雷神技術公司 (RTX) 2016 Q1 法說會逐字稿

Good morning, and welcome to the United Technologies first quarter 2016 conference call.

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

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

Please note, except for otherwise, noted the Company will speak to results from continuing operations, and excluding restructuring cost and significant other items of nonrecurring and/or nonoperational nature, often referred to by management as significant other items.

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

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

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

You may ask further questions by reinserting yourself into the queue as time permits.

Please go ahead, Mr. Hayes.

Okay.

Thank you, Kaley, and good morning, everyone.

As you saw in today's press release, we reported EPS in the first quarter of $1.47, and 2% organic sales growth in the quarter.

These better than expected results were against a difficult prior year compare, and reflect solid operational performance.

So we're off to a good start, and as a result, we remain very confident in our 2016 guidance, with top line organic growth of 1% to 3%, and adjusted EPS of $6.30 to $6.60.

Importantly, we also continued to make progress on the key strategic priorities we laid out at our December and March investor meeting.

And you can see these on slide 1.

The first priority as always, flawless execution.

Beyond better than expected Q1 results, were truly a team effort.

Pratt is ramping up production as planned.

Our Middletown, Connecticut and West Palm Beach engine centers had the strongest Q1 output we've seen in over a decade, and that includes both commercial and military engines.

At our Climate, Controls & Security business, they drove another 70 basis points of margin expansion in the quarter.

The Aerospace Systems team, they completed a major ERP implementation, while continuing to meet program and customer milestones.

And importantly, Otis delivered a solid 3% organic sales growth in the quarter, despite China sales being down 3%.

Also new equipment orders for Otis in China grew 2% year-over-year on a units basis, something we haven't seen since the end of 2014.

On the innovation front, there are now five A320s in revenue service, all powered by the Geared Turbofan engine, and they're providing our customers with better than expected performance.

The dispatch reliability across the in-service fleet is over 99%.

That's great news for the airline, and bodes well for the future of the program.

In Carrier Transicold, we recently delivered the world's first naturally refrigerated truck trailer that operates exclusively with the environmentally-friendly refrigerant CO2, yet another example of our commitment to and investment in sustainable technologies.

On cost reduction, that's a way of life here at UTC.

Look at our SG&A in the quarter, down year-over-year, both in absolute terms and as a percentage of sales.

UTC's SG&A is now at 10%, which is best-in-class versus the peer group.

And as always, we're disciplined on capital allocation.

As you saw earlier this week, we raised our dividend for the 13th time since 2001, representing a 12.5% cumulative average growth rate over the last 15 years.

We're proud of that record, having paid cash dividends for 80 consecutive years.

We're also executing on the $6 billion accelerated share repurchase plan, or ASR that was launched late last year.

On top of that, we expect to do another $3 billion in share repurchases this year.

We're going to continue to drive our share repurchase program, as long as there a significant disconnect between our view of the intrinsic value of UTC and our share price.

And we continue to expect to return at least $22 billion to shareowners from 2015 to 2017.

As always, we remain focused on what we can control, and this means driving productivity, while continuing to invest and deliver differentiated products and services that bring value to the customers.

And this focus will drive sustainable long-term growth and, of course, increase shareowner value.

Across the business, we continue to achieve significant program milestones, and secure key wins that position the portfolio well.

At Pratt as I mentioned earlier, the GTF is doing well on the NEO, and the CSeries is on track for entry into service at the middle of the year.

On the military side, we're honored to have been selected to supply the engine on the new B-21 Long-Range Strike Bomber.

And together with the JSF, this positions Pratt well on key DoD programs for decades to come.

As you know, we have strong content on new programs in our Aerospace Systems businesses as well, and these innovative products should deliver nearly $1 trillion in sales over the next 25 years between Pratt and Aerospace Systems.

Innovation is also driving growth in our commercial businesses.

Climate, Controls & Security recently launched its Onity direct key system for mobile access at Hilton Worldwide.

This is a cloud-based technology that allows for a straight to the room option for hotel guests with their smartphone.

On the Otis side, in the quarter, we installed the world's largest double-deck elevator at the Lotte World Tower, Korea's tallest building, and announced that we'll put elevators and escalators in the Aurora Melbourne Center in Australia, which will be the tallest residential building in Melbourne.

These are just few examples of many of where our investments and innovations are starting to pay off.

Let me turn it over to Akhil and Paul to take you through the first quarter results, and I'll be back with just a few closing comments, before we start Q&A.

Akhil?

Thanks, Greg.

I'm on slide 2. As Greg said, organic sales were up 2% in the quarter, in what continues to be a slow growth and challenging macroenvironment.

Once again, it looks like the US economy grew at a slower than expected pace in the first quarter, leading to a downward revision of the full year GDP outlook, and still relying on a stronger second half growth rate.

However, for our commercial businesses, the US remains a bright spot.

We saw 4% growth in the Americas, driven primarily by Otis which was up 9%.

North American commercial HVAC was up 4%, and residential was up 1%.

You will recall that Q1 of 2015 benefited from above normal [CF13] shipments.

Excluding that impact, resi sales were up high single-digits in the quarter.

Sales were down 2% in Europe and the Middle East, driven by CCS.

Mid to high single-digit declines in commercial HVAC, commercial refrigeration, and fire and security businesses due to tough compares, were only partially offset by a double-digit increase in truck trailer refrigeration.

