Good day, ladies and gentlemen, and welcome to Honeywell's First Quarter 2016 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 call is being recorded. I would now like to introduce your host for today's conference, Mark Macaluso, Vice President of Investor Relations.
Thanks, Cynthia. Good morning, and welcome to Honeywell's Q1 2016 earnings conference call. With me here today are Chairman and CEO, Dave Cote and Senior Vice President and Chief Financial Officer, Tom Sloczek. This call and webcast, including any non GAAP reconciliations, are available on our website 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 will review our financial results for the Q1 and share with you our guidance for the Q2 and full year of 2016. And 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.
Good morning, everyone. As I'm sure you've seen by now, Honeywell delivered another strong quarter to kick off 20 16. EPS of $1.53 increased 9% coming in at the high end of our guidance range. Sales of $9,500,000,000 were up 1% on a core organic basis above the high end of our sales guidance. We outperformed and saw growth accelerate in Aerospace Commercial Aftermarket and Transportation Systems, in our Residential and Commercial and China Excluding the dilutive impact of M and A, segment margin expanded 20 basis points in the quarter to 18.9%.
We generated significant sustainable productivity in the quarter. The Honeywell user experience is driving new products at higher margins. Our factories and sourcing organizations continue to mature and we continue to reengineer our products to make them easier and less expensive to manufacture. HOS Gold and our key process initiatives that generated that productivity allowed us to overcome previously discussed significant headwinds in segment profit. These included over $40,000,000 of additional aerospace OEM incentives, additional depreciation stemming from our ramp up in high ROI CapEx, the strengthening of the U.
S. Dollar and difficult comparisons at UOP and Sensing and Productivity Solutions, which Tom will take you through further. Our segment margin rate was slightly lower than our guidance primarily due to a combination of higher than expected sales of lower margin products like in BSD and commercial aviation OE and lower sales of higher margin products like in ESS and UOP Catalysts. We still expect to be within our segment margin guidance range for the full year as sales growth modestly improves in the second half of the year, basically just from the absence of declines in UOP that we encounter in the first half. We will of course continue with our disciplined cost controls focused on commercial excellence and execution of previously funded restructuring actions.
Our strong start and the momentum we see in parts of the portfolio allow us to raise the low end of our 20 16 full year earnings guidance to a new range of 6.55% to 6.70% or up 7% to 10% year over year. Our planning framework has not changed. We will support growth wherever we have it to drive outperformance. We'll be cautious in our sales planning. We will continue to plan our costs and spending conservatively, ensuring we remain flexible as a company and we'll maintain our seed planting investments for the future, supported by a robust pipeline of funded restructuring projects and continued investment in R and D.
In the second quarter, we expect EPS growth of 7% to 10% in line with the full year range. There's a number of exciting things that are happening across the company. I'd like to spend a moment on them here. Earlier this month, we appointed Darius Adamczyk to the newly created role of President and Chief Operating Officer reporting to me. In this role, he will drive continued profitable growth of our operating businesses through HOS Gold breakthrough strategies and advanced software offerings that complement Honeywell's diverse technology portfolio.
Honeywell remained very active on the capital allocation front in the Q1. We opportunistically repurchased over $1,000,000,000 of Honeywell's shares at a weighted average price of approximately $104 and we deployed another $1,000,000,000 to acquisitions. We announced and closed 3 deals in ACS, Xtralis and RSI Video Technologies in Security and Fire and Mobilizer in Sensing and Productivity Solutions. And as we discussed in January, we acquired the remaining 30% stake in UOP Russell, a global leader in modular gas processing technology and equipment. Each acquisition brings differentiated technology and a software focus to drive new growth and greater profitability while building on our great positions in good industries.
Our acquisitions across the portfolio last year to bolster our connectivity and software offerings are already paying dividends with new wins announced by Elster, Aviaso and ComDev. In excess, one of the largest multi utility distribution system operators in the Netherlands, selected Honeywell Elster to deliver more than 1,000,000 smart electricity meters over the next 5 years as part of the country's efforts to meet the European Union energy efficiency goals. Aerospace's Aviaso business was selected by Etihad Airways to provide fuel efficiency software and analysis to uncover opportunities for fuel savings and measure the effectiveness of fuel efficiency initiatives already in place. Com Dev, part of Defense and Space and Aero, recently announced the launch of our world leading ferrite technology on the European Space Agency's Sentinel-3A satellite. Our systems enable fast, reliable connectivity to provide near real time data from the satellite's measurement systems.
We continue to be excited about the growth opportunities these businesses bring to Honeywell and look forward to telling you more about our progress. And some of you may have seen last month that Honeywell Green Jet Fuel is now being used by United Airlines to power 12,500 flights from LA to San Francisco as part of its efforts to reduce carbon emissions and support energy diversification. Honeywell Green Jet Fuel can replace as much as 50% of petroleum derived jet fuel used in flight without any changes to the aircraft technology, while meeting the current ASTM jet fuel specs for flight. Depending on the biofeedstock, Honeywell Green Jet Fuel can offer a 65% to 85% reduction in greenhouse gas emissions compared with petroleum based fuels. We have lots of exciting new innovations and initiatives driving growth and margin and We've got a lot of momentum across the portfolio.
Innovation and execution, our seed planting for the future, great positions in good industries and the power of 1 Honeywell continue to be differentiators. So with that, I'll turn it over to Tom.
Thanks, Dave, and good morning. I'm on Slide 3, which shows the Q1 results. So sales of $9,500,000,000 increased 1% on a core organic basis. Each of the segments exceeded the sales guidance we provided in January, led by Commercial Aviation, Building solutions and distribution and process solutions, which I'll talk more about on the business slides. By region, core organic sales modestly declined in the Americas and increased high single digit in Europe.
