Honeywell International Inc. (NASDAQ:HON) Q4 2022 Earnings Call Transcript

Honeywell International Inc. (NASDAQ:HON) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Thank you for standing by, and welcome to the Honeywell Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s call is being recorded. I would now like to hand the call over to Sean Meakim, Vice President of Investor Relations. Please, go ahead.

Sean Meakim: Thank you, Crystal. Good morning and welcome to Honeywell’s fourth quarter 2022 earnings and 2023 outlook conference call. On the call with me today are Chairman and CEO, Darius Adamczyk; Senior Vice President and Chief Financial Officer, Greg Lewis; President and Chief Operating Officer, Vimal Kapur; and Senior Vice President, General Counsel, Anne Madden. 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 that are based on our best view of the world and of the 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. 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 fourth quarter and full year 2022 and discuss our 2023 outlook, including sharing our guidance for the first quarter of 2023 and full year 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.

Darius Adamczyk: Thank you, Sean, and good morning, everyone. Let’s begin on slide two. The fourth quarter was another challenging one, with supply chain constraints and inflation headwinds still at play. But Honeywell’s disciplined execution and differentiated solutions enable us to deliver on organic sales, segment margin, earnings and free cash flow commitments. Organic sales were up 10% year-over-year or up 11%, excluding the impact of the wind-down of operations in Russia, led by double-digit growth in commercial aviation, building products, advanced materials and UOP businesses, a testament to the underlying strength we are seeing across our end markets, particularly in long-cycle businesses. The fourth quarter was another strong one for our backlog, which grew to a new record of $29.6 billion, up 7% year-over-year and 2% sequentially due to strength in Aerospace and Performance Materials and Technologies.

Orders were also a positive story in Aero and PMT, leading to a 2% organic orders growth and 6% sequential growth in the fourth quarter. The tailwinds we’ll continue to see in these two businesses gives us confidence in our 2023 outlook, which Greg and Vimal will share more detail about in a few minutes. Our segment margin expanded 150 basis points year-over-year, led by over 900 basis points of expansion in safety and productivity solutions as volumes improve. And we continue to stay ahead with the inflation curve through our strategic pricing actions. Excluding the year-over-year impact of our investment in Quantinuum, the margin expansion was 180 basis points. Free cash flow was $2.1 billion in the fourth quarter, with 125% adjusted conversion, down 18% year-over-year but delivering in line with our original guidance for the year.

Capital deployment in the fourth quarter was $2.3 billion, including $1.4 billion of share repurchases, bringing our full year total to $4.2 billion in shares repurchased and exceeding our goal of $4 billion from our March Investor Day. For the full year 2022, we delivered outstanding results above the high-end of our initial guidance for segment margin and adjusted earnings per share, despite approximately $2 billion in year-over-year top line headwinds and constantly shifting macroeconomic conditions. We finished the year with 6% organic sales growth, 70 basis points of margin expansion and $8.76 of adjusted earnings per share, up 9% year-over-year and above the top end of our original $8.70 guide. Orders ended the year up 8% on an organic basis.

And our backlog reached an all-time high of $29.6 billion. We generated $4.9 billion of cash in the year, 14% of our revenue. The appendix of this presentation contains a slide highlighting our guidance progression through 2022 as well as our performance against these guides. Capital deployment for 2022 was $7.9 billion in total, in addition to the $4.2 billion in share repurchases, which lowered our weighted average share count by 2.5%. We deployed $800 million to high-return capital expenditures and $200 million on closing the acquisition of US Digital Designs. Finally, we maintained our dividend growth policy, paying out $2.7 billion and raising our dividend for the 13th time in 12 years. As always, we continue to execute on our proven value-creation framework, which is underpinned by our Accelerator operating system.

