Solstice Advanced Materials Inc. Q2 FY2025 Earnings Call

Thank you. Good morning, and welcome to Honeywell's second quarter 2025 earnings conference call. On the call with me today are Chairman and Chief Executive Officer, Vimal Kapur; and Senior Vice President and Chief Financial Officer, Mike Stepniak. This webcast and the presentation materials, including non-GAAP reconciliations, are available on our Investor Relations website. From time to time, we post new information that may be of interest or material to our investors on this website. Our discussion today includes forward-looking statements that are based on our best view of the world and of our businesses as we see them today and are subject to risks and uncertainties including the ones described in our SEC filings. This morning, we will review our financial results for the second quarter, share our guidance for the third quarter, and provide an update on full year 2025. As always, we'll leave time for your questions at the end. With that, I'll turn the call over to Chairman and CEO, Vimal Kapur.

Thank you, Sean, and good morning, everyone. Honeywell again delivered solid results in the second quarter, meeting or exceeding all our financial commitments in a time of significant global economic change. Our organic sales and orders growth both accelerated during this quarter as we are seeing the benefit of our consistent spending and execution on new product development across our businesses. Given the strong first half performance, we are raising sales and earnings guidance for the full year, while incorporating into our outlook all currently known tariffs and the uncertain business conditions going forward. Our proactive multi-pronged mitigation efforts, coordinating closely with suppliers and customers on productivity and pricing initiatives have been working as planned. And because of our systemic approach, we are in a position to deliver strong sales profit and cash flow growth in 2025. As our business leaders have been solely focused on meeting and exceeding our financial commitment, management and the Board have been fulfilling our promise to transform our portfolio ahead of our upcoming separation to best position each of the future independent company's success. Throughout the comprehensive portfolio review I initiated shortly after becoming CEO, we have diligently analyzed how to further simplify and optimize Honeywell. Earlier this month, we entered the final stage of this process, announcing our intention to pursue a strategic alternative for our productivity solutions and services, and Warehouse and Workflow Solutions businesses. The results of this pursuit, whatever they may be, will clarify the standalone automation company's go-forward strategy and value proposition. With many changes in flight, our dedicated separation management office has kept us right on track to execute our spin-off transaction, both on time and without commercial disruption. Let's now turn to Slide 3 for a further update on our formation of three industry-leading public companies. We continue to make great progress along the path to separate into three independent companies, which we believe will maximize long-term value for all Honeywell stakeholders. As independent entities with clear alignment and purpose, increased organization agility and customized capital allocation priorities, each will be better positioned to accelerate future growth opportunities. Given the pace of our progress, we cannot narrow the timing for the spin-off of this Advanced Materials to Honeywell shareholders to the fourth quarter of this year. Solstice shares will trade under the ticker SOLS on the NASDAQ Stock Exchange. A few weeks prior to the spin-off, the Solstice leadership team will host an Investor Day in New York. They will lay out in detail the powerful investment case for this innovative market leader in secularly growing Advanced Materials market that will carry on Honeywell's legacy of operational excellence. We hope you will join CEO, David Sewell, and his team at this event. We're also making great progress on the Aerospace spin, which is planned for the second half of next year. Last month, Aerospace President, Jim Currier, and I presented an investor reception ahead of the Paris Air Show. Jim highlighted Aero's industry-leading position as a mission-critical supplier of systems across aerospace verticals and platforms. In addition, he provided insights into drivers for our strong growth profile, underpinned by a broad aerospace and defense upcycle, which we enhanced with a powerful decoupled sales initiative, ongoing supply chain transformation efforts, and robust research and development investments over time. We look forward to providing you with more details on standalone Honeywell Aerospace in the coming quarters. And yet we are not waiting for the separation to reshape our portfolio for future growth. We continue to selectively deploy capital towards acquisitions, announcing two new deals in the past couple of months. We are also looking to recycle capital, as I discussed earlier, by pursuing alternatives for businesses that do not fit our future. In combination with these actions, we will drive value creation as we await becoming separately publicly traded vehicles. If you turn to Slide 4, I will discuss our recent portfolio announcement in more detail. In June, we agreed to a GBP 1.8 billion bolt-on purchase of Johnson Matthey's Catalyst Technologies business. We have long identified our UOP process technology business as a natural owner of this highly complementary business because it gives us additional capabilities in sustainable methanol, sustainable aviation fuel, hydrogen, and ammonia to better serve our extensive customer base. It also brings attractive sales from catalysts, which fit very well with our existing offerings. The transaction is expected to close in the first half of 2026 and will enhance our growth and margin profile over time, while providing a strong financial return. In early July, we also announced a technology tuck-in acquisition of Li-ion Tamer that enhances our building automation capability in high-growth energy storage and data center end markets. While such smaller deals do not often get much investor attention, in aggregate, they can accelerate our strategic roadmap and boost growth with a lower risk profile. We recently announced our intent to evaluate strategic alternatives for our PSS and warehouse automation businesses. Just as we want to acquire businesses such as Catalyst Technologies and Li-ion Tamer, where we believe we are a natural owner, we must also acknowledge that when the time comes, they will be better owners of parts of our portfolio. We're looking to create a pure-play automation company with a consistent business model and focus on end markets in which we have durable competitive advantages. Both PSS and Intelligrated have strong customer bases, a long history of innovation, and best-in-class operation, and we will evaluate options for them from a position of strength. To avoid interfering with the review process, we will hold further updates until it's completed. I will now turn it over to Mike to provide more details on our excellent second quarter results.

