Good day, ladies and gentlemen, and welcome to Honeywell's 4th Quarter 2014 Earnings Conference Call. At this time, all participants have been placed in a listen only mode and the floor will be open for your questions following the presentation. As a reminder, this conference is being recorded. And I would now like to introduce your host for today's conference, Mr. Mark Macaluso, Vice President of Investor Relations.
Thank you, Lisa. Good morning, and welcome to Honeywell's 4th quarter 2014 earnings conference call. With me here today are Chairman and CEO, Dave Godey and Senior Vice President and CFO, Tom Klosek. This call and webcast, including any non GAAP reconciliations, are
available on our website at www.honeywell.com/investor.
Note that elements of this presentation contain forward looking statements that are based on our best view of the world and of our businesses as we see them today. Those elements can change and we ask that you interpret them in that light. We identify the principal risks and uncertainties that affect our performance in our Form 10 ks and other SEC filings. This morning, we'll review our financial results for the Q4 and full year 2014 and share with you our guidance for the Q1 and full year of 2015. Finally, as always, we'll leave time for your questions at the end.
So with that, I'll turn
the call over to Chairman and CEO, Dave Cote. Thanks, Mac. Good morning, everyone. We delivered another excellent quarter capping off terrific 2014. In this 4th quarter, we delivered better than expected operational performance in each of our key growth in the Q3.
And we continue to drive margin expansion, up 130 basis points excluding the impact of the Q4 2014 Aerospace OEM incentives, which we discussed in detail last month. We delivered earnings per share of $1.43 up 15% year over year or up 11 percent normalized for tax. So another quarter of double digit earnings growth and $0.01 above the high end of our guidance range with strong execution across the portfolio. For the full year, we increased sales on an organic basis 3%, while continuing our seed planning with investments in new products and technologies, high ROI CapEx and expansion of our global footprint. We achieved significant margin expansion with benefits from our key process and productivity initiatives.
And we've been able to achieve all this in what continues to be a slow growth macro environment. The momentum we saw in the second half gives us confidence in this year. Our short cycle businesses continue to improve with good organic growth in the commercial aftermarket business, ESS, Advanced Materials and Transportation Systems, all suggesting a modest improvement in end market conditions overall. We're also seeing good momentum out of our long cycle businesses building on a robust backlog. We believe the portfolio is well positioned to deliver this year and beyond enhanced by the smart game deployment actions we've taken over the past years.
While I believe the global economy could be a bit better this year than economists are forecasting currently, we will as always plan conservatively in our outlook and remain flexible. As you'll hear in a moment, we continue to plan for a slow to no growth environment in Europe. We've hedged over 80% of our P and L exposure related to the Europe and we remain focused on controlling our spend. As Tom previewed in December, we sold the final 1,900,000 shares of BE Aerospace stock this quarter. To remind you, we originally received 6,000,000 shares as part of the consideration for the sale of our aero Consumable Solutions business in 2,008.
At that time, those shares were worth about 150,000,000. We sold those shares over the course of the last 5 quarters for a total of about 500,000,000 dollars We've deployed the resulting gains for restructuring and other actions to proactively position the company for future growth and profitability. The actions in the Q4 will significantly benefit Aerospace over our 5 year plan and we believe we're well positioned for future success with our commercial OE customers as a continue to be a lot of exciting things happening across the portfolio that drive those results and to highlight a few, Honeywell Scanning and Mobility delivered another quarter of double digit organic sales growth, benefiting from new customer wins. Following the success we've had with Intermec, HSM announced in December the acquisition of Datamax O'Neil, a global manufacturer of fixed and mobile printers used in a variety of retail, warehouse and distribution and healthcare applications. This acquisition positions HSM to expand in the $1,500,000,000 global biocode printing segment and build on their existing printing capabilities acquired with Intermed.
The team is really excited about this acquisition, which extends our global reach and provides scale and significant synergy opportunities. Transaction is expected to close this quarter. While our deal activity in this past year was modest, the M and A pipeline remains robust. We intend to maintain our disciplined process and extend our strong track record. We've also talked a lot about our Solstice line of refrigerants, insulation materials, aerosols and solvents that have ozone depletion of 0 and a global warming potential lower than CO2 and that's a 1000 times better than what it replaces.
Earlier this month, we announced that our Fluorine Products business has started full scale commercial production in our Baton Rouge, Louisiana facility of the newest Solstice product, HFO-twelve 34ZE. Now that is one impressive catchy name. So I think we're going to probably stick with Solstice. We're seeing increasing demand for our entire Solstice suite of low GWTP materials. The lifetime value of signed agreements in 2014 exceeds $2,300,000,000 and we have an additional $1,000,000,000 plus under negotiation.
Process Solutions has also been a bright spot as we closed out the year. Organic sales growth accelerated in the second half of the year and orders were up double digit in the 4th quarter supporting continued growth this year. HPS is transforming project execution with LEAP, that is lean execution of automation projects and is innovating to win in the market with automation offerings across control and safety systems, field devices, plant optimization software and services. We're also excited about the growth synergies from the work HPS and UOP are doing together. Our ability to match UOP process and operating knowledge with HPS control and advanced software solutions we'll enable unmatched operating excellence for our refining, petrochemical and gas processing customers.
You can expect to see more of our innovation on display at the March Investor Day, where each of the businesses will highlight a number of HUE influenced new products and roadmaps for future growth and productivity. We also plan to share with you how HOS Gold is evolving throughout the organization, which we believe is a key differentiator. We held our annual senior leadership meeting earlier this month and I could tell you that each of the businesses are hard at work finding new and innovative breakthrough objectives to drive growth and margin expansion. Having successfully performed against the 5 year targets we set for 2010 to 2014, we're now focused on delivering 2015 and the 5 year targets we issued last March for 2014 to 2018. 2014 was a strong start.
Our business model works, having a strong portfolio with great positions in good industries, making sure the machinery works better every day for our customers, suppliers and employees and a culture that focuses on 1 Honeywell and evolving our capability and technologies. From our culture, we get sustainability results. So with that, I'll turn it over to Tom.
