雷神技術公司 (RTX) 2016 Q2 法說會逐字稿

Good morning and welcome to the United Technologies second-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 costs and significant other items of a 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 the opportunity to participate.

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

Please go ahead, Mr. Hayes.

Thank you, Karen.

Good morning, everyone.

So a really solid Q2 and a great start to the year.

With these results we are very, very comfortable with our long-term outlook and we continue to be on track to the 2020 growth targets that we laid out back in March of this year.

As I have told you previously, we are focused on execution and delivering on our commitments.

The old UTC of under promise and over deliver is our goal again.

As we are seeing the results of that focus reflected in our Q2 performance, Q2 adjusted EPS was $1.82, almost $15 billion of sales.

Through the first half, adjusted earnings per share are up 6% on 2% organic sales growth.

We are also of course raising the bottom end of our guidance by $0.15.

We now expect adjusted EPS of $6.45 to $6.60 and we are also increasing the bottom end of our sales expectations.

We now see 2016 sales of $57 billion to $58 billion.

That is up from our previous expectations of $56 billion to $58 billion and we continue to expect organic growth of 1% to 3% in what remains a low growth and volatile macro environment.

I will turn it over to Akhil and Paul in a moment to walk you through the details but four key takeaways from today.

First of all, execution remains our top priority.

The Geared Turbo fan is performing exceptionally well and service 99.8% dispatch reliability with over 5000 revenue hours and four operators.

We are meeting our commitments on fuel burn, noise and emissions.

Second, we continue to invest and innovate for growth.

CCS has introduced several new innovative residential products and we recently announced Otis partnerships with Microsoft and AT&T to collaborate on digital solutions that will enhance connectivity and the customer experience.

Third, we are also of course seeing the benefits of our cost reduction efforts and we remain focused on cost reduction -- structural cost reduction.

CCS expanded margins by an exceptional 130 basis points in the quarter and corporate expenses were nearly 20% lower versus last year.

Number four, finally we continued to stay disciplined with our capital and evaluate the best ways to utilize our cash to maximize shareowner value.

We will complete the $6 billion accelerated share repurchase plan in the third quarter and we are on track to return $22 billion in cash to shareowners from 2015 through 2017.

And we recently announced two strategically important acquisitions that are right in the core of our business.

Otis will acquire Schindler's service business in Japan and CCS acquired a 70% stake in Riello, which is a heating and cooling business in Europe.

This will enhance our offerings to our European customers.

Just exactly as we said, in the core and disciplined.

These are just a few of the many examples of why we are executing on our key priorities.

Let me turn it over to Akhil and Paul to take you through the results and I will be back in a moment with some closing comments.

Akhil?

Thank you, Greg.

Taking a look at slide two, organic sales went up 1% in the quarter.

Most recent data on the US economy continues to be encouraging.

Consumer spending remains strong and job creation, wage growth and unemployment trends point to a steady growth environment although more likely in the 2% GDP growth range as opposed to the 3% plus we would all like to see.

During the second quarter, our commercial businesses saw 3% growth in the Americas driven by Otis which was up 10%.

Sales at CCS were flat as lower commercial HVAC exports and field and securities sales were offset by 3% growth in US residential HVAC.

Looking at Europe and the Middle East, sales were flat at both Otis and CCS reflecting little change in the trends or the macro conditions.

While Brexit has caused some uncertainty in the region, we don't expect a near-term impact in our businesses.

In China while the number of property transactions and home prices particularly in the Tier 1 cities showed growth year to date, the elevator new equipment market is down and price pressure has increased.

For Asia as a whole, sales were down 3% principally driven by China where consistent with our expectations we saw sales at Otis decline 7% while CCS sales in China were down 2%.

Commercial Aerospace sales growth of 7% was primarily driven by another strong aftermarket quarter at Pratt and mid-single digit growth in both Commercial OE and aftermarket at Aerospace Systems.

On the military side, sales were down 8% driven by original equipment declines at Pratt primarily due to headwinds from the F-117 program where as you know engine production finished in Q1 this year and declines in the Aerospace Systems aftermarket as the C5 Nacelle retrofit program is now complete.

Taking a closer look at our end markets on slide three, just a reminder, we will talk to Otis and CCS orders on constant currency basis as we usually do.

So at Otis, new equipment orders were down 4% driven by China where orders were down 14% on a dollar basis.

They were up 4% on a unit basis however.

Excluding China, new equipment orders at Otis were up 3% with low single-digit growth in the Americas and EMEA in both cases off tough compares.