And in a sign of stabilization, Otis sales were flat in the EMEA region.

In China, Otis and commercial HVAC were both down 3%, slightly better than our expectations.

We saw good growth across rest of Asia at both Otis and commercial HVAC, up 7% and 8%, respectively, partially offset by declines in the refrigerated container business.

Commercial Aerospace growth of 4% was primarily driven by Pratt, where the aftermarket was strong.

On the military side, sales were flattish for both the OEM and the aftermarket.

Production declines in program, such as the C-17 at UTAS and Pratt, were offset by higher Joint Strike Fighter engine deliveries at Pratt.

Let's look at our end markets on slide 3. As always, we'll talk to Otis and CCS orders on a constant currency basis.

In our commercial businesses, we continue to see good momentum in North America, particularly at Otis, where new equipment orders were up 33% in the quarter, the 16th consecutive quarter of growth.

At CCS, as I said before, residential HVAC sales were up slightly in the quarter, while orders for residential equipment were up 15%.

Commercial HVAC equipment orders were down 7% in the quarter, driven by lower exports.

Domestic commercial equipment orders were flat.

Orders in Europe and the Middle East were weak in the quarter, partly due to tough compares.

Otis new equipment was down 13%, driven primarily by Russia.

At CCS, commercial HVAC equipment orders were down 10%.

As you know, China reported Q1 GDP growth of 6.7%, the lowest rate of growth there since 2009.

But recent indicators including home prices, number of property transactions, and exports have been better than expected, showing some signs of economic stabilization.

At Otis, China new equipment orders were down 7% in the first quarter in dollar terms, a little better than we had expected coming into the year.

And at CCS, commercial HVAC was down 6%, and fire and security orders were down slightly.

On the Aerospace side, consistent with our expectations, commercial aftermarket sales were up 1% at UTC Aerospace Systems.

On the other hand, Pratt & Whitney commercial aftermarket sales grew 19% in the quarter, largely driven by timing of deliveries associated with strong Q4 2015 orders, and some advanced purchases by customers.

Now moving to slide 4. Total reported sales of $13.4 billion were flat versus the prior year, as 2% organic growth was offset by 2 points of headwind from the stronger US dollar.

Adjusted EPS of $1.47 was up 2%.

On a GAAP basis, EPS was $1.42, which included $0.05 of restructuring charges.

Free cash flow was 43% of net income, and in line with our expectations.

Cash flow was pressured by inventory build to support the Aerospace production ramp, and included a payment of nearly $250 million related to the charge taken in Q4 2015 for the Canadian royalty settlement.

This was the first of four annual payments.

We continue to expect full year free cash flow to net income in the range of 90% to 100% in 2016.

As Greg said, we have confidence in our full year outlook, sales of $56 billion to $58 billion, and adjusted EPS range of $6.30 to $6.60.

With a solid first quarter under our belt, and a weaker than expected US dollar thus far, our contingency at $6.45, the midpoint of our range is now up to $250 million, assuming the current FX rates hold for the rest of the year.

With that, let me now hand it off to Paul, to take you through the segments in more detail.

Paul?

Okay.

Thanks, Akhil.

Turning to Otis on slide 5. In the quarter, sales were $2.7 billion, up 4% at constant currency and 3% organically.

Otis profit was $481 million, and down 5% at constant FX, reflecting continued pricing pressure in China and EMEA, more than offsetting drop-through from stronger volume in other areas.

Foreign exchange translation was a 5 point headwind to sales and earnings.

New equipment sales at Otis increased 6%, led by 21% growth in North America, 6% growth in EMEA, and mid teens growth in Asia, outside of China.

China new equipment sales were down 6% in the quarter.

Otis service sales were up low single-digit overall, as mid single-digit growth in both Asia and the Americas was partially offset by a 1% decline in EMEA.

New equipment orders were up 1% in the quarter.

Orders in North America were up 33%, while in EMEA, we saw new equipment orders down 13% on a tough prior year compare.

Recall, orders in the first quarter of last year were up 37%.

China orders were down 7% on a dollar basis, with 2% higher unit bookings.

Outside of China, Asia was strong, with orders up 11%.

And for the year, guidance at constant currency remains unchanged at $75 million to $125 million of profit decline for Otis.

Moving to slide 6, Climate Controls & Security sales were flat in the quarter at constant currency, with 1 point of growth from acquisitions, offset by a 1% organic sales decline in what will be the year's toughest quarterly compare.

Profits were up 4% at constant currency, with benefits from lower commodities and other productivity.

Operating margins were up 70 basis points to 17%.

FX at CCS was a 3 point headwind to both sales and profit.

During the quarter, we saw continued growth in HVAC sales, with both North America residential and global commercial HVAC up 1%.

Globally, the fire and security business was down 4%, with a high single-digit decline in the global fire products business from tougher compares in EMEA, and continuing weakness in the oil and gas sector.

Transport refrigeration sales were flat in the quarter, with a nearly 25% decline in the container business, offset by continuing growth in truck trailer.

Global refrigeration sales were down high single-digit.

CCS equipment orders declined by 8% in the quarter.

Transicold was down over 25%, off a very strong first quarter last year.

Globally, equipment orders at both the fire and security and the commercial HVAC businesses were down 7%.

