind of a feel for what you're working with here as we look forward.

Yes. I mean, if you think about HBT and PMT, they were down in the teens is the way to think about it. You know, obviously in aero they were down mid-double digits. I mean they were significantly down. But I think, there's a couple of really important things to remember. Our total Honeywell backlog actually is up 3%. And even the PMT backlog is up 2%. So, obviously orders actually kind of came in, more or less where we expected them to do. But overall, the backlog position improved, which I think was a pretty good sign. So all-in-all, not as bad as we anticipated.

Right, thanks. I'll pass it.

Thanks, Jeff.

Hey, guys, good morning.

Morning, Steve.

Regarding Aerospace in the third quarter, what are your expectations for original equipment and aftermarket sales? Do you anticipate one will increase while the other declines? On a year-over-year basis, how do you see the dynamics between these two segments in the commercial sector?

Yes, I'll start by breaking it down into three segments. First, in defense and space, we anticipate continued growth, which has been a strong point for our aerospace business in Q2 and we expect this to carry on into Q3. Regarding original equipment (OE), we expect it to remain flat to decline compared to Q2 for a few reasons. First, we had some carryover shipments from Q1. Second, certain segments of our OEMs are not showing the strong production rates we had hoped for in Q3, so we don't see any improvement there. For the business aviation aftermarket, we expect a slight increase compared to Q2. Lastly, predicting the ATR market is more challenging. While flight hours are projected to improve, we experienced a significant year-over-year reduction in Q2 and estimated Q3 to be in the 50s, which might be an aggressive estimate. It's important to note that there is both a lead and lag effect to consider, as well as uncertainty regarding potential cannibalization of parked aircraft. Therefore, it's difficult for us to provide precise guidance since these factors are unpredictable. Airlines increased flights in July and August, but they reduced their schedules somewhat in August, adding to the complexity. Overall, the ATR aftermarket situation is the most challenging to forecast.

And sorry, when you talk about kind of that USM, the used parts dynamic, your business is electronics. There are some software, obviously, you have some mechanical components. But I mean, outside of putting business jets aside, just looking at the large commercial stuff, I mean, how much of your business is even kind of exposed to that? It wouldn't seem to me to be a material mover maybe by few hundred basis points, but not something that can really swing things around in a major way. Correct?

No, I don't think it's going to be dramatic. However, it wouldn't be accurate to attribute the aftermarket performance solely to the quarter-over-quarter flight hours. We believe flight hours will improve in Q3 compared to Q2, but it isn't just a straightforward correlation. We anticipate a very modest impact. Additionally, we had some orders from Q1 that were still fulfilled in Q2, so there was a bit of a lead/lag effect. Therefore, I don't expect anything dramatic, as the natural assumption would be that Q3 will be significantly better. The reality is that we're uncertain and need to see how various factors develop.

Yes. I don't think airlines' behaviors aren't necessarily solidified yet.

Yes. One last one, just getting at the cost discussion with a bit of a different way. Probably in the worst quarter hopefully that you ever see as CEO, you guys are putting up headline decremental of 33%. Would the goal be to kind of on the way up, leverage it when things normalize, kind of leverage at a comfortable number that's comfortably above that? Would that kind of be the high level total?

Yes, I believe that 33% is quite good considering the sudden halt in our business. Given our exposure to aerospace and oil and gas, I think this performance is respectable.

Which by the way was substantially different than ‘08 and ‘09? The aftermarket up here is multiples of what it was in '08, '09 recession, which really puts a lot of pressure on those decrementals.

Our plan is to show improvement from this number going forward. I don't anticipate a dramatic increase in Q3, but we do expect modest improvement in some areas within that 33%. That's how we're approaching it.

Right. Okay. Thanks a lot. Thank you.

Thank you.

Hey, good morning guys.

Good morning, Scott.

There was a lot of excitement surrounding the SAP Cloud Forge. Could you provide some context on its size? How does the payment structure work, and what opportunities does it present? Additionally, what early indicators are there regarding the take rate? I would appreciate any insights on the potential benefits of this partnership.

I find it very exciting because Honeywell and SAP have complementary growth strategies. We initially focused on buildings, but I believe we have much broader opportunities ahead. For perspective, the connected buildings segment was a significant highlight in our second quarter, demonstrating 26% growth. Given the current environment, I see this as tremendous progress, clearly indicating we are on the right path. Some of the key growth drivers include energy savings, security, and a cohesive interface that allows building owners and managers to monitor operations effectively. Additionally, we focus on optimizing building occupancy, and with the introduction of healthy business buildings, we are also addressing social distancing, PPE usage, temperature monitoring, and air quality. These aspects are integral to our connected buildings initiative, which we are enhancing with an emphasis on fostering a healthy environment for office workers. Lastly, in our HBT business, we are reorienting ourselves to be more end market vertical focused. For instance, we plan to tailor solutions for healthcare facilities, stadiums, airports, office buildings, and data centers. This strategy evolution will enable us to become more effective by fostering closer relationships with our customers and better understanding their needs.