Thank you, Vimal, and good morning, everyone. Let's begin on Slide 5. In the second quarter, we built upon a strong start to the year as we again exceeded our guidance for organic sales growth and adjusted earnings per share. Our results demonstrate the resilience of our accelerated operating system to adapt to changes in the environment quickly and deliver on our financial commitments. At the same time, we remain committed not to compromise on our investment in growth initiatives as we are beginning to see evidence of our progress. Second quarter sales grew 5% organically, with three out of our four segments above this level. Defense and Space and UOP led growth with double-digit performances. Segment profit expanded 8% from the prior year, in line with sales, and segment margin finished nearly flat and within our guidance range. Margin expansion in Building Automation and Industrial Automation and lower corporate costs were slightly more than offset by margin pressure in Aerospace Technologies and Energy and Sustainability Solutions. An increase in research and development expense, up 60 basis points as a percentage of sales from the previous year to 4.6%, pushed down current period margin at the segment level, but will enhance future period growth. Earnings per share in the second quarter were $2.45 per share, up 4% from the prior year, while adjusted earnings per share was $2.75 per share, up 10% year-over-year. Organic and inorganic segment profit growth as well as the lower tax rate more than offset headwinds from higher interest expense and lower pension income. You can find the bridge for adjusted earnings per share from 2Q '24 to 2Q '25 in the appendix of this presentation. Orders were $10.5 billion in the quarter, up 6% year-over-year, excluding the effect of acquisitions and divestitures, led by a strong double-digit increase in Aerospace orders. Backlog grew 10% organically from the prior year to a new record of $36.6 billion. Second quarter free cash flow was $1 billion, down roughly $100 million from the previous year, as tariff-related cost inflation pushed up inventory levels, and capital project spending expanded as planned. We continue to dynamically allocate our excess cash flow and balance sheet capacity based on the best opportunities the market presents to us. During the second quarter, our capital deployment was well balanced, with $2.2 billion used to complete the accretive acquisition of Sundyne and over $2.4 billion returned to shareholders, roughly $1.7 billion of share repurchases and $700 million of dividends. We also allocated $300 million for capital projects. Now let's turn to Slide 6 to discuss our second quarter performance by segment. I will give a high-level view of results, with additional commentary provided on the right-hand side of the slide. In the second quarter, Aerospace Technologies grew 6% organically, highlighted by another strong quarter from our Defense and Space and Commercial Aftermarket businesses. Segment margin contracted 170 basis points to 25.5% as 11% output growth, commercial excellence, and productivity actions were more than offset by higher cost inflation and the impact of the CAES acquisition. In Industrial Automation, sales were above our guidance range, coming in flat on an organic basis. Segment margin expanded 20 basis points to 19.2%, driven by productivity actions and commercial excellence, which more than compensated for cost pressures. In May, we completed the sale of the PPE business, which will be accretive to organic growth and margins in the second half of the year. Building Automation delivered another quarter that surpassed our expectations, with sales increasing 8% organically from the previous year. Second quarter margin expanded 90 basis points year-over-year, led by volume leverage and full quarter benefit from Access Solutions. Energy and Sustainability Solutions sales grew 6% organically in the second quarter, exceeding our expectations, driven by double-digit growth in UOP. Segment margin contracted 110 basis points to 24.1% as volume leverage and benefits from the margin-accretive LNG acquisitions were more than offset by the impact of a customer settlement as well as cost inflation. Now we'll move to Slide 7 to discuss our third quarter and full-year guidance. Our first-half outperformance has given us confidence to increase our outlook for the year, even as we remain cautious regarding the lagging effect on business demand from tariffs announced in recent months. Despite this, our framework for the year remains largely unchanged. We are factoring in non-tariffs as they are written, assuming any moratoria means a later revision to higher rates, net of all of our mitigation options. Keeping in close communication with our customers and suppliers, we remain committed to fully offsetting the effect of these tariffs with a combination of productivity, pricing, and alternative sourcing as we balance protecting both margins and demand. We are raising the lower end of our full-year organic sales growth guidance range by 200 basis points. Factoring in our first-half performance and recent short-cycle order trends, we now project growth of 4% to 5% for the year or 3% to 4% when excluding the prior year impact from the Bombardier agreement. Our year-to-date results have exceeded previous expectations while maintaining a pragmatic approach to the back half. We have increasingly seen large energy projects and catalyst spend, which can carry attractive incremental margins in our UOP and Process Solutions business, pushed out into 2026 because of macroeconomic and legislative uncertainty. Full-year sales are now projected to be $40.8 billion to $41.3 billion, driven primarily by better organic growth, tailwinds from foreign currency translation, and the additional revenue from the Sundyne acquisition in June. We expect year-over-year organic sales improvement to be similar in both the third and fourth quarter when excluding the impact of the Bombardier agreement in the fourth quarter of last year. We anticipate the third quarter organic sales growth of 2% to 4%, which equates to $10 billion to $10.3 billion. For the full year, we now expect our overall segment margin to be up 40 to 60 basis points or down 30 to 10 basis points excluding Bombardier. Reduced margin expectations from the prior guidance stemmed from the high decrementals of delayed energy project work and the lag effect of pricing relative to tariff-related cost pressures in our Aerospace business. In the third quarter, segment margin is anticipated to be in the range of 22.7% to 23.1%, down 90 basis points to down 50 basis points from the prior year with BA margins expanding, ESS margin roughly flat, IR margin contracting modestly, and Aero margins similar to its second quarter level. We now expect full-year earnings per share of $10.45 to $10.65, up 6% to 8% or up 1% to 3%, excluding the 2024 impact of the Bombardier agreement. Earnings per share in the third quarter are anticipated to be $2.50 to $2.60, down to up 3% to up 1% from the prior year. I will provide further details on changes to our full-year EPS guidance later in the presentation. We continue to expect free cash flow for the year between $5.4 billion to $5.8 billion, down 2% to up 5% excluding Bombardier, which remains approximately in line with adjusted earnings per share growth. We'll give additional information on changes in free cash flow from the prior year in the appendix. Having deployed $7.8 billion in the first half of the year for share repurchases, acquisitions, dividends, and a couple of projects, we remain opportunistic in allocating additional capital beyond that already committed for the rest of the year. To summarize, our strong execution in the first half has raised the bar for the year, even as we prioritize setting prudent expectations in a highly dynamic environment. Focusing on what we can control, our company remains poised for strong performance ahead of our pending separations.

