雷神技術公司 (RTX) 2017 Q2 法說會逐字稿

Good morning, and welcome to the United Technologies Second 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 the UTC 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 of a nonoperational nature, often referred to by management as other significant items.

The company also reminds listeners that their earnings and cash flow expectations and other forward-looking statements provided in the 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 re-inserting yourself in the queue as time permits.

Please go ahead, Mr. Hayes.

Okay.

Thank you, LaToya, and good morning, everyone.

As you saw from our press release this morning, UTC reported another solid quarter.

And with a strong first half behind us, we're now raising the lower end of our adjusted EPS range for the year by $0.15, with a new range of $6.45 to $6.60.

Importantly, we're also raising our sales outlook in that we now expect 2017 sales of $58.5 billion to $59.5 billion.

That's up from our previous expectation of about $57.5 billion to $59 billion.

And we now see organic growth of 3% to 4% versus 2% to 4% on an improving macroeconomic environment.

So we reported Q2 2017 adjusted earnings per share of $1.85.

That's an increase of 2% over the prior year.

And sales in the quarter were $15.3 billion, and that included 3% of organic sales growth.

That's consistent, of course, with our first quarter.

Free cash flow was robust at 118% of net income, with all of the businesses generating strong cash performance, while we continue to invest to support growth for the long term.

Right now, we're focused on executing on our strategic priorities.

And we're pleased with the progress we've seen in the first half of 2017, and specifically, our emphasis on creating innovative products and services, which is starting to generate solid organic sales growth.

At CCS, where we've continued to invest in new products and sales resources, organic growth was 5% in the quarter, with organic growth in the North American residential business up double digits.

CCS's equipment orders grew 11%, with all of its business segments contributing in the quarter, and that follows strong new equipment orders growth of 7% in Q1.

At Otis China, we saw orders growth of 7% in units, while the China market continues to be challenging.

We'll talk more about that.

On the Aerospace side, Pratt & Whitney sales grew 6% organically in the quarter.

And Pratt, of course, continues to focus on execution, including the Geared Turbofan.

As Bob Leduc mentioned at the Paris Air Show, a supplier quality issue impacted some of the GTF deliveries late in the second quarter.

The issue has been addressed, and we remain confident in our commitment of 350 to 400 engines for the year.

In Q2, our Aerospace Systems businesses expanded their operating margins by 70 basis points versus the prior year even as the portfolio transitions to the next generation of OEM products.

And our capital allocation remains disciplined.

We still expect to spend about $3.5 billion on share repurchases this year, completing our plan to return $22 billion to shareowners between 2015 and 2017.

On the M&A front, acquisitions we completed at CCS and Otis last year are contributing to our growth story this year.

And we continue to have a placeholder of $1 billion to $2 billion for M&A this year.

But as I've said before, we'll be opportunistic for the right deal.

So a solid quarter, but our focus, of course, is on the long term.

We feel good about UTC's performance and the improved 2017 outlook.

We're executing on our commitments in growing the business with innovative products and focusing on cost reduction, while also being efficient and disciplined in our capital allocation.

We'll turn it over to Akhil and Carroll to take you through the individual business unit results.

Akhil?

Thank you, Greg.

I'm on Slide 2. So Q2 was solid.

Reported sales of $15.3 billion were up 3%.

3% organic growth.

One point of net acquisition benefit was offset by one point of foreign exchange headwind.

Adjusted EPS of $1.85 was up 2%.

Reported EPS of $1.80 included $0.05 of restructuring this quarter and was up 5% on a comparable basis.

Cash generation was also very strong, free cash flow of 119 -- 118% of net income.

For the first half, free cash flow was 84% of net income, including the adverse impact from the Watsco transaction and the payment of the Canadian royalty settlement.

As we have said before, we continue to expect full year free cash flow to net income towards the lower end of the 90% to 100% range.

On Slide 3, you'll see on the left the trends of our organic growth over the last 5 quarters.

And on the right-hand side, you see the breakdown of the Q2 organic performance.

Looking at our commercial businesses geographically.

Americas remains solid.

Otis sales were up 8% on top of 10% growth in last year's second quarter in the Americas.

Sales at CCS were up 7%.

In EMEA, sales were flattish, with slight growth in Europe offset by continued weakness in the Middle East.

Asia sales were flat as well in the quarter, driven by China, which was down 10% for Otis.

For rest of Asia, Otis was up low single digit and CCS, high single digit.

On the Aerospace side, commercial Aerospace sales were down 1% in the quarter, almost counterintuitive, right, as strong growth in the aftermarket businesses at both Pratt & Whitney and Aerospace Systems was more than offset by a contraction in OEM sales.

UTAS commercial OEM sales were down 8%, driven by 777 landing gear resourcing and legacy program rate reductions.

Pratt Canada OE engine shipments were also down 19%, driven by the helicopter and general aviation end markets.

Year-to-date, commercial Aerospace sales were up 2%.

Military sales were very strong, up 30% at Pratt & Whitney and 5% at Aerospace Systems.

The continuing strength in orders at our commercial business units that Greg mentioned and solid Aerospace backlog gives us confidence in increasing our organic growth expectation for 2017 and the lower end of the EPS range.

That said, unlike in prior years, EPS in the second half will be lower than the strong first half.

Segment operating profits will be up $0.12 to $0.15 sequentially in spite of higher negative engine margin in the second half.

However, higher interest and taxes will more than offset that.

In addition, we will also see higher eliminations and increased investments in digital initiatives in the second half.