Thanks. I'll follow up with you on the sizing. And it doesn't sound like you want to answer that part of the question.

Yes. I think, I'm not ducking the question, because frankly, we're creating the market. Whenever you create a market, it's hard to guess at the sizing. But just our own installed base is vast. We think that over time, this could be a billion-dollar business just that's sort of our scope. And we don't think that that's like decades away. So, we have big hopes in double-digit growth rates are in expectations. And the good news about that is, even in an environment like we had in Q2, which was an all-time worst for Honeywell, I mean, literally, it was probably the worst quarter hopefully I'll ever see, 26% growth gives you the kind of traction we're gaining in this segment.

No, you answered the question. So just a quick follow-up. The order growth in Intelligrated is pretty dramatic and not a total surprise, but they're big numbers. Can you actually satisfy that demand without incurring some extraordinarily kind of costs around, maybe over time or…?

Well, you heard Greg discuss this. We're aggressively investing in our CapEx.

And people.

And people. So we're cutting in some areas, because we have to, but we're actually adding a lot of people in others. So, $250 million of incremental CapEx that we never had in our budget. And Scott, I think this is an important data point. I just want to give you and I think it's one to remember. When we bought Intelligrated, it was roughly an $800 million to $900 million business per year. We booked $1.2 billion this past quarter. That gives you the kind of growth profile we're seeing in that business.

Hi, good morning.

Hi, Julian.

Hi. Maybe just the first question around the free cash flow. So you had good conversion in Q2, but I think the first half was running in the 80s percent-wise on conversion. You talked about some restructuring going perhaps in the second half. Greg, so maybe just help us understand where you're seeing free cash flow conversion perhaps for the year as a whole. And any other major swing factors in the second half that we should think about?

I'm not going to provide a conversion rate, as that is dependent on our bottom line, which we have decided not to guide on today. Regarding some pressure points, we successfully managed our receivables in Q2 and reduced some pass-through receivables as well. We worked closely with our customers, especially in the airline sector, to mitigate risks. I'm pleased with those results. However, I believe solvency risks are ahead of us, which could pose challenges in the latter half of the year as we anticipate more bankruptcies. This largely hinges on travel behavior, any stimulus that may arise, and similar factors. Additionally, I mentioned repositioning, and we booked over $300 million on that front, with a quick payback period, generally under a year. Much of this involved significant severance costs, and we spent around $170 million in cash on repositioning in the first half. I expect that amount to double in the second half. This will also put pressure on us. We are continuing to invest in capital, maintaining our capital budget at about $900 million for the year despite the downturn. We did manage to cut CapEx in areas where there was a slowdown, but we're adding growth programs that have high returns, so our total CapEx remains at $900 million for the year, with just $370 million spent in the first half, so we'll see an increase in the second half. Also, we mentioned during our initial guidance call earlier this year that we would experience an additional payroll cycle in 2020, which is expected in 4Q, amounting to about $150 million to $170 million. I believe this will be our strongest cash quarter of the year. We are satisfied with our efforts in receivables management, but we now need to focus on our inventory management. These are the key points I wanted to emphasize, including CapEx, repositioning cash, the payroll cycle dynamics in 4Q, and the need to address our inventory management.

And I think from an investment perspective, I would just add that, we're nearly doubling our growth CapEx from our original plans, because to be honest, I haven't seen IRRs ever that were triple digit. And it's by far the best we could put our capital to work with some of these high return CapEx projects and they're terrific. And we're not afraid to, I mean, if need be, we may even be targeting more investments for growth in the second half.

Thanks, Darius. So yes, I think you point just now on the scores that you're thinking clearly about the recovery and how to position Honeywell for that in terms of organic investment. I guess following up on that, how should we think about capital deployment from here? You're making that push on the organic side. Are you looking out at the M&A landscape and your balance sheet and thinking this is the right time to go ahead and start to upscale the portfolio through acquisitions as you try and position yourself for the next upturn? Or is it we probably should expect a balance of M&A and buyback for the next six or 12 months?

Yes, I believe we will continue to see some level of activity. We are hoping for a balance moving forward, which I think will be part of our strategy. I can assure you that our M&A function is active. It was wise for us to take a brief pause in Q2 to better understand how the situation develops and changes. You can see the strong performance we had in working capital, and we've also strengthened our balance sheet further. I believe you would agree that our balance sheet is robust and well funded. In summary, we are very much open for business regarding M&A and potential buybacks. We have already committed to maintaining a flat share count from this point, which is new information, and we will evaluate opportunities that arise in the second half of the year. The M&A environment is currently slower as many are focused on addressing the crisis, but we anticipate that it may become more active in the second half, and we hope to engage in it.

Great. Thank you.

Thank you.

I guess, good morning.

Good morning, Andrew.

I have a question regarding the defense and space sector, which was a highlight in the presentation. How much clarity do you have on the Department of Defense's ability to expedite payments on programs? Specifically, what should we expect in 2021? I'm not inquiring about the broader market outlook, but rather the basic cash flow dynamics from the Department of Defense regarding existing programs. Does this imply that 2021 must decline, or is there potential for it to remain stable, particularly in Defense and Space?

Yes. At this stage we're not expecting a decline in 2021 at this point. We feel like the defense budget is as you highlighted is still fairly robust. So, not expecting a material downshift from 2020 to 2021.

And just a follow-up question. You highlighted masks and just I guess, two-pronged questions, I think. It was a great strategic move on your part in respiratory protections. So A, do you have plans to continue to increase capacity on masks? And part two of the question, does it open sort of strategic opportunities for you down the line and safety to build on this new strength?

Yes, Andrew, I'd say that it's more than just masks. Masks are part of it, but we are also focused on other personal protective equipment and expanding our capacity in the sensing business for pressure sensors, which are essential for medical equipment that hospitals need. Our capacity expansion is more comprehensive and not solely centered on masks. However, looking ahead, this creates new opportunities for us. It's less about masks specifically and more about directing our business towards serving the medical sector. That's how we view it.

Are there any plans to increase N95 capacity in the second half beyond what you mentioned?

Yes, we've been gradually increasing our capacity. As we continue to see strong demand, we are open to expanding even further. It’s very likely that we will add more capacity in the second half of the year.

Thank you very much.

Thank you.

Thanks. Good morning, everyone.

Good morning, Joe.

Hey, Darius, maybe let's just start on UOP and HPS. I know when we kind of talked into the quarter, it seems like you were a little bit more sanguine about UOP kind of recovering quicker just given miles driven, should be fairly more resilient this cycle versus prior cycles. I'm just curious whether that's changed at all? And what you're seeing along those lines?

Yes. I believe the most challenging segment for UOP has been our gas processing segment, which is closely linked to unconventional gas production primarily in the U.S., and as you know, that has faced significant challenges. We have seen a considerable drop-off. However, even before this crisis, the mix within UOP could vary greatly from quarter to quarter or even year to year. We always anticipated a heavy equipment mix in the business during Q2 and Q3 of this year. Even without the recession, we faced a tough mix going into it. When you add in the delays in catalyst refills and project timelines, it's clear that refining capacity and demand were not as strong as we had hoped for in Q2. Taking all these factors into account, UOP faced more challenges than some of our other businesses, while HPS performed quite well during the quarter. Some of our product businesses faced more difficulties compared to our systems businesses, but overall, these results were in line with our expectations. Regarding advanced materials, that segment was significantly affected by shutdowns in auto manufacturing and our supply sources, but we expect to see some recovery in the second half of the year.

Okay. Fair enough. And then, maybe just one follow-up question. Going back to the cost commentary, Greg, this one's for you. You mentioned the fixed cost pressure in the third quarter compared to the second quarter. How should we consider the benefits that are actually being realized in the third quarter versus what was realized in the second quarter? Also, could you discuss how any temporary reversals in the third quarter might be affecting that figure?

Yes, that's exactly why I chose my words carefully. Some of the temporary measures, such as furloughs and reductions in discretionary spending, might start to increase during the third quarter. As I mentioned, we're compensating for that with some of our more permanent actions. However, these developments will unfold over June, July, August, and September. The impact of that compensation is likely to be more pronounced in the fourth quarter than in the third. We are working hard to keep our fixed costs stable. They may not remain flat in the third quarter, but I expect the range we discussed, one-four to one-six, with 700 already achieved in the first half of the year, will see the remaining balance skewed more towards the fourth quarter than the third.

Got it. And maybe like, I don't know, like sequentially, like, I don't know, call it, $50 million in pressure in 3Q verses 2Q?

I'm not going to quote you a specific number, Joe.

It's challenging to predict the exact timing of that. Temporary actions are easier to manage since they can be implemented unilaterally. In Q3 and Q4, we are transitioning some temporary measures from Q2 to more permanent solutions. The timing of this shift can't be precisely determined. As Greg mentioned, it seems likely that there will be more emphasis on Q4 compared to Q3.

Okay, fair enough. Thanks guys.

Thank you.

