雷神技術公司 (RTX) 2017 Q1 法說會逐字稿

Good morning, and welcome to the United Technologies First Quarter 2017 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 from UTC's website at www.utc.com.

Please note, except where otherwise noted, the company will speak to results from continuing operations, excluding restructuring costs and other significant items of a nonrecurring and/or nonoperational nature, often referred to by management as other significant 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, Chelsea, and good morning, everyone.

United Technologies is off to a good start in 2017.

Today, as you saw, we reported Q1 adjusted EPS of $1.48 and importantly, 3% organic sales growth.

All 4 businesses saw organic sales growth in the quarter, and orders were impressive across all 4 businesses.

As a result, of course, we remain confident in our 2017 expectations with sales of $57.5 billion to $59 billion.

And that includes 2% to 4% organic growth.

And adjusted EPS, as we said earlier, of $6.30 to $6.60.

So we continue to make progress on our 4 strategic priorities.

Those are of course execution, structural cost reduction, disciplined capital allocation and the one I'm most excited about, innovation for growth.

The investments we've made in the past few years and the investment we're making today is driving organic revenue growth.

And that's just growth this year and will be growth for years to come.

Looking at each of the businesses in the quarter.

At Climate, Controls & Security, the investments in new products and the investment in additional feet on the street are indeed paying off.

We saw 2% organic sales growth and new equipment orders in the quarter were up 7%.

At Otis, we continue to feel good about our overall market share.

Even in China, we saw new equipment orders grow 1% in units in a still very challenging market.

We also continue to make progress with our service transformation at Otis.

We're on track in 2017 to provide half of our 31,000 service technicians with the digital devices, applications and training to significantly increase their productivity.

This initiative is a critical step in providing better value and quality to our service customers around the world, which will in turn improve both top and bottom line.

On the aerospace side, at UTC Aerospace Systems, our commitment to developing Aircraft Systems with greater data connectivity has yielded a couple of key wins.

Recently, Lufthansa Technik underwent an extensive industry-wide evaluation for an aircraft interface device and selected our offering based on our ability to connect multiple data sources from the aircraft into the cockpit, a key win.

Pratt & Whitney.

We, of course, remain focused on the Geared Turbofan engine ramp and entry-into-service for our customers around the world.

The GTF has been in operation for more than a year now and has more than 150,000 hours of passenger service.

The GTF is in service at 13 operators currently flying over 100 destinations on 4 continents daily, providing 16% better fuel burn, 50% lower emissions and a 75% reduction in noise footprint.

To be fair, of course, we have had a couple of issues that we need to fix in order to improve durability on the GTF.

First, let me start off by saying that we know that we've been causing our customers pain with these issues.

As I said in January, they're not happy and we're not happy.

The good news today is that we're well on our way to solving these early entry-into-service issues.

2 weeks ago, the European regulators certified the improvement package we developed for the carbon seal issue.

It is being incorporated into engines in the field as we speak.

We plan on having most of the retrofits complete by the middle of May, and all new production engines being shipped today include these upgrades.

On the second issue we discussed, we expect to see upgraded combustor liners to be available in engines starting in the fourth quarter.

As we've said before, neither of these are flight safety issues, and we'll continue to support operators with additional spare engines while we upgrade the fleet.

The good news is, as I said, 13 operators, about 100, a little over 100, engines in service today, it's a manageable problem.

With regard to capital allocation, we've remained disciplined.

During the first quarter, we spent over $930 million on share repurchases.

That's well on our way to the $3.5 billion placeholder we have for the year.

We also continue to have a $1 billion to $2 billion placeholder for opportunistic M&A.

At the same time, we continue to invest in the business beyond typical research and development.

We're focused on new materials and manufacturing processes, which include additive manufacturing technology, along with a big push into digital.

We recently launched a state-of-the-art Digital Accelerator in Brooklyn, New York.

This is a $300 million investment over several years, and it's focused on leveraging software analytics and the Internet of Things across our businesses to develop enhanced customer experience and product innovation as well as to drive continued productivity.

Let me stop there and turn it over to Akhil and to Carroll to take you through the actual business unit results.

Akhil?

Thank you, Greg.

I'm on Slide 2. So reported sales of $13.8 billion were up 3% year-over-year.

Organic sales were also up 3% with stronger growth across the 2 aerospace segments.

Acquisitions benefited us by 1 point largely at CCS, and that was mostly offset by translation headwind, FX translation headwind.

Adjusted EPS of $1.48 was up 1%.

Reported of $1.73 had the benefit of $0.29 from the sale of our stake in Watsco that we talked about in March, and there was a press release in February.

That was offset partially by $0.04 of restructuring.

Free cash flow to net income, 48% for the quarter, in line with our expectations and ahead of prior year, especially when you take into account the fact that the Watsco transaction increased our net income by about $250 million in the quarter, but the cash that came from that transaction of roughly $450 million was reported in the investing line, so causing obviously an adverse impact to the metric.

On top of that, if you add the Canadian payment of about $250 million as well, it has, for which the net income charge was taken in Q4 of 2015, it has a depressing effect, a reduction in the ratio.

Overall, cash was exactly what we expected and we feel very good about being able to get to our full year guidance of 90% to 100%, although because of the Watsco transaction, probably more at the lower end now.

