Honeywell International Inc (HON) — Q3 2022 Earnings Call Transcript

Thank you for standing by, and welcome to the Honeywell Third Quarter 2022 Earnings Conference Call. Please be advised that today's call is being recorded. I would now like to hand the call over to Sean Meakim, Vice President of Investor Relations. Please go ahead. Thank you, Liz. Good morning, and welcome to Honeywell's Third Quarter 2022 Earnings Conference Call. On the call with me today are Chairman and CEO, Darius Adamczyk; Senior Vice President and Chief Financial Officer, Greg Lewis; and President and Chief Operating Officer, Vimal Kapur. This call and webcast, including any non-GAAP reconciliations, are available on our website at www.honeywell.com/investor. Honeywell also uses our website as a means of disclosing information, which may be of interest or material to our investors and for complying with disclosure obligations under Regulation FD. Accordingly, investors should monitor our Investor Relations website in addition to following our press releases, SEC filings, public conference calls, webcasts, and social media. Note that elements of this presentation contain forward-looking statements, which 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 you to interpret them in that light. 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 third quarter of 2022, share our guidance for the fourth quarter and full year 2022, and provide some preliminary thoughts on 2023. 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, Sean, and good morning, everyone. Let's start with Slide 2. Our strong discipline and effective execution allowed us to meet or surpass guidance for all third quarter metrics despite ongoing supply chain challenges and inflation pressures. We outperformed the high end of our third quarter adjusted earnings per share guidance by $0.05. In a challenging environment, we achieved organic sales growth of 9% year-over-year or 10% when excluding the effects of winding down operations in Russia, driven by significant double-digit growth in our Advanced Materials, commercial aerospace, and building products sectors, showcasing our resilience and commitment to operational excellence. We increased segment margin by 60 basis points year-over-year to 21.8%, surpassing the high end of our guidance range by 60 basis points, with margin growth across all four segments as we remain proactive in managing inflation impacts through continued commercial success. Adjusting for our investment in Quantinuum, margin expansion was 90 basis points year-over-year. Our backlog remains robust, increasing by 9% year-over-year in the third quarter, led by aerospace, PMT, and HBT, indicating strong demand. Although orders were down 1% on a reported basis, they rose by 2% organically year-over-year, with Aerospace and PMT orders growing in double digits, indicating resilience in these markets amid economic uncertainties. Excluding the impact of orders, as previously discussed, orders in the rest of the portfolio increased by 8% reported or 11% organically year-over-year. Our record 2022 orders in backlog will support our growth in a fluid operating environment. Cash flow was another highlight, with $1.9 billion in free cash flow for the quarter, more than double that of the previous year, positioning us well to meet our full-year free cash flow target. In terms of capital allocation, we used $1.2 billion for share repurchases, dividends, and capital expenditures. We capitalized on our strong balance sheet to purchase over 2 million shares during the quarter, reducing our average share count to 680 million shares, and we continue to commit to repurchasing at least $4 billion in shares this year. Looking ahead, I remain optimistic about the strength we are observing in various parts of our portfolio as we apply our proven value creation framework and accelerator operating system to deliver exceptional value for shareholders. I take pride in Honeywell's ability to excel again this quarter despite a challenging macroeconomic environment. Now, let's move on to Slide 3 to discuss recent senior leadership additions. In September, we announced that [name] will take over as President and Chief Executive Officer of our Performance Materials and Technology segment, allowing Vimal to fully transition to his new role as Chief Operating Officer for Honeywell. [Name] joins us from Eastman Chemical Company, bringing extensive experience in global strategy, business operations, and financial performance, including roles as Executive Vice President. Starting as a chemist, he has held various leadership positions at Eastman, and his extensive global experience and deep knowledge of the chemical process industry will be vital for leading PMT, which is uniquely positioned to enhance sustainable technologies and support the energy transition while also benefiting from our strong presence in traditional energy markets. We also welcomed a new Independent Director to our Board in September, [name], who will serve on our Audit Committee. [Name], previously CEO of [company], led its transformation into an integrated engineering and consultancy firm. His extensive industry expertise, including in sustainable technologies like carbon capture and hydrogen, will be key as we advance Honeywell's leadership in the energy transition and broader ESG initiatives. We are saddened to learn about the passing of our Board member and friend, [name], on October 23. He contributed significantly to our company over the past 14 years. He will be greatly missed, and we extend our deepest condolences to his family. During his Board service, [Name] was the Chair of our Audit Committee. Scott Davis, our Lead Director, will serve as interim Chair until a successor is appointed. Next, let’s move to Slide 4 and discuss some other exciting recent announcements. Earlier this month, we unveiled a new innovative ethanol-to-jet fuel processing technology that enables producers to convert ethanol-based feedstock into sustainable aviation fuel. The aviation sector faces challenges due to limited supplies of traditional feedstocks, and ethanol provides a widely accessible, economically viable option. Depending on the type of ethanol used, the Honeywell ETJ process can significantly reduce greenhouse gas emissions by 80% on a total life cycle basis compared to petroleum-based fuels. Additionally, we have opened two capacity expansions for our Solstice business this quarter. We launched the first large-scale manufacturing site for Solstice Air, a near-zero global warming potential medical propellant for respiratory inhalers. Solstice's air technology has an up to 99.9% lower global warming potential compared to current propellants used in respiratory medicine. AstraZeneca is currently working to incorporate our Solstice air technology into their full inhaler portfolio pending regulatory approval. Separately, we opened a plant in India to manufacture our Solstice ZD solution, which is utilized in blowing agents for foam insulation and refrigeration liquids. Lastly, we recently published our first quarterly Environmental Sustainability Index, which reports on sustainability decision-makers' sentiment regarding progress, upcoming plans, and 2030 goals. Two-thirds of the S&P 500 have set some form of emissions reduction targets, and our index highlights past achievements and future expectations towards these goals. Given our long history in sustainability, Honeywell is well positioned to provide this valuable public service. The initial survey indicated that approximately 97% of organizations plan to increase budgets in at least one sustainability category this year, and Honeywell remains dedicated to supporting our customers in reaching their sustainability objectives. Now, I'll hand it over to Vimal on Slide 5 to delve deeper into our third quarter operating performance.