Thanks, Dave, and good morning. Let's begin on Slide 4, which recaps our 4th quarter results compared with the guidance we gave you last month at the December outlook call. On the left hand side, we've outlined the guidance we shared with you in December. And on the right, you can see our results for the quarter as reported. I'm not going to walk through each line item here, but you can see based on the check marks that we delivered or exceeded our guidance on each line item, including the top and bottom line.
The incremental sales and segment profit enable us to beat the higher end of our EPS guidance range and also to fund incremental restructuring and other actions in the quarter. There are a couple of transactions that occurred in the 4th quarter that are worth reminding you of and again they unfolded exactly as we forecasted in December. First, we completed the sale of the remaining beef shares as Dave said, resulting in a $114,000,000 gain, dollars 0.14 per share on an after tax basis. The timing of the sale was important from a tax perspective as we noted in December. The timing allowed us to offset that gain with other items and therefore incur very little income tax on the transaction.
Also in the quarter, our Aerospace business recognized the cost of certain commercial OEM incentives that became due when our customer achieved contractual development milestones on platforms, which will include Honeywell Avionics and our mechanical content. The cost was $184,000,000 or $114,000,000 on an after tax basis, that's $0.14 per share. As you know, we've won significant content in the Air Transport and Business Aviation sectors and such upfront incentives are part of the business model. And as you're also aware, accounting for these incentives is quite conservative. Many others in the industry defer these types of costs on their balance sheet and expense them over the life of the platform.
We believe charging incentives upfront gives greater transparency to our OEM profitability in the segment. Also, the OEM incentives position us well on the platforms already won, but also to win new business on the content to be selected in the future. I'm now on slide 5, which shows the 4th quarter results without the Arrow OEM incentives or the Beav gain. Sales of $10,500,000,000 increased 1% or 4% on an organic basis. The absence of friction materials and the strengthening of the U.
S. Dollar were headwinds to reported sales growth in the quarter. You'll recall we divested Friction Materials in the 3rd quarter, so there will continue to be unfavorable sales headwinds throughout the first half of twenty fifteen. We are encouraged with the growth momentum that is beginning to emerge. We achieved 4% organic sales growth in the second half of twenty fourteen compared with 2% for the first half and 2% for all of 2013.
The growth we saw in the 4th quarter was broad based and resulted in better than expected performance across the portfolio. I'll provide more color as we review the business groups in a moment. You can see that segment profit increased 9% with segment margin expanding 130 basis points. Our efforts to drive commercial excellence supported by differentiated technology continued to produce results. In addition, productivity remains a key driver of margin expansion offsetting inflation and our continued investments for growth.
EPS was $1.43 up 15%, consistent with our historical practice. This excludes the annual mark to market adjustment for our defined benefit pension plan. In the Q4, this mark to market adjustment was approximately 249,000,000 dollars or $0.23 per share, principally driven by lower discount rates in our German and Dutch plans. So the 4th quarter reported EPS was 1.20 dollars And for reference purposes, the mark to market adjustment in 2013 was $51,000,000 or about $0.05 a share. Finally, free cash flow in the quarter of $1,300,000,000 representing conversion of 119% and an increase of 6% from 2013.
So overall, we generated very strong results in a relatively slow growth environment and we increased our annual dividend in the 4th quarter by 15% to $2.07 a share, continuing our commitment to growing the dividend faster than the earnings rate growth and a trend you can expect will continue. On slide 6, same 4th quarter results we're presenting on a reported basis. So as you can see, our reported sales decreased 1% and that was driven by the aero OEM incentives. No change to the 4% organic sales growth in
the quarter that I showed
in the previous page. So on a reported basis, segment profit decreased 2% with margins contracting 20 basis points to 15.9% in the quarter. Again, the only difference from the previous slide on segment margins is the inclusion of the 184,000,000 dollars charge for the Arrow OEM incentives. Moving to net income. The BEES gain and the OEM incentives fully offset one another on a net of tax basis and normalized per tax EPS in the quarter increased 11% year over year.
The rest of the figures on this slide are identical to the prior Q4 slide. I'm now on slide 7 to recap the full year 2014 results again without the impact of the aero OEM incentives or the BEVE gain. Full year sales of $40,500,000,000 up 4% or 3% on an organic basis. The primary difference between the reported and organic rates is the Intermec acquisition net of the impact of the Friction Materials divestiture. We saw good organic growth across the portfolio including in scanning mobility, the Fire and Industrial Safety Businesses, transportation systems and UOP.
Segment profit increased 8% demonstrating strong sales conversion and resulted in a 70 basis point improvement the segment margin rate to 17%. All this resulted in earnings per share excluding pension mark to mark adjustment of $5.56 a share, up 12% over 2013, representing our 5th consecutive year of double digit earnings growth and EPS $0.01 above the high end of our December guidance range. Our reported EPS of $5.33 for the year again reflects the $0.23 mark to market adjustment that I mentioned for the Q4. So finally, free cash flow was $3,900,000,000 in line with our guidance. Free cash flow increased 16% year over year despite an approximate 16% increase in CapEx investments in the growth areas we've previously shared with you mostly in PMT.
So let's move to slide 8 to show the full year 2014 results including the impacts of the Arrow OEM incentives and the BEAVE gain. To quickly recap, 2014 sales were up 3% on both reported and organic basis to $40,300,000,000 Second profit was up 5%, resulting in a 30 basis point margin expansion to 16.6%. So the aero OEM incentives reduced the growth the reported growth from 4% to 3% and reduces margin expansion from 70 to 30 basis points. The rest of the page again remains the same as the previous slide. And now I want to move on to slide 9 and discuss the businesses starting with Aerospace.
