雷神技術公司 (RTX) 2015 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, President and Chief Executive Officer; Akhil Johri, Senior Vice President and Chief Financial Officer; and Paul Lundstrom, Director Investor Relations.

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

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

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

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

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

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

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

Please go ahead, Mr. Hayes.

Okay, thank you, Amanda.

Good morning, everyone.

As you all saw on the press release this morning, we reported 3Q earnings of $1.61 per share on sales of $13.8 billion and segment operating margins of 17.6%.

Today we are also reaffirming our full-year EPS expectations of $6.15 to $6.30 a share on sales of $57 billion to $58 billion.

And of course that is all ex Sikorsky on a continuing operations basis.

On Sikorsky the divestiture process remains on track.

We recently received regulatory approvals from the United States, the EU, Japan and South Korea.

A couple more to go but we expect the other necessary approvals to follow in the coming weeks which gives us confidence that the transaction will close shortly.

As previously discussed, we plan to use the roughly $6 million of net cash proceeds for additional share buyback and we will do that in a form of an Accelerated Share Repurchase program.

And this will bring our total share repurchases initiated this year to about $10 billion.

As you may have heard us say at a conference back in September, we are going to keep driving the share repurchase agenda as long as we feel that there is a significant discount between the intrinsic value of UTC and the share price.

We continue to see that today, of course; that is why our Board recently authorized a new $12 billion share repurchase program.

That includes the $6 billion ASR that we just discussed.

All told we now expect to make at least $16 billion in share repurchases from 2015 through 2017.

When you couple that with our dividend of more than $2 billion a year our plan will return more than $22 billion to share owners over the three-year period.

And of course we continue to work restructuring opportunities with projects focused on long-term cost competitiveness.

These actions will allow us to further leverage our global scale and drive long-term value.

To put it simply, we have remained focused on what we can control, which means aggressive cost control and continuing to invest in differentiated products and services that will deliver real value for our customers over the long-term.

So despite the mixed macroeconomic environment that will likely continue into 2016 and perhaps beyond, we are executing on the necessary changes to bring about long-term, sustainable earnings growth.

When the Sikorsky sale is complete the UTC portfolio will be focused on its core businesses and that is supplying innovative, game changing technologies for the buildings and Aerospace Systems industries.

Going forward UTC will have a better organic growth profile along with higher operating margins and a stronger more predictable cash flow.

And defense exposure for UTC goes from 19% to 13% post Sikorsky.

All of this gives us clear line of sight to mid-single-digit organic sales growth over the long-term.

And we're confident in this outlook based on the investments we have made, which resulted in an order book of roughly 7,000 Geared Turbofan engines at Pratt & Whitney, increased ship set content on the new platforms at Aerospace Systems business, and a more focused innovative product portfolio in our commercial businesses.

Thinking about buildings and aerospace portfolios, we are very well-positioned.

Otis is the best elevator business in the world.

And I say that because we've got 1,800 branch offices, we've got 3 million unit installed base, and we service over 1.9 million elevators on a daily basis.

Climate, Controls & Security is a leading global building systems and service provider and that of course combines world-class brands like Carrier, Kidde and Chubb and many others.

And of course we have doubled down on innovation at CCS over the last five years and it is paying dividends today in the form of a resurgent commercial HVAC business and more cost competitive products across the CCS portfolio.

And strategically our aerospace businesses have never been better positioned.

Our aero backlogs are at their highest levels ever giving us confidence that Pratt and UTAS can deliver the strong revenue growth goals that they have laid out.

Personally I've never been more confident in the future of UTC.

The long-term outlook remains solid.

Innovative products, industry-leading franchises, global scale and solid market fundamentals in our core businesses driven by revenue passenger mile growth, and the global expansion and continued urbanization of the middle class -- all of these things have positioned UTC to deliver strong earnings growth well into the future and all of it will create long-term share owner value.

Let me stop there and turn it over to Akhil and Paul to take you through the Q3 results.

I'll come back with a few closing comments before we get into Q&A.

Akhil, the floor is yours.

Thank you, Greg.

Moving to slide 2, organic sales contracted by 1 point in the third quarter driven by Pratt, which was down 8% as the recent transition to a new material logistic center disrupted Q3 engine deliveries.

These cut over issues are now largely behind us and Pratt expects to recover the majority of this impact in the fourth quarter.

In the commercial businesses Asia was down 2% reflecting the slowing environment in China which was down high-single-digits.

Europe sales were flattish in the quarter.

On a brighter note, we continue to see growth in the Americas which was up 7%.

On the aerospace side commercial contracted by 2% and defense sales were down 4%, both mainly driven by the timing of engine deliveries at Pratt & Whitney.

Taking a closer look at our end market trends on slide 3, and just a reminder, as we always do, we will talk to the Otis and CCS orders on a constant currency basis.

For our commercial businesses, construction markets in the US remain strong.

We continue to see that at Otis where North America new equipment orders in the quarter were up 47% including a large order for the Hudson Yards project in New York City.

North America new equipment orders are up over 20% year to date and that is on top of 40% growth in 2014.

At CCS, Americas commercial HVAC equipment orders were up 8%, consistent with the first half growth rates.

Residential HVAC equipment sales grew 7% in the quarter.

Shifting to EMEA, the overall environment remains mixed and our commercial business order activity reflects that.

While Otis new equipment orders in EMEA were down 9% in the quarter, they were up low-single-digit in Western Europe.

Orders for the CCS business in EMEA were down slightly.