Total equipment orders at CCS were down 4% driven by transport refrigeration which was down almost 30%.

Recall that in Q2 of 2015, carrier transicold was up almost 30%.

Excluding transport refrigeration, orders were flat in the quarter low to mid single-digit growth in fire and security and commercial refrigeration orders was offset by a high single-digit decline in commercial HVAC entirely due to Europe and the Middle East.

Commercial HVAC equipment orders in the Americas were up low single-digit with mid single-digit growth in Asia.

While US residential HVAC sales and that is what we include in the total equipment orders metric were up 3%, orders were actually up 11% in the quarter.

Moving to Aerospace, at UTC Aerospace Systems after a slow start in Q1, commercial aftermarket sales were up 5% and Pratt & Whitney saw another quarter of very strong commercial aftermarket sales up 20% driven primarily by the V2500.

Moving to slide four, total reported sales of $14.9 billion were up 1% versus the prior year as 1 point of organic growth and 1% from acquisitions were offset by a point of headwind from foreign exchange.

Adjusted EPS of $1.82 was up 9%.

On a GAAP basis, EPS was $1.71 which included $0.11 of restructuring and other one-time significant items.

As Greg said, we continue to focus on cost control and you will see that our restructuring spend year to date is about $180 million.

Based on the first half spend, we now expect our full-year restructuring to be approximately $400 million, down from the $500 million previously discussed.

However, we will still realize the expected savings as we have been able to successfully divest a couple of businesses which were on the restructuring list and we have been disciplined about not fully replacing voluntary accretion.

Free cash flow was 100% of net income in the quarter driven by strong working capital performance in our commercial businesses partially offset by the continued aero ramp related investments at Pratt & Whitney.

As Greg said, we have increased the full-year outlook and now expect sales of $57 billion to $58 billion and adjusted EPS range of $6.45 to $6.60.

With a solid first half, we are confident in raising the low-end of the EPS range by $0.15 and we still have about $75 million of contingency at the higher midpoint of $6.53.

We continue to expect organic sales growth of 1% to 3% and full-year free cash flow to net income in the range of 90% to 100%.

There are some puts and takes within the business unit guidance that Paul will go through but as we look to the remainder of the year, we expect the businesses to generate slightly higher earnings in the second half as compared to the first half.

We will also benefit from slightly lower share count in the second half.

However, this will be entirely offset by higher interest expense in the second half compared to the first half as well as some higher second half expenses below the segments.

As a result, second half earnings per share are likely to be around the same levels as the first half earnings per share.

Bottom line is that we feel very good about our improved outlook for the year.

Looking beyond 2016, we continue to see macroeconomic uncertainty and pressures.

Two watch items that have recently come on the radar screen after Brexit.

One, general strengthening of the US dollar and second, lower yields on both long and short bonds.

As you know, lower discount rates could have a significant impact on our pension expense for 2017 and beyond.

While it is still too early, as a reminder, every 10 basis points change in the discount rate is around a $30 million profit impact.

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

Thanks, Akhil.

I am on page 5. And please note I will be speaking to the segments at constant currency and adjusted to exclude restructuring charges and other significant items as we usually do.

Also note we have included an appendix on page 11 with additional segment data that you can use as a reference.

Hopefully that is helpful.

In the quarter, Otis sales were $3.1 billion.

That was up 2% at constant currency.

Otis profit at nearly $600 million was down 4%.

Continued pricing pressure in China and EMEA coupled with additional E&D investments more than offset contribution from higher volume.

Foreign exchange translation was a 2 point headwind to sales and a 1 point headwind to earnings.

New equipment sales increased 2% led by 24% growth in North America.

The North America new equipment business continues to benefit from the strong orders intake we have seen over the last few years particularly in office space and in hospitality.

China new equipment sales were in line with expectations, down 9% in the quarter.

Otis service sales were up 3% driven by high single digit growth in modernization and repair while maintenance sales were up slightly in the quarter.

Better than expected foreign exchange translation -- based on better than expected foreign exchange translation, we now expect full-year operating profit at Otis to be down between $150 million and $200 million.

That is a $50 million improvement from the guidance that we laid out in December on low single-digit organic sales growth.

On the next page, Climate, Controls & Security sales were up 1% at constant currency with 2 points of growth from acquisitions, the majority of which came from the acquisition of Riello.

That growth from acquisitions was partially offset by a 1% organic sales decline.

Profits were up 8% at constant currency.

FX translation was a 1 point headwind for both sales and profits.

As with Otis, you can find global segment data in the appendix.