Thank you, Darius, and good morning, everyone. As Darius mentioned, we achieved strong results in the third quarter despite a challenging operating environment. Our disciplined approach to Honeywell's value creation framework gave us the operational flexibility needed to meet or exceed our financial targets. Sales for the third quarter increased by 9% organically or 10% when excluding the shutdown of our operations in Russia. This growth was attributed to double-digit organic growth in our HBT, PMT, and Aerospace segments. Demand remains robust with our backlog close to record levels. However, ongoing supply chain challenges have impacted overall volume growth. We observed a slight sequential improvement in volume, leading to a decrease in backlog in SPS, HBT, and PMT, thanks to our reengineering efforts to qualify alternative parts and our proactive collaboration with distributors and alternative suppliers for priority sourcing. Our preparation in aerospace also led to a modest sequential increase in output. We are benefitting from Honeywell's investments in digital transformation made over the past few years, using these digital tools to enhance our commercial and operational actions, which helped us stay ahead of inflation and increased our segment margin by 60 basis points year-over-year to 21.8%. We are also beginning to see improvements in inventory management from our digital advancements in planning and sideline. Now, let me highlight our third quarter performance by business. Aerospace sales increased by 10% organically year-over-year, with commercial aviation sales achieving double-digit growth for the sixth consecutive quarter, despite ongoing supply chain obstacles. If we had maintained a steady backlog, we could have delivered an additional 9% organic sales growth. Demand for commercial aftermarket services remains strong, with continued recovery in flight activity leading to higher shipments and repair and overhaul sales. Both air transport and business aviation aftermarket sales rose over 20% organically during the quarter. Commercial original equipment sales saw a 30% year-over-year increase, driven by nearly 50% growth in our air transport original equipment sector due to increased deliveries. Although defense volumes decreased this quarter, we believe 2022 will represent the lowest point for this sector, bolstered by our strong backlog and anticipated growth in defense spending in the coming years. Aero segment margin improved by 40 basis points to 27.5%, as our commercial excellence measures offset cost inflation. Building Technologies emerged as our fastest-growing sector in the third quarter, with 19% organic sales growth. Sales of fire products and building management systems remained strong, leading to 23% organic growth in the Building Products portfolio, marking the third consecutive quarter of double-digit growth. Sales in Building Solutions increased by 13% as project volumes rose, despite ongoing component shortages. While our supply chains are still facing significant constraints, we experienced sequential growth in volumes for the third quarter in a row, indicating that supply chains are improving. Our backlog in the Building Projects and Services division remains resilient, staying about the same as the second quarter and 7% higher than the third quarter of 2022. Reported orders decreased by 3%, but grew by 3% on an organic basis, with strength in the U.S. and China somewhat offset by softness in parts of Europe and Asia. Our agile commercial strategies contributed positively to both revenue and profit growth this quarter, and segment margin increased by 60 basis points to 24.1%. Performance Materials and Technologies saw a 14% organic increase this quarter, despite a roughly 3% impact from the situation in Russia. Advanced Materials led PMT with a 33% organic growth, reflecting favorable demand particularly in our Marine Products division. UOP sales also rose by 6%, recovering from a 7% year-over-year drop caused by lost machine sales. Growth in UOP was driven by demand for gas processing and refining catalysts, alongside significant growth in sustainable technology solutions. Process Solutions increased by 6% organically due to ongoing demand for lifecycle solutions, services, and Thermal Solutions. Sparta Systems grew by over 40% for the second consecutive quarter, contributing positively to earnings. PMT orders grew by double digits in the third quarter, with Advanced Materials experiencing approximately 40% growth and UOP about 20%, supported by robust gas processing orders. Segment margin increased by 40 basis points this quarter to 22.6%, driven by commercial excellence measures that mitigated cost inflation. As anticipated, Safety and Productivity Solutions sales fell by 4% organically this quarter. We observed double-digit growth in the advanced sensing and gas detection segment of our Sensing and Safety Technologies line, along with organic growth in Productivity Solutions and Services. However, this growth was countered by expected declines in warehouse automation and lower volumes in personal protective equipment. Intelligrated will be a key focus for me as we strive to enhance our operations and promote margin growth in that area. Our strategic pricing and productivity improvements, along with a favorable business mix, raised SPS segment margins to their highest level since the fourth quarter of 2018, increasing by 250 basis points year-over-year to 15.7%. Honeywell Connected Enterprises continues to facilitate growth across our portfolio, with recurring revenue climbing over 10% this quarter and SaaS growth around 40%. The project segment excelled within CE, achieving over 40% growth, while cyber and connected building initiatives also saw double-digit organic increases. Overall, we achieved excellent operational results at Honeywell, and our SPD performance played a crucial role in our adjusted earnings per share growth for the third quarter. Adjusted EPS rose by 11% to $2.25, exceeding the upper end of our guidance range by $0.05. In terms of cash dynamics, we generated $1.9 billion in free cash flow this quarter, representing a 108% increase year-over-year. This growth was fueled by enhanced working capital contributions due to strong collections and a continued focus on aligning supply with demand, allowing us to reduce inventory for the first time in seven quarters—a promising sign of Honeywell's capabilities to deliver results amidst supply chain hurdles and extended lead times that we've faced in prior quarters. The Honeywell strategy continues to yield exceptional results, and these operational principles, combined with our favorable market dynamics and distinct portfolio of solutions, will support our resilience in the quarters ahead. Now, I'll hand it over to Greg for a deeper dive into our third quarter earnings per share and an update on our 2022 outlook.

