漢威聯合 (HON) 2022 Q4 法說會逐字稿

Thank you for standing by, and welcome to the Honeywell Fourth Quarter 2022 Earnings Conference Call. (Operator Instructions) 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, 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 and 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.

Thank you, Sean, and good morning, everyone. Let's begin on Slide 2. 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 margins, 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're 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 2 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 through the current challenging environment.

Now let's turn to Slide 3 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 HarbisonWalker 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.

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 3 of our 4 SBGs: HPT, PMT and Aero. We generated volume improvement from third quarter in Aero and HBT 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 enabled us to make a nimble and surgical approach to staying ahead of price/cost. While SPS was the 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 2 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 continued 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 past-due 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 D-U-E 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 continued 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 lost Russia 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 Solution also grew double digit in the quarter with a strength across the portfolio, led by thermal solutions, lifecycle 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 point 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 earning per share in the fourth quarter grew 21% to $2.52, $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 '21 to 4Q '22 can be found in 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 widebody 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 SBGs 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 noncash 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.

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 widebody 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 shipset deliveries for Honeywell, driving revenue growth but also translating into a corresponding increase in selection credits, a headwind to margins.

In Defense & 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 nonres 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 health care. 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's strong exit rate, resulting in year-over-year expansion for the full year.

In PMT, we're 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 in '23, 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 Act and increased customer focus on environmental responsibility. Orders in our Sustainable Technology Solutions business have accelerated dramatically over the past 2 years, and we're expecting more of the same in '23 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 '23. 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 '23. An Intelligrated decreased investment in new warehouse capacity will continue to limit near-term opportunities in our long-cycle projects business with a trough in demand likely coming this year before returning to growth in '24.

However, our aftermarket services business has been growing at double-digit rates, and we expect that to continue in 2023. In 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 7 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 noncash 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 '23 free cash flow story can be characterized as strong operational performance offset by a few discrete nonoperational 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 '23 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're 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 '23 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 guide.

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 noncash 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.

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 overdelivered on our financial commitments. While 2023 brings new (inaudible), 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 at that time. With that, Sean, let's move to Q&A.

Thank you, Darius. Darius, Greg, Vimal and Anne are now available to answer your questions. (Operator Instructions) Crystal, please open the line for Q&A.

(Operator Instructions) And our first question will come from Julian Mitchell from Barclays.

Just wanted to start -- my question would be around the first quarter outlook. So maybe 2 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 at SPS year-on-year and then maybe are 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?

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.

Yes. And maybe just to add to that, I mean, I think SPS's 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. They knew they were facing some challenges on the revenue side. They adjusted their cost structure. They maximized our aftermarket services business, which result 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 Instructions) And our next question will come from Steve Tusa from JPMorgan.

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, it was, I don't know, 29%. Are you guys still on track for that?

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?

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.

Yes. And maybe just some closing 2 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 Instructions) Our next question comes from Scott Davis from Melius Research.

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. And I'll pass it on after that.

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's 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're also sensitive that with the market being tighter compared to 2022, we want to also protect our volumes. And to that extent, we're watching how we want to adjust our price/cost algorithm. So that's kind of the overarching principles. They vary within the businesses little bit, but on -- directionally, that's our guiding principles. Maybe, Greg, if you want to add anything.

Yes. 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.

Yes. And I think that's important is that we do -- we just don't do pricing blindly. I mean, we do mark -- 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 3 to 4 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 Instructions) Our next question comes from Sheila Kahyaoglu from Jefferies.

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 '23? 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?

Yes. Let me kind of -- there's sort of not one way to describe it, but I'll give you a few metrics which indicate sort of the direction. I mean, I think the punchline -- the summary punchline, it is improving, and we saw that. I mean, we saw a reduction in our past due in 3 out of the 4 SBGs. The only one the past dues went up in Q4 was Aero. But we also saw very robust demand in Aero. So I think you have to offset that. Is that an issue instead of opportunity?

And I would tell you that our Aero output on a year-over-year basis was up around 15%. So that's actually a pretty good outcome, which also tells you that we're migrating in the right direction and given that the past due is reduced in the other one.

So let me kind of split the discussion on 2 segments. One, for semiconductors, it is definitely getting better. It is improving, and we see that sort of really moderating towards a normal state before the end of this year. That's sort of what we saw. We saw some clearing of the past dues. We still have some left, and that's how we see it.

In Aero, it's also improving. The pace is likely going to be slower than what it was in semiconductors. Our level of decommits in Q4 was below 20%, which was a low for the year. Every quarter prior to Q4, the level of decommits from our supply base was over 20% -- actually, under 20%, which is also a good sign. So we see a slow and steady improvement as we move throughout the year. That's sort of our expectation for the supply chain.

(Operator Instructions) And our next question comes from Nigel Coe from Wolfe Research.