Thank you, Mike. Honeywell performed admirably in the first half of 2025, with back-to-back quarters that delivered earnings above the high end of our target ranges. Our investment in innovation is gaining traction, driving improved sales growth and yet another record quarter for our backlog. On the back of this operational momentum, we are raising our organic sales growth and adjusted earnings per share guidance for the year, while being mindful that we may not yet have felt the full impact of the escalation of global tariff rates in recent months. Business demand has remained resilient in more sectors and geographic regions thus far, but we are well prepared for potential changes ahead in the macro, regulatory, and geopolitical environments utilizing a playbook that has served us well over many cycles. As our businesses focus on delivering our financial targets, we have also made substantial progress in transforming our portfolio to maximize their value. Through separation, acquisition, and divestitures, we are simplifying Honeywell for investors, customers, and our future shapers. All our transactions are proceeding according to plan. Even as the first chapter of my tenure as CEO comes closer to an end, with the conclusion of the comprehensive portfolio review, our dynamic approach to capital allocation and portfolio optimization remains evergreen. We are confident that the combination of our accelerating growth and high-return capital deployment will compound the value of Honeywell going forward. With that, Sean, let's take questions.

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

Our first question comes from Julian Mitchell with Barclays Bank.

Just maybe wanted to start off with Aerospace to try and understand kind of the moving parts there. I suppose it sounded in Paris as if there was a bit more confidence around sort of supply chain issues and getting those resolved, and that might help the Commercial OE top line, but it seems something sort of moved the other way. So just trying to understand, is that BGA or large commercial? What's the pace at which Commercial OE sales improve? And on the margin front, should we think about this sort of 25% to 26% margin being the new sort of baseline for the next 12 or 18 months?