Thank you, Vimal. Let's turn to Slide 6, and we'll unpack our EPS story a little bit further. In the third quarter, we delivered GAAP earnings per share of $2.28 and adjusted EPS of $2.25, which was up $0.23 year-over-year despite a $0.05 foreign exchange headwind as the dollar continued to strengthen throughout the quarter. Increased segment profit, driven by our strong commercial execution provided an $0.18 uplift year-over-year. A lower effective tax rate, 22.1% this year versus 22.9% last year, provided a $0.03 benefit, including a $0.05 tailwind from a one-time discrete change in German tax law. Share count reduction, driven by progress towards our share repurchase commitment from our March Investor Day drove a $0.06 year-over-year tailwind to EPS. We saw a $0.04 headwind from below-the-line items, primarily due to lower pension income. EPS was $0.03 higher than adjusted EPS due to a positive adjustment related to our wind down of our business in Russia. So overall, we delivered another strong quarter with results at or above our expectations, demonstrating our ability to operate seamlessly through challenging economic conditions. So now let's turn to Slide 7. We can talk about our fourth quarter and full-year guidance. While a number of challenges persist in the current operating environment, we're entering the fourth quarter with a very strong demand profile. Since we provided our initial 2022 guidance in February, we have battled supply chain constraints, encountered unprecedented inflation, contended with geopolitical disruption, and experienced rapidly rising interest rates. At each turn, our rigorous operating principles have enabled us to continue to deliver. As you saw from the 3Q bridge, the ongoing strengthening of the U.S. dollar has driven materially higher foreign currency impacts and has been a significant headwind to our guidance, which we have consistently offset at the EPS level. For our 4Q sales guidance, we expect to be in the range of $9.1 billion to $9.4 billion, up 10% to 13% on an organic basis or up 11% to 14%, excluding the 1-point impact of lost Russian sales. We now expect full-year sales of $35.4 billion to $35.7 billion, which represents a decrease of $100 million in the low end and $400 million on the high end from our prior guidance, incorporating greater foreign currency impacts. However, we're raising the low end of our organic growth range now at 6% to 7%, increasing the midpoint versus our prior guidance and narrowing the overall range. Excluding a 1-point impact of lower COVID-related mass demand and a 1-point impact of lost Russian sales, the organic growth range would be 8% to 9%. The difference between our reported and organic sales growth guidance is 3 points, driven entirely by foreign currency translation. To dimensionalize this further for the full year, on a year-over-year basis, we expect $1.1 billion of sales headwinds from foreign currency, which compared to our original guidance from February is approximately $750 million of incremental headwind, a substantial challenge that, as I mentioned, we've overcome on EPS. Moving to our segment margin guidance. We expect the fourth quarter to be in the range of 22.8% to 23.2%, resulting in year-over-year margin expansion of 140 to 180 basis points due to timing of high-margin catalyst shipments in PMT, stable business mix in productivity in SPS, and increased volume leverage in HBT. For full-year 2022, we are upgrading our segment margin expansion expectations by 30 basis points on the low end and 10 basis points in the high end to a new range of 21.6% to 21.8% or 60 to 80 basis points of year-over-year expansion. Our rigorous fixed cost management and disciplined price cost actions remain key elements of our operating playbook, helping us to drive margin expansion. Excluding the 30 basis point 4Q and full-year headwinds from Quantinuum, we expect margins to expand 170 to 210 basis points in 4Q and 90 to 110 basis points for the full year. Now let's take a moment to walk through fourth quarter and full-year expectations by segment. In aero, we anticipate demand across our businesses to remain strong, leading to sequential sales growth in the fourth quarter. The growth trajectory will largely be determined by the pace of our supply chain recovery, which we anticipate will be modest. Both commercial aftermarket and commercial OE should see another quarter of double-digit sales growth year-over-year in the fourth quarter as flight hours and build rates continue on their path to recovery. In defense, we view the third quarter as an inflection point, leading to sequential improvement in the fourth quarter to close the year as demand remains strong and modest improvements in the supply chain will allow us to deliver greater volumes. Orders in defense and space are up approximately 5% year-to-date, including high single-digit growth in the third quarter. So we've built a very healthy backlog to support sales growth as we lap similarly supply-impacted comparison period. Our full-year expectations for Aerospace are slightly improved on a stronger third quarter, and we now expect full-year organic sales to be up mid-single to high single digits year-over-year, with modest declines in segment margins as a result of OE mix. In Building Technologies, we expect continued sequential improvement in volumes to lead to another quarter of double-digit organic sales growth year-over-year. Our backlog for Building Products remains well above normal prepandemic levels, supporting sales growth as the supply capacity improves. Modest improvement in the supply chain enabled a sequential drop in pass-through backlog in the third quarter and we expect the same in the fourth quarter. We anticipate strong growth in building projects for the fourth quarter as our projects business has grown sequentially each quarter this year, an encouraging indicator of post-pandemic recovery. For overall HBT, we still expect double-digit organic sales growth for the full year, and increased volume leverage should allow for continued sequential segment margin improvement in the fourth quarter and healthy expansion for 2022 overall. In P&C, the favorable outlook in our end markets supports a strong fourth quarter with sales up sequentially from the third quarter and year-over-year. In Process Solutions, we expect growth to be supported by continued demand for thermal solutions and processes controls. In UOP, increased refining catalyst reload demand will support growth and provide margin benefits. However, the loss of Russia will continue to be a headwind in the fourth quarter. Advanced Materials will continue to outperform in the fourth quarter due to strong demand across the portfolio. Thanks to a strong third quarter, we now expect sales for overall PMC to be up double digits for the year, an upgrade from our outlook last quarter of up high single digits, and we expect segment margin to expand both sequentially and year-over-year in the fourth quarter. Looking ahead for FPS, we expect to see continued growth in the advanced sensing and gas detection portion of our sensing and Safety Technologies business, where demand indicators remain favorable and our backlog is robust. Warehouse automation demand will remain soft in the fourth quarter as customers push new warehouse capacity and investments to the right. So we continue to be encouraged by the bottom line benefits of our improvements in operational efficiency and our focus on higher-margin aftermarket services, which we expect to continue growing double digits. We still expect demand for warehouse