While orders were soft in Q1 at Climate, Controls & Security, with easier back half compares and continued productivity, we are confident in the full year profit growth of $175 million to $225 million at constant currency on low single-digit organic sales growth.

Turning to Aerospace on slide 7. Pratt & Whitney sales of $3.6 billion were up 8% organically in the quarter.

This was driven by strong growth in the commercial aftermarket, up 19%.

Military engines were also up in the quarter, with military OE sales up 16%, driven by higher JSF shipments, partially offset by the end of production for the C-17 engines.

OEM sales were down 12% and 15%, respectively, at Pratt Canada and large commercial engines.

Geared Turbofan shipments were exactly in line with what Bob Leduc laid out at the Investor meeting in March.

Pratt operating profit was $415 million, down $17 million or 4%.

Pratt saw a $70 million headwind from commercial OE margins, and another $50 million from adverse military margin mix as we shipped more JSF engines, and fewer of the fully [learned out] C-17 engines.

As we expected, E&D was also higher in the quarter, and we continue to expect a second half spending decline as we approach entry into service for the CSeries, and engine certification milestones on the remaining Geared Turbofan programs.

Partially offsetting these headwinds were drop-through from the strong commercial aftermarket volume, and both better pension and FX.

Last year's favorable contract termination of $0.03, was offset by a contract settlement this quarter for a similar amount.

For the full year, we continue to be on track for operating profit to be flat to down $50 million.

Turning to slide 8. Aerospace system sales were down 1% organically in the quarter.

Commercial OE sales were up 1%, with continued growth on the A350, and initial production on the A320NEO, partially offset by declines in legacy programs.

In line with our expectations, commercial aftermarket sales were up 1%, with low single-digit growth in both parts and repair, partially offset by a low single-digit decline in provisioning.

Overall military volumes were down in the quarter, with OE sales down more than 10%, driven by continued declines in the C-17 and other programs, while the military aftermarket was up slightly.

Aerospace Systems delivered $551 million of profit on 11% decline, in the face of a tough compare versus the prior year, which benefited from favorable contract settlements, and higher licensing activities.

Unfavorable commercial mix, largely from the transition to next-generation platforms and the drop-through from lower military sales were significant headwinds in the quarter.

These were partially offset by additional cost reduction actions and pension tailwind.

For the year, based on expected improvements in organic growth, and incremental savings from cost reduction actions, we continue to expect operating profit to be flat to down $50 million on low single-digit sales growth at UTC Aerospace Systems.

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

Okay.

Thanks, Paul.

I hope you guys got all that.

As I said at the beginning of the call, a strong start to the year.

We're delivering on our plan and delivering on our commitments, and I'm encouraged on the progress we're making on the strategic initiatives that we laid out back in March.

As I also mentioned before, let's just talk about guidance for a second.

We're confident in our full year 2016 outlook.

And as Akhil said, we've got a pretty significant contingency at the midpoint.

So while Q1 was a good start to the year, it is still only April.

A couple of things to think about.

The macro environment remains uncertain.

And like many others, we expect a much stronger growth in the second half of 2016.

And we're also continuing to watch the order rates at CCS, pricing at Otis in both Europe and China, and of course, the Aerospace aftermarket trends.

So while we considered bringing up the bottom end of the range, I think it's prudent at this point, just to leave the guidance range unchanged.

You know what our contingency is.

Also remember, it's our practice that we'll continue to watch these trends, and we'll revisit this at the end of the second quarter.

Okay.

We also continue to believe UTC is well-positioned for the long-term, and that is ultimately our mission.

We've got this focused portfolio of industry-leading franchises.

We've got innovative products in the pipeline, and we also have global scale, and a lean cost structure.

On top of that, solid market fundamentals which we've been talking about, and these trends are real, as revenue passenger mile growth, continued urbanization, and the global expansion of the middle class.

All of these together, are going to position UTC to deliver strong earnings growth, not just this year, but well into the future.

And, of course, translate into significant and long-term shareowner value creation.

So with that, let me turn it back to Kaley, and open up the call to questions.

(Operator Instructions)

Our first question comes from the line of Carter Copeland with Barclays.

Your line is open.

Hey, good morning, guys.

Hi, Carter.

Just wondered if you could give us a little color on the order commentary, and truck trailer versus containers?

I know you quoted the revenue, but just wondered if you could tell us how the orders are trending?

So Carter, the orders, as you know Transicold had a very, very strong orders quarter last year in Q1.

It was up 24% organically, with truck trailer North America up 73% last year.

So on the back of those compares, what we have seen this year is down 24% in Q1 year-over-year on orders, with container down 20% -- a little north of 20%, and North America truck trailer down a little north of 50%.

Europe truck trailer continued to be very strong, with up double-digit order growth.

I wouldn't read too much into these quarterly order rates either Carter.

You know this is a lumpy, lumpy business, both truck trailer and container.

Still feel confident in the full year guidance, and we still have a very, very good market share in both truck trailer, as well as the container business.

So it's lumpy, but it's early.

So I don't think there's any real cause of concern here.

Okay, understood.

And just as a quick follow-up, on the provisioning you mentioned; the down low single-digit.

Just for clarification, do we lap the fall off in those provisioning sales beginning next quarter?

Yes, there's going to be some improvement, as you will expect through the rest of the year.

I mean, our guidance for the year is to be flat.