For the full year, we remain confident in our expectations.

Q1 EPS of $1.48, adjusted was a $0.10 beat roughly versus our expectations.

I would say some of that was timing.

For example, at UTAS, provisioning was really strong in the quarter.

It was up almost 30%, largely driving the 12% aftermarket growth.

Now as you all know, provisioning can be lumpy.

We do expect full year still to be flattish, so we got some good benefit in the first half, in the first quarter.

Also at Pratt, negative engine margin will pick up, as sequentially every quarter, as we have delivery ramp of GTF.

And finally, I think our corporate expenses will be up in the back half, including investments in the Digital Accelerator that Greg talked about.

So we had a really good start with Q1, feel very good about that.

But it is only the first quarter of the year.

Looking at organic growth on Slide 3. Global environment remains mixed.

Americas remained strong, we saw improvement in Europe, but there is continued pressure in China and Middle East.

Looking at our commercial businesses, Americas, we saw Otis up 7% in the quarter.

And that's on top of 9% Q1 2016.

CCS was up 3%.

Within EMEA, Europe, excluding Middle East, was strong.

Both new equipment sales and orders at Otis were up substantially, and for the first time since Q2 of 2011, service in Europe, excluding Middle East, was up slightly.

CCS was also up in Europe, excluding Middle East, driven by commercial HVAC and commercial refrigeration businesses.

Middle East remained under pressure.

Commercial HVAC was down over 20% in the quarter and Otis new equipment sales were down less than, just around 40%.

Asia was down 2% with continued pressure from China new equipment at Otis and the container business at CCS.

For the rest of Asia, we saw good growth at both Otis and commercial HVAC.

Within the aerospace businesses, commercial aero is up 5%, largely on the back of strong commercial aftermarket at both Pratt and UTAS.

Military business was up 1%, driven by Pratt aftermarket and development revenue.

Pratt OE volumes and UTAS military business were down.

Q1 orders felt really good, as Greg said, particularly the strength in CCS; it is the strongest quarter of orders in over 2 years.

We saw growth throughout the business, and Otis new equipment orders, excluding China, were also up 11%, so pretty good growth there.

And that strength in orders gives us high confidence in the organic top line growth and earnings expectations for the year.

With that, let me hand it over to Carroll to walk through the business units.

Thanks, Akhil.

I'm on Slide 4. I'll be speaking to the segments in constant currency, as we usually do.

And as a reminder, there's an appendix on Slide 13 that has additional segment data as a reference.

Otis sales were $2.8 billion in the quarter, up 3% organically.

Operating profit was down 4%.

Contribution from higher volume was more than offset by continued pricing pressure in China and strategic investments in service, IT and E&D.

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

New equipment sales were up 2%.

High-teen growth in Europe and low-teen growth in North America were partially offset by continued pressure in China and the Middle East.

As expected, new equipment sales in China saw high single-digit declines.

Service sales were up 6%, including the benefit of acquisitions with strong growth in modernization and repair.

Maintenance sales were up low single-digit.

New equipment orders were up 4% in the quarter.

As Akhil mentioned, orders excluding China grew 11%.

Otis saw order growth of nearly 30% in North America.

And, recall, that was on top of 33% growth in Q1 of 2016.

Europe was also up nearly 30% with broad-based strength, and this was partially offset by declines in China, China was down 10% in value, and declines in the Middle East, which was down more than 40%.

Full year expectations remain unchanged.

We continue to expect operating profit to be down $50 million to $100 million at constant currency with higher investments in the remaining quarters and continued pressure in China.

Turning to Slide 5. Climate, Controls & Security sales grew 6% at constant currency in the quarter.

Operating profit was down 3%, and that included an unfavorable contract adjustment of $25 million that was recorded on a large commercial project during the quarter.

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

Organic sales at CCS were up 2% in Q1, driven by mid-single-digit growth in North America HVAC with strength in both residential and commercial.

Commercial refrigeration saw a mid-teen sales increase.

Fire and security sales were flat.

Transport refrigeration continued to experience sales weakness and was down 8%.

Within transport, container was down almost 40% and North America truck trailer was down 10%.

Total equipment orders at CCS were strong, up 7% in the quarter.

Transport refrigeration orders were up 30%; that was primarily driven by North America truck trailer.

With 6% growth in commercial HVAC and 8% growth in commercial refrigeration, CCS saw its highest organic order growth in a quarter since Q4 of 2014.

Operating profit gains from organic volume were offset by the contract adjustment I mentioned earlier.

Absent that adjustment, profit at CCS was flat in the quarter, including FX.

CCS saw margin pressure in the quarter from lower transport refrigeration sales and unfavorable mix within fire and security and commercial refrigeration.

And based on the strength in equipment orders and productivity initiatives, we remain confident in full year expectations for CCS of operating profit up $150 million to $200 million at constant currency on low single-digit organic growth.

Turning to aerospace on Slide 6. Pratt & Whitney sales of $3.8 billion were up 4% organically.

Aftermarket sales were strong with commercial and military each up high single-digit.

Despite a tough compare in the large commercial aftermarket, higher shop visits and content on V2500 more than offset declines in legacy models.

Commercial OEM saw 4% sales growth while military OEM was flat.

