Please stand by. Good day, ladies and gentlemen. Welcome to Honeywell's second 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 touch-tone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the star key, followed by the digit two. Lastly, if you should require operator assistance, please press star zero. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mark Macaluso, Vice President of Investor Relations. Please go ahead, sir.
Thank you, Lisa. Good morning. Welcome to Honeywell's second quarter 2015 earnings conference call. With me here today are Chairman and CEO, Dave Cote, and Senior Vice President and Chief Financial Officer, Tom Szlosek. 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 will review our financial results for the second quarter and share with you our guidance for the third quarter and full year of 2015. Finally, as always, we'll leave time for your questions at the end.
With that, I'll turn the call over to Chairman and CEO, Dave Cote.
Morning, everyone. As you've seen, Honeywell delivered another quarter of double-digit earnings growth, capping off a strong first half to the year and positioning us well to achieve our full-year outlook as we head into the back half. Reported earnings per share of $1.51 increased 10%, normalized for tax, coming in at the high end of our guidance range for the quarter. Sales of $9.8 billion were up 3% on a core organic basis. We saw organic growth accelerate in both the short and long cycle businesses within Aerospace, continued growth in our commercial and industrial businesses within ACS, and higher volume across our advanced materials portfolio, particularly in fluorine products. Each of our business segments achieved the sales estimates we provided in April, and we expect that the sales acceleration we enjoyed this quarter will continue into the second half of the year.
The absence of friction materials, strengthening of the US dollar, and raw materials pricings in resins and chemicals drove the difference between reported and core organic sales growth. Segment margin expanded 170 basis points to 18.4% in the second quarter. Similar to last quarter, a large portion of the margin expansion came from improving gross margins. Strong execution across the portfolio drove margin expansion in each of our three segments, at or above the targets we communicated in April. Our enablers and key process initiatives continue to deliver growth and productivity benefits, our previously funded restructuring actions provide the runway we need to continue improving our operations and cost base. We're keeping that pipeline full, which is critical to supporting our continued margin expansion into next year and beyond.
We proactively funded about $39 million of new restructuring in the quarter, building on a healthy pipeline of new projects. While managing cost is critical, we're also seed planting, that is investing in capacity expansion, new products and technologies, and resources in high-growth regions to drive future growth. We also continue to benefit from the strategic portfolio decisions we've made in the past and we're well positioned and aligned to favorable macro trends with significant runway to grow. There continues to be a lot of exciting activity across the portfolio, driving our strong results, so I can't help but highlight a couple. In June, our Process Solutions business hosted their 40th annual Honeywell User Group, or HUG, Americas Symposium, a forum that provides users of our process control and industrial automation systems an opportunity to exchange technical information and provide feedback on their equipment and service needs.
The sentiment was decidedly positive, the turnout of over 1,200 channel partners, end users, and Honeywell sponsors from over 300 different companies was our largest ever. Customer interest in Process Solutions that drive increased safety, reliability, and greater efficiency was noticeably higher than prior years. In addition, Process Solutions announced a partnership with Intel Security to help bolster protection of critical industrial infrastructure and data, combining the latest advances in cybersecurity technology with Honeywell's unique industrial process domain knowledge. Another example of our smart investments and commitment to growing our software capabilities, which we see as a key differentiator. In aerospace, we announced last month an agreement to supply our advanced Primus Epic cockpit technologies to Dassault's newly unveiled Falcon 5X.
The new plane combines the latest features for safety and performance, including SmartView Synthetic Vision, Next Generation Flight Management System, IntuVue Weather Radar, and SmartTraffic Collision Avoidance while achieving the lowest fuel consumption in its category. Our aerospace team at Dassault developed the next-generation cockpit with the future in mind, giving pilots and operators advanced communication, vision, and awareness features that simplify their jobs. In PMT, our fluorine products, additional $600 million in orders with key OEMs for our Solstice low global warming suite of products. Bringing the lifetime value of signed agreements to approximately $3.2 billion. We also have an additional $200 million in agreements currently under negotiation, which we anticipate finalizing by the end of the year. Our Solstice product has global warming potential less than CO2, making it a terrific choice for products and for companies seeking to reduce their carbon footprint.
EPA phase-out rules restricting the use of high global warming hydrofluorocarbons, or HFCs, in a variety of applications, including refrigerants, aerosols, and foam insulation blowing agents, coupled with approvals for the use of two additional Honeywell Solstice refrigerants as replacements for high global warming HFCs, continue to show that we're invested in the right place. The demand and adoption of Solstice products continues to be a great story for Honeywell. As we look ahead, we're not counting on a significant uptick in the current macro environment, but we are confident in our ability to deliver continued sales growth and to leverage that growth to drive further margin expansion. As a result of our strong first half performance, we are again raising the low end of our full year 2015 earnings guidance range by $0.05 to a new range of $6.05-$6.15, up 9%-11% versus last year.
We have a fantastic portfolio. We'll continue investing in high growth regions, high ROI CapEx, and new products and technologies while maintaining our cost discipline and ensuring we deliver the savings from restructuring projects funded over the past few years. We're in the midst now of our strategic planning reviews with each of the three segments. We're excited about each business's innovation pipeline and growth opportunities. Over the next planning period, you can expect us to build on our track record of outperformance through the consistent execution you've come to expect from Honeywell. We continue to enhance our focus on each of the 74 HOS Gold enterprises, which we believe will make us more entrepreneurial and nimble versus our competitors by identifying breakthrough strategies and moves into smart new areas and adjacencies. I look forward to sharing more with you, of course, as the year unfolds.
With that, I'll turn it over to Tom.