In Asia we continue to see the China market weakening.

Growth in fixed investments has slowed considerably.

Otis new equipment orders in China were down 19% in the quarter after being down 11% in the first half of 2015.

At CCS China orders were down 8% in the third quarter and down 12% year to date, so slightly better than the third quarter.

Asia excluding China, which represents about half of our overall commercial business in the region, continues to perform well with Otis new equipment orders up over 20% and commercial HVAC orders up low-double-digit.

Commercial aerospace aftermarket remains mixed.

Aerospace Systems commercial aftermarket sales were up 1% organically in the quarter with weakness in provisioning which was down over 20% offset by higher parts and repair.

At Pratt & Whitney commercial aftermarket sales were up 8%.

Both the Aerospace Systems and Pratt businesses benefited from a favorable contract adjustment in the third quarter.

Now since most of you have 2016 on your mind, let's see what these trends mean for us.

We will be giving formal 2016 guidance at our annual outlook meeting on December 10 as we typically do so things can change.

But this is what we are seeing today and I am now on slide 4. I will start with a few things that we know will be headwinds next year.

Commercial aero OE margins both at Pratt and at Aerospace Systems; the negative engine margin story at Pratt is well known at this point.

We have also talked about the mix impact at Aerospace Systems as production decreases on higher margin, fully learned out current platforms and increases on new platforms where the margins on early units are pressured by the learning curve.

OE mix pressure, along with the absence of a few favorable items in 2015 that do not repeat next year, will make it difficult for UTAS to grow earnings.

While we do not like the earnings pressure in the near-term, these are great strategic programs at both Pratt and UTAS that will generate increasing profits and cash flows for decades to come.

There is also some pressure in military aerospace.

The biggest item here is the C-17 where production is ending this year, that is primarily at Pratt.

And UTAS will face headwinds from declining military spending and completion of a few retrofit programs.

On the commercial side, consistent with what you are seeing in the general macro environment, we will likely see our business in China down 10% to 15% next year.

That will probably come with a profit decline of over $100 million.

Now moving to the middle column, Europe has been below expectations in 2015.

Order rates have been mixed with some pockets of growth and recent GDP forecasts suggest 2016 should be up just 1% to 2%.

Currencies have been moving around a lot and could move some more depending on what the Fed does with interest rates.

If I had to call it today I would say over $100 million of FX headwinds, largely due to Chinese yuan and other emerging market currencies and assuming the euro at $1.10 -- and I am talking about profit impact, not sales.

On the positive side the US markets continue to be good.

We expect stronger than growth GDP across our end markets.

We continue to see the benefits of restructuring and will do more next year.

Commercial aftermarket at both UTAS and Pratt, while pressured in the areas of provisioning and legacy fleets, should grow low-single-digit next year as airline profits remain strong and revenue passenger miles continue to increase.

This year we have had significant headwind from pension.

And while year-to-date returns on plan assets are trending lower than the expected returns, we still expect a tailwind of over $200 million next year.

Also, share buybacks that Greg talked about will be a benefit of approximately $0.40 in 2016 net of interest expense as the average share count comes down significantly.

Net-net, as Greg said last month, 2016 will likely be another challenging year.

Earnings in three of the four segments, Otis, Pratt and UTAS, will be flat to down even with the pension benefit.

Shifting back to the current quarter on slide 5, total reported sales decreased by 6% driven by 5 points of headwind from the stronger US dollar and 1 point of organic contraction.

Segment operating margins were 17.6%, down 50 basis points largely driven by headwinds at Pratt.

Excluding Pratt margins were up slightly.

Absent the impact of gains and restructuring earnings per share were down 2% and at constant currency earnings per share were up 1%.

Free cash flow was 44% of net income largely due to significantly higher working capital from the engine delivery delays at Pratt, a timing issue.

We have also seen some inventory build at Aerospace Systems as we prepare to support the growth in new programs.

Year-to-date free cash flow to net income is 71%.

The fourth quarter is typically our strongest quarter for cash and we still expect full-year free cash flow to net income of 90% to 100% in 2015, although it is likely towards the lower end of the range.

And for M&A we are maintaining our placeholder of $1 billion.

As Greg mentioned at the beginning of the call, we are confident in our guidance for earnings per share of $6.15 to $6.30 on sales of $57 billion to $58 billion.

Year to date EPS for continuing operations is $4.76, so we expect to Q4 EPS of $1.39 to $1.54.

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.

Turning to Otis on slide 6, in the quarter sales were $3 billion, which was up 2% organically.

Otis profit was $660 million and also up 2% at constant currency.

Foreign-exchange translation was an 11 point headwind to both sales and earnings.

Otis profit growth was driven by drop through from higher organic growth, lower costs from productivity and commodities and tailwind from foreign exchange-related mark-to-market adjustments.

Pricing and mix were a headwind in the quarter.

New equipment sales increased 4% led by strong growth in both North America and Asia outside of China.

EMEA new equipment sales were down about 1 point and China was down 9%.

Service sales for Otis were flat overall as a 3% decline in EMEA was offset by mid-single-digit growth in Asia and low-single-digit growth in the Americas.

We saw a decline in modernization sales from continuing contractions in France and Russia offset by low-single-digit growth in repair and maintenance sales up slightly.

Our portfolio of units under maintenance continues to grow and is now North of 1.9 million units.

New equipment orders were up 2% in the quarter.

The strong momentum in North America continued with orders up 47%.