Bottom line, we feel highly confident in our revised EPS range of $6.45 to $6.60, but we do not expect to deliver over $6.60, the high end of the range.

With that, I'll turn it over to Carroll, who will take us through the business unit details.

Thanks, Akhil.

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

And as a reminder, there's an appendix on Slide 12 with additional segment data as a reference.

Otis sales were $3.1 billion in the quarter, and that was up 1% organically.

Excluding China, organic sales were up 4%.

Operating profit was down 5% at constant currency.

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

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

New equipment sales were up 1%.

Mid-teen growth in North America and high single-digit growth in Europe were largely offset by a 12% decline in China, where the market environment remains very challenging.

Service sales were up 5%, including the benefit of acquisitions.

Otis saw solid growth in modernization and repair, while maintenance sales were up low single-digit.

New equipment orders were flat in the quarter, with 6% growth in North America offset by a decline of 14% in Europe on tough compares.

In China, Otis saw 3% orders growth, with unit orders up 7%.

Full year expectations remain unchanged.

We continue to expect operating profit to be down $125 million to $175 million at actual currency with slightly higher than expected pricing and mix pressure, but less FX headwind.

Turning to Slide 5. Climate, Controls & Security sales grew 7% at constant currency in the quarter.

Operating profit declined 1% at constant currency.

And FX translation was a one point headwind to sales and earnings.

CCS sales grew 5% organically in the quarter, driven by strong North America residential HVAC sales, up 11%.

Global commercial HVAC was up 3%.

And following a strong Q1, commercial refrigeration sales were up 12%.

And after more than a year of declines, transport refrigeration saw 3% growth.

Equipment orders at CCS were strong again in Q2, up 11% organically after 7% growth in Q1.

And as Greg said, the orders growth was across all major product lines.

Transport refrigeration orders were up 38%, North America residential HVAC was up 16% and commercial refrigeration was up 9%.

Commercial HVAC and Fire and Security products were up mid-single-digits.

In short, this was the best growth in CCS organic equipment orders since Q4 of 2014.

Despite solid top line growth, operating profit declined 2% from the prior year, including the impact of FX.

Consistent with Q1, we saw a negative impact from mix at several CCS business units.

Additionally, CCS added to the charge they took on the large commercial project in Q1.

That charge was largely offset by positive one-time benefits, including the sale of a Joint Venture investment.

Looking ahead, we expect improvement in the second half driven by strength in equipment orders, productivity initiatives and lower FX headwind.

We continue to expect CCS operating profit to grow by $100 million to $150 million at actual FX in 2017, but likely closer to the low end of the range.

We now expect that CCS will see low- to mid-single-digit organic sales growth for the full year.

Turning to Aerospace, on Slide 6. Pratt & Whitney sales were up 6% organically in the quarter.

This was driven by 30% growth in the military engines business, which benefited from higher F-135 deliveries, aftermarket strength and development revenues.

Commercial aftermarket sales were up 4%, with V2500 strength partially offset by lower sales at Pratt & Whitney Canada.

Commercial OEM sales were down 10%, with increased Geared Turbofan deliveries offset by lower shipments of V2500, GP7000 and Pratt & Whitney Canada engines.

The recent supplier quality escape discussed at the Paris Air Show, which was related to engines supporting the A320neo program, unfortunately impacted Airbus Q2 aircraft deliveries.

Pratt & Whitney worked aggressively to mitigate the impact of this temporary disruption.

Pratt delivered 134 GTF engines in the first half of the year, including customer deliveries and spares.

We continue to expect a full year total of 350 to 400 GTF engines, as Greg mentioned earlier.

Operating profit of $408 million declined 10%.

Drop-through from increased military sales, commercial aftermarket and favorable FX and pension was more than offset by the absence of the prior year's contract settlements and sale of legacy hardware.

Continued ramp-related investments and lower Pratt & Whitney Canada shipments were also headwinds in the quarter.

Based on first half results and anticipated increases and negative engine margin in the second half, we still see Pratt & Whitney full year operating profit being down $150 million to $200 million, but likely closer to the $200 million end of the range.

Turning to Slide 7, Aerospace Systems sales were down 1% organically.

Operating profit of $603 million was up 2%.

Commercial OEM sales were down 8%, driven by declines in legacy program volume that more than offset growth on new programs in the quarter.

Of note, the end of the Boeing 777 landing gear production at Aerospace Systems impacted commercial OEM sales in the quarter by approximately 3 points.

New program sales are expected to ramp more significantly in the back half of the year.

Commercial aftermarket was up 7%, driven by 17% growth in provisioning.

Parts were up 2%, while repair was up 7%.

Military sales growth resumed in Q2 and was up 5%, with growth in both OEM and aftermarket.

Operating profit growth was driven by drop-through on higher commercial aftermarket and military sales, continued cost reductions and favorable FX impact.

These tailwinds were partially offset by unfavorable commercial OEM volume and mix.

With solid first half results at Aerospace Systems, we continue to expect operating profit to be up $50 million to $100 million for the full year and likely toward the high end of the range.

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

Okay.

Thank you, Carroll.

So a solid quarter and a solid start to the year, all of which gives us confidence in our full year EPS guidance of $6.45 to $6.60.

This year is playing out just as we had expected.

Again, some puts, some takes, but still a lot to do.

And I think that's probably the motto.

We need to continue to focus on execution, we need to continue to focus on cost reduction and we need to be disciplined with our investors' money.

Having said that, UTC's portfolio is well positioned for growth in the future with the investments that we're making.

We remain focused on the aerospace and commercial buildings market globally.

And we think we've got the products and services that will allow us to continue to grow for years to come.