automation to trough in 2023 and our long-term outlook for the business remains positive. Our short-cycle productivity solutions and service businesses continue to deal with the impact of supply chain shortages and have seen some demand moderation, which may result in sequentially lower sales in the fourth quarter, but we expect our differentiated technology to allow us to continue to outperform against our peers. While we remain confident in the medium-term growth rate in SPS, short-term headwinds persist, and we still expect SPS sales to decline mid-single digits in 2022. However, we expect to see strong margin expansion both sequentially and year-over-year in the fourth quarter as a result of shifting business mix and our continued operational improvements. Turning to our other core guided metrics for overall Honeywell, the net impact, which is the difference between segment profit and income before tax, is expected to be in the range of negative approximately $60 million to positive $40 million in the fourth quarter and negative $125 million to negative $50 million for the full year. This guidance includes a range of repositioning between $86 million and $136 million in the fourth quarter at $375 million to $425 million for the year as we continue to fund attractive restructuring projects and properly position Honeywell for a good financial outcome in 2022. We expect the adjusted effective tax rate to be approximately 19% in the fourth quarter and approximately 22% for the year, and the average share count to be approximately 676 million shares in the fourth quarter and approximately 683 million shares for the full year, reflecting our commitment to repurchase at least $4 billion of Honeywell shares in 2022. As a result of these inputs, our adjusted EPS guidance range is between $2.46 and $2.56 for the fourth quarter, up 18% to 22% year-over-year. For full-year EPS, we are upgrading the low end of our guidance range by $0.15 to a new range of $8.70 to $8.80, up 8% to 9%, reflecting the confidence in our ability to more than offset foreign exchange headwinds of $0.19 year-over-year and $0.08 versus our initial guide from February, as well as absorbing ongoing macroeconomic risk. We still expect to meet our original free cash flow guidance of $4.7 billion to $5.1 billion in 2022 or $4.9 billion to $5.3 billion, excluding the impact of Quantinuum. So in total, we are raising the midpoint of our full-year 2022 organic sales growth, segment margin, and adjusted EPS guidance ranges while absorbing headwinds of $1.1 billion in sales and $0.15 in adjusted earnings per share versus our initial guidance from lost Russian sales and incremental FX, a strong indicator of our ability to successfully deliver results in a fluid operating environment. Details on our full-year 2022 guidance progression and FX impacts can be found in the appendix of this presentation. Before turning back to Darius, let's turn to the next page and discuss our preliminary thoughts for 2023. While the macro backdrop signals another year of volatility, we believe our historical execution through multiple downturns demonstrates our ability to move quickly and decisively to protect margins, drive growth, ensure liquidity, and position Honeywell to deliver in any environment. Our rigorous operating principles and favorable end market exposure will help us remain resilient with commercial aerospace recovery continuing, upcoming capital reinvestment in the energy sector, and increased sustainability and infrastructure spending. We have a strong setup that will drive growth in sales, margins, and earnings in 2023. We expect organic growth in aero, PMT, and HBT due to record-level demand in backlog in 2022 in our long-cycle businesses. In fact, both of our largest businesses are seeing double-digit orders and backlog growth, which will headline growth and profitability in 2023. This will be offset by lower demand in warehouse automation volumes, which we believe will trough next year. We expect supply chain dynamics to improve gradually but remain constrained versus prepandemic levels. With these dynamics in mind, let's look at each of our businesses. In aero, we expect the demand picture to remain robust with increased flight hours, particularly a recovery in widebody and increased build rates among aircraft manufacturers, which will support growth in our commercial aviation business tempered only by the pace of supply chain healing. We also anticipate a return to growth in defense and space on increased defense budget and elevated backlog and an improving supply chain. In HBT, stimulus-fueled investment in institutional markets, as well as elevated backlog levels from this year's supply constraints, should provide resiliency into 2023, regardless of the macro environment. Many of our offerings are aligned with key secular themes such as energy efficiency and decarbonization, and we expect the verticals we serve to remain strong on balance throughout next year. In P&C, we expect to continue to capitalize on the growth we have seen in 2022. Backlog built this year will drive growth in Process Solutions, LNG capacity expansion and improved comps as Russia headwinds fall off will support growth in UOP, and improvement in semiconductor supply among customers and continued demand for Solstice products will enable Advanced Materials to have another strong year. Sustainable Technology Solutions should also provide growth as the Inflation Reduction Act supports new SaaS and carbon capture opportunities. For Safety and Productivity Solutions, decreased investment in new warehouse capacity and potential recession impacts in our short-cycle businesses will provide headwinds in 2023. However, we have a strong portfolio with differentiated solutions that will allow us to compete regardless of the macro environment. Operational improvement actions that we've already begun implementing and shifting business mix will allow us to expand margins in '23, even if revenues decline year-over-year. Overall Honeywell, 2023 margins will benefit from the continued volume recovery on a streamlined cost base, anticipated pricing tailwinds, flight hour improvement in aero, and mix shift in SPS towards higher-margin businesses. We'll continue our investments in R&D and growth-oriented CapEx as we remain keenly focused on creating uniquely innovative, differentiated, recession-proof technologies to address the world's toughest process technology, digital transformation, and sustainability challenges. We expect our spend on repositioning to begin to normalize lower. However, that EPS benefit will be more than offset by significantly lower noncash pension income in a rising interest rate environment, which likely results in a higher discount rate and lower asset base next year. This accounting headwind is a noncash item as our overfunded pension status will ensure no incremental contributions are needed, which is a great position to be in for our employees, both former and current, and our shareholders. We have significant balance sheet capacity for meaningful M&A and expect a favorable deal environment going into '23, which supports our commitment to accelerate capital deployment. Overall, the resiliency of our end markets and demonstrated ability to operate under dynamic circumstances gives us the confidence that we can deliver a strong financial performance in '23, including overall sales growth, margin expansion, adjusted EPS, and free cash flow growth despite the environment. We'll provide more specific inputs in our annual outlook call once we close the year.