In our high growth regions, India grew double digit, while in China, aero and ACS increased double digit, partially offset by declines in PMT. On a reported basis, total sales increased 3% as acquisitions more than offset the unfavorable impact of the stronger U. S. Dollar and lower pass through pricing in resins and chemicals. Segment margin was down 60 basis points versus the prior year, but up 20 basis points, excluding the dilutive impact of acquisitions.
The businesses are driving benefits from HOS Gold, our focus on commercial excellence, new product development and functional transformation, while maintaining our investments for growth. I'll talk more about the segment margin in a minute. Earnings per share of $1.53 was up 9% coming in at the high end of our guidance range. Items below segment profit were favorable on a year over year basis. Consistent with our long term framework, we recorded approximately $40,000,000 of new restructuring projects, partially offsetting the benefit from higher pension income.
For the full year, we anticipate that additional restructuring charges will largely offset the incremental pension income positioning us well for margin expansion. Non controlling interest was also favorable year over year as anticipated given the purchase of the remaining 30% stake in UOP Russell. On share count, as Dave mentioned, we repurchased over $1,000,000,000 of shares at attractive prices, which brought our weighted average fully diluted share count to approximately 777,000,000 for the quarter. We have been and will continue to be opportunistic when it comes to share repurchases and deploy capital to opportunities that will create the greatest value for our shareholders. Free cash flow in the quarter of $63,000,000 was down from the Q1 of 2015, driven primarily by the timing of tax payments and higher capital expenditures, offset by better working capital performance.
Capital expenditures of almost $200,000,000 in the quarter increased 18% year over year. The first quarter has historically proven to be our lowest from a cash perspective and we will remain on track to our full year cash guidance of $4,600,000,000 to 4,800,000,000 dollars Overall, we continue to generate strong results in a relatively low growth environment. I'm now on slide 4 to provide more detail on our segment margin expansion. Our operating initiatives continue to drive segment margin growth led by the deployment of HOS Gold. We generated an 80 basis point operational improvement in the quarter, which compares well with 100 plus basis point improvement for the full year 2015.
We have differentiated technologies and a software focus, Our supply chains are becoming more lean. Our back office continues to get more efficient and there's strong collaboration across the organization to drive down our material costs and indirect spend. The previously funded restructuring as well as new restructuring actions have enabled us to continue improving our overall cost position. We were encouraged by the outperformance on the top line in Building Solutions and Distribution and in our commercial aviation OE businesses this quarter, but that overdrive as well as the lower UOP petrochemical catalyst sales and lower than expected products growth in ACS, scanning and productivity solutions business constrained the operational margin improvement to the 80 basis points that you see. Lower raw materials pass through pricing in resins and chemicals added 10 basis points.
The impact from the pricing dynamics in resins and chemicals should quarter. First, M and A accounted for 80 basis points primarily due to acquisition accounting and pay as you go costs. The incremental amortization from the deals will be a margin headwind for the rest of the year as anticipated. We're in the midst of integrating 8 acquisitions and are happy to report that each one is performing well and is ahead of our deal financial model. 2nd, as we previewed in our December outlook call, aerospace OEM incentives increased by approximately $44,000,000 from 2015, reflecting our continued investment in developing and growing our installed base on the right platforms in the commercial aviation industry.
Depending on their nature, the incentives are treated as a reduction to revenue or as a cost, but either way they reduce segment profit as they are incurred. 3rd, on foreign exchange as previewed, the strengthening of the U. S. Dollar drove our margins drove down our margins principally in Transportation Systems. You'll recall that we were able to hedge our euro earnings at approximately 1.24 in 2015 versus our 2016 euro hedge rate of 1.10.
So put
it into perspective, these three items accounted for approximately $63,000,000 of headwind in the quarter or roughly $0.06 of earnings per share. In that light, the $0.12 of earnings per share growth for the Q1 certainly stands out. I'm now on Slide 5, summarizing our Q1 segment margin performance versus guidance. We were off 30 basis points at the midpoint. This chart provides some color on that.
Aero and PMT were generally in line with what we guided. In Aero, we continued to drive strong productivity improvements, but we did see some impact from the higher than planned commercial OE content. In PMT, we hit the high end of the guidance range. In ACS, we experienced a sales shift that is lower than anticipated ESS sales including a double digit decline in scanning and productivity solutions but higher than expected sales in building solutions and distribution. The adverse margin impact of these sales shifts offsets the continued improvements we're seeing across the ACS portfolio from productivity initiatives, commercial excellence and restructuring.
As you'll see later, we continue to maintain our full year margin guidance, which includes an acceleration of restructuring benefits in the second half of the year. This while absorbing the adverse margin impacts of the M and A accounting, the aerospace OEM incentives and the strengthening of the U. S. Dollar. Let's turn to slide 6 with a quick update on some of our recent acquisitions.
In 2015, we announced 5 acquisitions aggregating over 5,500,000,000 in purchase price. These were across all of our SBGs following our consistent qualitative and quantitative methodologies. We've continued this into 2016 having already announced and closed the 3 additional deals highlighted on this page. Each of these deals allows us to put non U. S.
Cash to work and each advances the software content in the Honeywell portfolio. Starting with Xtralis and RSI Video Technologies, each of these acquisitions has excellent technologies including video analytics and software that complement and expand our current security and fire offerings. Xtralis is a pioneer in very early warning smoke detection technology, which enables customers to protect high value assets such as museums and historical buildings or facilities where continuity is critical such as IT data centers and warehouses. Xtralis is the clear leader in that space. RSI's advanced motion technology allows our commercial and customers to receive intrusion alerts through a live video stream over the cloud providing visual verification that an intrusion event has indeed occurred.