This first slide highlights the Q4 reported and organic sales growth rates for Aerospace. As a reminder, in the Q4 of 2013, Aerospace recognized an IP litigation settlement, resulting in a one time royalty gain of $63,000,000 in Defense and Space that was offset at the time by OEM incentives in BGA. Both of these items were included in and therefore netted out in sales and segment profit at the Aerospace level in 2013. Total reported Aerospace sales were down 6% in the Q4 of 2014 driven by 3 items: the $184,000,000 OEM incentives that we discussed in our outlook call back in December 2, the Friction Materials divestiture, which closed in the 3rd quarter and 3, the unfavorable impact of foreign exchange on reported results. However, on an organic basis, 4th quarter sales in Aero were up 4%, driven by strong execution across the portfolio as each of the 3 legacy Aero businesses accelerated growth in the 4th quarter compared with the 1st 3 quarters and Transportation Systems continued its mid single digits growth performance.
Organic sales growth in Arrow has accelerated throughout 2014 like Honeywell. So you'll recall Aero was up 1% in both the 1st and second quarters, 3% in the 3rd quarter, now 4% to close out the year in the 4th quarter. If I look at the individual pieces of Aerospace starting with commercial OE, sales decreased 14% on an organic basis or sorry, on a reported basis, driven by the net unfavorable impact of the OEM incentives. However, on an organic basis sales grew 7%. And that was principally the result of robust engine shipments and business and general aviation for the Bombardier Challenger 350 and Embraer Legacy 500.
Moving to commercial aftermarket, as you can see, 4% sales growth on both reported and organic basis. ATR spares growth was balanced across both mechanical and electrical product lines, offsetting moderation in BGA RMUs, that's retrofit modifications and upgrades. Both airline and business jet repair and overhaul activity improved in the quarter as well. Defense and Space sales declined 3% on a reported basis, driven by the absence of the prior year licensing royalty gain I just mentioned. However, on an organic basis, sales were up 2% in the quarter.
International programs continue to drive growth with double digit sales increases offsetting modest declines in our U. S. DoD and Government Service Businesses in the 3rd quarter sorry in the quarter 4th quarter. Finally, Transportation Systems sales declined 16% on a reported basis, reflecting the Q3 Friction Materials divestiture and foreign exchange headwinds. On an organic basis, TS sales increased 4% in quarter as we once again saw strong volume growth in light vehicle gas applications where we continue to see increased global penetration.
We also continue to see our European commercial vehicle volumes grow as we benefit from new programs following the implementation of Euro 6 emission regulations in the region. As you can see, the underlying business growth trends across the aero portfolio remain positive, consistent with the outlook we provided to you in December. So now on slide 10 continuing with Aerospace. The 4th quarter sales results and commentary are consistent with what I just discussed. So for the full year, Aerospace sales declined 1% on a reported basis, driven by the Friction Materials divestiture and the impact of the OEM incentives.
However, on an organic basis, sales increased 2%. Aerospace margins contracted by 160 basis points in the quarter, driven by the OEM incentives. But excluding the $184,000,000 charge for the OEM incentives, segment margins in the 4th quarter were actually up 2 10 basis points, driven by productivity, net of inflation, where material productivity continues to be a significant driver, also commercial excellence and the favorable impact of the Friction Materials divestiture. And for the full year, you can see that Aero segment margins expanded 140 basis points, again excluding the OEM incentives. Let's turn to ACS results on slide 11.
ACS sales were up 6% on an organic basis in the quarter, excluding an approximate 3% headwind from FX. The growth came in above our guidance with both ESS and BSD finishing the year strong. ESS sales for the products businesses were up 7% on an organic basis in the quarter, continuing the trend of progressively stronger growth noted in each quarter of 2014. Scanning and mobility continues to perform well, driven by new product introductions and large program wins such as the U. S.
Postal Service program we hired last quarter. In addition, we continue to realize integration benefits from Intermact, supporting the strong growth we've seen from the combination of the two businesses. The pending acquisition, as Dave mentioned, of DataMax O'Neil complements our existing portfolio in the attractive barcode printing space acquired with Intermac. As for the rest of ESS, growth was driven by new product introductions, further penetration in high growth regions, higher residential sales, which benefited both ECC and security and improvements in the non resi market, which benefited our fire and industrial safety businesses. Building Solutions and Distribution sales were up 4% on an organic basis in the 4th quarter with continued strength in the Americas Fire and Security Distribution Businesses and acceleration in Building Solutions.
Particularly within Building Solutions, we saw good growth in the Americas as well as an increase in higher margin service businesses. Both the Building Solutions backlog and service banks were up mid to high single digits on an organic basis, supporting our outlook and confidence for sales acceleration in 2015. ACS margins expanded 70 basis points to 15.9% in the quarter. The business continues to benefit from good conversion on higher volumes and productivity net of inflation supported by our HOS initiatives, offset by continued investments for growth. In addition, we continue to realize incremental synergy benefits from the combination of Intermec with HSM.
So overall, very good growth and execution at ACS and a lot more to come as the team continues to coordinate the individual businesses more and more through connected ACS, which is an initiative to drive an enhanced degree of integration across the businesses and in particular in the supply chain, in product development and in the marketing areas. Alex will talk more about this at our Investor Day in March. So moving to slide 12 for Performance Materials and Technologies. PMT sales in the quarter were up $2,600,000,000 up 3% on an organic basis or approximately flat on a reported basis driven by foreign exchange headwinds. We'll address the impact of lower oil prices on the PMT businesses in a moment, but there was very little impact on the PMT results in the quarter.
For the Q4, UOP sales decreased 1% on an organic basis. And as a reminder, UOP had exceptional organic growth in Q4 of 2013. You'll recall, they were up 17% last year, driven primarily by increased catalyst sales. So very difficult comparison year on year. UOP executed very well, reflecting strong licensing revenue, which partially offset the lower catalyst sales.
We also continue to see strong order trends in gas processing, particularly at UOP Russell, giving us confidence as we head into 2015. And we anticipate further sales growth in 2016 2017 for the new capacity additions across UOP and also to Advanced Materials, which come online in 2015. In Process Solutions, organic sales growth continues to accelerate. HPS was up 6% in the quarter, while on a reported basis sales were flat as the organic or the strong organic international growth was offset by foreign exchange headwinds. HPS saw strong volume growth driven by the Advanced Solutions Software business and the HPS Service business in all regions.