Thank you, Greg. Let's turn to Slide 9 and talk more about the aspirational approach we are taking to our ESG commitments. ESG is more than just an initiative for Honeywell. It is a common thread that ties our businesses together and helps us shape the future of the company. At a corporate level, we have set aggressive targets to reduce our impact and protect the environment. We've reduced our Scope 1 and Scope 2 emissions by over 90% since 2004. Committed to set a target for Scope 3 emissions, the Science Based Targets Initiative, we have pledged to be carbon neutral in our facilities and operations by 2035. Our world-class manufacturing sites go above and beyond our own strict requirements with 17 sites achieving ISO 50001, the global energy management standard for establishing, implementing, maintaining, and improving energy management. In this segment, a broad portfolio of ESG solutions helps our customers lower their environmental impacts as well. We're driving the next evolution of energy through sustainable aviation fuel, both through traditional renewable feedstocks using our Ecofining process technology and now with ethanol feedstocks using our new ETJ process technology, reducing emissions at manufacturing sites and improving worker safety using gas cloud imaging technology that can quickly identify leaks. We're supporting the circular economy through our Honeywell Aerospace trading business, which takes retired planes and recycles used parts, reducing landfill volumes and providing quality certified parts to customers. We're improving occupant well-being and energy efficiency in office buildings with our innovative indoor air quality offerings. You can find out more information about Honeywell's environmental impact reduction and innovations in ESG technologies in our recently published 2022 ESG report, which is available on our Honeywell Investor Relations website. Now let's turn to Slide 10 for some closing thoughts before we move into Q&A. We're executing on our value creation framework with the rigor you can expect from Honeywell. We met or exceeded our third quarter guidance for all metrics despite ongoing external difficulties, and we raised the midpoint of our full-year organic sales and adjusted earnings per share guidance as well as increased our segment margin range, fully absorbing a series of higher-than-previously anticipated negative impacts, including FX. I am encouraged by the strength we are seeing in many areas of our portfolio, and I remain steadfast regarding our ability to deliver differentiated results in 2023 and through this cycle. Thank you to my Honeywell colleagues for your unwavering drive to deliver in this challenging environment. With that, Sean, let's move to Q&A.