Julian, so I would say, first, orders in Aerospace, extremely strong, continue to be strong on all fronts, Defense and Space, Commercial OE, et cetera. What we see in our Commercial OE in the second quarter, it's really a transitory item, I would say. We experienced some destocking with one of our OEMs, and we expect our shipments to normalize to the OE build rates in the second half. So I feel very confident that you'll see better OE profile from us in the second half. But like I said, we feel quite bullish about Aero performance for the year. From a margin standpoint, as we talked earlier, we were integrating CAES, and that's about a 100 basis point drag for us year-over-year. That's going to start to normalize in the next year. CAES, by the way, is growing revenue this year at high double digits, so it's ahead of our pro forma. Really encouraged by that. And we are also year-over-year putting about $200 million of incremental R&D into the Aerospace business to help support our NPI growth and new revenue next year. So I think in the second half, margin profile for Aero will be better than what you've seen this quarter. And like I said, I'm quite confident about the high single-digit growth on revenue for the rest of the year.

Julian, I want to add that everything Mike mentioned pertains to transitional issues. The discussions about margins reflect changes in the operating environment due to destocking, and our R&D investments are being assessed to ensure future performance. This will establish a new normal. Additionally, the CAES acquisition is expected to provide future benefits. Therefore, in response to your other question about whether this creates a new baseline, the answer is no. These issues are indeed transitional, and we have a strong confidence in the Aero margin projections we have outlined.

Got it. And just following up on that, Vimal. So the sort of R&D hike, you think by the end of this year, kind of R&D to sales in Aero shouldn't be a headwind next year, and then CAES margins start to improve over the next year or so.

Yes. Both statements are true, and then the OE destocking issue also goes away because the rates will convert to the normal baseline. That's why I mentioned these are all transitionary issues. By the way, on the R&D spend, the R&D spend rise is not only in Aerospace. It's across all four segments of Honeywell. We feel continued confidence on our ability to accelerate organic growth through new products. We see part of that happening in Building Automation, pockets of Industrial Automation, Aerospace, we talked about wins. But overall, we have a meaningful acceleration of R&D spend for the right projects. And this is going to set up a new baseline for Honeywell for the future. So this is again a transitionary for the overall company. We don't expect that to repeat in the year ahead at the same level.

Our next question is from Andrew Obin with Bank of America.

Can we just talk a little bit about UOP? And my question is very strong growth this quarter, but you're seemingly talking it down for the second half of the year. Can we just understand what verticals drove the upside? And what verticals are driving the downside if we could disaggregate it?

So I'll say, Andrew, for the quarter two, we had two favorable items. We had a big licensing agreement with a customer, which gave us long strong growth. And also catalyst sales were much stronger in Q2. So some of the catalysts got pulled through from the second half to the first half. So that's more of a cycle in this long-cycle business. To the second part of your question, the impact we see is energy project spend is moving more to the right. Part of it is, I would say, economic uncertainty which got settled in and some of the regulatory items which got clarified with OB3 regulations. So we do believe they will settle. But clearly, we saw pressure on that for the rest of the year, which we have reflected in our guide for ESS business and, to a certain degree, also on IA for process automation.

And I would just add that just looking at the OB3 and the IRA, that's mostly preserved for us. So it's not really a headwind for us into next year.

I got you. And then on Industrial Automation, just to follow up. So HPS, similar dynamics. So is it fair to say that when you say weakened demand and price-cost deleverage in the second half in the slide that it mostly relates to HPS, and that's what's driving sort of slightly lower margin outlook there? Is that the key driver?

Yes. Primarily, I would say in case of HPS, the same energy projects, the projects part of the business will see the similar pressure. The services side remains strong. Mike, anything you want to add on the...

I would just say, Vimal, I continue to be prudent about the second half. A lot of moving parts. I feel confident we'll be able to deliver on the guide that we put upfront, but just continue to be prudent on the second half, especially around the short-cycle orders.

But you don't have one specific industry vertical or region to call out other than this big tariff uncertainty.

That's correct.

No, no. Absolutely right. I mean, in fact, we see much more balanced growth across the board. Now of course, the U.S. remains a leading growth, no doubt about it. But the headwinds we saw a couple of quarters last year, in particular on Europe and China, have subsided now. So the growth is more normalized across the globe, with the U.S. being the leading growth.

Our next question comes from Nigel Coe with Wolfe Research.