A little bit of the weakness in the first quarter was also driven by some push out of Airbus 320NEO deliveries as you can imagine, because that caused some of the airlines to delay their uptake of provisioning.

But we do expect full year to still be flat, and compares to get easier, as you pointed out.

Yes, and the fundamentals are good, right?

You've got A320 deliveries picking up, and NEO deliveries picking up.

You've got A350 deliveries picking up.

You've got CSeries going into service.

And all of those things would point to a much stronger back half, and to Akhil's point, much easier compares.

Great.

Thanks for the color, guys.

Thanks, Carter.

Our next question comes from the line of Nigel Coe with Morgan Stanley.

Your line is open.

Thanks.

Good morning, gents.

Good morning, Nigel.

Just maybe, Akhil, you've provided a range in mid March, $1.35, $1.40 as a placeholder for the quarter, came in at $1.47.

I hate to sort of be counting pennies here, but what drove the upside?

Did you see a better back half in March?

Was it some shift on commercial OE?

Can you -- maybe add some color to the upside?

Sure, Nigel.

It's always good to be on the positive side of a beat, as opposed to the other.

True.

It's the -- well, the reality is, our execution was much better.

I mean, as Greg said, UTAS was in the middle of implementing a huge ERP implementation, and we were just a little concerned, whether we would be able to catch up with the impact of that.

And as Greg said, the team did a fabulous job of making sure we met customer commitments, and were able to get past the SAP implementation, and still deliver on our commitments.

So that was a better, a slightly better performance at UTAS, versus what our internal expectations were.

Pratt executed extremely well.

The production output was the best ever for a Q1.

Again, we had a little contingency against that.

And then, Otis environment, from a macro point of view, Otis came in better both in China and in North America than we had expected.

Okay.

That's really helpful, Akhil.

A quick follow-on, Greg, maybe, there's a lot of obviously, a lot of news and noise about the GTF [technical] fix.

Maybe just bring us up to speed on how that's looking right here?

Yes, I think it's all really good news, Nigel.

As we look at it today, as I mentioned, we're at 99% plus dispatch reliability.

I think importantly, if you talk to the airlines, you talk to Lufthansa, you talk to Indigo, they're seeing better than the 16% fuel burn that we had been committing to, something like 18% better fuel burn.

So the engines are performing better than expectations.

We had a software drop last quarter or last -- yes, last month, reduced the nuisance faults in the cockpit by about 80%.

All of the other fixes that's we've talked about are going to be in production by June, and the whole fleet, the few engines that we do deliver in the first half will be retrofitted by year end.

So everybody feels good about the program on the NEO.

And I think it would be the same across all the GTF platforms, at Embraer, at Bombardier, and MRJ.

This is a great engine.

Okay.

Thank you very much.

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

Your line is open.

Yes, good morning, everyone.

Hey, Jason.

Hey, Akhil, I was wondering if you could give us a quick update on your cost structure initiatives?

Are they on track, both from a timing and financial impact perspective?

And maybe some quick comments on whether the political climate today is making things a bit more difficult, or giving you pause on any of your plans at this point?

Jason, let me take -- let me start off, and then Akhil can fill in the details.

But we're on track.

We're going to spend about $500 million this year on restructuring.

First quarter was light, only about $62 million.

But importantly, we announced a couple of big initiatives at the climate controls business, that is the closure of a couple of the big facilities.

Those as you can imagine, are very, very difficult decisions.

We think they're the right thing to do for the business, and we will continue to do the right thing for the business, even as we are perhaps chastised by some of the politicians.

The fact is this is a globally competitive marketplace that we operate in, and we have to do what's right for everyone, shareowners, the employees, the communities that we operate in.

So look, tough decisions.

We have plans in place to help employees through these transitions, through our employee scholar program.

We offer people a full four years of college education if they're displaced by any of this outsourcing.

We provide significant severance and outplacement assistance.

All those things, you have to do, keeping in mind, you still have to do the tough things.

And I give credit to the CCS team.

I know they're getting beat up a little bit out there in the media, but we have to do the right thing for the business, and we will continue to do that.

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

Your line is open.

Hi, thank you.

I just wanted to -- hi, I just wanted to start on Otis.

I guess, one of your peers had talked about Southern Europe stabilizing.

Doesn't look like you saw that yet in service.

And also, they seemed to find the competitive temperature of the water sort of heating up a lot in Q1.

Again, doesn't sound like you saw that in China.

So just wanted your thoughts on those two points?

Sure, Julian.

Look, I think Europe was a better story for us this quarter, than we have seen in the past.

If you go back and look at our last four quarters, the service in Europe had been down sort of mid single-digit, and this quarter, it's down 1%.

So it's a trend in the right direction.

We saw growth in our portfolio in the number of units under maintenance in EMEA were up sequentially from December to March.

So that's another good sign.

Pricing pressure continues there, but that's not a surprise.

That doesn't abate that quickly.

As you know, the big driver of pricing will be either conversion of new equipment into service contracts and/or inflation.

And those two are still not there in the European economy.

So I think we'll see that come through, but it's probably further out.

With regard to China, it was good to see the growth in the units, [off] 2% in the orders this quarter.

And the order rate in value terms, was better than we had expected.

So I think we're seeing some traction there, with improving sales effectiveness, with improving product positioning, so feel relatively good.