This verification is legislatively mandated throughout Europe as a means of reducing unnecessary police response to false alarms and we expect this type of legislation will become more prevalent globally. Mobilizer allows us to expand our offerings for the connected worker in sensing and productivity solutions. Mobilizer's cloud platform plugs seamlessly into our customers' ERP systems and enables them to develop, deploy and manage their workflow and field service operations through the mobilizer app. Each of these 2016 acquisitions are being integrated into Honeywell right now and each is tracking ahead of our financial deal model. Let's move to slide 7 and discuss the Aerospace results.
Sales were up 3% on organic basis and above our expectations driven by better than expected growth in the Commercial Aviation Business. Aerospace recently created 1 unified commercial strategic business unit named Commercial Aviation. This organization combines our business and general aviation and our air transport and regional business units to provide the consistent and world class support required to win and grow our OEM and aftermarket business. Commercial Aviation OE sales increased by 4 on a core organic basis driven by continued strong engine shipments and increased JetWave Satcom sales in Business and General Aviation and higher sales to OEMs in Air Transport and Regional, partially offset by a 6 point headwind from the higher OEM incentives that I previously mentioned. As we mentioned in January, the growth in BGA OE is driven by our HTF 7000 Series engine, which is 1 4 of the 5 super midsized business jet platforms.
Commercial Aviation aftermarket sales were up 6% on core organic basis driven by better than expected ATR flight hours and double digit growth in repair and overhaul activities. On the spare side, we saw an increase in airline spares, partially offset by lower spare sales in other parts of BGA due to the timing of channel provisioning. In China, both spares and R and O sales increased double digit on strong flight hours. Defense and Space sales declined 2% on a core organic basis driven by program delays and project timing in our U. S.
Service businesses. International business in particular faced a difficult prior comparison as larger projects were completed. As a reminder, the international defense business grew north of 20% in the Q1 of 2015. Additionally, we closed the Com Dev acquisition, that's the satellite communications business we bought in February and that integration is progressing nicely. Transportation Systems sales increased 6% on a core organic basis due to new platform launches and continued volume growth in both gas and diesel light vehicle applications.
On the gas side, we saw double digit growth in both Europe and China. On a reported basis, TS sales increased 3%, reflecting the stronger U. S. Dollar. Aerospace segment margin expanded 70 basis points or 90 basis points excluding the dilutive impact of acquisitions.
This was driven by productivity net of inflation and commercial excellence partially offset by continued investments for growth including the higher OEM incentives. Let's turn to the ACS results on Slide 8. ACS sales were up 4% on a core organic basis in the Q1 above the high end of our guidance. ACS continues to outperform in high growth regions. Sales in both China and India grew double digit in the quarter, driven by our connected ACS strategy and the benefits from our ongoing investments for growth.
Sales in Energy Safety and Security, so the products businesses, were flat on a core organic basis in the Q1 and include a negative 3% or 3 point impact from the 2015 completion of the U. S. Postal Services contract in Sensing and Productivity Solutions. That is excluding Security and Productivity Solutions, the other three business units within ES and S were up this quarter on an average of 3%. The momentum continued in Security and Fire globally with strong growth rates in both residential and commercial markets coupled with the benefit from new product introductions and further penetration in high growth regions.
We expect S and PS to return to growth in the Q4. Building Solutions and Distribution sales were up 11% on a core organic basis outpacing our expectations. We continue to see strength in the Americas Distribution business where sales increased over 15% on both the residential and commercial sides and growth has improved sequentially every quarter since the beginning of 20 15. In Building Solutions, sales grew mid single digit reflecting strength in both project installation and service businesses. Orders growth was also healthy approaching 20% with particular strength in the services and energy retrofit businesses.
We're encouraged by the solid improvement we have seen in our energy portfolio in HBS this quarter. Our selections so what we have chosen in an RFP but have not yet booked the order, those selections stand at nearly 500,000,000 and have been growing steadily over the past 18 months. In the past, I've described the slow pace of the conversion of this selection pool into orders. Well, we're starting to see some of the acceleration of that conversion. Energy orders were up over 3 50% in the Q1.
We expect orders growth north of 25% in the Q2. And for the full year, energy orders should nearly double. This has been driven by sales excellence and a differentiated offering that is leading to multiple awards in an industry that is expected to grow its strong mid single digits over the next 5 years. We're also seeing traction in the service business in HBS driven by focused investments in NPI. Overall, the HBS backlog increased mid single digit on an organic basis driven primarily by growth in Europe and Asia Pacific and the conversion of backlog is improving.
We converted on a number of larger projects in high growth regions particularly in India. The ACS margin rate contracted 140 basis points in the quarter, but was up 10 basis points excluding the dilutive impact of acquisitions. As I mentioned earlier, the margin expansion was below our expectations primarily driven by higher project installation and distribution sales which carry lower margins. ACS continues to benefit from commercial excellence, productivity initiatives and the impacts from restructuring. We continue to invest for growth in our connected product offerings and in high growth region sales, marketing and engineering resources.
As an example, we've received great feedback thus far on our 2nd generation of lyric products, including our water leak and freeze detector products following our launch in April. I'm now on Slide 9 with the PMT results. Sales in the quarter were better than expected primarily driven by strength in Process Solutions, a business that continues to outperform its peers in a challenging environment. Process Solutions sales grew 9% on a core organic basis driven by double digit growth in our project businesses and by higher services sales. Conversion of the global mega project wins in backlog where we serve as the main contractor providing control and safety solutions for large installations picked up in the Q1 and we expect this trend to continue throughout 2016.
Orders were down low single digits on a core organic basis, but improved in our higher margin software and service businesses. In particular, we see increased demand for our Assurance 360 service partnership offering, which is a multi year agreement to maintain, support and optimize performance of Honeywell Process Control Systems. In UOP, sales were down as expected, driven by lower gas processing, catalyst and equipment sales. Gas processing faced tough prior year comparisons in the Q1 and while the domestic gas processing environment remains muted, international activity continues to be encouraging. Catalyst demand overall remains strong, but it's not unusual to see variations from quarter to quarter as we've highlighted in the past.