Just wanted to dive into SPS a bit more. So if we think about -- maybe first of all, can we just dive in a bit deeper into what happened with the PPS. I know there's been some channel headwinds there, but that's a big change from what we saw last quarter.

And then when we think about the 2023 outlook, it looks like Intelligrated down 15%, 20%. Is that representative of the market? Or are you being more selective in terms of the projects that you've been accepting and therefore converting?

And then on top of that, I know that's only one question, but it looks like margins this year is high teens, maybe 20% range. When we normalize for mix beyond this year, are we going to be above 20%? Any color there would be helpful.

Can you repeat the last one because I didn't quite get the last question there, Nigel?

Yes. So the last part of the one question is when we normalize for mix to Intelligrated PPS in '24/'25, are we at 20-and-above margins?

Yes. I think that one was going to be -- it's probably too early to tell, but what I will tell you is that for -- we already basically demonstrated we can get to 20% margins in SPS in Q4. So the target hasn't changed in terms of what's happening overall with the business. Yes, Intelligrated is -- the markets are down. I mean, we see it, the warehouse and distribution segment is down. There's an overbuild that occurred in the year 2020 and 2021. The markets are absorbing that capacity. We do expect an uptick in orders and return to growth in 2024. We actually are encouraged by the pipeline that's starting to form.

And at the same time, we're also being a little bit more selective in terms of margin profile and so on. And we have an algorithm in terms of the kinds of orders that we want. So it's a little bit of both. PSS has been a bit softer than in the prior. We got to remember that we're coming off of record orders, particularly in the first half. But overall, we expect to see a fairly strong robust level of business in the second half of this year, and we still have a backlog to draw from.

So I don't think there's -- there was nothing in FPS in Q4 that was out of expectations. It was actually incredibly consistent. And frankly, I was very encouraged by the margin rate, and that team has done a nice job in really managing to the cards they're dealt from a revenue base, using our Accelerator operating system to really deliver a strong financial result even with some revenue headwinds. I don't know, Vimal, if you...

So IGS, I just want to add a comment on IGS. I think top line challenge will be there in '23. But we are focused on margin in this business. Our aftermarket service business is growing double digits for last several years. That trend will continue in 2023. In fact, we want to do everything possible to continue to drive that at a higher rate and other margin improvement opportunity but better operating efficiency, executing projects better and faster is going to be another focus area. So while the volumes are down, we are constantly looking at margin expansion strategy in Intelligrated business.

(Operator Instructions) Our next question comes from Andrew Obin from Bank of America.

Just a couple of questions on PMT. So first, on decarbonization, I mean, clearly a big revenue driver. But are you seeing any delays in process and fund disbursement at the federal level because we sort of heard about just shortage of staffing there? So that's question one.

And second, if you could just talk about visibility on advanced material strength because that seems to be just get better and better every quarter.

So on the -- Andrew, on the decarbonization, I would say, at least I see much stronger trend in orders in our Sustainable Technology Solutions business as we had forecasted, IRS at least helping. We had a pretty strong performance in our sustainable aviation fuel part of the portfolio. We see that further strengthening in 2023.

But in addition, now we see activity happening in carbon capture and hydrogen space. So we see more active projects where customers are making decisions. So we remain very optimistic on good performance by STS business in 2023.

On advanced materials, I would say the momentum on Solstice continue. We see more application adoption in newer areas. As an example, heat pump is becoming another exciting area where we are developing new application. And that business is all about expanding new application and expanding new geographies. So we see that trend.

There are pockets in advanced material where there is an economic headwind on residential side. So that's a smaller part of the business, but there are headwinds. There are pockets in electronic materials, where there's a server-related demand in PC. So we supply some products in that. But on an overall picture, advanced materials has a strong momentum. And you said it rightly, the momentum will continue in 2023 also.

Yes. Maybe just to add a couple of things and a couple of specific numbers. I mean, our orders in Q4, particularly in our Fluorines business, were very, very strong, I think, double-digit strong. Our LST business is strong. UOP is well positioned for the year. Sparta business was extraordinarily strong on the acquisition we made in 2021. So all in all, I think it was a very strong orders quarter.

As we pointed out on our track, if you remember, some of the very, very unusual cold weather that we faced around the Christmas time caused us some challenges in some of our process operations because, frankly, they're just not built to operate in 5-degree weather. That's not what you typically see in Louisiana in December. So all in all, I think that this is -- our AM and PMT business is well positioned. Good orders growth and strong performance should be expected.

(Operator Instructions) Our next question comes from Jeffrey Sprague from Vertical Research.

Just a follow-up on Aero margins from me, if I could. Appreciate the color on the OEM incentives. Just trying to think about the next couple years also, if you can give us some directional help, right? It's not hard to imagine those incentives continue to escalate the next couple years as Boeing delivers more, but I think you might be getting some help going the other way in business jet or other parts of Aero. So can you just give us a sense of, is 2023 kind of peak headwind for incentives, how it might play out in '24 and '25?