It's one quarter, but the trends were encouraging.

I think I'd also add there, Julian.

Akhil and I just got back from a trip to the Middle East and to Southern Europe.

We were visiting with Otis customers, and visiting the Otis branch offices.

And I think it's clear, that the guys running the offices have a good handle on what they need to do to stem the price erosion that we've seen.

Again, none of these things happen overnight.

It is good as Akhil said, to see some stabilization.

We visited both the Otis branded offices, as well as some of our second tier brands.

I mean, they have good strategies.

Again, I think as we saw in Spain, when we were in Madrid, the economy there has bottomed out.

Unemployment is getting a little bit better.

Even in Italy, despite some of the issues around the banking crisis, we still see growth in some of the major cities.

It's not doom and gloom in Europe.

I think it's stabilizing as we said, and should bode well for the years to come.

Thanks.

And then, just on my second question, just on aero systems, you had a pretty hefty EBIT drop in Q1.

I just wondered whether there was a big weighting within that of your, sort of the comp year-on-year from the contract and license agreements?

You had dialed in a $150 million headwind for the year from that item.

Is that very sort of Q1 or first half weighted?

I wouldn't call that out specifically, Julian.

That was about $40 million, of the [$150 million] was in first quarter year-over-year.

I think the bigger thing is, if you go back and look at the quarterly profile of UTAS, Q1 was their strongest quarter.

Again, organic growth was the strongest in Q1, profitability was the strongest in Q1.

Provisioning was pretty good in Q1 last year.

So I think as we go through this year, the compares get a little bit better.

This $68 million change in year-over-year profit was very much in line with our expectations, certainly for first quarter.

So no drama there.

What will happen is we will see better results from cost reduction efforts that Dave Gitlin and team are putting in, in the rest of the year compared to first quarter.

And the mix starts to get a little bit better, especially given what we saw, the decline in the legacy businesses in the first quarter of this year.

So it's more, I think, just again consistent with our expectations, no change, no drama.

I would say UTAS came in exactly where we expected it to.

Great.

Thank you.

Thank you.

(Operator Instructions)

Our next question comes from the line of Cai von Rumohr with Cowen and Company.

Your line is open.

Yes, thank you very much.

So I know that the 19% increase in commercial spares in the first quarter at Pratt presumably was the big price hike, plus the V25 turbine overhaul coming up.

Can you give us some color, I mean, is 0 to 2 still the right number for spares for the year?

And maybe focus both on Pratt and UTAS, and what your revised guide assumes for Pratt's aftermarket compares in the second half?

Thanks.

Sure.

So Cai, you've got both the points right.

I think we had the benefit of very strong quarters, very strong orders in Q4 of 2015.

And so, some of the sales associated with those orders flew in Q1, which was helpful.

We also saw some timing-related purchases in Q1 associated with V2500 engine as you pointed out.

So both those factors drove our exceptional 19% in Q1.

Compares will be more difficult in the back half, especially in Q4 which was a decent quarter for Pratt, as you know in commercial aftermarket.

So we, while we think there is upward pressure on aftermarket, commercial aftermarket at Pratt, I'd like to wait for one more quarter and see the trends in Q2 before taking, officially adjusting the guidance if you will for aftermarket for Pratt.

UTAS very much in line, with what our expectations were, 1% growth in commercial aftermarket for first quarter, low single-digit growth for the full year, slightly better in the back half than first quarter, largely on the back of provisioning and spare parts.

And I think we are all on track.

So you're still at 0 to 2 at Pratt?

It could be.

It is upward pressure there, clearly.

But to give you a more precise number, I think let's wait for one more quarter of trends.

I think, obviously, we're very encouraged, Cai, as you would expect with 19%.

But as Akhil said, the back half, especially fourth quarter compare will be more difficult.

But clearly, we think there may be some upside, but we'll see.

It is early as I pointed out.

It's only April.

So just keep those expectations in check here today.

Thank you.

Thanks, Cai.

Our next question comes from the line of Doug Harned with Bernstein Research.

Your line is open.

Thank you, good morning.

Good morning, Doug.

Good morning, Doug.

On Otis and CC&S, in China, when you look at where you stand right now -- I know, Greg, you've talked about the need at Otis for additional product development there.

It feels that over the last years, there's been a real focus on cost reduction both in CC&S and in Otis, with the goal of getting margins higher.

As you look at your position and products today, particularly with respect to China, both at Otis and CC&S, what do you see in terms of the positioning right now, investments that may need to be made?

Where is this likely to head over the next two years?

I think both Philippe and Bob McDonald laid it out pretty well.

We have to make some additional investments in the product line.

Especially if I think about CCS, that's got to be in the big chillers.

It's a big market in China.

We don't have huge share there, good share, but not leading share today.

And so, we have to continue to make investments in products.

It's the same at Otis.

Otis has got again, decent share in China but we need to make investments.

But we need to continue to drive the innovation theme, as opposed to the margin theme.

And as a result, you'll see -- Otis margins are down this quarter.

But that's okay.

I think our focus here is the long-term, and that is driving more products into the hands of the customers, so that service can ultimately be the driver of growth.

If you think about service in China today, it was up 15% in the first quarter at Otis.

So we're getting momentum.

Unit orders as we said, were up 2% even though overall orders, were down a little bit in Otis China.