I just want to pick up on maybe the first couple of questions. Just on the energy project timing, I guess, is that mainly on the clean energy project? So is it just large process projects in general? And then maybe just the final point on Aero margins. It seems like tariff inflation should be better news today than it was back in April. So I'm just curious what additional inflationary pressures you see in Aero.

The energy project is performing well, and I can provide some details on it. LNG continues to be strong. The business we acquired is doing exceptionally well, and we have a positive outlook on LNG, which will also benefit our ESS and process automation through our integrated approach. Sustainable fuels projects are experiencing delays, primarily due to policies surrounding the IRA and how they will evolve with OB3. However, things have become clearer recently, which we believe should boost positive momentum. On the traditional refining and petrochemical side, we observed increased catalyst spending in Q2, with some projects expedited, leading to solid performance. Yet, we are noticing some weakening demand, as customers are becoming more hesitant about significant catalyst investments in certain areas. Overall, our participation in the recent OPEC meeting reinforced our very optimistic view for the Energy segment, which encompasses coal, gas, refining, and future biomass-based products. Our outlook remains very positive, and we are currently experiencing a typical cycle in the energy sector.

And then on the Aero question, what I would tell you is that if you look at tariffs, tariffs, when we incur tariffs, we pay them in 10 days. It's easy to pass tariffs as far as timing on short-cycle businesses. When it comes to Aerospace and our OE contracts, these matters take a longer time because you have to open the contracts, and these contracts usually are set for 10 years and are prescribed by sterner frameworks. So the team is working through it, and it will take them a little bit longer to get that price aligned with the cost, as we obviously keep in mind on how it will impact our customers.

And Mike, could you maybe just touch on the changes to the R&D tax expensing for tax purposes? You've got about $1 billion of deferred tax assets. It's on your balance sheet. So just how does that unwind over the next couple of years?

Yes, I would say it's definitely a net positive for us. Right now, we're evaluating it with our tax team, considering everything that's happening and how to unwind it in the best way. I believe it will be a positive factor for us in 2026 and 2027. We'll be able to provide more information as we move into next year. You are correct, this is a positive factor for us.

Our next question comes from Steve Tusa with JPMorgan.

I'm trying to understand the margin guide for the year. You've provided some good details. Is Building Automation expected to be around 28% this year? Is that approximately correct?

I would say it really depends how you look at it and where you look at it. On the product side, obviously, the incrementals are extremely high for us right now. Projects are a bit lower, but I would say incrementals are quite high.

Yes. Steve, this is Sean. I would say, thinking about the full year, that's probably a little bit aggressive in terms of is that business capable of delivering a number like that. It has the capability of doing so.

It's fair to say, Steve, that BA will be the highest margin business in our portfolio in '25. So that will be a fair statement.

Okay. And then just one follow-up on the hedge, I guess, the contingency you put into place last quarter. What is the status of the contingency? Obviously, there is better visibility now, but I'm just curious about its current status.

We have gained significant insights over the past 90 days. During our last discussion, we were closely monitoring tariffs. Based on our recent guidance, I am confident that we can meet our targets. The third quarter is crucial for us. As mentioned earlier, some of the longer-cycle project milestones have been pushed out, and we are seeing weaker demand for catalysts. However, on a positive note, Building Automation and IA short-cycle orders have improved. Overall, we find ourselves in a similar position as we were last quarter.

Our next question comes from Scott Davis with Melius Research.

Guys, can we talk a little bit about Quantinuum? I mean, it looks like it's still bleeding a little bit of cash for you guys. But what are the hurdles? Specifically, what are you guys looking for to be able to get that to an IPO-ready situation?

We are committed to deconsolidating, and that plan remains unchanged. Currently, we are fundraising to capitalize the company between now and the IPO. Regarding your question, we are seeking more commercial evidence to demonstrate the revenue potential. Recently, we had a significant win in Qatar when the President visited, leading to an announcement that Qatar will invest in Quantum infrastructure. Successes like this boost investor confidence in the revenue stream. As for the timeline, I anticipate it will be at the end of 2027 at the latest, though there is a possibility we could move it forward by a few months or quarters. We are actively working with this timeline and have good visibility on commercial progress leading up to then. Additionally, we expect to reveal plans for Quantinuum around Q4, and we will keep our shareholders updated on our progress and share more broadly.

That's helpful, Vimal. Now, regarding R&D, I've never seen a company increase its R&D spending right before a breakup. I'm curious if this indicates that the businesses felt they were behind or if it’s simply coincidental. I'll leave it at that.