Thanks, Dave, and good morning. I'm on slide four, which shows the second quarter results. Sales of $9.8 billion were up 3% on a core organic basis. Each of our segments met or exceeded the top-line guidance we provided in April, led by our commercial Aero, the commercial and industrial businesses within ACS, and advanced materials. I'll talk about each of these more on the business slides. We're encouraged by the acceleration from Q1 and the momentum we have exiting the second quarter bodes well for the second half. As Dave mentioned, the friction materials divestiture, foreign currency, and the raw materials pricing in resins and chemicals all resulted in the reported sales decline for this quarter. Segment margin expanded 170 basis points to 18.4%. That's 20 basis points above the high end of our guidance.
Each segment is contributing to the impressive profit growth and margin expansion this quarter, good volume and strong operations are playing a big part. On the volume side, our continued investments for growth in sales, marketing, and new product development drove higher volumes in the quarter. On the operating side, we continue to drive improvement in our gross margin rates and continued moderation of our G&A rates through HOS Gold deployment and our focus on commercial excellence, new product development, functional transformation, and strong cost controls. Items below segment profit were favorable on a year-over-year basis, as we had anticipated. Higher pension income was largely offset by additional restructuring. New restructuring projects funded this quarter were approximately $39 million, building on our over $300 million-plus pipeline as of the end of Q2, which positions us well for continued margin expansion throughout our five-year plan.
We delivered at the high end of our EPS guidance range with earnings per share of $1.51, up 10%, normalized to our expected full-year tax rate of 26.5% in both periods. Once again, achieving double-digit earnings growth this quarter. Free cash flow, $1.2 billion, 5% higher than 2014. Free cash flow conversion was 98%, and we expect to be in a net cash position of between $1 billion and $2 billion by the end of the year if there's no significant M&A activity. Overall, we continue to generate strong results in a relatively slow growth environment. Let's turn to slide five. Our segment margin rate expansion was again very robust this quarter. As you can see, a majority of the improvement is coming from our operating initiatives. The benefits of HOS Gold are paying off, and we're seeing that in every segment's gross margin rate.
We have attractive products with differentiated technologies and a software focus. Our factories and supply chain are well run, our back office continues to get more and more efficient. In addition, new product introductions and further penetration in high growth regions, particularly at ACS, where we grew close to 10% in China and greater than 15% in India during the quarter, are also a big part of the story. The previously funded restructuring as well as new restructuring actions enable us to continue to improve our overall cost position. Our segment margin rate was positively impacted by the friction materials divestiture, our foreign currency hedging approach, and the resins and chemicals pricing model, collectively to the tune of approximately 60 basis points. We sold friction materials in July of 2014, so we'll lap this benefit in the second half of 2015.
This is a permanent improvement to our margin rate from exiting a business that did not meet our great positions in good industries criteria. On foreign currency, our hedging strategy, as you know, is to protect our operating results even as sales do fluctuate with changes in currency. Another solid quarter of margin improvement, driven by our operating system and key process initiatives. Moving to slide 6 on the aerospace results, sales up in the second quarter, 3% on a core organic basis, above the high end of our guidance range, driven by good volume growth and execution. Commercial OE was up 6% on a core organic basis, driven by double-digit improvement in business and general aviation engine shipments. Engine demand continues to be robust, we expect to see continued commercial OE growth in the second half, particularly in BGA.
Air transport was flat, a reflection of the pluses and minuses in our customer build schedules for the quarter, while on the regional side, we saw lower sales volume overall. Importantly, our installed base continues to grow in both ATR and BGA, which is a good sign for our future aftermarket business. To that point, commercial aftermarket saw a nice improvement from the first quarter. Sales were up 3% on a core organic basis, driven by continued strong growth in Repair and Overhaul activities and higher ATR spare sales, partially offset by lower BGA RMUs, or retrofit modifications and upgrades, in many cases, software-based. RMU sales growth can be lumpy based on the timing of new product rollouts. As you recall, 2014 was an extremely strong year for RMU sales. Looking forward, we're excited about our new product pipeline in this area.
Overall, we saw good growth in the aftermarket and anticipate further improvement in the third quarter and through the second half of the year. Defense and space sales were up 1% on a core organic basis, driven by near double-digit growth in our international defense business. Here, we continue to see strong demand in the aftermarket and for our training propulsion engines and missile navigation products in South Korea and other high-growth regions, including Turkey. While in the U.S., our sales were slightly down. Finally, transportation system sales increased 5% on a core organic basis due to new platform launches, strong volume growth in light vehicle gas applications globally, and growth in diesel applications, particularly in North America. This was partially offset by lower commercial vehicle volumes. On a reported basis, TS sales declined 25%, reflecting the friction materials divestiture and foreign currency headwinds.
On segment margin, the favorable impacts of the friction materials divestiture and our foreign currency hedges were drivers of the 140 basis points expansion in Aerospace, along with commercial excellence and productivity net of inflation, partially offset by the margin impact of higher OE shipments. TS was a major contributor to the margin enhancement Aerospace this quarter. Not coincidentally, that's a business where we see the greatest advancements in our HOS Silver certifications in our plants. Let's turn to the ACS results on slide seven. ACS sales were up 4% on a core organic basis in the second quarter, continuing the positive core organic growth trends we saw in the first quarter. High growth regions continue to stand out in ACS. We have good momentum heading into Q3 based on recent order trends. The margin expansion was robust.