Excluding the Hudson Yards order that Akhil mentioned earlier, North America was up nearly 20%.

New equipment orders in EMEA were down 9% with declines in Russia, the Middle East and Germany mitigated somewhat by growth in Spain and Italy.

China orders were down 19%, but Asia overall was down 10% with strong growth in South Korea, India and Southeast Asia.

We continue to expect Otis profit to be down $300 million to $350 million primarily due to the adverse impact of foreign exchange.

Moving to slide 7, climate controls and security grew sales 5% at constant currency with 3 points of organic growth and 2 points of benefit from M&A.

Profits were up 4% at constant currency.

Overall foreign-exchange translation was a 7 point sales headwind and a 4 point earnings headwind.

CCS organic growth was led by a 19% increase in our transport refrigeration business, Carrier Transicold, and continued strength in the Americas where US residential HVAC grew 7% and commercial HVAC was up 5%.

Both EMEA and Asia were down mid-single-digit organically with declines in China more than offsetting growth in other parts of the Asia region.

Operating profit growth of 4% was primarily driven by drop through on the organic volume growth and cost benefits including favorable commodity prices offset somewhat by adverse sales mix in the quarter.

Global Commercial HVAC equipment orders were up 3% in the quarter driven by 8% growth in North America and an 8% decline in EMEA.

Asia commercial HVAC was down mid-single-digit driven by a weaker China.

Transicold saw orders down 2% in the quarter while Fire & Security product orders were down mid-single-digits and F&S field was flat.

CCS continues to expect profit growth of $75 million to $125 million for the full year.

Shifting to aerospace on slide 8, Pratt & Whitney sales were down 8% organically.

As Akhil mentioned, we had some startup challenges at a logistics center that delayed some large engine shipments in the quarter.

Pratt's military aftermarket was down double-digits with declines in the F-117 program and Pratt Canada volume was down on lower helicopter and general aviation shipments.

These declines were partially offset by growth in the commercial aftermarket at Pratt, which was up 8%.

Within that large commercial engines aftermarket was up 6% driven by a favorable contract adjustment.

Excluding this adjustment engine services, that is our FMP or fleet management program business, was up about 20%.

The transactional business was down 13% on a difficult compare.

On a year-to-date basis the commercial aftermarket is now up 4% and as we move through Q4 we expect the commercial aftermarket to be in line with our prior guidance of up low-single-digit for the year.

Moving to profits, in the quarter Pratt operating profit was down 21%, the impact from lower military sales, higher negative engine margin, lower Pratt Canada engine deliveries and higher pension expense were partially offset with lower E&D spending and margins from the commercial aftermarket, including approximately $0.04 of favorable contract adjustments.

With the expected volume recovery in Q4 Pratt is on track to deliver on their prior earnings expectations of down $50 million to down $125 million.

Turning to slide 9, Aerospace Systems profits were down 2% on flat organic sales in the quarter.

Similar to what we mentioned the past two quarters, sales included the benefit of a change in arrangements that added around $60 million of pass-through sales with no margins.

Excluding those pass-through sales the commercial OE business was down 3% in the quarter from timing of deliveries on various platforms and a tough compare.

Military OE sales were down 7% in the quarter driven by declines on the C-17 and other programs.

Commercial aftermarket sales were up 1% organically in the quarter and included the favorable impact from a customer contract closeout.

Provisioning sales continue to be down significantly driven by lower 787 activity as well as the impact of higher surplus equipment availability for legacy fleets.

Piece parts volume was up low-single-digit.

Even excluding the impact of the contract adjustment, repair sales were still up mid-single-digit reflecting an improvement in maintenance volumes.

On profit the year-over-year decline was driven by lower military sales, unfavorable commercial OE and aftermarket sales mix and higher pension expense.

This was partially offset by continued cost reductions and around $60 million of nonrecurring income driven by favorable contract -- excuse me, favorable aftermarket contract adjustments and the benefit from asset and license agreements in the quarter.

We continue to expect operating profit for UTC Aerospace Systems to be down $25 million to $75 million for the year.

With that let me turn it back to Greg for a wrap up.

Okay, thanks, Paul.

Just let me highlight a couple of milestones that took place in the quarter that really better position the business to drive long-term share owner value.

As you know, we recently eliminated the building and industrial systems management layer; that was following the elimination of the Propulsion and Aerospace Systems layer earlier this year.

As a result we simplify the organization, we have a flatter more efficient structure with four strong businesses and four solid leaders that all report directly to me.

This focused organization will drive greater accountability and in turn help drive value creation for all share owners.

As I mentioned at the beginning of the call, the Sikorsky transaction is on track to close shortly.

This will leave us a more focused, more growth oriented and a higher margin portfolio business.

The long-term growth outlook remains exceptionally strong.

UTC has world-class industry leading franchises and we play in attractive end markets with our differentiated technologies.

And importantly, we continue to invest in innovation.

Also we have a significant base of recurring revenues which today account for about 45% of UTC sales.

And we generate reliable cash flows for all the business cycles.

As I mentioned earlier, we will return more than $12 billion to share owners this year and that includes $2 billion in dividends, $4 billion in buybacks year to date and the $6 billion Accelerated Share Repurchase that we'll implement upon the close of Sikorsky.

And we are not done yet.

All in, as I said earlier, we will do at least $16 billion of buyback and more than $6 billion in dividends from 2015 through 2017.

As a leading provider of high tech products and services to the aero and building industries, we continue to believe UTX shares are a great investment opportunity.

The UTC team is executing and building momentum by focusing on the things we control all while being laser focused on delivering maximum value to our share owners.

With that let me open up the call for questions.

Amanda?

(Operator Instructions).

Nigel Coe, Morgan Stanley.

So the 2016 roadmap is obviously helpful and quantifying some of the headwinds, $250 million from Pratt, about $100 million from China, $100 million from FX, and then I am assuming about $150 million from military.

So that adds up to about $600 million of headwinds.

You mentioned some offset from pensions, but maybe can you just fill in how -- I guess given the $400 million deficit ex pension -- with pension, do you think that growth in the commercial aftermarket, cost reduction, commodities, etc., can offset that gap you have from some of those headwinds?

You are already in the December mode, Nigel.

I mean this is all that details we will go through with you in December.

I think right now it is appropriate to say that the benefits of the capital deployment, the benefits of pension, the benefits from aftermarket growth, commercial aftermarket growth, US markets remaining strong will allow us to sort of offset the headwinds that you talked about so well.

I think net-net we can give you confidence that we will grow earnings next year.

Exactly how much that will be is something we will talk more about in December.

Okay, that is fair enough.

And then just on the cost reduction, you typically do in the range of about $300 million of restructuring a year.

What is the scope for 2016 to be a bigger year of cost reduction over and above what we normally see from UTC?

Nigel, I think what you are going to see is here in the fourth quarter we are going to announce some significant additional restructuring actions.

We have got this big gain coming from Sikorsky, and we have seen some opportunities to do some longer-term structural cost reduction.

We're not going to announce them today; we will give you all that detail in December.

We will take some overheads out, we will take some SG&A out, but primarily the focus is on long-term structural cost reduction, that means factory rationalization.

And those paybacks are a little bit longer, typically two to four years.

But all that gives us runway as we think about as we emerge from the cycle of investment on the aerospace side, even more earnings runway going forward.

Okay, that is very helpful.

Thanks, guys.

(Operator Instructions).

Ron Epstein, Bank of America Merrill Lynch.

Maybe just a real big picture question for you, Greg.

When you took over the reins you mentioned that kind of everything was on the table.

In some conversations post that we have had -- you talked about you guys are doing more regular portfolio reviews, that kind of thing.

And when you stand and look back at the UTX portfolio it really seems like there is a lot of value in the Company that is just not being realized yet by the market.

When you think about that are there other ways to start unlocking value in the portfolio?

Can you talk about that?

That is a really good question, Ron.

It is interesting, I took over just about a year ago.

And when I stood up last December and talked about going forward what we were going to focus on we talked about a couple of things.

We talked about how we were going to examine the portfolio and we were going to make sure that we had the right portfolio to drive long-term sustainable earnings growth.

And we said we were going to look for ways to increase shareowner value.

And so, as I think about it this is not a -- it is not a one year game.

In fact if you think about it, we are probably in the first inning of a nine inning game.

And we are building momentum.

We have done a lot of things.

The first thing is the structure of the business, we have got the right team together now.

We have also I think identified the fact that, look, sometimes the market doesn't recognize the real value.

And as a result, you see this morning we talk about this $16 billion share buyback program.

It is simply a recognition, Ron, that while we have to make investments in the short run, this is really a 30-year time horizon.

We are investing in engines today, we are investing in elevators today that we are going to service for 30 and 40 years.

So the focus of the business, yes, we are looking at the portfolio.

I think we have got a great portfolio that can drive long-term sustainable growth.

But I also think we recognize the reality of the short-term is that the market is discounting that long-term growth and so we have got a big disconnect between intrinsic value of the Company and what the share price is.

So I am going to take advantage of that.

And we are going to do the share buyback.

I think it is the right thing to do.

And I don't think it is any surprise.

We've been talking about the fact that we see this disconnect and so we are going to continue to buy back shares aggressively, $16 billion may not be done.

But again, we are looking at how do you drive sustainable long-term value while delivering short-term results.

And it is that balance that we are after here.

Okay, okay, great.

Thank you.

Doug Harned, Bernstein.

I wanted to talk a little bit about Otis.

Because you have talked about the loss of market share in China.

And if you look at growth in China, Kone has been growing faster than you have.

So what I am trying to understand is when you go forward are you satisfied with the current market share and the margins you are getting in China?

Or is this something where you see a different strategy where you would push for an increase in market share and possibly at the expense of margins?

Doug, that is an interesting question.

Am I satisfied with market share?

Of course not.

I think we have sacrificed market share for margins for a number of years and it is not just in China, we have really done that globally.

But we have got this great business, Otis, which has 20% kind of margins, $12 billion business.

But we have to grow.

And I think that has been the Achilles heel of Otis, that we have not seen bottom line growth in about five years.

So, we have to think about it differently.

Philippe Delpech is the new President of Otis, he has got a great team in place and we are going to focus on kind of the basics, if you will, of how do we get back to long-term sustainable earnings growth.

Part of it is going to be by gaining share because, again, it is that market share that ultimately provides the elevators that we are going to service.

And it is also by improving service productivity, making service more sticky to the customers, showing the value of Otis service versus the others.

So I think there is a lot to do.

Will margins suffer in the short run?

Yes, perhaps a little bit.

But, let's just be clear, this is not a pricing war I am talking about here.

I am talking about targeted market share gains where before we perhaps were not always being as aggressive as we could in pursuing some of these opportunities.

And so to your point, Kone has gained share on us in China.

We are not happy, we are going to go after that and not just China really, it is globally.

And you see that in the US especially.

Last year we grew Otis orders about 40% in the US, this year we are up about 20%.

We know how to do this.

It is about having great product and a great service team and great leadership.

And we have got that across the board at Otis today and I am confident we're going to be able to regain share without sacrificing a lot of margin.

And, Doug, if I might add to that a little bit.

The loss in China market share to some extent was driven by a conscious decision on our part not to play in certain segments.

So the low cost social housing segment we had underrepresented or under played that market.

Gaining share in that market doesn't necessarily have to come with price, it also comes with the right innovative, highly cost-efficient product and we are working on that.

Greg and Philippe have been talking about increasing some R&D investment in Otis to get the right products for the right market segments.

And I think by attacking market segmentation we have seen this strategy play out in Korea, we will do that in China as well.

It is not just about dropping prices to gain market share, it is about putting the right products in the right segments at the right value.

Okay, thank you.

Jeffrey Sprague, Vertical Research.

I was wondering, Greg, if you could just circle back to the share repurchase, a nice pop here for sure, more than a pop.

Just maybe a little color on how you arrived at that number, why that is the right number.

You have said obviously it could go higher.

But just how are you thinking about that relative to where your cash is actually geographically located?

And how you are trying to kind of balance the balance sheet and rating agencies and the like?

Well, I think you hit on exactly the right part, Jeff, which is we are trying to balance the cash in terms of keeping the rating where it is today, as well as where the cash is generated into the future.

Clearly we have been out with the rating agencies, we have talked to them about the fact that we want to continue to do share buyback, we want to take share buyback up.

And we still want to keep our powder dry to do M&A over the next couple of years.

So this was a number that we felt in working with the agencies gave us enough coverage to do aggressive share buyback while at the same time preserving a little bit of powder to go out and do M&A.

And if the M&A it doesn't happen we can do more share buyback.

And it really will depend upon how much of a disconnect we continue to see between intrinsic value as we believe it to be versus where the market sees us today.

So, there wasn't a magic number here.

I would tell you the $6 billion, that is the net proceeds from Sikorsky, we have talked all along about how we are going to reinvest that.

But it is really the confidence going forward that we see in the long range forecast that gives us the ability to go out and talk to the rating agencies and say, here is what the cash flows are going to look like not just for the next two or three years but out beyond that because of these investments.

As they start to tail off cash becomes very, very strong in the out years.

And we can afford to take out a little bit more leverage.

We don't want to be down in BBB from a rating perspective, but we did take a downgrade by a notch.

And I think that is appropriate today.

The capital markets are pretty well recovered from 2009.

And we felt like we didn't need to keep the A1 P1, but we still want to maintain some flexibility.

And, Jeff, the decision to buy back shares was pretty straightforward.

I am sure like you have, and many of the investors have, we have a 10-year cash flow model as well.

And when you look at that and the [virtual] assurance that some of our investments are going to deliver in form of great cash flows when the engines come back for aftermarket and when the UTAS systems come back for repair and overhaul, etc., the cash flow strength of this business is phenomenal.

The Otis business generates over 100% of net income every year as cash flow.

So given the strength of our cash flows over the long-term, clearly our discounted cash flows give us a much higher value of UTX today than the share prices.

And in that situation it is very easy to make that call.

Can I sneak one more quick one in on Otis?

Akhil, since you bring it up, there is a lot of concern out there as you kind of crank up the new product and try to recover share and the like that the margins need to go down materially in Otis.

You kind of disavowed that with some of the earlier comments both you and Greg made.

But can you give us some thought about what is kind of normal kind of margin rate for Otis or where things might settle out as you kind of work through this process?

Sure.

Think about -- the good thing, Jeff, is that unlike the aerospace business, we don't need to spend $1 billion to create innovative products in Otis.

The beauty of the Otis model is targeted investments in R&D of $10 million to $20 million can give niche product which can attractively easily attack market segments.

And that is what we are talking about -- increasing Otis R&D investment by $20 million to $30 million can allow us to capture the share and segment that we had vacated earlier.

So I think it is not about increasing huge amount of investments, it is about the right pricing decisions, as Greg said, it is about the targeted R&D investments.

And the other thing to keep in mind is Otis has the largest scale of any elevator company in the world.

So our ability to reduce costs day in day out at Otis is bar none.

And we have to be able to take advantage of that to keep our margins at levels where they are.

Will they come down temporarily short-term?

Sure.

And that is the right trade off to make.

But it is not going to be a 500 basis point margin reduction, it is maybe 100 or so.

Thank you.

Robert Stallard, Royal Bank of Canada.

Greg, maybe a follow up on Ron's earlier question about strategy and the big picture.

Your commentary earlier in the year was much more optimistic I think about your ability to make acquisitions.

Obviously the share price has changed since then.

But does maybe your lack of enthusiasm for acquisitions here reflect prices you are seeing out there or the quality of the assets you are seeing out there or maybe some other factors?

You pretty well hit on it there, Rob.

Look, we still want to do acquisitions.

This year we will do about $1 billion of acquisitions, some smaller things mostly on the commercial side of the portfolio.

But there remains an opportunity, both on the aerospace systems side as well as on the building side of the business.

We have not seen or found an asset of the quality that we like quite yet, but we continue to look.

And it ultimately comes down to can we buy a business and create real value for the shareowners without having to give all of that value to their shareowners in the form of a very high takeover premium.

So we are going to be disciplined; we are going to keep looking.

And quite frankly, I think this slow down that we've seen in the stock market over the last six months gives us opportunity going forward to be selective and to find targets that are out there.

I think what is off the table today is the bigger deal.

We will do deals in kind of that $1 billion to $5 billion range, things that we can finance with existing cash or cash flows or what we have on the balance sheet.

But any type of deal that would require us to use UT stock -- UTC stock -- in my mind is off the table, simply because of the disconnect.

I don't want to use a devalued currency to do a deal.

So over time as this UTC share price recovers back towards where intrinsic value is, we may think of a bigger deal.

But for right now, we are thinking about kind of that $1 billion to $5 billion range and we will continue to look.

And I give the team credit, we have been close on a couple of deals.

We have walked away because the value wasn't there at the end of the day after we did due diligence, and we did the right thing.

And we will continue to have that kind of discipline going forward.

That is great.

Thanks, Greg.

Carter Copeland, Barclays.

Just a quick clarification and then a question.

I noticed the disc ops was a loss figure in the quarter, and I know you are close to closing this deal.

But I wondered if you might tell us what actually happened with Sikorsky in the quarter.

And then just a question on the planning process.

I know there was a lot of attention last quarter to the plans around provisioning and service in Europe.

And obviously, it is the time of year where you guys have gone through that or are going through that strategic planning process for next year.

I wondered what sort of changes you may have implemented on the planning front.

I mean, obviously, you changed the organizational structure.

Can you give us some insight into just how that is coming together this year versus prior years, and what we should think that means for risk and anything else?

Sure.

So let me take that, and I am sure Greg will add to it.

But on the disc ops, it is a fairly straightforward situation.

There was about $0.16 of nonrecurring items in the quarter related to pension curtailment for the Sikorsky employees and income tax adjustment for taking away of the APB 23 assertion that we had for Sikorsky.

Those will be offset by the gains when we have that in Q4.

Operationally Sikorsky did what we expected -- it is on track to hit the full-year numbers, but the quarter was weak particularly on the oil and gas side and the shipments were down significantly on the S-92 and the S-71 platforms, as you would imagine.

But nothing inconsistent with what Bob Leduc said at the -- in the June Paris air show.

We are on track with the roughly $0.40 of operating income from Sikorsky and about $0.10 of separation costs excluding the restructuring type of items.

On the planning process, Carter, I think again, we have been spending a lot of time this year working in details with the business units trying to make sure we fully understand and agree to the assumptions that are being baked into the plans.

We will make sure we lay those out for you all to understand clearly as we stand up in December.

And at the same time we will be back in the mode of putting some contingency at the UTC level to make sure that we are -- we do not surprise.

That is the number one priority for us to make sure we live up to our commitments and deliver what we say.

If anything we want to get back in the mode of under promise and over deliver.

Yes, let me just go on top of Akhil there.

I think the new structure gives us the ability to dive deep into these individual businesses.

We have got four guys that are running these businesses and we are in lockstep with them in terms of the planning process and the key assumptions that they are making.

So I don't expect any surprises going into next year because we didn't understand what the assumptions were or it wasn't clear what the assumptions were underlying the plan.

And obviously when we get to December we are going to have those four business unit leaders there with me.

We are going to go through each of their plans, we are going to go through each of the key assumptions that make up the plan.

And there will be no surprise with investors next year.

Obviously we were too aggressive this year on commercial aftermarket.

Again there was a reason for that, it proved to be not correct, but we are going to make sure we don't have that mistake again.

So we will be a little more conservative, we are going to have adequate contingency at the UTC level and we are going to make sure that everybody understands all of the key assumptions that go into our plan.

There are things we can't control like what happens to currency and what happens in individual markets, but we are going to get the cost structure right and we are going to make sure we have got the right organization in place to deliver on the commitments that we are going to make.

All right, thanks, guys.

Julian Mitchell, Credit Suisse.

Just a question around CC&S, I think it is the one segment where an EBIT increase is reasonably likely for next year.

But I just wondered how you thought about the risks that this sort of replicates maybe some of the issues that Otis has had in the recent past.

The margins, not a huge increase, 500, 600 points in recent years.

Well above most industry peers now at about 18%.

So I just wondered what gave you the confidence that you will see further margin expansion in the future and whether that expansion is reliant on divestments or you think you can do operationally.

And then just a very quick one word one for Akhil.

Should we expect free cash flow conversion to improve next year?

Yes, let me start with CCS and then I will let Akhil or Paul pile in after me.

But very confident in the CCS outlook for the next few years.

If you think about it, Julian, we have been big investments in R&D; in fact, I think we doubled the R&D budget at CCS over the last five years.

We have got this great new commercial product line, we have been seeing very solid growth.

I think orders in the quarter were up 8% on commercial HVAC in the US.

Continue to seek good positive momentum on the residential side, sales are up about 7%.

So we are seeing good momentum.

The other beautiful thing about CCS is it is not just a US HVAC business, it is a global business but it has got fire products, it has got field, about 30% of their business is service.

It is really -- it is a global building systems portfolio.

And there is going to be growth in a lot of markets.

So we think clearly China will be down next year, we have seen that in the order rates this year, but the rest of Asia still looks very promising.

Europe, we would expect some recovery there next year.

We are not talking about 5% or 6% growth, but just modest recovery in Europe.

And I think what Bob McDonough has focused on is continued cost reduction and cost takeout to ensure that he can grow earnings next year.

So make no mistake, when we talk about three of the business will be challenged (inaudible) earnings, Bob will be challenged, but we are going to challenge him to grow earnings as much as he can.

On the cash flow side, Julian, we certainly expect cash flow for next year to be better than this year.

Keep in mind we have a 5 point impact on the German tax payment this year, right, which hopefully won't be there next year.

On the -- in terms of the makings of cash flow, we will still have a couple more years of pressure on the CapEx side because the aero ramp is not fully done yet.

We still have capital investments which are continuing to be made in both Pratt and UTC Aerospace Systems.

Obviously we will try and control that to the best we can.

And then we should start to see some improvement, we have also had build up of inventory as we get ready for the ramp.

So I think some of those factors will over time start to dissipate, but definitely just the fact we won't have the German tax payment disconnect should suggest a better cash flow to net income next year.

Great, thank you.

Sam Pearlstein, Wells Fargo.

I was wondering if you could talk a little bit more about the working capital you just mentioned.

Just can you quantify the impact of this Pratt logistics center transition?

What exactly happened?

What was the sales earnings, cash flow impact?

And is that the sole reason we saw working capital up the $966 million in the quarter?

Sam, let me start and just talk a little bit about the New England logistics center.

First of all Pratt this year, I think third-quarter this year versus last year was about 55 fewer engine shipments, about 6 of those were on the military side, the other 49 were commercial.

If you do the math that is a little over $500 million in sales that we missed year over year.

The New England logistics center, you guys have heard all about it, we had some startup issues.

The good news is today we are about 94% on time with the kits coming out of there, the kit fill rate.

We should be at 97%, which is the contractual target, by the end of this month.

And we should be able to make up almost all of that production by the end of the fourth quarter.

So again, one-time thing, expect a very big fourth quarter.

And I think the learnings out of the NELC, like everything else, we treat these as an opportunity to make sure we don't do things wrong in the future.

But also it is good learning in terms of process.

So the Pratt team is focused on right now delivering to customers and getting back on track.

The rest of the working capital, Akhil?

Yes, I think in addition to the fact that Greg just talked about, if you think we missed effectively the August shipments, right?

And timing of shipments is absolutely critical, as you know, because if we ship early in the quarter we can have the receivables collected within the quarter that converts into cash right away.

In the absence of not being able to do that in Q3 it left us with a much higher level of inventory and we weren't able to collect the receivables that got shipped for late in the quarter.

Same holds for Q4.

We expect to recover most of it.

The Pratt team is working very hard to make sure they can recover most of the shipment misses of August early in the quarter so that we can collect it within the quarter.

But that is the thing that we are continuing to work on.

The second point I mentioned earlier was, again, as the cut over to new programs is starting to happen at both UTAS and Pratt, there is some additional inventory which is being built.

It is almost like what CCS went through with the SEER13 transition last year, right, where you build some inventory, some safety stock and make sure that you can meet customer requirements.

So that is again a temporary short-term investment which hopefully goes away as the next year comes around.

Thank you very much.

Peter Arment, Sterne Agee.

Greg, just following up on -- could you give us an update now on where things stand on the GTF, how that is performing and also how you kind of quantify all the fluidness that is going on with the CSeries?

I think back in March you kind of indicated that 2017 was going to be the year where we still have probably more than 50% of the deliveries would be GTF coming out of Pratt.

Maybe you can just give us a little view of -- update on the program right now.

Thanks.

Right, so GTF, Geared Turbofan, is really five different programs.

I think the biggest program is obviously the A320neo program.

We continue in the flight test program with Airbus and we expect to have that aircraft certified later this year.

The good news of course is we are hitting the targets that we set out to initially, about 16% better fuel burn, about 50% reduction in emissions and a 75% noise reduction.

So we are right on top of what we told customers we would be six years ago when we started the program.

You have also of course got the GTF going on the Mitsubishi regional jet, we expect first flight probably in the next week or so over in Japan on the MRJ.

That will probably go into service in 2018.

Again, core is performing great and we are on track with the performance.

Bombardier, I think they have got six airplanes in flight test today.

We continue to see very, very positive results of that.

It is a great little airplane.

I think you have heard that and it is targeted to that 110 to 130 passenger market.

And we continue to support Bombardier.

I think we will do what we can to help Bombardier, we all read about some of the challenges that they have had.

But it is a great program, it is a great product and the engines are performing really well.

We have also of course got the GTF engine on the Embraer, the E2 platforms, those are a little bit further behind in the development schedule.

Those go into service in 2018/2019, but again the same core as the rest of the GTFs.

So from a performance standpoint from reliability, it is all going really well.

The gear architecture works, they haven't seen any failures related to that in any of the flight test programs.

So, we're very confident.

Of course the challenge as you know, Peter, as you go through this is you have got not just the R&D investment but the negative engine margin.

So that will be a stress over the next three years as Pratt ramps up and I think I saw the latest schedule, about 1,500 engines we'll be delivering in 2018 -- or 2019.

So $1 billion of negative engine margin.

So the investment continues, but it is an investment that we know is going to pay off because we are going to have a very, very solid aftermarket revenue stream for the next 30 years.

So, GTF is doing pretty well.

That is great, thank you.

Steve Tusa, JPMorgan.

Pretty strong margin at Otis this quarter.

I guess you talked about the profit decline is kind of in line for the year.

But maybe where are you going to be there in the fourth quarter?

You have got a range there, just maybe a little bit more of a point estimate on the fourth quarter.

Because it would imply that I think margins are down year over year in the fourth quarter if I am doing my math correctly.

So, I think if you are talking about total UTC guidance, Steve, it is (multiple speakers).

For Otis.

Otis will probably be at the midpoint of the range overall.

So I think consistent with what we have said all along.

I wouldn't want to give a point estimate for Otis.

But I think -- overall I think everything is on track with exactly what was said and communicated in July.

Okay.

So something -- you implied something in kind of the high teens, like 19% for the fourth quarter I think, something like that?

Yes, yes, yes.

Okay.

So, when you say the margin is going to go -- it is not going to collapse, it will go down 100 basis points or whatever.

I mean, are you talking about -- what base are we using?

Are we using kind of the exit rate for the year?

Is it kind of a 20% that you are still looking at for this year?

So can you kind of hold above 19%, is that kind of the guidance here that you are talking about when you say Otis margins will only be down -- I think you said earlier in the call about 100 basis points as you go through this transition period?

Yes, it is a starting point of 20%, because for a long time we have talked about Otis margins at 20% or so on a sustainable basis.

And I think what I mentioned was a 100 basis points or so reduction in a transition period as we reinvest into the business through either more market share gain or through higher R&D.

Steve, just to kind of put a little flavor on that.

Otis spends about 1% of sales on E&D, about $140 million a year.

So we talk about additional product investment, and we will make a couple of these things, you're talking $20 million to $30 million.

You are not talking about more than probably 50 basis points of headwind from E&D over the next couple of years.

So these -- it is not like we are going to see, to Akhil's earlier point, 500 basis points of margin deterioration.

I think the 20% level is something that is our long-term goal to maintain.

It will fluctuate over the next couple of years, maybe come down as we make some investments.

But long-term we still see that 20% as a target that is achievable even with what we see from a competitive standpoint today.

And, Steve, I would just encourage you and others to kind of -- one of the things we have been obsessively focused on has been the margin at Otis which probably has forced us into some bad decisions.

I think what is more relevant is operating profit growth.

And I think that is what our focus at Otis is going to be to try and generate profit growth.

And if that means that the margins are going to be a little different than what I said or what you expect, that is okay as long as they are gaining organic growth with appropriate margins to get better operating profit growth at Otis.

Sure, absolutely.

And then just one quick one just on US non- res construction.

I mean, there's a lot of things going on in the industrial economy.

Obviously there is probably going to be some regional pressure here as oil and gas is getting worse and hitting pretty hard.

Are you guys seeing anything in kind of the more oil and gas centric parts of the country that would make you worried about this?

It looks like a pretty stable -- still stable non-res recovery.

Anything in Texas that stands out on the commercial building front -- anything like that?

No, I mean the good news is there is not a lot of skyscrapers in Wyoming and South Dakota, so the commercial construction market -- as you know, Steve, it is on the coast and it is in the Southeast.

And we continue to see very, very solid growth in commercial construction.

As I said earlier I think we are up -- Otis is up 20% year to date in orders in North America after being up 40% last year.

So it all looks pretty good.

And I know people talk about an industrial recession.

In the markets that we play in in the US we don't see that.

I think, again, the non-res piece and the residential piece is all very good and commercial aerospace remains strong.

So, I like the hand we have got here.

Right, no elevators at a rig site, I get it.

Thanks.

Well, not ours anyways.

Jason Gursky, Citi.

Akhil, I just wanted to go back to Otis China.

Last quarter you mentioned that there had been some sort of degradation backlog conversion.

I was just wondering if you can give us an update on how things trended here in the third quarter.

And combining that thought with the orders being down 19% in the current quarter, what gives you confidence that we are only going to be down 10% to 15% next year?

So typically Jason what happens is you have got -- about 60% of current year sales come from backlog conversion and we have seen a couple of point reductions in that.

At the same time we have also seen order rates decline.

So the year-to-date orders are down about 13% for Otis.

We expect fourth quarter probably to be something similarly in line with that.

The expectation is that the Chinese government has been investing in infrastructure even though the property market has been weak, housing starts, housing completions have been down, but there has been investments in metros, in airports and Otis benefits a little bit from that as well.

So I think the overall view at this point -- again, this is early in the process; we will give you more specific guidance in December when we are up there.

And maybe our view might change a little bit between now and then.

But based on what we see today maybe orders down between 10% to 15%, some improvement through infrastructure investment the Chinese government is making, opportunity to gain a little share and the continuing growth in the service business which still continues to grow on the maintenance side in mid teens.

We do expect China at this point to be down between 10% to 15%.

Like what exactly it will be we'll tell you more in December.

Yes, the rate of change (multiple speakers).

(Multiple speakers) there been no further degradation in backlog conversion (multiple speakers)?

No, no.

Just to add one comment, Jason, on China that would be that although the rate of change for orders got worse for Otis it actually improved for CCS.

CCS orders in the second quarter were down in the mid-teens, they were down 8% in the third quarter.

Great, thanks, guys.

Thanks, Jason.

Okay, we are mindful of the time, our hour here is up.

Paul and the team will be available, of course, all day to take additional questions.

And we look forward to seeing everybody in December in New York, December 10 I think is the actual date for our 2016 outlook meeting.

And again, any questions please feel free to give us a call.

Thanks very much for listening, everyone.

Have a great day.

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

This does conclude today's program.

You may all disconnect.

Everyone have a great day.