Thank you, Darius. Darius, Vimal, and Greg are now available to answer your questions.

Just on Aerospace. What is the outlook for margins in the second, maybe in the fourth quarter, and then into next year? Pretty strong result despite OE picking up and defense hasn't really turned yet. So maybe just a little more color on aerospace margins as you head into next year from that perspective.

Yes. I think our view on margins is pretty consistent. I think the fourth quarter will look similar. It could be up 10 or 20 basis points. It could be down 10 or 20 basis points, something like that in the quarter as we continue to unlock the supply chain. It's a bit early to provide guidance for next year, but I would expect we're going to continue to be managing through the growth that we're seeing in OE. We have an investment portfolio. As you know, we talk a lot about the R&D investments we're making in the business. Aero is not the biggest grower of our margin expansion, as we've talked about. And I think that's going to remain pretty consistent into next year too.

Yes. And maybe just to add a couple of things, Steve. I think it's always done a great job expanding margins in a very difficult environment. And frankly, they have the toughest pricing environment out of any of our businesses. So they've done a great job. As we look forward to next year, there's a lot of puts and takes. I mean, the mix will get tougher, and some credits that we have to issue. So the OE growth is not obviously a favorable mix scenario. Now to offset that, the miles traveled in the aftermarket business, we don't expect as robust air miles next year as we do this year. However, it's offset by the fact that we do expect more wide-body miles next year. And as you know, the aftermarket opportunity of wide-bodies to narrowbodies is roughly 3:1. So all in all, we expect a solid year. The backlog at all-time records continues to grow. I think aero is positioned for a great year in '23.

Great. And then on SPS next year, you mentioned substantial margin expansion, but how do you kind of put that in the context of the long-term target?

Yes, I believe it's too soon to make changes. We are definitely maintaining our long-term target. In fact, next year should help us reach that target. We've acknowledged some weakness in warehouse automation, and I expect that 2022 will be the lowest point, with the business growing from there and achieving good margin expansion in 2023. It's hard to determine the exact figures at this stage, but we're not making any adjustments to our outlook.

Maybe two questions for me. I'll just wrap into one. First, just on the comment about the deal environment improving. Is that sort of a general comment, given just maybe bid-ask spreads kind of normalizing in this sort of tape? Or do you see it actually more active pipeline? And secondly, just on the whole pension dynamic. I get that it's noncash, but should we expect that maybe you dial back restructuring or something in 2023 to maybe offset some of that EPS headwind you're dealing with?

Let me start with the first question and then I'll hand it over to Greg for the second. Regarding the first question, the short answer is a bit of both. We believe that valuations are becoming more attractive, which is leading to an improved pipeline and increased activity. However, sellers need to adjust their expectations, as everyone wants to value their business based on last year's figures rather than the current situation. We're facing both challenges and opportunities. I don't anticipate a significant change in the valuation environment over the next three to six months, which is why we believe 2023 could still offer a favorable landscape. We are actively working to improve our pipeline, but we need to ensure we acquire properties at the right price, especially considering the current uncertainties. As for the second question, yes, we expect pension headwinds to be significantly higher than this year. Whether we will pursue additional restructuring is still to be determined. I want to highlight that we have an overfunded pension plan and do not expect any cash contributions regardless of circumstances. This situation is relatively neutral in the larger context.

Yes. Yes. No, that's right. And the pension headwind is large. I mean, it could be approaching $0.70. That, as you probably know, doesn't get finalized until the end of the year, and we'll snap the line on interest rates at that point, and we'll know what the overall pension asset has done during the course of the year. But it's going to be meaningful, but it's, again, noncash, and as Darius mentioned, we think we'll probably come down a little bit in repo, but not nearly enough to offset the order of magnitude that noncash pension income will put out.

And one last comment here, Jeff. As you noticed in our outline for Q4 and the year, we're going to be at the upper end of our repo number that we provided for guidance, which means we're really preparing the business for a somewhat tougher environment in some of our sectors, not all of them because we are well positioned, and HBT will do okay, although we have some challenges in SPS. So we're doing a lot of that preparatory work ahead of time, and we're bringing in a lot of our restructuring activities to 2022. Q4 will be a strong quarter, and that's all intended to position the business for a successful 2023.

I apologize, but I have a two-part question. First, regarding orders, I believe you mentioned they increased by low single digits in Q3, which shows a noticeable slowdown from Q2. Are there any specific regions driving that trend? Secondly, could you share your preliminary thoughts for 2023? Margins have increased by 100 basis points this year, excluding Quantinuum for the entire year. It doesn't appear, as shown on Slide 8, that there is a significant Quantinuum headwind in 2023. With supply chains improving and some growth in revenue, do you think we could see a similar margin performance next year?

Yes. I think I'll answer your second one first, which is it's really too early to tell, Julian. I think we're going to work through that. I think all I can tell you is we're going to expand margins. That you can count on. How much? Unfortunately, you're probably going to have to wait until the end of January or early February, whenever we issue our Q4 results and guidance for '23. On your former question, I just would like to point out a couple of things. If you exclude the impact of Intelligrated, and that was a very big bookings quarter last year, it's high single-digit growth for bookings. So just keep that in mind. So I'm actually pretty happy with the outcome. That's a strong outcome, and it's still up low single digits, inclusive of Intelligrated. So I think that's a good outcome. As I look at sort of regions and so on, as you would have expected, China was a little bit softer in Q3. There were some spots in Europe on the bookings that were softer, particularly in HBT, not a big shock. Those were a couple of soft spots. On the flip side, North America was strong. The Middle East was strong. There was kind of a balanced mix, some puts and takes. So really nothing dramatically different than our expectations.