Orders backlog and Service Bank growth also continued at a strong pace, up double digits on an organic basis in the quarter. And this orders growth increased steadily throughout 2014, which sets Process Solutions up nicely for accelerated sales growth in 2015 and beyond. Advanced Materials sales increased 4% on an organic basis driven by double digit sales and orders growth in flooring products as demand for our new low global warming potential suite of Solstice products continues to grow. This was partially offset by a decline in resins and chemical sales in the low single digit range, driven principally by the market based pricing model whereby selling prices are closely tied the market price of raw materials, most notably benzene, which is highly correlated to the price of oil. While sales can be volatile, the pricing model largely protects the profit dollars in resin and chemicals even on lower sales.
PMT segment margins were up 90 basis points to 16.5%, which exceeded our guidance, driven by higher volume and productivity net of inflation, partly offset by continued investments for growth. In UOP, the higher mix of licensing revenue in the quarter resulted in a tailwind to margin. HPS also converted particularly well, continuing its successful business transformation and benefiting from the growth I mentioned in the higher margin Advanced Solutions Software and Service Businesses. I'm now on slide 13, labeled 2015 planning update. And similar to what we did in December related to the impact of oil price declines on the portfolio, I wanted to address some of the major global trends affecting our portfolio and explain how each of these items are impacting our plans for 2015.
I'm going to start with oil price declines. Overall, we continue to view the impact from lower oil prices as being net neutral to UOP and HPS. The upstream exploration and production parts of the value chain continue to represent a relatively small portion of our portfolio, roughly 10% to 15% of the combined UOP and HPS businesses. And our upstream backlogs have held firm. We are beginning to see some delays further downstream in countries that are net oil producers such as Russia and the Middle East as refining and petrochemical project decisions are deferred.
On the other hand, in countries that are big importers of oil, most notably China, India and the Southeast Asia region, as we had anticipated, the lower oil price has stimulated more discretionary mid and downstream spending, where we are well positioned. This is being borne out, for example, in Process Solutions, where orders and backlog grew roughly double digits on an organic basis in the quarter as I highlighted earlier. So again, we think oil prices are neutral to the UOP and HPS businesses at this time. However, we continue to monitor this activity closely as we look ahead. Sales in resins and chemicals will be negatively impacted by lower prices for the lower oil prices for the reasons I mentioned earlier.
But while sales can be volatile, the pricing model again largely protects our profit dollars in this business even on the lower sales. Finally, we anticipate we'll begin to see the favorable effects of lower oil prices on our cost structure, in particular in our indirect spend and we believe this will accelerate throughout 2015. Of course, it remains to be seen how oil prices will impact the global economy should prices stay below $50 longer term. However, we continue this will be a net positive for the economy and Honeywell over the planning horizon. Turning to currency fluctuations, we've obviously seen the continued weakening of the euro.
As we highlighted in December, our 2015 plan is based on a euro exchange rate of $1.20 at the midpoint. We have hedges in place covering approximately 80% of our euro P and L exposure. So while there will continue to be pressure on the sales line, our euro based earnings are protected. We also continue to see volatility across our other currency exposures, which again are likely to result in headwinds to the top line. However, similar to the hedging we've done for the euro, the actions we've taken largely protect our 2015 earnings outlook for these other currencies as well, and we'll continue to actively monitor the situation.
The outlook for the U. S. Economy continues to improve and we're expecting a positive uptick in our U. S. Businesses as a result.
But we also remain focused on increasing our presence in high growth regions. As a reminder, HGRs now represent almost a quarter of our total business and are expected to drive 50% of the sales growth over the course of our 5 year plan. The population growth, urbanization and infrastructure development continue to create attractive opportunities across our entire portfolio. In China, we anticipate high single digit growth in 2015 after a year of roughly mid single digit growth in 2014. Our initiative on becoming the Chinese competitor continues to accelerate and bear fruit.
Investments in local sales and marketing resources are targeted to the higher growth cities in China, where local economies are growing much faster than the overall China GDP. Also, our 1 Honeywell approach, specifically in ACS, continues to drive cross selling opportunities across multiple channels. In addition, we're building a robust pipeline of new products geared towards the macro trends in the region, namely air purification, energy efficiency and security. All these factors give us confidence in accelerated growth for Honeywell in China in 2015. In India, after the investments across the region slowed in the first half of the year while the elections unfolded, the second half was 2014 was very strong for Honeywell.
And we anticipate growth will be roughly high single digits in 2015, driven by our international defense and space business, new launches in transportation systems, new product introductions in ESS across each of our major verticals and growth in BSD from infrastructure projects and services. In Russia, where our exposure is limited, we have less than about $500,000,000 in annual sales there. We continue to have a strong backlog in our long cycle businesses. We expect Russia to continue focusing their available capital on energy, so oil and gas and renewal of their aerospace sector, 2 areas where our portfolio is well positioned to grow. Our short cycle businesses in Russia have been impacted, particularly as it relates to currency devaluation, but again the exposure there is relatively small.
And while our management team is paying close attention to the issues facing the country, we're also continuing to look for opportunities to enhance our business in the region. In the Middle East, we expect continued double digit sales growth in 2015 after approximately 20% growth in 2014. And this is driven by big wins in both the short and long cycle businesses as infrastructure investments continue. Our portfolio is well positioned to benefit from and even outpace in some cases the attractive growth rates in these markets. Turning to the non residential sector, we're encouraged by the expected acceleration of commercial construction spending forecast to be up approximately 4.5% in 2015 and the continued solid growth on the industrial side in 2015.
So as a reminder, roughly 75% of the ACS portfolio serves the commercial industrial markets and our balanced portfolio is well positioned to capitalize on improvements in these areas. More specifically on the commercial product side, after modest growth to the 1st 3 quarters of 2014, we saw some acceleration in the 4th quarter with strong growth in the U. S. We expect the U. S.
To continue
to drive
further commercial products growth in 2015 as well as acceleration in our high growth regions with strength in our ECC and Fire Systems businesses in particular. In the industrial products markets, we expect higher sales of industrial safety equipment, particularly in the Americas, which represents about half of our exposure. As for Building Solutions, the backlog from our projects businesses and the Service Bank grew mid and high single digit respectively on an organic basis this quarter and we continue to expect energy efficiency projects to support global acceleration in 2015. With regard to our pension plans, the net effects of higher investment returns and lower discount rates will drive a $125,000,000 increase to pension income for 2015. Now we intend to fully offset that increase restructuring over the course of the year.