We once again exceeded the high end of our margin guidance range. ESS, the products business, sales were up 5% on a core organic basis in the second quarter, driven by strong performance in our scanning mobility, fire safety, and security businesses. Scanning mobility achieved its third straight quarter of double-digit core organic sales growth, driven by volume from recent wins, most notably the U.S. Postal Service agreement, and new product introductions in China, where we continue to build on our E3 pipeline to support future growth. We anticipate similar volume growth in the third quarter. We'll discuss in more detail shortly. The rest of ESS also continues to benefit from new product introductions and further penetration in high-growth regions. From a regional perspective, China was up high single digit, while in India, sales were up over 15%, with broad-based strength across the ESS portfolio.
Building Solutions & Distribution sales were up 3% on a core organic basis in the second quarter, with continued strength in the Americas fire and security distribution business. We saw continued organic growth in our project backlog and service bank this quarter, driven primarily by the Asia Pacific region, which will help to support a modest acceleration in the back half of the year. ACS margins expanded by 120 basis points to 16% in the quarter. The business continues to benefit from good conversion on higher volumes and significant productivity improvements net of inflation. We also continued our investments for growth, particularly in new product development and in high-growth regions.
Our efforts to drive the more connected ACS, which Alex spoke about at our March Investor Day, provide a runway for accelerating growth and continued margin expansion as we drive incremental synergies among our businesses through supplier rationalization, footprint consolidation, and back-office improvements. In total, another strong quarter of sales growth and margin expansion in ACS and continued outperformance in their key high-growth regions. I'm now on Slide 8 to discuss PMT results. PMT sales in the quarter, $2.4 billion, down 1% on a core organic basis, consistent with the guidance we presented last quarter. We exceeded the high end of our segment margin guidance by 70 basis points, driven by strong execution and productivity actions.
Starting with UOP, sales were down 8% on a core organic basis due to declines in our gas processing and equipment and engineering businesses and the timing of catalyst shipments, which we had previewed. Orders were down in the second quarter throughout the business, which is adversely impacting backlogs. However, activity in our gas processing business, both domestic and international, is encouraging, and we expect orders in that business to accelerate in the third quarter, which, along with the timing associated with catalyst reloads, will offset some of the softness we are seeing in UOP. In Process Solutions, our portfolio is broader and more diverse than our competitors. We have a unique combination of automation technology, field instrumentation products, and aftermarket offerings in the form of contracted and spot service, software and consultative solutions that our competitors do not have.
While our short cycle field instrumentation business faces headwinds like many others in the industry, we are seeing sales growth in our high-margin software and service businesses. Customers are looking to our optimization solutions for productivity enhancements to their current asset base. Overall, HPS core organic sales were down 4% and our orders were down only 2% in the quarter. Our large projects business had strong orders in the quarter, particularly in the Middle East, where we see infrastructure investments continuing. The HPS backlog is solid and increased over 15% organically, which gives us confidence in our growth projections. Advanced material sales were up 8% on a core organic basis. The growth was broad-based across the entire portfolio. Fluorine products grew double digits for the fourth straight quarter as demand for Solstice's low global warming products continued to escalate.
As Dave mentioned, we presently have roughly $3.2 billion of signed agreements and another $200 million under negotiation. To date, in 2015 alone, we've signed over $900 million in new orders. In addition, sales in both resins and chemicals and specialty products grew on a core organic basis on higher volumes as new product introductions here continue to drive results. On segment margin, the PMT leadership team got out ahead of the market pressures to ensure we deliver the 2015 commitments. Q2 segment margins exceeded our guidance and were up 330 basis points to 21.3%. This was driven by significant productivity actions net of inflation, commercial excellence, and the impact of raw materials pricing in resins and chemicals, partially offset by continued investments for growth. PMT continues to aggressively pursue further cost reduction opportunities, which should help sustain the strong margin expansion we've seen in the first half of 2015.
I'm now on slide nine with a preview of the third quarter. We're expecting total Honeywell sales of $9.7 billion-$9.9 billion, which would be up 3%-4% on a core organic basis. Segment margins are expected to be up again, approximately 120-140 basis points, and we expect our margin rate to benefit from operational excellence and good execution similar to the first half margin expansion. EPS is expected to be in the range of $1.51-$1.56, which is up 6%-9% normalized for tax at 26.5% in both years. Aerospace sales are expected to be up 3%-4% 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 the mid to large cabin business aircraft.
In commercial aftermarket, we expect core organic sales to be up low to mid-single digit, with continued Repair and Overhaul and ATR spares growth, partially offset by modestly lower BGA spare sales. Defense and space sales are expected to be up low single digit on a core organic basis, driven by continued strength in the international business where we anticipate double-digit growth, offset by a slight decline in the U.S. In transportation systems, sales are expected to be up low to mid-single digit on a core organic basis, driven by both light vehicle gas and diesel turbo volumes. We expect Aerospace segment margins to increase 80-100 basis points in the quarter, driven by commercial excellence, further productivity improvements, and the favorable impacts of the friction materials divestiture, which we'll realize through July.
ACS sales are expected to be up 4%-5% on a core organic basis, with mid-single digit core organic growth in ESS and low single digit core organic growth in BSD. We expect that growth in ESS will be driven by our scanning mobility, fire safety, and security businesses, along with the benefits from new product introductions and high-growth region penetration. ACS margins are expected to be up 50-70 basis points, driven primarily by good conversion on higher volumes and continued productivity net of inflation. We will continue ramping up investments in new product development and adding feet on the street in high-growth regions. PMT sales are expected to be flat to up 1% on a core organic basis.