The Q1 declines were consistent with this trend following strong catalyst shipments in 2015. UOP backlog UOP's backlog was up low single digits driven by our catalyst business. Advanced Materials sales were up 11% on a core organic basis driven by demand for for our Solstice global warming products as well as higher volume in resins and chemicals. The Solstice growth is accelerating even more than continue to build out our capacity to meet the increasing global customer demand. In resins and chemicals, the volume favorability was offset somewhat by challenging market conditions.
PMT segment margins were down 90 basis points to 20.6% or down 70 basis points excluding the dilutive impact of acquisitions. The decline was primarily due to lower UOP petrochemical catalyst sales, partially offset by strong improvements in margin rates in HPS and Advanced Materials. PMT benefited from commercial excellence, the favorable impact of raw materials pass through in resins and chemicals and the impact from previous restructuring actions. I'm now on Slide 10 with a preview of the 2nd quarter. For Honeywell, total, we're conservatively planning for sales of $10,000,000,000 to 10,200,000,000 dollars up 2% to 4% reported or down 2% to flat on a core organic basis.
Segment margins are expected to be up 40 points excluding M and A or down 10 to up 10 basis points on a reported basis. We see credible drivers to improving sales and margin expansion for the rest of the year including higher catalyst sales in UOP, higher product sales in ESS and improving segment profit from acquisitions as one time M and A related charges taper off. We expect the tax rate to be 26.5%. EPS is expected to be $1.61 to $1.66 up 7% to 10% versus 2015. Starting with Aerospace, sales are expected to be flat to up 1% on a reported and core organic basis.
Commercial aviation OE, we're expecting sales to be down mid single digit driven by the impact of aerospace OEM incentives. Excluding the OEM incentives, commercial aviation OE is expected to be up low single digit with a ramp up on key platforms in air transport and regional, partially offset by declines in BGA following significant double digit growth in the Q2 of 2015 driven by strong engine shipments. Commercial Aviation aftermarket sales are expected to grow mid single digit again with an increase in airline spare sales, improvement in BGA RMU sales and higher repair and overall activity. ATR flight hours continue to be strong and we're also delivering higher SAT com and other software upgrades to enhance our growth. We're seeing good traction from customers on our JetWave onboard connectivity terminal, which is currently undergoing certification testing for 26 different aircraft models.
Defense and Space sales are expected to be roughly flat with higher product sales to the U. S. Government offset by tough prior year comparisons in the international business as larger projects are completed and by continued softness in the U. S. Services business.
In Transportation Systems, sales are expected to be up low single digit with continued strong growth in light vehicle gas applications, partially offset by slower growth in diesel based on the timing of new launches. As for the Aerospace margin rates, we expect a reported increase of 60 to 80 basis points in line with the Q1 performance and an increase of 80 to 100 basis points excluding the dilutive impact of M and A. ACS sales are expected to be down 1 percent to up 1% on a core organic basis or up 9% to 11% reported, driven by the addition of Elster and the 3 acquisitions we announced and closed in the Q1. We expect ESS sales growth to be similar in the Q1 on a core organic basis as continued momentum in our Security and Fire businesses and in our key high growth regions is more than offset by the declines we highlighted in S and PS. S and PS is expected to return to growth in the Q4 when we lack the comparisons to periods containing the completed U.
S. Postal Service contract. In Building Solutions and Distribution, we're expecting low single digit core organic growth, driven primarily by continued strength in the Americas distribution and the recent improvements in the HBS orders and backlog. Excluding the dilutive impact from M and A, the ACS margin rate is expected to improve 50 to 70 basis points driven by commercial excellence, continued productivity and the benefits of restructuring. ACS's reported segment margin rate in the second quarter is expected to be down 20 basis points to flat.
In PMT, sales are expected to be down 3% to 4% on both reported and core organic basis. UOP sales are expected to improve sequentially in the quarter, but will still be down double digit on a year over year basis driven primarily by continued declines in gas processing particularly in the U. S. And the timing of catalyst shipments. Based on our stable UOP backlog and strong anticipated second quarter orders, we expect the catalyst business growth rates to improve in the second half of the year.
HPS sales are expected to be up low single digit on a core organic basis driven by continued conversion of global megaprojects and higher software and services sales, partially offset by declines in sales of field instrumentation products. Advanced Materials sales are expected to be up low single digit driven by strength in fluorine products, solstice sales and improving specialty products volumes, partially offset by the aforementioned pricing conditions in resin and chemicals. The PMT reported segment margin rate is expected to be down 10 to 30 basis points and down 20 basis points to flat excluding the dilutive impact of M and A and this is driven by strong productivity, net of inflation and the favorable margin rate impact of the raw materials pass through pricing in resins and chemicals. Let's move to slide 11 to discuss what to expect for the rest of 2016. Our planning framework for 2016 contemplates a second half core organic sales guide of approximately 2% and our full year guidance remains at up 1% to 2%.
There are a few drivers which we expect will contribute to this modest second half core organic sales growth acceleration. We expect aero and ACS growth rates in the second half to be similar to the first half. So in aerospace, we're expecting similar strong growth in aftermarket sales and for modest pickups in our Defense and Space and TS businesses to offset modest declines in the commercial OE business. We'll see tougher comps in the second half of this year across commercial aviation OE which as you'll recall grew high single digit on a core organic basis in the second half of twenty fifteen. In ACS, we expect S and PS business to return to growth in the Q4 as we lap the tough comps stemming from the completion of the U.
S. Postal Service contract. We also continue to see traction on our new product investments including the award winning water leak detector part of the lyric 2.0 suite of products. This together with ACS's continued strong performance in high growth regions particularly China and India will support continued modest second half growth. The majority of the improvement in the second half growth is expected to be driven by PMT.