This reinforces my message from last year that Honeywell's organic growth is gaining strength as we enhance our fundamentals. The two key fundamentals we are focusing on are improving our processes and ensuring we are investing in the right areas with the right talent. Last year, we decided to increase our investment in R&D where we see potential for growth. Hiring in sectors like Aerospace and Energy is a lengthy process; decisions made in June won’t yield results until much later. Therefore, we are investing more in R&D across the board, with a notable increase in Aerospace compared to other areas. I firmly believe this prepares Honeywell for future organic growth as we target the right opportunities. Some segments are already showing evidence of accelerated organic growth, and we expect more progress as we continue. While the spending increases and organic growth may appear linked, I view them as distinct. We are simply positioning ourselves better as a company focused on organic growth compared to our historical performance.

Scott, I believe this is beneficial for us, considering our goals for top-line growth. Transitioning to higher growth verticals is a wise investment that will yield a high return on investment for us in 2026.

I should have mentioned that we are consistently at the median of our R&D spending. I believe this will push us closer to the upper quartile as the year comes to an end. As you may notice, the figures will begin to reflect the investments we make for growth.

Our next question comes from Sheila Kahyaoglu with Jefferies Group.

If I could ask two Aerospace questions, please. The first one on aftermarket, the 7% growth decelerating from 15% in Q1 and lagging some of the early reports from peers. How do we think about what weighed on that growth? Was it Air Transport, Business Aviation? And how are you thinking about the full year there?

I would say that the aftermarket is normalizing for us. We expect the range we received in the second quarter to be similar to what we anticipated for the second half. As we catch up with demand, we view this as a more normal rate moving forward. The hours are fairly stable for both ATR and Business, and we see this as the new normal for us going forward.

Okay. And then if I could maybe hone in on the Aerospace OE decline once again, if that's possible. Why the destocking now? And it seems like deliveries are actually increasing. Was it related to one specific platform? Or is it inventory across multiple platforms?

The impact is mainly from North America platforms on the OE side. Last year, we were shipping a lot into our OEs' inventories, and now they're reducing those inventories. They have better visibility regarding how much safety stock they require. We're preparing for this temporary situation, and based on what I know, it should start to normalize in the third quarter, with a return to normalcy in the fourth quarter.

And then, Sheila, I would just add the nuance is not everything is the same inside of OE. And so electromechanicals where we've had the supply chain challenges and continue to work towards making sequential improvement, whereas electronic solutions have been caught up for quite a while. And so you can see a little bit of a difference in terms of what those needs look like for customers between those two businesses.

Our next question comes from Chris Snyder with Morgan Stanley.

I wanted to ask about portfolio actions. Vimal, you guys have remained quite busy here in the first half of '25 after you announced the separation in Q4 of last year. So should we assume that everything of size has been completed or announced at this point? And then just on some of the strategic reviews, I think I understand why PSS doesn't fit the Aftermarket business. But Warehouse is both automation and aftermarket driven. So it does fit the characteristics that Honeywell is looking for. Can you just talk about why that one doesn't fit in the future portfolio?

Yes, thank you, Chris. To answer the first part of your question, we have completed the portfolio review that I initiated two years ago. Moving forward, we do not anticipate any significant portfolio exits. While being a large company means there are always changes happening, we have fundamentally finished this process. The decisions regarding Intelligrated and PSS were primarily based on sector focus and the end markets we aim to engage with. Automation represents a vast market, with a total addressable market of $500 billion, providing us with substantial opportunities. We have established three verticals for ourselves: Industrial, Process, and Buildings, and we are now making strategic choices within these areas. We want to prioritize the verticals that promise higher growth to deliver value to our shareholders. While we see potential in the logistics, warehouse, and transport segments, we recognize that they have shown varying growth rates and volatility, which we believe may not align as well with our future portfolio. Therefore, we are making decisions about adding and subtracting certain areas. Warehouse Automation has strong aftermarket potential, but our focus is on market participation choices that influenced this decision.

I appreciate that. I just want to follow up on Building Automation. There has been an impressive turnaround in this area over the past year. Can you discuss company-specific actions that have contributed to this growth turnaround, especially considering that the global non-residential backdrop hasn't been very favorable? Additionally, are we experiencing revenue synergies from the significant security acquisition you completed last year?