We're expecting UOP to be down mid- to high single-digit on a core organic basis, primarily due to licensing and equipment declines and difficult year-over-year comps in our catalyst business, but partially offset by modest growth in the gas processing business. In HPS, we're expecting core organic sales to be slightly better than the second quarter as growth continues in our higher margin software and service businesses, and we see a modest uptick in our process technology business driven by a conversion of large projects in the backlog. HPS continues to be a strong contributor to the margin rate improvement in PMT, driven by sales growth in our higher margin software and service businesses and productivity initiatives. In advanced materials, we're expecting high single-digit core organic growth, principally driven by continued strength in fluorine products, as well as improving volumes in resins and chemicals and specialty products.
Overall, PMT segment margins in the quarter are expected to be up 230-250 basis points Driven by strong productivity net of inflation and the favorable margin rate impact of the market-based pricing model in resins and chemicals. While the second half of the year will be challenging for PMT, the strong growth in our advanced materials portfolio and our disciplined cost management and productivity initiatives give us confidence in our forecast. Let's turn to slide 10 to address the trends we're seeing in our key end markets and discuss how they're impacting our outlook. On balance, you can see an overall positive perspective. Beginning with the non-residential portion of ACS, we expect acceleration in commercial construction spending and our positive outlook for the year, the full year remains intact.
We saw strong growth in our short cycle businesses in fire safety and security and expect that new wins, commercial excellence, and initiatives in high growth regions, as well as positive end market trends, will continue to drive growth in these businesses. As for building solutions, the firm backlog in our projects business and growth in our service bank support an improvement for the remainder of 2015. On the industrial side, we continue to benefit from the demand for productivity solutions and increasing safety standards across the globe as activity picks up in both the U.S. and in our high-growth regions. Overall, good momentum as we head into the third quarter after solid core organic growth in the second quarter. In aerospace, our outlook on the commercial aftermarket continues to improve.
Flight hours for air transport and regional are expected to grow at approximately 4.5% in 2015, slightly above 2014. On the business jet side, we expect that flight hours for large cabin aircraft will continue to grow in 2015, up mid-single-digit, reflecting continued healthy demand. We anticipate that the good growth we saw in RNO this quarter will continue in Q3 and Q4, while sales of BGA spares will also improve, in part driven by the RMU portfolio. Overall, we expect a modest acceleration in the second half of the year for aerospace, commercial aerospace, that is. In defense and space, we're seeing strong international demand as defense budgets continue to grow. This is supported by the high single-digit core organic growth we experienced in our international business in the second quarter and our strong backlog.
Although still a modest headwind associated with lower government funding levels, we expect the U.S. portion of the business to stabilize, consistent with U.S. DOD budgets. Overall, we remain on track for low single-digit core organic growth for defense and space in 2015. On oil and gas, we actually are seeing a very robust level of proposal activity in both UOP and HPS. In some pockets, orders are expected to accelerate, such as in the UOP gas processing business, where we expect a reasonably strong third and fourth quarter for modular equipment offerings outside the U.S. On the balance, we're not expecting a broader recovery for UOP order rates in the near term.
In Process Solutions, we anticipate continued growth in orders in the second half in our solutions and software businesses and expect that a good portion of the large process technology orders booked in the first half will also convert to sales. Activity in the Middle East should continue to be strong, while in other regions, including China and Southeast Asia, we anticipate a continued slowdown in order activity for Process Solutions. As for the rest of the Honeywell portfolio, commercial OE, Transportation Systems, the residential businesses in ACS, and advanced materials, we're expecting continued good growth in the second half. Our installed base in commercial OE continues to grow with good wins on the right platforms. Global penetration of turbo technology, particularly for gas engines, will continue, and our track record of flawless launches in TS remains a key differentiator.
On the residential side, we expect growth to continue as we accelerate investments in the connected home space and build on our strong position. In advanced materials, customer demand for our low global warming suite of products is increasing, and we are encouraged by the continued adoption of Solstice on a global basis. I'm turning to our full-year guidance on page 11. As Dave mentioned, based on our strong first half performance, we're raising the low end of the full-year EPS guidance range with a new range of $6.05-$6.15. Everything else is pretty much intact as we head into the second half of 2015. We've demonstrated our ability to perform in a challenging environment. We're highly confident we can do the same again this year. Full-year sales expectations remain in the range of $39 billion-$39.6 billion, up approximately 3% on a core organic basis.
There are some puts and takes among the businesses, overall, we remain on track to the full-year guidance we provided in April. On the segment margin, we've increased our full-year guidance by 10 basis points on the low end as our deployment of HOS Gold continues to drive a better, more efficient operating system, both in our plants and in our back office. We now expect segment margins of 18.4%-18.6%. That's up 140-160 basis points versus last year, excluding the impact of the fourth quarter $184 million aerospace OEM incentives. On EPS, the new guidance range results in a 9%-11% increase from 2014. Again, we're planning for a 26.5% tax rate in the third quarter, with fourth quarter tax rate a bit lower to get to our full-year planning assumption of 26.5%.
We continue to expect free cash flow in the range of $4.2 billion-$4.3 billion, up 8%-11% from 2014, even with CapEx investments rising to roughly twice that of depreciation. Each of the businesses remains focused on driving further working capital improvement in the second half. Overall, we're forecasting another very strong year. Solid organic sales growth and strong execution that yield excellent segment margin and free cash flow outcomes. Another year of double-digit EPS growth, which would mark our sixth consecutive year of having done so. Let's turn to slide twelve. For the summary, we had a solid first half with second quarter performance, again, at the high end of our expectation, adding to our strong performance track record and creating momentum for the rest of the year. The uncertainty in the macro environment is not new for us.