Our UOP business was down significantly in the Q1 as we discussed. We expect a substantial improvement in catalyst sales as shipments accelerate on robust demand in the refining and petrochemical segments. We also expect improvement in the other UOP businesses. UOP's backlog is healthy, up 2% at the end of the first quarter, driven by the nearly $1,000,000,000 in 4th quarter orders in 2015 and we're expecting a robust orders performance again in the Q2. So with that, let's move to our full year 2016 guidance summary on Slide 12.
As Dave mentioned earlier, we're raising the low end of the full year EPS guide by $0.10 with a new range of $6.55 to $6.70 up 7% to 10% over the prior year. There are some minor puts and takes among the segments from the guidance we provided in March, but overall another very strong year expected for Honeywell in 2016. If we look at Honeywell in total, we expect 1% to 2% core organic sales growth and total sales are now expected to be between $40,300,000,000 $40,900,000,000 up 4% to 6% on a reported basis. This increase in the reported sales reflects the incremental sales from the 3 new acquisitions and an update to our foreign currency assumptions. From a sales perspective, we're now playing the euro rate at approximately 0.1 percent for the remainder of 2016, roughly in line with the prior year and up from our previous assumption of the euro at parity with the U.
S. Dollar. This change in assumption of course does not impact the expected core organic growth rate. Segment margin expansion is expected to be up 10 to 50 basis points or 80 to 110 basis points excluding the dilutive impact of M and A, driven by commercial excellence, restructuring benefits and a continued proactive cost management. Below segment profit, our restructuring and other expenses remained stable and in line with our previous guidance and we still expect the full year tax rate to be 26.5%.
Our pension OPEB income is expected to be approximately $100,000,000 higher than we anticipated in December due to lower service and interest costs as a result of our adoption of the spot rate methodology for our pension plans in the U. S. And the U. K. We continue to expect our share count for the full year to be approximately 774,000,000 shares or approximately 2% lower than the 2015 weighted average share count of 789,000,000 shares.
We plan to offset any incremental dilution from new exercises over the course of the year keep the share count at roughly $774,000,000 We've already spent over $1,000,000,000 in share repurchases in the quarter and while our strategy to keep our share count flat over the long term remains, we will continue to be opportunistic in our approach as the market allows. As I mentioned earlier, we expect free cash flow to be in a range of $4,600,000,000 to $4,800,000,000 up 5% to 10% from 2015 with CapEx investments roughly flat to 2015 approximately $1,100,000,000 This will drive free cash flow conversion of approximately 90% for the full year. And as I said, as a result of our strong Q1 performance and the benefit from lower share count, we're raising the low end of our 2016 earnings guidance by $0.10 at this time. Let's move to Slide 16 for a quick summary before turning it back to Mark for Q and A. Once again, we've demonstrated we can deliver on our earnings commitments, hitting the high end of our guidance range even in a slow growth environment, a big reminder of the value of our diversified and balanced portfolio and the strength of the Honeywell operating system.
Sales growth was better than anticipated in the quarter and we continue to invest for future growth in new products and technologies, high ROI CapEx and our presence in high growth regions. We're also continuing to invest in and execute on process improvements and restructuring. And we again put to work a sizable amount of shareholder capital which will pave the way for future earnings and cash growth. We have confidence in our full year guidance based on the tenants of supporting growth, being cautious on sales, planning cost and spending conservatively and continued seed planning. So while 2016 isn't the easiest economic environment, we are confident we will continue outperforming our peers and performing well for our shareholders.
As always, we're also thinking about what's beyond 2016. Each of our HOS gold enterprises are hard at work focusing on breakthrough goals and profitable growth that we expect will drive earnings outperformance through our 5 year plan and beyond. We look forward to sharing more over the course of the year. With that, Mark, let's move to Q and A.
Thanks, Tom. Cindy, if you could please open the line up for questioning.
Certainly. The floor is now open for questions. Our first question is coming from Scott Davis from Barclays.
Hi, good morning guys.
Hey, Scott.
Well,
ops here, but I just wanted to get a sense, Dave, and I know you're going to hate this question, but what's the signaling, if there is any, of making Darius COO now? I mean, I'll just leave it at that. What are you telling us? Are you telling us you might be thinking about retirement and this is a transition? Or are you telling us that you needed you need this role, you need a COO type role?
I would say that what I'm saying is that I think, Darius is a damn good guy and I don't want to lose him. If I didn't promote him, who knows where he'd have gone?
I wish my boss would say that, but all right, I'll move on. This I ask this question a lot because I don't kind of get it. What happens with the UOP catalyst business when it goes down this much? Do you get a snapback? I mean, I look back at history and I couldn't really find any real trends.
I mean, how long does it can take to convert orders to revenues? Because it seems like your backlog is there, but do things snap back or
is this
a multi quarter grind its way back?
Well, let me address it a bit and then I'll ask Darius who used to run that business to weigh in a bit here. The it ends up being pretty lumpy as you know like a lot of the stuff in UOP And we generally can tell what's going to happen because you don't get the order right away and ship it out like 2 weeks later. So you do have some idea. But it still ends up being pretty lumpy overall and that's why we said that this Q1 was going to be tough for us on both growth and margins because we knew that was coming. And that was the case here.
But that being said, we have a pretty good sense for the year and what happens in the second half versus rest of the year rest of the year. So Darius, anything you want to add?
I think that's right, Dave. What we saw in Q1 of 2015 was a very strong shipment quarter in terms of our catalyst portfolio. And even within that catalyst portfolio, there's variability and it was very, I'll say, margin accretive set of catalysts that we shipped back in Q1 2015. And in terms of being able to convert it, we can generally convert it relatively fast, certainly within a quarter or at most quarter or 2. So, as Dave pointed out, it can be lumpy.