I just saw your Q. It said price was up 11%. It's just literally twice the group average. Is there anything in your portfolio kind of thinking that would be skewing that a little bit on the higher side and maybe accounts for some of that? I'm trying to think like the project businesses, I would think are hard to get that type of a price. So maybe just a little bit of color on where you have the most price or the least price and maybe some of the puts and pulls there?

Yes, as Darius mentioned, I believe Aerospace has been the most challenging area for us. However, we have performed better than expected in our long-cycle businesses by adjusting prices in our backlog due to inflation. We’ve achieved some success in our project businesses by securing price increases. The product businesses are certainly the primary contributor to this, particularly in PMT, HBT, and SPS, which are all demonstrating strong pricing power.

The algorithm moving forward is likely to change. As we look into 2023, we may not experience as significant a shift from pricing, although we expect Q3 and Q4 to remain relatively strong. However, the algorithm will shift in 2023. Q4 may see a modest increase in volume leverage, while next year will likely bring more volume leverage but perhaps less from pricing. This means our approach to generating margin expansion for 2023 will be different. The supply chain has been challenging, but it is slowly getting better. We have reduced our backlog in HBT, SPS, and PMT, though Aero remains a more complex issue. However, looking at Aero's outlook for Q3, it was up slightly compared to Q2, which is different from the trend over the last five years where Q3 output has typically been about 4% to 5% lower than Q2. This indicates that there is some improvement in the supply chain, and we anticipate that to continue. Therefore, our strategy for value creation will be different next year.

I have a question regarding defense and space. Compared to competitors, it seems to be underperforming. What is the best way to correlate this business? Is it linked to a specific platform program? How should we model it against the budget since it appears to be lagging behind its peers? Additionally, what is the current status of the R&D tax credit? I heard there was a possibility of receiving some cash back. What is the outcome of that?

Let me clarify both of those points. Unfortunately, there isn’t a straightforward guideline I can provide for defense and space as we are dealing with a wide range of scenarios. If you look at programs such as hypersonics and T55, along with some helicopter engine projects, those are definitely beneficial for us. It’s important to note that this wasn’t our strongest quarter in defense and space, but we believe this marks the low point. Our backlog has notably increased, and our orders rose in the high single digits within defense and space. We believe we are at a turning point and expect growth in this sector for 2023. Our long-cycle backlog saw a double-digit increase this quarter, which gives us optimism for future developments in defense and space. Although this year has been disappointing for us so far, we are confident this is the bottom. Regarding the R&D tax credits, we won’t make any predictions until we see concrete results. As you know, we were perhaps the only company to exclude that from our cash forecast initially back in January, which cost us around $400 million. We’ve maintained that position, and so far, it has proven accurate. As for the outcomes in the lame duck session in November and December, it’s uncertain at this point. I personally view it as a 50-50 chance; it could go either way. We certainly hope for a favorable outcome, as that would improve our cash outlook for 2022. That summarizes our current situation.

Just so I'll keep it to one question. But maybe just clarify, the pricing is very, very strong. Advanced Materials being a disproportionate driver of that? Just curious on that. But on SPS next year, I think we all understand the headwind dynamics. You called out Project Solutions is a bit weaker into the fourth quarter. How do we think about weak warehouse, probably weak spending environment in '23 versus supply chain sort of pent-up demand as we go into '23 for the PS portion of the portfolio?

So let me start with the pricing in Advanced Materials. Absolutely, we got strong pricing because we have a differentiated product line. And that proves our focus on new products and differentiated position. But across the board in PMT, our pricing has been strong also in other segments too. So the PMT pricing growth is not only Advanced Materials story. It spreads across Process Solutions and UOP segment also. SPS question, Darius, I'll let you...

Yes. So for SPS, I mean, I think on the PS portion, it's been softer. We're lapping some very, very difficult comps. We have been sort of record volumes and orders in Q3 last year, nothing unexpected. It's probably a little bit better than the market. It sort of dialed into our algorithm going forward. What I will tell you is that our backlog is still relatively strong. I mean granted we've liberated some of that, but our backlog is still at an elevated position. The other thing I would tell, which was also a good sign is that sort of the channel inventory days of supply in North America actually dropped in Q3, which is always a good sign. So all in all, it wasn't the most robust quarter there, but not different than our expectations.

Darius, you guys have talked about $20 billion, $24 billion to $27 billion of potential capital deployment opportunities. I'd be curious to hear, as you're kind of thinking through the M&A environment, size of deals that you're looking at or could be looking at for the portfolio? And then secondly, you did talk about Quantinuum as a potential strategy to offload that piece of your business sometime over an 18-month period. I'm just curious whether the environment has kind of changed things at all just given the volatility that we've seen with stock action.

Yes, let me start with your second question. The short answer is that the market is not particularly receptive to companies like Quantinuum right now. When we take any action depends on the stock market conditions. The stock market is not having a great year, and we all know that, but I don't believe this situation will last forever. I wouldn't rule out the possibility of making a change with Quantinuum within an 18-month timeframe. I still see that as very much achievable in terms of doing something different with that business. I hope that answers your question. What was your other question? Yes. I believe our ideal range for purchases remains between $1 billion and $5 billion. We're open to other options, but as I mentioned in the previous earnings call, I'm inclined to avoid smaller deals unless they are extremely strategic, as they tend to require significant effort without a substantial impact. Therefore, we are likely to gradually increase the size of our deals. While I wouldn't rule out major deals, they are probably not highly likely.