We have, and will continue to plan conservatively. We'll continue to focus on executing sustainable productivity actions, including delivering on strong restructuring pipeline we've already funded. Innovation and new product introductions remain a key priority, as well as the investments we're making to further penetrate high growth regions and expand capacity. We're in the process, as Dave mentioned, of planning for the long term, including 2016 and beyond, and our management team is focused on execution. We feel confident that with our balanced portfolio mix, alignment to favorable macro trends, and focused cost disciplines, we'll continue to outperform. With that, let's move to Q&A.
Thank you.
Operator?
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 time your question has been answered, you may remove yourself from the queue by pressing the star key, followed by the digit two. If you are using a speakerphone, please pick up the handset for posing your question. Also, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again, please press star one to ask a question. We'll pause for just a moment to give everybody the opportunity to signal. Okay, we will take our first question from Scott Davis from Barclays.
Hi, good morning guys.
Hey, Scott.
I'm going to save the usual congratulatory language, Dave.
Well, thank you. It's still nice to hear it, Scott.
Yeah, I know it.
I know it kills you, too.
It does. It does. Anyway. Dave, I was going to ask about capital allocation, but I think that'd be a waste of a question at this point. What are you seeing in the world, Dave? The reason why I ask that question is last quarter you had 2% core growth, I think it was this quarter 3% core growth. Next quarter you're kind of guiding to 3%-4%. You've been sequentially improving or at least talking about sequential improvement, but the world seems like it is almost going the other direction. That sequentially it may be degrading. Are you not seeing that? Help us understand how the macro lines up with the guidance.
Well, I wouldn't say we're seeing a boomlet, and that's not what we've tried to convey. All in all, I think starting off with what was generally a slow first quarter for everyone when it came to sales growth, things have, in my view, improved a bit since that time. I'd say a lot of this is coming more under what we're able to control and what we're able to do, and we're seeing better performances in our businesses being able to take advantage of the growth trends that do exist. I'd also say, Scott, we benefit some from this diversity of opportunity that you hear me talk about, so that, yeah, okay, we've got some oil and gas exposure, but we're able to manage that, and it doesn't have such a deleterious effect on our performance that we can't manage above it.
I'd say it's more a combination of things than saying that it's slightly better than it was, but it's still not a boomlet. Tom, I don't know if there's anything you want to add there.
No, I would agree with that. The only piece of color to maybe provide is that when you look at the months sequentially, April was definitely the lowest from a growth perspective, up slightly, whereas the momentum picked up in May and June, it got us to that 3%.
Okay, that's helpful. Guys, how do you think about the interplay between growth and margin? What I mean is, you've been crushing it on margins. Core growth has really been pretty much in line with the group now for most of the last couple years, give or take one point. Are there conversations you have internally around that going after margin might be hurting growth to some extent, or is that just not related at all?
The two are interconnected, I look at it differently. If you go back to the beginning of my tenure here, I've always said growth and productivity go together. That as you grow, you become more productive, because you have more volume leverage. You're able to leverage your fixed costs better. By the same token, the more productive you become, the more money that gives you to reinvest in the things you'd like to do. As you know, I've always been big on this concept of seed planting, and that was pretty costly in the early years because we pretty much had an empty pipeline of everything, whether it was high growth regions, new products, new strategies, or technologies. We really had to fill the pipeline.
Margin expansion was a little more muted back then because we had to fill the pipeline on everything, that took us five or six years to do, which unfortunately took us right into the recession when, yeah, we were benefiting from some of that, it was just a hell of a lot less visible. Now that we're able to get some of the sales growth that we do, we're much better able to get that sales leverage. As minimal as it might seem in today's environment, we're still able to get leverage from that.
We're able to, I'd say, finally start seeing the benefits of HOS and some of our other initiatives on the gross margin side. That's where we're seeing the real leverage here. The two go together, I could promise you, we're certainly not under-investing, whether you look at R&D or CapEx or new product programs, our commitment to HUE, it's certainly not a case of under-investment, because we want to make sure we make not just this quarter, but the same quarter three years from now and six years from now.
Makes sense. The track record's there. Thanks, guys, and good luck, and have a great rest of summer.
Yeah, thanks. You too.
I will now take our next question from Joe Ritchie from Goldman Sachs and Company
Thanks. Good morning, guys. Nice quarter.
Hey, Joe. Thanks.
Good morning, Joe.
First question.
It's nice to hear it stated with no reluctance at all, Joe. Thank you. Unlike Scott.
Yeah, we differ in that way.
Just that way.
The first question I have is really around China. You guys seem to still be doing incredibly well there, growing at double digits. You've had some of your European peers come out and talk about credit issues recently, and fears are starting to intensify a little bit more around the region. I'm just wondering what you're seeing, specifically in the region and whether trends deteriorated at all during the quarter.
Joe, I'll take that one, Dave. China was a very good story for us in most of the pockets. ACS, as we said, was near double digit. Really, the changes that we've made to connect all of those businesses in China and get to tier 2, tier 3 cities and make investments that help all the businesses in the portfolio, running it as one portfolio, really having a huge impact. In fact, we expect that to continue. We expect to have very strong growth rates in Q3 and Q4. In fact, for China, some of our orders are actually, we use sales as a surrogate for orders. In some cases, we actually do have the orders, and what we're seeing really gives us good encouragement for the rest of the year in ACS. Aero was also strong.
If you know, it's mostly spares and R&O business there in China for us right now, up mid-single digits. We do expect that to continue. TS is a little bit smaller. The commercial vehicles segment in TS was challenged, so we were down in China for Transportation Systems. When you look at PMT, some challenges, particularly with cyclicality in UOP. The CAS shipments are quite lumpy, can be lumpy from year-over-year. In Q2, we had significant CAS sales. Tough quarter from that perspective, but we see that improving as we go forward into Q3. I think all of the businesses are expected to continue to grow and improve from Q2 to Q3, so we're encouraged by what's going on.