I think there are three strategies, which are, by the way, going to be the strategy for new Honeywell as we unveil that in late 2026. First is how we make our mix towards higher growth verticals. So in case of buildings, we are focused on three or four markets, hospitals, hotels, data centers, airports in high-growth regions. So one is pivoting more towards that. Action two is mining our installed base. We have a large installed base, how we mine it higher and deliver high single-digit growth in services. That's certainly working in Building Automation. And finally, the new product acceleration, the comment I mentioned to Scott's question, we have elevated R&D even in Building Automation, and they are the most ahead in delivering higher growth with new products. So when you pull the three things together, we are participating in high-growth markets. We are mining our installed base better. We are turning more new products. That's becoming the driver for higher growth. The final point there is we had some pressure in some geographies. Like there was a drag in China. There's a drag in Europe in some pockets. Those have normalized now. So the Building Automation growth is double digit in North America, but like low single to mid-single in other different parts of the world. So that also helps because we don't have any pullbacks from some other geographies, which normalize our results here.

Our next question comes from Andy Kaplowitz with Citigroup.

Vimal, can you give a little more color into what you're seeing in Defense and Space as it continues to accelerate here? I think the growth you've talked about in the past has been pretty balanced between the U.S. and international. But I think international defense spending is just starting to accelerate. So could you talk a little bit more about what you're seeing?

Yes. I think the Defense and Space growth is driven by both on the supply chain healing. Because it was last to heal, we have much more mechanical content in Defense and Space compared to Commercial. So that's certainly seen as part of our results. And on the demand side, the orders remain very strong, both domestically and international defense, which is our strength, is growing double-digit, and it will remain so for many years to come. We see strength in Europe. We see strength in parts of Asia, like Korea, et cetera. So I think it's a combination of accelerated demand with the geopolitical circumstances in the world and the supply chain healing, which is giving us the performance in Defense and Space as we are demonstrating.

And then, Vimal, I want to ask you about a couple of other initiatives. You've been working on direct material productivity and harnessing AI. You seem to mention quite a bit today about cost inflation you're facing across the portfolio. But I imagine a lot of that should have been expected. So update us on your ability to offset that with your initiative here around direct material savings and then maybe how sticky have your price increases been that you've made here this year.

I think our pricing initiatives have proven to be quite effective. We have developed a strategy that not only safeguards our earnings but also maintains our volume, aligned with our goals for 2025. Achieving this balance can be challenging, as we want to avoid raising prices to a level that negatively impacts demand. Despite a minor exception in Aerospace OE due to contract delays, we have successfully implemented our pricing strategy throughout Honeywell. Additionally, our focus on productivity is significant, providing us with more options regarding pricing in specific segments versus margins, which we can enhance through productivity. Value engineering is particularly thriving, with AI playing a key role in streamlining the design process. By using AI, we can now determine board designs in a week instead of the previous two to three months, which accelerates the cost savings we can achieve within a given year. My confidence stems from the increasing importance of value engineering for Honeywell; it's something we can rely on and incorporate into our financial planning, serving as a lever for pricing versus volume not just for 2025, but beyond.

Andy emphasized the importance of demonstrating consistent growth over a longer period by focusing on both top line and bottom line growth. He mentioned that teams now have a better understanding of managing factors like price, volume, and mix based on their specific verticals and customer sets. The goal is to establish a framework for consistent delivery over time.

Our next question comes from Deane Dray with RBC Capital Markets.

I was hoping to get some color on free cash flow. So you boosted the EPS guide, but cap free cash flow guidance, the same. Just are there any puts and takes related to free cash flow for the second half you'd like to highlight?

Sure. So we have a pretty broad range on cash flow, the $5.4 billion to $5.8 billion. If you look at the moving pieces, I would say our inventory got a little bit worse just because of what we are facing right now in Aero. That hopefully will normalize in the second half. On the other hand, we have a little bit of tailwind from stronger collections and higher sales and pricing. So net-net, we're the same. We're really focusing on moving towards that 90-plus percent conversion in 2026.

Great. And then just a related question. Anything in the second half on price cost that you'd particularly want to highlight here?

So I think, generally, if you think about our guide, our price probably, vis-a-vis the last time we talked, we're probably 100 basis points better. So if you thought about price of 1% to 2%, now it's 2% to 3%. Volume is probably going to be 1% to 2%. And then from a cost price standpoint, short-cycle businesses will offset. And then Aero, like I said earlier, is still working through their OE contracts, and that should normalize going towards year-end and early half of next year.

Our next question comes from Joe Ritchie with Goldman Sachs.

I just want to make sure I understand the relationship between the tariffs and the demand contingency. And so it seems like the moratorium is you kind of kept the kind of tariff rates at a higher rate. And if the moratorium were to become permanent, I'd assume that maybe the demand contingency gets released to some degree. Just trying to make sure that I understand that correctly. And are there any specific segments that you could see benefiting in the second half of the year if, in fact, tariffs come in at lower rates permanently?

