Good day, ladies and gentlemen. Welcome to Honeywell's second 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. If you would like to ask a question at that time, please press star one on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. Lastly, if you should require operator assistance, please press star zero. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Elena Doom, Vice President of Investor Relations.
Good morning. Thank you, Leo. Welcome to Honeywell's second quarter 2014 earnings conference call. Here with me today are Chairman and CEO, Dave Cote, and Senior Vice President and CFO, Tom Szlosek. This call and webcast, including our non-GAAP reconciliations, are available on our website at honeywell.com/investor. Note that elements of today's presentation do 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 would ask that you interpret them in that light. We do identify the principal risks and uncertainties that affect our performance in our Form 10-K and other SEC filings. This morning, we will review our financial results for the second quarter, share with you our outlook for the second half and the rest of the year, and then leave time, of course, for your questions.
With that, I'll turn the call over to Dave Cote.
Thanks, Elena. As I'm sure you've seen by now, Honeywell had another terrific quarter and a very good first half of 2014. EPS of $1.38 increased 12% year-over-year when normalizing for tax. Another quarter of double-digit EPS growth, with earnings coming in above the high end of our guidance range. We saw strong execution across the portfolio, with margin expansion in each of our four businesses. We're continuing to benefit from our enablers and key process initiatives that are delivering growth and productivity benefits. We're achieving this while continuing to invest for the future, planting the seeds that'll drive outperformance and achievement of our new five-year plan. In the quarter, we were encouraged to see that our organic sales growth accelerated 3%.
We saw continued improvement in our short cycle order rates as the quarter progressed, with steady growth in ESS, a return to growth in Advanced Materials, especially in fluorine products, and a continued healthy pace of recovery in Transportation Systems. Our robust long cycle backlog, which stands at $15.7 billion, up 4% from the end of last year, continues to support a favorable outlook with record orders for UOP and a continued uptick in new process solutions orders. We've also seen a moderation of the sales declines in Defense and Space that we saw earlier in the year. Speaking of D&S, I'm encouraged to see that the headwinds are nearly behind us. We're expecting growth in D&S in the third quarter. In fact, we had 9% international growth in this last quarter. Early indications point to a modest increase next year.
We recently celebrated the centennial anniversary of innovation and leadership in the aerospace and the oil and gas industries, two examples of where we have great positions in good industries. Honeywell Aerospace has been a pioneer in aviation for the last 100 years, offering products and services that can be found on virtually every aircraft worldwide. We've led the way from the beginning with firsts, like the first autopilot, the first truly automatic flight management system, and the first transatlantic biofuel flight. We have differentiated through disruptive technologies across our electrical and mechanical portfolios, as well as our push into global connectivity, as you've seen with recent partnership announcements with Inmarsat and AT&T.
In oil and gas, where our UOP business created the first conversion technology for upgrading crude oil, jumpstarting the modern oil refining industry, we're a driving force for innovation for the global petroleum and natural gas industries. Today, our leadership continues with new process technologies designed to get more valuable products from every barrel of oil, convert coal and natural gas into plastics, and convert biofeed stocks such as algae into renewable fuels. We not only saw double-digit sales growth this quarter in UOP, but record orders and backlogs, so the future continues to be promising. Another innovation I'd like to point out is our new Lyric thermostat, designed for how people really live today.
Using the location of your smartphone, the geofencing feature automatically turns the thermostat into energy saving mode when a home is empty, senses when you're coming home, and heats or cools the house to your preferred temperature. It's just another example of how the Honeywell User Experience, or HUE, or Huey, depending upon how you want to pronounce it, enables us to move quickly to develop exciting new products that are easy to use, easy to maintain, easy to install, and exceed customer needs. ECC has seen continued good growth through the retail channel, and that's up 40% in the second quarter. We think the portfolio is well positioned, aligned to favorable macro trends, and there is significant runway to grow. We remain confident in our outlook for this year.
As a result of our first half performance, we are raising the low end of our guidance again by $0.05, giving us a new pro forma EPS guidance range of $5.45-$5.55, or up 10%-12% for the year. The closing of the sale of Friction Materials was a significant step in positioning our existing portfolio for continued outperformance. We also realigned the Transportation Systems business segment into Aerospace to better take advantage of the engineering and technology similarities and the shared operating practices between these two business units. Under the realigned segment reporting structure, the parts of Friction we're keeping will remain under Transportation Systems reported within Aerospace. We just concluded our strategic planning reviews with our businesses, in these all-day sessions, each of our businesses presents their five-year strategic plans.
While we're not expecting much help from the macro environment, I can tell you that each business has a strong roadmap to the 2018 targets we laid out for you back in March. The growth opportunities and new product pipeline are quite impressive. We approach the finish line of our previous five-year targets confident in the strong foundation in place for continued outperformance. We have great positions in good industries. We're investing both organically and inorganically to grow faster than the markets we serve, we'll stay the course on seed planting and continuous improvement initiatives. We're going to stay flexible and deliver on 2014 and beyond. With that, I'll turn it over to Tom.
Thanks, Dave, and good morning. On slide four, let me walk you through the financial results for the second quarter. Sales of $10.3 billion were up approximately 6% on a reported basis, that's 3% organically, came in just above the high end of our guidance range. As we highlighted previously, the low first quarter organic growth was a bit of an anomaly, with declines in Defense & Space and Scanning & Mobility driving roughly two points of top-line decline in the first quarter. As we signaled, these headwinds have dissipated. The contributions in 2Q from the businesses were broad-based, with each SBG sales growth at or above the guidance we had communicated. Regionally, organic sales were up 2% in the U.S., despite the drag from Defense & Space, 5% in Europe, Middle East, and Africa, 10% in China.
In China, we saw good growth in our short cycle businesses, namely ESS and Transportation Systems, in addition to continued long cycle growth, particularly in UOP and Process Solutions. Once again, our quality of earnings was strong, with most of the improvement coming from segment profit, which increased 10% in the quarter. Segment margins expanded 60 basis points to 16.7%. That's 70 basis points, excluding the dilutive impact of M&A, 20 basis points higher than the top end of our guidance. We had profit growth and margin expansion in all four businesses, so really a balanced contribution across the portfolio. It's also notable that the better-than-expected performance from Intermec reduced the segment margin dilution from M&A in the quarter. Overall, we continue to see significant benefits from our productivity initiatives and proactive restructuring actions while continuing to invest for growth. Items below segment profit were mostly as anticipated.
You'll recall that in the second quarter of 2013, we recognized an OPEB curtailment gain of $42 million, which was more than offset at the time by restructuring actions, so really no year-over-year net impact. In the second quarter of 2014, we funded $14 million of restructuring projects, bringing the total for the year to approximately $100 million. On a reported basis, the tax rate of 26.1% in the quarter represented a $0.06 headwind compared to the second quarter of 2013 and about a $0.01 tailwind relative to our guidance. EPS was $1.38, $0.02 above the high end of our guidance range. $0.01 was from operations, and $0.01 came from the better tax rate I mentioned. EPS increased 8% on a reported basis or 12% when you normalize for the income tax rate.
This was again driven by the 10% increase in segment profit, slightly more favorable below-the-line items, and a minor benefit from lower share count. Finally, on free cash flow, approximately $1.1 billion in the quarter, 5% higher than 2013, and 101% conversion, despite a 17% increase in CapEx and higher cash taxes. Year to date, free cash flow is up 28% through the first half. Moving to slide five, we're looking at Aerospace. This is prior to the realignment of Transportation Systems into Aerospace. We'll adopt that change in the third quarter. You'll also see us file an 8-K in the third quarter reflect this change on our historical reporting. When it comes to all the forward-looking guidance that I'll touch on later, we do reflect the new reporting structure.
Aerospace sales were flat in the quarter, which is in line with our guidance, with 1% commercial sales growth offset by a 1% decline in Defense & Space. Despite the challenging top line, segment margin was up 30 basis points, driven by commercial excellence and productivity net of inflation, partially offset by BGA OEM payments, a higher mix of OE content, and investments in growth programs. The flat commercial OE sales reflect strong growth in large air transport driven by OE build rates offset by lower regional jet sales, engine shipment timing, and higher BGA OEM payments. As a reminder, we have won significant content on a number of new OE platforms and have and will continue to incur upfront costs as a result.
These costs are fully contemplated in the five-year planning we have shared with you and our accounting for these costs is very conservative compared to the industry. The Aerospace business model is fully intact, and these wins, coupled with the exciting new technology offerings in Aero, give us full confidence that the growth will accelerate over the five years in our plan. Commercial aftermarket sales up 1% in the quarter with continued strong spares growth in both ATR and BGA. The strength was offset by lower R&O revenues, a reflection of fewer maintenance events and timing, particularly in business aviation. Aftermarket backlog levels in R&O, along with robust spares demand, underpin an acceleration of aftermarket growth in 3Q. Defense & Space sales were down 1%, a nice improvement from the 8% decline in the first quarter.
U.S. Defense aftermarket and government services declined, significantly moderated from first quarter levels, and growth in international markets, which Dave referenced earlier, helped to offset those declines. Defense & Space is tracking to a 3% decline for the full year. On slide six, we're looking at ACS results for the second quarter. ACS sales were up 10% on a reported basis and 3% on an organic basis, in line with our expectations. The difference in the two rates principally reflects the contributions of Intermec. Looking at the businesses, ESS sales, so the products businesses, were up 4% organic, with ECC and Scanning & Mobility showing particularly strong growth. ECC continues to benefit from strong residential end markets and new product introductions, particularly in the retail channel. Dave talked about Lyric, and overall, the thermostat category is performing very well for us.
As for Scanning & Mobility, following the ramp-down of certain large programs in Q1, it returned to strong organic growth in the second quarter. New wins, which ramp over the course of the year, are driving sustained growth. Intermec also continues to perform very well, supplementing the growth we're seeing out of the core HSM business. Our fire safety and gas businesses have shown continued strength as well. On a regional basis, penetration of high-growth regions remains a big driver of growth in ESS, as we saw strong double-digit growth in both China and the Middle East. Moving to Building Solutions and distribution, sales were up 2% with strength in the Americas distribution business offsetting pockets of weakness in Building Solutions, specifically the U.S. energy retrofit business. We are encouraged, however, as Building Solutions project and services backlog continues to grow.
I'd like to take a minute to comment on what we're seeing in the commercial building sector. We've seen modest improvement from the first quarter to the second quarter in the ESS products businesses that serve this sector, primarily ECC and fire safety. We are anticipating further improvement in the second half. In the Americas energy business, as I said, orders have been delayed due to financing and municipal contract holds up. While the projects can be lumpy, we are seeing bid activity heating up, especially in the Middle East and China, and energy-efficient projects globally. This, along with the easing of year-over-year comps, gives us confidence that our commercial building-related sales will modestly accelerate in the second half. Moving to ACS margins, expansion of 50 basis points to 14.8% in the quarter, up 80 basis points, excluding M&A.
ACS continues to benefit from productivity net of inflation, commercial excellence, as well as higher volume, while also continuing to invest for future growth. Moving to slide seven, Performance Materials & Technologies. PMT sales were $2.6 billion, up 6% organic, and were above the high end of our guidance, driven primarily by stronger than expected results in UOP. UOP sales increased 17% in the quarter, driven by increased catalysts and gas processing sales, reflecting continued strong refining petrochemical and gas markets. UOP had a record quarter for both orders and backlog, which currently stands at $2.6 billion. We saw a continuation of orders trends in gas processing, particularly at Thomas Russell, so continued benefit in UOP from oil and gas investments occurring globally.
In Process Solutions, sales were flat on an organic basis, primarily driven by a couple of large projects completed in the prior period, offsetting growth across the remainder of the portfolio in high-margin areas like services and advanced software solutions. Process Solutions orders growth accelerated in the quarter, up approximately 7% organic, and as we will preview, modest sales acceleration is expected in the second half of the year. Advanced Materials sales increased 5% in the quarter. We saw volume increases across the businesses with particular strength in fluorine products, driven by new global warming molecule offerings. These volume increases were partially offset by unfavorable pricing, particularly in resins and chemicals, as we've been signaling. We expect these pricing headwinds to moderate in the second half of the year.
Segment margins for PMT were up 30 basis points to 18%, consistent with our expectation, driven by productivity net of inflation and higher volumes, partially offset by price, raw headwinds in resins and chemicals, unfavorable UOP catalyst shipment mix, and continued investments for growth. On slide eight, you can see Transportation Systems, which again, to remind you, includes Friction Materials for the second quarter. TS had another strong quarter with sales up 8%, that's 4% without foreign exchange, and segment margin expansion of 310 basis points. The sales increase was primarily driven by turbo volume growth across our three largest regions, Europe, North America, and China. In each of these regions, our volume growth outpaced auto production. The growth we're seeing in Europe was strong in both the light and commercial vehicle segments.
We've benefited from an uptick in European commercial vehicle demand, primarily driven by the Euro 6 regulation shift in the region. Outside of Europe, both North America and China saw strong volume increases in light vehicles, both diesel and gas, which more than offset lower commercial vehicle volume sales in those regions. In North America, specifically, commercial off-highway sales remained soft, consistent with trends in mining and agriculture segments. Overall, we continue to benefit from improving global industrial macros on vehicle production, regulation, turbo penetration, and our strong win rates. As we begin to lap the strong second half performance from 2013, however, we do expect some moderation in these growth rates beginning in 4Q 2014. The segment margin improvement to 16.4% reflects the strong productivity and volume leverage in turbo, and the benefits from restructuring and other operational improvements.
With the closing of the Friction Materials divestiture behind us, let's now turn to slide nine and walk through our guidance for the third quarter under our new reporting structure. We're expecting sales of $9.9 billion-$10.1 billion, which will be up 3%-5% reported, or 3%-4% on an organic basis. Segment margins are expected to be up approximately 50 basis points, and earnings per share is expected to be in the range of $1.37-$1.42, up 10%-15% from the prior year. For Aerospace, as I indicated earlier, we are providing guidance under the new reporting structure, with Transportation Systems included. Sales growth on a reported basis is expected to be flat to down 2% in the quarter, reflecting the year-over-year absence of Friction Materials sales in the quarter.
On an organic basis, or in other words, without the Friction Materials business, sales are expected to be up approximately 2%-3%, with growth across the portfolio, commercial, Defense & Space, and Transportation Systems. In commercial, OE sales are expected to be approximately flat year-over-year, with continued growth in ATR offsetting declines in BGA, similar to the second quarter. However, we are expecting acceleration in aftermarket growth in the quarter, up low single-digit, driven by continued spare strength, and higher airline maintenance events. We're also expecting to see a return to growth in Defense & Space, as Dave indicated, up low to mid-single-digit, where international programs continue to drive growth. In Transportation Systems, we're expecting mid-single-digit organic sales growth in the quarter. As for margins, we expect an increase of approximately 150 basis points, with significant contributions from both the aerospace and TS businesses.
For ACS, sales are expected to be up between 8% and 10%, or 3%-4% on an organic basis. As a reminder, we closed Intermec in the third quarter of 2013, so this will be the last quarter of M&A impact from that transaction. Organically, we expect continued mid-single-digit growth in ESS and improvement in BSD. Our short cycle orders have been trending up at ESS and the backlog is growing in Building Solutions. Both trends bode well for our third quarter outlook. ACS margins are expected to be up approximately 20 basis points or approximately 40 basis points, excluding the dilutive impact from M&A. ACS continues to ramp their investment for growth in new products, as well as adding feet on the street as we continue to further penetrate high-growth regions. In PMT, sales are expected to increase between 4% and 6% in the third quarter.
In UOP, we foresee another quarter of increased catalyst growth. However, similar to the first half, product mix in Q3 will result in a headwind to UOP margins. As a reminder, UOP sales can be lumpy quarter-to-quarter based on the timing of product, as such, we are forecasting a sales decline of approximately 10% in the fourth quarter for UOP against a much more challenging comp. However, our outlook for the year remains intact for mid-single-digit growth in UOP, with the record orders and backlog we experienced in Q2, we expect strong growth to continue over our five-year plan. In HPS, after several quarters in a row of strong orders growth, we're expecting to see sales accelerate in the back half of the year, carrying into 2015 with continued strong margin expansion.
The increased orders growth will really start to show in the fourth quarter, as we're expecting high single-digit sales growth in HPS. In Advanced Materials, we anticipate another quarter of broad sales growth across the portfolio, including improved production levels in resins and chemicals, and increased sales of low global warming products and fluorine products. Overall, PMT segment margins are expected to be up slightly versus the prior year, reflecting similar trends that we explained for Q2, with the exception that pricing pressures in Advanced Materials are expected to moderate. Let me move to slide 10, where I'd like to take a moment to refresh our 2014 segment outlook. This guidance reflects the realignment of Transportation Systems and aerospace, as well the transition of Process Solutions into PMT that occurred in 2Q. Let me explain the setup here. The left half represents the guidance we provided in April.
With Process Solutions already in PMT, but prior to the sale of Friction Materials and prior to the movement of TS. The right side reflects our current outlook, including the Friction Materials divestiture, and the realignment of Transportation Systems into Aerospace. At the bottom of the page, you can see our new sales guidance, which reflects the absence of approximately $300 million Friction Materials sales in the second half, and our increased segment margin guidance for the year, driven by our strong first half performance and the margin accretion we will experience from the absence of Friction Materials sales in the second half. There are some comparable dynamics to be aware of as you think about the full year.
First, in Aerospace, with the inclusion of Transportation Systems, we're expecting 4Q sales to be down low single digit on a reported basis, but up about 1%-2% on an organic basis, driven primarily by the timing of OE shipments in our air transport business. However, you can see the significant margin expanse we're expecting this year, with contributions from both Aerospace and Transportation Systems businesses. Also, as I referenced, we expect a decline in 4Q sales in UOP, all timing and comp related. I want to reiterate that we anticipate another year of good growth in 2015 from UOP, given the significant multi-year backlog we're building there. There are some minor puts and takes, but no real changes to ACS or PMT from their prior outlooks, with continued margin expansion in both businesses.
Turning to the next slide 11, you can see the basis for our 3Q, 4Q, and raised full year guidance. Full year sales are now expected to be $40.2 billion-$40.4 billion, reflecting first half performance and a modest organic sales acceleration in the second half. Estimated full year sales are lower at the midpoint from our previous guidance, reflecting the absence of approximately $300 million of Friction Materials sales in the second half. On an organic basis, we continue to expect about 3% growth for the full year. Although acceleration is expected in the second half, most notably in Defense & Space, Process Solutions, and Advanced Materials, we will see tougher comps in the fourth quarter, specifically in UOP and Aerospace, as I mentioned.
As you'll recall, we saw a strong acceleration in organic growth at the end of 2013, with growth of 5% in the fourth quarter of last year. On segment margin, we've increased our full year guidance and now expect 16.8%-17%, up about 60 basis points at the midpoint versus last year. On EPS, we're raising the bottom end of our pro forma guidance by $0.05, making the new range $5.45-$5.55, or an increase of 10%-12% versus the prior year. We are planning for a 26.5% tax rate in 3Q, with 4Q just slightly higher to get to our full year planning assumption of 26.5%. Overall, we feel like we're executing well and delivering on the high end of our 2014 commitment.
I'm now on slide 12. Before wrapping up, I want to give you an update on our new five-year plan out to 2018. On a total Honeywell basis, the targets are identical to those we shared at the March investor day. However, the individual components now reflect our new business segment reporting structure. Even with the Friction Materials divestiture, the overall Honeywell targets are identical to those originally communicated. We're continuing to target a 4%-6% organic sales CAGR and segment margin in the range of 18.5%-20% by 2018, which is 220 to 370 basis points improvement from 2013. Strong earnings growth, which you've come to expect from Honeywell. On the left side of the page, you can see the previous outlook by business based on our old reporting structure.
Moving to the right side of the page, our current targets now reflect the combined Honeywell Aerospace and Transportation Systems businesses, less Friction Materials, as well as HPS transition to PMT. Some minor puts and takes, but overall, very consistent with what you heard in March, significant contributions across the portfolio. As Dave continues to emphasize, the growth and margin story doesn't end in 2018. Each of our businesses still has significant runway based on the continued evolution of our internal processes, global growth and execution, and the value we add for the customer through innovation and the Honeywell User Experience. Even more to come. Let me finish on slide 13. The second quarter results put us another step closer to delivering on the high expectations for 2014 we laid out in December.
The pace of accelerations in organic growth over the course of the quarter gives us confidence in our second half outlook, where we expect a modest uptick in organic growth and continuation of strong productivity. We're going to keep investing for our future, focused on our new five-year plan. Innovation and new product introductions, which are the lifeblood of our growth, remain a key priority, as well as the investments we're making to further penetrate high growth regions. We feel confident that our balanced portfolio mix, alignment to favorable macro trends, and focused cost discipline will enable us to continue to outperform. We're focused on executing sustainable restructuring actions, productivity actions, including delivering on the strong restructuring project pipeline we've already funded. With that, Elena, let's go to Q&A.
Thanks, Tom. Leo, we'll now take our first question.
The floor is now open for questions. At this time, if you have a question or comment, please press star one on your touch tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that you pose your question, please pick up your handset. Thank you. Our first question is coming from Scott Davis of Barclays.
Hi. Good morning, guys.
Hi.
You didn't really talk much about M&A in the release, or I'd say not at all. Roger Fradin now has had a couple of months in the role. Can you give us a sense of how he's progressing as far as pipeline and changing the M&A process and your confidence in being able to do deals in the next 12 months?
Yes, Scott, I'm happy to answer that. As you know, historically, our approach to M&A has been really a bottoms-up process from the businesses. Each business has resources and has an action plan to maintain a robust portfolio of M&A targets, and that's what you've seen generate the deals that we've done over the years. As you alluded to, when we did the appointment of Roger into the vice chairman's role, one of the things Dave asked him to do was to focus with our M&A team on the pipeline and that portfolio. We've kind of gotten a tops-down focus from Roger in addition to the process that we've had in place. In our history. What you've got is you've got two ways of looking at it.
When you look across the portfolio, we are seeing quite a bit of interest as a result of this process. As you know, we're quite active in looking at potential deals in aerospace, ACS, and in PMT. I think that activity will continue.
For what it's worth, Scott, Tom has also said he enjoys having Roger report to him on this.
Well, good luck. We'll be watching closely on that. Guys, can you give us a better sense, I've struggled to understand this business for a lot of years, and I'm talking about UOP, and kind of the quarter by quarter variability. It's a fantastic business, but I have no idea how you forecast it or how you really have any confidence one quarter to the next in that regard. How does a business like that have such a strong quarter without there being an inventory build or something going on at the customer level that may come back and bite you in the tail in a quarter or two? I just don't understand it, I guess.
Well, I'll answer first, then turn it over to Tom. I'd say, on an annual basis, it's pretty forecastable. They don't have a lot of inventory to have to fool with in the first place. A lot of this is a technology sale. There is some inventory, but not a huge amount. It's between quarters that can be more variable, but even that variability is generally forecastable. It's just that you can end up with lumpiness when it comes to one quarter versus another, but we generally have a pretty good handle on what's going to be going out the door.
Yeah, I think Dave hit it on the head, Scott. It is quite lumpy, but because of the long cycle nature of it, and we referenced the backlog earlier. We're at a record backlog, $2.6 billion, up double-digit from last year. We have good insight into what's going to happen quarter-over-quarter. That backlog dissipates, and we'll end up in our P&L over a fairly short timeframe, a year and a half to two years. We do feel like we have a good track on forecasting that.
Okay. Last, just quickly, in TS, we used to think about turbo as being one of those businesses that was kind of 600 basis points over auto SAAR, maybe a little bit better in some quarters, maybe a little bit worse. Has that changed at all? Is there a different thought process in how that grows versus auto SAAR globally?
Well, we do end up with a regional mix difference that can impact us, because we've got a strong position in Euro diesel. That was one of the things that really helped us, just that industry bottoming out this year so that all the wins finally started to show up as opposed to mitigating the declines we were seeing in Euro autos. Overall, yeah, it's going to continue to grow well for a long time.
Yeah. I guess what I'd say is that I'd reemphasize the growth profile that we've got going. It's in all of our big regions. In North America, both on the diesel and gas side, a strong double-digit growth. China, strong double-digit growth on both diesel and gas as well, and Europe's doing pretty well as well. The commercial vehicle side in Europe in particular is a very strong growth. Those regulations and the other things.
That 600 basis point above SAAR, has that changed? Or are you punting on the answer?
Well, Scott, I would say that European light vehicle production in the quarter was flat. For turbo, we had organic growth of 5%, so 500 basis points within that range.
Okay, good. That's what I really wanted to know. Thanks, guys. Good quarter. Thanks. Good luck.
Thanks, Scott.
Our next question comes from Steven Winoker of Sanford C. Bernstein.
Hey, thanks, good morning, everybody.
Hey, Steve.
Hey, Dave, just an initial question on that turbo move in transport to aero. How much is cost a part of that, or should I say, how much cost reduction are you expecting from delayering? Is there any in there in addition to the technology justification?
No, not really. In fact, our turbo business is pretty lean already, and I'm hoping, when we reference operating practices in the release, I'm hoping for more leanness to transfer into the aero business, looking at turbo as a model.
Okay. The rationale here is sort of subscale and existing a separate reporting segment now. Obviously, the technologies always overlap, but you could've gotten that otherwise and maybe some practice opportunities here. Is that how I should think about it?
Well, I might modify that a bit. I agree on size. Subscale, I don't know that I'd call it that, because within that industry, their scale is quite good. On the technology side, it's one thing to tell two businesses to, "Hey, would you guys cooperate?" I could say over 12 years, there's been an evolution there. It used to be the aero business wanted to charge the turbo business $200,000 per person for cooperation. Yeah. You might remember those days. Things have changed.
I didn't, yeah
a lot, and we've progressed to the point where we co-locate engineers, as I've mentioned in the past. That being said, you still get a different dynamic when you put the businesses together. We're putting them together in a way that allows us to get much further advantage out of that technology benefit that we have with Aero technology, because as you know, turbos are just a derivation of a jet engine, and we're the only guys who have that, so we want to take further advantage of it. I'm also hoping for a lot more of those lean practices to transition into Aero, because the aerospace industry is, let's say, rife with opportunity when it comes to running more leanly than it does today.
While I'm pretty proud of what we've been able to do and where we've been able to get to, at the end of the day, I think there's still one hell of a lot more opportunity there for us, and this is a good way to have best practices in-house that they can be looking at.
Okay. Speaking of moving organizationally to drive better financial results, HPS within PMT now, just maybe talk about the projects that are complete. It's down 1%, flat organic. Again, this sort of North American build-out that's just at the very, very early stages, what are you seeing there? Any hope that we should anticipate a ramp up soon?
Yeah. Steve, like we said, first of all, there's a lot of excitement around the combination of those two businesses. We do think that market-wise, it's going to enable us to better serve the common customer base that's there. I think you're referring specifically to HPS. The second quarter orders were very strong, up 7% on an organic basis. That's another quarter of pretty good growth for them on the order side. As I said, that has been factored into our full-year guidance. UOP as well. As I said, both orders and backlog are strong. Talked about the lumpiness, the same trajectory for both of those businesses is really good. Unlike the TS, as Dave said, I do hope to get a little bit of productivity out of that combination as well.
Okay. Just lastly, you mentioned you just wrapped up the STRAT process. Again, just remind me, what macro assumptions did you give the business, the SBUs to use for the five-year plan in terms of top-line base growth?
I think we used the Global Insight GDP forecast.
Okay
3%. Yeah, about 3%-3.5% is kind of the assumption globally.
Nominal.
Not different than what we've said back in March, just because, I don't think that much has changed since that time.
I think the FX, we assume the euro at above EUR 1.30.
Okay, great. Thank you. I'll hand it off.
See you, Steve.
Thanks.
Our next question comes from Steve Tusa of J.P. Morgan.
Hi. Good morning.
Hey, Steve.
Hey, how bad is UOP going to be in the fourth quarter?
What an interesting way to put it. I don't know that I would say it's bad. I would say, it's all contemplated within our fourth quarter guidance, because Steve turned up pretty well for the year.
Yeah.
I don't know, Tom, if there's anything else you want to share there.
Full year UOP will be 5%, as I said, down 8% in the fourth quarter. First quarter was 9%, this past quarter was 17%. We'll see mid-single digits in third quarter and probably 8 to 10 down in the fourth quarter. Full year, right on track, and again, with that order and backlog should be very strong for UOP.
I don't think there's an issue with the trend of the business. I'm just trying to kind of reconcile the 3% organic growth you did this quarter, and the only thing that really seems to be getting worse or just on a lumpiness or a quarterly basis, whatever, just from the math, would be UOP. Everything actually seems to be looking better, like accelerating, and so I'm just like the 3% organic, even with UOP, unless it's dramatic, which 8% is a pretty big number. I'm just trying to reconcile that 3% you did this quarter versus why, with things getting better, why that should be 3% in the fourth quarter.
Yeah.
Go ahead.
I'm just going to add that I think we also mentioned that we do have other tougher comps, in particular in Air Transport OE and also in Transportation Systems relative to both those were up 15% in the fourth quarter of 2013.
Right. You didn't really grow in commercial aero this quarter. Are you going to be down in commercial aero in the fourth quarter?
Our ATR OE growth this quarter was loaded.
Oh, okay. The biz jet stuff kind of offset that.
Right.
Okay.
Your thesis, though, Steve, the way you're talking about it seems reasonable.
Right. Okay. Then just, I guess I'm just going to ask this every quarter, this quarter was particularly interesting because DuPont pre-announced negatively, I got a flood of emails about R-22 pricing. I don't really get the questions around chemicals pricing for a lot of the other companies that I follow. With the resegmentation you just did, you kind of went to a little less disclosure, which I don't particularly view as a good thing. Is this the final kind of iteration of, outside of acquisitions, of what the portfolio looks like? Could we maybe break out the more processed kind of oil and gas related businesses and maybe again, kind of at some point evaluate this chemical business as a part of the Honeywell portfolio?
I would say in terms of organization, I kind of like it just the way it is now.
Okay, no change?
No.
Okay. Thanks.
If there was, you couldn't expect me to say anything anyway, Steve.
That's my job, to ask the questions. Thanks.
All right.
Our next question comes from Jeff Sprague of Vertical Research.
Thank you. Good morning, folks.
Hey, Jeff.
Hey, how's it going, Dave? Could we get a little more color on commercial building for U.S. specifically? The color Tom gave, I think was global and helpful, but a little lay of the land on U.S. specifically, if you have it.
Yeah. I would say, Jeff, the growth in the products businesses that are serving commercial buildings are reasonable. Mid-single digits in the second quarter. I expect that to continue for the remainder of the year, if not accelerate a little bit more modestly. In terms of the pure building solution business, the business in the U.S. was tempered a bit by the energy business. We had a couple of really large projects completed in 2013 that tempered the sale. In terms of the orders growth there, it's flat globally, but on the America side, it's been picking up through mid to high single digit, is what I'd say.
Mid to high single digit U.S. energy retrofit, but global flat on orders.
Yes.
Okay. Thank you. I was just wondering, Dave, if you could address Europe a little bit more specifically. I think the +5 was an EMEIA comment. How is core Europe actually doing, and was there any slowdown in Europe in the quarter or in June that you noticed?
Overall, it's kind of interesting, is our Europe orders have actually done okay, as you've been hearing us say for the last 2 or 3 quarters. I'm a little surprised, actually, given that the overall economy doesn't perform all that well, and we don't have a lot of expectations for the economy to perform all that well over the, say, next 2 or 3 years. That being said, our orders are okay there.
And just 1 final one from me, and I'll move on. Perhaps too granular for this call, but are you seeing any signs of toppiness pressure in the commercial helicopter market?
I can't say no. I don't think so. We actually think that's going to be a pretty good market for a while.
Yeah, just some cautionary comments out of Eurocopter this week and Farnborough and some toppiness at Bell also. Maybe it's just noise in the quarter.
Yeah.
Great.
I can't speak to that. I'm not sure of what their expectation was either. I'd say overall, we still think that's a growth market.
Great. Thank you, guys. Take care.
You're welcome.
Our next question comes from Howard Rubel of Jefferies.
Good morning.
Hey, Howard.
How are you?
Good.
Numbers are nice.
Thank you.
Couple things. You never stop pushing excellence, while Friction Materials is the last obvious divestiture, how do you think about keeping the guys at the back of the line equal with the people outperforming at the front?
Well, that's something we pay a lot of attention to all the time and in several different ways. One of the ways we'll be doing that more in the future is through this HOS Gold effort that you've heard us talk about. Especially as we go through the strategic planning or what we call strap exercise, we spend a lot of time looking at that. I can't say that we look at it and threaten sale if they don't come up to par. At the end of the day, I'd say I'm really encouraged by the upside I see across the portfolio in the implementation of HOS Gold and the ability to raise sales growth and margin rates everywhere.
Staying with that theme, you're spending a lot of money on new products, and you highlighted a couple of them in ACS. Can you sort of talk about are you getting the productivity you want? How do you think about maybe how much of this is contributing to organic growth as opposed to just the normal economy?
You're talking about new products or productivity, Howard?
Well, I guess I mixed them both. One is the productivity associated with new product development, second is how is that contributing to the organic growth, Tom?
Well, first off, if you look at in pure financial metrics, we're not decelerating at all on investments in new products. For example, if you look at R&D investments, that's not per se generating productivity. When you look at productivity across direct materials and our people costs, I would say that has been as strong as it's been in the last couple of years, is the way I look at it.
Last, Intermec looks like you're getting the top line you expected. How would you evaluate where you are in terms of the integration process, and when do we really see its profitability normalize with the rest of the business units?
I'd say, Howard, the way we look at that one is, one year ago, everybody, when we closed the deal, it was a business that was not very profitable, if profitable at all. You fast-forward to now, if you look at what we've done, just to look at the multiple that was paid compared to today, you would say we're at 17, 18 times multiple. You factor in the synergies it's gotten and that are in place, we're down to sub 5 type multiple. It kind of gives you an idea that we feel like we've been successful. When you look at the plan itself and you look at both revenues and the income and the cash, all of those metrics were performing a lot better than the plans.
John and his team in Scanning & Mobility as well as the Intermec have really done a nice job of integrating those two businesses.
Thank you very much.
You're welcome.
Our next question comes from John Inch of Deutsche Bank.
Thank you. Good morning, everyone.
Hey, John.
Morning. How did your businesses, I realize it's not a huge exposure, but how did your businesses fare in Latin America? The corollary might be, does market weakness in Latin America, Dave Cote, maybe provide you an opportunity perhaps with respect to capital deployment or step up some investment spending there or something like that?
We continue to do very well in everything south of the Rio Grande. When you look at the big ones, Mexico and Brazil, we continue to do well there. Mexico, we've got about 14,000 employees. In Brazil, we've got about 1,000. Our sales have been quite good there. In terms of investing, I still think that there are places where you think about it before you do it. It's not a no-brainer. Overall, those have been very good markets for us.
Were your Brazilian businesses up in the quarter?
Yes.
Yes, I'd say, I'm getting vision.
Defense and Space. Were there any pockets of Defense and Space or expectations of Defense and Space pockets within the framework of that business that you expect to actually get better over the course of the year? I'm curious, kind of how, if anything, has changed with respect to how you're seeing this business, how you're going to manage it. I'm assuming it kind of gets managed down over time, but maybe not.
Yeah. John, the way I think of the Defense and Space business is it has two pieces, a products business where we're dealing with the U.S. government and/or the prime contractors. Then there's a service business that's largely unrelated to the aerospace industry. That's where we've seen the most pressure. Thankfully, it's a lower margin business. That's where the top lines for Defense and Space are the most pronounced for us. We're now approaching periods where we're going to start lapping comps. That pressure will subside. The other thing that we've got going on there is the international side. If you read the paper this morning, unfortunately, those things happen, but that tends to bode well for military budgets outside of the U.S. We're seeing an uptick, as Dave referenced, in sales on the international side of Defense and Space.
You got some balancing dynamics going there, and I think they'll net to the positive as we head into the second half of the year.
I think the other thing to recognize, John, is, as we've said before, Defense is really more of a sales channel for us. It's not like we have-- While the jet engine might be unique to a certain defense application, at the end of the day, it's still coming out of a jet engine factory that also produces things for commercial engines.
Right. All incremental. Maybe one more. If global markets, Dave Cote, kind of do not begin to show more signs of life, I realize you're outperforming today, but let's call it over the course of the coming year, does that cause you to perhaps modify or even accelerate aspects of your operating framework to hit or hopefully exceed your five-year targets?
Well, as you know, I've been one of the guys who's generally been more negative on the global outlook for the last four years, so far, that's been a pretty good call. I'd say the way we've forecasted this year and the way we've looked at our five-year plan is pretty consistent with that. I've never counted on much, so far, that's been a good call. I feel pretty good about where we are and what we're saying.
Thank you very much.
You're welcome.
Our next question comes from Christopher Glynn of Oppenheimer.
Thanks. Good morning.
Chris.
Hi there.
Your brother-in-law, Tom, says hi.
Thanks for passing that along. I got a text from him last night.
I guess this is going to be an easy question.
We'll see. I want to follow up on the M&A, and part of Roger's job now, I think, is the opportunity to look at sourcing larger deals, and we see the Intermec integration was pretty rapid fire with the benefits. I'm wondering, are you just starting to develop the pipeline for larger deals, or is that something that's already kind of established?
I don't think there's been a concerted effort to find larger deals with Roger joining that area. I do think that He has the tendency and the license and the idea of looking across Honeywell and trying to identify opportunities that might touch on more than one business, or that might be in an adjacent business, adjacent to the three business segments that we have. That might lead you to think that there's larger deals in the making. I would say that's not the primary objective. I'd say the primary objective is to augment those existing portfolios and find good growth ideas that are in industries of like.
I'd add, Chris, that while we did an okay job on origination, as Roger's starting to get into this around the company, looking at it within the businesses, across the businesses, and adjacencies that might make sense, he's really invigorating the overall kind of origination process. I think it's going to give us a lot more ideas to work with than what we've had in the past. You've heard us talk about many times, that we have and want even more of a robust pipeline. The more ideas you have, the more stuff you can go after and the more opportunities it gives you, and it also allows you to be more selective.
You can end up being, I'd say, in a much better position to negotiate if you have nine other good deals that you can do, so that you don't do something silly when it comes to pricing.
Right. Well, we haven't seen that be a problem. I think our bias then would be more to higher frequency of deals in your accelerated capital allocation rather than seeing something larger.
Well, I guess it depends how you define larger, but I would say, you've heard me say many times, we never say never on any of this, it's going to depend upon the construct of the deal. Whatever we do, I can promise you, will be consistent with the financial and operating discipline model that we've talked about in the past, and will have strong cost synergies that come out of it, consistent with Tom's point on Intermec, that certainly is one of the things that I think has helped define our track record.
Great. Thanks, guys.
Leo, we have time for just one more question.
Very good. We'll take a question from Andrew Obin of Bank of America.
Yes, good morning. Just a little bit more color on UOP and HPS. Could you just comment more on petchem demand by region? We're hearing mixed commentary this earnings season.
UOP by region?
Yeah, HPS. Just it seems that some pieces of oil and gas and petchem industry are moving in different directions by industry. Just trying to get what you guys are seeing.
It's pretty broad-based. If you look across all of the regions. Oil and gas has been particularly strong, both in the West, the Middle East, China in particular. Anything, Tom, that you could add there?
Yeah, I'd say the Middle East has been outstanding for both UOP and for HPS, China as well. I think those are really good.
No. Canada, I suppose.
Just a question on Aerospace. You sort of noted that RMU's growth is moderating, and I think you guys were positive. Can you just talk about what's happening there and any sort of broader trends that are taking place?
I think on RMUs, the sales levels are very strong. It's just that we had such an uptick in the early and middle part of 2013, and really even into 2014, that we're starting to lap periods that are really strong. We're sustaining the level of new product development there, and the offerings that are going onto those platforms, particularly on BPA side, and particularly related to software.
Thanks a lot.
Well, thank you for your participation today. I do want to turn the call over to Dave Cote for any final comments.
Well, we're quite pleased with our second quarter results and our outlook for the year, and I think it's a good reflection of our expectations for ourselves over the next five years. We have a great portfolio to grow with. Our process initiatives continue to progress, and our culture provides sustainability as we evolve and continue seed planting. We're building on a great base, and with the addition of our drive for HOS Gold, software, including CMMI Level 5, and HUE, we see a lot of good things to come for Honeywell. Thanks.
Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day.