If I could add to that, Joe, you'd have to say, overall, clearly the Chinese economy is straining a bit more than it has in the past. All that being said, it's still pretty good. We see the oil and gas side, Tom's point, on balance between the growth that does exist there, plus our own strength as we develop more China-based products, I think puts us in a pretty good spot.
That's helpful, guys. I guess maybe following up on oil and gas and specifically the margins this quarter, they were pretty phenomenal. I'm just wondering if you can help parse out the 330 basis points. Clearly, you still expect oil and gas margins to continue to be good in 3Q, despite a deteriorating backdrop. Just help us get a little bit more color into that.
Yeah. Thanks for pointing that out, Joe. As you know, PMT margins were up to 21.3%. They were 18% last year, so a really nice 330 basis points. We had great contributions from some volume in advanced materials, as we talked about. Very good productivity, strong cost controls, lower indirect expenses. Also at the same time, as Dave said, continuing the investments. Productivity was definitely a big driver. We're also seeing good results in terms of pricing. That seems to be holding up well, and as I said, there are some things that have driven that down a little bit. The catalyst comps year-over-year, a little bit of a tougher story. The overall volume declines that we mentioned in UOP and HPS were dragged. To summarize all that, I'd say good commercial excellence, good performance on the commercial side.
Tough from a volume perspective, but really nice work on productivity.
All right. Great. Thanks, guys. I'll get back in queue.
Thanks.
We'll take our next question from Nigel Coe from Morgan Stanley.
All right, Dave, I'm very enthusiastic. Great quarter.
Thank you. Much appreciated.
Could you feel that coming through?
I like it.
Obviously the full year plan pretty much intact, a little bit higher at the low end on the margin line. Just reading through the commentary, it feels like Commercial Aerospace is a little bit better in the plan, perhaps PMT a little bit weaker. Is that a fair comment, perhaps, Tom?
Yeah, I guess PMT might be a little weaker than what we thought because oil and gas had a slightly bigger impact than we'd thought at the beginning of the year. Still, pretty much within the forecast, and I'm pretty sure I think all three segments beat their sales numbers based on what we had committed anyway.
Yeah, for the quarter.
Yeah.
Okay. The mix is pretty much as you expected. Okay.
Yeah.
That's great. Just switching to the Solstice backlog, $3.2 billion, that's obviously a very impressive number given the size of that business right now. Can you give us any sense on how that backlog is aging and how much of that backlog converts in the next couple of years?
Most of it is all forward. We're not going to age the backlog, but I would say it's going to be a good contributor to us over the next two or three years, especially as you think about that PMT inflection that we talk about. It's going to be driven by the UOP MTO stuff and the fluorines capacity, both of which we're investing in today.
Yeah. Okay. Just the final one. I think, Tom, you mentioned 3Q TS up low single digits, I think there's an expectation that European volumes might pick up in 3Q. I'm wondering, number one, did you see that coming through in Europe? Secondly, are we seeing a big offset from the commercial weakness there?
Yeah, I think in the second quarter, TS in Europe was, you're right, pretty strong from an organic basis. Mid-single digits, as we said, in line with overall TS. We see that continuing for the third quarter. It's a mix of some platforms expiring and new platforms coming on. There are some offsets that also come into play. The commercial vehicles overall, both in China and the U.S., as we've talked about, has been kind of one of the challenges we're dealing with. Overall, Europe should be up mid-single digits or even higher for us in the third quarter for transportation systems.
Okay, that's great. I'll leave it there. Thanks a lot, guys.
Thanks.
We'll take our next question from Steven Winoker from Bernstein.
Thanks, good morning, all.
Hi.
Hey, Dave, the only thing I can say is the share price is thanks enough, so I'll leave it there, okay?
Well, we want to keep everybody comfortable, Steve.
It's important, Dave. Need these results. Let me just ask quickly on the quarter for Q3 guidance. It looks like it's up, I guess, 5% year-on-year, which implies the fourth quarter's got to be up like 15%. Maybe talk about the cadence there, and particularly within Aerospace, that you've got lower margin expansion on higher core growth than you did before. Even though that's a strong 80-100 basis point number, is that just mix offsets, or what are the headwinds there?
Well, first of all, I don't think the beat percents are quite as dramatic as you indicated, but I'll turn it over to Tom.
Yeah. We will have a very strong fourth quarter. There are some nice inflections coming in PMT as an example. Again, there's some lumpiness in the CAS business. We think that in PMT, we're going to see some nice growth coming through in those businesses in the fourth quarter. Overall, it is our highest quarter from a volume perspective. The basis is really driven by what we see, the visibility that we have to the sales pipeline.
The margins in Aero, even though it's 80-100 basis points, again, the core growth's looking strong, and you did more before. What are the headwinds there?
Say it again, Steve?
Just the Aerospace.
Yeah.
What are the headwinds to not putting up even higher Aerospace margins in Q3?
Well, we get more comparability from a FX perspective, of course, friction materials is in the business as well. The two of those temper the significance of the margin increase. If you go back to that page, I think it was page five in our slide, you see the big impact from those three factors. Those tend to subside as we get further into the year, particularly FX and the friction materials.
Because friction was.
How's the.
mid-July last year.
Yeah.
Yeah.
Yeah, operationally, all the factors we talk about from an operational perspective still should hold in pretty firm.
How's the cash flow progress in Aero? Is that improving? As you see that improving, Dave, you've talked about a lot of opportunity there going forward.
Well, their cash flow is still good. They just need to do a significantly better job on inventory than they have in the past.
Yeah. Okay.
Which would be upside.
Maybe just lastly, on gross margin, just a little bit bigger picture question. This is the highest Q2 gross margin we've obviously seen in a very long time. As you see that crossing 30% now, Dave, from a pricing and business model perspective, you think it can continue at that same pace? Do you think it can accelerate, decelerate? How are you thinking about that?
Oh, yeah. I think this is going to be an ongoing phenomenon for us. I'm not going to commit to what it's going to get to at some point. Certainly, it's going to be an important factor as we continue to grow our overall operating income percentage.
Great. Okay. All right. Thanks.
See you, Steve.
We will take our next question from Jeff Sprague from Vertical Research Partners.
Thank you. Good morning.
Hey, Jeff.
Dave, the 40th anniversary Honeywell User Group, did you guys print up some shirts, like give me a hug or something like that you could send around?
Only for you, Jeff.
Okay. I'll be checking my mailbox. Hey, just a couple things, actually. First, thinking about business jet and particularly large cabin, there's some cracks showing up in what some of the OEs are saying, pressure from wealthy developing countries and the like. It sounds like you're pretty constructive on the back half, do you see any reduction in the order books going forward there?
Not for us. I would say while they may be seeing some softness, which will get reflected for us also, it's going to be more than offset by all the gains we've had.
Both on the equipment side and on R&O. I mean, strong R&O performance as well in BGA. It looks like that'll hold up for the rest of the year.
Okay. On gas processing getting firmer, I guess you pointed to emerging markets, is there something really specific driving that? Is there some share gains or what's actually the driver behind that?
Well, if you go back to the premise of the Thomas Russell acquisition that we did then, it was primarily a U.S.-based business. We said at the time that our intent was to grow it more internationally, which takes some time to make happen. You're starting to see the benefit of a lot of that from all the seed planting that we did over the last two or three years to make that happen. That's mostly the effect you're getting.
Finally, maybe for Tom, I was just wondering on hedges, have you done anything new there, rolled it forward? Or are we kind of making the bet here, kind of this whole euro trade has played itself out, and you're going to let things roll off? What's the thought process there?
We're not betting, first of all. What we told you at the end of the first quarter, is pretty much consistent with where we are right now. You know the story on 2015, pretty much fully hedged for the rest of the year. 2016, we've got the euro hedged, probably about three-quarters of the exposure and some selective hedging in some of the other currencies. We keep our eye on it. We talk about it every week. We're all closely interested in seeing how that plays out.
What's the exchange rate on the hedge for 2016?
As we said, for the euro, it's 110.
110. Okay. Thank you very much.
See you, Jeff.
Thanks.
I want to take a question from Steve Tusa from J.P. Morgan.
Hey, good morning.
Hey, Steve.
Congratulations on the use of the word deleterious. It sounds more like Harvard than UNH, but so good work on that.
You have no idea what UNH is capable of, Steve.
On PMT, the UOP business, Thomas Russell, how bad was it in the quarter? Do you think that there's enough out there that you can confidently say that you may be able to kind of fill this domestic hole and actually hold the business flat next year?
We're still in the process of planning everything for 2016. Overall, I think Tom alluded to this earlier, is that we've got pretty good quote activity going in both oil and gas, UOP, and process controls. We'd like to think now that quote activity is not synonymous with an order, but it's certainly a nice, hopefully leading indicator of where things could go. That being said, that's too early to declare victory.
Yeah. I mean, sequentially, we're seeing improvement from first quarter, second quarter, third quarter expectations on orders in the gas business. There's a reasonable degree of visibility to some of the revenues that we expect to see in the second half. As Dave said, we're watching it closely, but there are some positive signs for that business.
Is there another part of PMT, are there benefits from what's going on in downstream margins globally, or it seems like a lot of this stuff is much more UOP specific, so a little bit tougher to call by looking at just the macro. I mean, is that the right way to think about it? I guess, are you still in a growth mode again for UOP in 2016? I know you guys talked about that last quarter, that you expected to grow it in 2016.
Well, I guess a couple of things that I'd mention is, one of the things we've said in the past is that you have to kind of break out that oil cycle between the exploration side that's more price-driven and the refining petrochemical side that's going to be more driven by economic activity. You're seeing a bit of a drag on that second part because of how people have reacted to the first part. Overall, their margins, as you know, have looked pretty good. We think over time, that investment begins. When it comes to UOP, they've still got the capacity expansion that's coming, and that stuff, we've got to complete that plant on time because we need to ship, and projects are already being built. I certainly feel more than okay about it.
You still feel pretty confident with the fluorine stuff coming on, that incremental revenue chart you guys put up in March with, I think it was $1 billion in incremental revenues in 2017, even with the oil and gas macro headwinds out there, that there's no changes to that view?
Yes.
Even better.
Even better with the fluorine products.
Yes.
One last question. Any degree of evolution at all on the balance sheet? You guys are clearly executing well, so there's really not a need for significant urgency around the balance sheet, but any of these properties that you covet loosening up at all with what's clearly a tougher macro environment out there, or no change?
Well, I'd have to say the strategy hasn't changed, and like I've said with the retail story, you never know when these things are going to hit. You never know when the customer's going to walk in. We are armed and ready.
Okay, no big buyback near term.
Strategy's still the same.
Okay. Thanks a lot, guys.
I will now take a question from Howard Rubel from Jefferies.
Thank you very much. Tom, you called this out a little bit, but maybe you could elaborate a bit. SG&A was down substantially. I think it fell from 13.4% to 12.7%. Can you elaborate on some of the causes? Some of it may be FX, but a bunch of it's probably process changes.
Yeah, I think, Steve, when the percentages you're mentioning.
Howard Rubel.
Oh, sorry, Howard.
I do not want to get confused with Steve, please.
Yes. I'm sorry about that, Howard.
Okay.
I think when you look at the percentages you're talking about, since the FX is affecting sales more than it is the cost numbers, you do get a little bit of a margin impact. For us, the initiatives that we've got going on, the continued work that we're doing in functional transformation, the continued work that we're doing in managing the indirect cost that those groups and functions spend, the e-auction process that we're using. All the initiatives are really having a solid impact and are coming through. There's not one thing in there. It's just continued, sustained momentum that we've got.
You've talked a lot about one of the things that makes a difference at Honeywell has been new products, and we can see it in fluorines, and we can see it in a few other places. Do you have a metric that you look at in terms of new product sales as a comparison to a year ago?
Actually, Howard, I've always tried to stay away from that, because if you want a metric that can be easily gained internally and externally, that's it. I go more by are we growing faster than our competition? When I see things like the Dassault cockpit and what we're able to do with fluorines and what ACS has coming and the HUE basis that everybody's using for it, then I know it's happening.
I hear you. If I could just go back.
In other words, if you said, geez, we want to see 50% of your sales coming from products introduced in the last three years, my guess is every company can generate that metric for you, regardless of how they're performing.
Fair point. The last thing, I think a number of people before me have asked the same question in another way. It seems as if in PMT, the oil and gas expectations that had been laid out earlier have shifted to the right. Have you gone back in and examined exactly why? Or even, have you added some belts in the suspenders to the process to make sure that, in fact, the second half that you're looking for is going to play out the way you'd like?
Well, we're not counting on a huge second half on oil and gas. It's kind of static. Maybe a little bit better, we're not counting on anything big.
No, I think you'll see an uptick in orders, knock on wood, for gas, as we've said, as well as for catalysts. On balance, I don't think we're expecting a major material change right now.
All right. Thank you.
Yes.
I will now take a question from Christopher Glynn from Oppenheimer.
Thanks. Good morning.
Hey, Chris.
Hey, Dave. Hey, Tom. You talked about the inflections at Aero and PMT.
Hello, Chris?
Yeah. Hello.
A question for you first. How's the ankle?
Oh, thanks. Slow, but better than ski season.
Well, the rumor we heard is that you drank a six-pack and tried to jump into a dinghy. Is that true?
I think it was a 12-pack.
Just so you know, we have feelers out there, too.
I guess you do. No, that was a day with the kids. That was a clean day. Like all of them. With ACS, you've talked about the inflections at PMT and aviation. With ACS, if we look at a few more years where the macro remains in this way, can HUE and VPD actually drive some acceleration there? Or is 3%-4% in this environment kind of the reflection of that?
I would say we're counting on 3%-4% is kind of like a nice, steady grower in an industry that's going to be growing slightly. I do think, to your point, that kind of the HUE-based onslaught that they're going to be showing over the next few years will make a difference, and there's a potential for it to be better than that. Tough to predict at this point, but I'm encouraged by what I see out of the ACS guys.
Okay. You used the word boomlet. I will compliment you on that one. If you were to see a boomlet, what is an area or two where that could be? Do you have drivers in there for commercial aftermarket or just as an example?
Well, I guess I got to be careful that Steve doesn't put deleterious boomlet together. At the end of the day, it's the way I'd kind of still describe it. On the commercial side, I think it's doing slightly better for us. You will start to see an inflection as we go out into the future because we're finally going to see the benefits of all the wins. That starts building our installed base, as Tom pointed out on the engine side, which all proves good for us. Tom, anything you want to add there?
Okay, thank you.
Ladies and gentlemen, due to time constraints, we will take our last question from Deane Dray with RBC Capital Markets.
Thank you. Good morning, everyone. Thanks for fitting me in.
Thank you.
Dave, I thought at some point you would have worked in a free Brady into your remarks.
I was expecting you to talk about Deane, so I guess we both were disappointed.
Yeah, Dave's spirits are still deflated on that one.
Oh, geez.
Understood.
Bad, very bad.
One of the bullish comments that you had was on non-res. Just maybe just expand a bit on the dynamics in the market, kind of the data points. Is this part of the boomlet that you'd expect to see in the second half?
Yeah, I'd say it continues to get better, as we've talked about in the past. I don't think you're ever going to see a boom in non-res construction, largely because there was never a real crash. It was kind of that slow in, slow out kind of thing that we've talked about with the recession. I think that's what we're going to continue to see. On the residential side, my guess is you're going to continue to see that do better because rents have been going up, and that'll spur more activity. I think for non-res, that's the right way to think about it. It's kind of slow and steady.
Yeah. That's where we've seen our best growth in ACS, particularly on the industrial side, the industrial piece of the non-res. Commercial buildings as well, trends are very good. The products that we sell into there in ECS, fire, and security, all of them are doing well.
Great. Thank you.
Ladies and gentlemen, this does conclude today's question and answer session. I would like to turn the conference back over to today's moderator for additional or closing remarks.
Thank you. I'd like to turn the call back to Dave for some closing comments.
Well, it certainly feels good to give all of our investors such good news as you look forward to your summer holidays. We've got a track record of outperforming our peers. We intend to continue that outperformance. We want all of our investors to know that they can enjoy the summer because they have their money invested in Honeywell. From all of us here at Honeywell, have a fun and relaxing summer. Thanks, guys.
Ladies and gentlemen, this does conclude today's conference. We do appreciate your participation. You may now disconnect.