Please stand by. Good day, ladies and gentlemen, and welcome to Honeywell's third quarter 2015 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 star two. Lastly, if you should require operator assistance, please press star zero. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mark Macaluso, Vice President of Investor Relations.
Thanks, Heather. Good morning and welcome to Honeywell's third quarter 2015 earnings conference call. With me here today are Chairman and CEO, Dave Cote, and Senior Vice President and CFO, Tom Szlosek. As a reminder, this call and webcast, including any non-GAAP reconciliations, are available on our website at www.honeywell.com/investor. Note that elements of this presentation contain forward-looking statements that are based on our best view of the world and of our businesses as we see them today. Those elements can change, and we ask that you interpret them in that light. We identify the principal risks and uncertainties that affect our performance in our Form 10-K and other SEC filings. This morning, we'll review our financial results for the third quarter, share with you our guidance for the fourth quarter, and as well provide initial framework for 2016.
Finally, as always, we'll leave time for your questions at the end. With that, I will turn the call over to Chairman and CEO, Dave Cote.
Morning, everyone. As I'm sure you've seen by now, Honeywell delivered another quarter of double-digit earnings growth highlighted by our strong execution across the portfolio. Reported EPS of $1.60 increased 10% normalized for tax, reaching the high end of our guidance range for the quarter. Sales of $9.6 billion were up 1% on a core organic basis. We saw continued growth in our business jet engines and repair and overhaul activities in aerospace and in our short cycle residential, commercial, and industrial products businesses in ACS. In PMT, demand for UOP catalysts and Solstice applications continued. We generated free cash flow of $1.4 billion in the third quarter, with free cash flow conversion coming in above 100%, and we expect that to continue in the fourth quarter.
While we always like more, our top-line growth was respectable in this softening macro environment. Our relentless focus on execution once again resulted in outstanding margin expansion and cash conversion while continuing to do the seed planting for a bright future. Our segment margin expanded 190 basis points to 19.3%. Each of our three segments delivered margin expansion above the guidance we communicated in July. HOS Gold and our key process initiatives continue to drive productivity benefits. Our previously funded restructuring actions will help us to continue improving our operations. We proactively funded over $60 million of new restructuring in the quarter, building on a healthy pipeline of new projects. We intend on keeping that pipeline full to support strong margin expansion next year and beyond.
There continues to be a lot of exciting developments across the portfolio. Let me tell you about a couple of them. We announced the acquisition of Elster on July 28th for $5 billion. Elster is a leading provider of thermal gas solutions for commercial, industrial, and residential heating systems and gas, water, and electricity meters, including smart meters and software and data analytics solutions. Infrastructure investments and increasing gas consumption in high growth regions like India and China will continue to drive demand for Elster's gas heating assets, strengthening our existing gas combustion portfolio to create a full solution offering. Elster's metering portfolio consists of basic and smart meters, which measure volumes consumed by commercial, industrial, and residential users. The growth here will continue as the adoption of smart meters and data analytics increases and as the legislative mandates in Europe, China, and other major regions take shape.
In addition, Elster has a complementary presence to process solutions in natural gas transportation and storage. A large portion of natural gas reserves are found in remote regions. As the long-term trends in natural gas remain positive, the need to transport it from these geographies to the rest of the world continues to grow. That means more pipelines, regulators, control valves, and metering systems. With Elster, we'll be positioned well at each point of the value chain. Elster is expected to add $2 billion in sales at approximately 20% operating margin, building on our great positions in good industries in ACS and PMT. We expect approximately 8% of sales as cost synergies. Our deployment of HOS Gold across the Elster enterprise will be the key to achieving the integration benefits.
We're also confident that there are significant sales synergy opportunities, particularly in high growth regions like China, by leveraging our current channels and infrastructure. We continue to expect the deal to close in the first quarter of 2016. We're actively planning the integration. We continue to believe we can significantly enhance share owner returns through M&A, as we've proven in the past with acquisitions like UOP, Intermec, Thomas Russell, and EMS. In August, Honeywell's partner Inmarsat successfully launched the third Global Xpress, or GX satellite. The latest launch completes the GX satellite constellation, which will ultimately provide passengers, air crews, and operators with high-speed internet connectivity anywhere in the world, including on transoceanic flights.
Aircraft connectivity is one of the biggest technological revolutions happening within the commercial aviation sector. As the number of aircraft equipped with passenger connectivity systems is expected to double to more than 4,000 by 2016, and wireless in-flight entertainment is expected to be on about a quarter of the global commercial fleet by 2018. Honeywell is positioned to benefit from the growing demand in connectivity as the exclusive hardware provider for Inmarsat's GX satellite constellation and the exclusive wireless airtime reseller for Inmarsat Global Xpress, Ka-band aircraft connectivity services for business aviation operators. As airlines increasingly look at how they can utilize real-time connectivity for flight operational tasks, like real-time weather and database updates to the cockpit and proactive maintenance, and as passengers continue to request faster Wi-Fi connections in flight, the need for Honeywell's JetWave high-speed satellite communications hardware will continue.
We currently have orders for over 300 JetWave systems in 2016 across our air transport and business aviation customer base, with additional awards expected soon. In transportation systems, we unveiled our 2015 global turbocharger forecast at the annual Frankfurt International Motor Show. We now estimate that by 2020, roughly half of all cars on the road will have turbocharged engines, up from one-third of all passenger vehicles today. In addition, global market demand will drive an increased desire for turbo technology innovations that enhance a vehicle's overall powertrain system, reduce complexity, and are tailored to local market needs. In this period of accelerating turbo penetration, Honeywell is well-positioned to meet the changing demands of our customers, and we expect to continue growing faster than the industry due to our differentiated technology, global footprint, and the Honeywell Operating System.