Geared Turbofan shipments increased in the quarter and totaled 70 engines.

And that included 26 engines to be used as spares in support of customer fleets.

With additional industrial capacity being added through the year, Pratt & Whitney remains on track to build 350 to 400 GTF engines in 2017, including spares.

Pratt operating profit of $393 million was down 5%.

Headwinds included higher negative engine margin and lower OEM shipments at Pratt Canada and military.

And also recall that Q1 2016 benefited from a favorable contract settlement that contributed $0.03 to earnings last year.

These headwinds are partially offset by margin contributions from commercial aftermarket and FX benefit.

We continue to feel confident in Pratt & Whitney full year operating expectations of down $150 million to $200 million, including the benefit of FX.

Turning to Slide 7. Aerospace Systems reported profit of $599 million, up 9%, on $3.6 billion of sales and included 5% organic sales growth.

And as you may recall, the first quarter of 2016 does offer the year's easiest compare due to the transition to a new ERP system that was implemented last year.

Commercial aftermarket was up 12% with high single-digit growth in both parts and repair and nearly 30% growth in provisioning.

As Akhil mentioned, provisioning did include some one-time benefits in the quarter.

If you exclude these items, provisioning was up 4%.

Commercial OEM sales were up 2% while military sales were down 2%.

And that military sales was against the 2016 compare that included the delivery of the final units for the C-5 nacelle retrofit program.

Operating profit growth was driven by drop-through on higher commercial aftermarket and continued cost reduction that was partially offset by an unfavorable commercial OEM mix and higher E&D.

With a solid start to 2017, Aerospace Systems continues to expect operating profit to be up $50 million to $100 million for the full year.

And with that, I'll turn it back to Greg.

Okay, thanks, Carroll.

So I think we said it often enough, a good start to the year, confident in the full year.

I'd also tell you that we're encouraged by signs of momentum in the global economy.

We've seen really good strength here in the U.S. We've seen a recovery in Europe.

Even in China, we saw good economic growth in the first quarter, although some of the markets that we operate in remain challenging from a pricing standpoint.

Every CEO in corporate America talks about uncertainty.

I'm not so worried.

The fact of the matter is we all face the same headwinds, the same uncertainty.

We're going to focus on what we control, and we're going to continue to invest for the long run.

And I'm confident that UTC is well positioned for the long-term because each of our businesses is supported by solid long-term market fundamentals.

Those fundamentals, along with innovative new products, a relentless focus on cost reduction and our commitment to providing the best possible value to our customers is going to drive both top and bottom line growth for years to come.

We're confident in the outlook not just for this year but for 2020 and beyond.

So with that, let's open up the call for questions.

Chelsea?

Ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your telephone keypad.

If your question has been answered, or you wish to remove yourself from the queue, please press the pound key.

As a reminder, 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.

Thank you, and our first question comes from the line of Julian Mitchell with Credit Suisse.

Hi, good morning.

Just a first question on, or the main question, on CC&S.

Obviously, people are very sensitive to any sense of margins plateauing in that business.

So maybe you could walk through how quickly some of those issues around the unfavorable mix and the Transicold volumes, how quickly they'll reverse over the balance of this year?

Is that something that can come in Q2 or it's really a second half issue?

So Julian, I think the 140 basis points, just to do a quick math for you first, 140 basis points decline in margin obviously, on the face of it, looks shocking.

Half of that is just on the basis of that contract adjustment that Carroll talked about, the $25 million.

40 basis points comes from acquisitions that we did.

As you know, acquisitions in the early years don't necessarily come in at the same ROS levels as the existing business, but over time, that improves.

So we got sales with little earnings on acquisitions; that was 40 basis points.

The mix impact was, a little bit, the rest of it, right?

So to give you some examples of the mix, within fire and security, we had growth in the installation business while service business declined.

That will change as the year goes by.

Similarly, in the commercial refrigeration business, we saw growth coming largely from new products where costs in the first quarter were not at the levels at which they will be sequentially as we go through the year.

So cost-reduction effort through the rest of the year will drive margins higher on these new products that have been introduced in the commercial refrigeration business.

So we think the mix gets better.

We also think that transport refrigeration business gets better.

Container business was down 39% in the first quarter.

We know that the refrigerator trade is growing 3% to 4% every year, so that market is going to bounce back.

Our expectations now are that the market will probably be seeing some recovery in the second half.

It certainly won't be down 39% for the year.

So I think the mix gets better as we move through Q2 and the rest of the year.

Julian, I'd also add just 2 points.

One, we continue to invest in R&D.

R&D was up about $10 million in the quarter there, so there's a little bit of headwind there.

The other thing is we talked about this investment in feet on the street, some additional salespeople out there to try and drive additional top line growth.

You guys should be assured, we haven't lost our focus on cost at CCS.

Bob McDonough is, he's gating all of these headcount additions to make sure that he can meet his commitments for the year.

He, and we, remain confident in his overall guidance for the year.

So look, it was a bad first quarter, but as Akhil said, there was a couple of very specific things that caused it.

Bob's got his eye on the cost line.

We'll get the margins back to where you expect.

Great, thank you.

Thank you, and our next question comes from the line of Myles Walton with Deutsche Bank.

Your line is now open.