In total, our international pension plans represent approximately 25% of our worldwide defined benefit pension obligations. In the U. S, we ended the year with a discounted rate of 4.08% and a return on assets of 8%, which resulted in a U. S. Funded status of approximately 95%.
Globally, the funded status is about 94%. We don't we do not anticipate any 2015 cash contributions related to our U. S. Plan. Let me turn to slide 14 to summarize our outlook for 2015.
Our full year guidance is identical with what we shared with you in December. We continue to expect sales in the range of $40,500,000,000 to $41,100,000,000 up 1% to 2% on a reported basis and up approximately 4% on an organic basis. The reported sales growth is expected to be lower than organic, primarily due to the impact of Friction Materials divestiture and the foreign exchange headwinds. We're planning segment margin expansion of 100 to 130 basis points or up 60 to 90 basis points excluding the 4th quarter OEM incentives. We're projecting EPS and this excludes the pension mark to market adjustment of $5.95 to $6.15 representing 7% to 11% growth versus 2014.
The quarterly growth trends remain in line with our prior year results and this range also continues to be based on a full year income tax rate assumption of 26.5% and share count held roughly flat to 2014 levels. Free cash flow is expected to be in the range of $4,200,000,000 to 4,300,000,000
dollars up
8% to 10% from 2014 with CapEx investments peaking at roughly 2 times the depreciation. At a more normalized rate of CapEx investments, so around 1.25 times depreciation, we expect free cash flow conversion to be at roughly 100%. So I'll now turn on slide 15 with a preview of the Q1. For total Honeywell, we're expecting sales of $9,400,000,000 to $9,600,000,000 That's down 1% to 2% reported, but up 3% to 4% on an organic basis. Segment margins are expected to be up approximately 110 basis points and EPS is expected to be in the range of $1.36 to 1.41 up 6% to 10% versus 2014.
Starting with Aerospace, sales are expected to be up 3% to 4% on an organic basis or down 2% to 4% on a reported basis, reflecting the year over year absence of Friction Materials as well as foreign exchange headwinds. We're expecting positive organic sales growth from each of the 4 businesses in the quarter. In Commercial OE, we're expecting sales up low to mid digit driven primarily by new platform wins in BGA. The growth is driven by favorable demand trends for high value business jet platforms where we have significant new engine content. In commercial aftermarket, we're expecting sales to be up low single digit with continued repair and overhaul growth as well as ATR spares growth in the quarter, driven by higher demand for both mechanical and electrical products, partially offset by a decline in BGA RMUs against the challenging prior year comparison.
Defense and Space sales are expected be up low to mid single digit in the quarter, driven by continued strength in international businesses. In Transportation Systems, sales are expected to be up mid single digit on an organic basis, but down significantly on a reported basis driven by the absence of friction and the foreign exchange headwinds I mentioned. On organic basis, the growth in TS is primarily driven by new launches and strong light vehicle gas demand at each of our 3 key regions, the U. S, Europe and China. As for Aerospace margins, we expect an increase of 100 basis points to 120 basis points, driven by commercial excellence, significant productivity improvements across the portfolio along with a favorable impact on the margin rate from the Friction Materials divestiture.
Turning to ACS, sales are expected to be up 4% to 5% organically or flat to up 2% on a reported basis, with continued mid single digit organic growth in both ESS and BSD. The difference between reported organic rates reflects the foreign exchange headwinds in the quarter. The end markets where we primarily participate residential, commercial and industrial are all looking moderately better as we start 2015 and we continue to benefit from new product introductions and high growth region penetration. Also the strong orders growth we saw at the end of 2014 in both the short and long cycle businesses gives us increasing confidence in our outlook for 2015. ACS margins are expected to be up 100 to 120 basis points with continued benefits from commercial excellence and productivity, net of inflation, while accelerating investments for growth in new product areas such as connected homes and in high growth regions.
Further, we expect to realize synergies from the integration of Datamax O'Neil acquisition 2014. In PMT, sales are expected to be approximately flat on an organic basis and down approximately 1% to 3% reported, driven by foreign exchange headwinds and the impact of lower oil prices on resins and chemicals, a point I made earlier. Excluding these factors, PMT sales are expected to be up approximately 4% in the quarter. We're expecting UOP to be up low single digit with gas processing sales expected to drive majority of the growth. In HPS, we're expecting organic sales of mid single digit.
The favorable orders and backlog growth we saw in 2014 will support the sales acceleration in 2015. On the Advanced Materials side, we're expecting a low to mid single digit organic sales decline, principally driven by a double digit decline in resins and chemicals due to the factors I mentioned earlier. These declines are offset by continued strength in our flooring products business, which is benefiting from increased demand relating to the new products, principally the Solsys product suite. Also PMT segment margins in the quarter are expected to be up 100 to 120 basis points versus 2014, driven by higher volumes and productivity as well as the favorable margin rate impact of the market based pricing model in ResMed and Chemical. Let me move to slide 16 for a quick wrap up.
In 2014, we demonstrated once again that Honeywell can deliver on its commitment in a relatively slow growth economy and amidst some very volatile global trends. Reminder once again of the value of our diversified and balanced portfolio, the management team focused on execution and the strength of the Honeywell playbook and key enablers. Combined, these enabled us to add to our performance track record as we exceeded guidance on sales, achieved significant growth in segment margins and delivered on double digit EPS growth we originally laid out last December. We're going to continue investing in our future with a focus on profitable sales growth. This will continue to mean investments in high ROI CapEx, in new product development and in sales and marketing resources, particularly in high growth regions.
The investments are paying off and you can see it in our results. As we turn our attention to 2015, we recognize the uncertainty in the macro environment, but this is not new for us. We have and will continue to plan conservatively. We're confident that our portfolio is well positioned for continued outperformance. Our order trends both short and long cycle point to accelerated sales growth for next year that should enable continued strong improvement in our profitability.