With just over two months left in the year, we're confident in our ability to deliver on the earnings guidance we set for 2015 last December, despite the slower growth environment in the global economy since then. We are confirming our full-year 2015 earnings guidance at approximately $6.10 per share, representing growth of 10% versus 2014, which would be our sixth consecutive year of double-digit earnings growth. We'll continue to be flexible and plan conservatively as we move into 2016. Tom will preview our initial planning framework for next year, and as you'll see, there are bright spots in what will be a slow growth environment. We've demonstrated that we can execute well, particularly in a tough macro environment, a big reminder of the value of our diversified and balanced portfolio and the strength of the Honeywell process initiatives.
Segment margins are expanding, while at the same time, we are continuing seed planning in high-growth regions, high ROI CapEx, process improvements, and new products and technologies. The restructuring we funded will provide runway for future margin expansion throughout our five-year plan. We're excited about the year ahead and look forward to discussing our plan with you in December. With that, I'll turn it over to Tom.
Thanks, Dave, and good morning. I'm on slide five, which shows the third quarter results. Sales of $9.6 billion were up 1% on a core organic basis as we were able to overcome a sluggish macro environment. Growth was particularly noteworthy in BGA OE, where engine shipments were strong in our ACS short cycle products businesses across residential, commercial, and industrial end markets, in UOP catalysts, and in our Solstice suite of refrigerants. The growth in these areas helped us to mitigate the ongoing challenges we have discussed in the oil and gas, commercial vehicle, and energy retrofit markets which we serve. On a reported basis, the sales decline this quarter was again driven by foreign currency and lower pass-through pricing in Resins and Chemicals. Segment profit increased 5%, with segment margin expanding 190 basis points to 19.3%.
As Dave mentioned, all three of our segments came in above the high end of the guidance we issued back in July. We continue to benefit from HOS Gold, our focus on commercial excellence, new product development, functional transformation, and strong cost controls across the portfolio while maintaining our investments for growth. Really nice work across each of the businesses in a relatively tough environment. Similar to the prior quarter, items below segment profit were favorable on a year-over-year basis, as we had anticipated. Higher pension income was offset by additional restructuring. As Dave said, we funded over $60 million of new restructuring projects this quarter, building on our $300 million-plus pipeline as of the end of the third quarter, which positions us well for continued margin expansion throughout the five-year plan.
On share count, in addition to our normal repurchasing to offset current dilution, we accelerated our repurchase activity in the third quarter, given the market downturn in the late summer. These actions will enable us to offset the expected dilution in the next few quarters and brought our weighted average, fully diluted share count to approximately 790 million shares for the quarter. We expect the count to be approximately 781 million shares in the fourth quarter as the full impact of this repurchasing activity kicks in. Reported earnings per share of $1.60 was up 10%, normalized to our expected full-year tax rate of 26.5% in both periods. Again, coming in at the high end of our EPS guidance range and marking another quarter of double-digit earnings growth.
Finally, free cash flow was strong in the quarter at $1.4 billion, up 43% versus 2014, with conversion of 110%, largely driven by improvement in net income and working capital. We anticipate free cash flow conversion to continue above 100% in the fourth quarter. Overall, another quarter of strong earnings growth. We're confident in achieving our EPS guidance for the year. Let me move on to slide five. You'll recognize this format we use to explain the components of our robust margin expansion in the quarter. A majority of the expansion is coming from our operating initiatives, which, as you can see, generated 140 of the 190 basis point margin improvement. HOS Gold is the overall driver. New product introductions and commercial excellence continue to drive volume growth despite the slow growth environment.
Each segment is generating significant productivity, we're continuing to see that improve our gross margin rates. Our supply chains are becoming more lean, there is strong collaboration across the organization to drive down our material costs and indirect spend. We're also seeing savings from previously funded restructuring actions. Moving over on the slide, the friction materials divestiture, our foreign currency hedging approach, and lower raw materials pass-through pricing in R&C also enhanced margins collectively to the tune of about 50 basis points. We sold friction materials in July of 2014, so we've largely lapped this benefit. However, it is a permanent improvement to our margin rate, reflecting our continued approach to capital allocation. On foreign currency, our hedging strategy protects our operating results even as sales fluctuate with changes in currency. There is a lift in margin through year-end.
Finally, as we've discussed, our pricing model in Resins and Chemicals protects profit dollars in a period of lower selling prices, thereby increasing the margin rate. Another solid quarter of margin improvement driven by our operating system and key process initiatives. We expect to see similar outperformance in the fourth quarter, as we'll explain shortly. Moving to Slide 6 and the aerospace results. Sales for the third quarter were up 2% on a core organic basis, driven by continued growth in BGA OE engine shipments, commercial aftermarket, and light vehicle gas volumes, offset by lower commercial vehicle production and transportation systems. Segment margin expansion continued to be strong at 150 basis points, we exceeded the high end of the guidance in the quarter.
Commercial OE was up 4% on a core organic basis, driven by a double-digit increase in BGA engine shipments as sales were up across all of the large business jet platforms on which we participate. Deliveries of our HTF engines continue to grow, we expect engine demand to be robust into the fourth quarter. Similar to last quarter, air transport OE sales were flat as planned, while regional sales declined due to intentional delays on shipments to certain emerging market customers. Commercial aircraft sales were up 3% on an organic basis, driven by continued strong growth in repair and overhaul activities, partially offset by lower spare sales. R&O sales were up high single digit in the quarter and have improved sequentially throughout 2015.
We saw strong growth globally in ATR R&O, particularly in Europe and APAC, while our BGA R&O business continues to perform well in its key North American market. On the spare side, RMUs, or retrofit modifications and upgrades, have continued to moderate as we had planned. In ATR, spare sales were slower than expected, approximately flat in the quarter, driven primarily by lower than expected demand in certain high-growth regions, principally China. Looking ahead, we expect that our SATCOM and other RMUs will offset some of this spare softness. Defense & Space sales were up 2% on a core organic basis, driven by double-digit growth in our international defense business. Demand from our Middle East and Asia Pacific customers was strong, while in the U.S., our sales were slightly down.