I am confident in the strength of our backlog and the tailwinds, we’re seeing across our end markets, and I’m proud of our ability to execute and drive shareowner value to the current challenging environment. Now let’s turn to slide 3 and to discuss an important development from the fourth quarter, which further improved our company’s strength for the future. In the fourth quarter, we announced the final court approval of our buyout agreement with the NARCO Trust, providing the elimination of our funding obligations in exchange for our $1.325 billion cash payment to the trust. This liability has been weighing on our balance sheet since 2002, one of the numbers of legacy liabilities the company has been carefully managing. We recognized the charge from the buyout in the fourth quarter, and the cash outflow took place in January.

Partially offsetting the impact of the buyout is the sale of Harbison-Walker International, the reorganized and renamed entity that emerged from the NARCO bankruptcy, which announced that and will be acquired from the Trust by private equity firm, Platinum Equity. We expect this transaction to be completed later in 2023, reducing the net free cash flow impact by approximately $300 million. This development represents a significant improvement in our financial strength. Specifically, it simplifies our balance sheet by eliminating our evergreen funding obligations, eliminates quarterly asbestos charges related to NARCO and extinguishes any further uncertainty on our company’s financial health. Now let me turn over to Vimal, to discuss our fourth quarter results in more detail on slide 4.

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Vimal Kapur: Thank you, Darius, and good morning, everyone. Let’s turn to slide 4. As Darius mentioned, we continue to deliver on our financial commitments, despite a very challenging operating environment. In the fourth quarter, sales grew 10% organically with double-digit growth in three of our four SBGs: HPT, PMT and Aero. We generated volume improvement from third quarter in Aero and HPT despite continued supply chain constraints. As expected, we are seeing some signs of demand weakness in pockets of our shorter-cycle businesses in SPS and HBT, but demand across our long-cycle portfolio remains robust with the exception of warehouse automation as evidenced by 2% organic growth in orders and 7% growth in backlog. Supply chain remains a constraint on our overall growth, but we are encouraged by another quarter of sequential volume improvement in Aero as output expanded by double digits in 4Q.

Alongside solid organic growth came robust segment margin expansion of 150 basis point year-over-year to nearly 23% as our investment in Honeywell Digital enable us to make a nimble and surgical approach to staying ahead of price/cost. While SPS was a lone segment to experience a decline in revenue year-over-year, the business also generated the most profitable quarter in its history, which we will discuss in more detail shortly. Let’s spend a few minutes on the fourth quarter performance by business. Aerospace. Sales for the fourth quarter were up 11% organically year-over-year led by 23% growth in commercial aviation. This marks the second consecutive quarter of double-digit Aerospace organic sales growth and the seventh straight for commercial aviation, which gives us confidence despite the state of the aero supply chain over the past two years.

Supply chain remains a gating factor to volume growth, though we made a further progress this quarter with a factory output up 15% year-over-year and 14% sequentially. Our past-due backlog grew an accelerated pace in the fourth quarter, but this was more driven by the strength of inbound orders. Growth was highest in commercial OE, where increased ship set deliveries led to 25% sales growth year-over-year. Commercial aero aftermarket sales were up 20% in the fourth quarter as increased flight hours resulted in higher spare shipments and repair and overhaul activity. While defense volumes continue to be in the lower on a year-on-year basis in the fourth quarter, our order rates remained strong, up high single digits for the quarter and mid-single digit for the year, giving us positive momentum for 2023.

Aero segment margins contracted 120 basis point to 27.8% due to higher sales of lower-margin OE products, partially offset by our commercial excellence efforts. Building Technologies delivered another outstanding quarter with 15% organic sales growth year-over-year. Modest improvement in supply chain enabled us to reduce our cost to use backlog sequentially and deliver more fire products and building management systems, resulting in 21% organic growth in building products. However, supply chains still have not fully unlocked. We exited 2022 with higher past due backlogs than we entered the year and considerably higher levels than our pre-COVID norms. Building solutions sales also increased organically with double-digit organic growth in project sales for the third consecutive quarter.

