雷神技術公司 (RTX) 2013 Q3 法說會逐字稿

Good morning, and welcome to the United Technologies third-quarter conference call.

On the call today are Greg Hayes, Senior Vice President and Chief Financial Officer; and Jay Malave, Director, Investor Relations.

This call is being carried live on the internet, and there is a presentation available for download from UTC's website at www.utc.com.

Please note, the Company will speak to results from continuing operations, except where otherwise noted.

They will also speak to segment results adjusted for restructuring and one-time items, as they usually do.

The Company also reminds listeners that the earnings and cash flow expectations, and any other forward-looking statements provided in this call, are subject to risks and uncertainties.

UTC's SEC filings, including its 10-Q and 10-K reports, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements.

Once the call becomes open for questions, we ask that you limit your first round to two questions per caller to give everyone the opportunity to participate.

You may ask further questions by reinserting yourself into the queue, and we will answer as time permits.

Please go ahead, Mr. Hayes.

Okay.

Thank you, and good morning, everyone.

You saw in the press release this morning, UTC reported third-quarter earnings per share of $1.55, that's up 13% versus 2012.

We also saw a resumption of organic growth, albeit modest, and margins expanded to 16.6%.

There are always a few bumps in the road, such as the recent political impasse in Washington, that has threatened economic recovery.

But our strategy to deliver double-digit earnings growth remains in place.

Following solid year-to-date performance, we are now confident in our earnings-per-share range of $6.10 to $6.15 as per the 14% to 15%, at the high end of our previous expectation of $6 to $6.15.

That's despite slower top-line growth.

The majority of our end markets are gradually improving, but with defense down more than expected, and based on where we are year to date, we now expect full-year sales to be about $63 billion, which is our prior estimate of $64 billion.

There's still a couple of puts and takes to the year.

As I said earlier this month, some headwinds at Otis and Sikorsky have up-sided the other segments.

And, absent a significant external event, we see a path to the high end of our earnings-per-share range based on our proactive and aggressive restructuring and cost reduction actions, as well as improving end markets.

As you see on slide 2, organic sales grew 1% in the quarter, with good growth across most of our end markets, tempered by relatively flat European markets, and continued significant declines in defense.

Our commercial businesses grew a combined 3%.

We saw a continued recovery in North America, with sales up 3%, led by residential HVAC and Otis new equipment.

Europe declined 1%.

And China was up 11%, and continues to be the bright spot in Asia, where overall sales were up only 3%.

The aerospace business continues to see good growth in commercial OEM and recovery in the commercial aftermarket.

Revenue passenger miles were up 6.8% in August, and are up 5% year to date.

Oil prices have dampened profitability a bit, but the airlines are still forecasted to earn $11.7 billion this year and $16.4 billion in 2014.

So, a healthy industry, and we see this in our business, with our commercial aero sales up 7% in the third quarter.

On the other hand, the military business remains a headwind, with sales down 14%.

We see this, in fact, across our aero businesses, but most acutely at Sikorsky.

And given the continued impasse in Washington, we don't expect this trend to improve over the next year.

Okay.

Taking a look at orders on slide 3. At Otis, new equipment orders were up 4%.

That's solid growth off a tough compare with the third quarter of last year, which had a major contract award in the UK.

North America and China both saw double-digit increases.

Climate controls and securities, global equipment orders grew 13%, a strength in Transicold.

And commercial spares orders were up 17% at Pratt Whitney, and 5% at UTC Aerospace Systems on a pro-forma basis.

All right, slide 4. Total sales increased 3% in the third quarter.

Net acquisitions including Goodrich, which closed on July 26th last year, contributed 2 points, while the FX impact was negligible.

Segment operating profit grew 14%, and operating margins increased 160 basis points.

And that includes about 100 basis points from the absence of the inventory step-up amortization at UTAS last year.

As you heard from Geraud at our recent Investor Day in Monterrey, Mexico, CCS continues to drive synergies and leverage their global scale.

Operating profit grew 10%, leading to margin expansion of 170 basis points.

Pratt and Whitney also expanded margins, 290 basis points, a higher commercial aftermarket, and aggressive cost reduction.

And Sikorsky maintained double-digit margins in the face of significant headwinds from sequestration and reduced defense spending.

So, the third-quarter earnings per share grew 13%, and we initiated $103 million in restructuring actions.

Excluding restructuring and gains from both periods, earnings per share grew 19%.

As previously noted, we expect to invest about $500 million in restructuring this year, including over $150 million in the fourth quarter.

For the year, we continue to expect restructuring to be offset by one-time items.

Free cash flow in the quarter was 82% of net income.

This was unfavorably impacted by an increase in inventory of over $500 million, primarily at Pratt Whitney and Sikorsky as each ramps up for shipments in the fourth quarter.

While we continue to see progress on the CMHP with the commencement of pilot training and we are maintaining our placeholder, eight aircraft, in the fourth quarter.

In addition to the four aircraft at the training facility in Shearwater, Canada, we have six aircraft fully assembled and flight tested at the [Plattsburgh], New York, storage facility.

And seven are undergoing flight testing at our West Palm Beach facility.

And Dallas has a 28-aircraft RN production, but the program continues to advance.

And we'll provide updates as more progress is made.

In the quarter, capital expenditures were $383 million, and a little more than $1 billion year to date, as we invest for the aero ramp-up at both Pratt Whitney and UTC Aerospace Systems.

For the year, we expect CapEx to be in the range of $1.6 billion to $1.7 billion, as we noted before.

Also in the third quarter, we bought back $330 million of stock, and expect to buy back about $200 million in the fourth quarter.

We remain confident that free cash flow will equal net income in 2013, and we increased our dividend to $0.59 per share in the quarter, a 10.3% increase.

I'll be back to talk about 2014 in just a second, but let me stop there and turn it over to Jay and have you take it through the business unit results.

Thanks, Greg.

Turning to page 5. Open sales improved 4% at constant currency in the quarter, led by solid high single-digit growth in new equipment and continued growth in service sales.

New equipment sales were up in all regions, led by double-digit growth in China, Russia, and the Americas.

Operating profit was flat at constant currency, but operating margins remained solid at 22%.

Continued growth in China was largely offset by transitioning costs associated with the factory transformation in North America.

In developed Europe, the rate of profit decline is slowing, with sequential growth in Northern and Central Europe offsetting continued weakness in Southern Europe.

New equipment order growth was up 4% at constant currency, with mid-teens growth in Americas and Asia, and continued double-digit expansion in China.

Orders in Europe were down high-single digits as the prior year benefited from a major contract award in the UK.

Excluding this award, as well as a significant order this quarter, Europe new equipment orders grew 12%.

Given the headwind from the manufacturing and supply chain transition from Nogales, Mexico, to South Carolina and continued weakness in Southern Europe, Otis now expects full-year profits to be up around $25 million, from up $75 million to $100 million and mid-single-digit sales growth.

On slide 6, Climate Controls and Security increased profits 10% in the quarter on flattish sales, resulting in another sharp increase in margins, up 170 basis points from prior year to 17.1%.

CCS is continuing to see slow but steady improvement in organic growth, as Q1 was down 3%, Q2 was up 1%, and now Q3 is up 2%.

As we've seen all year, organic growth is mixed across geographies.

Europe was down low-single digit.

China was up mid-single digit, while Asia overall was down about by 1%, driven by a decline in Australia.

Americas was up low-single digit, driven by a 9% growth in the residential HVAC business.

Transicold was up 22% on a robust recovery in the container market after an exceptionally weak period last year.

On profit, CCS had another solid quarter of earnings growth, driven by strong conversion on organic sales, restructuring and productivity, including continued savings from the consolidation of Carrier, and Fire and Security, and lower commodity costs.

Global commercial HVAC equipment orders were up high-single digit, with growth in Asia and Europe more than offsetting flat orders in North America.

Orders for global fire and security products were up mid-single digit, while the field businesses were down high-single digit.

Commercial refrigeration orders in Europe were up 2%, while Transicold was up 70%, driven by container on an easy compare over last year.

With continued solid results through 3 quarters, and steady sequential organic improvement, we expect profit growth to be around $200 million, the high end of the prior guidance range of $175 million to $200 million on 1% organic sales growth.

All resulting in operating margin above 15%, 2 years ahead of target.

Turning to aerospace on slide 7. Pratt & Whitney delivered solid results, with 18% profit growth on 5% lower sales resulting in margin expansion of 290 basis points.

Organically, sales were flat as 22% growth in commercial spares was offset by lower military engine sales.

Reported sales were down due to the power systems business divestiture.

Profit growth in the quarter was driven by higher commercial spares volume and restructuring benefits, partially offset by pension headwinds and lower military volume.

As you will recall, last year had the benefit of a supplier settlement that was largely offset by the benefit from licensing agreements this year.

For the full year, we now expect Pratt & Whitney operating profit to grow $150 million on low-single-digit sales growth.

We expect profit growth to be at the high end of the prior profit range, as large commercial aftermarket has stabilized and the benefits of proactive cost actions are realized.

UTC Aerospace Systems delivered another solid quarter, with operating profit of $525 million on sales of $3.3 billion.

On a pro-forma year-over-year basis, sales were up low-single digit, with mid-single-digit growth in both commercial OE and aftermarket, partially offset by low-single-digit declines in both military OE and aftermarket.

Year-on-year profit growth was driven by the absence of last year's inventory step-up costs, an additional month of Goodrich, and continued synergies realization.

UTC Aerospace Systems expects to deliver around $250 million in synergies for the year, and is well on track towards achieving the $500 million synergies target by 2016.

Orders for commercial spares grew 5% on a pro-forma year-over-year basis, with improvement in both parts and provisioning.

With approximately $1.6 billion of operating profit generated year to date, we are confident in the full-year operating profit outlook of $2.1 billion on sales of around $13.5 billion.

Turning to Sikorsky.

Operating profit decreased by 21% on 7% lower sales.

During the quarter, Sikorsky shipped a total of 61 aircraft, including 42 based on military platforms, and 19 commercial.

The sales decline was driven by lower military OEM and after-market volumes, partially offset by strong growth in commercial shipments.

The lower overall sales volumes, as well as headwinds from higher pension and compliance costs, contributed to the operating profit decline.

Sikorsky continues to see robust demand for its commercial product line, with orders this quarter of over $400 million, and strong backlog in excess of $2.5 billion, including approximately $350 million from customers in China, as of quarter end.

For the full year, based on continued pressure in military aftermarket, we now expect profit to be down around $150 million, the low end of our prior guidance range, on the low-single-digit sales decline versus up low-single digits previously.

With that, let me turn it over to Greg for wrap up.

Okay, thanks, Jay.

Before we take a look at 2014, there some other key items to note in the quarter.

In late September, we announced the creation of our new Buildings and Industrial Systems organization under the leadership of Geraud Darnis.

While they will remain separate reporting segments, this will strategically unite Otis and Climate Controls and Security.

This will create the leading commercial building organization in the industry, and will allow us to accelerate growth by fully utilizing our unmatched capabilities in scale.

Building on the success of combining our HVAC and fire and security platforms under CCS two years ago, this new organization creates opportunities to unlock further synergies and leverage each organization's field network to service customers in a wider geography.

And with 30% of revenues in emerging markets, we will focus our innovation on next-generation buildings and integrated systems where we see opportunities to create value for our customers.

Also in the quarter, Pratt & Whitney and UTC Aerospace Systems supported the maiden flight of the Bombardier C Series aircraft on September 16th in Mirabel, Canada.

Our PurePower geared turbofan engine performed flawlessly on this historic flight of the first next-generation narrow-body aircraft.

We're confident that the flight test program will further validate the performance characteristics for its noise, lower emissions, and significantly better fuel efficiency.

While we always like to focus on the improved fuel burn of the GTF designs, just as importantly, the GTF noise footprint is up to 75% smaller than today's engines.

And this creates opportunities to fly more direct routes into congested noise-controlled airports.

Smaller noise signature also allows for streamlining airport operations through expanded runway usage, as well as expanding current operational curfews at airports in heavily populated areas.

This will give airlines the opportunity to work with airports to generate more revenue by opening additional takeoff and landing slots, a good example of the value creation that our game-changing technologies will bring to the table.

Pratt & Whitney's performance, its best-in-class technology ratings, and program execution is the reason why the GTF has captured orders for more than 4,700 engines.

We also saw the first flight of the Boeing 787-9 in the quarter, as UTC Aerospace Systems continues to support Boeing and the development of this next generation family of aircraft.

So, a busy quarter, and several significant milestones at UTC.

Let's change gears for a second here and take a look at 2014.

Again, no surprises.

That's compared to what we talked about just a couple of weeks back.

Our strategy remains in place, and we continue to target double-digit earnings growth in 2014.

We expect solid growth in commercial aerospace and the commercial construction markets in North America and Asia, and more than offset declines in our military aerospace business.

As you all know, Europe remains a question mark.

We'll take a cautious approach, and we're not planning for growth in Europe as we sit here today.

The good news is that we'll finally see some tailwind from pension next year.

There were approximately $800 million of pension expense flowing through the P&L this year, and it will be a welcome relief to see some benefits from lower amortization charges and a higher discount rate.

On the other side of the ledger, we do have about $0.30 of headwinds from three significant items.

There's obviously a continued reduction in defense spending, both sequestration as well as the overseas contingency spending.

There's also pressure on the tax rate, primarily from the expiration of the tax extenders.

And lastly, we will see some headwind from the initial GTF engine deliveries.

It will improve as the technology matures, but Pratt & Whitney will face some negative engine margin on deliveries of each platform over the next several years.

These are great long-term programs that point toward a bright future for Pratt & Whitney, but we'll need to work down the learning curve as these aircraft enter service.

So, there's always some pluses, some minuses, and question marks as we look towards next year.

We continue to leverage our industry-leading franchises in global scale.

We have the right strategy in place and we remain committed to delivering double-digit earnings growth once again next year.

So, with that, let's open up the call for questions.

Thank you.

(Operator Instructions)

David Strauss of UBS.

Good morning.

Morning, David.

Greg, in terms of looking at your revenue guidance and what's implied for the fourth quarter, it looks like it's implied about 4% organic revenue growth.

The comp is a little bit tougher relative to the third quarter, so can you talk about how you get there?

What's different in the fourth quarter versus your the third quarter?

I think, David, you're right on.

And I think we will see organic revenue growth of about 3% to 4%, probably closer to 4%, as we sit here today.

Again, you're going to see better deliveries at Sikorsky.

I think Sikorsky takes up deliveries to about 80 aircraft in the fourth quarter, and delivered about 160 year-to-date, so you get a little bit of a bump there.

That's both commercial and the military.

You'll see a little bit better performance at Pratt, especially on the military aero side.

I think we'll ship about 20 JSF engines in the fourth quarter.

And you're going to see, on the commercial side, an acceleration of organic growth just because of the orders that we've seen going into the year.

We saw that here in Q3 at Otis.

I think organic was up 4%, orders remained strong.

So we'll see, again, acceleration of growth at Otis, and acceleration of growth at CCS into the fourth quarter.

And then on the orders side, obviously, the comps get a lot tougher as well in the fourth quarter (technical difficulty) order growth will still be positive in the fourth quarter at Otis?

Absolutely.

I think, again, Pedro and team would tell you that their order trends remain, the bookings look very strong.

We're still seeing good strength in North America, we're seeing good strength in China, and even Europe is recovering.

Again, I think as Jay noted before, if you take out that big UK crossrails order for Q3 of last year, I think the quarters actually grew about 12% there.

So the economies are recovering.

And commercial construction seems to be at the leading edge of the recovery here.

The one caveat I would say is Asia outside of China has not been so great.

India has been down, Japan, Korea, Australia.

So, that maybe the damper on the growth story in the fourth quarter, but we still expect solid orders growth.

Same with CCS, again, Transicold had a huge quarter.

Orders were up 70% in the quarter at Transicold, but again, that was off a very easy compare.

Compares will get more difficult.

But, again, good momentum going into the fourth quarter.

Okay, thanks.

I'll get back in the queue.

Thanks, David.

Carter Copeland of Barclays.

Hey, good morning, guys.

Good morning.

Just a couple of quick ones.

First on the commercial, the spares piece.

I wondered if you might provide a little bit more color around that growth rate, and what you saw in the Vs versus the PW-4000s and some of the other engines?

Sure, Carter.

What we saw is growth in the PW4000 as well as the V2500, and that more than offset some declines in the PW2000.

On both really sales and orders.

If you think about it, I think on a legacy basis, Carter, legacy Pratt's spares are up about 10%, even though overall spares are up 17%.

So really good strength in the V. Again, it's a young fleet.

We're starting to see shop visits pick up, as we expected.

And then a little bit of softness on the 2000, but again, the legacy businesses is recovering.

Okay, great.

And on the military side, you talked about fewer engine shipments.

Obviously, the weakness at Sikorsky on the aftermarket side, but and you kind of look around against some of your peers.

The size of the weakness at Sikorsky certainly stands out as kind of anomalous, at least from what we can see so far today.

So, are there any other elements of weaker military spending that aren't captured in those two?

And with respect to what you're seeing at Sikorsky, what do you think is making that stand out so much more versus what we're seeing elsewhere across the defense space?

Yes, I guess there's a couple of pieces here to look at.

Military aero was down across all three of the aerospace businesses.

You've seen it in Pratt again.

We've stopped the 119 deliveries last year, so we've got some headwind from F-119s.

The F117 that goes out of C17, that's going down.

And JSF is really ramping very, very slowly.

So, that's not a great story.

Although, the aftermarket there is okay.

At UTAS, we actually saw a reduction in military that surprised us a little bit.

And this is not sequestration so much as just some of the government agencies just failing and cutting back on some of their spending at our sensor's business, which was most impacted.

And then we go to Sikorsky.

And Sikorsky, there's a couple of things there.

Obviously, the aftermarket that we've see orders down 50% for the year, which is completely unexpected.

And we expected it to be down, but not by 50%.

And then you've got, again, just the reduction on the quantities for the multi-year eight versus multi-year seven.

And the timing of some of the international military, which is also getting pushed out of this year and into next.

So it's been almost a perfect storm at Sikorsky this quarter.

And as a result, they're going to be down at the high end of their earnings range, down about $150 million for the year earnings.

And as far as the Sikorsky spares go on the aftermarket side, how much visibility -- how far out does that visibility go in terms of as you think about the impact on next year and how that rolls through.

How much longer could this persist?

Or are you just assuming we get down to this level and stay there?

Any color would be great.

Yes, so couple of thoughts there.

I think part of this, again, the big ramp that we've seen over the past five years in military spares at Sikorsky was really funded by the overseas contingency spending for the awards in Iraq and Afghanistan.

And that is coming down, and we expected that come down.

The rest of the military spares piece I would say though that we didn't see the bump in the third quarter that we had expected.

Typically at the end of the fiscal year for the government, we see a large influx of orders as everybody tries to spend their budget.

We didn't see that this year because of the uncertainty, I would say, around military budgets and what's just going to happen in the last quarter of the year.

So, I would say we should have about 50% of next year booked, and we don't have much visibility into next year as we sit here today.

I think the good news for Sikorsky is the commercial business is taking off.

It's been very, very well.

We're ramping up production in the aftermarkets picking up, but unfortunately, it's 20% of the business versus the 80% which is military.

So, Sikorsky is going to have a tough year next year.

I think that's the long and short of it.

And it's not unexpected given the next step down in sequestration, which I think takes another $12 billion out of defense spending starting in January.

So a tough couple of years for Sikorsky.

Great.

Thanks for the color, Greg.

Nigel Coe of Morgan Stanley.

Thanks, good morning.

So just looking at the 2014 framework, obviously no changes since when you published in Monterrey.

Just looking at the question mark column, and you got commodities/pricing in there and no surprise it's in there.

But based on the ramp down, and copper hedge prices for 2014, and assuming the price remains pretty solid, what would you expect in terms of tailwind for next year at current levels?

There should be some modest tailwind from copper going into next year.

Copper has come down, but I think it's still trading around $3.50 or so a pound.

Also, we've taken down the amount of copper, as we talked about at the visit, across all of CCS.

I think six, seven years ago, there was 120 million pounds, we're down to 50 million or 60 million pounds.

So while copper is an important element of their cost structure, it's not as big as it used to be.

We're also seeing a little bit of headwind on steel, which is going to impact both Otis as well as the CCS.

But it's kind of early.

I think, generally speaking, I would hope that that commodities pricing is going to move over into the positives as we get towards the end of the year when Louis stands up and gives guidance.

But, we'll just have to wait and see how this last quarter plays out.

Okay.

And then if we've done anything about the price inside of the equation, it sounds like spares pricing is still pretty good.

Both (inaudible) pricing looks very solid.

Otis seems quite negative.

So I'm just wondering, if we look at the backlog build that we've seen at Otis, what kind of margins are you seeing in that backlog?

Well margin in backlog has actually started to improve a little bit in North America.

We've got some new products out there.

We've been able to get a little bit of pricing.

But again, not big numbers there we're talking about.

And in China we continue to see pricing pressure at Otis on new equipment.

Not a surprise.

I think the beauty of Otis is they continue to be able to reduce costs to the factory to offset the pricing pressure, and still deliver significant margin on new equipment as a result of the scale of the factories and the relentless focus on cost reduction.

Okay.

And just a quick one on Pratt margins.

Obviously, very impressive there.

You've run through some of the factors.

But the de-consolidation, or rather the sale of Rocketdyne and Power Systems, did that have a positive impact on mix?

Well Power Systems are up maybe a little bit there, Nigel.

But again, by and large what we saw in that the 290 is really the benefit from the aftermarket mix with the spare parts as well as the restructuring benefits.

Yes.

Keep in mind, when took Rocketdyne out, we restated the numbers for last year and this year.

So the year-over-year doesn't really have any impact with those discontinued ops.

Good point.

Yes, thanks a lot guys.

Jeff Sprague of Vertical Research Partners.

Thank you.

Just back to Otis.

Greg, just thinking about the South Carolina factory disruption.

Can you quantify how much of that kind of played into the Q3 margins?

And as you look into Q4, obviously, the guide kind of speaks for itself.

Do you think that fully encompasses kind of correcting the issues and you have that behind you by the end of the year?

It's not going to be completely behind us, Jeff, by the end of the year.

I would tell you in the quarter, the impact was less than $15 million call it $0.01 a share from the disruption at Florence.

At the same time, I think they're making good progress.

They took overdue from 1,000 units at the end of the second quarter down to about 350 units, rather, at the end of Q3.

Hope to get the overdue all out the door by the end of the year.

But some of the root cause issues, some of the systems issues and some of the other factory issues that we've seen today are still going to take some time to work through.

Having said that, I think what we're not going to see is a repeat next year all of the additional costs.

We kept the Nogales plant open for an additional six months or so this year.

That's closed as of the end of September, so that's going to be tail wind for next year.

I think the strategy, it's going to work.

We want to have all of the CLC, all the engineering, all the manufacturing, all the procurement, all in one place down in Florence.

The workforce is coming up to speed.

It's getting better.

It's just going to take some time.

But I don't think we're going to see a full run rate savings that we had expected until probably towards the end of next year there.

So we should have a non-repeat of at least kind of $50 million of costs on import sales?

Yes.

I think that's probably the best way to think of it.

You probably won't see big year-over-year savings, ex that $50 million of costs that won't repeat.

And this subset is pretty significant at Otis.

And I'm just wondering on CapEx also in aggregate, I don't think you said $1.6 billion to $1.7 billion before.

I think it was $1.7 billion.

Not to split hairs, but are you finding ways to bend the curve a little bit on that CapEx bubble, and what you think about next year?

Yes, so year-to-date we've spent a little over $1 billion on CapEx.

I think we spent $383 million in the quarter, that's up $65 million.

We are trying to, as you said, bend over that curve.

I think we're trying to keep that number closer to $1.6 billion than $1.7 billion.

75% of that spend is at the aero units.

And it really goes to the ramp up that we're going to see in production.

You've got the five GTF engines.

We've got the big ramp up at UTAS and the consolidation of the Goodrich Hamilton businesses.

So there is pressure on CapEx, and I think next year will probably be the peak year which could even be up from what we're seeing this year.

So we're going to do what we can to try and push this capital into the supply chain.

We're looking at partners for much of this work, and we're doing a lot of things I think to try and address this.

But the bottom line is that there's a lot of CapEx coming in the fourth quarter of this year, and you'll see even more the next year.

And then finally, can you just give a little more color on the European building-related businesses, both Otis and CCS.

I think Jay said field weakness in the Fire and Security organization, but equipment orders I guess were better at Otis.

Just a little more color on the lay of the land there, and how things are playing.

Sure, Jeff.

I'll go through sales, and then I'll do orders.

I'll start with CCS.

Commercial HVAC was down low single digits.

Fire and security was down low single digits.

And the products were down slightly, and the field was down low single digits.

Commercial refrigeration was up slightly.

Then switching over to orders at CCS, commercial HVAC was up mid teens, and commercial refrigeration was up low single digits.

As far as Otis, as we said, sales were actually up in the quarter low single digits, and orders were down high single digits but for that big order last year.

And again, as both Greg and I mentioned, excluding these big one-time orders, it would've been up 12%.

So if you think about it, it really -- it looks as if we're positioning here for improvement here as we go into the fourth quarter and into next year as we deliver on these.

So, it's been a tough year, but we do see signs of stabilization there.

It's not getting worse.

CCS I think we were down 2% in the quarter.

But again, the orders would indicate that there should be recovery here in Europe, although we're not going to count on a whole lot as we go into next year.

At least we don't think it's going to get worse.

All right.

Thank you very much.

Okay, Jeff.

Thanks.

Howard Rubel of Jefferies.

Thank you very much.

More on housekeeping side of things for a moment.

Greg, first, R&D for the year continues to trend up.

How do you see that playing out from here?

And you talk about a lot of work on GTF.

One would think you're getting closer to a peak on that.

Yes, so GTF actually did peak.

I think what you saw at Pratt was that E&D was actually flat in the quarter.

We were down $50 million at year-to-date.

You're going to see a further reduction in the fourth quarter at Pratt as these engines get certified and we complete much of the testing.

The whole growth in third quarter E&D was at legacy Goodrich.

It's just the fact that we had Goodrich, I think it was up $40 million year-over-year.

So, I think we're right on the plan that we had expected.

In fact, Pratt we had said down $75 million to $100 million, probably closer down to $100 million, which will help fourth-quarter margins.

Okay.

I've never gotten a tax rate right this year.

Me either.

No, but you find things that sort of help matters.

So how do you think about a normalized tax rate?

I recognize that some of it will be a function of repatriation and every other credit one can find.

Yes, I think with a normalized rate with the tax law as it stands today, I'll be very specific there, it should be around 29%.

The fear of course is the tax law changes next year, and we lose some of the benefits from the tax extenders like the R&D tax credit and the CSC look through rules.

And that wants to put upward pressure between a point and a point and a half on the rate.

So, as you think about next year, and we're keeping probably to 30.5% tax rate, unless by some miracle the folks in Washington that get those tax extenders passed, but I think that unlikely that anything is going to happen down there this year yet.

And then finally, you talk about restructuring of I think you said $150 million in the final quarter of the year.

Can you sort of -- can you outline a bit where you plan to target it, and how are you anticipating capturing some gains?

Well, there's always a few things out there in terms of the gains.

There's probably a little bit on the tax side.

We'll probably get another a couple of one-time items there that will help fund some of this restructuring.

But I'm not counting on it.

The fact is, most of the restructuring in Q4 is actually going to go to Pratt, as they're again, preparing for the ramp up at the same time they're trying to adjust their cost structure to the reality of today.

UTAS, I think again, you're going to see further synergy plays there with headcount and further restructuring.

And the same at Otis and CCS.

So there's again, that $150 million is pretty well spread across the businesses.

Sikorsky is going to be teeing some things up too, I think, and if anything that number probably wants to go up.

And if it doesn't go up in the fourth quarter, it will go up in the first quarter.

Okay.

Thank you very much.

Julian Mitchell of Credit Suisse.

Hi, thanks a lot.

Yes, I was just curious about the extents of the expansion in your gross margin.

That was sort of flat to down in the first half, up almost 190 bips year-on-year in Q3.

You mentioned lower commodity costs in CCS helping.

I just wondered if there was anything exceptional in that gross margin in terms of input costs or mix, or it really does reflect kind of the benefits of restructuring and is something that should be sustainable.

Well there's a couple of pieces there, Julian.

I think, again, one of the biggest pieces is the absence of the inventory step up amortization.

Last year was I think was at $100 million?

$150 million.

$150 million in the third quarter, and again in the fourth quarter.

So, that really helped the UTAS margins improve.

As far as Pratt, the big improvement in gross margin was really the recovery in the commercial aftermarket as well as the restructuring savings from all of the actions that we took in the first nine months of the year.

Got it.

Thanks.

And then on -- just following up on R&D, you didn't put it in your sort of outlook for next year.

Is the assumption then that it will just track in line with the sales development?

Because you've still got a lot of legacy Goodrich stuff to catch up on.

Well I think because there's -- if anything, E&D should start to trend down, especially on the aero site here.

We're completing the 787-9.

We're completing the GTF engines.

And again, I'm not talking about a huge step down.

But it generally trend down over the next couple years, which should be helpful.

Again, there's not a lot of newer platforms, but we do have to complete all of the work that out there from the Embraer aircraft to C-Series and the Neo.

So there's a lot of work to do.

But I think again, it's generally going to trend down slightly.

Got it.

Thanks.

And then lastly just within Otis.

I think your EMEA services revenues were down low single digit in Q2.

Is that still running at the same trend here in the second half?

Yes.

It was down slightly in EMEA in this third quarter.

Yes, and I think pressure there is not surprising.

Spain is down, Italy is down.

But we are seeing good traction.

I think France is up a little bit, Germany is up a little bit.

So it's really the same story that we've been talking about for the last year and a half.

Southern Europe continues to be a head wind, although much, much less so than in the past 18 months.

Got it.

Thank you.

Myles Walton of the Deutsche Bank.

Thanks.

Good morning.

The first one is clarification just on the CMH.

So 8 deliveries are baked into that dime headwind is in the numbers for the fourth quarter at this point?

So to be clear, the eight aircraft we've assumed that we're going to ship those in the fourth quarter.

But year-over-year, it's actually tailwind, Myles.

Because you recall last year, we took a $157 million charge.

Those eight aircraft would go out with negative margin of around $120 million.

So there's actually tailwind in Sikorsky's numbers in the fourth quarter from CMH, as strange as it sounds.

So I was just thinking -- I was just saying versus your underlying EBITD guidance down to $150 million.

Yes.

That's in there.

The -- (multiple speakers)

Okay, great.

And then, Greg, can you talk about the other operating cash flow line item?

I think that $350 million negative swing this year, and I think -- and some of it's the fleet management, some of it's the total revenue going the opposite direction.

But can you talk about the trend for the rest of the year and also into 2014?

Yes, I think you saw -- it was a little bit of an anomaly here in the third quarter.

What we saw is some higher costs on some of the fleet management programs that you noted there is at Pratt Whitney, where we're incurring costs up front to get these engines up to the kind of rebuild to a pristine condition before they go back in the field.

So, those costs go on the balance sheet, it goes out in other cash flows.

There was a couple of other minor things in there.

I don't know, Jay if there's --

Yes, we just had some increases in long-term receivables, particularly again in the aero businesses.

And then just again some payments in terms of on some of longer-term reserves, like in restructuring type of reserves where you're liquidating those reserves.

You want other payments.

But nothing I would say structurally different going into the rest of the year here or even to next year that I would be that concerned about.

Okay.

So into 2014, that becomes more of a historical trend?

Yes.

Okay.

Thanks again.

Joe Nadol of JP Morgan.

Thanks.

Good morning, Greg and Jay.

On UTAS, so your EBIT was -- adjusted EBIT was down a hair sequentially.

And just thinking about this, we should have over time sequentially we should be thinking about aftermarket getting I think a bit better.

And we should be thinking about synergies from Goodrich getting better.

So, was defense the negative sequentially?

And if so, could you help quantify that a little bit?

Yes.

There was actually a couple of pieces of headwind there.

And I think you hit on the biggest piece, which was defense.

And that's again, both at the legacy Hamilton business as well as the Goodrich and the sensors business.

We saw a headwind there.

We also saw additional headwind as sales pick up on 787.

There's still a negative margin there.

But we also booked some loss reserves associated with the C-Series aircraft, which again, is a very long-term program.

But as you first start out, you're high on the learning curve, so there's a little bit of loss associated there.

And that gets better over the next couple of years, but those are really the three biggest pieces, if you will.

Okay.

So as we think going forward into Q4, your guidance implies kind of flattish EBIT again.

But as we think about that going into next year, how do you think about those various pieces?

Particularly, are you worried more that Goodrich defense business was just a home run for them in the last couple of years of their independence.

Is that somewhere where we could expect or fear more downside?

Well again, the sensors business is not really a DOD business.

It's a US government business.

So they're not selling as much as you might think to DOD.

Although there is some there.

But there's clearly going to be a little bit of headwind, but this is not a huge, huge number for us next year.

I think again, we come down the learning curve on the 787 next year, so that's going to improve.

We'll come down the learning curve on C-Series.

Sequestration will be an impact at UTAS, a bigger impact next year at Sikorsky.

But I think it's all kind of captured in that.

And we talked about a $0.12 headwind from sequestration.

And probably a third of that is going to be at UTAS, and two-thirds of it will be at Sikorsky.

Okay.

And then just one more.

I think you tweaked down your cash flow guidance from better than or equal or better than to earnings to just essentially in line with.

What were the changes there?

Well again, I think what we've always said we target free cash flow equal to net income.

And I didn't mean to imply that there was anything significantly different.

As we get towards the end of the year, we clearly have line of sight to free cash flow equal to net income.

I think we're 91% year-to-date.

Fourth quarter is typically a big from cash flow standpoint.

So, I can guarantee you one thing, it won't be exactly 100%.

It might be a little over, it might be a tiny bit less.

But we're targeting in the range of net income, so no surprise there.

I think, again, we're on track to deliver.

And the same thing with the guidance.

We tightened the guidance range to that $0.05.

We see a path to the high-end.

But I don't see a path above the high end.

So as you guys think about the year, we're thinking about cash flow equal to net income at $6.15.