Transportation system sales increased 1% on a core organic basis due to new platform launches and continued volume growth in light vehicle applications. Sales growth overall was lower than expected due to lower commercial vehicle volumes, particularly in North America and China. We expect that commercial vehicle volumes will improve sequentially in the fourth quarter. On a reported basis, TS sales declined 16%, reflecting foreign currency headwinds and the friction materials divestiture I talked about. I want to take a minute to address some of the questions we received about the impact of the Volkswagen emissions matter on turbo technology and on our turbo business. I wanted to explain why this is far from a disaster from Honeywell, and in fact, it's still an organic growth story.
While we value the relationship with VW as we do every customer, our sales to VW represents less than 1% of total Honeywell sales. While significant, we're not dependent on any one vehicle manufacturer globally. The benefits of diesel engines remain compelling. Diesel engines operate at higher levels of compression, enabling them to achieve higher fuel efficiency and lower CO2 emissions than gasoline engines. In addition, diesel delivers significantly higher torque, enabling better acceleration and greater towing capacity and payload in trucks and light commercial vehicles. The output for diesel supply continues to be robust, as diesel will always be one of the useful outputs from the oil refining process. As long as there is oil being refined, there will be an ample supply of diesel.
Last, in the unlikely event there was a gradual shift away from diesel technology or from a particular OEM, we are well-positioned on other existing OEM platforms and expect that we'll continue to win a significant share of new platforms, particularly in gas, where we have an increasing position. On a year-to-date basis, our TS business has grown 3% organically, and we expect that growth to continue into 2016 as global penetration of diesel and gas turbocharger technology accelerates to roughly half of all vehicles on the road by 2020. Transportation systems continues to be a key element of the Honeywell growth story.
Aerospace margin expanded 150 basis points above the high end of our guidance range, driven by commercial excellence, productivity net of inflation, and the favorable impacts from foreign currency hedges and the friction materials divestiture, partially offset by the margin impact of higher OE shipments and continued investments for growth. These include flight testing of our new connectivity offerings on the Boeing 757 test aircraft, which some of you have may seen in Paris, and new product introductions across our mechanical and electrical portfolio to ensure we continue to win on the right platforms. Let's turn to the ACS results on slide seven. In ACS, Alex and his team continue to advance our connected ACS initiative.
ACS has realigned four of its businesses into two strategic business units, namely Honeywell Security and Fire, or HSF, and Sensing and Productivity Solutions, or S&PS, which encompasses the legacy sensing and control and scanning and mobility portfolios. The broader scope of these businesses will provide us better scale in our high-growth regions and differentiated connectivity solutions, and will position us to better capitalize on growth opportunities across residential, commercial, and industrial markets. You will hear us reference these businesses throughout the rest of the presentation. ACS sales were up 3% on a core organic basis in the third quarter, as we experienced continued growth in our short-cycle products businesses. ACS continues to outperform in China, up 10% in the quarter, driven by our Connected ACS China business and continued investments for growth.
The ACS margin expansion was again very strong at 130 basis points, and we exceeded the high end of our margin guidance range this quarter. Energy, Safety, and Security sales were up 4% on a core organic basis in the third quarter, driven by the strong performance in our Honeywell Security and Fire and Sensing and Productivity Solutions businesses. S&PS delivered another quarter of solid double-digit core organic sales growth, driven by volume from program wins, most notably from the U.S. Postal Service agreement, along with new product introductions in China. The rest of ESS also continues to benefit from new product introductions and further penetration in our high-growth regions. This was partially offset by volume declines in our industrial safety business, due principally to oil and gas-related discretionary cuts. Building Solutions and Distribution sales were up 1% on a core organic basis in the third quarter.
We continue to see strength in the Americas distribution business, where sales growth has improved sequentially every quarter in 2015. This was offset by a decline in Honeywell Building Solutions, driven primarily by softness in the project installation and energy retrofit businesses. In the energy retrofit business, we currently have been selected in competitive RFPs for approximately $500 million of U.S. federal and municipal business, which will subsequently convert to orders and then to revenues. The conversion of these RFP wins into orders has unfortunately taken a longer time than we've historically seen, driving this pool of pre-orders to more than 2X prior year's levels. But as a precursor to future orders and backlog, this is a positive sign. On the federal side in particular, with a presidential challenge requiring award by the end of 2016, we believe these pre-orders will start to convert to orders in the coming quarters.
Overall in HBS, the backlog is flat year-over-year, as growth in products and services has been offset by this energy challenge. Also, conversion of orders and backlog has been slower than anticipated, particularly in the Americas and EMEA. ACS margins expanded 130 basis points to 17.2% in the quarter. The business continues to benefit from good conversion on higher volumes and significant productivity improvements net of inflation. At the same time, we continue to make strategic investments in new product development, connected product offerings, and in our high-growth regions, which, as we've noted, drove double-digit growth and continued order momentum, particularly in China. We expect further margin expansion in 2016 and beyond as the team integrates and builds out the Connected ACS initiative we described at our investor day. I am now on slide eight to discuss PMT results.
PMT sales were down 3% on a core organic basis in what continues to be a challenging market environment for oil and gas. Darius and the PMT team have been resilient and unrelenting in their focus to overcome these headwinds. We exceeded the high end of our segment margin guidance by 80 basis points, driven by strong execution and continued productivity actions while maintaining our investments for growth. UOP sales were down 15% on a core organic basis, driven by lower gas processing, licensing, and equipment sales, partially offset by robust catalyst demand as we had planned. Catalyst shipments for the new olefin units accelerated in the quarter, while catalyst orders were strong, which we expect will drive substantial catalyst sales growth in the fourth quarter. The higher catalyst sales benefited PMT margins in the quarter as well.
In gas processing, we're seeing some signs of life coming out of a quiet first half. We signed orders for two new Russell modular units and expect the orders to further build into the fourth quarter, driven by international opportunities. In Process Solutions, core organic sales were down 5%, driven by double-digit declines in our short-cycle field products business and weakness in long-cycle projects, partially offset by higher sales in our service contract business. The HPS projects and services backlogs remain solid, up over 15% on a combined basis. In services, we saw an increase in demand for our Assurance 360 service partnership offering, which is a multi-year agreement to maintain, support, and optimize performance of Honeywell control systems. Organic orders were down 6% in the quarter, and we expect similar challenges for the rest of the year in HPS as customers delay capital spending decisions and cut discretionary spend.
Some of the spending cuts reflect a hesitancy in our install base to remove high capacity and highly profitable plants from operations, even for short maintenance periods. This deferred maintenance will eventually require addressing, which will benefit our HPS service business and, for that matter, our UOP catalyst business. Advanced Materials sales were up 8% on a core organic basis, driven by Fluorine Products, which grew double-digit for the fifth straight quarter as demand for Solstice global warming products continues to ramp. In addition, specialty products continue to benefit from investments in new products. On a reported basis, advanced material sales declined 8%, primarily due to the impact of the lower pass-through pricing in Resins and Chemicals, as we've highlighted previously.
PMT segment margins were up 330 basis points to 20.8%, which again exceeded our guidance driven by significant productivity actions net of inflation, commercial excellence, and the favorable impact of raw materials pass-through pricing in Resins and Chemicals. PMT initiated cost management actions late in 2014 to address the challenges we anticipated in the oil and gas environment and have been very focused on reducing direct material and indirect costs. This was partially offset by continued investments for growth in capacity expansion and R&D to develop groundbreaking new products like Solstice. We have also benefited from ongoing restructuring and reducing our fixed cost structure, which should help to sustain the strong margin expansion we've seen year-to-date. I'm now on slide nine with a preview of the fourth quarter.
Before I get into the preview, I want to spend a moment reminding everyone of the gain from the sale of the B/E Aerospace shares and OEM incentives from the fourth quarter 2014. We sold the remaining $1.9 million of BEAV shares in the fourth quarter of last year and separately incurred a charge of $184 million for commercial OEM incentives in Aerospace. On an after-tax basis, there was no impact to EPS for the quarter or full year from these two transactions. The cost for these OEM incentives was included in the Aerospace segment as a reduction of revenue, while the gain from the sale of BEAV shares is below the line and not included in the Aerospace segment. The 2014 reported sales and margins for Aerospace were comparably low.
Moving to the fourth quarter of 2015, we're expecting another quarter of double-digit earnings growth to cap off the year. EPS, excluding pension mark-to-market adjustment, is expected to be approximately $1.58, up 10% year-over-year. Total Honeywell sales are expected to be $10 billion-$10.2 billion, or up 1%-2% on a core organic basis. Segment margins are expected to be up approximately 120-140 basis points, excluding the impact of the $184 million fourth quarter OEM incentives in 2014. We expect our margins will continue to improve on operational excellence, similar to what we've seen throughout the year. We're still planning a full-year tax rate in 2015 of 26.5%, inclusive of a fourth quarter tax rate of approximately 27.5%. As I mentioned earlier, we expect the share count to be approximately 781 million shares in the quarter on a weighted average and fully diluted basis.
We intend to be opportunistic based on market volatility and be ready to step in again when we see good buying opportunities. Aerospace sales are expected to be up 1%-2% on a core organic basis. In commercial OE, we expect that core organic sales will be up mid-single-digit, driven primarily by continued healthy engine demand in mid to large cabin business aircraft. In commercial aftermarket, we expect core organic sales to be up low-single-digits with similar trends to what we saw in the third quarter. That is strong repair and overhaul offset by spare softness. Defense & Space sales are expected to be flat to slightly up on a core organic basis, with continued modest declines in the U.S. and slower growth in the international business against a more difficult prior year comparison.
As a reminder, Defense & Space International increased 17% in the fourth quarter of 2014. In transportation systems, sales are expected to be up low-single-digit on a core organic basis driven by both light vehicle gas and diesel turbo volumes, partially offset by continued headwinds from lower commercial vehicle production, particularly in China, as we have discussed previously. Aerospace segment margins are expected to increase 40-60 basis points, excluding the fourth quarter of 2014 incentives. This is driven by commercial excellence, further productivity improvements, and partially offset by the margin impact of higher OE shipments. Moving on to ACS, sales are expected to be up 2%-3% on a core organic basis, with low-single-digit core organic growth in both ESS and BSD.
Growth in our residential and commercial businesses within ESS should be similar to what we saw in the third quarter, with good performance in Security and Fire in particular. On the industrial side, S&PS growth will be slower with the completion of the U.S. Postal Service deployment, and we expect continued oil and gas-related headwinds in industrial safety. In BSD, we expect continued growth in Americas Distribution to be partially offset by slower conversion of orders out of backlog and Building Solutions. ACS margins are expected to be up 70-90 basis points, driven primarily by commercial excellence, continued productivity net of inflation, and the benefits of prior period restructuring. We will continue the investments in new product development and in high-growth regions to support further growth in the fourth quarter and into 2016.
PMT sales are expected to be down 2%-3% on a core organic basis, reflecting the slowdown we've experienced. We're expecting UOP to be up mid-single digit on a core organic basis, primarily due to strong double-digit petrochemical and refining catalyst growth, partially offset by continued declines in our gas processing and process technology and equipment businesses. In HPS, we're expecting core organic sales to be down mid to high single digit with declines in each line of business. We continue to see delays in discretionary spend across the portfolio, and the conversion of orders into revenue has slowed. However, our win rate on mega automation projects is helping to mitigate these declines and drive a strong backlog. Year to date, we've won well over 50% of these mega competitions. In advanced materials, we're expecting core organic sales to be down slightly, principally driven by timing in Fluorine Products.
PMT segment margins in the quarter are expected to be up 300-320 basis points, driven by strong productivity net of inflation and the favorable margin impact of raw materials passed through pricing in Resins and Chemicals. While the fourth quarter will again be challenging for PMT, our disciplined cost management and productivity initiatives give us confidence to deliver on our commitments. Let me move to slide 10, where I'd like to review our full year 2015 outlook. Our sales are now expected to be approximately $38.7 billion, up approximately 2% core organic and down 4% reported versus the prior year. As for segment margins, we're expecting the full year to be approximately 18.8%, up 220 basis points or 180 basis points, excluding the fourth quarter OEM incentives from 2014.
This puts us well above the high end of the margin rate guidance we shared with you last December and on track to achieve our 2018 long-term targets. There are some puts and takes among the segments since our last update, but we continue to have confidence in the segment margins for each business, roughly 21% for both Aero and PMT and 16.5% for Aero. Strong performance across the portfolio, and as Dave mentioned earlier, we're confirming our full-year EPS guidance at approximately $6.10, representing 10% growth. While there's still work to do to ensure we deliver on our full-year results, we have commenced our 2016 planning. On slide 11, I'd like to walk you through some of our key planning assumptions and initial thoughts by business. The table you see depicts our initial 2016 view by business compared to 2015.
Just so I'm clear, neutral indicates a similar growth rate in 2016 as 2015. Likewise, plus indicates a stronger growth rate in 2016 versus 2015. In Aerospace, commercial OE growth will be in line with 2015. Our strong positions on successful platforms will drive continued shipments of new engines to key OEMs following double-digit BGA OE growth in 2015. On the ATR side, we expect slightly better growth as production of the Airbus A350 ramps. These and other new platforms will continue to support growth in our ATR and BGA installed base and service business as we move forward. Our aftermarket business will be slightly better in 2016 due to continued strength in airline repair and overhaul activities and higher engine maintenance events in BGA, tracking in line with flight hours.
Our aftermarket business will continue to fluctuate based on flight hours and maintenance events, inventory levels, and customer buying patterns. Defense & Space sales are expected to be largely in line with 2015 or approximately flat to up slightly. We anticipate the U.S. portion of the business will continue to stabilize as we benefit from our strong installed base and service offerings. Our international business should continue its strong performance despite facing tougher comps year-on-year after several quarters of double-digit growth in 2015. As Tim highlighted back in March, direct international sales are expected to be about 35% of our Defense & Space business by 2018. It will remain a growth engine for us as we move forward. Finally, we expect growth in transportation systems from new platform launches and steady volume growth in light vehicle gas applications globally, particularly in Europe.
Similar to 2015, we expect to see moderate headwinds from lower commercial vehicle sales. Also anticipate that the steep declines in CV sales will moderate. Overall turbo penetration continues to grow as OEM develops global engine platforms, which can fill needs in multiple markets, and we believe we're well positioned to meet those OEM demands and win a significant portion of all new platforms. As a reminder, a majority of our FX exposure is in Aerospace within transportation systems. Based on today's rates and our FX hedging strategy, we continue to expect a year-over-year EPS headwind in 2016 of roughly $0.15. For ACS, we're expecting growth similar to what we've seen throughout 2015. Roughly 20% of the ACS portfolio is in residential markets, with the remainder serving the commercial and industrial markets.
Growth in ESS will be driven by new product introductions and further penetration in high growth regions. Our Security and Fire business is well positioned for continued growth, and we expect that our energy efficiency and connected products and technologies will drive further outperformance. As we've mentioned, the acquisition of Elster is expected to add approximately $2 billion in annual sales. The sooner we close the deal, the better. On the industrial side, we don't expect any near-term improvement to the headwinds we're facing in industrial safety and also see more difficult comps in S&PS after four straight quarters of double-digit growth. In BSD, we expect the Americas distribution business to continue to perform well and that the Building Solutions backlog and service bank will continue to grow. However, we expect a continued slow conversion into revenues, particularly in Americas and Europe.
Moving to PMT, we do expect improvement in HPS growth rates driven by the strong backlog and improving service bank. In UOP, we've seen increased levels of project quotations, and the UOP team is optimistic of strong fourth quarter orders. The backlog of equipment and gas processing orders will be down year-over-year, which will make growth in 2016 challenging. UOP expects sustained catalyst demand after growth in the mid-single digits in 2015. In advanced materials, we expect to benefit from our significant Solstice wins as demand for our next generation refrigerants continues to grow, and we build upon our over $3 billion in signed agreements. We're continuing to make significant CapEx investments in UOP and Fluorine Products, and 2016 will be at a similar level of spend to 2015.
This will support an expansion of catalyst production capacity in both the U.S. and China, including MTO and other catalysts, as well as growing backlog of Solstice orders. Looking at segment margin, we have strong confidence in our ability to sustain the pattern of expansion you've come to expect from us, even in this slow growth environment and even with the potential foreign exchange movements I mentioned. As we pointed out, we continue to have opportunity to close the margin rate gap versus our peers. It starts with new products. They are almost always margin enhancing, and our investments to develop new products are sacrosanct in Honeywell, as evidenced by our R&D as a percent of revenue averaging approximately 5% over the last three years. Our HOS Gold enterprises have the market and customer connection to ensure that the R&D spend is properly allocated.
Pricing has also continued to hold up well. We have a standard pricing methodology, tools, and organization focused on maximizing value capture. We're as equally focused on cost. The Honeywell Operating System permeates everything we do. Take our number one cost category, direct and indirect materials. We continue to mature our already world-class sourcing processes and tools, which are creating an ongoing productivity paradigm. We're also continuing to invest in value engineering to lower our existing BOM costs and make products easier to produce. There is also our factories. The HOS methodology is pervasive throughout the supply chain, and in every one of our factories, you can see the lean manufacturing, supplier kanbans, visual process management, and collaboration that makes HOS work. Also, our creation of production centers of excellence, where we perform similar activities in one place, is starting to mature and pay off.
An example is our electronics manufacturing COE in ACS, where we're now producing printed circuit boards in one location instead of seven. Our high growth region footprint is providing a low cost base to support this consolidation, one where we derive the benefit of the stronger U.S. dollar as well. In addition, our functional transformation and organizational effectiveness initiatives designed to improve quality of support to the businesses and reduce costs are stronger than ever. We have dedicated teams supporting FT efforts in our back office organizations like IT and finance, and we're confident that these groups can drive sustained productivity while improving service levels. Backing up all these efforts is our restructuring pipeline. We have over $300 million in unspent funding that will enable us to support the initiatives I mentioned.
We're in the middle of our Annual Planning Process, and we look forward to providing you more details regarding our 2016 guidance during our outlook call on December 16th. Let me sum it up on page 12. Once again, we've demonstrated we can deliver on our earnings commitments despite limited help from the macro environment, a big reminder of the value of our diversified and balanced portfolio and of the strength of the Honeywell Operating System. We met our margin expansion and earnings growth expectations in the quarter, with margins expanding in each business as we continue to execute well across the portfolio. We did this while maintaining our focus and investment for the future as our investments in new products and technologies, high ROI CapEx, process improvements, restructuring, and high growth regions continue to grow.
As we head into the fourth quarter, we expect earnings to grow again 10%, which will set us up for our sixth consecutive year of double-digit earnings growth. We've had good momentum on margin expansion and free cash flow conversion, which will continue as we close out the year. There'll continue to be puts and takes across the portfolio as we head into 2016. Our strong segment margin performance and balance sheet capacity give us the confidence and flexibility to manage through the uncertain economic climate and provide a good foundation for continued earnings outperformance in 2016 and throughout our five-year plan. With that, Mark, let's move to Q&A.
Heather, if you could, please open the line for Q&A.
Certainly. 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 star two. We ask that when you pose your question, please pick up your handset. Thank you. Our first question is coming from Scott Davis with Barclays.
Hi. Good morning, guys.
Hey, Scott.
It's good to see a decent print in what's been a pretty crappy tape overall.
Well, thank you.
You're keeping the wheels on. In that spirit, it's interesting. You've done a lot of what you call seed planting over the years, and your margins are exceptional. The core growth continues to be just a little shy of global GDP. What do you really attribute the lower core growth and the beats on margins? What I mean is that is the seed planting and such and the new products, is that more of a margin mix shift, improving position, and you're willing to trade some volume for margins? Or is it just a function really of the end markets you're selling into?
I'd say it's a combination of things, Scott, and I think you touched on most of them. One is, it is a slow growth environment overall. Within that, with the new product launches that we've done, those end up being margin-enhancing launches. As we also said back in the Investor Day a couple of years ago, that we were really going to start to see the sales inflection as we got towards the end of 2016 and into 2017, as we got the plant expansions done, the aerospace launches occurred. We pretty much expected it was going to work out this way. In the meantime, we had a lot of seed planting we'd done on the process improvement side, which continues.
There's just a lot of process improvement still available to us, which is going to allow us to continue to expand margins at the same time that we invest in R&D. From an overall sales perspective, while I wish the macro environment cooperated a little more, certainly it's less than what we expected at the beginning of the year. We're going to continue to deliver very well on that sales growth because we anticipated that it was going to be on the lower side for 2015 and some into 2016, but that the inflections would occur after that.
Right.
Tom, anything you want to add?
It makes sense. Dave, you've been doing this a long time, and we see at least, or those of us been around a while, see some similarities here in 2015 to 2001, and even end of 2007 or early 2008. How do you think about the weakness in emerging markets and the falloff, and how that increases risk, at least, I'll just call it a recession risk, that a small event could take us off the cliff. How do you think about that, and how do you plan for it?
From my perspective, it feels like markets really think there's a chance of a recession here. I guess while there's always a chance, if there were some untoward terrorist event somewhere or something drastic like that, I really don't see that. This feels a lot different than it did in 2001 or 2008 to me, just because after a great recession, we've never really had a recovery. 2010 was the only real recovery year that we had. After that, it's really been a slow growth environment, and I think that's kind of what we can expect over the next two or three years and just the way we ought to think about things. I don't see a boom coming. By the same token, I don't see a crash coming.
I really think that the ability to perform in that kind of slow growth environment is what's going to differentiate companies. That's the way we're planning. That's the way we're thinking about things. As you know, we always tend to be conservative on sales, and we're going to continue to do that, especially in this kind of environment.
Yeah.
Does that help?
Yeah, it does. I went back and I read all the transcripts from 2008, and everybody held on, held on, and held on, and somewhat similar comments. Then all of a sudden, the wheels fell off. If you're in our job at least, you have to start scenario analysis planning here. It's feeling a little sloppy, that's all.
Well.
Don't disagree with your assessment.
No, I can understand the transcripts, but if you look at debt position of, say, just the American consumer back then versus today, very different. Bank capability, bank reserves, they're very different then than what we're dealing with today.
Yeah, certainly on credit. Okay. I'll pass it on. I know you have lots of questions. Thanks, guys.
We'll take our next question from Jeffrey Sprague with Vertical Research Partners.
Thank you. Good morning, everyone.
Hey, Jeff.
Hey, guys, I was wondering if we could drill a little deeper into UOP, and what you're actually expecting in Q4 in terms of catalyst and other activity. Just triangulate us some. Where does that bring UOP for the year in terms of year-over-year change versus the prior year for the total year? Really where I'm going with that too then is just thinking about your framework for 2016, the reduction that you're looking for in activity. Is that actually an outright decline in UOP for 2016? Any other color there you could give us would be helpful.
All right. Some overall comments, then I'll turn it over to Tom. I'd say you're going to see at least three different phenomena, I guess. One would be what happens on orders, what happens on sales, what happens on catalysts. From an orders perspective, that's been declining, as you know, and it's been a little lean here during this year. I would expect next year, orders activity is going to pick up, and we see that already, as Tom mentioned, on quotes activity. We expect the backlog to start building again next year. When it comes to sales, because of the lag from backlog to sales, we expect that sales will be down next year in UOP versus this year, largely because of that backlog completion and the time it takes to build it back up again. The third phenomenon, catalysts.
We've seen that starting to pick up again, which is a very good sign, as you know. We also feel that there's this unrequited demand at this point for refinery reloads. That refinery's been making a lot of money, they haven't wanted to ever shut down to reload and have preferred dwindling yields to shutting down and getting the better productivity. In other words, wanting to produce while the timing and pricing was in their favor. We've seen catalysts start to pick up, and we expect that that'll continue through next year. You put all those together, next year we expect sales to be down, but orders backlog to start building up. This is just why we have a diversified portfolio.
I always say diversity of opportunity for us to be able to manage that because it will come back, and I have no doubt in a very good way. Tom, anything you want to-
Just to put a little more specifics on it. Definitely as Dave said, orders have been down, particularly on the equipment and gas processing side. With that said, there's a very strong pipeline for the fourth quarter. We track the quotation activity in our salesforce.com applications, and we are seeing a significant amount of inquiries and requests for proposal and the like. We've got visibility to what could be a strong fourth quarter for orders. In terms of the backlog, by the end of the year, sure, it'll be down year-over-year, but it's not going to be earth-shattering down. Could be high single digits, maybe slightly into double digits, but that will be manageable.
On the catalyst side, they're having a fantastic year, and they had a fantastic orders quarter in the third quarter, and it's going to lead to a really strong fourth quarter on the catalyst side. We'll probably be mid to high single-digit growth on catalysts for the full year. We hope to sustain that level of sales in 2016 on catalyst to offset the pressure that you'll see a bit from the backlog that I mentioned.
Jeff, I should add on the process control side, we actually expect sales will be up next year versus this year as we start to see the benefit of those mega projects that we've won.
That was going to be my follow-up question, and you answered it, so I'll let it go there and pass the baton. Thank you.
We'll take our next question from Joe Ritchie with Goldman Sachs.
Thanks. Good morning, everyone.
Hey, Joe.
Hey, Joe.
Maybe I will follow up on that last point on HPS because it seems like the growth in HPS clearly hasn't been as bad as some of your competitors. Maybe you can comment a little bit on the share opportunities there and what, if anything, you're seeing in terms of pricing pressure in that market.
Well, it's a tale of two cities. On the short cycle side, we have seen the decline there that we've talked about. On the other side, looking at these big projects, the mega projects where we've always said that is really where our big market is and where we do particularly well because of the complexity and the numerous amount of input and output points that you have to maintain. We've always done well there. We've done really well over these last couple of years, winning a lot of these big orders that are going to do very well for us and plant the seeds for the future.
When you put all that together, while this year has been a little tougher because of that short cycle impact and the fact that the mega projects don't come in right away, that reverses next year, and we start to see the benefit of that mega project coming through.
The other thing I would add, Joe, you asked about pricing in Process Solutions. It is holding up well. As you might expect with the discretionary cuts in our customer base that you'd see some pressure there. The technology that we have really allows us to deliver some value that we're capturing pricing on. It's holding up fairly well in that segment.
Okay. No, that's helpful. Maybe kind of following up a little bit on Scott Davis' comment from earlier and asking explicitly, we've been in an organic growth, call it the doldrums, for the last few years, then your margin expansion has been really impressive. You've been able to eke out double-digit earnings growth. As you look into 2016, is there an opportunity for you guys to continue to do double-digit type growth in the environment that we're in today?
Well, I'd say that's certainly one of the things we're going to be looking at as we go through our AOP planning. As I've probably mentioned in the past, we started planning for 2016 in particular back in January of this year, recognizing that the kind of macro environment we were in, that it would require more advanced planning than I'd say a lot of companies do when it comes to how far out you look. We're going to talk a lot more about that at the December call. I fully expect that in a slow growth environment, we're going to continue to expand margins in a way that people are going to like.
Okay, fair enough. I'll get back in queue and give somebody else a shot. Thanks, guys.
I used as many words as I could, Joe Ritchie, to not give you the answer that the numbers are going to look.
That's fair enough. I expected you to.
We'll take our next question from Howard Rubel with Jefferies.
Thank you very much. Dave, your China numbers were pretty good. Could you elaborate a little bit on that? It's probably a tale of multiple cities and products as to what worked, what didn't, and how are you seeing the environment?
Well, yeah, you're right. China's a bit of a, let's say, a dichotomy at this stage because there are some things that are still doing well and some things that aren't doing so well. Depending upon which company you talk to, you can end up on either side of that. We're one of the guys that are doing pretty well overall. I'd say we are seeing the oil and gas negative impact there, just like we are around the rest of the world. When we take a look at our aero and turbo business, that's doing fine. When we take a look at ACS in particular, that's doing great. Still doing double digit, and as you know, it's been very good for the whole year. I'd say driven by a couple of things.
One is the kind of seed planting that we've done in the past that we've talked about, where we want to be the local guy, and to have more mid-market product, and that's really helped us to be able to expand the markets that we serve. Pulling together all of the ACS stuff into a single China operation has helped us a lot there also. I think a good chunk of it is just our increased competitiveness and the ability to go after mid-market. On the other side of it, the second point of it, we're still in a decent spot. When you take a look at the overall need for construction, retrofit, old buildings, there's still a lot of upside there for us with ACS. I'd attribute it to the two. Tom, I don't know if there's anything you want to add.
No, I think you hit on them all, Dave.
Just as a follow-up and a little bit broader, a lot of the results were driven by productivity or HOS Gold or some things like that. This has been a terrific program for a long time. How do you modify it or change it so that people don't become complacent?
The other thing I would add in that is all the new products that we add, that we introduce into the system that have higher margin rates than what we had before because of the value it's able to provide to the customer through either HUE or combining functions or being able to give them a better price with better performance. That really does make a difference over time. It just makes you much more competitive and a lot more profitable. That impact is in there also. In terms of keeping it fresh, that's not that difficult, I'd say, for us to do. I oftentimes say the only thing that I ever worry about when it comes to Honeywell generally is if we lose our hunger. I don't think that's going to happen.
Everybody's still pretty hungry and wants to perform, and we want that multiple premium that we think we deserve, and we're going to keep doing everything we need to to get it. I can promise everybody's thinking that way.
Thank you very much, Dave.
You're welcome.
We'll take our next question from Andrew Obin with Bank of America Merrill Lynch.
Hi. Yes, good morning.
Hey, Andrew.
Andrew.
Hey, great execution in a tough environment.
Thanks. Much appreciated.