But to call out a few highlights during the quarter we saw 3% organic sales growth in North America residential HVAC.

As you heard us discuss midway through the second quarter, we had a slow start to the cooling season but sales picked up significantly in June.

In fact for residential, it was the best June we have seen in about seven years.

On the other hand following the weak orders we saw in Q1, Transicold sales were down 6% in the quarter.

Weak freight rates in the global shipping lines continue to put pressure on the container business which was down 39%.

Despite a softer topline, CCS continued to deliver profit growth.

Earnings were up 8% driven by benefits from lower commodity costs, restructuring savings and other productivity initiatives.

Although operating margins grew to a record 20.4%, we continue to invest in product development holding E&D to prior-year levels.

For the year, although first half organic growth was weaker than expected with easier back half compares, continued productivity momentum and favorable foreign exchange translation, we continue to expect operating profit growth of $100 million to $150 million at actual FX on low single-digit organic sales at Climate, Controls & security.

Turning to Aerospace on slide seven, Pratt & Whitney sales of $3.8 billion were up 4% organically.

This was driven by another strong commercial aftermarket order up 20% including 3 points of benefit from a sale of legacy hardware.

Strong V2500 activity drove the growth in the form of both pre-buy from a service bulletin and also from where we are in the cycle for this engine.

The average age of the V2500 fleet is now about nine years old and that is a sweet spot for overhaul activity and we continue to see RPM growth.

In the large commercial engine business, Geared Turbo fan shipments in the quarter were higher than in Q1 but less than we expected back in March.

Although it is safe to say that our customers would love to take additional engines this year, we continue to expect to deliver about 200 GTF engines in 2016.

For Pratt Canada, engine shipments were down versus the prior year as we continue to see weaker demand in the general aviation and helicopter markets.

Pratt operating profit was $452 million, down 8%.

Drop through from the strong aftermarket volume and benefits from pension and FX were more than offset by headwinds from higher negative engine margin, adverse military mix and higher E&D.

We also made some additional investments to support the industrial ramp.

The absence of last year's gain from a product line sale in contract closeouts were a headwind but were offset by favorable contract settlements and the legacy hardware sale I mentioned earlier.

For the full year, we now expect the commercial aftermarket to be up mid single-digit.

Drop through from that higher aftermarket volume will be more than offset however by headwinds from lower than expected military sales, fewer Pratt Canada engine shipments, higher E&D and the additional ramp related investments.

Add it all up and we now expect operating profit for the year to be down $50 million to $100 million at Pratt & Whitney.

At Aerospace Systems, operating profit increased 2% on 2% organic sales growth in the quarter.

Sales growth was led by commercial OE, up 5% with growth on next-generation platforms partially offset by declines in legacy.

Commercial aftermarket volumes accelerated as anticipated also up 5% and included growth in parts, provisioning and repair.

Consistent with our full-year outlook, the growth we saw in commercial OE and aftermarket was partially offset by a mid single-digit decline in military.

Military OE sales declines were driven by continued lower legacy fighter trainer and transport programs while the military aftermarket decline was driven largely by the expected completion of the C5 Nacelle retrofit program.

Operating profit growth was driven by strong conversion on higher commercial aftermarket sales, pension, tailwind and continued cost reduction progress.

As expected, headwinds included adverse military OE mix primarily from declines in legacy program rates and lower military volume.

With first half results largely in line with our expectations, an improving organic growth profile and solid execution on cost reduction initiatives, we continue to expect full-year operating profit to be flat to down $50 million on low single digit sales growth at UTC Aerospace Systems.

With that, I will turn it back to Greg.

Okay.

Thanks, Paul.

So encouraging start to the year with 2% organic growth and slightly better than expected earnings.

Based on this first half, we feel very good about the year.

We obviously raised the low-end of the guidance by $0.15, we took up the low-end of the revenue guidance so again very comfortable about the year.

But as Akhil noted, let's not get ahead of ourselves.

There is still a lot of uncertainty and volatility in the global macro environment and this is a long journey and we have laid out a plan through 2020 and we feel very confident about that plan.

For the meantime though we are going to remain focused on our key priorities.

That is cost reduction, always doing more with less; investing in innovation for growth; being disciplined in our capital allocation, and most importantly, we are going to focus on executing on the record Aero backlog.

As I said many times before, I've never been more confident in UTC's long-term outlook.

With the Aero backlog and the investments we have made in all of our businesses, we continue to be set up for above GDP growth well into the future.

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

Karen?

(Operator Instructions).

Ron Epstein, Bank of America Merrill Lynch.

Good morning, guys.

A quick question on Pratt.

You had good aftermarket growth but the organic growth was well below that aftermarket growth.

So what shrunk in the quarter to offset what happened in the aftermarket?

Sure.

If you notice, Ron, the commercial OE shipments were lower than last year.

Also on the military OE side, we had fewer engine shipments and then Pratt Canada OE shipments were lower as well.

So I think it is more about the OE story where commercial and military OE was down.

Okay, super.

Thanks.

Julian Mitchell, Credit Suisse.

My question would be on Otis.

So Otis China, you seemed to see the price mix delta get quite a bit worse in Q2 than Q1 similar to the market leader there.

I think price mix must have been down high teens against down 9 in Q1.

So I guess the price mix headwind for the year in EBIT is probably bigger than what you guided back in December and March.

What are the offsets in the organic earnings guide in Otis, is it cost-cutting or Europe aftermarket?

Julian, first of all even though the delta between the value at 14% down versus units up 4% feels large, 18 points, only half of that is pricing.

The rest had to do with more the mix if you will.

We had last year significant major projects at higher value per unit and this year that has not been the case.

So it is about 9% price out of that delta which is a couple of points worse than what we saw in the first quarter, not the dramatic number that you would conclude without having this context.

So overall we think pricing for China this year is just slightly worse for the P&L impact for this year.

Yes, the margin in backlog is a little worse than what we were expecting but offset to that as always in China is to get greater cost reduction from suppliers.

Price pressure in China is not new.

Otis is very used to dealing with that, they also can get significant cost reductions from suppliers and that is what they will do.

Great.

Thank you.

Sam Pearlstein, Wells Fargo.

Good morning.

I was wondering if you could talk a little bit about the Aerospace OEMs?

And we saw a supplier yesterday talk about slow payments, I know they have been pushing change in terms.

And just if you can talk a little bit about that, just I noticed the receivables were up about $600 million sequentially, not sure if that plays into it at all but just what is happening from the OEM customers?

I would say the pressure on cost continues unabated at the OEM levels.

We have [scope] program currently at Airbus, we have talked to Boeing about Partnering for Success 2.0.

There is obviously a lot of pressure in a very competitive environment to reduce costs and we obviously are working with the customers to find ways to take cost out of the product but it has got to be win win for us.

As far as the payment terms, I know there has been some talk out there.

We have not seen any extension of payment terms beyond that which we have in the contract and we have general terms agreements with both Boeing and Airbus and they pay to those terms.

So we have not really seen any big deterioration in receivables as it relates any or either of the operators.

Just to clarify, Sam, the increase in receivables that you referred to, some of it has to do with the acquisition that we had and also we had a very strong June as Paul referred to in the script.

So when you have late sales in the quarter you tend to have more receivables because you just haven't had enough time to collect it as part of our normal terms.

Strong residential HVAC sales in June.

Thank you.

Jeffrey Sprague, Vertical Research.

Thank you.

Good morning, everyone.

I was hoping to ask a multifaceted question on cash.

Thank you for the pension color on the P&L but just thinking about cash this year and into next year, can you give us an update on what if any cash call the pension could have next year?

And then Akhil, it was interesting, the restructuring is coming down a bit, is there some cash use relief there?

Finally, cash working capital actually looked okay in the quarter relative to what I was expecting.

How does that play out over the rest of the year and maybe the ability to whittle away some of the safety stocks in the next year?

Great question, Jeff.

Good to see the focus on cash.

But clearly I think on the pension side, we have no mandatory requirements to fund.

Of course depending on where the discount rate ends up on December 31, the pension deficit could be a little worse than what we reported at the end of December last year but definitely there is no mandatory requirement for us to fund a domestic pension plan.

We will evaluate it as part of our normal cash utilization capital deployment plan and see if we need to do anything on a voluntary basis but no call on it.

The second question was about restructuring.

It is not a meaningful change, Jeff.

The $100 million reduction that I talked about for the year essentially we are keeping the savings intact, could benefit able bit on the cash side but again that is small and doesn't pay out in one year, it generally pays out over a couple of years.

Finally on the working capital, as you know, I think as Greg has mentioned many times we are not satisfied with where our working capital is but we also understand the need to make up for some of the weaknesses we still have on our supply chain side through buffer stock and that is not necessarily going to come down that quickly.

It is probably a multiyear effort as we get our suppliers to performing in goal levels which are very high standards by the way.

We want people to have 95% or more on time delivery and less than 500 ppm on quality.

All that says that in order to meet our customer commitments, we need to have a little bit of buffer stock for a year or two more.

Just a quick one.

Is there anything nonoperational in the Otis margin?

Thank you.

No, not this quarter.

Howard Rubel, Jeffries.

Thank you very much.

I'm going to try to stick to one question and just to talk about this investment in Pratt, Greg, how do you see that paying out or over time or the returns occurring in time?

Howard, as you know.

It is an expensive game in the commercial engines business and as I have said before, we are going to invest or we have invested about $10 billion in CapEx and R&D over the last dozen years or so to bring the products to market.

The good news is at the end of the year we should have all of the aircraft engines certified.

We will get Irkut, we'll get MRJ, we will get Embraer.

So the big phase of investment is really we will slow down after this year.

We are not done but in terms of the major spending, we should start to see that turn down.

At the same time as you know we are going to see an uptick in negative engine margin and as I look out over the next 10 years or so, you are going to see a big number there, close to another $10 billion of negative engine margin out of all of these platforms.

And it is going to step up in the next couple of years to get to about $1 billion in 2018.

It will stay about that level as -- even though production rates will increase, costs will come down.

But that is a significant investment.

The good news of course is the aftermarket will come.

As we saw this quarter on the V, when the engines get out there in that six-, seven-, eight-year timeframe, the engines do need to be overhauled.

We will see the returns but this is not a short-term game.

These are 30-year programs.

The returns remain on track to what we had expected which is well in excess of our cost of capital.

But it is not for the faint of heart either as you know, Howard.

We are in it for the long-term.

We've got great engines.

The performance has been phenomenal out of the box.

Right now our focus is just on delivering engines and then servicing them for the next 25 or 30 years.

Thanks, Greg.

Steve Tusa, JPMorgan.

Good morning.

Paul, thanks for all the detail on slide 11, very value-added.

On CC&S, what is the now commodity spread for the year and what was it in the quarter?

$50 million good news in the quarter.

This was probably the best quarter from a commodities point of view.

For the full-year, we expect about $125 million.

And is that a change from what you guys had before?

Just slightly higher, not meaningful.

Aluminum has been slightly better than we expected and that is showing up but maybe $20 million to $25 million, not too much.

Yes, to give you a little more breakdown on that, Steve, when we talked about our guidance for CCS for the year, we had commodities and price together so there is a price offset there in the second half so it won't see quite as much tailwind as the $125 million.

Okay.

And then just on the transport -- and sorry -- that is price cost, that is not just commodities, right?

Correct.

And then just on the transport business, you mentioned the container business was down substantially.

What was kind of core US truck trailer down and can you just remind us of -- I know that is a profitable business, just the margin profile and the mix within there because your margin is really good despite transport being down.

So obviously it wasn't a mix drag that you weren't able to overcome.

So if you look back a few years ago, the Transicold business, there was some disparity in margins amongst the different segments.

Container was quite high and North America truck trailer was quite low and that has changed over the years.

If you look at the average margin, it is sort of at the CCS broader average today and there is no major difference between the different segments.

A little bit of color just on the quarter, North America truck trailer was essentially flat but orders were down similar to what we saw in the first quarter.

Looking ahead to the second half of the year at least for the North America truck trailer piece, we are largely booked for the third quarter as we should be at this point so I would say we are okay.

Okay, great.

Thanks a lot, guys.

Jason Gursky, Citi.

Good morning.

I just wanted to go back to the military business for a moment, Pratt and you guys.

Akhil, you did a nice job at explaining some of the puts and takes there but I was wondering if you could perhaps let us know when you feel like you are going to have kind of clean comp on a year-over-year basis given the C-17 and the C-5?

And then you said the first quarter 2017 I guess is the question.

And then on Pratt, you suggested that it was worse than expected this quarter in the military.

Can you just dive a little bit deeper on why it was worse than expected?

Thanks.

So the first question in terms of when do we expect a turn in the military side.

I think on Pratt probably 2016 is most likely a low point because of the mix shift that we have talked about and the reduction in the F-117 engines.

First-quarter next year you will see improvement there on the F-117 compares.

For UTAS, the C-5 that we have talked about, we saw some benefit of that in the first quarter this year as well so that too compares would become easier starting second quarter of 2017 onwards.

For this quarter, it is slightly weaker than Pratt expectations, actually a lot of it was in line with what we expected.

I didn't necessarily say it was usually weaker than expected, it was the slight shortfall was on the OE shipment side which was down year-over-year partly due to what our production schedule was and partly due to some parts availability but overall it is okay.

Nigel Coe, Morgan Stanley.

Thanks, good morning.

I echo the comments on slide 11, very helpful.

Unfortunately it has taken half my questions but I'm sure that was the reason, Paul.

It sounds like the news flow on the neo engine was positive from Farnborough.

Can you maybe just comment on that Greg, and just give us an update on the quarterly phasing for the engine shipments in the back half of this year.

And on top of that, does that place additional pressure on Pratt margins versus 2Q?

I think as you saw coming out of the airshow, we had a very productive airshow from an order standpoint, a couple of big orders.

Right now we stand at about 8200 firm and option orders for the GTF and I think the operators as I said all seem to love the engine.

The dispatch reliability is good so things look very positive from that standpoint.

As far as production, I think it was Paul mentioned, we are going to build about 140 engines in the back half of the year.

That will probably be spread pretty evenly over both of the next two quarters.

That is up from 36 engines I think -- we built 60 engines, 36 got delivered in the first half.

So production ramp is continuing as we expect, a little pressure on negative margin in the back half of the year as we ramp up.

But the good news is we are coming down the cost curve exactly as we had expected.

We look at it every month.

We look at it by engine.

We are right on that 87% learning curve that Bob Leduc laid out earlier this year so we feel good about the cost of the engines.

We feel good about the ramp, always a challenge but we are working through it.

Great.

Thanks.

Carter Copeland, Barclays.

Greg, I wondered if you could expand on that a little bit.

It looked like on the commercial OEM revenues you were sort of off tens of millions but the op profit delta year-over-year was probably more like 150 or 200 with Pratt being the vast majority of that.

I wondered if you could speak to are you seeing higher losses per engine or is there a nonrecurring cost element in it?

That just seemed like a pretty large number there on a year-over-year basis.

So I think the best way to answer that, Carter, would be to give you the EBIT roadmap if you will for Q2 for Pratt.

So the negative engine margin first of all is exactly in line with what we expected.

It is not higher, there are some additional ramp up costs that Paul referred to but overall we've got about $120 million good news year-over-year on commercial aftermarket plus we had another $55 million or so of good news between pension and FX.

Those were offset.

So $175 million of good news offset by $70 million of negative engine margin, $50 million on the military mix issue that we have talked about before F-117 principally and others, another $35 million net of pension increase in E&D and then the rest about $50 million plus dollars on Pratt Canada OE shipment reduction and the ramp up costs that we talked about.

So that is essentially the makeup of the earnings as to why Pratt earnings were down in spite of good strong commercial aftermarket.

I think it is important, Carter, to point out Pratt is doing what they need to do in terms of investing in the ramp.

We have added about 400 people to the supply chain this year to make sure that the suppliers have adequate plans in place to deliver on their commitments for the ramp.

Some of that investment that we are making will continue on into next year.

It is a little bit more than what we had originally expected but it is what we need to do to make sure we get these engines out on time so a little bit higher investment but tracking exactly where we expected on cost.

Perfectly clear.

Thanks for the detail, guys.

Cai von Rumohr, Cowen and Company.

Thanks so much.

So it sounds like what you are saying is you expect now to deliver 175 engines versus 200.

How are you doing on the supply chain because I know that has been an issue and where are you with all the little technical issues, the start time, the error messages on the engines and when do you expect to have those behind you?

Let's be clear on the production, we are going to deliver 200 engines this year.

We built 60 in the first half of the year, we are going to build about 140 in the back half of the year which is exactly what we talked about or Bob Leduc talked about back in March.

So timing of revenue recognition might be a little different.

Like I said, we actually in revenue we recognized about 36 in the first half.

Again there is engines that are sitting there on the docks, sitting in transit so feel good about the build plan.

We are not going to come off of the 200.

As far as the supply chain goes, there are always challenges but if you think about this with 8000 parts and about 800 different subassemblies in this engine, there is a handful of parts that are causing some pain in the supply chain right now and Bob and the team are all over this and we will get through this.

On the technical stuff, I would tell you it is in the rearview mirror.

The start time with the software drops have been pretty well addressed, the nuisance faults are behind us.

As I said, 99.8% dispatch reliability with the four operators, over 5000 hours of revenue service since its introduction back in January.

So the engine is performing exactly as we had expected and no surprises on cost, no surprises on delivery.

How come you missed by -- I guess you deliver 36 but you built 60.

How come given Airbus claims they want to have the engines, how come you were not able to ship more?

They don't all go to Airbus.

Keep in mind some go to Embraer, some go to Bombardier, some go to MRJ.

There is also a large number of spares that we built in the first half of the year to support the in-service fleet.

So it is not just production there.

Obviously Airbus would like engines sooner but we are exactly on the production plan we committed to them earlier this year.

Thank you.

Noah Poponak, Goldman Sachs.

Good morning, everyone.

Greg, you mentioned a few times through the call your confidence in your two 2020 revenue growth targets.

And when I look at the slide from the investor day, there is some pretty strong rates in there, it is a low of 4 and a high of 10 depending on the segment and all kind of blends to 5 to 6. And I guess the numbers you reported today are pretty good but we are still walking along these low single-digit organic revenue growth levels.

Not a ton of reason I don't think to expect 2017 to materially accelerate from 2016.

Correct me if that is wrong.

So you would kind of need 2018, 2019, 2020 to be growing high single digits organically.

Is that realistic and what makes that happen outside of the macro getting better?

I think you need to break that down as you mentioned.

With the four segments, I would tell you, I've got the highest confidence in Pratt and in UTAS just based on the backlog and the skyline that is coming out of Boeing and Airbus.

We know the aircraft are going to be built.

We've got those in backlog so Pratt should see close to 10% organic growth.

Keep in mind 200 GTF this year, the 400 and 800, they are ramping up to almost 1500 engines so you will see growth accelerate on the GTF in all those platforms.

And while the V goes away, it gets more than replaced with volumes, with the Neo plus you've got volumes at Embraer, C-Series, MRJ.

All of those things give us very high confidence on the organic outlook at Pratt.

And similarly at UTAS, the Aerospace Systems group, they've got line of sight probably to 5% to 7% growth over this time period.

The commercial businesses could be more challenging.

I think that is the one soft spot we saw in CCS this quarter, down 1% organically.

Otis only up 2% but we are making the right investments, we are spending money on E&D on new products.

We are spending money at digital on the commercial side to enhance growth.

So I still see a clear pathway now.

Again, we assume the world is going to grow at 3%, not 2% and if the world grows at 3% and we can get a little share with these new products, we can be in that 4% to 5% range as we move towards 2017, 2018.

But clearly, it is more of a challenge on the commercial side.

At the same time keep in mind urbanization trends continue.

The growth of the middle class continues.

All of those things favor the commercial products, people need air-conditioners and people need elevators.

So we are confident in the product mix and in the growth outlook.

Noah, one additional data point on the UTAS business, I think we have talked about this, the content per aircraft is significantly higher on the new platform than the platforms that are being replaced as we talked about going from 2 million per ship set to 4 million per ship set.

So even if the production rate of the aircraft does not increase too much, just the change in the introduction of the new platforms is going to increase the UTAS sales in any case.

So I think Aerospace as I said, very high level of confidence.

We don't have to go out and complete those every day again for the 2020 skyline.

It is more the commercial businesses.

That is helpful.

And Akhil, what is now in the 2016 guidance for Eurodollar?

It is $1.10.

So no change.

I'm sorry, you were at $1 before, correct?

Right and that is part of the reason why we increased the bottom end and also the Otis guidance if you will because the euro has been around $1.12 or so for the first six months and we are expecting $1.10 for the next six months.

Understood, thank you.

(Operator Instructions).

Myles Walton, Deutsche Bank.

Myles Walton

Thanks, good morning.

I think you said that aftermarket is now mid single-digit growth at Pratt and the plan which probably gives you north of $150 million of additional EBIT but the segment came down 50.

So $200 million of higher EBIT in their being absorbed I guess by E&D and ramp costs.

Is that how you would characterize it?

So let's do the full-year math on (multiple speakers).

So commercial aftermarket would give probably $125 million of good news versus what we expected.

That will be offset by $50 million more in E&D, $50 million lower from military business and the remaining $75 million from the fewer Pratt Canada engine shipments plus the additional ramp costs that we talked about.

So three high-level things offsetting the good news from commercial aftermarket.

Got it, that is perfect.

And if you think about, Greg, you said this is a follow-up so this is the same question, you said the certifications of the engines were all done this year.

E&D, how quickly does that drop over the next couple of years?

Thanks.

I think the roadmap has us going down about $250 million over the next three years as we look at the R&D and again just because the engine is certified doesn't mean all the flight testing is done so there are still is significant cost out there.

And we are not going to stop investing in the technology either.

We are not going to go to zero but clearly you can expect to see it probably in that 4% to 5% range as a percentage of sales going forward.

Thanks.

David Strauss, UBS.

Thanks, good morning.

Greg, wanted to touch on Otis new equipment in North America.

The orders were up this quarter but I think the smallest kind of increase we have seen in quite a while.

Can you just frame the North American new equipment market and do you think we have peaked out there in terms of order rates?

Thanks.

Just to be clear, the US order rate was actually up I think about 6% in the quarter.

Canada was down big.

There were some big projects that didn't repeat year-over-year but we still see growth in the backlog at Otis this quarter in North America.

So has it peaked?

I don't know that it has peaked.

It is clearly back to where it was in 2007 which is good news and we won't certainly see double digit growth, we are not expecting double-digit growth over the next year or two.

In the back half, David, you are right.

There were some very strong orders in Otis North America last year like the Hudson Yards.

So in the back half we saw almost 50% growth in North American orders last year and that clearly is going to be tough compares to jump off of.

So don't be surprised if the orders in North America are down year-over-year in the back half.

Again, very robust economy.

Things still look pretty good.

The good news is that the orders from what we have seen over the last several quarters are converting into sales now so the new equipment sales are very strong in North America and we expect that to continue for a period of time.

Thanks for the color.

Doug Harned, Bernstein.

Thank you.

Good morning.

On Otis and CC&S, after a few years of cost focus, you have talked about the need to spend more on product development in each of those business areas.

Could you give us a sense of where that spending is going to occur and is this something we should see over the next couple of years and then see a margin benefit subsequently?

Could you give us a sense of what that trajectory would be for the two businesses?

Right, so we talked about Otis spending only about 1% of sales on E&D and a very small part of that was on actual new product, most of the E&D historically has been on cost reduction.

We can see that doubling over the next couple of years.

We saw E&D up this quarter at Otis.

We will continue to see it grow over the next couple of years.

They are investing in a couple of different things.

First of all, we are refreshing the aesthetics in the cab, very important.

We are doing that across the globe and that is done in each individual market.

We are also investing in high-rise new belt technology and looking at ways to again enhance the offering on the service side.

So investments in new equipment, investments in service technology, investments in service productivity tools.

On CCS, they have already doubled E&D over the last four years, five years.

It is right about 2% of sales and it should continue at that level.

The focus there is really on the large commercial chillers where we had not had a competitive offering for a number of years.

Reinvesting in that business we continue to see big opportunities in the big chiller side but it will take several years and some additional R&D expenditures to get the product line where we need it to be.

Are these levels that you expect to continue as sort of a natural level for investment in these businesses or would there be a margin benefit that we would expect in a couple of years down the road?

I think you've got to continue at this kind of 2% level of sales.

Think about a $30 billion commercial business, 2% of sales is about $600 million a year.

It is not an unreasonable amount of money.

These are long-term businesses and you have to continue to invest.

So if I'm looking for margin opportunities on the commercial businesses, it is going to come from improving productivity on the service side at Otis and it is going to come from cost reduction on the CCS side.

Okay, great.

Thank you.

George Shapiro, Shapiro Research.

Good morning.

R&D was up $30 million year-over-year, Greg, and you talked about it being up at Pratt, Otis.

Can you break out how much it was up at each of these sectors?

Sure.

So the number I quoted on Pratt up $35 million was excluding pension because that we took out in the math on the good side.

So they numbers that you see in the $30 million include the benefit of pension so the Pratt number was a little north of $20 million, about $25 million increase.

Otis was another $10 million or $11 million increase and then offset by a slight decrease in UTAS and CCS or (inaudible) and corporate office was down slightly.

That is the net math of 30.

And then quickly, it looked like F-35 engine deliveries were less than the first quarter where I would have thought they would be ramping.

So can you just talk about what is going on there?

Some of it, George, was just simply the Q4 deliveries which got pushed into January.

It drove up the Q1 more than what we originally scheduled was.

So I think it was a little bit of catch up in Q1 that you saw.

Q2 is more in line with what we expected and I think you will see some ramp up happening in the second half but again, the profile was not very different.

It was just that Q1 was higher than originally we had expected because of the [fleet] -- the move from Q4 to Q1.

Okay, thanks.

That concludes our question-and-answer session for today.

I would like to turn the conference back over to Greg Hayes for any closing comments.

Thank you, Karen.

Thanks all for listening today.

As always, the investor relations team will be available for follow-up after the call and thanks very much and have a wonderful day.

Take care.

Thank you.

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

This does conclude the program and you may now disconnect.

Everyone have a good day.