Thanks and good morning.

I'm just wondering if I could do the same litany, I guess, on Otis.

It looks like services sales were up nicely in the quarter.

That should have helped mix, presumably.

Can you talk about the margin driver and the pressure from China?

And also how much of the $75 million year-on-year growth in R&D dropped in 1Q?

So the easy question first.

I think $17 million of the $75 million was in the first quarter.

That's the strategic investments in totality.

But there is also the pressure that you saw last year in our booking, in terms of the China new equipment, ultimately translated into the earnings as you would have expected, right?

Where the pricing pressure from China is where essentially a lot of the margin pressure at Otis is coming from.

If you look in totality, Myles, the first quarter in Otis was not that far off from what you'd expect for the full year.

We do expect margins at Otis to be down this year, around 100 basis points or so, a little more than 100 basis points, and the first quarter was a little worse than that but not that much.

So I wouldn't say Otis was a reason for concern.

I think it's just the pressure in pricing at China that is continuing through the P&L now and will continue for a while, the mix, the move towards the lower mix as well in China.

But rest of the business is performing well.

And remind me, the service expectation for the year versus the new equipment expectation for the year in terms of total sales growth?

So service, we expect to be low- to mid-single-digit growth, and new equipment is low single-digit growth.

Now in service, keep in mind, I agree with you that 6% should have given greater drop-through, but part of the service growth came from acquisitions that we did in Japan last year.

And again, same phenomenon, right?

When you have intangibles amortization associated with new acquisitions, the drop-through is not that great.

So a little bit of impact from acquisition there in Otis Japan.

Fair enough.

Thanks.

Thank you, and our next question comes from the line of Carter Copeland with Barclays.

Hi, good morning gentlemen.

Greg, I wondered if you could give us some color.

It looks like you recently got the number 3 bearing fix certified.

I wondered if you could give us some color on the path to getting all of those retrofits done and the cost there?

And then Akhil, I wondered, just in light of all this cost growth, something I know we talked about before, but I wonder if you could give us an update: when you look at the IRR of the program, the GTF, and incorporate some of this cost growth that you've seen, does that have a material drag versus what your initial business case may have planned?

Any color there would be great.

Thanks.

Is that all, Carter?

So let's start, I think, on the thing that's on everybody's mind, as I mentioned before.

This is the carbon seal on the number 3 bearing on the Geared Turbofan.

Obviously, as we said back in the first quarter, it was causing the customers pain.

And there was some work that we needed to do to go out and verify the engineering fix.

We completed that flight testing about a month or so ago.

We had the European airworthiness authorities, they approved the fix in, about 2 weeks ago now.

We have all the hardware for the fix pre-positioned out in the field.

We've got about 25% of the engines retrofitted today.

This is a 4- to 5-hour retrofit.

They do it on the overnights.

So we expect, as I said, most of these aircraft engines will be upgraded by the middle of May, and there will be a few stragglers, but for the most affected populations, we'll have it all done by the middle of May.

So that's the good news.

Look, it seemed like it took a long time, and I always tell guys around here, when we have customer problems, we look at our watch and not our calendar when we're trying to solve these things.

Let me tell you, Pratt's done a pretty good job within the constraints of all of the airworthiness authorities in getting the proper testing done.

But to that end, we're going to continue to do additional endurance testing, working with Airbus through the back half of the year.

We'll spend another $40 million or $50 million doing that testing to ensure that there's not another problem out there.

We've got 150,000 or so hours on the fleet.

We haven't seen any other surprises or concerns so far, but just to be cautious and to be complete, we're going to continue to do endurance testing.

So is the problem completely behind us?

Obviously not.

Some of these engines, you'll still see some removals.

But I'd tell you, the Pratt team has jumped on this just like the combustor issue that we talked about, and we have a solution.

So the good news, Carter, if you think about it, as I said, only about 100 engines out there in service.

This is not a huge cost.

The cost to do the retrofits, the cost in terms of helping the airlines through some of this, it's all in Pratt's numbers already for the year.

Akhil can take you through the longer-term implications.

But I would tell you again, it's not material.

Yes, I think, just as Greg said, Carter, I think the IRR, still above cost of capital clearly.

On the GTF, the additional, the higher volumes are certainly helping the business case there.

The incremental costs are very early in the program.

As Greg pointed out, it's only 100-odd engines at this point, which need to be retrofitted.

I'd rather see these problems being discovered now than when we have 1,000 engines out in the field.

But the other more encouraging part is that with all the sensors that we have put in the GTF, compared to the old conventional engines, there is so much more data that we are getting.

And taking benefit of that digital effort, we would be able to be much better at predictive maintenance and therefore, reduce the cost of maintenance over the long-term.

So that, I don't believe that has fully been factored into the business cases as well.

So while, yes, there have been some negatives with regard to the cost early on, there is also a huge opportunity with the digital aspect of the GTF engine that can give us some improvements versus our long-term business case.

Thank you very much, gents.

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

Thanks, gents, good morning.

So just going back to Otis China orders down 10%, I didn't hear the, how that's split between units and price.

If I missed it, I'm sorry.

But if you could just give that data point.

And down 10% versus a big pickup in residential construction in China during 1Q, so I'm just wondering, if at all, when you expect to see that uptick in activity coming through on orders?

Sure, Nigel.

So I think 1% up in units, that's more in line with the China residential activity.

Unfortunately, the value doesn't necessarily represent what's happening with the market.

It's the units that you have to look at, and we believe we did better than the market.

The market, again exact data is not available, but the best estimate is that first quarter was probably flat to maybe slightly down in terms of units.

In terms of value, the difference still remains the same.

We are seeing continuing price pressure in Otis China.

Roughly half of that disconnect of 11 points was pricing and the rest was continuing move towards the mix of lower-priced, lower-value units being sold or being asked for by the customers.

So unit is still decent, market share gains at Otis China continuing and the pressures, unfortunately, on the negative side on pricing and/or mix continuing as well.

Okay.

So price down 5% to 6% roughly.

So that's in line with your full year plan, I think?

Yes.

On the mix side, how does the margin in some of these lower-end residential units, how does the margin compare on those to obviously your typical margins on residential?

So margins as a percent is relatively close, Nigel.

But as you can imagine, since these are lower-value, lower-priced overall, it hurts the margin dollars.

And that's one of the issues that we have to continue to face and deal with.

We keep looking for more cost opportunities out of the product through reengineering, through using alternate materials, but the commodity price increases, which have been happening not just in China but globally, are not helping that very much.

So that definitely is a negative, which we continue to watch at Otis.

Okay.

And then a quick one as well, just on the OE side in North America and Europe, are we seeing OE margins rising with the volumes?

The OE margins, I would say, on the new equipment side are still okay; some of the order strength still has to flow through the sales line.

The book margin seemed to be consistent, in fact, slightly better than what we have seen in the past.

But I would say no perceptive, no material changes.

Okay, thanks, Akhil.

Thank you, and our next question comes from the line of Howard Rubel with Jefferies.

Thank you very much.

Maybe you could talk a little bit more about UTAS and, sort of, efforts to reposition the business a little bit?

By that I mean, using the example of the electronic controls and the interface with the customer and avoiding some of the commodity products in the past that have given you fits on pricing.

Fits on pricing, we'll stay away from the pricing discussion, Howard.

But look, I think as you think about the Aerospace Systems business, it's obviously one of the most complicated businesses that we have.

And as a result, it's complicated to do business with Aerospace Systems.

We have over 300,000 separate parts that we sell, and the efforts underway today are to make those transactions with our customers much more seamless.

And again, this is where the digital initiative comes into play.

First of all, being able to predict when parts are going to fail, being able to communicate that, having the parts available but also having a single interface for an airline technician who's out on the line to be able to diagnose, and then order, and then reinstall a part seamlessly is all part of the long-term goal of where we're going with digital here.

So it's not something we're going to finish this year or next.

It's a longer-term journey, as you can imagine the complexity of this.

But they've got a good start.

We talked about this $300 million investment we're making in digital; Dave Gitlin's folks will be a big part of that initially.

I think they've got a very good road map in terms of where they want to be.

The technology clearly exists to do all this, we just have to put it all together, and I think we've got the right channel partners to do that.

We've got the right folks internally to help.

Thank you.

Thanks, Howard.

Thank you, and our next question comes from the line of Sam Pearlstein from Wells Fargo.

Good morning.

Looking at the balance sheet and looking at the inventory growth of $680 million, I know there's always a seasonality with regards to Carrier at this point in the year, but can you just, kind of, help us understand what's the normal growth and what's really extra or excessive because of, say, the Geared Turbofan issue?

I'm just trying to help size the opportunity for shrinking the inventory levels.

Sam, you hit on one of the hot button issues that we have around here.

And there's no bigger sinner from an inventory standpoint, of course, than Pratt & Whitney.

They've got almost $4 billion of inventory today; That's up over $1 billion in the last 18 months.

The good news is the parts are flowing in, engines are being built, but I think Pratt, in order to protect schedule and in order to ensure that we have all the hardware we need, they have been more aggressive in bringing parts in than we probably needed.

But it's okay, that stuff will work itself out.

As you think about going from 160 engines last year to 350 to 400 this year, and then doubling again next year, the inventory turns will improve and those inventory balances, while they seem large aren't, they'll get more in line over the next 18 months or so.

CCS, the U.S. res business, obviously it's all seasonal, inventory is up a couple hundred million there.

The other piece, of course, is at Aerospace Systems.

They have some opportunities on the inventory side as well, but certainly not at the same magnitude as the engine company.

Thank you.

Thank you, and our next question comes from the line of Ron Epstein with Bank of America Merrill Lynch.

Thank you, good morning, guys.

We've seen a nice rebound in air freight.

And given the engines that Pratt has out in the field and their exposure to that, did we see a pickup in order activity at Pratt related to that, or just broadly speaking, the level of air traffic growth that we did see so far in the first quarter of the year?

Most of those, Ron, as you can imagine, are old PW4000 engines.

We did not really see a pickup there.

Most of the pickup that we did see at Pratt was on Vs.

We continue to see again a lot of hours on the V fleet, a lot of activity there on our shops on V. But I wouldn't say we saw anything abnormal in terms of growth.

The good news is, as air freight does improve, that means they're putting hours on those engines, so they will come back for their normal scheduled overhaul, but that's probably 18 to 24 months out.

Yes, the normal phenomenon, Ron, is continuing.

We saw good, higher shop visits and content at V2500, but the legacy spare parts, legacy aftermarket associated with PW4000 and 2000 was down.

And those trends we expect to see continue in spite of some of the other macro things that you mentioned, like air freight, etc.

Okay.

And then Akhil, one follow-up for you.

You mentioned a 40 basis point hit to margins due to some acquisitions in CCS.

Can you give us more color on it?

Like, what did you guys buy that would give you that kind of headwind?

Because that seems a little high.

Well, this was basically acquisitions we did last year, Ron.

I think there was a company in Europe that we bought, which was in the commercial HVAC and heating space.

And if you look at the appendix, you'll see that CCS had 4% benefit in their reported sales from acquisitions, and that essentially is about $150 million or so.

And that comes with very little earnings to begin with.

Now those acquisitions will give us earnings as we grow, as we continue to take costs out of those.

But initial amortization of the intangibles, initial margins that come in, always keep pressure on any acquired entity, and we fully expect those to improve.

The acquisition CARs, or our business cases, are all in double-digit IRRs, so good value-creating opportunities, but the initial economics is always tough from an accounting point of view.

Okay, great.

Thank you very much.

Thank you, and our next question comes from the line of Noah Poponak with Goldman Sachs.

Hey, good morning everyone.

In the aerospace aftermarket, I think you said the 12% reported in UTAS was 4%, excluding provisioning.

Did I hear that correctly?

And then I also heard high single-digit in parts and repair.

So if it's, what's the variance between the high single-digit in parts and repair and the 4% ex-provisioning?

And then if you can maybe just speak a little bit more qualitatively, I guess, to what you saw in the quarter, are airlines no longer delaying shop visits?

Or are you seeing less third party parting out?

Or anything that changed in terms of the trends you're seeing in the business?

So first, just a reconciliation on your UTAS math.

So the 12% overall commercial aftermarket growth was made up of roughly 30% on provisioning and high single-digit on repair and parts.

The 4% number that was quoted was just provisioning by itself, excluding some of those one-offs, a large sale of an A380 landing gear, for example, or new higher engine build units that we had anticipated to support the Pratt, the neo nacelles, which go into the lease pool.

So it's special exceptional items like that that grow the really exceptional growth in provisioning, which is a lumpy business, as you know.

So we wanted to give you the color of 4% to make sure that you guys don't start projecting 30% growth for every quarter going forward.

So that was the-

I see.

So what was the UTAS commercial aftermarket ex-provisioning?

So it will be about 6% to,well, ex-provisioning, it will be about 7% to 8%, somewhere in that range, yes, which was still pretty good.

So we feel good about things there.

It's an on-condition situation, which is not so much the number of shop visits or other, so the more flight hours are translating into better parts requirements.

So that's certainly very encouraging and good.

Obviously, it's just one quarter.

We've got to continue to see how that trends.

Our internal dialogue, with Mr. Gitlin, is to try and see if he can do better on his commercial aftermarket than the guidance that he gave.

But obviously, we'll have to see how the next few quarters play out.

Okay, thank you.

Thank you, and our next question comes from the line of Cai Von Rumohr with Cowen and Company.

Thank you very much, so of the 70 deliveries of the PW1000s in the first quarter, how many of those went to customers?

And how many were for spare, were revenue deliveries?

And how many were spare engines just so that they could keep their planes going?

And maybe walk us through the expected pattern of shipments over the year and the expected build in the engines that go out for spares.

Yes, Cai, we had 44 deliveries to customers and we had 26 spares, which when you think about the mix, spares to deliveries, we expect obviously it to shift towards deliveries as the year progresses.

Yes.

For the full year, I think we expect, Cai, a little over 50 engines to go into the spares to support the customer fleet.

So this was in conjunction with Airbus, we agreed to pull forward some of the spares, spare engines, for the entire year into first quarter, so we could support the customer fleet today for the issues which we're having.

Given the improvement package that Greg described, we expect the need for spares to come down a little bit as we go through the rest of the year.

And so for the full year, we still expect a little over 50 going into the spare pool.

So the 139 large engine deliveries for the full quarter includes the 44 PW1000s?

Yes.

Thank you, and our next question comes from the line of Steve Tusa with JP Morgan.

Hey guys, good morning.

So just on this provisioning and kind of the aftermarket growth there, will there be any comp dynamics through the rest of the year, where the aftermarket there could actually go negative?

I don't, I haven't gone back to check on how that provisioning growth was over the last 3 quarters of last year.

But just from a quarterly progression perspective.

Yes, Steve.

I mean, I think when you look at the comps going forward, obviously you get tougher comps in Q3.

We still feel like provisioning is likely to be flat on the year.

Akhil mentioned the A380 spare landing gear.

That's a big-ticket item, don't expect it to reoccur during the year.

So yes, to get to flat on provisioning obviously from where we're starting from, we expect some tougher comps and some lower requirements.

Right.

And I guess we can just use this quarter's, kind of, influence as a base for how it would influence the total reported number at UTAS for aftermarket?

Well, I think our expectation for UTAS is still to do low- to mid-single-digit type of growth in commercial aftermarket.

I think it was originally low.

We are hopeful that maybe they do a little bit better than that, given the strength in the first quarter.

But that's again, we still have to watch.

As you know, 2015, everybody was a little disappointed, including us with the falloff we saw in provisioning in the back half of 2015.

And this year, I'd rather have a good quarter to begin with as opposed to relying on a heavy back half.

So if anything, this gives us more comfort about the full year guidance.

And then in CC&S, any update to your price cost spread there?

So I think if you, again, you've got to look at it business by business.

I think in the residential side, we feel still, you know, the commodity prices have been going up, and so the benefit that we expected on, most of the industry got last year from commodities is certainly not there this year.

We were sort of flattish at CCS on commodity, on pure commodity.

Pricing in the residential space feels okay, although the season is ahead of us, so we've still got to see what exactly happens and how the industry behaves as the season comes around.

On the commercial side, pricing remains a little bit of a pressure, right?

So we're still seeing more competitive pricing environment in the commercial HVAC space, not just U.S., but globally.

And so that is one thing we are watching.

So I would say, net-net, in our original road map, we had probably $25 million of tailwind from price commodity.

I think that probably is looking more like flattish.

On the other hand, we think to compensate that, we probably see a little higher volume than we were expecting at the beginning of the year.

So I think, net-net, still feel good about the guidance for CCS, but maybe a little more pressure on price and commodity.

Okay, great, thanks a lot.

Thank you, and our next question comes from the line of Peter Arment with Baird.

Thanks, Greg, Akhil, good morning.

Greg, just a quick one, when we were in Florence, there was discussion in fire and security about modeling kind of the oil and gas market, end market flat for 2017.

And it was kind of a watch item on the CapEx front.

What's the latest update there and, kind of, how are you bracketing that?

Yes, I would tell you the first quarter was not a great quarter in oil and gas.

I think everybody is experiencing this still with the volatility in oil prices.

We had some hope when we saw oil up at $60 a barrel, but when it trades below $50, I think it puts a little bit of a challenge into the plan for the year.

Again, not a huge driver at Climate, Controls & Security.

But clearly, it's one of those things that Bob has got on his watch list that we have to be looking at for the rest of the year.

Okay.

And then what was, I guess, the planned restructuring for CCS this year?

The plan for restructuring across all businesses collectively is about $300 million.

CCS is a portion of that.

I would say the largest one is UTAS, where we continue to look for continuing benefit on the footprint side.

They need the cost reductions to help offset some of the mix problem that we have talked about there with the new products being, new products coming in.

So CCS has a portion of that.

I wouldn't like to give out an exact number on that.

Okay, thanks, appreciate it.

Nice quarter.

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

Thanks, good morning.

Greg, in the prepared remarks, you guys talked about Otis Europe service improving, I think, for the first time in 5, 6 years, something like that.

Can you talk about how you feel about the sustainability of that?

And then second question, on GTF, specifically on the A321neo, what's going on there?

I think your engine certified before the LEAP, yet the LEAP had their first delivery on the A321neo.

Just what's holding up things there?

Thanks, David.

On the service side, there was very good strength in Europe as, I think, Carroll pointed out in the remarks.

There was good news really in repair and modernization.

Those are the pieces that drove big service growth.

And repair and modernization has been a little bit lumpy.

You recall, there were some programs 5 years ago, required upgrades that drove modernization.

We've seen a very, very low uptake there for the last couple of years.

So it's encouraging to get these repair and mod jobs back in line.

But having said that, even what we call our O, or our basic maintenance, was up in Europe.

And it's market by market a little bit different, but there was strength in most of the European countries, a little bit of growth in the O. We saw some pricing stability, I would tell you, on the service side.

In some countries- but not broadly

Yes, right.

So there's still challenges out there, as my CFO will point out here, but broadly speaking, I think the trends are encouraging on the service end.

As you recall, the key for the O service growth or the basic maintenance is to just get a little bit of inflation in the system, and I think we're finally starting to see that.

And as unemployment has come down, as the economy gets better and quite frankly as our service quality gets better, we're starting to see a little traction there.

So I think it's all very encouraging.

Then on the 321?

Yes, on the 321neo, nothing really to mention specifically, David.

I think it's just more a function of Airbus and the customers in terms of how they want to prioritize their requirements.

But our engine again continues to be, we continue to work on as per the customer requirements.

I think the big news, the good news, as Greg pointed out, is that we have the improvement package in place now, which has been approved by the regulators.

So as soon as that's in the new engines and retrofitted on the existing fleet, we should start to see significant confidence.

Yes, Dave, I think the real question here is are we on track to our contractual commitments to Airbus for the year for the GTF?

And the answer is yes.

We continue to see a path, as we said 350 to 400 engines for the year.

We should hit the delivery requirements at Airbus.

How they allocate those engines, it obviously changes month-to-month, quarter-to-quarter based upon customer input, customer needs.

But there's not an issue with the A321 versus the A320 or the A319.

All right.

Thanks, guys.

Thank you, and our next question comes from the line of Jason Gursky with Citi.

Hey, good morning everyone.

Just a quick question on Otis and the longer-term, kind of, margin trajectory there.

I think again as we were down in Florence, I think one of the keys to margin expansion at the time were going to be some of these productivity tools that you're rolling out into the service area.

So can you just quickly provide us an update on the further rollout of those productivity tools and when we should expect to hear from the outside that rollout to have a material impact on margins at Otis?

Thanks.

Sure, Jason.

So I think as Philippe mentioned in March, we have started the rollout.

The launch country was Hong Kong and we are seeing some really good results there.

The mechanics seem to be very excited with the new tools and everything that's going on with the new apps and everything else that comes with it to improve their productivity and also the customer experience, by the way.

As Philippe said, we have plans to get roughly half, 16,000 of our 31,000 technicians, with the new tools, followed by the remaining half in 2018.

So the impact of that obviously we expect to start to see some returns on the investments this year.

Coming into 2018, that will only be for part of it, technicians that will have the tools with them.

Certainly, 2019 will be the first full year with all technicians around the world having the tools.

And as we have said many times, a 1-point improvement in the productivity of the technicians can yield $30 million of benefit.

So I think you'll see the real benefit starting to show up in 2019 to a full extent, and then it should only get better after that.

That's great, thanks.

Thank you, and our last question today comes from the line of Doug Harned with Bernstein Research.

Yes, thank you, good morning.

I'm interested in looking at this, at the 5-year guidance, that you've given for Otis and CC&S.

And in Florence you talked about a level now which is really a 3% to 5% CAGR in top line over the next, over the 2016 to 2020 time frame, and that really appears to tick up in 2018, 2019 and 2020.

So when you look at those 2 businesses, what are the things that you're expecting to see that will make you confident that you're going to see that upturn in growth?

Is that some specific improvement in the market?

Is it market share?

What should we watch for to know that it's really going to be on track to have that growth?

Yes, Doug, a couple of different things.

Obviously, the dynamics of each of the businesses are different.

I think what you want to look at for Otis is really what's happening with order backlog on the new equipment and the translation of that new equipment into the service portfolio.

We've been very encouraged.

I mean, these last couple of years, we've had very, very solid new equipment growth.

And as you know, that will translate into new equipment sales between 6 and 36 months out.

I mean, we've got some of these major things that we're doing like the Willis Tower in Chicago; that's a 3-year project that's in backlog.

So I think from Otis' perspective, the metric you want to be looking at is new equipment orders.

The other thing, of course, on Otis is all about service conversion.

And we track that, as you would imagine, on a monthly basis.

And as the conversion rate continues at historical levels, that will translate into sales.

So Otis is the easy one.

I think Philippe talks about regaining a little bit of global market share.

I think we've been doing that very effectively with some of these new products that we're going to be introducing as well as, again, a more targeted sales and marketing effort.

On the CCS side, it is, as you would expect, more market-driven.

But we still expect a point or so of growth from market share gains, and that's going to come from continued investment on these new products.

We had 130 new products go into production this year.

The pipeline remains robust within the whole Climate, Controls & Security portfolio.

We're always looking for ways to upgrade the products, improve value, improve efficiency.

And so that's the market share gain.

And I think you really need to look at market share of all of the businesses within CCS.

And the thing that you can't, of course, control when you have a container business that's down 40% because the ship ward or the shipowners are having a difficult go.

Those things are temporary.

You want to look at the underlying markets for refrigerated transport, which Akhil said it grows at 3.5% or 4% a year.

Those things all support that 3% to 5% organic sales growth that we were expecting for CCS.

Yes, and I would just add that, as you know, the residential market in U.S. is seeing some good strength, some solid market fundamentals both in terms of new housing starts as well as replacement market that comes in.

A large part of the installed base was created in the early 2000s.

And that material, all that 100 million of split units and 50 million of furnaces and coils are going to be replaced over the next 4 or 5 years.

So as we look at the market fundamentals, they're pretty solid.

And in addition, with the innovative new products, we should be able to gain some share.

So that's a combination.

But I just want to make sure I understand on Otis, which makes sense that it's a more predictable one, given that a very large portion of your OE sales are in China, you've had the pricing pressure, you've had the mix shift to lowering products.

When you look at that market, how do you get comfortable about the service conversion there?

I know this has been something that has been improving over time.

But it seems that that would be a very important part of your scenario for 2016 to 2018 for Otis?

Yes, Doug, you're exactly right.

I think what you've seen over the last 3 years is about 20% compound growth into the service portfolio.

We've got about almost 200,000 units under service today.

We expect that to continue to grow, kind of, 10% to 15% a year each year.

And part of that is conversion, but also there's a large number of elevators out there that do not currently have service contracts that were out.

And the key for us there is, of course, hiring enough technicians to actually do the work.

That's the challenge.

But yes, service in China will be a big driver of growth in China.

But still, if you think about it, that's less than 10% of the China market for elevators is in service.

So there has to be a normalization of the OE market in China as well to support that 3% to 5% because, to your point, it's still the world's biggest elevator market.

Okay, great, thank you.

Thanks, Doug.

Thank you, and this concludes today's question and answer session.

I would now like to turn the call back to Greg Hayes for any closing remarks.

Okay, thanks, Chelsea.

I just want to thank everybody for listening in today.

As always, Carroll and team are available to answer all of your questions, and appreciate the confidence in UTX.

Take care.

Thanks.

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

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

Everyone, have a great day.