But we're getting some traction, but more investment.

So we're not done there on the innovation and the investment side.

Does this mean that in both units, should we expect to see a little bit of margin headwind, say this year and next?

I know that was kind of what it looked like at the Investor Day, with the margin expansion really coming farther down the line, so the 2018 to 2020 time frame?

Yes, I think -- keep in mind, CCS still has some margin runway as Bob pointed out.

70 basis points this quarter is a little bit more than what we expected, but the organic was down 1. So I think Bob's got some opportunities on the cost reduction side, as well as the top line.

For Otis, we are going to see a little bit of contraction clearly, as we try and regain market share.

You're going to see pressure on the margins.

But as we've talked about many times, I think the focus is on starting to grow operating profits at Otis, not focusing so much on the margin percent by itself.

Because ultimately, it will be better for the shareholders if we can start growing earnings at Otis, even if it comes with a slightly lower margin percent.

Right.

You can't service elevators, you don't sell.

Okay.

Great.

Thank you.

Thanks, Doug.

Our next question comes from the line of Jeffrey Sprague with Vertical Research Partners.

Your line is open.

Thank you.

Good morning.

Good morning.

I wanted to focus in on HVAC.

And I guess, I'll put Transicold and resi aside, because as you said, we can get whipsawed on comps in Transicold, and Resi we got the [13] to [14] [here] noise.

It does look and feel like there's some slippage there though in the commercial business.

I guess, Greg, you addressed it a little bit on China just now in chillers.

But can you update us on where you're at on product rollout in that business?

Do you think there is some share erosion in North America, and how do you plan to you address that?

Yes, one quarter does not a trend make, Jeff, as you know.

I think last year, as we looked at the market share trends improving, that was on the back of, I say some big new product introductions, especially in the big, big machines, the 3,000-ton chillers.

First quarter was weaker than what we had expected, clearly on the commercial side, not just in the US but globally.

But we have been making investments.

We've doubled the R&D spend at Carrier on the, especially focused on the big machines on the commercial side.

So feel pretty good about where we are.

But still a lot of work to do.

I think this is the one area where Bob has got the team focused.

Because the rest of the business, I think in the resi business in the US very strong, solid market share, good margins.

Refrigeration business, as I said lumpy, but still very, very solid from a market share perspective.

Commercial HVAC, there's some work to do here.

And as one of the things, Jeff, Bob talked about at the March meeting.

Middle East, we are seeing particular pressure in the commercial HVAC business.

I think the orders there were down over 40%, and that shows up in the overall numbers.

It's an important area for us, for CCS and that's facing its own challenges right now.

Just a quick one on Otis, and I'll pass the baton.

Just bridging the gap from units up [2], to dollar revenues down [7], that 9 points, I assume that's not all price.

But can you give us some color on price mix within that spread?

Sure.

Pricing is a large part of that, but there is some mix element as well.

I would say probably 80% of that figure that you quoted would be price, and the rest would be mix.

But I don't have the precise data here.

But I think it's not -- pricing was a little worse than what we expected, but not that much worse.

I think there is always a concern when the market goes down, price tends to follow that a little bit, as all players start to go off lower market units.

But it was good to see that Otis was able to stake its own claim, in terms of growing the number of units in the order base, and that was encouraging for us.

I think the other thing to think about, Jeff, is China actually looks like it's stabilizing.

We've seen some rebound in the residential housing market.

As you know, that's 60% of what Otis sells there goes into the resi market, residential housing.

So that looks like it's stabilizing.

We're starting to see an uptick, in especially Tier 1, Tier 2 cities in terms of residential sales again.

So while we had kind of planned for the worst, I don't think it's going to be as bad as what we had thought in China, and we should get a little bit of traction there on the, as the recoveries in the residential market.

Great.

Thank you very much.

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

Your line is open.

Hey, good morning, guys.

Hey, Ron.

Just a quick question for you, Greg, on the B-21 engine.

Will that be produced on the same line as the F-35 engine and the GTF?

Ron, I'd love to be able to talk about it.

But I really -- all I can tell you is that, yes, we've been selected by Northrop and the DoD to partner on that, with an engine.

But I really can't talk about anything specifically, unfortunately.

But again, it just bodes well, if you think about for Pratt's military business, really for decades to come.

Now we have the JSF.

We've got the Long Range Strike.

Clearly, Pratt's got a huge backlog coming.

Okay.

And then, maybe just one more quick engine question, right.

I mean, there has been all this press about A320s piling up, because of engines and so on and so forth.

Can you give us some color on, kind of where we are on that, and what's going on with the fixes to the engine, to get everything kind of back to normal?

Yes, I think well, we mentioned it earlier.

We delivered, I think, 14 engines in the quarter.

We're exactly on plan with Airbus in terms of the ramp up that we had expected.

As I mentioned as well, 99% plus dispatch reliability, getting better fuel burn than what we expected.

We had the latest software drop that Bob Leduc talked about in March, that corrected about 80% of the nuisance fault.

Everything else by June, will be incorporated in the production engines.

And by the end of the year, we'll have retrofitted all the engines we shipped in the first half of the year, with the software and everything else.

So the engine's performing well, and couldn't be happier in terms of the dispatch reliability.

If you talk to the pilots, who talk to the airlines, they like the engine, and no bad news here.

All right.

Great.

Thank you so much.

Our next question comes from the line of Peter Arment with Sterne Agee.

Your line is open.

Yes, good morning, Greg.

Greg, I wanted to go back to kind of Cai's question on commercial aftermarket within UTAS.

Just -- I get it that the growth is in line with expectations, and I know predicting aftermarket growth is more art than science.

What, this seems to be trending a little below, either what we've seen from other companies reported.

Maybe you could give us a little color kind of specifically what's going on in UTAS commercial aftermarket?

Look, it's trending about in line with what we had expected, to your point, Peter.

This is more art than science, but we know the fundamentals are still out there.

We know that NEOs deliveries are going to pick up.

We know you're going to see CSeries enter into service here, the middle of the year.

A350s are going to ramp up.

So we would expect to see a better trend, as we go throughout the year.

Keep in mind, first quarter, a tough compare at UTAS on the initial provisioning.

We saw initial provisioning drop off significantly after the first quarter of last year -- I think that's right, Akhil.

And so, it should be a little easier compare will help.

RPMs continue to be strong.

Is there upside at UTAS?

I don't know.

Certainly, Pratt looks more promising today.

But it is early in the year.

So I don't think there's anything to panic about.

It's just a lot of it timing.

Okay.

No, that's helpful.

Thank you, Greg.

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

Your line is open.

Well, thank you very much.

Greg, I want to go back to sort of something you talked about at the very beginning, and said the contingency has expanded, and it's now at around $250 million.

Can you elaborate a little bit on your thought process in terms of how you might want to use that going forward?

Some of it might very -- well, I'll just stop there.

Keep it simple.

(laughter) You help us, go ahead.

(laughter) Mr. Ruble, how would you like me to use that?

Should we pass it through in higher earnings?

No, look, it's as we said, as Akhil said, $250 million of contingency at the midpoint, it's $6.45.

Clearly, it's early, but what that does, it bodes well.

I think we've got a range out there for a reason of $6.30 to $6.60.

I think as we get to the end of this quarter, the second quarter, we'll take another look at the overall results.

And if everything is in line, you could expect us to probably take a really hard look at the range again.

But it's early, it's April.

Could you see higher earnings than the consensus out there, $6.50?

Maybe.

But look, let's just wait.

The other thing, Howard, is as you know FX can change very quickly, right?

Only six months ago, people were talking about going to parity for euro, and now at 1.13, and everybody's feeling good.

All it would take is for Fed to signal that they're going to take the interest rates up here, and you'll see euro go back down towards that level.

So it's April, it's too early.

The CCS order trend is something we need to continue to watch, as we have said.

And then, if the Pratt aftermarket stays at this level, then obviously that's good news.

But it could change again.

So it's -- I know I have developed an internal nickname here of wet blanket, but I think it's appropriate to kind of use -- (laughter)

We like to think of as balanced works at UTC, right?

So Akhil's pessimism, my optimism, which is unusual, it all kind of balances out here.

So we like where we are.

We think the consensus is right in line, and there's not much more to say about it, Howard.

No, I appreciate the candor and color.

Just as a follow-up a little bit.

The benefit of where you have been is, that there are some markets where commodity prices have been a little bit better, and there's some other cost benefits that have sort of come out of where you are today.

What are you doing, or what have you asked some of the operating executives to do to either take advantage of this continued weakness in commodities and other markets to help the business longer term?

Sure.

So as you know, Howard, on the CCS side, we have a program in place to hedge through our copper requirements specifically.

And we have through our supply agreements, we have long-term arrangements with suppliers where we have a price fixed for copper for the next several quarters.

And based on that, we know that our first half commodity tailwind is slightly greater, than what we expect for the second half.

We are looking at some of the similar arrangements on the Aerospace side, particularly with regard to a couple of long lead items like nickel and others, but there's still some work to be done on that.

But that's the direction we have, with the copper executive, with Peter Longo, in new role as the Ops VP is looking at that hard with the business units.

Thank you very much.

Thank you, Howard.

Our next question comes from the line of George Shapiro with Shapiro Research.

Your line is open.

Yes.

You may have addressed this, but there's a lot going on today.

But at Pratt, did deliveries in the quarter were 9 or 10 less than what Bob Leduc had shown us in the March slides.

So I was wondering, what that disconnect was?

And then the second part is, with aftermarket at Pratt as strong as it was, it's probably up $250 million with commensurate aftermarket profits.

It seemed like the margin at Pratt was a little bit lower, even after going through your comments about the losses on the new engines.

So if you could further explain that?

Thanks.

Sure.

So the EBIT road map for Pratt, let me answer that first, and then maybe touch back on the quarter question that you asked on the deliveries.

On the EBIT road map, I think Paul mentioned, we had about $70 million headwind from the commercial OE mix, on the OE side, right, for large commercial.

That included both large commercial engines and Pratt Canada, $60 million of the $70 million was negative engine margins up year-over-year.

$50 million Paul talked about a headwind from military mix that was there.

And then there was another $25 million higher E&D when you strip out FX and pensions.

So that was the net negatives in the Pratt EBIT.

On the positive side, you had about $80 million drop-through from the higher commercial aftermarket.

We had about $40 million good news from pensions, and another $15 million from Pratt Canada FX.

So when you net all that, you are within the -- within rounding of $17 million of down year-over-year profit.

With regard to the deliveries, I think we saw some change, a slight change in the V2500 deliveries, Paul.

Is that -- ?

Yes, but importantly, GTF was exactly what Bob had laid out, and what we had talked about in March.

Okay.

Akhil, so $80 million aftermarket, I would have thought the aftermarket profit would have been somewhat bigger, given the aftermarket revenue.

But maybe some of it -- ?

Keep in mind, George, that this includes the repair side of it as well.

It's not just all spares, right?

So it has the overhaul and repairs aspect, the wrench-turning side of it, which comes with much lower margins as you can imagine.

And then there is always some element of mix that comes in, with regard to whether it's more of the IE deliveries, which come with some kind of intangible amortization that relates to the Rolls Royce payments, right?

So combination of all that, is what drives that drop-through of $80 million.

Okay.

Thanks very much.

Thanks, George.

Our next question comes from the line of Steve Tusa with JPMorgan.

Your line is open.

Hi, Steve.

If your phone is on mute, please unmute.

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

Your line is open.

Thanks.

Good morning.

Good morning, Myles.

Hey, maybe Akhil, because you're the pessimist in the family.

The cash flow performance in the quarter and the conversion, even if you correct for the settlement charge, it did seem light.

And so, getting to that 90% to 100% every year, seems like a bit of a stretch.

But this year, you're even more looking like you're down the road to a stretch.

Is this a really 4Q weighted load, or do you start to see material improvement here in the nearer term?

Well, Myles, first quarter was a little light, but it's not -- again, not unexpected.

As I adjusted for this Pratt Canada, the Canadian royalty settlement, we were about 65%.

And if you go back and look at our history, there have been quarters where we've been 44%, and fact as low as 34%, because I did look at that just to satisfy myself, that we were still on track.

And we've hit 100% of net income.

So this year, with the aero ramp, we obviously do not want to disappoint our customers, and we're making sure that we have inventories and buffer stock, and all the things that Bob Leduc talked about, ahead of when our needs are, to some extent.

We do expect still to be able to get to the 90% to 100% level, maybe towards the lower end of that range, but definitely towards the 90% to 100%.

I think, Myles, to keep in mind, working capital grew almost $370 million more this year in first quarter than it did last year, and most of that was at the engine company.

And that's again, the back end load of the production build on the GTF as we do the ramp.

So naturally you're going to see the liquidation of some of that inventory.

Bob is obviously more concerned, I think about making deliveries, today than he is about inventory.

He understands the need to liquidate that through the course of the year.

So better to be safe than sorry, I would say at this point.

Okay.

And then the dividend raise yesterday or the day before, obviously, in line with your implied EPS growth.

Do we expect that to kind of be the go-forward pattern as you accelerate your earnings into 2017 and 2018, similarly the dividend growth would return?

Yes, I think, as we said we've been -- maybe the thing to focus on here, Myles, is the payout ratio.

It's 41% with the last dividend raise.

So while it was a modest 3% increase, last year earnings did not go up.

In fact, they went down this year, modest growth in earnings, dividend rise in line with that.

But as earnings accelerate through the end of the decade as the top line grows as we expect, you can expect to see that payout ratio remain in that kind of 35% to 40% range, maybe closer to the 40%.

But clearly, we've got confidence in the future.

And we didn't -- as we debated how much to take the dividend up, I think this was the prudent course at 3%, with a 41% payout ratio, and we continue to look at it every year.

Okay.

Thanks.

Our last question comes from the line of David Strauss with UBS.

Your line is open.

Good morning.

Thanks.

Hi, David.

Greg, on -- first question, back on GTF.

Recently in the press, I saw something saying the ramp is going to be 200, 400, 600 engines per year.

I want to make sure that we're still on track for kind of the 200, 400, 800, and that you're still thinking 2018 is the peak loss?

That's exactly right.

So this year, Pratt's committed to just over 200 engines.

Again, the majority of that's on the NEO.

Some of those are going to Bombardier on the CSeries, and that doubles next year.

Then it goes up another 200 the following year.

And to your point, we'll see maximum negative engine margin in 2018.

It's nice to say, we're coming down the cost curve, as we're delivering these engines, still a long way to go.

But I think Bob would tell you, Bob Leduc that is, got high confidence in hitting target cost here.

And seeing those negative engine margins then to start to flatten out, and then decrease somewhat as we conclude the decade.

Okay.

And I'm sure you don't want to talk about 2017 but -- ?

No.

(laughter).

Just a quick one there.

Well, you've previously commented that you would expect Otis EBIT to -- Otis and UTAS EBIT to grow in 2017.

And I guess, now that we're a little bit further in, how do you feel about that?

Look, do I think they should grow?

Yes.

We're not going to give guidance though, David, today on 2017.

There's a lot of moving pieces here.

The Otis part especially, because some of the continued investments we're going to make in R&D will give them some headwind next year.

It's hard to say where China and Europe are going to go.

But generally speaking, they're making the decisions today to take cost out, to invest, and we feel good about the prospects as we go through these next couple of years for both businesses.

All right.

Well, thank you everyone for listening.

Again, good first quarter.

Paul and team will be available all day for any follow-up questions.

We thank you for listening, and we'll see you all next month at EPG.

All right, take care.

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

This does conclude the program, and you may all disconnect.

Everyone, have a wonderful day.