And what we're really focused on right now is 2014.

Right.

Your guidance did change from October 1 to today in terms of what's in your slides.

So, I guess that's -- it's just based on where you were.

Yes.

It's just based on the reality as we get towards the end of the year.

Will we be a little over a net income?

Maybe, but we're not at 115% of net income.

And I didn't want to imply.

That's why we really tweaked the guidance to say it's going to be essentially equal to net income.

Okay.

All right.

Thank you.

Shannon O'Callaghan of Nomura.

Morning, guys.

Hey, Shannon.

Hey Greg, as you looked into this military aerospace weakness, have you been able to get a feel for how much of this could be inventory reductions and when those might sort of play themselves out?

Again, I think what we're really seeing is just a reluctance on the military services to spend on spares.

And what that's most impacting I think is fleet readiness.

We've seen the Black Hawk readiness decline significantly, because they're not working the hours, they're not doing the repairs.

And for right now, everybody seems to be comfortable that they can take doubtful readiness, but that trend cannot go on forever.

I think we expect to see a recovery to more normal aftermarket levels across all of the defense businesses next year.

Once we get this thing with sequestration sorted out.

Okay.

And then just maybe a little more color on Europe in terms of the commercial businesses.

Otis and commercial HVAC are seeing these better European orders.

What do you make of those?

Are those or are you seeing sort of a material swing go on there?

Or what color do you have around what you've seen drive it?

Let's be careful there, Shannon.

I think, again, we are seeing a recovery, but we're still well below peak rates that we saw 2006, 2007.

So, orders are coming back and they're off of really, really low levels.

So, recovery is coming.

It's very slow.

And I'm not expect -- and again, orders are good.

And they're good in northern Europe, primarily, but there's still a lot of uncertainty in Europe.

So we're going to be cautious.

But again, I think it's all trending positively.

Okay.

Thanks, guys.

Thanks Shannon.

George Shapiro of Shapiro Research.

Yes, good morning.

Hey, George.

Greg, if I look at Pratt, you had big drops sequentially and even year-over-year in the large commercial deliveries.

What was going on there?

You had a strong second quarter, but what was happening in the third to be that low?

George, that really just normalized.

I think you would expect -- in the fourth quarter would expect that number to probably jump a little bit to the $150 million range, in that ballpark.

And the second quarter was just high quarter.

Okay.

And then the 14.4% margin, obviously, got helped by the lower deliveries and the higher aftermarket.

Was there anything else in there, or is that kind of a sustainable kind of new level margin for a while now?

Well, no.

You've got again, to the earlier point, commercial OEM is going to go back up in the fourth quarter.

The other piece you're missing is is the restructuring savings.

Pratt is taking out close to a thousand people this year in the first nine months, and most of that came second quarter.

So you're going to see that benefit continue.

And again, those spares should be better, so that will help.

But you're going to get a little bit of an offset as commercial OE picks back up in the fourth quarter.

Okay.

Thanks very much.

All right, George.

Thanks.

Deane Dray of Citi Research.

Thank you.

Good morning, everyone.

Hey on Fire and Security, could you just give us an update in terms of traction in the quarter?

What it means on a non-resi side?

And any developments on the portfolio rationalization?

It sounded like there were still some divestitures that could potentially be done on businesses you couldn't scale.

Let see, what I'll do, I'll give you some data points just on fire security globally.

The products were up low single-digit in sales, and orders were up mid-single digits.

On the field businesses, those were down high single-digits in both sales and orders in the quarter.

So that's pretty much what we saw on Fire and Security globally.

Yes, this is not a new trend, Deane.

We've again, some of the field business, again, we have been mostly deemphasizing, but we've been somewhat more selective as Geraud said about not taking some of these installation, which is just installing the pipes, if you will, for sprinkler systems.

We're trying to but higher margin, higher value add that can pull some of our product along.

So, making good investments on the product side, and we're seeing that traction in orders.

But the service side continues to be a drag, especially in Europe.

Great.

And I might have missed this, but on the Canadian Maritime, are you -- have you made progress in the renegotiation of the contract?

Any closer to that resolution?

I'm going to be very cautious here.

It's atypical of me.

But I would say that we're making progress, although it's slow.

And I think again, we haven't really started formal contract negotiations.

The good news is the aircraft are up in Shearwater.

They're flying.

We are getting traction with the customer.

And I think everybody recognizes they want to find a solution here, both at the Sikorsky and at the Canadian government level.

So we're making progress.

It's a great helicopter.

We were just down in West Palm Beach the other day.

I was talking to the test pilots.

It's a phenomenal aircraft, but it's just going to take a little bit of time.

So I'm hope when Louis stands up in December, that we'll have some really good news to report.

Great.

Thank you.

Okay.

So thanks, everyone, for listening today.

As I just said, we look forward to seeing you all at our annual investor and analyst meeting on December 12th in New York.

We'll do the same as last year, we'll be giving guidance on 2014, and look forward to seeing you all there.

Thanks very much.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the program.

You may now disconnect.

Have a wonderful day.