We finished the year with higher project backlog levels than the start of the year, providing a solid runway for 2023. Our continued commercial excellence in this inflationary environment enabled us to expand HBT segment margins 370 basis point to 24.8%, substantial progress nearly reaching our long-term margin target of 25%. Performance Materials and Technologies sales grew 15% organically in fourth quarter despite a 4% headwind from Russia. Advanced materials grew 20% organically in the quarter as we continue to see robust value capture across the portfolio and demand in fluorine products. The quarter was the fourth consecutive quarter where advanced materials led PMT growth. UOP grew 13% organically, overcoming 9% headwind year-over-year from loss ratio sales.

Growth in UOP was led by refining catalyst shipments, and we also saw a double-digit sales increase in Sustainable Technology Solutions. Process Technology returned to growth in the quarter as a result of strong gas processing demand. Process Solutions also grew double digit in the quarter, with a strength across the portfolio, led by thermal solutions, life cycle solution and services and projects. In late 2022, weather freeze caused some operational challenges at one of our plants, reducing output in the quarter. PMT orders once again grew organically in the fourth quarter, underpinned by strength in Fluorine products. Segment margins contracted 100 basis points in the quarter to 22% driven by cost inflation and higher sales of lower margin products, partially offset by our commercial excellence efforts.

Safety and Productivity Solutions sales decreased 5% organically in the quarter, in line with our expectation, as continued growth in sensing portion of sensing and safety technology business was offset by lower volume in warehouse automation and productivity solution and services. While Intelligrated volumes declined overall, our aftermarket services business saw another quarter of double-digit growth. PSS continues to see some demand moderation from macroeconomic conditions, but we remain confident in our differentiated solutions. Segment margin was a standout for SPS with expansion of 940 basis point to 20.2%, our highest ever in this business due to commercial excellence, improved sales mix, and productivity actions more than offsetting lower volume leverage and cost inflation headwinds.

Growth across portfolio continues to be supported by accretive results in Honeywell Connected Enterprise. We had another quarter of double-digit revenue growth, including over 20% growth in our recurring and SaaS business year-over-year. Cyber, Sparta Systems and Connected Building all grew by more than 35% year-over-year in the quarter. For the full year, SC sales and profit both grew by double digit, which is an indicator of the power of a strong software franchise. Overall, this is a great operational result for Honeywell. Adjusted earnings per share in the fourth quarter grew 21% to $2.52, a $0.01 above the midpoint of our prior guidance range. Segment margin drove 29% of year-over-year improvement in earnings per share, the main driver of our year-over-year growth.

A lower adjusted effective tax rate contributed 10% of improvement, and reduced share count added an additional $0.07. A bridge for adjusted EPS from 4Q 2021 to 4Q 2022 can be found in the appendix of this presentation. Moving to cash. We generated $2.1 billion of free cash flow in the quarter, down 18% year-over-year but delivering the midpoint of our full year free cash flow guidance at $4.9 billion. Cash continued to be challenged by higher receivables and inventory as we continue to work through the supply-constrained environment as well as $200 million headwind from Garrett receipt in the fourth quarter of 2021. So overall, Honeywell’s rigorous operating principles allowed us to manage successfully through another challenging quarter as we close our 2022.

Now let’s turn to Slide 5 to talk about where we expect to see across our end markets and the broader macro environment in 2023. Looking ahead to 2023, we see a continuation of many of the challenges we faced in 2022. But we also see ongoing progress in our key initiative to unlock more volume from our supply chain in order to meet very robust demand in several of our key end markets. Commercial Aerospace will continue to be a standout in terms of demand, both build rates amongst our OEM customers as well as aftermarket flight hours, particularly as wide-body makes a more meaningful contribution on its way back to normalization. Alongside that strong demand profile, we expect steady progress of the Aero supply chain in 2022 to continue in 2023.