We're forecasting strong organic growth in 2015 and over 100 basis point improvement in our margins as our HOS gold initiatives are deployed across the portfolio. In addition, we have significant restructuring savings in the bank for 2015. So we'll continue to execute in 2015 and beyond. We're very excited about the upcoming year and have a lot of momentum across the portfolio as we head into year 2 of our 5 year plan. We look forward to telling you more at our March 4 Investor Day.
So with that, Mark, let's go to Q and A. Thanks, Tom.
Lisa, if you would, please open the line for questions.
Thank you, sir. The floor is now open for questions. Thank you. Our first question comes from Steve Winoker with Bernstein.
Hey, good morning all. Hey, Steve. After last quarter's multitude of congratulations, I'm hesitant to say it again Dave, but I will say nice quarter. And I guess I'll get blamed by all my colleagues out there for doing this.
It's a shame to be nice. You wouldn't want to do something like that.
Well, I'm trying to be very cautious on that front. It's one of my development needs. So anyway, listen, on last on the outlook call, we spent a lot of time you guys provided a great amount of detail for thinking through the oil price, declining oil price impact across all your businesses. And I'm trying to compare that to what Tom just walked us through. But the thing that really is of maybe concern to me is the midstream, downstream commentary where in December you really talked about that it was a net positive in terms of refined product demand investment downstream and other areas.
I'd just like to get a little more color on that particularly around the impact of maybe narrowing oil and gas spreads on some of those investments that are happening out there. Just some more color on why we shouldn't be worried about this for you guys and why it's actually a good thing?
Well, I'll kind of start with my perspective on it then turn it over to Tom for even more color commentary. But there's a difference between the upstream and the mid and downstream segments as you know. And the mid and downstream, my view, are going to be driven more by overall economic activity. Demand for that is going to be driven more by overall economic activity than whatever oil prices are. As a result of that, I'm expecting to see increased demand for refined goods and products, which is going to cause greater demand on the mid and downstream side.
Offsetting that, at least in the short term, is probably going to be some of the investments in places like Russia and the Middle East, perhaps some in Brazil, but they'd already slowed significantly. That will be more than offset by what everybody has to crank up everywhere else around the world. So that's kind of the overview that I see for it. And as you probably know, I'm a for the first time in 5 years, I'm actually a little more bullish on where the global economy is going than economic forecasters are. The last 4 years have been more negative generally and so far that's been a good call.
But this time, I think it could be more positive than what they think because that impact the lower oil prices is causing this major redistribution from oil producing to oil using economies and those oil using economies are quite large. So overall, I think this is a good phenomenon is going to help drive more of that mid and downstream investment.
Tom? Yes. Again, what I would reiterate is the portion of our HPS and UOP business that's in the mid and downstream, number 1. Number 2, the backlogs really backed up by the strong second half, particularly in HPS, are really strong. You look at HPS, the backlog on a constant currency basis is up 12% year over year and the UOP backlog is also up sorry, the UOP backlog is relatively flat, 0% to 1%.
But when I look at UOP, continues to be always a lumpy business. 4th quarter was a difficult comparison, as I said. We had 17% growth in the Q4 of 2013, but the backlog is as strong as it's ever been. It's holding up. And our growth rate in 2015 we're forecasting for UOP is that mid single digit growth.
So we're confident with all the indicators.
And dual piece lumpy, but with a very positive trend line.
Yes. And Tom, you're not seeing any backlog price renegotiations? There's a lot of chatter about that in the market.
No, not at all. And we've probed and probed and probed this as you might imagine. And the only development I would say is deferrals on new orders where they're multi $1,000,000,000 investments where decisions are being thought through carefully in the regions that Dave mentioned. But by and large, that's about the only impact that we've seen so far.
Okay. I'll hand it off. Thanks.
Our next question comes from Scott Davis with Barclays.
Hi. Good morning, guys.
Hey, Scott.
I'm glad to see you guys are bullish. We haven't had a lot of positive conversations in the last couple of months. But maybe you can I think your view on oil is pretty clear, Dave, but give us a sense of your view on currency? And really the angle I'm looking for is with that such a violent move that how does it change the competitive landscape? Do you see guys who can come in from Japan or other high cost regions like in Europe that can now suddenly compete against you in areas where they couldn't compete against you before?
Is that real or not real?
Well, the Japan phenomenon has been a currency phenomenon, it's been a couple of years in the making. And I can't say that we ever saw much of an impact from any of that. I guess it remains to be seen on what happens with European competitors. But again, not seeing much of anything happening there. When it comes to the overall currency, the we've assumed the U.
S. Dollar would strengthen for a while now and we're a little surprised actually that didn't happen sooner than it has. So I would say it's one of those things we've been kind of counting on happening. And as you know, this is the first time in well, this is my going into my 14th year, this is the first time we've ever hedged the euro translation. And it was solely because it seemed like that was 70% bet at this point.
Who knows? Things have a way of changing in ways that you never predict. But I still think that the prospect of €110 this year is entirely possible.
The other thing I'd add, Dave, is the our cost base. We do benefit in some cases from the decline in currency. Scott, you're fully aware, we have significant production capacity in China and Mexico and other parts of Eastern Europe. So we do feel like our position from a supply chain perspective and cost base perspective does enable us to continue to compete with the likes of the competitors you referred to.
I guess a good point Tom just made Scott.
Okay. We have
great presence in Europe already. We have a big base there about 30,000 employees. So we have a base to compete from.
Okay. Fair enough. And then guys give us a I was encouraged by what you said about non res and our forecast is actually a little bit higher than your forecast. So I hope we're right and you're not right. But either way directionally is the right answer.
But can you walk around the world a bit on that? And what's really tough for us to get a feel for is we've got great data in the U. S. On non res or things at least we can track. And once we get outside of the U.
S. It starts to get a little bit more difficult. So can you walk us around the world and more in context of maybe your order book or backlog or how you see it playing out in different regions?
Sure. It will be pretty consistent with how we're seeing the economy. So the U. S. Would say, I hope you're right also, we're a little lower in our estimation, but we think that continues to rise upward and it's still kind of a reflection of the great recession.