Sure. Looking at the second half, the short-cycle businesses are managing quite well, and we haven't seen any issues with pre-buy or demand disruptions. Building Automation is performing well, and our IA segment is doing better than expected. The focus is really on our energy business and how orders convert into revenue since we are at a point in the year where getting an order for an energy project requires time for engineering. This means that some revenue may not materialize within the year. We're managing that aspect while looking ahead to the first half of next year and also keeping an eye on our catalyst orders, which have been softer than forecasted. This behavior from our customers can lead them to postpone catalyst orders by a quarter or two while still operating their refineries and facilities at reduced output.

Got it, Mike. That's helpful. And then maybe just my quick follow-on on the strategic alternative announcement on PSS and warehouse. Kind of looks like the demand environment there is getting a little bit worse again, so kind of bouncing along the bottom. I guess, Vimal, I know that we can't bank on any outcome here. But I guess, how are you thinking about the timeline for a decision to be made on that piece of the business?

We initiated the process just last week following our announcement. We expect to have more clarity on the available strategic options by the end of the year, as there are multiple choices to consider. While it’s difficult to provide a specific timeline right now, we aim to share our decision on which option to pursue before the year concludes. Ideally, we want to have a streamlined portfolio by the time the spin is finalized, which is why we started this strategic review to align the timing. However, as you can understand, it's challenging to guarantee a timeline at this moment.

Our next question comes from Nicole DeBlase with Deutsche Bank.

Maybe just starting with some of the order trends that you guys saw throughout the quarter. How would you say that orders progressed each month and then into July? It sounds like maybe energy was the only area where you saw a discernible difference. But if you talk a little bit about IA, BA more on the short cycle side through the quarter, that would be helpful.

Sure. So I would tell you, overall orders, 6% up. Really pleased with that better orders than in the first quarter. Aero led the orders growth for us. Once again, very strong orders on both Defense and Space and Commercial. Building Automation was low single digits, but it had tougher comps. So we didn't see anything there. And then for IA and ESS, I would say we saw strong first two months, and June was a little bit softer. Going into July, on the other hand, orders are continuing to be strong. So June might have been kind of a false positive. In general, I feel like orders are sticking. And the second quarter was better than the first quarter. And in terms of what the teams showed us for the third quarter and the forecast, we don't see a lot of concern in our order rates slowing down.

Okay. Got it. That's really helpful. And then there's a lot of discussion around what you guys are doing from a portfolio perspective, but I don't think we talked much about future M&A plans. And you guys have clearly been a lot more active recently. How does the M&A pipeline look today? And what is your appetite for doing more deals before the spin happens?

So Nicole, we absolutely are building our pipeline. We are going to be slightly slowing down given the activity we have or the spins in motion and some acquisition integration work we are doing. But we are not slowing down on building the pipeline. The pipeline remains strong, and we'll execute opportunities as they become available. I think what gives me more confidence is that we're getting much more comfortable not only doing the normal deal, but also acting like a sponsor to do carve-out deals. We have demonstrated that capability repetitively now over the last two years. And that additional skill increases our optionality now because we are willing to go to other partners, suggest an optionality for them to create value for both sides. And that gives me confidence that we can remain active in the portfolio side in the years ahead. So more to come. We'll continue to build our portfolio as a higher priority item under my leadership.

We have reached the end of the question-and-answer session. I would now like to turn the call back over to Vimal Kapur for closing remarks.

Thank you. I want to again once express my deep appreciation to our shareholders, our Honeybee team, and our customers for their continued support during the transition time for the company. And we are excited for the future and look forward to sharing more of our progress as we deliver on our commitment. Before we close out today's call, I want to take a moment to remember our pivotal former leader of Honeywell that we lost this week, Larry Bossidy. Larry was the Chairman and CEO of AlliedSignal and led the company's acquisition of Honeywell in 1999. He was a forefather of operational excellence that Honeywell is known for today and served as combined company's Chairman and CEO until his planned retirement in 2000. He then came out of retirement briefly to offer his leadership again as Chairman and CEO during a challenging period of our company. And under his very deep leadership, the Board hired Dave Cote as Honeywell's new CEO, and setting up the company for the next two decades of tremendous value creation. He was a remarkable leader, a committed family man. And our thoughts are with his family and friends at this point in time. So thank you again, everyone, for listening, and please stay safe and healthy.

This concludes today's conference call. We thank you for your participation. You may now disconnect from the conference.