雷神技術公司 (RTX) 2014 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 remind listeners that the earnings and cash flow expectations and any other forward-looking statements provided in this call are subject to risk 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.

(Operator Instructions)

Please go ahead, Mr. Hayes.

Okay.

Thank you, Stephanie, and good morning, everyone.

As you saw in the press release today, UTC reported solid third quarter earnings per share of $2.04 on 5% organic sales growth.

Gains net of restructuring was $0.22 in the quarter, which is higher than previously expected, largely due to the timing of some tax settlements in the third versus fourth quarter.

Excluding the impact of restructuring and one-time items, earnings per share was up 12% and segment operating margins expanded by 60 basis points, to 17.2% in the quarter.

That's a record for UTC.

With three quarters of the year now in the books, we can look back at a pretty good start, 4% organic sales growth and earnings per share up 11% year-to-date, excluding the impact of restructuring and one-time items.

As a result, we remain confident in our 2014 EPS expectation of $6.75 to $6.85.

That's earnings growth of 9% to 10%, on sales of about $65 billion.

Turning to slide 2, organic sales.

As you see, organic sales grew 5% in the quarter, with solid growth across all five of our businesses.

In the commercial businesses, we saw 5% growth in the Americas, led by 9% growth in North American residential HVAC, as the US economy continues to improve.

In Europe, where the economic recovery is uncertain, organic sales were up 1% in the quarter.

The commercial businesses also saw 7% growth in Asia.

In China specifically, sales were up 9%, led by Otis, which was up 12%.

Shifting to Aerospace, for the first time this year we did see growth in the military business, which was up 3%, led by development programs at Sikorsky; and solid growth in commercial OE and aftermarket continued, where overall sales increased by 9%.

Slide 3. Let's take a closer look at our end markets.

Overall trends remained positive for a majority of our portfolio.

And just a reminder, we're going to talk to the commercial business orders on a constant currency basis, as we typically do.

In our commercial businesses, we continue to see momentum in North America.

US consumer sentiment reached a 14-month high in September, on employment gains and optimism over wage growth.

As I mentioned before, North American residential HVAC sales were up 9% in the quarter and orders were up a multiple of that, very strong, but driven primarily by early order activity ahead of the SEER-14 standard change that goes into effect in January, 2015 for the Southern and Western regions of the US.

Positive ABI trends continue and the outlook for commercial construction remains encouraging.

And we saw proof of that again at Otis, where North American new equipment orders were up almost 60% in the quarter.

In Europe, a little different story.

Eurozone PMI was at a 14-month low, although it did remain in modest expansion territory, and economic sentiment fell to a 10-month low in September, as concerns over the economy increased.

We're obviously keeping a close eye on the economic situation in Europe and we saw mixed orders there in the quarter.

Commercial HVAC orders were actually down 11%, although we did see 15% growth in commercial refrigeration, and fire and security product orders grew by 12%.

Shifting to China.

On Otis, new equipment orders were flattish versus the prior year, reflecting the slower conversion of pipeline opportunities to book orders.

However, new equipment backlog continues to remain strong at Otis and is up 14% versus the prior year.

Orders for CCS commercial HVAC and fire products were both down slightly in the quarter.

Earlier this month, in a move to bolster the housing market, the Chinese government cut mortgage rates for second-home buyers and lowered down payment rates to 30%, from 60% to 70% previously.

This actually marked the first time since the 2008-2009 financial crisis that mortgage rates were reduced in China and signals the government's continued willingness to use fiscal policy to support growth.

While we continue to expect growth in China will moderate, it should continue to outpace global GDP.

And our building and industrial systems businesses remain well positioned in the region.

Moving to Aerospace, with robust airline profits and ongoing growth in air traffic, we continue to see solid conversions of our original equipment backlogs and growth in our commercial aftermarket businesses.

At Pratt Whitney, total commercial aftermarket sales were up 7% in the quarter and large commercial engine spare orders were up 1%.

In our Aerospace Systems business, commercial aftermarket sales were up 10% and commercial spares orders were up 11%, reflecting strength in both parts and provisioning.

You'll notice on the chart that we're highlighting a new metric beginning this quarter, that is, commercial aftermarket sales for both Pratt Whitney and Aerospace Systems that better reflect the evolving business model from a transactional parts sales business to a comprehensive service business.

Let's talk a little bit more about that on slide 4. You can see that illustrated for Pratt.

10 years ago, only 10% of our engines were covered under a fleet management program, or an FMP.

As you can see, we've migrated.

Last year, about 50% of the Pratt fleet was under an FMP.

And this is going to continue to increase with time.

The next generation engines, the GTFs, will have about 80% of those engines covered under an FMP, or fleet management program.

This creates value for our customers, the airlines, as well as Pratt Whitney.

We're incentivized with the airlines to keep the engine on a wing as long as possible and to improve reliability.

As we've entered into these FMPs, our customers have seen a significant improvement in reliability of the engines, because we are able to maintain those engines at an OEM standard.

So over time, we'll see a gradual decline on the transactional spare parts business, as the legacy fleet starts to retire.

The good news is that you've got the V2500 fleet and the new GTF fleet replacing those spare parts sales with FMP sales.

So again, a changing business model.

And we'll continue talking about aftermarket sales growth going forward for both Pratt and Aerospace Systems, as it's a more meaningful metric.

Taking a closer look at the third quarter results, total sales reported increased 5%, that's all organic.

Segment operating profit was up 8% and operating margins increased by 60 basis points, including the benefit from pension.

CCS saw the benefit from organic growth and cost reduction initiatives, where operating profit grew 9%, leading to margin expansion of 110 basis points.

Pratt & Whitney and Aerospace Systems each expanded margins by 130 and 110 basis points, respectively.

Earnings per share of $2.04.

That's up 32%.

And of course, that benefits from the $0.22 of favorable one-time items, net of restructuring costs, in the quarter.

Recall that third quarter 2013 had $0.08 of net restructuring charges.

So absent the impact of these items in both 2013 and 2014, earnings per share were up 12%.

Free cash flow in the quarter was 83% of net income.

Capital expenditures were $415 million, and that's up 8% versus last year, as we continue to invest for the ramp-up in commercial Aero.

And investment in working capital grew in the quarter, as well.

We acquired $425 million of our stock under our share repurchase program, and we now expect to buy back another $400 million in the fourth quarter.

And that will bring share repurchase to a total of about $1.5 billion for the year.

Let's stop there now.

I'll be back to talk more about the full-year and provide a glimpse of how we're thinking about 2015.

But first, let me turn it over to Jay to take you through the segments.

Thanks, Greg.

Turning to page 6. Otis sales improved 4% in the quarter, led by high single-digit new equipment sales growth, most notably in China and the Middle East.

Service sales were up low single-digit overall, with solid mid-single-digit growth in our businesses outside of Europe, where we saw a slight decline in service sales in the quarter.

Operating profit was up 3% at constant currency.

Profit growth in the quarter was driven by contribution from volume and net productivity offset by continued pricing pressure.

New equipment orders were up 4% in the quarter.

New equipment orders in China were flattish, reflecting a slower conversion of jobs in the pipeline to actual booked business.

We were encouraged by results in other areas, especially the Americas, where orders were up sharply for both the quarter and year-to-date, whereas new equipment orders in developed Europe were up mid-single digit in the quarter.

The recent strengthening of the dollar is creating headwind on Otis profit, and we now expect profit to be up $50 million, compared with previous earnings growth guidance of $100 million to $125 million.

On a constant currency basis, we still expect Otis to grow profit by about $100 million for the year.

On slide 7, Climate Controls and Security increased profit 9% in the quarter on 3% higher sales.

Margin expanded by 110 basis points from prior year, to 18.2%, continuing the CCS momentum in margin expansion.

Organic sales were up 4%, with growth reported by all regions.

We saw strength in the Americas, with the residential HVAC business reporting 9% growth and commercial HVAC up mid-single-digit.

Outside of the US, both EMEA and Asia reported low single-digit growth.

Commercial refrigeration was up mid-single-digit, while Transicold was up slightly.

Profit growth in the quarter was driven by contribution from organic volume, as well as benefits from restructuring and integration savings.

CCS global equipment orders were up 5%, excluding the impact of a shift in order timing driven by the pending US region cooling efficiency standard change.

Orders for global fire and security products were up high single-digit, more than offsetting flattish fire and security field businesses.

Transicold orders were up low single digit.

Based on year-to-date results, we continue to expect profit growth of $225 million to $250 million for the full year at CCS on low single-digit organic sales growth.

Turning to Aerospace, on slide 8. Pratt & Whitney delivered solid results, with 15% operating profit growth on 5% higher organic sales, resulting in 130 basis points of margin expansion.

Higher aftermarket sales across the businesses, including 7% combined growth in large commercial and Pratt Canada aftermarket, more than offset declines in military OE.

Operating profit was driven by higher commercial aftermarket sales, favorable pension and restructuring benefits, which more than offset higher E&D.

The quarter also benefited from favorable aftermarket contract performance and licensing agreements which exceeded similar benefits from 2013.

Large commercial spares orders were up 1% year-over-year and up 3% sequentially, building off the 7% sequential improvement in the second quarter.

Year-to-date, overall commercial aftermarket sales are up high single-digit, as industry fundamentals and demand remains solid.

This supports our full-year sales growth expectation for the commercial aftermarket business of up mid-single digit, despite more difficult year-over-year compares as we close the year.

Given the strong year-to-date performance, we now expect Pratt & Whitney's operating profit growth to come in at the high end of the previous guidance range of $175 million to $200 million on low single-digit sales growth.

UTC Aerospace Systems recently celebrated the second anniversary of its formation, following the July, 2012 acquisition of Goodrich.

We are proud of the way the teams have come together to integrate the businesses, while improving on our already high level of customer service, as well as delivering over $350 million in run rate synergies in just over two years.

In the quarter, Aerospace Systems continued to deliver strong results, with operating profit up 14% on 7% higher sales.

Commercial OEM sales were up 8%, as we continue to benefit from growth in new programs, such as 787 and A-350.

And commercial aftermarket increased 10%, while military sales improved for the first time this year, up 2% versus 2013.

Profit growth was driven by higher commercial volume, continued synergy traction and the benefit of lower pension expense.

Operating margins increased 110 basis points, to 17%.

Commercial spares orders increased 11% in the quarter, with strength in both parts and provisioning.

Overall commercial aftermarket sales are up 10% year-to-date.

For the year, UTC Aerospace Systems now expects profit growth of $325 million to $350 million, from our previous expectation of $300 million to $350 million, a mid- to high single-digit sales growth.

Turning to Sikorsky on slide 10, operating profit decreased by 11% on 5% higher sales.

During the quarter, Sikorsky shipped a total of 54 aircraft, including 39 based on military platforms and 15 commercial.

The sales increase was driven primarily by development programs, as well as higher international military and commercial OE volumes, partially offset by lower aftermarket and US government OE volumes.

The operating profit decrease was driven by unfavorable mix in our military business, the impact of lower aftermarket volumes, and the absence of prior year favorable contract adjustments, which more than offset benefits from pension, lower engineering spend, and cost reduction actions.

For the balance of the year, we anticipate stronger profit growth from higher volume and continue to expect operating profit growth of about $25 million on low single-digit sales growth.

Earlier this month, Sikorsky unveiled the S-97 radar prototype, featuring X2 technology; and we are pleased to announce that the Sikorsky Boeing team was selected to continue development of the Sikorsky Boeing Defiant demonstrator aircraft, with first flight expected in 2017.

We believe our technology is well positioned for the next generation Future Vertical Lift program.

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

Thanks, Jay.

So in summary, I think all we can say is a really solid quarter for UTC.

And what the difference a quarter makes.

You'll recall, the second quarter there was some concerns around organic growth and development program execution.

I hope that we put all that to rest with our performance this quarter, where we saw solid organic growth across each of the businesses, with good bottom line conversion and key development programs on track, as well as major program awards which will drive top line growth in our businesses for years to come.

Let me just take a minute and highlight a couple of the big wins in the quarter.

As you know, of course, Pratt & Whitney and our Aerospace Systems business supported the maiden flight of the Airbus A320NEO aircraft on September 25 in Toulouse.

All of our systems, including the Geared Turbofan engine, performed well on this historic flight.

We are confident that the flight test program will further validate the performance characteristics for reduced noise, lower emissions, and significantly higher fuel efficiency, and we look forward to the continuation of that successful test program.

I'm sure you also all saw the announcement from Gulfstream last week.

We're delighted to see the introduction of the PW800 engine for the new Gulfstream G-500 and G-600 long-range business jets and yet another platform for our engine business.

The PW-800 engine is optimized for long-range business jets and shares the same proven, rigorously tested core technology using Pratt & Whitney's award-winning PurePower family of commercial engines.

We are equally pleased with the Aerospace Systems content, where we'll provide several critical systems for these new business jets.

The Building and Industrial Systems businesses also had a solid third quarter, with Otis and CCS delivering 5% and 4% organic sales growth, respectively.

As you know, the third quarter marked the one-year anniversary of the formation of our Building Industrial Systems business, and integration activities continue to progress well.

In the quarter, we saw another example of revenue synergies in Australia, at the Sydney Airport.

At the Sydney Airport, Otis has had a long-term maintenance contract which allowed CCS to win a contract covering the installation of detectors, fire indicator panels, and emergency warning systems across one domestic and one international terminal and a five-year service contract for maintenance and repair work across the airport site.

BIS does work.

As you can see, each of the businesses is well positioned in our core markets.

We're delivering real value to our customers and securing key orders that will drive top line growth well into the future.

All right, taking a look at the rest of the year.

As you know, the compares will get tougher in the fourth quarter.

But order and end market trends through Q3 continue to support our expectation of 4% organic sales growth for the full year.

As I mentioned at the start of the call, Q3 gains are stronger than previously anticipated; and this was driven mainly by a US tax settlement that closed a few weeks earlier than expected, moving the gain from Q4 to Q3.

We continue to anticipate that net one-time gains and restructuring costs will offset for the year.

And we see a path to the high end of the range of $6.75 to $6.85, although there is some pressure, given the recent strength of the US dollar.

For the year, we continue to anticipate debt pay down of $1 billion, and we now expect share repurchase of $1.5 billion, up from our prior expectation of $1.35 billion.

And we expect M&A spend will be a little less than $1 billion.

Year-to-date free cash flow is 82% of net income and cash is generally strongest in Q4, as you know.

We expect free cash flow of about 90% of net income for the full year of 2014.

Moving on to slide 12, let's take a look at 2015 briefly.

As we move within any year, of course, there are some positives out there, there are some headwinds, and a lot of question marks.

But let me touch on a few of the big ones here.

A couple of things that we know are going to be headwinds next year.

Commercial Aero OE margins, both at Pratt & Whitney, as well as Aerospace Systems business.

As we ramp up production on the GTF, we'll see some margin headwind at Pratt.

We'll also see a little bit of that at Aerospace Systems, as production rates increase on the new platforms.

And as you would expect, the margins on early units going out the door are pressured with the learning curve.

These are great long-term programs that point to a bright future for both Pratt and our Aerospace Systems business and are key building blocks for our long-term strategic plan.

On the military side, the biggest issue here is the C-17 program.

Pratt, as you know, supplies the engines on the C-17, 4 per aircraft, volume that will decline as production ends next year.

So that will be a headwind, as the F135 engine production has not yet ramped up.

Looking at the middle column here, some questions.

First of all, what happens in Europe?

When do we see a sustainable recovery there?

Emerging markets, now we put China in that category.

You know they will grow.

The question is, how much will they grow?

Pension, as you know, was also a big driver at UTC.

And if we were to snap the line at the end of September, the discount rate was 4.2% and would give us a headwind of about $160 million next year.

As you know, every 10 basis points of discount rate change, there's nearly $30 million of earnings impact year-over-year.

On the positive side, the pension portfolio has performed well and should offset the discount headwind of 4.2%.

I put it in the question mark column, because it's too tough to call when rates will be when you snap the line on December 31.

We also expect the new mortality rate tables to be introduced in the coming months.

While it's great that we're all living longer, this does increase pension expense by about $180 million a year.

Just not clear yet whether this starts next year or the year after, so we've got a question mark as we sit here today.

In the plus column, well, first of all, we think the US economy will continue to recover, even in the face of slightly rising interest rates.

And our businesses have good, solid momentum here.

Commercial aero aftermarkets, as well as the business in general aviation, should continue to benefit from solid fundamentals and, of course, cost reduction.

Since 2009 through the end of last year, we've done some $2.6 billion of restructuring.

We've got another $375 million this year, which would give us a couple of hundred million dollars of tailwind into 2015.

So as always, some pluses, some minuses, and a few question marks as we look towards next year.

As we sit here today in this challenging and uncertain macro environment, earnings for next year look to be around the mid-single digit mark.

But it's still early and we continue to work the plan for next year.

We are executing the long-term strategy that we presented earlier this year at our March Investor Day.

The portfolio is well positioned to take advantage of the urbanization and commercial aerospace megatrends through the end of the decade and beyond.

The investments that we're making today position us for sustainable earnings growth well into the future.

We'll continue to leverage our industry-leading franchises and global scale, and we believe we've got the right strategy, the right portfolio, and we've made the right investments to continue to drive sustainable long-term earnings growth.

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

Stephanie?

(Operator Instructions)

Carter Copeland, Barclays.

Hello.

Good morning, gentlemen.

Just a couple quick ones.

First, with the decline in the service sales in Europe at Otis, was that related to pricing or something else?

I think you had said previously that the pricing had kind of stabilized there.

Did that change, given the change in the macro environment there?

Yes, Carter, we still continue to see some pricing pressure there.

It's moderated from what we've see over the past couple of years, but there's still a little pricing pressure on the portfolio.

I think we've done a pretty good job in terms of stemming the tide there.

We've got some new programs out there trying to be a little more aggressive in terms of the retention of the portfolio.

But it's still a pretty tough environment on the service side.

Can you characterize the magnitude of the pressure relative to what you've seen in the past couple years?

Yes.

You're talking less than $0.01 in the quarter of pressure from pricing.

Okay.

Great.

And then with respect to the SEER-14 transition and the order trends that you talked about, can you help us think through beyond the order trend, in terms of production and shipments and how that impacts Q4 versus Q1?

My recollection was that you -- this was when they could be manufactured in Q4 but shipped in Q1.

How are you thinking that that's going to work out as the year end approaches?

Yes.

I think that's exactly right.

I think we saw really strong order growth on the resi side.

And we don't actually think that that's indicative of what's going on in the market.

It's probably closer to the 9% growth that we saw in the sales for the quarter.

The plan, as we sit here today, of course, is to manufacture all of these SEER-13 units that have been ordered.

And most of them will sit in inventory through year end and we'll ship them into the first and second quarter of next year.

So you'll have a more, I'll say, steady-state in terms of what the market really looks like, as opposed to 2005, where we had the big, like 1 million unit pre-order across the industry and there was huge shipments in the fourth quarter.

We're not planning to do that.

That obviously has an impact on inventory, probably $150 million or so of additional inventory that we'll see on the books at year end.

But the fact is, we don't want to push this out to the distribution if the ruling -- it's just going to sit on the shelves.

So again, good solid order growth rate.

We think, again, share is remaining where we expected it to be.

So just no big bump this year in the fourth quarter.

Okay.

Great.

Thanks, Greg.

I'll pass the mic.

Thanks, Carter.

Julian Mitchell, Credit Suisse.

Hello.

Thank you.

Just on the Aerospace businesses.

I think R&D had been up, company funded, about 4% in the first half.

A lot of that was in UTAS.

And you talked before about flat R&D for the year as a whole.

So I just wondered how was R&D in UTAS in Q3 and how are you thinking about it for the next 12 months?

In fact, if you think about -- the plan going into the year was that E&D was going to be relatively flat.

I'll tell you that's not going to happen.

It's probably going to be up about $100 million across all of UTC, and really, that's the aero units.

The big increase in the quarter where we saw -- I think it was up about almost $50 million -- that's all Pratt Whitney.

UTAS was relatively flat year over year in the quarter.

But we're going to continue to see a little bit of additional E&D into the fourth quarter.

But think about that as $100 million or so year over year.

And then again, benefit next year, as we'd expect that to go back down to prior years' level.

Thanks.

And then at Pratt, restructuring the last six months has been very low, even though the two minus points you call in out the 2015 outlook both pertain to Pratt.

Again, keep in mind, Pratt has done a significant amount of restructuring in the last three years.

They did the 20% across-the-board reduction in SG&A at the beginning of last year.

We continue to take cost out, closing floorspace both in Canada and here in the US.

So I think they have done what they needed to do from a cost reduction standpoint, in terms of the back office and the factory footprint.

The cost reduction focus today at Pratt is all on the new products going out the door.

So, again, I think you won't see big restructuring dollars.

But what we're doing is obviously focusing on GTF cost reduction to hit those target costs that we have out there as the production ramps.

Thanks.

And then just very quickly, you don't call out anything on the balance sheet in the 2015 outlook, but I guess share count is a small tailwind exiting this year.

Anything else you'd like to say on the balance sheet for 2015?

Well, it's a little early.

I think Louis will probably talk about it.

The only thing I would point out that is obvious is share count will probably increase a little next year, absent share buyback, because of the -- what do we call those -- the convertibles, the MSUs, that are out there.

So we'll issue, I think, 11 million shares first of July.

Obviously, we're going to probably have share buyback that will try and offset that.

But full-year share count might creep up a little bit next year.

Great.

Thanks.

Thanks, Julian.

Robert Stallard, Royal Bank of Canada.

Thanks so much.

Good morning.

Good morning, Rob.

Greg, I was wondering if you could carry on in the previous vein.

I wonder if you could talk about your plans for debt retirement and any sort of impact that could have on the income statement next year?

So again, we have some debt that's coming due, I think, in May.

There's a 6% note out there.

The thought is, again, we'll probably just refinance that on the short end with commercial paper.

So again, we'll pay down $1 billion of debt this year, just exactly as we had expected to do.

But next year, I wouldn't expect to see further debt reduction.

Great.

And then on the commercial aerospace aftermarket, in the past you've given us a little bit of a breakdown of Pratt in terms of the trends you've seen in the V2500 versus the wide-body engines.

I was wondering if you could give us that again.

And then also, at UTAS, I was wondering if you could break out how much the provisioning might have added in the quarter.

Thank you.

Sure, Rob.

For spares, in terms of the orders, the V-2500 was up, the PW2000 was up, and the PW4000 was down.

As far as UTC Aerospace Systems, as far as orders, both the parts and provisioning were up around the same amount as the overall order rate.

And on the sales basis, parts were up mid-teens -- or, I'm sorry -- were up high-single digits, and provisioning was up over 20%.

Great.

Thanks, Jay.

You're welcome.

Jeff Sprague, Vertical Research Partners.

Thank you.

Good morning, gentlemen.

Good morning, Jeff.

Greg, if I heard you correctly, so basically you're pointing us towards kind of mid-single-digit EPS growth in 2015.

Obviously, there's of long list of pluses and minuses.

Just on the ones that you do have dialed in a little bit better, I just wanted to make sure I was clear.

On pension, are you telling us that asset issues offset discount rate and therefore the headwind, if there is one, is simply on mortality tables?

That's exactly right.

I think if we snapped the line at the end of September, despite a lousy September in the markets, the pension performance is going to trump the discount rate down at 4.2%.

If I snap the line today, of course, the discount rate is 4%.

So I'm just going to ignore that for now.

The real issue is whether we adopt mortality tables.

We're waiting for them to be published.

If they get published this year, we'll probably adopt them.

If they get published early next year, we'll wait and adopt them in 2016.

And your comment about earnings growth next year assumes the mortality table is adopted?

It assumes that the mortality table is adopted, yes.

So right now it would be a headwind.

But I put in the question column, because again, it's middle of October as opposed to middle of December.

So when Louis stands up, we'll obviously have some clarity there.

And it sounds like you've got a pretty good dial on Pratt margins or headwinds next year.

Obviously, unforeseen challenges on ramps can occur.

But can you give us a little bit more color on what you're pointing us to there, what the ramp pressures look like?

I don't know if you can express it in dollars or margin points or what.

Maybe the best way to think of that, Jeff, is you've got a couple of big known headwinds, that is negative engine margin -- that's on the V2500 as well as the GTF, primarily the NEO, as that enters service at the end of next year.

And so we know that's out there.

And it's a pretty good-sized number, as well as the US military.

As the C-17 production stops, we make good money on that, both on the OE and on the support side of that.

So that kind of goes away next year.

But you do have some offsets.

I think, obviously, the commercial aero aftermarket will be better.

Pratt Canada continues to get better.

You've got good news probably on the E&D front.

I think right now I would tell you that at Pratt, we'll struggle to grow earnings, if at all.

And that's really the challenge that we have in the next couple of months is to understand, Pratt right now is signaling -- there's no growth there.

And I think that is probably our biggest challenge for next year, because of these big headwinds.

And just one more and I'll move on.

So we've had the question and the discussions about aero ramp CapEx and working capital.

And you have some working capital noise in Carrier here at quarter end.

Would you foresee conversion actually moving back above net income next year?

Or would net income be the reasonable bogey?

I think net income is a reasonable bogey.

I think, obviously, even this quarter, we had 83% of free cash flow to net income, you had about $400 million of gains or one-time items that flowed through that had no cash impact.

So there's a little bit of noise outside of just the pension.

Obviously, pension becomes less of a tailwind next year.

But also, from a cash standpoint, there's no cash coming in from pension.

Good news, anyway.

So CapEx ought to come down a little bit next year.

So all in all, I would say, I think we ought to be targeting, as we typically do, free cash flow equal to net income.

Always bumps in the road as we put the plan together.

But I'm pretty confident when Louis stands up, he'll be guiding towards that 100%.

All right.

Thank you.

Joe Nadol, JPMorgan.

Thanks.

Good morning, guys.

Just a couple on Otis, to start.

So the guidance for profit is lower -- profit growth is lower, exclusively because of currency, or is there anything else in there?

Currency is the biggest driver.

It's about $50 million year over year of headwind.

I think, again, the pricing pressure that we talked about in Europe earlier continues to be a bit of a headwind, but it's not a big driver.

It really is primarily FX.

Again, I would say Otis is recovering.

The Florence factory is doing much, much better.

Still some room to go there.

But there's no big operational misses here.

It's really just pricing in Europe, I would say, and FX.

Okay.

And then on China, on Otis China.

Can you tell us about unit orders year on year?

Was that also flat, or was there a change there?

And maybe just provide some color on what you're seeing more qualitatively as we head into Q4 and into next year.

So the units were up in the range of mid-single digits.

So we continue to see growth in units year over year.

The other piece of it is we still see strong award activity.

And just as a reminder, we do not record orders until such time to receive a deposit.

So it's been a little bit slower converting the awards into booked orders from a cash conversion into positive perspective.

But the activity still remains pretty solid.

I think you've got to keep in mind, Joe, backlog is still up 14% year over year.

So I think the sales forecast that we have for the year is solid.

And we should continue to see solid growth next year, despite what is, we all recognize, a very -- or a slowing housing market there.

The Chinese government's taken some steps here with reducing down payments on second homes to try and stimulate some growth there.

But it'll be challenging.

It is a 600,000 unit elevator market, though.

Just keep in mind, it's the world's biggest by a factor of probably 5. So it's a huge market.

And the opportunity there, as you know, is going to be on the service side, long term.

And that's really where we're focused.

And I think service will probably grow 20% or so again this year, after growing 20% in each of the last two years.

So the team's focused on service and delivering service across the entire region, which is, again, a big challenge.

But that's where the growth is going to come from.

Okay.

And then Greg, I just wanted to clarify one item, which is the Pratt guidance.

I don't think I heard you say this specifically, but are you guys going to stop providing guidance or color on spares, specifically, and just move to aftermarket?

Because I understand longer run, as you move to 80% type of pick up on service contracts, that's going to be an even more relevant benchmark.

But in the nearer term, for the next couple of years, just the one-off spare sales are still going to be extremely important.

We will be transparent on the spares orders.

We put it out there in the press release, not trying to obfuscate anything.

But the fact is, we know spares will continue to be going -- or declining, as the retirements kick in on the 4000 and the 2000.

So we wanted to put both metrics out there.

The point of is this is that longer-term, we really need to start thinking about commercial aftermarket as opposed to just the spares.

Because, as you know, the fewer spares we sell, the better we are on the FMP contract.

So for the next couple of years, we'll continue to report both spares and commercial aftermarket.

Just understand -- and again, the point here is there is a transition here in the business model of Pratt that is significant, and we think, again, an opportunity for Pratt long-term on the margin side.

Okay.

Very good.

That makes sense.

Thanks.

Thanks, Joe.

Sam Pearlstein, Wells Fargo.

Good morning.

Just wanted to go back to one question.

You mentioned about China and the elevator margin.

You talked about some of the stimulus.

I thought there also was some movement towards changing some of the rules in terms of the aftermarket contract that might help the OEM do a little bit more.

So can you talk a little bit about where that stands and what your attachment rate has been in terms of some of the more recent selling there?

Yes.

I think, again, this is a regulatory change that had started to get rolled out last year.

It's been rolling out province by province.

This is a requirement that the OEMs actually do service the elevators.

And as a result, again, you're seeing that in the increase that we're seeing in our aftermarket attachment rate.

I think we've got about 135,000 elevators under service contract in China today versus 110,000 last year.

So we're getting good traction.

The regulatory change, though, will be slow to be adopted, I would say, across the country.

But it is a net positive trend for us.

And then just on Sikorsky, I was wondering if you could clarify something.

If you're going to generate $25 million growth in terms of adjusted profits this year, it would seem to imply a very strong fourth quarter.

I just want to make sure I understand that.

And related, just wanted to know if you could talk a little bit about the energy market and what that's doing to commercial helicopter demand right now.

Yes.

That's -- okay.

Let's just talk about Sikorsky.

We've got a big fourth quarter, as they typically do.

We'll have about $2 billion of sales at Sikorsky in the fourth quarter.

So growing.

I know they're down a little bit year-to-date.

But the $25 million ought to be well within the reasonable range of what they can deliver for the full year, again, on a strong fourth quarter delivery.

As far as offshore oil, we actually had a conversation with them yesterday about this.

And they are seeing some pressure because of offshore oil.

And with fracking in the US growing so significantly, we're seeing less of the oil and gas exploration expansion, which had driven the big ramp-up in commercial helicopters.

We are going to deliver 40 S-92s this year.

We'll probably deliver a couple more than that next year.

Is there still a market for the helicopters?

It's just were not seeing quite the same growth because of the prevalence of fracking here in the US.

That's great.

Thank you.

Thanks, Sam.

Nigel Coe, Morgan Stanley.

Thanks.

Good morning.

Good morning.

Greg, I wanted just to go back to the 2015 framework and, obviously, a big question mark around the magnitude of the OE mix headwind.

And I'm wondering, can you just put -- give us some sort of working range on that?

Because it is a key debate.

And I'm wondering around that, will there be an impact from the collaboration accounting or is this primarily just UTF?

And is there a circumstance in 2015 where you get the OE ramp up and the headwind, but not the corresponding reduction in R&D?

Well, I think, again, the R&D is almost a natural reduction.

When you think about it, we're going to be done on C Series flight test.

We've got the engine certified, the NEO engine certified.

You've got MRJ.

We just rolled that out.

You're going to see just a natural progression of E&D coming down over the next few years.

Still have some spending out there.

You've got the Embraer, the E-2 jets.

You've got the Irkut jet.

But should just be a natural roll down in E&D to a more, I'd say, normal level.

As far as the commercial OE, the headwind.

I guess the way to think of that is probably somewhere around -- I don't know -- $0.10 to $0.12 a share for next year.

Maybe a little more than that, but kind of in that range.

Okay.

And is that just GTF ramp, or is that also including some collaboration accounting?

There's no -- it's not collaboration.

There is some additional V, some new Vs out there that weren't included in the contract when we bought Rolls' share of IAE.

So those new engines will go out with some negative margin, as well.

Okay.

And then just a quick one on pension, Greg.

You mentioned possibly adopting the new mortality tables this year.

But does that put any incremental funding pressure for next year, if it does get adopted?

No.

In fact, I think with the new pension rules that our friends in Congress passed, we don't actually have to fund that until sometime in 2020.

I would tell you, though, we'll probably fund at service cost level for the next few years.

As you know, we've sunset the plan, the old FAE plan.

We took that really tough action back in 2009.

That's been paying off.

But as we switch to the newer pension scheme with a cash balance plan, we'll probably funding that on a more normal service level going forward.

So you think about $300 million or so of cash next year for pension funding in the US and probably a couple of hundred million for international.

Great.

And a quick one on euro rate for 4Q.

What's the euro rate you're using for Otis in 2014?

Well, I think we're at $1.27 in our current forecast, which is right about where we are today.

I think it dropped a little.

Was at $1.28 yesterday, came down a little today.

So I think we're kind of in the ballpark.

Now recall, last year -- or going into the year -- we're kind of in the $1.30 range, and for the full year, we're at $1.33 this year.

So there is some certain FX headwind year over year going into the fourth quarter.

Okay.

Thanks, Greg.

Thanks, Nigel.

Howard Rubel, Jefferies.

Thank you very much.

Greg, one of the things you talked about was the opening or the difference between restructuring and gains.

Could you refresh us on where you are then for the fourth quarter?

Yes.

So we've spent in restructuring $243 million, not to be terribly precise, on a $375 million forecast for the year, meaning we've got about $132 million of additional restructuring teed up in the fourth quarter.

And that's all subscribed.

We've got plans in place to spend all of that.

And in fact, there could be some additional gains in the fourth quarter.

We'll see what happens with the taxes.

We also got tax extenders out there that could happen in the fourth quarter which might allow us to do some additional restructuring.

So as we talk about the plan for next year, one of the keys is what additional cost reduction restructuring actions can we take to help ensure we have a decent plan going into next year?

So that's where we're going to focus on over the next couple of months is looking for additional restructuring opportunities.

And don't be surprised that that $375 million goes up a little.

Yes.

Because the reality is that, without that, you'd actually do a little bit better than the high end of your range for the year.

Yes.

So again, I don't think there's any -- look, we're going to stay within the range.

As I said before, we have a path to $685 million.

It's a little tougher with this big currency headwind we've got in the fourth quarter, but there's still a path out there.

But I would not look for us to significantly over deliver on the basis of additional gains.

I understand -- no, it wasn't gains so much, but the absence of -- I get it, though.

Just to stay for a moment on restructuring, could you provide some indication of the successes you've had combining CCS and Otis internationally?

Well, I think the biggest from a restructuring standpoint, the biggest success, is think about, Otis has 2,500 branch offices out there.

And the ability to consolidate offices -- I mean, it saves a lot of money.

I think Geraud's got a target of about $300 million of savings from the synergy of collapsing the offices and running the business as not just Otis, not Fire and Security and Carrier, but as BIS.

So you have one back office.

You have one management team.

Again, sales forces are all different.

Field service is different.

But you are getting synergies out of the consolidation of the offices.

And then just one last, if I may.

When I look at your tax rate, and we'll call it 30%, versus your peers, or other large multinationals.

They all have something that begins with a 20, high 20s.

Going forward, is it possible that we could see a tax rate in the -- I'll use 28% plus range?

You know, it's hard to imagine us absent -- of course, with tax reform, Howard, anything's possible.

And again, I think that's the real issue.

Our tax rate normally wants to be about 32%.

We do some tax planning that allows us to get it down to around 30%.

That's primarily permanently reinvesting foreign earnings.

But the fact is, the rate wants to probably be around 30%, absent the tax extenders.

You get the R&D tax credit and the CFC look-through rules, that'll drop the rate about 1 point.

We're obviously hopeful we're going to see something in December from Congress on that to hopefully make permanent the R&D credit.

Because it's crazy to wait and spend money in anticipation of a tax law change.

So that's an opportunity.

But again, as the tax rules become more and more difficult -- you've heard of this BEPS project out there where everybody's looking for additional tax revenue.

The tax authorities around the world are becoming more aggressive.

We've taken a relatively conservative view on the tax rate.

We could certainly drive it down for a year or two.

But reviewing this over the long term, it probably wants to be 29% to 30%.

Thank you, Greg, very much for your time.

Thanks, Howard.

Myles Walton, Deutsche Bank.

Thanks.

Greg, there was a comment in the press release on increased revenue synergies being realized in Building Industrial Systems.

Wonder if you can put a little bit of color behind that, substantiate the rationale of the combination and also give us some color on the hunt for larger industrial M&A.

Thanks.

I think on the BIS revenue synergy, it's obviously early.

The businesses have been together exactly a year here, as of September 30.

We highlighted we had this project in Australia that was bringing in some fire and security product, some CCS product.

Last quarter, we talked about a project in Hong Kong we were able to bring a Otis elevator contract.

In the Middle East we've seen some good pull through where the legacy Carrier business has a very good relationship in the Middle East.

We're able to bring in some of the Otis elevators and win some relatively large awards.

But these are all kind of one-off today.

I think the whole focus here of managing this as a BIS organization is to make that more routine as opposed to one-off.

And I think that will take some time.

We're certainly getting some market acceptance today.

And as we talk to developers, we talk to the building owners, they see the benefit of BIS versus the individual businesses going to market.

So we've got a key accounts leader in place today for the US.

We're working that out internationally.

So again, there's momentum building here.

I think when Geraud stands up in March next year, he can share some more of the wins with you then.

Are you looking at something like combined capture rates or combined bid rates?

Is that the way you're internally looking at the metrics?

Myles, I'm not sure I actually have seen the exact -- in fact, we've got our business review tomorrow with BIS.

I haven't actually seen the new metrics that we're using.

Obviously, we're looking at this more holistically as opposed to just order rates at Otis or order rates at Fire and Security or Carrier.

Again, we're trying to attack this from a top-down level with the customer.

So I haven't actually seen what the new metric is going to be.

We can come back to you with that.

I'm sorry, what was your second question?

The M&A, the hunt for the big fish.

We're still fishing.

Like I said, I think back a couple of months ago, the pipeline is not terribly robust.

There are opportunities out there.

Obviously, on the commercial side, we're focused on building out.

The buildings side and the systems side, continue to look for opportunities there.

But the market's been tough.

As you know, equities have run up quite a bit, prices are very difficult.

And even with the recent price correction, if you will, we haven't seen M&A prices correct along with the rest of the equity market.

So we're going to be disciplined.

We're going to be patient.

We're going to look for properties in the core.

Obviously, the focus is on the commercial side.

Not to say we wouldn't do an aero deal if one came along.

But the pipeline is not terribly full, but we continue to spend a lot of time looking at various opportunities.

Thanks.

Thank you, Myles.

George Shapiro, Shapiro Research.

Yes.

A couple of quick questions, Greg.

Pension income, I assume, was about $0.09 a share this quarter, $125 million or so.

Yes.

That sounds about right.

And then I want to follow-up a little bit with Pratt, because if Pratt gets like maybe $50 million of the pension income, you still had profits at Pratt up $20-plus million year-over-year, despite R&D up $50 million and spares up $7 million.

That obviously offset some of it.

But still seems like there had to be some strong performance elsewhere to get the number as good as it was.

So just wonder if you could provide a little bit of color.

I mean, V- 2500 engine deliveries are probably a little higher this year than last year, so --

George, we saw nice growth in Canada.

That was up low-double digits, both in OE, as well as the aftermarket.

So again -- and also strong with their spare parts business.

So Canada contributed.

As we saw -- as I said, we also had strong performance under our contracts and we saw a benefit there in the range of about a couple pennies.

And so those contributors -- again, as we talked about, we did get -- we have seen some benefit from cost reduction and restructuring.

So all that taken together has helped really offset that higher E&D in the quarter, as well as margin pressure.

The OE business was up a little bit and the large commercial business, but really not a significant factor.

And Jay, you said that spares were up a combined 7% at Pratt Canada and large Pratt.

Was it about equal at both?

That was -- the total aftermarket was up 7%, not just the spares.

But on a sales basis, Pratt's -- the large commercial spares were pretty much flat.

And the spares at Canada were up high teens.

Okay.

Thanks a lot.

Okay, George.

Thank you.

Doug Harned, Sanford Bernstein.

Good morning.

Good morning, Doug.

Greg, on Otis China, you talked about services, and that's clearly long-term the target here.

But as services grow, how should we think about margins on that, given that, in the early couple years, these elevators are under warranty and you don't have the scale yet you have in Europe or in the US?

Yes.

I think, Doug, you hit on a key issue with service.

Today, the margins on service are not much higher than what they are on the OE side.

Although they're still very good.

The opportunity, obviously long term, as you get group density across China, as we build out all of these branch offices and add all these service technicians, margins should continue to improve.

It's not clear we'll ever get to developed country type margins in service, but there's still opportunity here.

Again, I think the idea here today is to focus more on getting the contracts and servicing the customers as opposed to margin expansion.

That will come naturally over time, as we get more productivity from the sales or the field force.

Keep in mind, we're adding 1,000 people a year to the service network in China.

And we've got to bring them in, we've got to train them.

We've got to teach them how to service elevators, and we've got to deploy them out into the field.

All of that is holding down margins in the near-term.

But again, still a profitable business in China, still good margins.

Just not the kind of margins that we would expect long-term.

And then on Pratt, when you look at 2015, and clearly for the year, Turbofan, the A320NEO is the really big deal here.

But when you look at the C-series, how are you looking at, in 2015, -- what are you looking at in terms of the trajectory of deliveries?

And if that were to get delayed, is that something that would have any kind of a material impact on your either revenues or margins at Pratt?

We're delivering some engines this year.

I think we'll probably deliver the same number of engines, roughly, maybe a few more next year.

So it's not a big driver of year-over-year margin degradation at Pratt.

And again, they've had some recent wins.

We feel pretty good about it.

The plane's up and flying again.

And they should be on track to get this thing in service by the end of next year.

The bigger ramp will obviously come on the Airbus A320NEO.

Again, there'll be huge volumes by 2017 where we could be delivering 500-plus engines a year from zero today.

So the C-series itself, you're not -- that's probably not -- the timing on that is probably not much of an issue for next year then.

We don't see it as a big year-over-year driver, as we sit here today.

Okay.

Great.

Thank you.

Thanks, Doug.

Peter Arment, Sterne, Agee.

Yes.

Good morning, Greg, Jay.

Just a quick one regarding update on the synergies you mentioned, back to Howard's question.

The Goodrich synergies, can you remind us where they're tracking to?

Is the number still, I think, $500 million that you had previously indicated?

And also, if you could also give us an update on CCS synergies, too?

So if you think about the synergies, I think through last year we'd recognized about $270 million or so of synergies.

There's another $100 million plus this year.

We're on track probably next year to deliver close to another $100 million of synergies.

And I'm sure there are more synergies beyond the $500 million.

But again, I think talking about synergies versus typical normal cost reduction and other restructuring activities gets very difficult as we get past about the third or fourth year of the acquisition.

So we'll talk about them this year and we'll talk about the tailwind next year.

And I think, again, we'll hit that $500 million by the end of next year, and then we're just going to keep going and continue to drive margins up.

You can call it synergies.

You can call it cost reduction.

You can call it just what we do at UTC.

But we're going to continue to drive margins up beyond that which the benefit we're going to get from the $500 million of synergies.

In terms of the BIS synergy, we talked about a $300 million number.

Not a big number this year.

Maybe $50 million of savings between what we're seeing in the segments.

And again, part of the issue is where we still keep Otis and CCS separate from a reporting standpoint.

So when we close a CCS office, that restructuring savings may show up there.

If we close an Otis office, it shows up in that segment.

But again, that will accelerate in the coming years as we continue with the consolidation process.

Okay.

That's helpful.

Thanks, Greg.

Okay.

Thanks, everyone, for listening today.

We look forward to seeing you at our annual investor and analysts meeting on December 11 in New York, where Louis will give guidance -- complete guidance for 2015.

The IR team will be around throughout the rest of the day to take your questions.

So thank you very much and have a great day.

Thank you, ladies and gentlemen.

That does conclude today's conference.

You may all disconnect and everyone have a great day.