雷神技術公司 (RTX) 2015 Q2 法說會逐字稿

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

On the call today are Greg Hayes, President and Chief Executive Officer; Akhil Johri, Senior Vice President and Chief Financial Officer; and Paul Lundstrom, Director of Investor Relations.

This call is being carried live on the internet, and there is a presentation available for download at 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 listener that the earnings and cash flow expectations that any 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 detail and 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.

Thank you.

Good morning everyone.

Before we get to the webcast slides, I just want to make a few comments.

I'm sure many of you saw yesterday's announcement that UTC has reached an agreement to sell Sikorsky to Lockheed Martin for $9 billion, and of course, it's subject to regulatory approvals and to customary closing conditions.

We will be moving Sikorsky to discontinued operations in Q3, and we would expect to close the transaction around year-end, either by December 31 or shortly thereafter in the first quarter of 2016.

This is a very good deal all around.

It's good for Sikorsky's employees and customers, as well as for UTC shareholders.

At UTC, we now see a portfolio that's more focused on the core, and that is supplying systems and technologies for commercial buildings and aerospace.

And we're better positioned to create long term value for our shareholders.

The balance of our portfolio will continue to deliver over the long term, with clear line of sight to mid single digit organic top line growth, based on the success of the Geared Turbofan engine at Pratt, and higher ship set values on new platforms at our UTC Aerospace Systems business, and of course a more focused, innovative product portfolio in our commercial businesses.

The sale is expected to generate approximately $6.2 billion of available cash.

We plan to use the proceeds to repurchase UTX shares, and we would expect to offset the EPS dilution from the loss of Sikorsky earnings through the share buyback program.

Now, coming back to 2015.

Top line growth remains solid in Q2, with 3% organic growth and a continuing slow global economy.

However, as you saw in the press release this morning, we are lowering expectations for the year for EPS.

After a half a year of actual results, it's clear that the commercial aftermarket assumptions that our Aerospace Systems business used were overly optimistic, and this, along with continuing weakness in Otis Europe, and a significant slowdown of construction markets in China, have caused us to reevaluate our outlook for these two segments.

Needless to say, we are not happy with this performance, and we'll take decisive action and response, including accelerating cost reduction action across the businesses, and aggressively identifying additional structural actions focused on product cost and productivity, that can drive earnings growth well into the future.

We also intend to explore additional benefits from capital deployment, both M&A and share buybacks.

Let me assure you, while we see near-term weakness in some end markets, the long-term outlook remains strong.

Innovative products, global scale, and strong market fundamentals, that is RPM growth and urbanization, will allow UTC to deliver strong earnings growth well into the future.

Akhil and Paul will take you through the Q2 results and revised expectations in more detail in just a second, and then I'll be back with closing comments before we get into the Q&A.

Akhil?

Thanks, Greg.

Before I talk about the full year, let's look at Q2 results and end market trends for a little more context.

UTC reported Q2 earnings per share of $1.73, down 6% versus the prior year, and in line with the expectations that we discussed last month in Paris.

Excluding the impact of restructuring and one-time items, EPS was down 2% in the quarter, but up 2% for the first half of the year.

The stronger dollar was a headwind of $0.13 in the first half, which equates to about 4 points on prior year earnings.

Organic sales grew 3% in the quarter, same as the first quarter, and that marks the eighth consecutive quarter of top line organic growth.

In the commercial businesses, we saw continuing growth in the Americas, which were up 8%.

Asia grew slightly, reflecting the slowing environment in China, which was down low single digit, and sales in EMEA were flattish in the quarter.

On the aerospace side, commercial grew by 3%, as high single digit original equipment growth was partially offset by the aftermarket, which was flattish.

Defense sales were up 5%, mainly on higher military engine deliveries at Pratt.

Taking a closer look at our end markets on slide 3, and just a reminder, we'll talk to the commercial business orders on a constant currency basis, as we usually do.

For our building systems businesses, construction markets in the US remain a positive, and we continue to see that at Otis, where North America new equipment orders were up 10%.

At CCS, Americas commercial HVAC equipment orders were also up 10%, and residential HVAC equipment sales grew 7% in the quarter.

Turning to EMEA, the overall environment remains mixed, and our BIS order activity reflects that.

Transport refrigeration orders in EMEA were a bright spot, up over 25%, while after adjusting for a large order in Saudi Arabia, Otis new equipment orders were up 3%.

This was driven by solid growth in Germany, Switzerland, the UK, and Spain, with France and Russia down.

Orders for commercial HVAC in EMEA were flattish.

In Asia, the China market has clearly slowed.

Real estate investment, new construction starts, and floor space sold are all under pressure.

Otis new equipment orders in China were down 10% in the quarter, and we also saw a slowdown in the rate of backlog conversion.

Excluding China, rest of Asia continues to do well at Otis.

At CCS, China orders were down 15%, driven by commercial HVAC.

Shifting to commercial aerospace aftermarket, at Pratt & Whitney, sales were up slightly, with mid single digit growth in both Pratt Canada and large commercial engine transactional services.

Shop visits for engines and the fleet management program were lower in the quarter, reflecting our strategy to improve time on wing.

UTC Aerospace Systems' commercial aftermarket sales were down slightly, largely driven by the ongoing weakness in provisioning and repair.

New test parts sales continued to be strong and were up 8% in the quarter, consistent with Q1.

Taking a closer look at the second-quarter results on slide 4, total reported sales decreased by 5% as 3% organic growth and a point from acquisitions were more than offset by 4 points of headwind from the stronger US dollar and 5 points from the absence of the prior-year CMHP adjustment.

Segment operating profit was down 3% in the quarter, and operating margins were 16.6%.

Earnings per share of $1.73 were down 6% in the quarter.

Recall that restructuring and gains were balanced in the second quarter of 2014, while we saw $0.08 of net restructuring and one-time items in the second quarter of 2015.

Absent the impact of gains and restructuring, earnings per share were down 2%, while at constant currency, earnings per share were up 2%.

Free cash flow was 76% of net income, and was adversely impacted by a payment of about $250 million for the previously-discussed German tax matter.

Excluding this payment, free cash flow would have been a little over 90% of net income.

For the full year, we continue to expect free cash flow to net income of 90% to 100% in 2015, and we are maintaining our placeholder of $1 billion for M&A.

On slide 5, as Greg mentioned, we are lowering our expectations for the year.

On a continuing operations basis, excluding Sikorsky, we now expect earnings per share of $6.15 to $6.30 on sales of $57 billion to $58 billion, reflecting roughly 3% organic sales growth.

That's down from our prior continuing ops expectation of $6.35 to $6.55 EPS on sales of $58 billion to $59 billion.

So looking at the changes on the right hand side of the page, UTC Aerospace Systems profit expectations are lower by about $300 million, and Otis by about $200 million.

So total segment profit growth expectations are down around $0.38 versus our prior forecast.

There are no changes to the earnings expectations at CCS or Pratt.

We have offset about $0.15 through lower minority interest, some FX forecast contingency, and lower incentive compensation, among other things.

Now, let's walk through what's driving these changes at UTAS and Otis, so I'm on slide 6. For UTAS, commercial aftermarket sales look to be down slightly in 2015 now.

Our prior expectations included high single digit sales growth in the commercial aftermarket.

We continue to see good demand for parts based on solid airline industry fundamentals; however, after a very strong 2013 and 2014, provisioning now looks to be down about 10% versus our prior expectation of up 10%.

Repair volumes have also been weaker than expected.

In addition, the military aerospace business is slightly lower, both for the OE and the aftermarket segments.

So for UTAS overall, we now expect low single digit organic sales growth for the year, down from the previous expectation of up mid single digit.

Primarily due to the shortfall in high margin aftermarket sales, we are changing UTAS profit expectation to down $25 million to $75 million from up $225 million to $275 million previously.

At Otis on slide 7, we haven't yet seen an improvement in the European service business, and are adjusting up our prior expectation of a second-half recovery.

We now believe that consistent with first half, EMEA service sales for 2015 will be down mid single digit, as compared with prior expectation of up low single digit.

China has also slowed.

Overall, we now anticipate Otis' organic sales growth to be up low single digit for the year, as compared to our prior expectation of up mid single digit.

With this change in the growth outlook, we now expect Otis profit to be down $25 million to $75 million at constant currency, compared with the original expectation of up $100 million to $150 million.

Including the adverse impact of FX, we expect operating profit at Otis to be down $300 million to $350 million, assuming Euro at $1.10 for the balance of the year.

Let me stop there and turn it over to Paul, to take you through the business unit results for the quarter in more detail.

Okay, thanks Akhil.

So turning to page 8. Otis' second quarter sales were $3.1 billion, and up 1% organically.

Profits were $635 million, and down 1% at constant currency.

Operating profit margins remained strong at 20.5%.

Foreign exchange translation was a 9 point sales headwind, and an 11 point earnings headwind.

Profit was down in the quarter, as the unfavorable impact of price and mix more than offset contributions from volume and productivity initiatives.

New equipment sales grew by 4% in the quarter, with solid double digit growth in the Americas.

EMEA new equipment sales were essentially flat, and we saw a 4% decline in China, driven by weaker orders, and a slower conversion of new equipment backlog to sales.

Otis service sales were flat overall, as a 4% decline in EMEA was offset by mid single digit growth in Asia.

Service sales in the Americas were flat.

New equipment orders were up 5% in the quarter, driven by a large project in the Middle East.

New equipment orders in North America were again strong, up 10%, and orders in EMEA were up 32%.

Excluding the large Abraj Kudai hotel project in Saudi Arabia, EMEA orders were up 3%.

Asia orders were down mid single digit from weaker demand in China, which saw a 10% decline.

Outside of China, orders in Asia were up mid single digit.

As Akhil mentioned, we now expect Otis profit to be down $25 million to $75 million at constant currency.

Including the negative impact of foreign exchange, we expect profit to be down $300 million to $350 million.

On slide 9, we saw continued momentum at Climate Controls and Security in the second quarter.

Sales grew 8% at constant currency, with 5 points of organic growth and another 3 points from net acquisitions.

Profits were up 6% at constant currency.

Overall, foreign exchange translation was a 5 point earnings headwind, and a 7 point sales headwind.

CCS organic sales growth was led by the Americas, where residential HVAC grew 7%, and commercial HVAC was up in the low teens.

Transicold saw continued strength, with sales up low teens.

EMEA was essentially flat, with growth in F&S products offsetting a decline in commercial HVAC.

Asia was also flat in the quarter, with declines in China offset by growth elsewhere in the region.

Operating profit growth of 6% was primarily driven by a drop through on organic volume growth, and cost benefits, including favorable commodity prices.

CCS equipment orders were up 4% in the quarter.

Transicold was up nearly 30%, with broad based strength across the business.

Global commercial HVAC orders were down 5% in the quarter, led by a sharp decline in China.

CCS continues to expect profit growth of $200 million to $250 million on a constant currency basis, on mid single digit organic sales growth for the full year.

Solid results in the first half, along with better than expected commodities and some favorable non-recurring items mentioned in Q1, helped mitigate pressure from a slowing China, and a softer Europe.

Turning to aerospace on slide 10, Pratt & Whitney sales of $3.7 billion were up 2% in the quarter, largely driven by double-digit growth in military engines.

The commercial aftermarket business was up 1%.

Within that, large commercial engine transactional sales, including both parts and repair, were up 4% in the quarter.

That was with a V2500 spares increase of nearly 30%, partially offset by declines in legacy platforms.

Aftermarket shop visits for our fleet management programs were down, which again means engines were on wing longer, benefiting both customers and Pratt.

Pratt operating profit was $489 million, which was down 6%.

Headwinds from higher negative engine margin and pension were partially offset by lower E&D spend, and the drop through from higher volume in the military engines business.

The absence of last year's gain on the sale of a product line was a head wind, but it was more than offset by another non-core product line sale, and a contract close out.

Looking at our 2015 full-year expectations, we now expect commercial aftermarket sales to be up low single digit.

That's down from our prior expectations of up high single digit.

Higher military engine sales, better commercial aftermarket margins, and lower E&D spending will offset the impact from the lower commercial aftermarket volume, and so we still feel comfortable with the full year guidance at Pratt.

Turning to Slide 11, UTC Aerospace Systems profits were $580 million in the quarter, which was down 4%.

Sales of $3.6 billion grew 2% organically in the quarter.

Similar to what we mentioned last quarter, sales included the benefit from a change in arrangement that added around $80 million of pass through sales with no margin.

Commercial aftermarket sales were flattish and continued to be below expectations, with lower provisioning and maintenance sales in our repair shops offset by high single digit growth in parts volume.

We've seen a 10% decline in provisioning so far this year.

That's very different than the 10% growth we envisioned for 2015, driven by lower 787 activity, as well as the impact of higher surplus equipment availability for legacy fleets.

The lower repair activity reflects better reliability, the impact of competitive pricing pressure, and airline maintenance efficiencies.

On profit, the year-over-year decline was driven by lower military sales, unfavorable commercial OE mix, and higher pension expense, partially offset by continued cost reduction.

In addition, the absence of last year's customer contract settlement benefit was partially offset by other favorable contract settlements this quarter.

As Akhil mentioned, we are lowering our profit expectations for UTC Aerospace Systems to be down $25 million to $75 million.

Turning to Sikorsky on slide 12, operating profit increased 26% on a 6% organic sales improvement in the quarter.

Organic sales growth was driven by higher development program sales, led by the ramp-up of the US Presidential and combat rescue helicopter programs.

Overall aircraft shipment volumes were down compared to the prior year, but aircraft completion, again that's the aircraft customization that occurs following baseline delivery, those completions were up significantly over the prior year.

So overall, growth from development programs and aircraft completions were partially offset by lower military and commercial aftermarket volumes.

The operating profit improvement was driven by favorable year-over-year contract adjustments, and drop through from higher development volume, offset by lower commercial aftermarket volume.

With that, let me turn it back to Greg for the wrap-up.

Okay, thanks, Paul.

So disappointing news on the Otis guidance, on the UTAS guidance, but there is still positives, and I think we need to reflect on that, as we think about the quarter.

These positives actually support the long-term investment thesis of UTC.

First of all, we continued to achieve significant milestones in our programs.

We secured key wins, and we have positioned the portfolio now to drive long-term shareholder value.

As you know, we announced significant wins across our aerospace business at the Paris Air Show last month.

Pratt & Whitney announced additional orders for over 600 Geared Turbofan engines, including options reflecting continued strong customer demand.

Turkish Airlines and Korean Air both selected the GTF for the A321neo aircraft at the air show.

Customers can see the advantage of our engine and have placed firm and option orders for about 7,000 engines.

And in our commercial businesses, we also continue to secure key wins.

As Paul mentioned earlier, Otis secured an order worth more than $100 million for the Abraj Kudai in Saudi Arabia.

The win includes 370 elevators and 104 escalators for what will be the world's largest hotel when it opens in 2017.

So again, the long term growth story hasn't changed.

Our businesses continue to be well positioned in our core markets, and this along with ongoing product innovation, will allow us to drive sustainable organic growth.

As I said at the beginning of the call, with the divestiture of Sikorsky, the portfolio is more focused on the core, that is, aerospace and commercial buildings, and we're better positioned to drive long term shareowner value.

Finally, before we wrap up, I would like to thank the many folks from Sikorsky and the corporate office who have worked tirelessly over the last couple of months to complete the Sikorsky transaction, and while we're not quite done, I think it's been great work by the entire team, and just want to thank them publicly for that.

So with that, let me stop, and let's see what's on everybody's mind.

Questions?

(Operator Instructions)

Our first question comes from the line of Jeff Sprague of Vertical Research.

Two questions, Greg.

The first one, actually much bigger picture.

With Sikorsky out of the way obviously, and the redeployment can roughly replace that, but you also alluded to other actions.

And just thinking about your flexibility here, and how you might push things, right, Sikorsky might be actually a little bit credit negative.

Therefore, if you do something else, you need to be more aggressive with the balance sheet, or use equity or some combination thereof.

Just where is your head on that, and where is the pipeline on what might be the next step, once you get past Sikorsky?

That's a good question, Jeff.

Look, we have been focused for the last three months, as you can imagine on the divestiture of Sikorsky.

I think we're done with the big divestitures.

We've done $15 billion now, including Sikorsky, in the last five years, so we like the portfolio that we have, as a base off which to grow.

So the question is, with capital deployment, where are we going to grow?

Are we going to do more share buyback or are we going to go to M&A?

And obviously the preference is M&A.

You alluded to the credit metrics, Jeff.

I think obviously, the spin versus the sale to Lockheed Martin, that doesn't really change the credit metrics that much, and I still think we have flexibility on the balance sheet to do things.

And so the team is focused right now on M&A.

We've got some things in our sights that hopefully can come to fruition this year, but we're going to be more aggressive.

I think we have to continue to use the balance sheet to grow the portfolio.

Absent that, there is share buyback, and I think we're never going to say no to more share buyback.

I recognize that puts stress on the debt rating, but we're going to do what's right for shareowners, to make sure that we're driving long term sustainable growth.

And then just thinking about the outlook, Greg.

I don't know if you can hear it from your seat, but certainly there's a lot of murmuring out there that something isn't quite right, and it just doesn't feel like the UTX we've come to know with the water torture on the guidance.

What is your confidence level now on where you cut things?

How aggressive is the forecast as it stands today, and where is the soft spot in the guide still in your view?

Good question, Jeff.

Look, to say that I'm disappointed would be a significant understatement.

We're all disappointed in having to take the guidance down, and we talked back in June about softness in aerospace aftermarket at UTAS, and we talked about Europe.

What we have tried to do today is to put a stop on the downside, and I think the guidance that we've given for both Otis and for the Aerospace Systems group is guidance we feel confident that we can hit.

And I'm tired of delivering bad news and so we've probably been more aggressive on the downside, because we don't want to overpromise and underdeliver.

And it's tough to do.

It's tough to get this bad news out, but quite frankly, as we closed out the second quarter and we met with the folks at UTAS, and we met with the Otis team, with Geraud and company.

It became apparent that we weren't going to be able to hit the guidance numbers that we had laid out.

Europe, we had expected a recovery there, up low single digits.

It's going to be down low single digits.

We continue to see pricing pressure in the Otis aftermarket in Europe.

The slowdown in China is worse than what we had expected.

And on the Aerospace Systems side, we were way too aggressive in terms of our assumptions for the provisioning of spare items, and spare parts are fine at UTAS.

There's some other things that are moving around, but ultimately it's the provisioning orders from airlines, which as Akhil said, have been up nicely in 2013 and 2014, and we expected them to be up another 10% this year.

This forecast assumes we are going to be down 10%, which I think is probably, we hope, worst case, so I think we bounded the guidance on the downside.

And the whole idea here is let's not deliver more bad news, and let's position the Company to grow earnings next year.

And as I said, some of the headwinds that we're seeing this year, they are going to continue into next year.

The negative engine margin at Pratt doesn't go away.

The China slowness doesn't go away, and the European economy doesn't miraculously recover.

But there are bright spots, and I think the US economy is a lot better than what we are expected this year, and that should continue.

The aerospace aftermarket will continue to grow, and I think what we're trying to do is the right thing long term for the business, in terms of making these tough decisions today.

And we're going to take out another hard look at restructuring.

I think there's more to do from a cost take out standpoint.

There's more to do that we can position ourselves, to make sure we aren't going to disappoint into the future.

So look, we're beyond disappointed about this, but we're going to fix it, and we're going to get back to the UTC mantra of underpromise and overdeliver.

Great, thanks a lot.

Thank you.

Our next question comes from the line of Myles Walton of Deutsche Bank.

Greg, when I look at the underlying expectation for EPS for this year, the $6.15 to $6.30, is the right way to think about it to add back the Sikorsky, and then that's the base from which to grow?

Or are we really talking about inclusive of the repurchase effort on Sikorsky, that's what we're growing to, so we're using the $6.15 to $6.30 base and target of 10% on that?

Yes, I think the key there, Myles is, will the Sikorsky transaction will close, let's call it January 1. We'll take the net proceeds, and we'll start buying back stock.

You're not going to get the full benefit of the stock buyback next year.

You'll probably get 80% of it, so if you think about, we'll replace 80% of Sikorsky's earnings next year and the remaining 20% the following year, just because it takes us a while to buyback what will probably be somewhere between 55 million and 60 million shares of UTX stock, so you just don't do that overnight, unfortunately.

Then Akhil, the $0.15, it sounded pretty temporary, so is that permanent cost take out or business improvement, or is that going to be headwind to 2016?

Some of it is going to be headwind, Myles, because as I said, it's incentive comp coming down this year.

We hope that we will do better next year, in which case the incentive comp will have to go back up.

Some of it was just a release of contingency that we had, you'll recall the Otis guidance previously was at $1.13 Euro and we had a slight contingency at UTC level at the $1.10, Otis and CCS both, so that's just the math of contingency release, if you will.

So I would say they are not necessarily permanent.

On the other hand, we do have more permanent cost reduction actions coming out of the corporate office, which we should see the benefit for in next year.

Okay, I'll take two.

Thanks.

Our next question comes from the line of Howard Rubel of Jefferies.

I want to go to Pratt for a moment.

At the air show, you talked about GTF getting up and flying again early this month, and I think the last reported news was that that's not happened.

How are you thinking about the risk there, Greg?

So we've been working closely with Airbus, and I think they've got the flight test engines back in Toulouse right now.

We expect to be up in the air, I think, early next week, and right now, it looks like we will complete the flight test program in the September time frame, certification of the aircraft in November, and entry into service in December.

So still targeting year-end entry into service, I think we'll probably ship about 36 engines or so to Airbus this year, and we're still on schedule to do that.

So yes, a little bit of a delay.

As you know, these things just always take more time, but it's not like the guys have been sitting there doing nothing.

They have been doing a lot of ground test runs and other testing that they can do before return to flight, so we feel pretty good about the schedule right now.

And then second is, I'm sure you've never seen a gain that you didn't want to take advantage of in some fashion.

How are you going to think about this?

Some of it, obviously, will flow to the bottom line, but some of it can really change the nature of how you think about yourself, and where you want to go in the future.

Can you, I know it's premature to some degree, but it's been there for a while, so maybe if you could give us some general constructs, on what you're thinking about?

Yes, I think it's a very good question, Howard.

The fact that we will have a very large gain on Sikorsky, and passing through the gain in terms of EPS has never been something we thought we got paid for from the shareowners.

So I think this will be thought of very similar, and that's why I've asked the guys to take a very hard look at the big structural cost reductions that can help us position the business longer term.

And again, I don't have a plan today on what we're going to do.

We've got, in my view, six months while we're working on closing the Sikorsky transaction, to figure out what all of those actions are.

But my goal would be to use the gain to induce significant additional restructuring.

Thank you very much.

Our next question comes from the line of Julian Mitchell of Credit Suisse.

I just wondered, within Aerospace Systems, if you could maybe split out within that commercial aftermarket volume 250 million, how much is, of competition, which I think you talked about in Paris as well, versus just provisioning and repair top line weakness?

And whether you think those issues at Aero Systems could persist through into next year as well?

Sure, Julian.

So if you think about what makes up the commercial aftermarket at UTAS, roughly $4.5 billion, as Greg mentioned in Paris.

That's made up of spare parts, about $1.5 billion or so provisioning of a little over $1 billion, and $1.8 billion or so of the repair business.

The biggest change actually is in the provisioning part of it, as Greg said, which was expected to be up 10 on the back of up 12 in 2013, and up 19 in 2014, so very strong provisioning growth in 2013 and 2014.

We had expectations for a 10% increase, assuming that some of that strength which we saw through 787 would continue.

We had assumed that in spite of fewer Operators taking new aircraft in 2015, we would see almost similar level of 787 activity in 2015, as we saw in 2014.

That's obviously not happened at this point.

It's looking more like we will probably be down roughly 40% on the 787 portion of the provisioning.

And then on the legacy side also, we have seen slower take up than we had seen in 2013 and 2014, partly due to maybe a high level of inventory of provisioning parts at the airlines.

And I think that's seen the biggest change.

So that's not really competition.

It's probably more a function of the inventory at the airlines, and the resetting of the expectations on 787.

The provisioning associated with new aircraft, 350 and the 320neo that Dave had talked about, we still expect that to happen, and that should come through in the second half.

On the repair side, which is where the competition part is, as you said, again, there we have seen the better reliability of the products translating into lower activity -- lower repair activity, which is creating some pricing pressure.

And that we do feel that would be a surplus part availability, and the airlines using green time, specifically for out of production aircraft, has had some impact on our expectation on the repair side as well.

That phenomenon might continue a little longer, but we do think provisioning should come back.

The piece parts business has -- it continues to do well, maybe just a little bit lower, but still up high single digit, as compared to our prior expectation of 10%, so hopefully that gives you color on UTAS.

That's very helpful.

And then my second question would just be on Otis.

Not so much the end market trends, because you laid those out very clearly, but more in terms of Otis' own strategy, how you looked at the competitive landscape.

Are there things you think you can do differently, because at the moment, it feels like market share may be going down, margins going down as well?

So is there any kind of rethink about what Otis needs to do from here to reverse those things?

Julian, I think Otis -- the key for Otis really is to regain market share.

Over the last 10 or 15 years, we've seen a continued erosion of Otis' market share, as we have pursued margin expansion.

And I think we have taken margin expansion to the point now where we're not terribly competitive, based on new equipment pricing, and quite frankly, you've got to feed the service business with new equipment orders.

And so we started to see a pick up in new equipment in the US.

We started to see a little bit in Europe, but we have seen a big slowdown in China.

And I think we need to fundamentally think about how we're going to grow top line new equipment and regain market share.

And so Geraud and the team are laser focused on coming up with strategies to regain share.

There's also the issue, of course, of service in Europe, and that is probably the biggest issue.

Otis has 1.9 million elevators under service, about 1.1 million of those are in Europe, and that's where we seen the biggest pricing pressure, and we've seen no growth in that market for the last couple of years.

So we've got to return to growth on new equipment, and we've got to stem the service degradation on pricing that we have seen in Europe, as well.

So one of the things which the team is focused on, Julian, is to try and address the attrition of the service contracts that happen in the business on a normal course.

And Geraud has put a lot of focus on making sure that our attrition rates, particularly in Europe, come down from what we have seen over the last few years.

Secondly, we need to continue to work on developing the technology-based differentiation in our service offering.

That can then allow us to command the price premium that we have always had in the service markets in Europe as well.

And finally, we're going to continue to look for a little bit more of acquisition of service portfolios to help density, which is the name of the game, as you know, on the service side.

So those are some of the things that are being worked on to improve the service situation in Europe faster.

Ultimately, we do believe, as the new equipment market improves in Europe, which there are some early signs of still mixed but certain markets like Spain is showing signs of improvement, which has been down for a long time.

That will certainly reduce a little bit of pressure on the service side, as more activity starts to happen on the equipment.

Great.

Thank you.

Our next question comes from the line of Carter Copeland of Barclays.

Just a quick question.

First one on China.

How much, when you look at the revision to the full-year plan, how much sequentially are you planning on China revenues at Otis being down in the second half?

And if you can break that up, residential versus the service and infrastructure pieces, it would look like that's -- you're expecting declines there in the 30% year-on-year comparisons in residential.

Is that about right, or how should we think about the exit rate in the back half of the year?

So for the -- I'm not sure I understand the 30% comment, Carter, but overall I would say for Otis new equipment we expect China to be down probably low single digit in the back half of the this year in terms of sales.

And order rates obviously could be -- that's the more uncertain part, but that, as you know very well, doesn't necessarily impact the current year as much.

The positive thing on Otis in China is that the service market continues to grow, we all know it's a small base, but in spite of all of the turmoil in the construction industry there, the service business in China for Otis grew again 15% in the current quarter, which was encouraging.

And then with regard to the break up between, say, residential and commercial, if that's what you were asking on the Otis side, I can tell you from a brand perspective, certainly the Otis brand, which is more on the large commercial prestigious jobs, did a lot better both in terms of new equipment orders and in terms of new equipment sales in the quarter, than the Shihtza?

brand, which is more at the residential and lower end of the segment.

Can you quantify the magnitude of OCL and how much it was up versus Shihtza?

and how much it was down?

In terms of new equipment orders, 10%, I think OCL was flattish, maybe just down slightly, while Shihtza?

orders was down in teens, like over 10%.

Okay, thank you.

And just a bigger picture question on the planning process, Greg.

When you look at Akhil's comments about the expectation for 10% growth and provisioning on the back of a 12% year, and on the back of a 19% year the year before that.

When you look at the plan and say, what was missed, or what was it about the specific parts that are being procured, or the planning function that drove that outcome, that can be so far off?

When you look back on that, any color about how a miss like that could be that far off, in what we think of as a pretty stable aftermarket business?

Yes, I think to Akhil's earlier point, when we came off of two very strong years of provisioning growth, I think we just assumed that we were going to continue to see that kind of growth.

And even like Akhil said, it was 19% last year, so we thought it would slow down to 10% this year.

There were plans by airline, where that provisioning was going to come from.

But the fact is they didn't, the airlines, for various reason, didn't take the provisioning.

The rollout of the neo and the C Series has been slower than what we expected, so we haven't seen provisioning there.

So I would tell you, probably the root cause is we pushed the Aerospace Systems guys to have a plan that was going to be up roughly $300 million for the year, and in order to do that, they had to push the aftermarket guys to deliver a much bigger number.

And at the end of the day, I don't think there was a strong basis in that aftermarket assumption, around how we were going to get there.

Again, they were looking at trends, but I don't think we delved deep enough into -- we didn't question enough the assumptions underlying how they were going to get there.

And so I would tell you that's a miss on my part, that's a miss on our part from a planning perspective, that we didn't dig deep enough last year when these plans were getting put together.

And we have obviously spent a lot of time in last month, Akhil and myself, with Dave Gitlin's team, and we've done the same thing with Geraud on the Otis side.

We have dug deep into this, in terms of the planning assumptions, and I think on the Otis, it's actually easier to understand, because there, we had expected a recovery in Europe, like Akhil said, up low single digits, and it's not there.

In fact, it's still going to be down, but the aftermarket assumption at UTAS, that's just a miss.

Okay, thanks for the color Greg.

Thank you, and our next question comes from the line of Nigel Coe of Morgan Stanley.

Greg, the comments about the desire not to deliver anymore bad news is well taken.

The question we're getting is why didn't you opt to do this at the Paris Air Show when you adjusted Sikorsky?

And did you not enough official at that point, because it seemed pretty clear that you were going to fall pretty far short on both Otis China and the UTAS aftermarket?

Nigel, obviously we had expected some pressure on the UTAS guidance.

I think Dave signaled that.

Had we taken the number down in early June, I would tell you we wouldn't have taken it down enough though, and our concern was, let's make sure we really understand how bad this is.

Dave had some plans in the back half of June in terms of orders that he expected to get that he didn't get, and quite frankly, it was a lot worse than I think Dave or anybody else expected when he stood up in June.

So in that respect, we could have taken it down a little bit, but it wouldn't have been enough.

On the Otis side again, I think that we were still hoping for some recovery, better news out of China in June.

It was a big month for orders, and we were also expecting to hopefully see a reversal of trend in the European market that we have not seen.

Again, the Europe stuff easier for me to understand in terms of from a forecast standpoint, we had a big assumption, we were wrong, okay.

But on the Aerospace Systems side, that was just again, a big miss.

Okay and obviously there was a lot of transition going on at the end of last year, but it did feel like the plan was a little bit too blue sky, not just on the provision side, but Otis China and one or two other areas.

Is that recognized, and are you putting in steps to cure that problem?

Yes, just on Otis China, we entered the year with a 13% increase in backlog, and we had expected orders to be only up about 5% for the year.

The fact is orders are down 10% so yes, maybe we were too aggressive there, but a 5% increase didn't seem like overly aggressive, from a new equipment standpoint.

Property markets come down a lot faster in China than we expected, we have seen a lot of pressure there.

And I think the other planning assumptions, did we push hard?

Yes, we did.

To your point there was a lot of transition last year, obviously have been a lot of changes since we put these plans together.

But again, I'll tell you, it all ultimately falls on me, and it's my responsibility to make sure the forecasts we put together are the right forecasts.

And I think we just got way too aggressive on the aftermarket at UTAS, and the European recovery, and it hasn't happened.

Fair enough.

And then finally, Greg, on the Sikorsky, the buyback from the proceeds, do you intend to get a little bit ahead of the closure on Sikorsky with that buyback, or do we have to wait until we get the cash in before we can do the bulk of that?

I think Nigel, we'll have to see what happens to the stock price here over the next couple of months.

Obviously, as we get certainty of close, and we'll see -- I would think in the next three or four months, I think we'll have an indication from the Department of Defense and from Justice and some of the other regulatory authorities about certainty of close.

And whether we wait until the day I see the $9 billion clear, or we do it a month or so early, I think that will just be determined upon the market and what we see with the stock price.

Okay, thanks, Greg.

Thank you, and our next question comes from the line of David Strauss of UBS.

Greg, wanted to follow-up on your market share comments on Otis.

Was that comment specifically addressed to the China market, where it appears that your competitors are doing a little bit better than you are?

Because it looks like in North America, you've done pretty well.

Can you just give a little bit more color around your comment on Otis market share?

Yes, I think overall, Otis has lost share really across most markets except North America.

I think the North American market has actually remained relatively robust for us from a market share standpoint, but clearly we've lost share in China.

You'll recall seven or eight years ago, we thought we had roughly 25% market share.

Today, that number is probably less than 15%.

I think, again, some of the competitors have come in under us from a pricing standpoint, probably been more aggressive, and we have lost share.

It's not just in China, but obviously China is the biggest market by a factor of I don't know, three or four, or more.

So that's really when the lion's share where the market share loss has been.

And then thinking about Otis into 2016, obviously given the lead times on new equipment, we already have a bit of a clue what 2016 is going to look like.

Can you help us, in terms of thinking about 2016 for Otis?

At this point, should we expect China to be down next year on the new equipment side, in terms of sales?

Yes, it's a little early to talk about 2016 in specifics, but I think it's not too difficult to project that China is likely to be down next year in terms of new equipment, so you would see pressure.

And China, by far, even in dollar terms, it's more than 40% of Otis new equipment sales, so therefore that market is going to be under pressure.

The question is, and that's a determination we'll all have to make together over the next three, four, five months, as we come close to giving guidance for 2016, what happens in Europe?

Because if the European service market starts to recover, and the European economies start to get better, that can, because it's such a large business and it's profitable business, can offset some of the issues that we might see in China.

We do expect US to continue to be strong, but the real question mark is what happens to Europe, and whether it is enough to offset China or not.

Great, thank you.

Our next question comes from the line of Ron Epstein of Bank of America Merrill Lynch.

Greg, if you could maybe walk us through, how are you thinking about the portfolio now?

There's some quotes that you maybe made this morning in the press that you were saying that UTC is done getting smaller.

Can you elaborate on that?

And then part of that is, what do you see now as the long term organic growth of the Company?

Is UTC just fixed now forever being a global GDP grower, or how do you think about that?

Let's talk about first of all the portfolio, and as I said last year when I took over, we were going to take a hard look at the portfolio.

I think we have done that for all of the major pieces of the portfolio.

Obviously, shedding Sikorsky was a big decision.

But for the most part, I would tell you, and as I think I said this morning when we were talking to some reporters, we're done getting smaller at UTC.

We shed $15 billion in sales since 2010, and again, most end markets where we didn't see great growth, or we saw a lot of uncertainty, or very low margin business.

So I think the portfolio that we have today is positioned to grow a heck of a lot faster than any of those businesses that we left.

And the thing about Pratt, again, this quarter, sales growth, nothing to write home about, but the fact is, we'll be shipping 7,000 GTF engines over the next 10 years.

Pratt's top line is going to go from $15 billion to $25 billion.

You're going to see very solid organic growth there.

The same on the Aerospace Systems side, as you get through all of these new programs, we've got more than 50 new systems on these new aircraft that are going to be delivered.

So the long term organic growth story in the aerospace side, I think is solid.

It remains solid, I would tell you on the CCS side over in BIS, we've seen very good continued growth there.

The Otis business is a challenge, and I think we had expected mid single digit growth that's probably only going to be 2% for this year.

We've got to again get -- return to market share growth in order to make sure we're driving more than GDP growth in the Otis business so there's work to do there.

But I would tell you the portfolio as far as the platforms that we want to be in, is exactly right.

I think again, we've got a good balance between commercial and aerospace, and I don't see any more big divestitures.

I think instead what we're trying to do is we're going to build this business and we're going to build it through M&A.

And to the extent that we can't find M&A that creates value, we're going to return the capital to you and let you invest it.

But right now, our goal is to grow UTC, and I think we can grow organically even without big M&A, but we're look to find ways where we can add M&A that makes a lot of sense, and that creates value.

Got you and if I can, just one follow on one of your earlier comments.

You talked about pushing the plan in UTAS, and that the aftermarket guys game back.

Culturally, does bad news flow up at UTC, or is that something within the culture of the Company that has to change?

It does now.

Look, I think there was a reluctance from people to flow bad news up, and I think people took the challenges and they tried to figure out a way to do that.

And for the most part, the Aerospace Systems guys have done a good job over the last three years since the acquisition of delivering on their commitments, and so I can't fault them for one awful year.

The business is still going to generate $2.5 billion of profit this year.

It's just not going to grow.

And shame on us, on the forecast side.

But the fact is, we need to make sure that when there is bad news, it does flow up, and we understand what the issues and challenges are, and so Akhil and I have put that in process.

We're out.

We're doing more business reviews, we're spending more time on the road to make sure that we truly understand what's going on in these individual businesses.

And I think that was a discipline that we had lost over the last few years, and we've got to put back in place.

Okay great, thanks.

Our next question comes from the line of Sam Pearlstein of Wells Fargo.

Greg, I just want to go back on a comment you just made about if you can't find high return M&A, you would return the capital.

Can you just kind of talk through how selling Sikorsky and paying on the order of 31% taxes makes -- that tax leakage makes more sense than just having spun it out?

And how you thought about that?

Yes, okay.

Let's walk through that.

So when we looked at Sikorsky as a standalone business, we'll do about $600 million in EBIT this year.

However, when we did the spin, we were going to add about $100 million of cost to the Sikorsky business in order to be a standalone business.

That's IT, that's finance, treasury, all those things that UTC provides has to be done on a standalone basis.

And so when we looked at Sikorsky standalone, we thought about our business was worth about $500 million of EBIT, and we figured it would trade for around 10 times EBITDA as a defense contractor, which is a market multiple.

That gave you a $5 billion valuation for Sikorsky if we spun it out.

Even if you got a 10 or 15% premium on that $5 billion for a potential take out, you're still looking at less than $6 billion of value, in terms of what is Sikorsky worth as a standalone business.

I think the fact that we're going to net over $6 billion on this deal, and the fact that its certain, it's today, it's cash, made a heck of a lot more sense than the risk associated with the spin, the cost, and how the market reacts.

And I think Sikorsky will have a tough couple of years in front of them.

They've got some big development issues and programs they've got to get past.

It's a very solid Company long term with great technology, but that $5 billion valuation wasn't even certain.

So when I got an offer that I considered to be compelling, with a Company that I thought was the perfect fit for Sikorsky, we did the math, and it came out to be pretty simple at the end.

Okay, thank you.

And then also, this year, you had been talking about $300 million worth of gains in restructuring.

I imagine some portion of that was going to Sikorsky in terms of the actions.

Do you slow those down or stop those, and does that give you any sort of net gain over restructuring, or how do you think about that?

Not materially, Sam.

I think there was some amount of restructuring that you saw in the second quarter at Sikorsky, the $25 million range if I recall, or something in that range.

I think we continued to do the right thing for Sikorsky, and that's why we bothered to launched the action early as the volume fell off, but I wouldn't expect for that to have a material impact in the back half.

Thank you.

Thank you.

Our next question comes from the line of Jason Gursky of Citi.

Just wanted to go back to Otis for one second.

You mentioned the backlog conversion in China is slowing.

I was wondering if you could offer just a little bit more color on that, how bad is it getting the conversion?

And if you can reflect on maybe some prior cycles, maybe another geography, maybe we can learn a bit from what we've seen in other geographies in different time periods, to get an understanding of how bad that backlog conversion could get, and whether there's still further risk there?

Sure, Jason.

I think typically what we find at Otis is that you'll see a 60% conversion of the opening backlog, and then the rest of the sales essentially comes from current year orders.

What we have seen is that a couple, 2 to 3 points slowdown in that conversion rate from the backlog this year, and that's largely due to the credit availability issues in the China market.

We typically like to have to make sure that we get our money before we release equipment, and that's where we have seen some of the slowdown in the conversion.

So at this point, the team believes it's appropriately sized, 2 to 3 points, and maybe there could be a point or two to go, which is what we factored into our back half forecast here for China right now.

So between 55% to 60% conversion should still be possible and doable.

Obviously, as you know, the Chinese government is doing everything it can to try and help the economy improve the credit availability in the marketplace, as some of what they can do to prop up the real estate markets again.

So we'll see where it all ends up, but I think we are appropriately sized at this point.

Okay great and one question on commercial after market.

There were two phrases that you used that sound interesting.

Pricing pressure, and part availability.

Obviously, it sounds like we've got quite a bit of inventory out there.

I was wondering if you could make some attribution as to where that part availability or inventory is coming from.

Are we seeing more parked aircraft of where your install base is shrinking perhaps, a little bit?

(multiple speakers)

Yes, I would say it's not so much about retirements of part availability.

I would attribute it more to airline efficiency, in the sense that there is greater -- in the marketplace there is more efficiency in terms of either pulling of parts, less parts or easier identification of where the parts are.

So when an airline is looking for a particular item for repairs, it almost feels like it's a little easier these days to find that part in the surplus market, as opposed to necessarily going for the new one.

That's probably the change that is there on the airline efficiency part, I would call.

It's not that the retirements are going up.

It is just that the market is a little more efficient now.

No pricing pressure from PMA or any other issues, you think that encapsulates all of the pricing pressure?

No, and I think there, our strategy of going for more FMPs in the Pratt situation, where we are getting more than 80% of our engines now under fleet management program, and improving that rate to over 60% in the case of the care program for UTAS, is the right strategy to address that part of the issue.

It's more about making sure we have a larger part of the service activity under our management and under our control, which helps the airlines as well, because we do a much better job of maintaining the aircraft and our parts for them, and they're under program in the fleet management program.

Great.

Thank you.

That's all the time we have for questions.

I'll hand the call back over to Mr. Hayes.

Okay, thank you very much, and thanks, everyone for listening today.

Not the results that you would come to expect from UTC, but you can be assured that we are working it diligently.

The IR team with Paul and company will be available throughout the day to take your questions, and have a great day.

Thank you.

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

That does conclude today's program, and you may now disconnect.

Have a great day, everyone.