With that, let me stop and open it up for questions.

LaToya?

(Operator Instructions) The first question is from Nigel Coe of Morgan Stanley.

Your line is now open.

Thanks.

Good morning, guys.

So I just wanted to start off with Otis, plus 7% order growth in units and plus 3% overall in China.

So just doing the math, 4 points negative from price/mix.

Is that the right arithmetic, Akhil?

And if that's the case, that sounds like good news, so maybe just comment on that.

Sure.

So this is truly the best quarter we've seen in a while on that price/mix balance, Nigel, to your point.

It's actually 5 points, and then we get a negative 5 points from price/mix, we get 1-point benefit from major projects, so, but still negative 5 versus negative 11 that we saw in the last quarter, so pretty good, or negative 13, actually, in the last quarter.

So good progress there.

But as you know, the data, the orders that we book this quarter will actually show up in sales some time probably second quarter next year, right, first and second quarter next year.

So I think there's still a long way to go.

It's one quarter, but it's encouraging.

Any reason to assume that wouldn't continue in the second half of the year?

Well, there is still overcapacity in the Chinese market, as you know, and we've got to just see how it plays out.

There is still 700,000 elevator unit capacity as against a demand of maybe 500,000, 525,000 units.

So that pricing pressure will continue.

The challenge we are seeing in China, though, is on the input side a little bit more than we had expected.

The material productivity, which used to offset the pricing pressure, has not been forthcoming this year just because commodity price increases and some of the other, that's keeping a little pressure on the margins in China.

But certainly on the top line, it's an encouraging sign to see the price/mix equation move in the right direction.

So let me just add, perhaps, the more bullish view on China, which is, it is still a growing market.

The GDP there will grow more than 6.5%.

Property prices remain strong.

The long-term outlook is very good.

Look, we're suffering this year through the, well, really, the remnants of what were a tough 2 years where pricing was very, very difficult.

But I think, to Akhil's point, it's encouraging what we're seeing here in the quarter.

And while we won't see these in actual results play out until early next year, it's still encouraging to see the Chinese market growing.

And I think, to Akhil's point, we did not get the benefits we thought out of commodities this year.

As the dollar has weakened, commodity prices have gone up, not unexpectedly.

And that's played out both at Otis and at the CCS business this year.

So again, some good, some bad.

But long term, we remain bullish on China.

Great.

And then a quick follow-on just, maybe just mark-to-market on how the U.S. dollar versus raw materials are looking right now versus plan.

And maybe just touch on the contingency you have right now at the midpoint.

Well, just on the dollars versus commodity, we did not plan for copper to be at about $6,000 a ton today, which is about $3 a pound.

That's up significantly from the year, but we'd also, as you recall, planned for a euro closer to parity with the dollar...

$1.05.

$1.05 closer, right, versus where it is today.

So what we're losing on commodities, on steel and on copper, more than making up for that in the, on the currency side.

As far as the contingency...

Yes, Nigel, as you know, the FX can move a lot, right?

I mean, last year, as we were looking at, in the second quarter, a euro of $1.12 on average, third quarter, it was $1.13.

And then it went down towards the $1.05, $1.03 level.

So yes, it feels good today.

With regard to our forecast, what we've assumed is in Q1, we saw $1.06 euro; second quarter $1.09.

We have assumed it will be $1.11 for the rest of the year.

And if that's what it stays at, we have about roughly a $50 million pickup in earnings from FX.

That's, as Greg said, we'd probably lose more than that in the commodity side for both Otis and CCS.

So net-net, contingency still where it was, given the raise in our guidance, at the bottom end.

At the new midpoint, I would say the contingency is about $70 million.

At the top end of the range, there is no contingency.

Great.

I'll leave it there, thanks a lot.

Thanks, Nigel.

Thank you.

The next question is from Jason Gursky of Citi.

Your line is open.

Good morning, everyone.

Akhil, I was, or Greg, can you, I was wondering if you could walk us through the expected [earnings] over the next [4] quarters on the Aerospace side of the business.

We've got lots of moving parts, obviously, with the Geared Turbofan ramp.

You've got the wind down on some of your work on the 777.

But maybe just help us from the outside on how you see this playing out from a year-over-year perspective.

Can you point to any particular quarter where things begin to align and growth resumes from a top line perspective?

And if you do see that, can you talk a little bit about your assumptions around aftermarket growth?

You've got lots of, I guess, what I'd describe as lumpiness given the initial sparing activity that's going on there.

But when do we get kind of a momentum going on a clean quarter without a lot of lumpiness and wind downs?

Thanks.

Yes, unfortunately, lumpiness is part of life in aerospace, to some extent, right?

I mean, that's just how life plays out.

But in, for UTC Aerospace Systems, Jason, I think we expect commercial OEs to be up in the second half a little bit.

But overall, for the full year, we expect flattish commercial OE.

On the other hand, we do expect the commercial aftermarket business to be up mid-single-digit as opposed to the low-single-digit we were thinking before.

So a little more positive on the commercial aftermarket side, largely because of the strength we've seen in provisioning in the first half.

Compares will get very difficult for provisioning for UTC Aerospace Systems in the fourth quarter, which was a very, very strong quarter last year, as you know.

So I think there is some lumpiness which will come.

But on the commercial OE side, which was a bit of a surprise in Q2, we do see the new programs pick up in their production rates in the second half.

That will more than offset the bad news from the 777 resourcing and the cuts we have seen on the wide-body market.

So I think, net-net, still feel overall good.