Hey, a question on BSD conversion. It has been slow for a while. What do you think it really takes for it to pick up, and when was the last time we saw that kind of phenomena?
Yeah, I think, Andrew, you're referring to the orders phenomenon.
Yeah
about the backlog. Yeah. Well, I think that it's interesting that the mandates on the federal side by the president have been pretty clear to the agencies. They've gone out and done all the RFP work. They've found the vendors that they want to work with. They've held the competitions, right now they're in a state of needing to move to close these out and actually get the work implemented. We're seeing some delays on that as they go through the budgeting process for next year. I fully expect that as they are preparing budgets, particularly on the federal side, that this will be a factor that they have to consider and incorporate.
When was the last time we saw something like that?
Yeah, I don't recall.
Me neither
experiencing this in.
This one's kind of unusual, I have to say. We've been a little surprised by it ourselves. It just shows there's a lot of pent-up demand out there. You are dealing with government, they don't always move as quickly as any of us might like. That's all going to play in at some point here.
Can I ask you.
I would say it's a good deal for them. This is one of those things where, with no money out from them, they end up saving money, which oftentimes takes them some work to be able to understand and convince others, but once they do, it generally gets there. I'm pretty confident this stuff's going to convert. It's a question of timing.
If you can give us a preview, and I know you guys are going to have a call about this, but just in terms of five-year plan, if you look at revenues, it's no surprise, I think that the revenues are running at the low end of the low end of expectations. At the same time, if I look at the margin performance, it's just amazing. How should we think this framework growth versus margin in the longer term? Do you need to adjust people's behavior inside the company to get more margin in a lower growth environment?
I'm not worried about changing behaviors to get the margin rate performance, because we're doing all that stuff now, so it's going to work out. That'll work out fine. When it comes to how do we perform versus the five-year plan, who knows what the economy does in 2017 and 2018? As I oftentimes say, the future has this odd way of unfolding differently than all of us predict, and while I'm predicting slow growth right now, there is a chance it could go the other way around. I don't see a recession. However, there is a chance that this could just become something a lot better. Put all that together, and I'd have to say the sales growth, to your point, that we estimated in the five-year plan, looks sporty at this point, even with the inflection that we're expecting.
On the margin rate side, still have high expectations there. As you recall in the Investor Day, one of the things we tried to show was not just the five-year plan, but where we thought each business and the company could get to. When you look at that, I'm pretty sure we had a chart in there a couple of years ago when we did this. When you look at that, you see, geez, there's still a lot of room to penetrate, and we have higher margin rate peers in every single business that we're in, and for the company in total. We're going to be able to continue to drive that, and everybody in the company is driving to those long-term numbers, not just achieving the five-year plan.
Terrific. Thank you very much.
You're welcome.
We'll take our final question from Gautam Khanna with Cowen.
Hi, good morning. I have two questions, if you wouldn't mind. You mentioned the strong bid pipeline for the Thomas Russell natural gas processing opportunities. I was just wondering, if you were to book a couple of those in the next few quarters, could that actually backfill the decline you're expecting at UOP next year? Are these projects mostly for delivery beyond 2016? I had a quick one on the aftermarket as well.
I'd say on the gas side, to the extent that we get those orders, we can turn them pretty quickly. We're going to stay conservative on what do we really expect when it comes to orders. We were encouraged that we got a couple of orders there in this past quarter versus none in the first six months of the year, and we're hopeful that we land a couple more in the fourth quarter and early next year. Too early for us to commit on that. In terms of would that alone be enough to not have a decline in UOP sales next year, I'd say that's unlikely. Most likely, what we're going to be dealing with is a sales decline when it comes to UOP.
As you know, catalysts are pretty good for us, and we expect that catalyst to perform well, and that's, let's say, good mix to have.
Fair enough. Thank you. If you could talk a little bit more about the commercial aerospace R&O spares trends. You mentioned some of the geographies were weak. Do you think there's been destocking going on in certain geographies this year? Can you also talk about provisioning this year and perhaps next year, given the A350 ramp you cited on the OE side? Thanks.
Well, a couple of comments, then I'll turn it over to Tom. Trying to understand exactly what is happening out there when it comes to spares is always work, because you've probably heard me say this before, but it's kind of an amorphous blob in terms of trying to understand what's in there and what's happening. As a result of that, it's another reason we tend to stay pretty conservative in terms of what we expect. Overall, though, we'd expect continued spares growth next year. It may show as in the repair and overhaul area, rather than what we might define as spares. Overall, we'd expect growth to continue there. There has been some softness in China that we've talked about. The overall way to look at it, I think, the indicator that I always pay attention to is what's happening on flight hours.
As long as flight hours are growing, it means that there's going to be a demand and pull for spares and repairs of some kind, and that's the overall long-term phenomenon that matters. How it plays out in the short term is a little tougher to figure out. Tom?
Yeah, you pretty much said it, Dave. The R&O work that we do does consume a lot of spares, and that R&O business is growing very strongly. When you consider them in their totality, it's very healthy, and it is in line with the flight hour growth. That's what we expect to continue. Yeah, maybe there's some consolidation in airlines or different buying behaviors. Overall, we've become accustomed to those and dealing with it with our approaches. I expect us to continue to be in line with flight hours.
Provisioning, do you expect any change there year-to-year?
I think year-over-year it should be fairly stable.
Okay. What % of the ATR aftermarket today is provisioning, if you could just remind us?
I don't think we go into that generally. Nice try, though, Gautam.
All right. Thanks a lot, guys.
All right, bye-bye.
That concludes today's question and answer session. At this time, I'll turn the floor back over to you, Dave Cote, for any additional or closing remarks.
Thanks. We're quite pleased with our continued ability to deliver double-digit earnings growth even in this slow growth economy. We recognize that kind of outperformance is what you have come to expect from us, and we intend to continue outperforming. The growth programs that we have funded in every business and region will continue to deliver, and even more so in the future. That growth, combined with continued process improvements from things like HOS, functional transformation, and HUE and the like, will add to our capability to grow margin rates. We look forward to continuing to deliver for our investors. Thanks.
That does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day.