Just one follow-up on pricing, and then I'll ask my other question. Just kind of going back to Scott's point on how strong your pricing has been. I guess it's been an unprecedented environment, obviously. And is there a risk that pricing in some categories would have to decline if deflation continues or moderation in commodity prices continues? And then secondly, what's the path back to free cash conversion of 100% plus? I suspect that this will probably take some time because it's taken some time for inventory to build.

Yes. Regarding the risk of pricing declines, given our extensive portfolio, there may be instances where this is true. We monitor demand elasticity to ensure we are not harming demand. Overall, we anticipate positive pricing next year. Inflation is not decreasing; it is moderating and remains elevated, having stabilized to some extent. Thus, while there are likely pockets where pricing could decline, we don't foresee this as a broad risk. On the topic of free cash flow returning to 100%, we believe that ratio is not particularly useful. We focus more on free cash flow margin, aiming for a mid-teen range, which we are confident in achieving. It may take time to reach 100% free cash flow, but that is not our primary goal; instead, we aim for a healthy mid-teens free cash flow margin as a key metric for our company.

Yes. I believe our outlook for next year reflects this. We anticipate growing free cash flow next year, approximately in line with earnings per share, excluding the significant impact of pensions. Despite facing substantial challenges, we have managed to retain our original free cash flow projections for this year. I want to highlight that we might be one of the few, if not the only, companies that haven't reduced our free cash flow expectations for the year, despite encountering significant headwinds. Since our outlook call in January, we've seen about a $0.15 impact on EPS due to Russia and foreign exchange fluctuations. Year-over-year, the impact from Russia and FX is closer to $0.30. It's crucial to emphasize how much we are actually raising our outlook for the year while maintaining it. I don't think this is widely recognized, and it is something that sets us apart.

Darius, I wanted to ask you about PMT and Vimal as well. We've seen some major reactions in oil prices with news around price caps in Russian oil and OPEC production cuts. Can you maybe talk about what the volatility in oil prices is doing to near-term order activity in PMT and as you think about the longer-term potential for the business across LNG, battery technology, and the sustainability portfolio?

Yes. So our business, as we mentioned during Investor Day and other events, that we are much less linked to upstream. We are much more linked to downstream segments in PMT. So the volatility in oil price does determine customer decision on how they want to spend capital based on the returns they will get. What we have seen there is that investments are slowly getting better. We clearly see investments getting better in the sustainability side of the portfolio. We continue to roll more and more offerings in that segment. So that's how I would see linkage on the oil price. Speaking more broadly of the PMT portfolio, look ahead, we remain confident of a good growth year for PMT in 2023. That is supported by the capital growth to a certain degree, sustainability investment, but also we're going to carry stronger backlog for Process Solutions. And as it's a long-cycle business, that will convert in 2023. So overall, we remain quite optimistic on the PMT performance for the next year.

Just a question on backlog. And Darius, you touched on it a few times in terms of this working down of past due. But if I look on Slide 8, it does look like there was a tiny sequential downtick. I'm just wondering that as supply chains free up here, are you seeing any sort of air pocket where folks are realigning lead times to what they need versus needing to go out much further? And any comment on kind of maybe core backlog versus some of this past due stuff would be helpful.

Yes, you are correct. There was a slight decrease in our backlog, specifically in PMT, HBT, and SPS, although there was an increase in aero that balanced this out. We're witnessing some improvements in the supply chain across those three segments, but there are significant challenges within the aero supply chain despite the strong order rates. Aero has increased considerably, but lead times remain lengthy. They are improving, particularly in SPS and HBT. The major factor for unlocking potential in aero as we move into 2023 will be labor. Honeywell has labor resources, but some of our Tier 3 and Tier 4 suppliers may face difficulties. If the economic environment in 2023 turns recessionary, it could negatively impact labor availability in the aerospace sector. I hope that clarifies things.

Liz, we have time for one more question.

And just for Vimal, want to first congratulate you on the new role. And it sounds like your initial focus is going to be on Intelligrated. Just could you share with us what your approach is and other areas of the firm that you'll be focusing on?

Yes. So I think specifically in Intelligrated, as we mentioned, that we are seeing a reduction in volumes there. So we are really focused on how to make the business processes more robust in this cycle. So we're taking a lot of actions on our process maturity and digitization in the business so that we come out stronger in our margin rate expansion in 2023 in the times to come. On your broader question, yes, I'm looking at opportunities across Honeywell, how we can drive our long-term commitments on organic growth and margin expansion and working with all my SPG colleagues and Honeywell Connected Enterprises, and we are committed to improving our operations so that we can deliver our long-term commitments on earnings.

Thank you. I want to thank our shareholders for your ongoing support. We delivered strong third quarter results and continue to navigate effectively through multiple uncertainties with the typical level of operational rigor and agility you've come to expect from Honeywell, enabling us to drive superior shareholder returns. Thank you all for listening, and please stay safe and healthy.