And you heard us say at the time about V shape in, V shape out, slow in, slow out and non res construction is more of a slow in, slow out. So we think it's a nice steady gain and that just continues. You could argue there's some offset to that with oil and gas CapEx, but that has really minimal effect on our non res construction business. In Europe, it will consistent with the economy is going to be very slow. China, probably going to continue to be a mix and interesting phenomenon there because the Tier 1 cities that are still that are experiencing more of the economic slowdown, they still could use more housing.
And in some of the Tier 2, Tier 4 cities where GDP is going to be growing faster, may have been overbuilt a little bit. So that one is still to be figured out, but overall we think is still a net positive on non res construction. India, there could be an awakening in India. And I've never seen such excitement in the business community in the 20 plus years that I've been going there. So I'm actually pretty encouraged about what they could be doing.
And in fact, I'm going there tomorrow to be there for the President's visit as part of this U. S. India CEO Forum. And I really think there could be a takeoff there that we've all really been waiting for, for at least 10 or 12 years now. And that one could turn out to be quite a good positive.
Yes. The thing I would add to that, Dave, is Scott, to get your question on the non resi. I look at our exposure on the in the products businesses in ACS, principally in fire and in some of the commercial businesses in ECC. As I said in my comments, the growth rate has been very nice, mid single digits approaching double digits in some cases. So good trends there.
And then in Building Solutions, where we have the we provide both projects and services in that same space, the order rates and backlogs have been good. If you look at the backlog overall for the business, it's up about it's up mid single digits over last year. And it's across all the regions. It's actually double digits in Europe, but that comes off a lower comparison. But overall, each of the regions are in that range.
So we feel like it's headed in the right direction.
That's encouraging. I'll have a safe trip to India, Dave, and give the President my
Okay.
See you. Thank you. Our
next question comes from Jeff Sprague with Vertical Research.
Thank you. Good morning, gents.
Hey, Jeff.
Hey. Just a couple of things back to energy exposures and the like. On UOP in particular and kind of the capacity that you've put in place, do you guys have people contractually locked up there? Is there any kind of take or pay? Or if this thing does kind of unexpectedly take kind of a sharper turn for the worse you're kind of exposed there?
Yes. Exposure is not that great and it helps that we get upfront payments on the technology licensing. So yes, if there was a severe downturn, of course, we'd feel it, but I'm not that worried about it right now, Tom.
Right. I mean, we are seeing a few refinery recancillations in the U. S, just 2 this week alone. I was also just wondering on hedges, Tom, how those work? Is there was there a P and L expense in 2014 to prep yourself here for 2015?
Or is it is that running through on the balance sheet somehow? How do you think No.
Good question, Jeff. The all of the hedges qualify for mark to market accounting or I'm sorry, qualify for not mark not to put mark to market accounting. Sorry about that.
I was going to say wait a minute.
So they would the impact of the hedge instruments when they settle would be recognized at the same time the underlying items that are being hedged are recognized. So there's nothing unusual. It's just the extent of the currencies that we've gone out and hedged.
Okay. And I was just wondering if you could give a little more specific color on aero spares. I mean you spoke to kind of aftermarket generally and kind of all in with R and O. But what's going on in spares trends? Are you seeing more activity in older airplanes that might be fuel cost related or anything that kind of stands out?
I'd say on the it's a little bit of a dichotomy between ATR and BGA, but real strong growth on the ATR side and mid single digit growth on the spares. It's growing on BGA side as well, but not as significantly. But we do expect those that to improve and the ATR trends to continue for 2015.
Okay, great. Thank you, guys.
You're welcome.
And we'll take our next question from Steve Tusa with JPMorgan.
Hey, guys. Good morning.
Hey, Steve. Mediocre quarter, but it's good enough these days.
Good. So
just on UOP, just remind us how much of that business is new projects? And if you were to see an air pocket in new projects, what kind of backlog do you have today to kind of give you a little bit of leeway to take action? So for example, in the Q1, if you saw that number go down 30%, when does that hit you revenue wise? I mean is that even a 2016 issue? Or is that more of like a 17 issue?
Or is it a 2015 issue?
Well, I guess, I would consider the composition of the UOP backlog, Steve, to kind of answer that question. As I said, the backlog has held up very well.
I have a tough time seeing it. Even in the recession, I don't think it was that big big. Yes,
I think on the capital side, a lot of these where we come in on these capital projects is sort of the middle or at the end. And so that most of the capital is spent in the ground and we come in and install the systems and the technology. So the backlog is holding up. I would also say that if you look at the composition of the backlog, it's in the catalyst, it's in equipment and it's in gas. And in all three places, it's holding up and there's really not any material difference from what we've seen.
So like Dave said, I haven't heard or seen anything in terms of potential declines there. Right.
But I guess, I'm just trying to understand what kind of visibility and timing dynamics play into your ability to take action if you do see something like that?
We'd have time to react not just there but around the company.
Right. And your orders and backlog in UOP in the orders in the Q4 and then what is your backlog in the year at?
I don't know. What do we disclose? The backlog.
Was it something like $2,800,000,000 or something like that at the end of the 3rd quarter?
I know you guys gave a
number at your HPS Day in November, I believe. No?
Yes. Not off the top of my head, but we can get back to you on that one.
Okay. And I guess just one other question on capital allocation. Any kind of change in philosophy around buybacks versus deals here? Anything getting a little more attractive as the market kind of bumps around?
I wouldn't say philosophy has changed and that's why you saw us increase the dividend greater than the earnings rate this year, because that's consistent with our 5 year plan of raising the payout ratio over this 5 year period. So that's going to continue to be a priority for us. And I'd say on the M and A pipeline, I'm actually feeling better about that than I have in these past few months. I always felt good about it, but I'd say the work Roger is doing and its businesses are doing is improving that overall pipeline. It doesn't mean anything is going to be happen soon, But I can say I feel better about it.
I think there's some increasingly, let's say, good properties that would be a very good fit with Honeywell if we can make them happen.
Got you. Great. Thanks a lot.
You're welcome.
Our next question comes from Nigel Coe with Morgan Stanley.
Thanks. Good morning.
Hey, Nigel.
Hey, Dave. So you mentioned you're feeling more bullish on the consensus for the first time in 5 years and everyone else again fearful asset prices come in somewhat. It sounds like you might be about to deploy the balance sheet. Is that a fair comment? You mentioned the backlog is looking pretty fertile, but just conceptually is that correct?
Just to make sure I understood, are you saying am I ready to am I getting ready to do something?
Well, just given asset multiples have come down a little bit and you've got a more bullish view on the economy than most competitors.
Yes. Well, I would never of course say anything one way or the other there, Nigel. I'd say, I'm encouraged by the work the guys are doing on the pipeline and the stuff I'm seeing. And we've got the capability and we're just going to continue to be smart about it.
Okay. That's fair. And obviously, the commentary around Building Solutions is really encouraging. And it's obviously, we've seen a pickup in general construction activity. But I'm wondering the performance contracting, NG saving part of that portfolio, are you seeing similar trends there?
And there's a bit of a debate that low energy prices means that some of this work could get pushed out. Do you agree with that thought process?
I guess you'd have to say, yes, it's possible, but we're not seeing that because it's not like $50 oil is cheap, remember? It wasn't that long ago that we were concerned that it could be a recession if it hit $35 So 50 is not cheap. It's cheaper than it was, but it's not cheap.
Okay. Are you seeing similar trends in the performance contracting side,
Dave? Yes. Orders are good there.
Okay. And just a quick one on the hedge accounting, Tom. So the way that works is, you take the full impact on the top line and then the mitigation is through the COGS line?
Well, actually the items that we're hedging and we can get into a complicated accounting lesson here. But the items that we're hedging are actually cost items and we're doing it selectively throughout the portfolio. As you can appreciate, we have a global supply chain and a lot of currency movements across borders. But we do what we do is focus on hedging the expense items. And you let the that enables you to protect the overall P and L.
But what that leaves open is the top line. And so the top line is in a lot of cases exposed to currency movement.
Right. And then just quickly, I think you've mentioned you hedged down to 110, is that correct Tom?
No. I said our plan was based on 120 and we've hedged at a rate that I think protects that pretty well.
Okay. Great. Thanks a lot. We'll
take our next question from Joe Ritchie with Goldman Sachs.
Thank you. Good morning, everyone.
Hey, Joe.
Dave, I guess since the last time I saw you, I got to say congratulations to your pats, the flategate notwithstanding. But the
I'm not reading the post in the news just they're having a ball so to speak with this.
Yes. Indeed they are and they probably should. But moving on to maybe a question on capital allocation. I just want to ask Nigel's question slightly differently. Valuations have come down especially in oil and gas.
Has your priority in terms of where you're looking for the next targets, has that changed at all just given clearly there are more attractive valuations on the oil and gas side today?
Well, I would say, I'd back up on it, I guess, and say that great positions in good industries are still going to be kind of the fundamental for us. And secondly, pricing makes a difference. So there's a lot of stuff that we've liked in a lot of different segments, many of which we've outlined for you in the past. And we're going to continue to look at, does pricing make sense? Does it make sense today versus further into the future?
And we tend to try to be pretty careful about timing when it goes into even picking off a great position in a good industry.
Okay. That makes sense. And I guess given that given this month you just got back from your top three hundred meeting, I'd be curious to hear
how you feel about the progress that
you guys are making in terms of pivoting the company really to an organic growth story. The margin story is there, but really pivoting to organic growth and improving your cash flow conversion over the next few years?
Maybe the best way to say it is that coming out of that meeting, we had 300 unbelievably energized people even more so than I've seen in the past. And everybody is really pretty bullish, not just about what we've done, but about where things are going. And HOS Gold and what we're doing to develop and fund the breakthrough initiatives for the 76 enterprises is really energizing everybody around the world. It's just wonderful to see.
Okay. All right. So pretty confident in the outlook there. And I guess maybe one last follow-up question on TS. Tom, you mentioned that the growth has been really good.
Your exposure is predominantly to Europe and you've got auto builds that are expected to moderate in 2015. But you mentioned in your prepared comments that there's been increasing improvement in the light vehicle gas application. And so is your portfolio positioned well for that opportunity? And maybe just a little bit of color there.
Yes. Well, first of all, the and what I'm referring to is the increased penetration turbos on the gas combustion engines on light vehicle. That's just a trend that we're seeing in the U. S, China, India everywhere. And we're well positioned to take advantage of that.
We've got not just manufacturing capacity in each of those places, but also local product development capacity and engineering teams that work with the OEMs in those regions. So I feel like we're pretty well positioned and the growth rates support that.
Okay. Thanks guys. I'll get back in queue.
And we'll take our final question from Christopher Glynn with Oppenheimer and Company.
Thank you. Good morning. Hey, a lot of detail already. Just drilling into ACS a little bit, it was nice to see a 6% organic number against the 5 percent organic comp the year ago in particular. I'm just wondering, how you guys are kind of parsing attribution here in terms of markets versus execution against VPD and HUE and things like that?
Pretty well overall. I'd say some of the businesses are doing extremely well with it. So the scanning and mobility, for example, we'd have to highlight the gas detection business has done extremely well with it. And then I'd say everybody else is kind of in the middle of progress, but progress is good everywhere. It's really working well.
Okay, thanks. That was all.
You're welcome.
I would now like to turn the conference back over to Mr. Mark Macaluso for any additional or closing remarks.
Thanks, Lisa. With that, I'd like to hand the call back to Dave for final remarks.
Well, we're proud of what we've done, but even more importantly, we're excited about where we're going. Our business model really does work. And while I believe that lower oil prices will lead to a slightly better global economy than what's forecasted currently, we'll plan conservatively as always to ensure that we do deliver on our commitments to you. We believe we're well positioned to deliver on our 5 year commitment to you and we look forward to seeing many of you at our March Investor Day, where we'll share more about how and why we'll get there. And in the meantime, the next the following Sunday in a very American sport, I hope we can all be patriots.
Thank you.
Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful