雷神技術公司 (RTX) 2016 Q4 法說會逐字稿

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

On the call today are Greg Hayes, Chairman and Chief Executive Officer; Akhil Johri, Executive Vice President and Chief Financial Officer; and Carroll Lane, Vice President Investor Relations.

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

Please note, except where otherwise noted, the Company will speak to results for continuing operations excluding restructuring costs and other significant items of non-reccurring and/or non-operational nature, often referred to by management as other significant items.

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

UTC's SEC filings include its 10-Q and 10-K reports; provide details of important factors that could cause actual results to differ materially from those anticipated in those 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, Brian, and good morning, everyone.

So 2016, a solid year for UTC.

We delivered on the commitments that we set back in December of 2015 and today we reported adjusted EPS of $6.61, just a penny above the high end of the outlook range that we provided.

I think importantly, sales $57.2 billion and organic growth of 2% and free cash flow to net income was 93%, even with the continued investments in the aerospace ramp.

Both of these, of course, were within our expectations with the range for the year and, of course, we continue to be disciplined with our capital deployment in 2016.

We returned $4.3 billion to shareowners in the form of share repurchases and dividends on top of the $10 billion from 2015.

Looking forward to 2017, we remain confident in our full-year targets.

Adjusted EPS again in the $6.30 to $6.60 range and sales of $57.5 billion to $59 billion.

Again, with organic growth projected to be somewhere between 2% and 4%, of course that is on top of the 2% organic growth we reported in 2016.

During 2016 we saw a number of significant accomplishments across all of the business units.

Both Pratt & Whitney and our Aerospace Systems business had impressive years in the area of innovation and they achieved some noteworthy program milestones.

We feel good about the GTF accomplishments, that engine is now in service powering 46 A320neo and CSeries aircraft with more than 82,000 revenue hours.

We are also addressing some durability issues on the GTF.

We have some fixes identified and of course we are supporting our customers in the field.

With that though, we remain very excited about the value proposition of the engine since we are meeting or exceeding both the fuel and noise and the emission targets right out of the gate.

Pratt was also awarded the engine contract last year for the B-21 Raider.

With that win Pratt has added another program to the already impressive military portfolio including the Joint Strike Fighter and the refueling tanker.

Pratt's military business is truly set up for a very bright future.

In Aerospace Systems last year we supported 15 critical program milestones including first flights, entry into service and aircraft certification across a multitude of commercial, military and business jet platforms.

At Otis 2016 marked a year of market segment gains for new equipment orders globally and most impressively in China.

These gains were driven by higher engineering development investments, that was up almost 30% in the year.

It was also helped by better market segmentation and improved sales coverage.

But we're not just investing in new products, we are also investing in service transformation including new IT platforms and digital tools for our 31,000 service technicians.

All of this to increase our productivity and improve the customer experience.

As you know, driving cost out of the business is part of our DNA.

As an example, CCS expanded their margins by another 60 basis points in 2016.

And over the last four years since 2012 Climate, Controls & Security has achieved 400 basis points of margin expansion all while continuing to increase R&D and spending.

The investments of course drive new product introduction and last year CCS introduced over 100 new products into the market.

Aerospace Systems, another great story.

Last year they had about $300 million of adverse impact from declines in the high-margin legacy products and they were able to offset almost all of that through product cost reductions, lower E&D and lower SG&A, really solid performance by Mr. Gitlin and team.

So I am pleased with the progress we have made at each of the businesses.

And despite the continued macro uncertainties, we are confident in UTC's 2017 outlook.

Our continued focus on the key priorities around innovation, execution, cost reduction and disciplined capital allocation were a major factor in achieving 2016 results and they will continue to help us meet our 2020 goals of delivering on long-term sustainable growth at UTC.

With that let me hand it over to Akhil and Carroll to take you guys through the results.

Akhil.

Thanks, Greg.

So lots talk a little about Q4.

We reported good performance in line with expectations and what we had said in December.

Adjusted EPS of $1.56 was up 2% year-over-year.

On a GAAP basis the earnings were $1.26, so that had $0.30 of restructuring and other significant items, about $90 million from restructuring.

We talked about some pension liability reduction initiatives that we had taken in October -- that we had announced in October.

That came with a one-time non-cash charge of $423 million or about $0.32 per.

We also redeemed some high coupon debt, about $2.25 billion of that in November and that caused -- that gave rise to a $164 million or $0.13 charge also in the quarter.

Partially offsetting that, on the positive side we had additional tax settlements with the US IRS and that gave us a benefit collectively between that and some French tax law changes of about $0.23 below the line that also we have pulled out of our adjusted EPS.

Overall cash flow came in strong, 116% for fourth quarter, 93% of net income for the full year, slightly above expectations.

So pleased with that performance.

If you look at the organic growth on slide 3, no major changes in the trends that we were seeing throughout the year, just some minor puts and takes here.

Americas for the commercial businesses had continued with strong growth, Otis particularly up 4% in the quarter year over year.

That was on top of 10% growth that they had in Q4 of 2015 over 2014.

So again strong performance.

CCS was up 2% largely on commercial -- both residential and commercial HVAC showing decent growth.

Within EMEA actually the change -- the data decline that you see on the page, it is entirely a function of Middle East.

Middle East sales saw the pressure from the order reductions that we've see in prior quarter and were actually down 35% year-over-year for commercial HVAC and nearly 40% down year-over-year for the Otis new equipment business.

Excluding that Europe was actually up low-single-digit support Otis, largely on the strength of new equipment business and CCS was down low-single-digits.

Asia was flat, continued pressure from Otis China new equipment, which was down low-double-digit 12%.

And both the CCS and Otis were both up in rest of Asia nicely.

Now aerospace, the quarter is not really meaningful because you'll recall we had some volatility last year between third and fourth quarter as a result of the new logistics center that we had launched last year in Q3.

So what is more meaningful certainly from my perspective is looking at the second half in totality.

And if you do that we were up 4% to 5% for UTAS and Pratt combined in the second half, which is more in line with what we expect in 2017 and going forward through our 2020 target.

So in line with that so the fourth-quarter number is not that meaningful there.

The interesting thing -- and encouraging thing frankly for me was the orders.

We saw pockets of improvement in some of our commercial businesses.

Firstly for the first time this year on a quarterly basis, CCS equipment orders were up; they were up 2%.

In fact, if you include services they were up 6% year over year.

So an encouraging sign as you go into next year.

Otis China and new equipment orders were also flat on a dollar basis.

Now we all know one quarter doesn't make a trend.

But this is still encouraging.

And as I said in December, obviously Q1 2017 we will see probably the lowest organic growth at CCS in terms of their full-year outlook.

We also expect EPS for first quarter to be in the range of $1.35 to $1.40 largely driven by two facts.

I think if you look at our bridge for the full year that we shared with you in December, we expect $0.32 of good news from share buybacks, or lower share count.

First quarter will have a smaller portion of that, so it is only $0.04 to $0.05 good news in the first quarter.

Secondly, for the commercial businesses, both Otis and CCS, we expect to see better year-over-year profit performance in the second half than in the first.

And so that is impacting the first quarter to some extent.

But overall pretty good start and with that let me hand it over to Carroll to walk through the BU details.

Carroll.

Okay, thanks, Akhil.

I am slide 4 and I will be speaking to the segments at constant currency, as we usually do.

And as a reminder, there is an appendix on slide 14 with additional segment data that you can use as a reference.

So Otis, in the quarter sales were flat to the prior year at constant currency while profit was down 4%.

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

Profit in the quarter benefited from higher service volume, productivity and mark-to-market FX tailwind.

These benefits were more than offset by continued pricing pressure in China and EMEA as well as additional E&D investments.

New equipment sales were down 2% driven by low-double-digit decline in China and close to a 40% decline in the Middle East.

Offsetting these headwinds, we continue to see strong growth in North America with new equipment sales of 13% as well as solid growth in Europe; Europe was up 7%.

Otis service sales were up 3% with continued growth in modernization and repair; maintenance sales were up slightly.

New equipment orders were up 3% in the quarter.

We saw mid-teen growth in EMEA and low-double-digit growth in Asia excluding China.

This was partially offset by North America down about 20% off-tough compares.

You'll recall last year North America orders were up over 50% in the fourth quarter.

New equipment orders in China were flat on a dollar basis but up 5% in units and that is despite a market estimated to be down mid-single-digit.

For the full year, operating profit was down about 6% in constant currency on 1% higher organic sales.

Organic sales excluding China were up 4%.

FX translation for the year had a 2-point unfavorable impact on both sales and profit.

Turning to slide 5, Climate, Controls & Security sales were up 5% in constant currency in the quarter; that was all due to acquisitions.

Profits were up 5% driven by acquisitions and lower cost partially offset by around $15 million of impact from the devaluation of the Egyptian pound.

FX translation was a 2 point headwind to sales and earnings.

Organic sales at CCS were flat this quarter with strength in North America residential HVAC offset by declines in global fire and security and Middle East commercial HVAC.

Transport refrigeration was down 1% with container down slightly and that was a sequential improvement after being down almost 30% through the third quarter.

Commercial refrigeration was up 9%.

Total equipment orders at CCS were up 2% for the quarter and up for the first time this year, as Akhil noted.

Strong growth in commercial refrigeration, up nearly 20%, combined with high-single-digit growth in fire and security products more than offset continued pressure in North America truck trailer.

Global Commercial HVAC equipment orders declined 5% and that was primarily driven by the Middle East, which was down over 50%.

For the full year CCS grew operating profits by $130 million at actual FX with organic sales down 1%.

FX translation for the year had an unfavorable 1 point impact to sales and profit.

Operating profit growth was driven by continued productivity, restructuring gains and tailwinds from commodities.

Okay, shifting to aerospace on slide 6. Pratt & Whitney sales were flat organically in the quarter.

The military business saw low-single-digit growth driven by OEM development programs and aftermarket.

We also saw growth in commercial OEM driven by favorable mix and development revenues.

For the year we delivered a total of 138 GTF engines and now support 13 operators in service.

In the quarter we delivered 62 GTF engine supporting customer requirements and that was the highest output for a quarter to date on the GTF for Pratt.

Commercial aftermarket was down 6% in the quarter.

In the large engine business the transactional aftermarket was up 3% and up off tough prior year compares.

However, this strength was more than offset by unfavorable long-term contract adjustments for fleet management programs.

Pratt Canada aftermarket saw growth in the quarter up 6%.

Pratt operating profit was down $80 million driven by the unfavorable contract adjustments in the commercial aftermarket, additional ramp-related costs and unfavorable mix in military engines.

And that did include the absence of F-117.

This is partially offset by tailwind from pension, FX and lower negative engine margin.

For the full year organic sales were up 6% and operating profit was down $162 million.

Higher negative engine margin, E&D and ramp-related investments were partially offset by drop through from the double-digit sales growth in the commercial aftermarket, as well as tailwinds from pension and FX.

Turning to slide 7, Aerospace Systems operating profit was up 4% in the quarter on flat organic sales.

Commercial OEM sales were down 1%.

Continued growth on next-generation platforms was more than offset by a decline in legacy volumes.

Commercial aftermarket was up 3% with 4% growth in parts and repair combined and a slight decline in provisioning.

As we have seen throughout the year, military sales declined in the quarter, down 4%, and that included the continued headwind from the completion of the C5 Nacelle retrofit program that wrapped up earlier in the year.

Operating profit growth was driven by drop through on higher commercial aftermarket sales, continued cost reduction and pension tailwind, partially offset by unfavorable commercial OEM mix and lower military volumes.

In line with expectations full-year operating profit was essentially flat on 2% organic growth.

Strong performance in cost reduction offset new program mix in military volume headwinds.

And with that I will turn it back to Greg.

Okay, thanks, Carroll.

So overall 2016, no drama at the end of the day.

A lot of challenges throughout the year, but good execution by the entire team.

And as a result it will meet all the commitments that we laid out for the year.

So that is 2016.

Let's focus now on 2017 for just a second.

A lot of challenges ahead of us.

I think all of us recognize we have got a new administration in Washington, which has an agenda to be friendly to business.

And I think we are anxious to see how all of that will play out.

Certainly tax reform is the biggest single item that we are focused on this year.

On top of that, however, there is always the issue of FX.

You'll recall we've pegged the euro at 1.05 to the dollar; we are a little bit better than that today, I think it is at 1.07.

But FX remains a watch item for the year especially with the impacts of tax reform potentially impacting the exchange rates.

We are also of course closely watching the economic environments in both China and Europe, our second and third largest markets.

Also of course what happens with Brexit and also the elections in France and Germany will create some uncertainty as we move through the year.

Despite all of this, though, I am very confident.

We have a portfolio of industry leading businesses, we have got a global footprint, we've got global scale, we have got a strong balance sheet, as well as an experienced management team.

All of those things give me high confidence in our ability to deliver on the guidance that we laid out a month ago.

We of course remain committed to the key priorities.

We are going to continue to innovate for growth.

We are increasing R&D investments at both Otis and CCS.

And we are going to continue to drive cost out through restructuring and product cost reduction.

We will also remain disciplined in our capital allocation.

You'll recall last year we had a placeholder of $1 billion to $2 billion for M&A; we ended up only doing about $700 million.

So again, trying to be disciplined with your money.

This year we have got a placeholder of $3.5 billion for share buyback and $1 billion to $2 billion for M&A again.

High confidence that we will continue to buy back stock as we continue to see intrinsic value at UTC significantly in excess of the current share price.

In total we remain on track to return $22 billion to shareowners from 2015 to 2017.

The entire organization is focused on execution in meeting these commitments.

These include commitments to both our customers, our shareowners and our employees.

We have never been better positioned for growth.

We have got strong backlog in these great forward global franchises that all provide recurring revenues and resilient business models.

UTC is uniquely positioned to deliver shareowner value well into the future.

So with that let me stop and open it up for questions.

Brian.

(Operator Instructions).

Sam Pearlstein, Wells Fargo.

Can you talk a little bit more about the Pratt and Whitney aftermarket?

You mentioned a long-term contract impact, I'm trying to -- is that a one -- I guess can you size it?

Is it one time; is it something that is ongoing?

And is there any way to read into that how you were able to get price in terms of the fourth quarter because that's usually when we would see the pull forward in terms of -- that is probably more the parts side.

Yes, Sam, I think you are exactly right though.

The contract adjustments, we typically see these on a quarterly basis at Pratt.

We go through all of our -- I think we have got some 80 long-term contracts out there with the airlines.

And we look at each one of these every quarter.

Because of some issues that we have seen in the V2500 we went back and we had some negative adjustments on some long-term contracts specifically related to the V program.

Again, I would say it is not a one-off, it is just something that we look at every quarter.

You will recall, we get good news some quarters, we get bad news some quarters.

This year I think net probably $200 million of bad news on these contract adjustments.

But I wouldn't read anything into it.

The good news of course is we are selling more spare parts.

And you saw that -- I think spare parts were up 3% or so in the fourth quarter and that was off of a really difficult to compare from 2015 where I think we were up 19% or so.

So, I wouldn't read anything into it.

I think it is just kind of a one-off thing at Pratt.

Clearly something we had anticipated as we started looking at this.

And it is the reason Pratt is kind of at the low end of the guidance range for the year.

Keep in mind, Sam, that for the full year Pratt commercial aftermarket was 10% up, which is exactly what I think we had said sometime middle of the year.

So we have seen some good strength on the transactional side, as Greg said.

Some of it was driven by some of these issues that we have seen.

Unfortunately the reverse side of that shows up in our FMP contracts.

And so, the net-net is still a pretty good solid story.

Okay, thank you.

Carter Copeland, Barclays.

Greg, I wanted to ask about the GTF and just what you guys have been seeing in terms of in-service reliability.

Clearly you've been swapping out some engines; there have been some to come off wing.

I just wondered if you could speak to how that is trending and what you guys are seeing in terms of deliveries of spare engines.

And how that trended versus your original expectations.

And just sort of what the implications are for how that engine is performing given it has got such a high level of FMPs.

Yes, so, Carter, that is a good question.

As we looked as we exited the year we saw really two issues around the durability I would say of the engine.

We have got 82,000 hours now in service on the engine and we are starting to see some issues out there.

But it is really related to two specific things.

And one we have been talking about since probably the middle of last year which is the combustor liner.

It is not having -- in some harsh environments like India we are not getting the life out of that combustor liner that we had expected.

So there is a redesign that is being implemented, we'll get those out there in service later this year.

Second issue is an oil seal or a carbon seal where we have seen, again, some premature failures on that.

We are working with the supplier on that to correct that.

Again, we've got a fix in place that should be delivered by about May I think of this year.

So these are annoying things for the airlines, they obviously cause them some disruption.

We have got a lot of spares out there to try and keep the fleet running.

And in fact, we have been doing a pretty good job of supporting them, but it is still a pain for the airline.

So a little bit of noise in the system.

But I would characterize it as typical of a new program introduction.

And again, we exited the year on a good trajectory for production.

I think we built 62 engines in the fourth quarter.

This year we are going to build 350 to 400.

A big chunk of those, over 50 of those engines will be spares, again, to support the fleet going out there to make sure when we do have these issues that the customers are not impacted too much.

So just normal growing pains in any new engine.

But I would say nothing that is causing us to lose a lot of sleep.

And, Carter, just to put it in perspective, you know this industry better than I do, but certainly to put it in perspective, historically when we introduced engines, in addition to some teething pains we also struggled with fuel burn and some of the other commitments.

And the good news is that this time at least those key performance characteristics are being met right out of the box and that is unusual.

So that makes us feel good.

The gear architecture is holding up very well.

And so the fundamentals of the engine are still very sound and it delivers the fuel performance.

So some teething issues will get through, this is always part of what happens.

And the good news is we are catching these early and we will fix these as soon as we can.

I think to get to Akhil's point too, Carter, I would just say the gear system has performed flawlessly.

This oil seal issue that we talked about has nothing to do with the gear system.

So medium fuel burn, we are doing everything -- there's been no order cancellations.

It is really just normal new product introduction issues that everybody goes through.

And just as a clarification on that topic.

Do you build in cushion into the long-term service agreement to account for this sort of stuff?

Yes, absolutely.

When you take a look at all of these contracts, you build in a warranty cushion, if you will, in terms of what you are going to have to give away for the first couple of years.

So we don't see any big drama on the long-term FMPs as a result of this.

Again, we have got fixes identified, we will get them in the fleet this year.

These contracts last or run over 10-plus years, so they are still flying the hours, which is the good news there.

Great.

Thanks for the color.

Cai von Rumohr, Cowen and Company.

This is Lucy on for, Cai.

Can you talk about the moving parts of the Trump administration policies in terms of any tax cuts or the border adjustment and whatever manufacturing implications may be?

Sure, Lucy.

Well first of all, we have obviously been following the Trump administration closely in terms of what they are talking about on tax reform.

I mean it looks like we are going to be following the Chairman Brady blueprint out of Ways and Means, which would lower the top rate to somewhere around 20%, eliminate deductibility of interest but also provide for immediate expensing of capital.

Also provide for a territorial system, which is really good news for us because, as you know, we have got about $6 billion in cash sitting overseas that we can bring back to the US very cost effectively.

So we look at this as a huge opportunity to, again, drive growth in the business.

And growth here in the US by being able to bring the cash back.

There is still some question mark about border adjustability.

And we are a net exporter, so if that border were to remain in place probably a positive for us.

But again, there is a lot of moving pieces in tax reform and we will be actively involved with the debate.

Again, the good news is if it does happen this year it is going to be a net positive for the US economy.

Great.

And can you just say is it a net positive favorable or not?

I would like to say it is going to be a net positive.

But as you know, Lucy, the devil is always in the detail around taxes.

Our effective tax rate is about 28%.

If they drop the rate to 20% or even 15% obviously that would be helpful.

Lose the deductibility on interest, which we have got about $1 billion of interest expense a year so that would hurt.

Again it will all be what happens in the transition rules too and how do you transition into lower rate, how do you transition into border adjustability.

But net-net I think it is positive.

Even if our effective tax rate doesn't drop all the way down to 20%, just having access to our foreign cash through a territorial system is a very, very positive net for the US economy.

That is helpful, thank you.

Howard Rubel, Jefferies.

Greg, you have talked a lot about innovation and focus on new products; R&D is up a little bit in 2016.

Where are your initiatives for 2017?

And what will we see the spending on other than obviously improving GTF?

Yes, so, if you think about it, last year we spent about $2.3 billion; we saw probably the biggest increase percentage-wise at Otis.

And then I think it was just some deferred maintenance where we hadn't been spending enough on new product introduction.

So you will see Otis E&D go up a little bit again this year as we look both to introduce some new products as well as to help on the service side on some of the service tools.

As far as the Aerospace businesses go, Pratt ought to start coming down the E&D curve here relatively soon.

I think we have got one more big first -- well, we have got the MRJ certification, I think that happens in the first quarter; we have got Embraer out there.

Once those get behind us we should start to see E&D tail off.

And trying to deal with these reliability problems has caused a little bit of additional E&D, but that is not really significant.

And the same at Aerospace Systems, I think we ought to see that number start to tail off as you get some of these new program introductions behind us.

And then just as a follow up, on Otis you very much called out the change in trajectory with orders.

And it sounds like there is a lot of organizational items that went into this.

Could you elaborate a little bit on is it customer touch or -- or what is it in the organization that made for this change?

So a couple of things I would say, Howard.

One thing is when Philippe is [put in] a management team -- we still have the typical Otis structure, which is really based on branch offices and regions.

But we now have a president of the service business, we also have a president globally of the new equipment business.

And the idea here is to drive commonality and to drive best practices across all of the Otis organization.

And sometimes, as you know, in a decentralized organization like Otis things might not always be as easy to change as you would like.

And so, I think Philippe with this new organization is really encouraging the collaboration and trying to, again, push best practices throughout the entire organization.

For instance, when we look at our business in Japan we have got a cancellation rate of less than 2%; globally it is north of 5%.

So I think there are things we can learn in Japan.

Similarly what we are doing with new products coming out of France and coming out of Spain, I think we can do some things and use some of that knowledge to help us in our businesses here in North America and South America.

So a lot of things to do from the organizational standpoint but the key is focus.

The new equipment market, again, very competitive.

It is about driving cost.

On the service side it is about improving the customer experience.

We talk about these 31,000 service mechanics at Otis, those are the touch points for our customers.

Those are the people that represent Otis to the customer.

And giving those folks the right tools is imperative.

We started rolling out some of these digital tools in Hong Kong here in the fourth quarter.

We will roll out digital tools to about half of the service technicians this year, that will cover about 75% of our total service sales.

So a lot of things to do, a lot of best practices and it starts at the top with having the right organization.

But I think Philippe and team are on track.

Yes, on the new equipment site, Howard, I think some of the more encouraging things I have seen is really thorough segmentation of the market, looking specifically targeted sales force additions.

So seeing markets where maybe it is a Tier 3 city in China or a Bangalore in India where we are underrepresented vis-a-vis some of the other sales people from other companies and adding selectively sales force in those markets to provide better coverage.

So, it is really a very deep down analysis with targeted investments beyond just the new product stuff and other things that Greg talked about.

So really happy with the progress we have seen on the new equipment side there.

Thank you.

Julian Mitchell, Credit Suisse.

My question was on Otis.

Yes, you talk back in December about maybe a slightly narrowing or at least leveling out of the price mix headwind in 2017 for Otis.

I just wondered in China it does look as if the price and mix declines are kind of narrowing in your order book at least.

Maybe just give some color around that.

Julian, I would say it differently because it did narrow.

If you think about it, our sales were down -- were up in units; our orders were up in units 5% and dollars were flat.

So that gap was only 5 points this time compared to a larger gap that we have seen in the earlier quarters.

On the pricing side, we did see pricing pressure go down to 6% to 7% range from the 9% range that we had seen before.

And if you recall from our December conversation, that is what our plan is for next year.

Now obviously one quarter does not make a trend.

And the local team would still say it is very competitive out there in China, a lot depends on what happens with the policies on the real estate side and the housing market in China.

But certainly Q4 was a little more encouraging than what we have seen for of the first three quarters.

Thanks.

And just a quick follow-up.

Did you see the same in Europe?

How is the pricing in the EMEA sort of particularly aftermarket business right now?

Unfortunately not much of a change there.

For Europe service business has seen similar level of pricing pressure that we have seen historically.

The real thing there that will change that, as you know, is two things.

One is inflation, because most of our contracts have built in price increases related to customer price inflation, etc.

And we have seen virtually no sign of that.

So if that starts to change that will automatically ease some of the pricing pressure.

The second thing that will probably change that dynamic will be greater strength in the new equipment business because that will drive better conversion and it will also drive a little easing off of the competitive pressure on some of the people.

So there at least we saw some signs.

The new equipment orders in Europe, excluding Middle East, were up 13% for the year.

That is a pretty strong sign of new equipment progress.

The modernization side is also up strongly, the backdrop for modernization in Europe was up over 30%.

So when you look at those data points it is encouraging, but really not much change in the service pressure yet.

It is a long-term story; it will probably take another year or two before we'll see that.

Understood.

Thanks.

David Strauss, UBS.

Greg, F-35, obviously the new administration has taken a lot of interest in that pushing on the cost side.

Given you are the engine provider, can you talk about how you might be participating in that as well?

So just to be clear, David, we negotiate separately from Lockheed on the engine -- we negotiate directly with the joint program office, the JPO.

As we have said for a number of years, we remain committed to a cost curve that we established back in 2010 which is essentially an 88% learning curve, meaning that every time we double production we will take the price or the cost down by about 12%.

And we remain on that 88% learning curve.

I think we are just on lot -- or LRIP 11 negotiations right now and limiting any drama with us and the JPO on cost as we continue to meet the commitments we have there.

Obviously Lockheed has got some work to do, but I think even as Mrs.

Hewson said yesterday they are coming down the cost curve nicely as well.

They'll have a JSF out there that is a lot less than $90 million from over $100 million today.

So there is cost reduction coming, volumes are picking up and it is a great aircraft.

I think if you ask the Marines, they like the aircraft and service.

And certainly the Israelis and some of the other foreign buyers are very happy with the aircraft.

So there is always going to be pressure on price for what is the biggest DOD procurement program in history.

But I think Lockheed is committed to continued cost reduction as is Pratt & Whitney.

Okay, thanks.

And as a quick follow up, on the outlook of call, Greg, I think you talked about the idea that we could see share repurchase come down significantly in 2018 relative to 2017, more of a focus on M&A and dividend.

Could you just expand a little bit on that and your thinking there?

Thanks.

Yes.

So as we think about it we will do about $3.5 billion of additional share buyback this year, which is a little bit above the historical norm.

So remember back in late 2015 we committed to this $22 billion of capital redeployment or capital returning to shareowners.

We are on track to do that.

As I think about when we get to 2018/2019, we will probably go back towards that $2 billion a year -- $1 billion to $2 billion a year of share buyback.

And we need to do a little less than $1 billion a year just to offset dilution.

So that is I would say the minimum number out there.

But we will continue to just be judicious in terms of where we spend the capital.

I am not looking to do big M&A, but again, if you get cost or if you get tax reform this year you could actually see a little bit different capital allocation because maybe you can take the dividend up if you know you can get access to your foreign cash.

And right now, as you know, about half of our cash is generated overseas and most of the cash that is going out is for US purposes like the dividend, like debt repayment, etc.

So, having access to that foreign cash through tax returns I think would be very beneficial to us and allow us to really relook at this whole capital allocation strategy that we have.

Nigel Coe, Morgan Stanley.

Greg, just turning back to the V mark that you took on the long-term contracts.

I am sorry if maybe you provided more color, I was going back and forth on another call.

But can you maybe just provide a bit more color on what drove those adjustments?

And given that you review these contracts periodically, to what extent do you think there could be further contract adjustments over the next 12 months?

Nigel, as you know, the way the process works is we have got about 80 contracts that Greg mentioned earlier and we look at them on a quarterly basis.

And as we have more data on cost performance or the product performance, that factors into re-estimating the overall cost.

It is also a function of what time period the contract is in, if it is 8 years out of 10 already done there may be a cumulative catch up which has an impact a larger impact than normal.

And I think some of the -- some of what you saw in this quarter was a function of that.

Again, no surprises here, we kind of knew.

As we saw the transactional spares come in stronger as a result of a couple of these technical issues we had talked about, there the impact on the FMPs was going to be adverse and that is what we had factored into our guidance and was affected in our Q4 as well as in Q3.

So I think periodically as we do these things we catch up.

But I think it is behind us.

I don't expect that --.

Yes, look, I think the issue that has caused the re-estimation bad news is a specific durability issue that we saw on V related to a part that's supplied from one of our partners.

We are in the process of campaigning the fleet.

What that's -- because we've had to campaign the fleet it has been a little bit more expensive when we do the overhauls in the shops.

But to Akhil's point, that means we are also selling a lot more spare parts to those non-FMP customers.

This is not a flight safety issue, this is just kind of one of those things that you encounter with an engine that has been out there for a while.

But again, not a big surprise; we knew this was coming.

But there shouldn't be, to Akhil's point, more bad news related to this issue.

We think we have gone through all the contracts and have done all the catch up that we need to do.

Great, thanks.

That is great color.

And then just switching back to Otis pricing.

Obviously good news directionally on that.

Do you think that the pricing umbrella in China is getting -- do you think that is reflective of just the broad pricing in China or is this -- do you think this is Otis specific?

And any color on market share trends would be helpful too.

Clearly on the market share, that is an easy question to answer right now because we have seen 4% to 5% growth in our unit orders and we know that the market has declined by about 5%.

So I think that's clear demonstration of a share gain.

And this is just China I am talking about.

I think if you do the similar analysis in most parts of the world you would see that the Otis new equipment business in orders has done really well and gained share probably on a global basis this year.

So that is really encouraging.

On the pricing side, Nigel, I think while pricing pressure has always been in China, it used to be in the 3% to 5% range.

It escalated a little bit to the 8% to 9% type of level early in 2016 and that was partly a function of the fact that the market declined in unit terms for the first time in many years and therefore people were responding to it through price reductions.

I think that is not something that can sustain forever.

So we are seeing a little reduction in that.

But on the other hand we also see commodity prices going up.

So I think that may have some impact on pricing as well.

We will see how it all plays out but, as you know, our guidance is for a 5% to 6% decline in pricing next year for Otis new equipment business.

And similarly on the CCS business we expect slight decline in pricing there, low-single-digit, which are both better than what we had experienced in 2016.

That is great color.

Thanks, guys.

Jason Gursky, Citi.

Sorry if this has already been covered, I actually have been having to bop between a couple of different calls.

But on the Geared Turbofan, [I think] you said 64 units delivered in the quarter.

Can you confirm that?

And then just talk about the ramp as we move into 2017 and 2018, some updated thoughts on that.

Sure.

62, Jason, to just correct that data point, it's 62 units in fourth quarter which -- and the good news is that the run rate in December was exactly in line with what we need in the first quarter.

And January so far has been trending okay as well and this is largely on the fan blade side, which is what we have talked about a lot.

The key data points that we track that Greg looks at almost on a weekly basis is the yield and the throughput from the fan base facility.

And that has trended up, so we are at about 80% yield on the fan blade facility and a throughput down to 45 days.

Both those are significant improvements from where we were in June of last year.

So feel a lot better about our plans there.

As you know IHI, our partner, had certified facility in fourth quarter and now are going to start producing [for us] fan blades in first quarter this year, plus we are making excellent progress on the second facility in Michigan which will add capacity in the second quarter of this year.

So given all those actions, we feel a lot better about the fan blade situation and overall industrial plan for Pratt GTF production capability and feel very good about being able to deliver the 350 to 400 that is our goal for this year.

Yes, just to add some color there, Jason.

We reviewed this in detail yesterday with the Pratt team.

There is about 1,200 engineered components on a GTF and Pratt has engineer responsibility for about 1,000 of those.

Of that 1,000 that Pratt has responsibility for there is literally six parts where we have some concern about availability to MRP.

And there is a plan for each one of those parts as well as the other 1,000 parts that are out there.

So this is -- there will always be challenges as you are ramping up a new engine, there is always learning that you are going to see out there.

But I feel very good about what the Pratt team has put in place in terms of the leadership and in terms of the analytics around understanding what is going on in the supply chain and understanding where the shortages might be and working aggressively to address those things.

Okay, great.

One last clarification question here.

You suggested second half profit in the commercial business and I couldn't hear whether you said CCS or in Otis, second-half profitability is better than the first half.

Can you confirm which business it was?

And then what are the major drivers of that ramp and kind of what are the risks there?

Sure.

So in the case of CCS, listen it is just a function of the organic growth.

Because as you saw the order rates in Q4 came up, but we still expect the trend would be a relatively low organic growth in first Quarter for CCS and then that order rate will continue to drive better organic growth in the second half.

So it is more a function of superior organic growth later in the year driving better profitability at CCS.

In the case of Otis, as you know, we are still in the process of making strategic investments that Greg described a little bit about.

So there will be more cost upfront before we start to see the returns on that.

The second point is pricing pressure in China is more intense in the first half because of what we saw in the order book in the third and second quarters this year which gets translated into sales in the first half.

So I think Otis similarly will see better profit in the second half on a year-over-year basis than in the first.

That is great.

Thanks, guys.

Ron Epstein, Bank of America Merrill Lynch.

Maybe a little more detailed question on the GTF.

Just kind of surveying around some of the folks looking at it closer.

It seems like you guys are on the fifth generation of combustor for the engine.

Does that fall in the realm of normal for a new engine, five combustors?

It seems like a lot to me.

I don't know.

Any thoughts?

So I think your math is a little off.

But let me -- so the first 17 engines went out with what we would say was the first combustor.

We knew that that had to be upgraded and in fact so the B combustor is the current configuration that is out there on the field.

As I talked about some of the durability issues that we are having, the combustors -- the B version of the combustor is not having the life that we would hope it to have in these very harsh environments, like India.

And so we have actually got one more combustor redesign on the way; we will have that in place later this year.

So I am not sure where you got five, but we are clearly working on the third version which we think will give us the expected life that we had committed to the airlines.

And again, it is one of those things where you don't know until you get out there in service.

And not all operators are having issues with the combustor.

But the ones that are it is certainly a pain for them.

So we are working aggressively with spares to make sure that they have got the right level of spares out there to be able to deal with this lower than expected life on the engine.

Okay, cool.

And maybe one more follow on kind of along the same lines.

One management team ago the goal was set forth that maybe one day you guys would be able to sell engines at breakeven OE.

And given that the GTF compared to its closest competitor has what, 30% fewer parts, so there is less in it.

Is that still a goal that one day you could sell these things at breakeven as opposed to losing money every time you ship one?

I had a dream just like Akhil had had a dream that one day we would be able to sell these at breakeven.

But the fact of the matter is just with the market dynamics out there and the very competitive marketplace, pricing just does not allow us, or the market doesn't allow us to sell these new engines at anything other than a loss.

The good news is I think longer-term the value is still there.

And the IRR on the GTF program is still north -- well north of our cost of capital and we continue to see opportunities to improve that.

So this is a game not for the faint of heart, Ron, you know that.

I mean these are long-term programs, returns come in the later years.

The good news is most of the investment is behind us.

We are going to continue to invest in negative engine margin for the foreseeable future.

But three or four years from now if we start seeing the first overhauls on these engines, it's going to be very profitable at Pratt Whitney.

So again, we all dreamed about breaking even and getting real value upfront, but unfortunately the market did not allow us to do that.

The other thing, Ron, I think is we are being very disciplined and selective with regard to the campaigns as well.

I think if you look at -- and some of that shows up in our market share.

We are not chasing market share here, but we are chasing more profitable part of the engine portfolio.

And trying to make sure that we are being disciplined and at least filter that windmill a little bit.

So that is part of what we need to do.

Got you, got you.

And then maybe one last one.

A while back there was some talk about maybe doing a big sister to the GTF, right, a higher thrust engine.

If an aircraft OE were to do a middle of the market airplane, and there is some speculation that one based in Seattle may.

Would you guys want to do an engine for that?

I mean, what is your thought on doing a wide body version of the GTF?

Would we want to do an engine?

Of course we would want to do an engine, Ron.

I think the question always go back to business case.

And you'd have to make sure that the economics work for a single point aircraft.

And that goes to how big is the market, that goes to what pricing looks like, that goes to as well whether or not there is going to be one or two engines offered on the aircraft.

So all of those things will go into our decision.

We are obviously working with that company in Seattle on trade studies on the engine.

But just like they are not committing to it I would say we are not going to commit to it and we will see what happens with the economics.

As you know, in the airline business it is all about cost, cost and cost.

And we are trying to make sure that whatever product that we have out there can meet the very stringent guidelines around cost while also delivering on the fuel burn and other key parameters for this new engine.

So, we will see.

All right, cool.

Thanks.

Doug Harned, Bernstein.

On Otis in China, if I go back a while ago, you used to talk about margins, OE margins in China as running kind of at the same level as Otis overall.

Back in those days it was kind of a 20% type level.

But recently, since we have seen these price declines, and they may be slowing some; but if we are down 6% now, we were down 9% before.

When you think about Otis margins in China, where are they headed now for OE?

I mean, are we looking at something that has a lot more pressure on it than we have seen in the past?

Or have you been able to get cost down in a commensurate way?

Yes.

So I think the answer is yes and yes.

The team in China has been very good at getting cost out of the supply base, that is step number one.

And then they have also been consolidating the operations within China to make sure that we have a common supply chain, we have a common management team managing the supply chain, and factories have been shut down and consolidated.

So I think the team is very active at ensuring that we can offset.

And thus far they have been successful.

Although, you are right, there is increasing pressure.

Pricing pressure is greater, commodity prices are starting to become more of a problem now.

But we still remain committed to trying to keep the margin at a pretty good level on the OE side in China.

And then on the service side, I mean a big part of this is trying to get the attachment rates up.

And you saw the regulatory reform, it has been about two years now in terms of needing service contracts for elevators that have been installed.

What does the attachment rate look like now and how are you seeing the trends both in your service volume as well as service margins?

So as we look at -- the attachment rates are still around 35%-ish --.

Improved slightly.

Yes, which improved slightly over the last couple of years.

The problem in China on service from a profitability standpoint is still lack of density in many of the routes.

It is fine in the Tier 1 cities, but we are still struggling on the profitability side.

So service margins are pretty close to what you see on the new equipment side, you don't see the big differentiation there.

That should change over time.

But part of this too is regulation in China which requires two service mechanics when you visit an elevator as opposed to one.

So that is driving cost up.

We expect I think service this year will probably grow another 10% in China, we feel very comfortable with that.

The key for us though is actually getting the service technicians, we need to hire over 1,000 people again this coming year to meet the demand for these higher levels of service.

So again, it is a very long-term gain for service in China.

Service didn't -- the market is still new relatively speaking.

So we will get there eventually, but it is going to take a lot of hard work and more investment I would say on the Otis side.

But that is the ultimate prize is the service portfolio.

There are over 2.5 million elevators in service in China today.

There is a lot of opportunity there.

And the conversion rates, Doug, within the Otis business in China, as you know as we've talked about this before, the higher end the conversion rates are even closer to the Western markets, which you would expect.

Because they are the people -- the customers are more reliant on and more -- are more careful about making sure they have the right people doing the maintenance work.

But on the lower end it is significant, the regulation hasn't quite kicked in yet.

But is there a point where we should expect this to really take off?

In other words, do you have goals for volume, market share, those sorts of things that would give you the kind of density you want at a certain point in time?

I am trying to understand when we can see this as an important contributor, if it is 10 years away or if it is 3 years away.

It is probably five years away, Doug.

As I think about it we have got about 165,000 under current maintenance contracts, maybe 175,000 through December.

We have got another probably 50,000 out there under current -- like one year service warranty that we give.

So I think once you get north of 250,000 to 300,000 elevators, again it is a big country you need density.

But once you get to that level we should start to see profitability increase.

Again, it's still a new business and there is still a lot of work to do to get the workforce trained and to get the efficiency of the service technicians up to the efficiency levels that we see in the rest of the world.

Okay, great.

Thank you.

Steve Tusa, JPMorgan.

On the GTF, just to make sure that we are kind of reading the comments right.

You are still saying that the 2018 peak loss is intact and there is not risk that there is extra cost on top of that just to make that clear, right?

Yes.

No change to the outlook of $1 billion of negative engine margin in 2018.

Right, okay.

And then on CC&S for the year I think it is kind of like a mid-single-digit type of increase in profit; you said it is going to start a little slow.

Will it still grow here in kind of both quarters here in the first half?

Just trying to judge the magnitude of the ramp expected in the second half of the year, profit wise.

I would say this, I think the CCS team would be very disappointed if they don't grow there.

So used to delivering profit growth every quarter that they would be disappointed if they don't grow.

Now the magnitude of that is -- and the question and that is what I was referring to more than their ability to grow earnings.

They're a very determined team and they know that shareholder value gets created by growing earnings.

Okay.

And that's for the first half, right?

Growing profits?

Yes, but at a very low rate probably compared to the second half.

Okay.

And any -- last one -- any change on the price cost dynamics there given a bit of a move up and kind of a bit of a backup recently in commodities?

Certainly CCS will not see the kind of commodity tailwind they saw in 2016.

And that pressure has been there a little bit.

The pricing side still has to play out.

As you know, the biggest pricing plays out in the residential market and for that the list prices are up; I think all competitors have done that.

We'll have to just see how it all plays out as the market goes into the cooling season.

Okay, great.

Thanks a lot.

Thank you.

Ladies and gentlemen, this is all the time we have for questions today.

So now it is my pleasure to hand the conference back over to Mr. Greg Hayes, Chairman and Chief Executive Officer, for closing comments and remarks.

Sir.

Okay, thanks, Brian.

Thank you all for listening in.

I would just remind everybody 2017 is a lot of challenges out there, but we remain highly confident in the guidance that we've got.

And again, for us it is about execution this year, execution, execution.

And we are confident we are going to -- we have got the right team to do that.

So Carroll and his team will be around for the rest of the day and tomorrow to answer any questions you guys might have.

I want to thank you guys all for listening.

And have a great day.

Take care.

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

This does conclude the program and you may all disconnect.

Everybody have a wonderful day.