As a result, we expect acceleration in Aero’s top line growth compared to 2022, potentially achieving low double digits. We continue — we see continued tailwinds for investment in sustainable building solutions, particularly through institutional channels as well in the production of both current and future energy supply as evidenced by strength in orders across both sustainable building technologies and sustainable technology solutions, including green fuels. We expect a moderation in raw material inflation but for it to remain at elevated levels. Coupled with a gradual improvement in supply chain, we should see more of a balance between volume and price to drive our top line growth in 2023. Our order growth of 2% decelerated in the fourth quarter compared to 8% for the full year, but remained in positive territory, including sequential growth from the third quarter for Aero, PMT and SPS.

Our backlog of almost $30 billion remains at record levels, growing 7% year-over-year in fourth quarter. We reduced our positive backlog in all SPGs except Aero for the second consecutive quarter, reflecting supply chain loosening and the effects of effort to mitigate part shortages. The current macroeconomic uncertainty is giving some customers pause amongst our short-cycle businesses in SPS and HBT, and there’s a lot of near-term uncertainty regarding how the reversal of China’s Zero COVID policy will impact 1Q, particularly the potential impact of Chinese New Year, though this may be a tailwind in the second half. As discussed on the third quarter call, lower non-cash pension income is a headwind to EPS growth in 2023, but our underlying segment profit growth continues to look robust.

Underpinning our expectation is the confidence we have in our continued operational execution, underpinned by our operating system called Honeywell Accelerator. We’ll manage through another challenging operational environment with the rigor you have come to expect from us. Now let me turn it over to Greg as we move to Slide 6 to discuss in more detail how these dynamics come together for our 2023 financial guidance.

Greg Lewis: Thanks, Vimal, and good morning, everyone. Given the backdrop Vimal just shared, in total for 2023, we expect sales of $36 billion to $37 billion, which represents an overall organic growth sales range of 2% to 5% for the year. While we’ll continue to drive pricing actions where needed to offset the impact of cost inflation, we expect more balance between the contributions of volume and price in 2022. Similar to last year, we believe the first half of the year will be slower as supply chains improve sequentially throughout the year and potential headwinds from the reversal of zero COVID policies in China are strongest in the first quarter. In Aerospace, the demand backdrop remains very encouraging in both commercial aviation and defense and space.

In the commercial aftermarket, we expect continued flight hour growth, particularly in wide-body as international borders open and travel further normalizes to drive growth in air transport aftermarket sales. The policy change in China should provide added fuel to this dynamic. On the commercial OE side, build rate schedules among the OEMs are trending upwards year-over-year, leading to more ship set deliveries for Honeywell, driving revenue growth, but also translating into a corresponding increase in selection credits, a headwind to margins. In Defense and Space, we plan to convert our strong order book into sales and expect defense to return to growth in 2023 as the supply chain improves. Supply chain constraints, not demand, remain the gating factor to both commercial and defense volume growth in 2023, but we’re encouraged by the improvements our team has executed in recent months, resulting in 7% output growth in 2022.

The sourcing environment for electronic components in Aero improved over the past quarter, but the supply chain for mechanical components remains constrained due to skilled labor shortages among Tier 3 and 4 suppliers. We entered 2023 with Aerospace backlog levels that are more than 20% higher year-over-year, giving us confidence in our growth projections. For overall Aero, we expect organic growth for the year to be in the high single-digit to low double-digit range. While Aerospace will likely be our strongest top line grower in 2023, we expect only modest margin expansion year-over-year as increased volume leverage is largely offset by unfavorable mix due to increased selection credits in the commercial OE business. In Building Technologies, we’re cognizant of the broader economic environment and expect private investment in non-res construction to continue to be impacted by increased financing costs.

However, throughout 2022, we built a strong slate of orders, partially as a result of the supply chain environment that provides solid sales visibility and buffer for 2023. In addition, we believe that institutional investment will remain robust buoyed by government stimulus funds that have not yet been deployed, supporting key verticals such as education, airports and healthcare. We see the most significant sales growth this year coming from building projects and building management systems as we capitalize on a robust 2022 book-to-bill in these businesses. We also expect increased spot orders for our building services throughout the year as the supply chain normalizes, layering incremental demand in. For overall HPT, we remain cautious in the current environment, expecting our strong backlog to support us early in the year and anticipate low single-digit organic sales growth for 2023 overall.

However, we remain very confident in our long-term framework for Building Technologies as much of our portfolio is aligned with secular trends of sustainability and energy efficiency. On the segment margins, we expect to carry the momentum from 2022 strong exit rate, resulting in year-over-year expansion for the full year. In PMT, we are set up to build upon an impressive 2022 and convert favorable macro conditions into another solid year with sales growth sequentially throughout the year. Backlog built through 2022 will enable another year of growth in Process Solutions led by Lifecycle Solutions and Services and thermal solutions. In UOP, improved comps as we lap the lost Russian sales headwinds will provide support to a business that already has potential for upside.

Our Process Technologies business returned to growth in the fourth quarter and is poised to continue to grow at 2023, while catalyst shipments should remain robust throughout the year. Demand for new energy capacity to offset lost Russian supply will also be a tailwind, particularly for our LNG business. In Advanced Materials, growth will continue despite difficult comps, thanks to strong demand for our Solstice products and supply chain improvements. In addition to Solstice, our other sustainable offerings will benefit from legislation, such as the inflation reduction app and increased customer focus on environmental responsibility. Orders in our Sustainable Technology Solutions business have accelerated dramatically over the past two years, and we’re expecting more of the same in 2023 as we continue towards our $700 million sales target by the end of 2024.

In total, we expect PMT sales to be up mid-single digits for 2023. PMT margins should expand modestly as a result of improved volume leverage and continued pricing and productivity actions. Turning to Safety and Productivity Solutions. That will be the business most impacted by the macroeconomic environment in 2023. And Intelligrated, decreased investment in new warehouse capacity will continue to limit near-term opportunities in our long-cycle projects business with the trough and demand likely coming this year before returning to growth in 2024. However, our aftermarket services business has been growing at double-digit rates, and we expect that to continue in 2023. And productivity solutions and services, short-cycle demand softness and the distributor destocking will impact sales in the first half of ’23, but we expect this dynamic to taper off and should see sequential improvement later in the year.

In sensing and safety technologies, sales growth will continue in ’23 after a strong finish to 2022. In total, we expect SPS sales to be down mid to high single digits for the year. From a margin standpoint, ’23 should be another solid year for SPS, as we continue to benefit from improved business mix and drive our operational improvements. While 4Q ’22 was a high watermark for the business and will not necessarily be the new standard moving forward, we believe high-teen margin rates are achievable in 2023. So we expect our overall segment margin to expand 50 to 90 basis points next year, supported by higher sales volumes, our continued commercial excellence efforts and productivity actions. Similar to last year, we expect SPS margins to expand the most, as we build on our operational improvements in ’22 and continue to benefit from improved mix and cost structure in that business.

For the year, we expect earnings per share of $8.80 to $9.20, flat to up 5% adjusted, despite an approximately $0.55 headwind from lower pension income. Excluding this impact, our adjusted EPS range would have been $9.35 to $9.75, up 7% to 11% adjusted. On the free cash flow front, we expect a range of $3.9 billion to $4.3 billion in 2023 or $5.1 billion to $5.5 billion, excluding the onetime $1.2 billion net impact of NARCO, HWI and UOP matters. I’ll walk through the puts and takes for our ’23 cash flow in greater detail in a couple of minutes. But first, let’s turn to slide seven and walk through our EPS bridge for 2023. As you can see, segment profit will be the key driver of our earnings growth in ’23, contributing $0.59 at the midpoint of our guidance range.

Net below-the-line impact, which is the difference between segment profit and income before tax, is expected to be in the range of negative $475 million to $625 million, which includes capacity for $200 million to $325 million of repositioning, which is lower than the approximately $400 million we used in ’22. For tax, we expect an effective tax rate of approximately 21% for the year. With these inputs below the line and other items, excluding pension, are expected to be up $0.05 per share year-over-year at the midpoint of guidance, primarily driven by lower repositioning and asbestos charges, partially offset by higher net interest expense. For share count, our base case for 2023 is that our minimum 1% share count reduction program will result in a benefit of approximately $0.15 per share, reducing our weighted average share count to approximately 672 million from the 683 million in 2022.

As we previously communicated, we expect a large decline in pension and OPEB income this year, as a result of the increased interest rate environment. For the full year, we expect approximately $550 million of pension and OPEB income, down about $500 million from 2022, driving about $0.55 headwind to EPS. However, this is a noncash accounting item as our overfunded pension status will ensure that no incremental contributions are needed. We ended ’22 with a pension-funded status of over 125%, as a result of diligent management and strong returns, a great position to be in for our employees and shareholders. In total, we expect ’23 earnings per share to be in the range of $8.80 to $9.20, flat to up 5% year-on-year on an adjusted basis. However, excluding the impact of non-cash pension headwinds, our guidance would be a range of $9.35 to $9.75, up 9% at the midpoint.

Now let’s turn to slide 8 and talk about the drivers of our free cash guidance for 2023. As we’ve outlined in the bridge, our 2023 free cash flow story can be characterized as strong operational performance offset by a few discrete non-operational items. Income growth is the largest driver of free cash flow, and we expect to make further progress this year on working capital as the supply chain normalizes. We expect 2023 free cash flow, excluding the settlement of the legacy legal matters we discussed earlier, to range between $5.1 billion to $5.5 billion, up 8% year-over-year at the midpoint as we had previously spoken about. Accounting for the settlements, we are expecting free cash flow for 2023 in the range of $3.9 billion to $4.3 billion.

Now let’s turn to slide 9, and we can discuss our guidance for Q1. As we highlighted earlier, we entered 2023 with record backlog, providing a solid foundation for the first quarter. Supply chains remain constrained, however, we anticipate modest sequential improvement in volumes. We’re closely monitoring the impacts of Zero COVID policy changes in China as the country reopens and eased its COVID restrictions and are wary of potential Q1 impacts. However, we anticipate that these policy changes will be a net positive for demand as we progress throughout the year and will result in a robust second half in China. Looking at the segments. We expect sales growth in Aerospace in the first quarter as the demand environment remains robust, and we execute on our strong backlog.

However, the rate of growth will be more subdued than our full year expectations as we anticipate 1Q will be the most supply constrained for the quarter. In Building Technologies, we anticipate modest organic sales growth in the first quarter as we work through our backlog and the supply chain continues to heal. We see the strongest sales growth in building projects, followed by increased sales of fire. In PMT, we expect another quarter of year-over-year growth in 1Q. We expect that growth to be once again led by advanced materials with Process Solutions, the laggard, though still with strong year-over-year growth. We’re expecting, sorry, we experienced a disruption in one of our PMT plants that will cause some unplanned downtime, though that is embedded in our guidance.

In Safety and Productivity Solutions, short-cycle and warehouse automation demand softness will offset growth in Intelligrated aftermarket services and the sensing part of our sensing and safety technologies business, leading to a decline in year-over-year sales. However, we expect another strong margin performance in the high teens. So for overall Honeywell, we anticipate sales in the range of $8.3 billion to $8.6 billion in the first quarter, up 1% to 5% organically. We expect margins in the range of 21.4% to 21.8%, up 30 to 70 basis points year-over-year as we remain diligent in our price/cost management and benefit from favorable business mix. The net below the line impact is expected to be between $165 million to $210 million of an expense with a range of repositioning between $80 million and $120 million as we continue to provide capacity to fund our transformational efforts.

We expect the effective tax rate to be in the range of 21% to 22% for the quarter and average share count to be approximately 675 million shares. As a result, we expect first quarter EPS between $1.86 and $1.96, down 3% to up 3% year-over-year or up 5% to 10%, excluding the year-over-year impact of lower non-cash pension income. And lastly, while the first quarter is already historically our lowest from a free cash flow perspective, the settlement payments related to the aforementioned legal liabilities were paid out in January, and we expect cash from operations to be a net use in 1Q. Overall, while we maintain a prudent level of caution, we’re confident in our operational abilities and our portfolio of differentiated technologies. Our portfolio is well positioned for this stage of the cycle, and we’ll continue to innovate and invest in the businesses to support long-term growth.

Now with that, I’ll turn the call back over to Darius on slide 10.

Darius Adamczyk: 2022 was another year of both challenges and progress for Honeywell. Despite another host of macroeconomic and geopolitical difficulties, we attacked the challenges we faced head on, we over-delivered on our financial commitments. While 2023 brings new — including potential recession scenarios, leading to uncertain demand in short cycle with a record $30 billion backlog, a robust balance sheet and one that has been further derisked due to the NARCO settlement and the ability to deploy capital organically and inorganically, I remain optimistic about the future of Honeywell and believe the company is well positioned to drive innovation to solve some of the world’s most challenging problems. One last item before we move to Q&A.

I’m pleased to announce that our 2023 Investor Day will be held on May 11 in New York City. At this Investor Day, I, along with our other members of the senior management team, will provide an update on Honeywell’s business strategy, exciting new growth opportunities and our long-term growth algorithm. We look forward to sharing more about Honeywell’s future data. With that, Sean, let’s move to Q&A.

Sean Meakim: Thank you, Darius. Darius, Greg, Vimal and Anne are now available to answer your questions. We ask you please remindful of others in the queue by only asking one question. Crystal, please open the line for Q&A.

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Q&A Session

Operator: Thank you. At this time, we will conduct the question-and-answer session. And our first question will come from Julian Mitchell from Barclays. Your line is open.

Julian Mitchell: Hi. Good morning.

Darius Adamczyk: Good morning.

Julian Mitchell: Good morning. Just wanted to start — my question would be around the first quarter outlook. So maybe two parts on that. Firstly, just on the segment margin assumption. Are we assuming within that, that you have a sort of 200 or 300 points increase that SPS year-on-year and then maybe down in Aerospace and PMT on margins? Just wanted to check that? And then also in Q1, should we expect orders to be down after they were up kind of low-single-digit in the second half of last year? Thank you.

Greg Lewis: Thanks, Julian. First off, we don’t guide orders, so we’re not really going to comment on that specifically. As it relates to the margin outlook you highlighted, I think you’re in the right neighborhood. Again, we don’t guide our individual margin rates for each of the segments. But to expect that Aero might be down in 1Q is probably a reasonable expectation. And as I highlighted, SPS is going to be on the top end of our margin expansion all year long, frankly, given all the work that, that team has done, adjusting their cost structure for the realities of the sales environment that they’ve been in as well as, as we talked about before, the reductions in Intelligrated sales are actually not painful from a margin standpoint. They actually help given the margin profile of that business. So, I think your instincts are right, but we’re not going to be specific on that guide.

Darius Adamczyk: Yes. And maybe just to add to that, I mean, I think SPS results, particularly in Q4, really exemplify our — the strength of our operating systems and how quickly we adjust to market conditions. As you saw, they posted record margins. And that’s not by accident. That’s by very pronounced actions that — they were facing some challenges on the revenue side. They adjusted their cost structure. They maximized our aftermarket services business, which resulted in a really nice margin profile. That’s an example of how Honeywell operates, which is when we see challenges, we act upon them early and make sure that we still print very good results despite some market headwinds.

Operator: Thank you. And our next question will come from Steve Tusa from JPMorgan. Your line is open.

Steve Tusa: Hi, good morning.

Darius Adamczyk: Good morning.

Steve Tusa: Can you just give a little more color on how much the OEM incentives are, what kind of headwind that is? And then are you guys on track for the longer term target? What’s — any color on the trajectory and timing towards that? I think you said historically or last year was, I don’t know, 29%. Are you guys still on track for that?

Darius Adamczyk: Yes, I mean we absolutely are. I think that we’re very committed to that number. As we look at the outlook for this year, we’re very much within our operating algorithm that we provided last Investor Day, sort of — if you just take the midpoint, we’re sort of at the lower end on revenue, but we’re above our margin profile. But in terms of our commitments to our long-term gains, it’s very much on track. The OEM credits are significant as a headwind. And Greg?

Greg Lewis: Yes. So — and think about that — that is tied to Boeing’s delivery, specifically of airplanes and incentives that we have for — with the airlines who are taking those airplanes and that is going to be a multiyear realignment. Today, they’ve promised in excess of their production rate in terms of deliveries. And so that’s going to — that’s what’s going to move the needle. It’s going to impact our sales. When we print our OE sales growth rates, you’re going to see that as an offset, and it’s obviously a margin headwind. So, it’s measured in the hundreds of millions of dollars. We’re not going to be precise about what that is. And again, there’s going to be variability around that, depending on the actual delivery performance of the OEs to the airlines themselves.

Darius Adamczyk: Yes. And maybe just some closing two points, we do expect modest margin expansion in Aero. And we’re very committed to the goal we gave you at the last Investor Day.

Operator: Thank you. Our next question comes from Scott Davis from Melius Research. Your line is open.

Scott Davis: Good morning guys and Anne.

Darius Adamczyk: Good morning.

Scott Davis: I was wondering if you guys could walk through a little bit of what your cost inflation assumptions are and maybe a little color around kind of that — the price/cost environment. Just in context, are we kind of done with the inflation part of the cycle? Are your suppliers still raising prices on you guys? And are you still raising prices on your side? And just a little bit of color per segment, I think, would be helpful. Thanks. And I’ll pass it on after that.

Vimal Kapur: Scott, as a headline, I would say that inflation is moderating. It’s not going away. So we are not losing our eye on our model on driving positive price/cost. And — but on a trend basis, there is some deflation in some commodities. But labor costs still high, energy costs are kind of more on a standstill basis. So that’s our entry assumption that it’s on a — more on a reducing trend but not getting — moving away. So our pricing targets have been adjusted. We still want positive price/cost model into our P&L. So we’re not going to go away from that execution we did in 2022. But we are also sensitive that with the market being tighter compared to 2022, we want to also protect our volumes. And to that extent, we are watching how we want to adjust our price/cost algorithm. So that’s kind of the overarching principles. They vary within the businesses a little bit, but directionally, that’s our guiding principles. Maybe, Greg, if you want to add anything.

Greg Lewis: Yeah. I mean all I would say is that means rather than double-digit price increases, we’re planning on mid single-digits, maybe low single-digits this year with inflation in that same neighborhood.

Darius Adamczyk: Yeah. And I think that’s important is that we do — we just don’t do pricing blindly. I mean we do watch demand versus pricing versus balancing our inflation. And we try to do that thoughtfully such that it’s not just blind increases. We also have to be mindful of market share, demand, et cetera. And we’ve got a set of analytics to do that. I mean this is the power of Honeywell Digital, which we’ve been implementing in the last three to four years. Our level of visibility accuracy is actually really good, and it’s a new set of muscles we’ve developed actually in the last 1.5 years as we face this inflationary environment.

Operator: Thank you. One moment for our next question. And our next question comes from Sheila Kahyaoglu from Jefferies. Your line is open.

Sheila Kahyaoglu: Hi. Good morning, everyone and thank you.

Darius Adamczyk: Good morning.

Sheila Kahyaoglu: Maybe if I could ask about supply chain improvement. You have a little bit of improvement in working capital year-over-year on supply chain. Can you frame the total impact in 2022 of supply chain? And how do you expect it panning out in 2023? You called it out in Aerospace with the Tier 3, Tier 4 suppliers having labor issues. Where else are you seeing it? And how do you kind of expect it to improve across the segments?