We had a very strong Q1 2015 shipment and I would say at some very favorable margin rates, which we expect to get those orders back in the second half of
the year. Yes. The other thing to keep in mind here is the this is our downstream business. It's serving refineries and petrochemical plants. The demand for the output from those units is very strong and a lot of our catalyst activity has to be scheduled with customer service intervals as well.
So that comes into play. And overall, I think you're right, Scott, the backlog I think speaks for itself.
Okay. I'll pass it on. Thank you, guys.
All right. Thanks.
And our next question comes from Steve Tusa from JPMorgan.
Hey, guys. Good morning.
Hey, Steve.
Congratulations, Darius.
Thank you.
Just on the ACS margins, could you maybe just give us kind of a definitely we couldn't expect, I think you talked about the mix. Can you maybe just give us a little bit of more color on that bridge more precisely on what you were expecting, where it ultimately came in? And then maybe just give us a little bit of color on the one time related deal stuff that kind of goes away either in the Q2 or over the course of the year because you didn't change your margin guidance for the year. And it just looks like a heck of a ramp to ultimately get there?
Yes. I'll a little bit and then turn it over to Tom. In terms of the ramp, it's no different than what we were saying back at Investor Day or back in December because this is pretty much what we expected. It was down a little bit from what we thought on guidance largely because of the mix difference as you look at what happened in the Building Systems division, which after it felt like 6 or 7 quarters of saying the orders are there, it's going to come, finally did, which was nice. It was a good thing to see.
So this is pretty much consistent with what we've been planning for all along. And as you take a look at second half growth for the total company, it's as I said largely driven by the absence of negatives than it is by any big thing that we're counting on. So Tom?
Yes, I mean, just looking a little more closer to details, I mean, Steve, the dilutive impact from margins was from Alstair and Datamax O'Neill a little bit. That was but it was 150 basis points or so. And that contains probably around $40,000,000 of one time kinds of things. But when you and that's like the upfront inventory write off and deal costs and so forth. So you're right, those will not be with us for the rest of the year, but that was already contemplated in our organic guidance that we had given you.
So if you look at it on that basis for the Q1, we certainly did have the productivity impacts that we thought we were going to have. So we have good material cost productivity, good performance on indirects and we actually had good performance on the commercial side. The issue was what Dave highlighted. I mean we had more sales and distribution, more sales of building solution products. I mean 17% up in our distribution business, 7% up in building solutions.
We also had in the S and PS a little bit of unfavorability beyond the Postal Service contract that we talked about. A little bit of channel softness and inventory shifts, we're keeping our eye on that as well. So those are the puts and takes. As we said, 2nd quarter, we expect to snap back to 50 to 70 basis points of expansion. We'll get the productivity.
I don't think the sales we're not planning for the is market of sales growth in BSD as we had in the Q1 and we get more restructuring benefit as we move along. That's the way I'd characterize it.
Okay. And the S and PS thing being down, I mean, that should have been that's kind of visible, right? I mean, that's something that you probably knew about earlier because it's a tough comp as opposed to a change in
the business environment? We certainly knew about the U. S. Postal contract completion. But when you look at the What else?
But it's a short cycle business and we go through indirect channels. And your visibility out on those is not much more than a few weeks, couple of weeks.
Now what happened on that to Thomas' point, there were 2 drivers. 1, we knew and planned for USPS. The second one was distributor inventory levels, which declined in the quarter and we expect will probably decline again in the Q2 before leveling out. And that one is one that we had not anticipated. It just kind of happened.
But we think is once the as you know, the level gets to where they want it then you get back to the growth you get back to the end market growth again.
Is there something is there an industry there that you're seeing? Is there something I mean, it seems like a lot of the macro inventory related stuff has stabilized. Anything more specific than that?
No, we don't think so from an end market perspective. It looks more like just distributors trying to be a little more cautious.
Okay. And then one last question just on the below the line stuff. You mentioned you're keeping your share count guidance the same, but then you said you're raising partly of share count dynamics. Could you just maybe clarify below the line what's changed, whether it's pension, restructuring share count? What has helped you on the guide?
Because it doesn't seem like the core profit guidance has changed very much.
No, that's right. I mean the big changes are the spot rate method on the pension side, which as we said, we fully expect to offset that impact with additional restructuring. We have 8 acquisitions that we're integrating. And when we start to carry out our cost synergy plans, we'll really need to lean on that restructuring funding. So that's the those are the major movements.
The raise to the guidance is a reflection of the strong Q1 as well as the share count that we mentioned.
Okay. Thanks.
Thanks, Steve.
And our next question comes from Stephen Winoker from Bernstein.
Thanks and good morning all.
Hey Steve. Hey Dave, I think a
skeptic maybe look at some of the segment margins over time now and in this quarter, for example, even ex M and A and say, look, after more than a decade of almost 1,000 basis points of segment margin expansion and well past prior peak in all cases, what are that is just getting harder and harder and bumpier for whatever reasons, mix, etcetera. What would you say what is the 1 or 2 things that you'd point to to say no, that's wrong, very explainable as you just went through ACS and here's why that's wrong?
Geez, an analyst skeptic, isn't that an oxymoron?
Pay to be skeptics, not cynics, Dave.
Well, first of all, we forecasted this was going to happen in the Q1. And yes, okay, we didn't beat it by 10 basis points, but we're certainly within the realm of reasonability. And if you take a look at the total years, quarters are a
little more
difficult, let's say, have things move always perfectly smoothly because you have things like UOP that just cause things not to be perfectly smooth. On a total year basis, there is this is going to continue. And it's not so much where you're coming from and the 1,000 basis points, yes, that's quite nice, but there's at least another 300 or 400 basis points left to go. If we take a look versus our high margin rate peers and we look at the industries that we're in and how others do in that industry. So this is going to keep going.