With regard to Pratt, I think the outlook is pretty solid, consistent good growth both on the OE side as well on the aftermarket side.

Again, compares get a little bit more challenging, but at least it's a good growth every quarter onwards through 2020, I would say.

And as you look out over the next couple of years and think about potential sunsetting programs, any come to the top of your mind?

Maybe talk a little bit about any kind of exposure that you might have on the A380 and just any other sunsetting programs that we all should be thinking about at this point.

Thanks, guys.

Jason, I think you probably hit on it with the A380.

We didn't ship any engines, GP7000 engines, this quarter, or just a couple, I guess.

But that program is essentially done for us now.

That's the GP7000.

That's our partnership with GE.

And we don't foresee production on that resuming.

You've also, of course, got the V2500 on the A320neo, which will be going out of production probably in 2019.

We see that stepping down significantly again next year.

Of course, the GTF, we'll build 350 to 400 of those this year.

Next year, you'll probably build north of 700 of those.

So that should pick up the slack that you'd see on the sunsetting programs on the Aerospace, or on the Pratt side.

As far as Mr. Gitlin's business, the Aerospace Systems, I think the biggest pain has already been felt.

That's the 777 landing gear, which, as you know, was resourced by Boeing to another company, and that business won't come back.

Having said that, though, we still are well positioned at both Boeing and Airbus on the Aerospace Systems and all the other new commercial aircraft, be it Embraer, be it the C-Series or even the MRJ.

All of those things will pick up in production over the next several years.

So a few negatives, but on the most part, it's pretty positive in terms of where we see top line.

Pratt will have 10%, kind of, organic growth through 2020.

And the Aerospace Systems guys probably in that 5% to 7% range, so all generally positive.

All right, thanks, guys.

Thank you, and the next question is from Julian Mitchell of Credit Suisse.

Your line is open.

Hi, good morning.

Just a question on CC&S.

The profit trajectory, even at the low end, I think, implies around 9%, 10% profit growth in the second half, after down 2% in the second quarter.

So maybe just if you could bridge how much really is coming from volume leverage, how much from extra productivity within that sort of step-up in year-on-year profits.

Let me start with that, Julian.

First of all, if you look at Q2, some anomalies have actually drove margin down.

First of all, of course, it's the acquisitions that we've made over the last 1.5 years or so.

That accounted for about half of the margin degradation that we saw.

But we also had some adverse mix.

And most of that, again, it's new products that we have been introducing, both on the commercial refrigeration and the transport refrigeration side, where we are still coming down the learning curve, much like we are on the GTF.

And so some of the products are not going out with normal margins.

We're also seeing strength in Transicold in Eastern Europe, where the price is much more competitive than what we typically would see around the world.

So there's some mix, there's some cost reduction.

At the end of the day, though, the back half is going to be driven by top line growth.

And I think when you see 11% orders growth in equipment here in the second quarter on top of 7% in the first, we've got a record backlog at CCS, which will play out.

So this is going to be a top line-driven recovery in the back half of the year.

Still confident in that, we call it, $100 million to $150 million of profit growth.

Probably towards the low end of that, just given where commodities are and some of the other macro headwinds, but we still see positive momentum going into the back half of the year.

Yes.

And Julian, I would just add that the mix story feels very real in terms of the changes.

The one example that Greg mentioned, the transport refrigeration business, as you know, both the container and North America truck / trailer businesses have been down or weak relative to the past experience.

And those are highly profitable businesses.

As we look at our backlog and the orders that we saw, both those businesses grew very nicely in terms of the orders and backlog.

And that should convert into good earnings in the second half.

Cost product, cost reductions in the commercial refrigeration space.

Also the mix shift between service and installed business within the Fire and Security field side, which is what has hurt us in the first 2 quarters, is expected to change a little as the focus of the management team changes.

And then Bob has several productivity initiatives that he has launched in addition to pricing actions that will help improve the back half.

But yes, you're right.

I mean, it still feels like a big hill to climb, but Bob has actions in place to help achieve, at least to the lower end of the range.

Thanks, and then just one quick follow-up on Aerospace.

Within Pratt & Whitney, the margins seemed to be hanging in there quite well considering everything that's going on.

Do you think you're within sort of touching distance now of the floor on margins in that division?

And I guess, related to that, any change to that $350 million commercial OE mix headwind you'd guided for this year?

Julian, I think, first question first.

I would say that just math would suggest that probably next year will be the low point of the margin at Pratt, right, because we've talked about peak negative engine margin coming in, in 2018.

Sales will grow nicely in 2018.

But I think the profit is still to be discussed and to be worked out.

So I think there will be some margin pressure at Pratt in 2018.

With regard to the current year, I mentioned this at our last event at the Paris Airshow as well, I think for this year, negative engine margin is likely to be higher than the $350 million that we had.

Exactly what, we will work through over the next few months and see where it all ends up, just because of the extra costs we have been incurring with, associated with the ramp, some early issues that we have been dealing with, which have pushed out some of the cost reduction actions that were in place before.

But that is being offset by a stronger commercial aftermarket.

So we feel good about the Pratt guidance overall, but there is some puts and takes, as Greg said at the beginning of the call.

Thank you.

Thank you.

The next question is from Sam Pearlstein of Wells Fargo.

Your line is open.

Good morning.

If we remember last year, in the second quarter, you had exceptionally strong V2500 aftermarket sales.

So this Pratt & Whitney aftermarket is against a very difficult comp.

How should we be thinking about Pratt aftermarket sales in Q3, Q4 in terms of the comparisons get a little bit easier?

Yes.

Sam, overall, the Pratt large engine aftermarket is doing pretty well.

We're going to do more V2500 overhauls this year than we did last year.

There's probably demand out there for better than 900 shop visits on a worldwide basis, so that's good news.

The content has also been pretty healthy there, as well.

But the overall trajectory hasn't really changed, when you think about the fleet demographics.

The 4000 continues to be in attrition mode.

We'll see fewer shop visits year-over-year there.

So overall, I think we're happy with how the aftermarket is trending this year.

Looks like it's going to be pretty decent rounding out the balance of the year.

But overall, no real change to the fundamental trajectory that we set coming into the year.

Okay.

And can you talk a little bit about Otis Europe service?

I know that there was improvement in the first quarter.

And I was surprised to see EMEA looked flat in the second quarter.

Just thought that that was starting to see more improvement.

Well, I think, actually, Sam, we, I would say we're starting to finally see some traction in service in Europe.

And there was still a little bit of pricing pressure on the regular maintenance.

We still saw some good traction in repair and modernization.

So I'd actually say Europe feels a lot better.

If you look at orders in Europe, I think in the quarter, we were down 14% for new equipment, but that was off of a 42% growth last year.

So still really good activity on the top line.

Again, part of the problem there is as we deliver all that new equipment, you're going to see margins in Europe contract a little bit because of the mix between new equipment and service, but starting to feel broadly better about Europe.

I think the economy is picking up there.

And we're starting to see some real traction.

Yes, Sam, I'll just add to that.

As you know well, I think the first sign of improvement comes through the new equipment order book.

And we are seeing, certainly, we are seeing that.

Otis new equipment orders were up 13% in Europe last year, up 28% in the first quarter this year and down, but off a very, very tough compare in the second quarter.

On the service side, pricing has been improving, but not at the pace, and we certainly didn't expect it to improve too much.

So it's still down year-over-year, but at a much lower rate than we have seen over the last few years.

So revenue per unit is improving.

We still have investments we are making on the cost side, particularly with the digital tools.

We now have about 10,000 of our worldwide technicians with the new digital tools.

That adds a little bit to the cost initially as we are taking people off their work routine and putting them through training, but that will start to deliver results over time.

So I think that equation still has to play out, but it's an encouraging sign.

The other aspect, I would say, is for Europe service.

Inflation is starting to at least be talked about a little bit, even though at very small levels.

But for many years, there was no discussion of inflation at all.

And now, at least there is some talk about potentially a little bit of inflation coming through, which will ultimately show up in our pricing and will relieve some of the price pressure we have seen in Europe.

But still a long way to go, I would say.

Okay, thank you.

Thank you.

Ladies and gentlemen, as a reminder, we do ask that you limit yourself to one question.

The next question is from Jeffrey Sprague of Vertical Research.

Your line is open.

Thank you.

Good morning, everyone.

Just back to CCS, if we could.

You went through kind of all the moving pieces there.

You do have a lot of product launches going on kind of across the portfolio.

A, I wonder to what extent you're using price to elbow back into some of these markets, or b, to what extent do you see a negative price response from your competitors as you work to kind of seat these additional products in the marketplace?

Look, Jeff, you've got to look at this market by market and product by product.

I would say, broadly, there is, continues to be price pressure, especially in some of the emerging markets.

And we see that in China.

Commercial HVAC, I think, was up 4% in orders in China this year -- this quarter, and it was on the back of new product introductions.

We've actually got some higher efficiency, bigger chillers that we brought to market.

But those, of course, will come at a lower margin just as you come down the learning curve on that.

As I said, I think CCS this year will introduce 130 new products.

If you think about commercial refrigeration, we have typically been in the stationary display cases.

And we have been moving to some of the smaller, more mobile display cases, again, to try and grow the top line there, which we're doing.

But it's coming at a lower margin.

And so I think that's just the natural progression of the business.

As you introduce new products, margins are going to be lower.

It will come down the cost curve.

Pricing will get better over time.

But emerging market pricing is always going to be tough.

If you're in Eastern Europe, if you're, whether it's Russia or Poland or the Czech Republic or in China, you're always going to see a lot of pricing pressure there.

So I don't think it's anything unusual.

Yes, the one place, Jeff, that seems to be holding up okay is the North America residential HVAC side, where pricing seems to be holding up okay.

But most other markets, we are seeing the equation, the dynamics that Greg mentioned.

If you recall, in the CCS road map, EBIT road map, we had talked about a $25 million tailwind from commodity price combination.

We now think it's probably a $25 million headwind for the year just because of the pressures in most of the markets, and no lift, no benefit from the commodity side.

Now more than half of that or half of that will be offset by FX, as Greg alluded to earlier.

But definitely, that dynamic is not quite playing out as we had expected.

All right, thank you.

Thank you.

The next question is from Ron Epstein of Bank of America Merrill Lynch.

Your line is open.

Good morning, guys.

Greg, if I may ask you a bigger strategic question.

This year, there's been a lot of talk, particularly at Paris.

And I think tomorrow, Boeing reports their first quarter, where they break out a new aftermarket service segment.

How do you think about that in light of your commercial aerospace businesses?

I mean, how much pressure have you seen so far from the various OEs trying to get a bigger piece of the aftermarket?

And then how do you think about that going forward when you're going to make investments in that business, you know what I mean, in terms of your returns, so on and so forth?

Yes, Ron, that is one of the fundamental strategic issues, I think, that the aerospace industry has going forward.

It's who gets to participate in the aftermarket.

And the model has always been that the OEs take big risks and invest big dollars, along with the first-tier suppliers, to develop all of these innovative products and solutions.

If we're going to change that model, where the OEs are going to take more of the aftermarket or demand more of the aftermarket, we're going to have to think about how we price our products to the OEs.

If you think about it, we spent $10 billion on the GTF platform just getting it to market.

And we're spending over, or we'll spend $1 billion a year on negative engine margin.

If all of a sudden, I lose that aftermarket, I don't have a business going forward.

And so I think we need to have these discussions as we have started to do with the big OEs about partnership, risk revenue sharing arrangements.

But clearly, you can't continue on with the current business model if the OEs are going to demand a bigger and a much more significant chunk of the aftermarket.

The good news is we've got great technology.

And I think as long as we continue to innovate and stay ahead of the curve on the technology, we'll have an ability to have those discussions on a kind of a level playing field with the OEs.

And I think that's very important as we go forward.

But it, there is a lot of pressure out there.

We've had the various SCOPE initiatives out of Airbus.

We've had PFS 1 and now PFS 2 coming from the Boeing company.

We've, again, it's tough.

We're always looking for cost reduction.

It's a very competitive marketplace.

And we just have to continue to invest and stay ahead, from an innovation standpoint, if we're going to continue with the business model that we've got.

But it's a tough question.

Now just if I may follow up on that.

Be it that you have a whole portfolio of businesses, if it really got tough enough, would you just start allocating capital someplace else?

Well, I think what you, again, the more difficult it gets from a pricing and aftermarket standpoint, I think what you'll do is you'll try and focus on those systems on the aircraft where you've got the best technology and the biggest competitive advantage.

And so we have some product lines that are not as robust from a market standpoint as others.

You may see us decide to allocate capital differently in that respect, as in we just don't invest in those things where we don't have a clear market lead or a clear technology lead.

But again, those are all good questions, I think, at the individual portfolio.

And it's the same thing, I would say, across the business.

I mean, there are places where we're not making money as much as we'd like.

We're not going to allocate capital there unless we know that we're going to get a return on it.

So it's not lost on us, Ron, I think, as it's one of the things we think about all the time and talk about all the time internally here.

Okay, great, thanks.

Thank you.

The next question is from Steve Tusa of JPMorgan.

Your line is open.

Hey, guys.

Good morning.

What do you guys see from Otis second half?

Is this kind of a sustainable trend now in China for those guys, from an OE perspective?

Difficult to say, Steve.

As you know, I mean, the market kind of moves, right?

So while the expectations for this year were flat, maybe 5% down in the new equipment order market, the first half has been a little better than that, we believe, for the market.

Certainly better than that for us.

So we hope that that trend continues.

But also, of all the markets that we play in, China is probably the one where it's more difficult to call in terms of exactly how it will play out.

The government there has abilities to move the markets much more than other markets.

And so my crystal ball is not that clear on Otis China.

Okay.

And then when it comes to the Pratt engine loss next year, so I think you said sales up, margins down a little bit.

Is there any change to kind of the year-over-year dynamics around, I think the engine loss is a little bigger this year, but any change to kind of the year-over-year for '18?

And do you think you have kind of your, kind of the, any incremental risk ring fenced at this stage of the game?

Or is it still kind of too early to call?

You keep trying, Steve.

And we keep saying we're not going to tell you.

But let me just put it this way.

We still believe 2018 is going to be the peak for negative engine margin at Pratt.

Whether it's going to peak at exactly what we thought 6 months ago, I'm not sure.

I'm looking at the learning curves on a monthly basis.

And we're still coming down an 87% learning curve on the engine.

Now we're a little bit behind in production.

We'll catch up in the back half of the year.

And we're still, there's things that we need to do, engineering changes to drive some costs out of the engine.

Some of those things are taking a little bit longer than what we expected.

Certainly, some of the support costs and for the supply chain has been a little bit more expensive than what we thought.

So all that will play into product costs next year, maybe not from a materials standpoint, but certainly from an overhead standpoint.

So Pratt is working through all that.

And we'll have a much better view here in a couple of months.

I would tell you, as we look out at the long term, by 2020, 2021, we are right on top of what we said we were going to be when we started the program.

So Pratt's got-- there's a lot of work to do as suppliers move from high cost to low cost.

There's redesigns that have to happen to drive some costs out.

But we're seeing the productivity, both in our factories and in our suppliers', that give us confidence we're going to hit that 2020 goal.

So again, we'll see where we are.

I would tell you, there's pressure on the negative engine margin next year.

Full stop.

Now whether that's $10 million or more, I don't know.

Akhil likes to say, "Don't say anything." So I won't tell you, but we're working through it.

Okay.

And then if, maybe you won't answer this one, either.

Akhil, you gave great detail on kind of the first half to the second half.

So much detail that, I'm not a math guy, so I had a lot of trouble kind of putting all the numbers in my spreadsheet.

Maybe you can help us out with the third quarter just number.

I mean, The Street is at $1.72.

You gave a ton of detail around the second half.

Is that around the right kind of number, so that we can all be kind of calibrated for second half?

Steve, saying you're not a math guy, really, it's a little disingenuous.

But okay.

I've never known a better numbers guy than you.

So I don't know, Akhil, you want to talk about third quarter?

I, we typically don't talk specifically about a quarter, right?

Steve, I mean, you know that the negative engine margin is going to be greater in the third quarter.

We've had a good strong finish to the second quarter.

Not all of, none of that, I expect, is going to flow through for the full year.

So it obviously has to balance out of Q3 and Q4.

You guys make a pick.

You are smart people, smarter than I am.

You can make a pick on how much comes out of Q3 and how much comes out of Q4.

Okay, now who's being disingenuous?

Thanks a lot, guys.

Thank you.

The next question is from Doug Harned of Bernstein.

Your line is open.

Thanks, good morning.

I wanted to talk about the Geared Turbofan because, I mean, Airbus only delivered 6 GTF-powered neos in Q2.

I mean, they've got a lot of airplanes on the ground in Toulouse without engines on them.

How do you see the 350 to 400 engines you plan to deliver, how do you operationally see that playing out this year?

Yes.

Doug, as we've pointed out back in June at the Air Show that we did have a sub-tier quality escape that caused us to retest a number of engines late in the second quarter, and that obviously caused some issues on the production line in Toulouse, which caused the small number of aircraft to be delivered.

As I think about it, we built in the first half of the year about 145 GTF engines.

We delivered a little bit less than 140.

The back half of the year, we'll do -- if we do 205, that takes us to the 350.

Clearly, we see line of sight to 350-plus.

And whether we get all the way to 400, I don't know.

But we've got a commitment to Airbus in terms of the number of engines that we have to get on dock.

We did that through the end of the second quarter, albeit with a lot of pushing and shoving at the very end because of this retesting that we had to with some of the engines.

So hopefully, we'll get some of these kinks worked out here in the third and fourth quarter and make it a little bit more seamless for Airbus because it's causing them pain on the line out there.

But what happens, given that in October, you should be delivering the new combustor, so the engines that you're building before then will be, I assume, with the previous design, which has the issues that we well know about.

How do you see that going forward since you're going to have this mix delivered out to the customer community?

And does this mean you're going to be ultimately doing a lot more retrofits later on?

Well, so what will happen, Doug, is we will, because the life on the current combustor is not what we had expected, we'll have to manage that configuration.

And our plans for the next couple of years will be to bring those engines in at probably an earlier overhaul interval than what we had expected.

We've factored all of that in, of course, from all of the contracts that we have already, because we know the timing of how long they'll last on wing.

And hopefully, by the time we get to this next generation of combustor, we call it the C-star combustor, we'll have adequate life on it so that we won't have to worry about it.

But it's just one of those configuration things that we'll have to manage with the airline operators.

The good news about the combustor is we can actually schedule overhauls.

It doesn't result in canceled flights.

It doesn't result in a lot of disruption to the operator.

And so again, you can manage that through spares and planned overhauls, because you could measure the deterioration of the combustor liner over time.

So while it will be a little bit more expensive, we've factored it in.

We're working with the airlines.

They understand the product that they're getting is not of the quality that we had originally expected, but we have, we've got a plan to get that fixed, and we'll manage it with them.

So presumably, this is all in your, the margin outlook guidance you're giving us sort of this year, next year?

Yes.

Keep in mind, these are 20-year aftermarket contracts, right?

So while the first overhaul might happen a little earlier, we'll incorporate other things that should keep this engine on wing longer, which will ultimately benefit the margins over the long term on the program.

Yes.

I just wanted to make it clear, Doug.

I mean, yes, it's all factored into 2017 the way we've made out our guidance.

But we have not yet given guidance for 2018.

So we've got, I know you guys are anxious to get to that, but there is a timeline we follow.

We want to get through our planning process and make sure we understand fully and give you a number that we can live by.

Okay, thank you very much.

Thank you and once again, as a reminder, please limit yourself to one question.

And the next question will come from Myles Walton of Deutsche Bank.

Your line is open.

Thanks, good morning.

First of all, I just want a clarification.

How big was that second charge at CC&S on the applied?

And then in terms of going back to I think Ron's question on the aftermarket, just when you think about your business and the mode around your business in spare parts, you clearly get massive notes.

But in your UTAS, in particular, the MRO business you have, how big is MRO versus what you'd consider more of your spare parts, closed off aftermarket in UTAS, where price is a determining, or at least partial, determining factor in retaining that business?

So first question, I think, on the charge, it's about $0.03 in the second quarter.

But as Greg said, or as Carroll said in the script, the -- it was almost entirely offset by positive sort of one-timers.

So I won't say that the charge, while it was painful, was the reason for the, for whatever performance you saw out of CCS in the current quarter on a one-timer basis, right?

And with regard to your second question, I think we've talked about the fact that UTAS commercial aftermarket is about $4.5 billion in totality.

And the repair part, the MRO part of that business, is probably $1.5 billion to $2 billion of the $4.5 billion, roughly, give or take.

$1.7 billion, $1.8 billion, or something in that range.

Of the remaining on the spare parts and provisioning side, I would say one thing, Myles.

It's not that easy.

When we have the aftermarket, we have IT and we have the technology content on those spare parts, the onus is on us to make sure that we stay ahead from a technology point of view.

There are no surplus or substitute parts available to displace us that easily, because that's where the value is, that's where we -- that's what we invested in.

And we have to get the returns on those.

So I don't expect that to become a source of great contention in terms of pricing or whatever.

We just have to make sure that we stay disciplined and keep that aftermarket to ourselves.

And then on E&D, I think it's up $60 million in the first half.

But Akhil, I think you mentioned it as a headwind in the second half.

What is it supposed to be up for the full year?

Are you talking about E&D for...

Overall, the company, at the company level.

Yes, I think, some of it is, it's, again, not that inconsistent.

We do expect E&D to come down in the back half for UTAS and level off at Pratt as well.

So I think, overall, we're probably thinking $50 million to $75 million overall for the year.

So whatever you've see in the first half is probably just going to stay at that level, maybe a little bit higher at Otis and CCS, but not that much more on the Aerospace side.

Okay, thank you.

Thank you, and the next question is from Peter Arment of Baird.

Your line is open.

Thanks, good morning, Greg and Akhil.

Greg, quickly on Pratt & Whitney Canada, shipments down 15% year-to-date.

How should we think about that for, I guess, just overall for the year?

And maybe if you could just give a little color on what you're seeing in general regarding the kind of the individual components.

I assume the weakness is just all biz jets and civil helicopters, but just a little color on that.

Yes, you've got it exactly right, Peter.

The fact is civil helicopter has been very weak.

Part of that has to do, of course, with the oil and gas glut, if you will, which has caused demand for civil helicopter to shrink dramatically.

The other issue, of course, business jets, we still, while we believe long term in biz jets and the marketplace, we still have not really seen a return.

And we're still significantly below peak levels of production on business jets.

And those are really the two big drivers.

The rest of the business, the regional, turboprops and all that, all pretty good.

But it really is just those 2 markets that have been much softer than what we had expected going into the year.

Yes, Peter, we'll see year-over-year declines on those volumes in 2017 throughout the back half, maybe some sequential improvement.

But as Greg just said, the long-term trend, it feels like it's yet to fully bottom.

So about what we expected coming into the year, maybe some modest improvement sequentially on volumes, but no major change.

Okay, I appreciate that.

I'll stick to one, thanks.

Thank you.

The next question is from Matt McConnell of RBC Capital Markets.

Your line is open.

Thank you, good morning.

Just switching back to Otis.

Do you expect 2017 to be the trough year for Otis margins?

And maybe you could walk through just upside, downside drivers heading into next year for Otis margins?

Matt, we have a lot of time to talk about 2018 in great detail at -- in future times.

I think the key thing to keep in mind is our focus at Otis is about starting to grow earnings.

It's not the story right now.

It needs, we need to find a way to start growing earnings, operating margin dollars, not necessarily operating margin percent.

What I can tell you with high confidence is that we do believe we will keep, maintain and have industry-leading margins at Otis.

And they will be significantly higher than the next competitor just because of the skill we have, both on the OE side and the density benefit we get on the service side.

We have nearly 2 million service units under maintenance, as opposed to 1.4 million for the next leading player.

So that 600,000 extra units gives density, which should allow for greater productivity for our technicians and should allow us to command a premium, and therefore an operating margin percent advantage over the second and third players in the industry.

But what that number is going to be, clearly, at 900 basis points, it was too high.

But could it be 300, 400, 500 basis points higher?

Absolutely.

When we get there, I think the first step is to start growing earnings at Otis, and that itself, right now, as we are going through some challenging phase of investment and still dealing with the pressures that we are seeing in China, the biggest market, it'll take a little time.

But I'm not going to necessarily talk about 2018 today.

Okay.

On the strategic investments, specifically, could you remind us how that spending trends into next year?

So think about it this way.

We've got about 16,000 of the 31,000 technicians will be equipped with the tools this year.

The rest will follow next year.

And additionally, we will also continue to see some increase in R&D investment a little bit next year as we try to get up to the 1.8% of sales level that Greg and Philippe have talked about.

We are about 1.6% right now, so slight growth in R&D, but not much.

And then we should start to see some returns on the investments we are making this year.

So net-net, exactly how that plays out is the subject of our planning process.

And we want to get through that before we'd really give you, with any confidence, on '18.

Yes, Matt, I think the one question mark on Otis which is overhanging in all these discussions is China.

And as we have seen this quarter, we're giving a little bit positive news in terms of what's happening with price/mix, but it's still down.

And part of that will play into next year.

And if the trends that we saw in the second quarter continue into the third and fourth quarter, I think we'll feel a lot better about Otis next year.

But again, I think that's the big question mark.

Okay, great, thank you.

Thank you, and the last question will come from Howard Rubel of Jefferies.

Your line is now open.

Thank you very much.

The -- in the past, Greg, you've been able to identify restructuring opportunities that continue to position the business for positive momentum.

You have only modest restructuring so far this year.

And yet you talk a lot about pricing pressure and some other competitive challenges.

Could you elaborate a little bit along your thinking at the moment as to where you are in terms of pushing the organization to find other opportunities to dig deep to find creative solutions?

Yes, Howard, that is a great question.

And as we think about 2018, it's one of the things that we are focused on, is structural cost reduction.

And one of the things that we're trying to do is look at organizational structure, trying to flatten things out.

We've got great people throughout the organization.

We want to free up the decision-makers that are closest to the business and remove some of the bureaucracy.

So we're looking to do some structural things in the back half of the year with the organization to kind of free people up to make those decisions more readily.

So we are looking at doing some things here.

Really, it's organization.

At the same time, the need to continue to reduce factory footprint remains.

I think Dave Gitlin has got some things on his plate.

I know Bob McDonough does as well.

So we're going to continue to kind of go by the playbook of taking out high-cost locations for low-cost locations where the markets are moving.

But at the same time, we're going to look internally and see what we can do to the organizational structure, kind of flatten it out and give ourselves some additional runway for the next couple of years.

Thank you very much.

Thank you.

Go ahead.

I'll turn the call back over to you for closing remarks.

Thank you, LaToya.

Thank you all for listening in.

Carroll and his team will, obviously, be around all day today and tomorrow to answer whatever questions you have.

Appreciate you guys taking the time to listen in.

Take care.

Thank you, ladies and gentlemen, this concludes today's conference.

You may now disconnect.

Good day.