Yes. Great question, Jeff, and your -- again, your instincts are on. This is a bubble, right, because they -- Boeing, in particular, was not able to deliver jets when they were grounded. And so that acceleration is going to go up and then come back down again.

As we see it right now, it looks like '23 is going to be the top, and then it starts coming back down. But again, that's going to depend entirely on the pace of those deliveries. But it ought to be, let's say, reoriented back with deliveries in our view by 2025, for sure, and maybe into 2024. So this is going to be a temporary headwind, and then things will realign back where deliveries and shipments come back into line. And so therefore, our P&L will become more aligned.

Yes. I think that's exactly right. I think that this is probably an unusual '23 headwind. But even with that headwind, we expect to modestly expand margins. But I think the most important thing that's missing here is we're very excited about the future of Aerospace. I mean, the orders are up. Backlog is way up. I mean, we think the next 3 years will be very exciting for Aero.

Supply chain is...

Supply chain is getting better. Our ISC teams have really demonstrated unlock of a lot of the capacity. And I think there's nothing other than to be excited for the next 3 years in Aerospace. It's -- I'm very confident in the backlog position, and it's going to be a really nice period for that business.

(Operator Instructions) And our next question will come from Andrew Kaplowitz from Citigroup.

So you mentioned capital deployment in line with 3-year $25 billion plan for '23, I think, which would mean another year somewhat similar to '22. You deployed almost $8 billion of cash. Obviously, out there, you've got National Instruments conducting a strategic review, as I'm sure you know. If Honeywell were to consider to be quite a bit larger than you've done in the past there, so we know you have the financial capacity to do it, but you've been disciplined when you've done M&A and really stuck to more bolt-ons. Can you remind us of your return hurdles to do a larger acquisition and what, if any, strategic requirements you have to make a larger acquisition?

Yes. I think good question. Yes. So I mean, obviously, we have a balance sheet that's strong. And over the last 2 years, we have, let's call it, roughly around $15 billion-plus to deploy it based on our 25 over the next 2 years, so we have the capacity. But I'd just point out a couple things.

Number one is we are disciplined in our approach. That's point one. So point two is we're a controls and automation and sustainability and digital company. And point three is we typically don't do hospital acquisitions. So we are interested in doing more M&A -- smart M&A in '23. I think you should expect that at some point. But it's going to be thoughtful. It's going to be acquired at a price where we have a lot of confidence in generating shareholder value. And it's going to be something that we can -- is truly strategic and fit what we do as a company.

(Operator Instructions) And our next question will come from Josh Pokrzywinski from Morgan Stanley.

I understand you guys have above-average backlog right now, obviously, some longer-cycle businesses as well as supply chain. Any way we should think about backlog conversion this year? Or where do you guys think maybe backlog should end or hopefully end if you're able to start getting more product out the door? I think teasing out the demand environment versus the supply chain environment has been a bit of a trick here for a while.

Yes. Maybe I'll start and I'll turn it over to Vimal. So first of all, we feel very good about the backlog because, if you sort of look at the backlog where we are in totality, it's about $3 billion to $4 billion more than what I call a normal state. If you go back 2, 3 years, if -- we can debate whether it's in that $3 billion to $5 billion more than normal. So the backlog position is very strong.

From a long-cycle perspective, Aero, especially PMT, very strong position. Even in the short-cycle businesses, which are predominantly HBT and SPS, we've got strong backlog through at least the first half of this year. We do expect an uptick as we go into the second half of this year in terms of some of those businesses because we have some unusual pull-forward order activity in the first half.

So especially as we get into the second half of this year, we don't know this yet, but we're cautiously optimistic it can actually be one of those unique periods where the short cycle and long cycle are turning at a really good pace. We have much more confidence in the first half based on the strength of the long cycle, and we expect an uptick in the second half in the short cycles (inaudible).

So maybe to impress on that in addition, as we talked earlier, we do expect supply chain performance to get better both on the Aero supply chain and semiconductor constraint, which will mean that we can burn our past dues/backlog better than our -- what we did in '22. And we also expect that our project businesses will also execute on our backlog on a more determined basis because they also faced a lot of headwinds on supply chain constraints in 2022.

Where the backlog will land, it's just indirectly answering the question of orders forecast, and we don't guide that. But we remain optimistic. We're going to get our fair share of demand in the market that we can commit. And as long as market performs, we will perform the -- in line with the market.

(Operator Instructions) Our next question comes from Joe Ritchie from Goldman Sachs.

I want to ask that last question maybe slightly differently because guidance is a little bit wider than normal. And so perhaps maybe under what scenario would you guys see yourselves coming in below the midpoint of the guidance -- the EPS guidance for the year?

Yes. I mean, I think -- first of all, let me -- there's a couple of questions. And the first one is, why is the guidance wider than normal? Because I think we would probably admit that in terms of the economic scenarios this year are probably a bit wider than most people guess. And you have anything ranging from a soft landing out there to a deep recession, and I've heard opinions anywhere in that range.

So I just think from a Honeywell perspective -- and this is, I think, consistent of how we guide every year is -- and probably this year more than ever, we try to have a little bit of a wider range, which is indicative of the uncertainty around the economic conditions. And I would say if I were compare this year versus '22 or '21, it's probably more uncertainty rather than less. So that's sort of the reason for the wide range.

In terms of the range, it's out, sure. At the lower end, it's probably -- it probably means that it's tougher economic conditions. The second half is the economic conditions turn worse. The short cycle is worse than we expect at the top end. It's a bit more of what we hope is the expectation, which is some of the order activity turns. Short cycle becomes more robust in the second half, and China returns to growth.

I mean, we -- Q1 -- we actually think Q1 in China could be challenging because of the lifting of the COVID restrictions, Chinese New Year and so on. And we embedded that in our guide. But we actually think that second half in China could actually be quite strong. And if that comes to fruition, that sort of points to the upper end of our guide.

So that's why we kind of have a bit of a wider range. And by the way, we did guide a wider range like this historically, of course, so it's not that much wider, and '22 was a little bit narrower. But I think it's just -- it's as simple as it's indicative of the economic uncertainty that I think many of us are facing. And there's a wide range of educated guess as to...

Yes. I think we'll know a lot more come June, right? I mean, as we talked about, I think we feel pretty good about where we are from a backlog position. And no one really knows what the level of activity in the economy will be. I mean, we've had some good things. The European winter has been more mild than people thought, and Europe's held up relatively well in versus what some may have figured it could be. But I think, as you said, we feel really good about where we are right now. And we'll continue to take that temperature as we go through the first 4 to 5 months of the year.

(Operator Instructions) And our next question comes from Deane Dray from RBC Capital Markets.

Start with congrats on getting to the finish line on the NARCO Trust. That was a really long road. And I know you had to get all the approvals. So nice to see.

Thank you, Deane.

Yes. I know, Anne, it's been a long road. But Honeywell was one of the first to pursue that trust, and you've got all the approvals with the plaintiffs and so forth. But great to see it derisked. And just a follow-up on the last question on the geography. Did anything really surprise you in the quarter in terms of the geographies? It seems like Europe -- was it just the weather that's not as dire on the energy side? But what were the surprises on the geographies? And what's baked in for '23 major geographies? I know you have a little bit on China, but if you could round that out, that'd be helpful.

Maybe I'll start, and Vimal will add any further commentary. I would say no major surprises, I mean, in terms of how we ended up. I mean, Europe was softer, particularly the U.K. was really soft in Q4. That probably stood out for us in Europe. But then as we looked at December, the exit rates weren't actually bad. So November and October were a bit weaker. December exit rates were better.

In terms of the overall business performance, I mean, it was actually incredibly consistent with what we guided. I mean, we guided -- we came in roughly at the middle of our range, a little bit better on operating margin. I mean, we guide for a reason, and that's sort of where we ended.

And by the way, thank you for acknowledging the NARCO. I mean, I think as you kind of read the articles and some of the other companies out there, I can't understate how important -- or overstate how important it is to eliminate liabilities from your balance sheet. And when you can do that permanently with confidence, it substantially derisks the future of the company.

I think maybe this didn't get as much offense as I think it should have because it was a huge deal. It hit up a lot of bandwidth. But I am thrilled to have this liability reduced off the balance sheet. Vimal, if you...

So I think the only thing I'll add is that I think everybody is aware of commentary on U.S. and Europe, so I won't repeat it. But high-growth regions represent a very large part of Honeywell revenue. We do expect China to have a strong growth in 2023. We are cautious in Q1 but very optimistic for the year.

But other high-growth region markets, we are confident on good growth. Middle East, we have good backlog and a very strong pipeline for orders. India, we remain very optimistic. Turkey, Central Asia, we remain very optimistic, ASEAN. So overall, that part of the world should offset some of the headwinds we see in Europe, and that's what we are kind of dialing in into our planning process.

That does conclude our question-and-answer session. I would now like to turn the conference back over to Darius Adamczyk for any closing remarks.

I want to thank our shareholders for your ongoing support. We delivered strong fourth quarter results and continue to navigate effectively through multiple uncertainties with the typical level of operational rigor you've come to expect from Honeywell. Our future is bright, and we look forward to discussing this further at our upcoming Investor Day in May.

Thank you all for listening, and please stay safe and healthy. Thank you.

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