It's not going to change. At some point, we will have to say, yes, we are the highest in the industry and we can't keep talking about our margin rate growth story, but it's going to keep going. HUS Gold hasn't finished. The whole idea of being able to grow sales and hold fixed costs constant. Those are still very real and there's still a lot of juice left a functional transformation, there's still a lot left there.
Yes, sounds good.
Yes, if I could add, the other thing I'd point to Steve is the unspent restructuring that we have. It's well over $300,000,000 and that will continue to replenish itself. We have requests for way more than we can fund every quarter and we think that will help it. The other thing is these acquisitions, I said we're integrating 8 So that's diluting down a portfolio. So as we continue to integrate those and bring those in, that's going to be a big driver for us as well.
Very helpful. Thanks. And Dave, what are you currently thinking in terms of M and A again? I know you get this question all the time and size. And I guess also just given a lot of investor discussions, are there any circumstances under which you'd actually revisit your UTX bid?
Well, starting with the second one first, no, it's done, it's passed. It had its time and that time is gone. The on the first one, while it's the same question, it's also the same answer. It depends. We work an active pipeline.
You never know when stuff is going to hit. And sometimes, we've been really fortunate this past 6, 9 months with a bunch of things that we were able to bring to fruition. Who knows, rest of the year there could be another 10 or it could be 0. And we're just going to continue to be smart about it. I still do the integration reviews like we've talked about in the past.
We're just as disciplined as we ever were. If something makes sense, we'll do it. If we can't find stuff that makes sense, we won't. I don't mind being out of the market for a while and seeing what develops. We're going to save that.
I'm sure you have a lot of folks in
the queue, so I'll pass it on. Thanks.
All right, Steve. See you.
And our next question comes from Andrew Obin from Bank of America Merrill Lynch.
Yes, good morning.
Hey, Andrew.
Just more general question. A lot of conversations with investors about sort of global PMIs bottoming and bouncing off the bottom. What are you seeing as the world truly reaccelerating as you look at your business? And when are we going to start seeing it in numbers? Thank you.
Well, hopeful that there is a global economic rebound, but we're certainly not going to count on it. If there was any region that surprised me in this past quarter, it was Europe did a lot better than I expected. I don't know if this is just a one time bounce or something that's But right now, we're going to stay with this whole idea that this is a nice surprise. I mean, we'll see how much that turns into something. But right now, we're going to stay with this whole idea that this is a slow growth global environment and it's just the smart way to plan.
And you see that reflected in how we are forecasting the 2nd quarter and how we're forecasting the total year. I just don't think there's any percentage right now on being bullish about it. If it happens, great. I think there's a greater chance it happens than there is that it doesn't. But that being said, I don't see any percentage in being bullish about it.
And just a follow-up question. The dollar has been hedging structure. And as this dollar trade is unwinding, A, how are you thinking about hedging in outer years? And B, other than hedging, weaker dollar, how does it impact your strategy?
It doesn't really impact our strategy all that much because we have never really changed the way we did it. We've always tried to match cost and revenue as best we can. So I want to be producing in the markets where I'm selling. And as a result of that, I think it's put us in a pretty good position where we don't get out of whack with any competitor because of a currency mismatch. When it comes to the translation question, that's a separate one.
We might consider taking some exposure off the table this year and next as we contemplate what could happen, especially as you look at Brexit and the possibilities there. But by and large, I don't feel as negative as I did about currency, as I did say a year or 2 ago.
Thank you very much.
And our next question comes from Jeffrey Sprague from Vertical Research Partners.
Thank you. Good morning, everyone.
Hey, Jeff.
Hey, a couple. Maybe actually one for Darius since he's on the line. I just see this morning that Grace is buying a BASF catalyst business today. Just wondering if you could speak to whether that was on your radar screen and maybe more generally do you see M and A opportunities in that space for UOP or kind of related assets in that area?
Well, obviously, as usual, I'm not going to comment on specific targets. So quick learning from Dave, but obviously the Catalyst space is interesting to us. It's something that obviously is core to what UOP does. And I would just say that that's an area that it's something that we're been looking at both organically and if the right opportunity presents itself, it's probably something that we'd be open to as well. But clearly, a space that's of interest to us.
Great.
And then, Tom, just on tax, Honeywell for years has had a very sophisticated tax planning effort solving to 26.5% almost precisely year after year.
Is there anything in what the treasury said
a couple of weeks ago when they were aiming at inversions that spills over and creates the risk to your tax planning strategies?
Yes. Well, first of all, my tax director is going to be thrilled that you referred to him as sophisticated. That's going to be a new one, but It's
a first for him.
Just kidding. Well, I mean, of course, we're not an inverted company, Jeff, as you know, but the new rules do apply to U. S. Multinationals as well. And there's specific criteria that intercompany loans are required to meet in order to be treated as debt as opposed to equity.
We're currently assessing all of our intercompany loans against these criteria. We'll likely be required to have more extensive documentation in place on our loans and it may have an impact on our ability to pool our cash globally as well. We're currently assessing that. But otherwise, we're not expecting a material impact, including in our ability to do M and A and including in our foreign operations. Thanks.
And just one more quick one if I could. Yes, we're all just trying to kind of get all the eyes dotted on margins as you can see on this call. Just the OEM payments for the year, if you gave that previously, I don't recall. Could you share that with us so we have that dialed in?
Yes. It's roughly $200,000,000 a little bit over $200,000,000 for the year.
Year on year. Right.
Year on year $200,000,000
Right.
Thank you, guys.
You're welcome.
And our next question comes from Gautam Khanna from Cowen and Company.
Yes, thank you. I was wondering if you've seen any change in customer buying behavior in the ATR aero aftermarket. We hear a lot about pulling of parts and part outs. Wondering if you're seeing any of that because the numbers don't suggest it.
Well, yes, those phenomena, both of those are real. And you're seeing the consolidation more in China, I'd say, than any place else. And the parting out is real. And we've referenced it ourselves in previous announcements. That being said, those are a couple of headwinds, but there are also tailwinds and that's flight hours, for example, where people are continuing to fly and that's always good.