Thanks. Good morning and really appreciate you making this a no-drama Friday. So, I want to go back to your comments around decrementals. And I appreciate the comments that you think he can generate better decremental margins into the back half of the year. And I'm wondering if that confidence extends to the aerospace margins. I think there were 39%, 40% or thereabouts in 2Q. And recognizing mix is an important factor there. But do you think that you can maintain or even improve on that performance?

Yes. I think the comment was more in total. I think Aerospace is the toughest to call because of the uncertainty around the mix that I talked about, particularly in air transport aftermarket, which is you can imagine a very interesting and higher margin revenue stream.

And you could very easily see it being sequentially down.

Yes. I can't assure you that Aerospace will have better decrementals in the third quarter. However, we are cautiously optimistic that Honeywell as a whole will continue to improve decremental margins as we progress from Q3 into Q4, provided we do not encounter a significantly broader and more aggressive phase two of COVID-19, which is a possibility depending on various opinions this fall. This is how we are approaching our projections for the remainder of the year.

Okay. Very, very clear. And then, again, look just peeking into 2021 within aerospace and think about business jets. At a very high level, how do you think the post-COVID will look for the categories you play in, which is obviously the upper end of the markets? How does that look from your perspective, your perch in the post-COVID world? It seems to me like there could be some benefits, but I'm curious how you think about that?

Yes. I believe we reached the lowest point in Q2 and will see a gradual improvement as we progress through Q3 and Q4, continuing into 2021. The significant change we anticipate, leading to a more marked improvement, is likely tied to a medical solution—most probably a vaccine—once it is distributed. The leisure travel segment is holding up better than we had expected, with people taking trips. However, we still need the business traveler segment to recover, which we believe will occur after the widespread distribution of a vaccine. It's uncertain when that will happen, but overall, I view the news positively. It’s not unreasonable to expect that we may have a certified vaccine by the end of this year, although distribution timing remains a factor. We are hopeful that a medical solution will emerge in the first half of next year, which will undoubtedly encourage increased air travel.

Great. Thanks very much.

Lauren, let's take one more question, please.

Thank you. Good morning, everyone. Thanks for squeezing me in here. Hey, Darius and Greg, so, if you look at your restructuring programs in the 60 to 70 of structural. How would you anticipate your pro forma headcount ending 2020? I just glanced at the K, it looks like you started the year with 113,000 employees. Where would we expect that kind of to end based on? And then, I don't mean on a furlough basis. I'm trying to sort of think about the significance in terms of headcount based on your structural actions that you're taking in which what you've called out?

It's difficult to provide a precise number at this moment. While we have a general idea of our restructuring plan and what that entails, we're uncertain about the capacity additions. Some reductions are happening in areas like aerospace and PMT, but we're also bringing in hundreds, potentially thousands, of new employees in SPS. We believe this isn't the end, as we plan to make more investments in both personnel and capacity. Therefore, it feels premature to say exactly what our staffing will look like at the end of the year, and I would prefer not to give a figure that might end up being incorrect.

No, that's fine. The magnitude of the action, Darius, seemed pretty substantial. So I'm just trying to sort of triangulate that? Could that mean, if you weren't adding capacity here, you're taking out 5% of your headcount or how -- what else would you say about that? I suppose is kind of question.

Yes, I believe it's significant in Aero, approaching double digits. In some other areas of the business, we're increasing headcount, so it's somewhat varied. We have made efforts to retain as many jobs as possible because we don't want to implement many job cuts. However, we also need to be realistic. We realize that this situation in aerospace is not just a temporary issue. Sadly, the business will likely decrease for some time. That said, I don't hold the pessimistic view that aerospace will be down until 2024, as some estimates suggest. I believe it will recover somewhat quicker, aligning with a medical solution. However, it probably won't return to 2019 levels until at least 2022, or potentially later. Consequently, we are adjusting our business to accommodate that kind of reduction.

Yes, that that makes sense. Just as a follow up, guys, you know this ultraviolet airplane cabin cleaning technology, is it applicable to what could you even sort of develop product for a commercial building application or even residential? That would seem like a pretty big deal if you can actually extrapolate that.

Yes, we are working on a solution that utilizes air and ultraviolet light, which significantly improves air quality compared to current options. This is a key focus for us, and we are conducting studies to determine the necessary timing and exposure to UV light.

Yes now you get that on the New York City subway, the economy might actually come back. Great. Thanks very much. Appreciate it.

Thank you.

I want to thank our shareowners for their continued support of Honeywell. We are focused on continuing to perform for our share owners, our customers and our employees in any environment. We are well positioned to manage through challenging times with our balanced portfolio, track record of execution and a strong balance sheet. I'm excited about the future of Honeywell, despite the current challenges facing the global economy. We are capturing new growth opportunities by providing innovative solutions for new customer needs, and our operational rigor will continue to serve us well. Thank you for listening, and please stay safe and healthy.