And it more than offsets the impact from those other items.
And in China, your spares were up quite a bit. Is there any what do you think is actually driving that? Is it a restock? Is there what's going on there?
I'd say it comes back to flight hours again. They fly a lot. And that's really the I've said many times that the biggest aerospace driver we have is flight hours. And it's not tied to OEM schedules or airline profitability or any of that generally. The long term trend is going to be driven by flight hours.
If they're flying, if everything ends up working out, whatever short term disruptions or benefits, whatever you're seeing, over time flight hours ends up being the driver. Yes. Flight hours continue to climb and that's a good phenomenon for us.
Yes. I'd also add that when you look back at the Q1 2015, there was an unusually low aftermarket sales, I think because of some of the factors you had mentioned, Gautam, and I think we'll continue to see the impacts of that, as Dave said. But overall for the full year, the flight hours are what is going to be what drives our aftermarket in China.
And just to follow-up on Jeff's question on the OEM preproduction payments, do you have any preliminary sense for what they might be in 2017?
I think the level will be similar in total to 2016, so flat year over year. And then it's down strong. And then, yes, it should recede in the years after that.
Okay. And last one, can you quantify the USPS headwind for us? Quarter over quarter what the decline has been?
In general, that's not the kind of specifics we'd share. We would say that as I said, we knew about some of it. We did not know about the distributor side of it. So that was kind of a surprise, but that will like any other inventory reduction that corrects itself over time.
All right. Thank you very much.
You're welcome.
And our next question will come from Nigel Coe from Morgan Stanley.
Yes, thanks for hanging in a bit late here as well. Darius, congratulations on the role. Fantastic. So we've spent a lot of time talking about catalyst. So I apologize for another question here, but it is a big swing between first half and second half.
Typically, how much visibility do you have on catalyst bed reloads? Is it 3 months? Is it 6 months? I mean and how much variability do you have once you have a job in the backlog? How much typically how much variability is there and the timing of that?
I can't imagine it's much, but maybe just comment on that please.
It's a mixture. I mean there's stuff that we know about a long time ahead because some customers place orders a long time ahead, others don't. But Darius, you'd know better than Yes.
I mean, I think when it comes to the second part of your question, which is once it's in the backlog, I mean, we can produce it fairly quickly, typically within 3 months. So I think the cycle, the conversion cycle time from booking to revenue is relatively short. In terms of visibility as to when the orders come in, frankly, the visibility isn't great. It's a bit of a random function. And Tom referred to this earlier, but one of the fundamental things that's going on, this is actually pretty good time for refiners.
So what we're seeing is that refiners are actually putting off their turnarounds, which they're going to have to occur at some point. When that's going to happen, that's not really certain. But I would say overall, the Catalyst booking pattern is somewhat unpredictable.
Okay. So the second half, Steve, is sort of best efforts, but locked in mainstream management. Okay. And then, obviously, you're getting beaten up a little bit on margin this quarter. Obviously, there's a lot of moving parts with the OE support payments and the FX hedge.
I guess the EBIT margin strength given those two headwinds is pretty extraordinary. But just Tom, maybe just comment on the hedge, the euro hedge. And if by some miracle, the euro did go to 124 by year end, that's still a benefit to your guide net net, but obviously that affects your margin somewhat. Is that the way to think about it?
No. If you recall, Nigel, beginning of towards the tail end of last year, we basically hedged the euro our euro based profits is the way to think about it. So they're hedged at about $1.10
At the income level.
Right. The profits are. The movement in our guidance was on reported sales. So we've never hedged at the sales line level. So we do see the variability if the U.
S. Dollar goes to if we go to $1.24 in your scenario, then yes, we would have more sales, but our margins would be the same. So that would have an impact on the margin rate. It's why
we stick
out the difference between operational and all the other items on the margin rate curve.
Okay. And just a quick one on inventories. The build in inventories, is that driven by the aero build cycle?
Yes. You've got a couple of things going on in inventories. I mean, I'd say the biggest thing is continuing to ramp up for flooring products. We've got significant pickup in as we said in the second half there. And the other thing is the M and A.
I mean more than half of it is of the inventory increases is from the acquisitions that we've done.
Of course. Yes. Okay. Thanks, guys.
Thanks, Diane.
And our next question comes from Andrew Kaplowitz from Citi.
Hey, good morning guys.
Hi.
Dave, the TS business seemed to pick up in 2Q. Can you talk about the improvement a little bit more? How Well, commercial is still tough on the TS side. What you're seeing
is Well, commercial is still tough on the TS side, which you're seeing more with the benefits of the wins in the passenger vehicle side.
Okay, that's easy. And then, Dave, just I know the answer to this, but I'm asking anyway. Can you talk about your organic growth guidance in 2Q versus the 1% growth you had in 1Q? Is there anything getting worse in the portfolio in Aero and ACS that leads to lower growth? Or is it just conservatism and you're not forecasting the BSD accelerate growth that you saw in the quarter?
I would say it's more a case where we want to stay careful. So yes, there's nothing that says there's a disaster in the Q2 or anything like that. We just want to make sure that we stay conservative. And hopefully the Q1 performance continues on organic growth, but we'd hate like hell to count on it, not have it happen and I'd rather have it be the other way around.
And that is all the time we have for today's question and answer session. Mr. Cote, at this time, I will turn the
conference back
to you for any additional or closing remarks. Well, we're quite pleased to outperform again this quarter. And what we accomplished on organic sales growth, beating our commitment and the productivity generated to offset the known headwinds gives us the confidence to raise the low end of our EPS guidance by $0.10 We're encouraged by what we're accomplishing this year and next. And of course, we all hope that you feel the same way. Thanks.
Thank you. This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful