雷神技術公司 (RTX) 2017 Q3 法說會逐字稿

Good morning, and welcome to the United Technologies Third 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's a presentation available for download from the 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 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.

In addition, in connection with the Rockwell Collins acquisition, UTC has filed with the SEC a registration statement that includes a preliminary prospectus of UTC and a preliminary proxy statement of Rockwell Collins, which is not yet effective, which contain important information about UTC, Rockwell Collins, the transaction and related matters.

(Operator Instructions) Please go ahead, Mr. Hayes.

Okay.

Thank you, Latoya.

Good morning, everyone.

You saw from our press release this morning Q3 was another strong quarter for UTC.

We saw adjusted EPS of $1.73 and adjusted sales of $15.4 billion.

That included organic sales growth of 6%.

Our performance through 3 quarters and a clear line of sight to Q4 gives us confidence to raise our 2017 EPS expectations to a range of $6.58 to $6.63, and that's up, of course, from $6.45 to $6.60.

Clearly, the investments we've been making into the business are translating now into sustained sales growth.

The third quarter was UTC's best quarter for organic growth since 2011.

And our year-to-date organic sales growth stands at 4%.

Pratt & Whitney's organic growth in the quarter was 15%.

Pratt shipped 120 Geared Turbofan engines, which includes some of those that were allocated to our spares pool, but that 120 shipments nearly matches the output for the entire first half.

So with 254 engines shipped year-to-date, Pratt remains well on track to the 350 to 400 engine target that we laid out earlier this year.

Maybe just a quick update on the GTF durability issues.

Pratt remains on track to certify a combustor upgrade to incorporate into new engines here in the fourth quarter.

With regard to the #3 seal issue, you'll recall that production engines began receiving upgraded hardware back in the second quarter of this year and then ongoing retrofits were completed out in the field.

While we're still seeing some success with the actions we've taken to date, we're also looking at design alternatives that are expected to further improve durability of the engine.

We'll continue to work closely with our customers to support their operations as future retrofits are completed.

At CCS, we have introduced more than 200 new products over the last 2 years and these investments in innovation are paying off with sales growth.

In the quarter, we saw 4% organic sales growth, with all the major businesses in CCS contributing.

Year-to-date, CCS new equipment orders are up 7%.

At Otis, as you know, we've increased our R&D investment over the last several years to accelerate the development of some innovative new products for our customers and to address some underserved segments.

In 2017, Otis will launch twice as many product variants than in 2015 and these innovations are helping to drive organic growth.

In the quarter, Otis saw 2% organic growth.

This is Otis' third quarter straight with organic sales growth in spite of the continuing pressure we see in China, which, of course, is the largest new equipment market for Otis.

As you saw, of course, in the -- we announced the appointment of Judy Marks as the new president of Otis recently.

I'm confident that, as you interact with her over the coming months, you'll be impressed with the leadership skills and strong focus on the customer as she drives both strategic growth, innovation and earnings growth at Otis in the coming years.

We're excited to have Judy on the team.

So a good quarter for UTC.

We remain focused on executing on our strategic priorities and we're confident in the improved outlook for 2017.

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

Thanks.

Akhil?

Thank you, Greg.

So I'm on Slide 2. Reported sales were $15.1 billion, up 5%.

That included 6 points organic growth and 1 point of favorable foreign exchange.

This was partially offset by 2 points from a nonrecurring charge at Pratt & Whitney related to customer contract matters.

This charge was driven by our decision to allocate more of the GTF engines produced towards spares to support the airline operators in the field who are dealing with the 2 durability issues that Greg mentioned and we have discussed throughout this year.

Adjusted EPS of $1.73 was down 2% from the year -- from the prior year.

On a GAAP basis, EPS was $1.67, down 4%, and included $0.06 of restructuring.

Nonrecurring items included a $196 million charge at Pratt.

This was entirely offset by gains on sales of securities and a tax adjustment.

Operating cash net of CapEx was an outflow of $472 million, driven by the $1.9 billion discretionary contribution we made to our domestic pension fund, which we had announced last month.

So no surprises here.

The quarterly cash, when you adjust for this pension contribution, was 88% of net income, in line with our expectations, and we remain confident in our full year free cash flow guidance of $3 billion to $3.5 billion.

Turning to Slide 3. You will see the drivers of our strong organic growth.

The macroeconomic environment continues to improve and we feel particularly good about the end markets we serve.

Commercial construction in Americas and Europe remains strong and global aviation traffic continues to grow at rates above long-term trends.

So looking at our commercial businesses.

In the Americas, sales were up 6% with solid growth in Otis new equipment and service businesses.

CCS was up 6% with strong growth across all product lines.

Within EMEA, sales were up 3% with low double-digit growth in the Otis new equipment business and 2% growth at CCS.

Also, for the first time in over 2 years, we saw orders grow in the Middle East for both Otis and CCS in the same quarter.

In Asia, sales were up 2%.

Otis China overall was down 7%, a slight improvement from Q2.

The rest of Asia was up mid-single digit for Otis and was flat at CCS.

On the aerospace side, commercial aerospace sales were up 7% in the quarter.

Commercial aftermarket was up 11% at both Pratt and Aerospace Systems.

OEM sales at Pratt were also strong with higher GTF volumes and higher spare engine sales on legacy programs.

Consistent with the first half, commercial OEM sales at Aerospace Systems were down.

Military sales were up 14% at Pratt & Whitney and down slightly at Aerospace Systems.

Now before I hand it over to Carroll, a note on 2018.

We are still in the planning process for the next year, but at this point, no change to the framework we provided last month.

For the existing portfolio, we continue to expect EPS growth in 2018 with each of our 4 business units being flat to up in earnings next year.

The areas we continue to watch carefully before finalizing the plan are, of course, FX and commodities, where we've seen some inflation coming through.

Bottom line, we feel good about our increased EPS outlook of $6.58 to $6.63 for the year and our ability to grow EPS in 2018.

Organic growth is happening now and will continue, helping us to grow earnings and cash flow over the years to come.

With that, I'll turn it over to Carroll for business unit details.

Okay.

Thanks, Akhil.

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

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

Otis sales were $3.2 billion in the quarter.

That was up 2% organically.

Operating profit was down 7% at constant currency.

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

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

New equipment sales were up 2%.

Low double-digit growth in Europe and high single-digit growth in North America were largely offset by a 10% decline in China, where the market environment remains 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 down 4% in the quarter.

25% growth in Europe was more than offset by a decline of 24% in North America, which had a tough compare, as well as declines in Asia excluding China.

In China, orders were flat in dollar terms with unit orders up 8%.

Full year expectations for Otis remain unchanged.

We continue to expect operating profit to be down $125 million to $175 million at actual FX.

Climate, Controls & Security grew sales 6% in the quarter.

Operating profit grew 5%.

FX translation was a 2 point tailwind to sales and a 1 point tailwind to earnings.

CCS grew 4% organically in Q3 with growth in every major product segment.

Commercial refrigeration was up 11% and transport refrigeration grew 8%.

Residential HVAC was up mid-single digits despite lower cooling degree days in the quarter.

Global commercial HVAC was up 4% with strength in the Americas and Europe more than offsetting weakness in Asia and the Middle East.

Total equipment orders at CCS were up 2% in the quarter, primarily driven by 7% growth in global commercial HVAC.

This was the first quarter of orders growth in the Middle East since Q3 of 2015.

Commercial refrigeration orders grew high single digits, offsetting a 10% decline in transport refrigeration.

Residential HVAC orders were down 3% after seeing double-digit growth in the first half of the year.

Global fire and security orders were up 2%.

Organic volume contribution in the quarter was mostly offset by price and mix headwind.

Productivity gains from restructuring and product cost reduction delivered 4% profit growth at constant currency.

For the full year, we remain confident that CCS will deliver low to mid-single digit organic sales growth and that operating profit growth will be at the low end of the $100 million to $150 million range at actual FX.

Turning to aerospace on Slide 6. Pratt & Whitney sales were strong, up 15% organically in the quarter.

Total commercial OEM sales were up 31%.

That was primarily due to higher Geared Turbofan deliveries and favorable mix on legacy programs.

Pratt & Whitney Canada OEM shipments were down.

Commercial aftermarket sales were up 11% on continuing V2500 strength.

Sales at the military engines business were up 14%, benefiting from higher F135 and tanker deliveries, aftermarket strength and development revenues.

Pratt & Whitney operating profit of $423 million was up 2%.

Drop-through from the commercial aftermarket and higher military sales, as well as favorable FX and pension, was mostly offset by higher negative engine margin and ramp-related costs as well as the impact of lower Pratt & Whitney Canada shipments and a customer insolvency reserve.

As Akhil mentioned, Pratt has increased the allocation of GTF production to the spare engine pool, which reduces total negative engine margin.

This, along with the higher commercial aftermarket volume, leads us to expect full year operating profit to be down $125 million to $175 million but likely closer to the $125 million end of the range, and that's an improvement over prior expectations.

So before I move on to Aerospace Systems, just a note.

The shift towards spare engines will also negatively impact corporate eliminations as UTAS intercompany profit on GTF completions is eliminated at the corporate level.

Turning to Slide 7. Aerospace Systems delivered 4% profit growth on flat organic sales.

Commercial OEM sales were down 6%, 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 4 points.

Commercial aftermarket was up 11% and was driven by nearly 30% growth in provisioning.

Parts were up 2% while repair was up 8%.

Military sales were down slightly in the quarter.

Operating profit growth was driven by drop-through on higher commercial aftermarket sales, continued cost reduction and pension tailwind.

These benefits were partially offset by unfavorable OEM volume and mix.

A favorable customer settlement in the quarter offset the absence of a prior year gain from the sale of a noncore asset.

With solid year-to-date 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 on low single-digit organic sales growth.

And with that, I will hand it back to Greg.

Okay.

Thanks, Carroll.

So again, good performance so far this year, and we feel good about our revised outlook for 2017.

But more importantly, we remain confident in the business units' 2020 targets.

We're also, of course, very excited about the Rockwell Collins deal and what it will bring to our aerospace portfolio.

Collins is the ideal complement to our Aerospace Systems business.

We've been very impressed with the team at Collins and we look forward to bringing together 2 world-class organizations.

We're also confident that the combination of Aerospace Systems and Collins will create significant value for our customers as we develop aircraft systems that are more electric, more intelligent, more integrated and more connected.

We're also confident that the deal will be accretive to earnings at UTC in 2019, assuming we close by the middle of next year.

This will create value for the shareholders in both the near term and for decades to come.

As always, we remain focused on delivering our commitments to our customers and our strategic priorities, which include focused execution and innovation for growth.

And with that, let me open up the call for questions.

Latoya?

(Operator Instructions) The first question is from Carter Copeland of Melius Research.

I wondered if you could help me understand the Pratt performance a little bit better, maybe bridge that 30% growth on -- clearly, you got 14% growth in large commercial engine deliveries.

Presumably that's related to the spares deliveries year-over-year.

Maybe help us bridge that.

And with respect to the charge on the spare engine deliveries, how many engines did that relate to?

I'm not going to tell you the exact number of engines, Carter.

You're very good at math, and that's something which is contractual, so I don't think we should try and talk about that.

But it's safe to say that, that charge takes care of an uncertain cloud that was hanging over our head to some extent that some of you have been commenting about, some larger numbers that might be out there.

So I think this takes care of that.

It puts an uncertainty behind us.

With regard to the sales, I think you hit it exactly right for Pratt.

The 31% growth in commercial -- large commercial engine business, OE side, was driven, to a large extent, by the mix of spare engines on the legacy side, which had higher dollar per unit composition as always.

And so that's what drove a 30% increase while the shipment increase was only 14%.

So is there a way to characterize how many fewer spares you delivered year-over-year in percentage terms?

Carter, let's think about it like this.

So we had a commitment to Airbus, we had a commitment to Bombardier to deliver a certain number of engines this year to support their aircraft production plans.

We made the decision early October or late September, I guess it was, that we were going to redirect a number of spares to our airline customers to make sure that they had enough assets to be able to fly their plane every day.

And while the GTF has a dispatch reliability of like 99.8%, because of these 2 durability issues that we've been talking about, there were a number of aircraft that were on the ground for unacceptably long time periods.

And so working with Airbus, working with Bombardier, we agreed to take production engines and divert it into the spares fleet.

Now there was a charge associated.

That's what Akhil was talking about.

It's both Airbus and it's Bombardier.

But the fact is we had to do what was right for the customer here.

And it gets this behind us.

I think the important thing is to look at the number of actual engines that we built in the quarter, which was 120, and we're well on our way to hit that 350 to 400 next year and probably almost doubling that again next year.

So I think Bob and the team have done a yeoman's work over at Pratt to get the production issues behind us, get the durability issues behind us.

And the airlines love the engine.

And so, look, it was unfortunate that we couldn't meet our commitments to Airbus and Boeing but -- Airbus and Bombardier, but they understood the need to keep the airline customers up flying, and we've done, I think, the right thing for the business in the long term.

The next question will come from Jeff Sprague of Vertical Research.

Greg, enjoyed reading the S-4 and it's...

Me, too.

So many questions to ask but I'll just make it one.

It sounds like the overture started with the idea of some type of partnership arrangement.

And I just wonder if you can elaborate a little bit kind of what that might have looked like and what it would have actually implied for the UTC portfolio.

It sounds like it was a quasi-breakup of the portfolio,is where I'm going.

I wouldn't go quite that far, Jeff.

But I think, when I first started these conversations with Kelly earlier this year, it was really around a way to try to unlock the value of a combination of Rockwell and our Aerospace Systems business in the most, I'll say, shareowner-friendly basis that we could come up with.

And so the original proposal that I went to Kelly with and our folks had come up with a structure where we would contribute our Aerospace Systems business, they would contribute their business into a joint venture, we would own about 2/3 of it, Rockwell Collins share owners would own about 1/3 of it.

And there's a very tax-efficient way to do this and you get all the benefits of the synergies.

After a lot of discussion with Kelly, I know Kelly and his board had spent some time going through this, they really had some concerns about how the governance might work with Rockwell Collins only owning 1/3 of the joint venture.

And so they came back to us, as it says in the S-4, and they suggested that we make an offer for the whole company, which we ultimately did.

This wasn't an idea to break up the portfolio, though.

I think this was how do you maximize the value of the Aerospace Systems business?

How do you get the synergies that you have with Rockwell in a manner that is as shareowner-friendly as you can do so there's no tax leakage, there was no big fees to pay.

If anything, it was just a pretty simple transaction.

But again, we were still going to control 2/3 of the combined partnership and still have all the benefits that would have accrued back to UTC shareowners as a result.

Would this thing have traded, Greg, like the Baker Hughes-GE thing?

Or would it just have been a private partnership between the 2?

No, it would've been a -- well -- so it would've been a private partnership, 1/3 owned by -- and again, the percentages are maybe a little off.

It may have been 35% or 38% or even 40% Rockwell Collins and then 66% to 60% UTC, but we would have owned it.

The Rockwell Collins shares would have continued to trade publicly, which would have been the proxy for what the -- at least 1/3 of the value was of the joint venture.

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

A couple questions for you.

Specifically on Pratt, the $196 million charge I guess you took, you also took about $100 million last year.

So why is that justifiably -- you take it out of the results.

I mean, isn't that just sort of an operating expense?

I mean, isn't it -- I don't know.

I mean, it doesn't sound fair to me to take it out.

Well, it's -- I'm not sure how fairness comes into the equation.

The thought was we want to be able to show what the Pratt business is doing on a run rate basis.

The fact is the nonrecurring gain that we talked about, Akhil, the sale of some assets was also an investment that Pratt had made years ago.

So the thought was pull everything out of the segment and keep it at the UTC level so you can see what the underlying performance is of the business.

However you guys want to model it, have at it.

I just -- we're going to be transparent about this thing.

That's why we laid it out there.

But we're not trying to hide anything.

We're simply just trying to see, here's what the run rate business looks like at Pratt & Whitney.

Yes.

And so it is for that reason -- Ron, just to be clear, consistently what we do is we take larger charges out of any segment.

It happened to be Pratt this time, but if it is something at CCS or something else which is nonoperational in nature and doesn't happen frequently.

I mean, this one, unfortunately, has happened twice now in 2 years, but we hope this is the end of it and we won't see it again.

So we wanted to give a sense of proper operational performance at Pratt and, as Greg said, gains also related to Pratt to some extent.

And that -- those were pulled out of the segment as well.

Okay.

Great.

And then maybe just changing gears real quick.

Looks like Bombardier might have hit a lottery ticket here with Airbus taking over the CSeries.

A, question one, if you can say, in aggregate, what is your content on the CSeries, right?

Because if you think about it, from the engines and all the Goodrich stuff, the air monitoring equipment and the nacelles and then all the stuff Collins has on an airplane, you guys are all over that airplane.

So just curious, if you can say, what is your content in aggregate?

Because I know you probably can't break it out piece by piece.

And then the second question is, if Airbus does sell 2,000 of these things, which they're talking about, what do you guys have to do to deliver on that?

Because all of a sudden this program might end up being a heck of a lot larger than anybody ever thought it would be.

Can I just say that would be really good news.

Look, the combined UTAS, Pratt and Rockwell Collins content on the CSeries is a little over 30 -- I think it's 34%, 35%.

So we have a big chunk of the bill of material and, therefore, a big investment in this aircraft and a lot at stake in seeing that it's successful.

I think talking to both Alain and to Tom Enders last week, I said it's a great deal for them, and I think long term it will be a good deal for UTC as well, given the content that we have on the aircraft.

Look, in my mind, it was a validation of the Geared Turbofan, because the GTF, as you guys know, is the sole source engine on the CSeries.

And despite all that's been written about the durability issues, blah, blah, blah, the fact is the engine works and Airbus has high confidence or they wouldn't have done this deal.

And so to me, it was really just validation of the GTF works.

The next question is from Julian Mitchell of Credit Suisse.

So maybe switching to the commercial side of the house.

In Otis, the adjusted profits were down more year-on-year in Q3 than they were in Q2 and your OE orders turned negative for the first time in a year.

So maybe give a little bit of context around how quickly you think that slide can be reversed, particularly as the China pricing doesn't seem to be getting any better.

So I just wondered, when you're looking ahead, what you think can get that profit or that adjusted profit ex currency back to a sort of flattish trajectory?

Yes.

Julian, great question.

So first of all, on the pricing -- price/mix side in China, there has been -- this is now the second quarter where we have actually seen some improvement from the trends that we were seeing prior to that.

Remember, the disconnects used to be a lot higher between units and the sales dollar value -- the order dollar value.

This quarter, while the number is an 8-point disconnect, right, units grew 8% while dollar orders were flat, half of that was just due to the function of absence of major projects.

As you know, major projects will have higher dollars per unit, and fewer major project orders booked in this -- in the third quarter this year resulted in about half of the disconnect.

So the price/mix was about 4 points, which is similar to what we saw in the second quarter, which was a lot less, less than half of what we saw in the first quarter.

So I think there is some improvement happening there.

There is also this pressure on the commodity side the Otis China team is feeling and the rest of the players are feeling as well, which is pushing a little bit better pricing discipline in China.

And we are hopeful that we will see some of that result into better price/mix going forward.

There's still a long way to go in China.

I'm not saying that we are out of the woods there, or the industry is.

But certainly there's gaining share that we are seeing in China.

And the detailed market segmentation our team has done is proving good in terms of at least the unit order volume growth.

As regards to the overall earnings for Otis, we still -- the team is still working hard to make sure that we can be flattish to up in 2018.

We are not done with the plans for next year.

But clearly, some sign of stabilization in Europe.

New equipment orders were up significantly.

Our portfolio growth in service was up in a more normal manner in the current quarter.

And I think the rate of decline in the service pricing in Europe has been lower in third quarter than it has been for the last several quarters, years.

So we feel some sign of improvement, but still ways to go.

The next question is from Cai Von Rumohr of Cowen and Company.

It's Lucy on for Cai.

Follow-up on the GTF.

Can you help us quantify how much the spare engines have helped in alleviating the negative engine margins?

And how do you think that looks -- the mix of spares versus customer deliveries will look going forward?

So the first thing, Lucy, is that the big change you see is in terms of improvement in the aircraft on ground numbers.

So the big benefit that we have seen is, by converting some of these engines to spare pool, we have alleviated the pressure and the pain that the airline operators were facing.

That's step number one.

In terms of the improvement in Pratt profit outlook, as you recall, we went from being down $200 million to down $125 million for this year.

That $75 million essentially is all a function of lower negative engine margin due to this shift in allocation.

So I think that's probably what it is.

In my view, Lucy, this is essentially front-running some of the investment we would have had to make in spare pools in any case.

Over the years, there is a certain ratio of spare pools to the number of engines that you have out in the field.

All we are doing is doing that investment earlier than what would've happened over the next couple of years.

I think we probably have 1 more year of similar level of investment in spare pools, but then that level of overall spares will help manage the growing fleet at GTF in 2019 and 2020.

So a little front-running of investment but overall not a bad thing.

The next question is from Sam Pearlstein of Wells Fargo.

Akhil, just to follow up on that.

If you did pull some of those expenses forward, or the shift in spares, you had talked about $1.1 billion worth of new engine margin losses next year.

How does this change in account -- in treatment affect that loss as we look into next year?

Yes, it doesn't change the absolute number for the negative engine margin next year, Sam.

So that's still $1.1 billion or so.

What it does do is it creates a little bit more headwind for Pratt on a year-over-year basis, because negative engine margin this year has come down, next year stays the same.

So it puts a little bit more pressure on Pratt in terms of staying flat for next year in earnings.

But they are working on it.

Commercial aftermarket has been a little bit better.

We do expect the GTF -- the V2500-related shop visits to continue to grow next year.

So we are all in the middle of working through all those dynamics.

Pratt Canada should be better.

Joint Strike Fighter production is better next year.

E&D should be flattish to maybe down.

So I think all those things are in the mix.

While there is incremental negative engine margin year-over-year, the absolute number does not change from the $1.1 billion.

And then on the pension contribution, can you talk about what that does to both the book and the cash taxes for this year and next?

How should we think about that?

So for this -- the tax benefit is essentially all this year.

There is no benefit to the book tax rate.

But certainly from a cash point of view, we do see a reduction in our cash taxes as a result of the $1.9 billion contribution.

And if you go back and look at the chart I had at the last webcast, which was middle of September, there was a reconciliation which took into account $1.9 billion going down to roughly $1.2 billion impact on cash flow for this year adjusted for the tax benefit that we got.

So that -- we took that into account when we gave the new guidance of the $3 billion to $3.5 billion.

The cash benefit on taxes was offset against the $1.9 billion.

The next question is from Nigel Coe of Morgan Stanley.

But just obviously the CCS trend is pretty robust across the board in terms of sales trends.

Thinking about just the high single-digits growth in non-resi and commercial construction -- commercial HVAC in North America, would you say that that's ahead of the market, in line with the market?

Do you think you're gaining share generally in commercial HVAC?

Yes, I think ...I think it was up about 8% in the quarter, which was the strongest quarter we've seen there in some time for commercial HVAC.

I think what it really is, Nigel, is just the introduction of new products.

We've been talking about the new big chillers that we've got out there, up to 3,000 tons.

This is just really the payoff from the investment that they're been making at the Carrier commercial HVAC business.

It's coming through in markets.

So I think we're probably gaining a little bit of share.

We'll see when the final numbers come out here shortly, but I think we feel pretty good about where we are.

Okay.

So it sounds like you're a little bit ahead of the market.

And then how do you then describe the price/cost dynamic in CCS?

Obviously, we're seeing commodity prices moving higher by the week.

So how is that looking today, and how is it looking into 2018?

Yes, that's the several million dollar question for 2018 that we are still working through.

Certainly, if you break down the markets, Nigel, I think North America residential business probably seeing the best level of discipline in terms of passing some of the cost inflation through price increases.

Other portions of CCS, not so much.

I think commercial HVAC continues to see significant price competition as does the fire and security business and the commercial refrigeration business.

So I think it's more a phenomenon where North America residential feels good in terms of the ability to pass some of the cost inflation, but the other places probably the dynamic shifts adversely.

Both in 2017 we have seen that, and I think that pressure will continue in 2018.

The next question is from Myles Walton of Deutsche Bank.

Greg, the hire you made with Judy over at Otis is the first outside kind of leader I can recall for one of your operating segments in some time.

So I'm just curious, can you talk about the desire to go outside the organization to look for a president?

It's kind of been tougher to find a sticky president in that business for a few years.

And also, does this equate to a fresh look for 2020 goals?

Well, let me answer the second question first, and the answer to that is no.

The 2020 goals are the 2020 goals.

And Judy and I have had some long conversations about that.

I think we've got clear line of sight to the 2020 goals at Otis.

I would tell you, when Philippe decided to leave earlier this year, we had a robust slate of internal candidates.

And there were 4 or 5 people that I was confident internally could do a great job running Otis.

But I also thought this was an opportunity to look outside to bring some additional talent into the organization.

And so we conducted a search.

We talked to a lot of folks out there.

And I've got to tell you, when we talked to Judy, I said this is absolutely the right person for the job.

She's got a great background.

She worked at IBM, she's worked at Lockheed, and she's worked at Siemens.

So she's got big company experience.

She knows international.

And I just thought she added a lot to the senior leadership team.

And again, it's a unique situation.

We typically have a very robust leadership development process here, again, lots of folks that can do that job, but this is just a unique alignment of the stars, I would say, where we found someone really, really super that I thought would bring the focus on execution as well as a global perspective to Otis.

The challenge at Otis, as you guys know, it's a decentralized organization.

It's a little bit like herding cats.

You've got to have strong process.

You've got to have a strong focus on execution.

And I think Judy brings all of those things to the table here.

Great.

I think it's a good hire.

And one follow-up.

The size of the UTAS gain, is it $25 million or so, Akhil?

Yes.

In fact, a little less than that, yes, about 2 cents.

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

Just to follow up on Otis China.

Good news that price pressure doesn't seem to be getting worse, but it's still been tough for a while and now there's probably raw material pressure on top of that.

And I guess my question is whether you believe that's starting to impact some of your small competitors more?

I mean, do you think you're closer to a shakeout of some of the excess capacity?

Are companies more willing to look to partner or get acquired or exit the market?

Any market changes you're seeing in Otis China now?

Not to a great extent, Matt.

I mean, that is our expectation.

We are certainly seeing -- if you look at the publicly disclosed results of the second tier players, people underneath Otis, some of who supply to all of the elevator manufacturers in China, they've seen significant profit reductions over the last year, almost 25% or so.

And so that situation cannot sustain itself for very long periods of time.

We haven't quite seen a shakedown or a reduction in capacity yet.

That is what will happen over time, but certainly there is more resilience in the Chinese market.

The profit expectations are probably much lower than what Western world would expect, and as a result, companies tend to stay longer than they would in some other markets.

But I think that's, again, a situation which won't last forever.

However, it is still continuing and keeping a little bit of pressure on the earnings in China.

And the next question is from Sheila Kahyaoglu of Jefferies.

Just switching gears a little bit on the aftermarket both in -- at Pratt and UTAS, if you could talk about what drove some of the strength.

How much was initial provisioning of the benefit?

If you could elaborate on that.

Sure.

So provisioning was pretty strong at UTAS.

And some of it is just as a result of the decision we took to move -- reallocate the engines away from the airframe manufacturers -- aircraft manufacturers to the spare pool.

That is counted as provisioning in the UTAS sales.

So that number was higher, to some extent, driven by that decision.

As Carroll said, that number unfortunately creates higher eliminations at UTC level as we have to eliminate the intercompany profit on those transactions.

Aftermarket at Pratt was up, largely driven by the V2500.

The strength there has been continuing, the number of shop visits growing again.

No surprise there.

I think it's coming in a little faster than we had expected.

That's why the aftermarket business for Pratt has been growing faster than our original guidance.

I'll let Carroll give additional color on that.

Yes, Sheila, it's a product of both higher volumes and shop visits on the V2500; really good content there as well.

The 4s and the 2s, the legacy models, they continue to be in attrition mode, and their shop visits were down as we expected.

But we saw a bit higher content on our legacy models than we had expected, some higher life-limited part replacement by some operators that's driving that strength.

And as we talked about earlier in the call, some of it's going to flow through.

The next question is from Peter Arment of Baird.

Greg, a quick one on just the -- on Otis, just circling back.

I know you've made a lot of investments in kind of the service transformation.

I think you're supposed to have full deployment across all your mobility devices as we get out to 2018.

How do we think about just the same profile regarding the E&D investments?

I know that was stair-stepping up.

But should that continue?

Or does it stabilize at some point?

I think, Peter, it's a good question.

As you think about, first of all, in the service deployment side, we've got about 13,000 mobile devices out there through the end of the third quarter.

As you know, we've got about 31,000 mechanics out there.

So we've been rolling these things out.

And change management is the key, obviously, trying to train the mechanics to use the devices and to get the productivity.

So we've been rolling it out quickly but trying, again, to do it in a rational fashion.

In fact, we probably won't do all 31,000.

There will be some markets where it just doesn't make sense.

It's not a big enough market to pay for the investment.

But we're on track with that initiative.

Similarly on the R&D investment.

We stepped it up over these last couple of years.

There's not going to be another big increment up in the coming years.

I think there's plenty to do right now with the money that we've allocated for R&D.

And I think Otis, as we've said, they've doubled the number of new product variations that they can offer just in the last 2 years by this increase in R&D.

You've got to keep in mind, an average R&D program at Otis is somewhere between $1 million and $3 million as opposed to $1 billion and $3 billion on the aerospace side.

So it's obviously a different animal over there.

But there's lots to do and I think we've adequately resourced the R&D function at this point.

The next question is from Doug Harned of Bernstein.

On UTAS, can you talk about the A320neo nacelles?

I mean, Airbus is moving to take those in-house.

And could you walk through what happened there and what you expect to be the impact on UTAS?

So -- okay.

It's a great question, Doug, and as with all great questions it's going to take a little bit of background to fully discuss it.

But we have been the supplier of the A320 nacelle for some period of time.

And with the Neo we have been -- we were selected for the nacelle for the life of the program.

We were -- as part of that contract, we were guaranteed all of the volume through the early 2020s, and then that kind of steps down through 2024.

I think we're guaranteed about 50% of the volume.

Airbus came to us a couple of years ago and asked us to -- or said they were thinking about in-sourcing.

They wanted to get pricing from us on the various components so that they could in-source the nacelle.

And we obviously talked a lot to them about that.

They've decided to go ahead in kind of the mid-2020s to offer a different nacelle to our customers.

At the same time, we'll continue to offer our nacelle to the customers through the life of the program, as is our right under the contract.

And we think, again, we've got the -- we have a great nacelle, we think to be a competitive one from a cost standpoint.

And we'll unfortunately be competing with our customer and the offering of that nacelle in the late 2020s.

But I've got to believe that the customers, once they have the Pratt GTF with the UTAS nacelle, the switching costs will be somewhat significant.

So I think the prospects of us losing that business completely are pretty low.

But we'll keep working with Airbus.

And I think we've seen this play before, where the aircraft manufacturers decide to in-source, and then after a while they recognize that some things they can do really well and some things not as well as some of their suppliers.

So we'll keep working with Airbus.

And we're going to keep our focus on delivering the best quality nacelle to our customers.

But this -- I mean, you went through the situation with Boeing on the 777 landing gear, where they clearly were looking for a lower price.

I mean, when you look across these situations, I mean, how pervasive do you see this in UTAS, where you're getting this additional pressure from the OEMs?

Look, the focus from the OEMs to reduce cost is never, ever ending.

We saw it with PFS 1. We've been talking to Boeing about PFS 2. And the fact is we recognize we have to continue to take cost out of our product if we want to be -- take cost out of our product if we want to be competitive.

And we've told both Boeing and Airbus we'll continue to work with them to find ways to do that across all of the portfolio.

But this is not going to end, right?

I think the landing gear was a particularly difficult discussion.

We've been making the 777 landing gear for a very, very long time.

Boeing asked for a large price reduction, which we could not accommodate, which would have been -- ended up us losing money on a product with no aftermarket.

And so we declined, and Boeing decided to resource it, as is their right under the contract.

So we're going to do what's right for the business.

I'm not going to start shipping my margin to the OEMs, though, without some way to recapture that over the long term.

The other element, Doug, as you well know, on this whole equation is technology, right?

So to the extent we can come up with differentiated products that can provide significant value to the customers, whether it's the airlines or the airframers, there should be no reason why we should worry about that.

But to the extent we go down the path of offering just commoditized products or print to order type of business -- build to print type of business, I mean, which would be generally low margin, it's okay if we lose some of that.

But it's not going to be just a sheer transfer of margin from our shareholders to somebody else's shareholders with no return for us.

If you think about it, the whole premise behind the Rockwell Collins acquisition is to find ways to be more innovative on the airframe, right, to take weight out, to take cost out and to offer innovative solutions to the airframers.

And the scale that they bring to us gives us the opportunity to do things that we couldn't do on our own.

And I think that's what you have to focus on with the Rockwell Collins, is there is a huge value proposition to our customers with this acquisition.

But it seems like a tough environment.

I mean, I would have thought the Goodrich acquisition would also have -- it would have had that argument, I would say, even more strongly because there was more overlap.

Well, there was more overlap from a mechanical systems content standpoint; you're exactly right.

But if you think about what's going to drive the next generation of airframe decisions, it's going to be about connected aircraft.

It's going to be about communication systems.

It's going to be about the ability to take digital across all of the systems on the airframe.

And that's one of the benefits to us, is we've got all of these systems that we can now connect, that we can do diagnostics on, that can really differentiate our offering and add real value to both the OEMs as well as to the airlines by providing real-time data, real-time diagnostics, real-time spare parts availability.

The next question is from George Shapiro of Shapiro Research.

I just wanted to follow up a little bit on Doug's question, Greg.

I mean, Boeing will say that they've not seen any benefit from the merger and that's their objection to Collins.

So if you look at the landing gear, you look at the nacelle, what you would point to as benefits that they've gotten from the Goodrich acquisition?

Well, there is something called PFS 1, which was a significant concession on the part of our Aerospace Systems business to take cost out, to reduce the cost to Boeing on the 787.

And it was a big bite at the apple, I would tell you.

And we have been working, as you know, to try and cover some of those costs.

The problem at UTAS today, of course, is we don't make any money on any product that we sell to the Boeing company.

None.

In fact, we lose money.

And so Dave Gitlin and his whole team are laser focused on how to take cost out to overcome the headwinds associated with all of these new OEM programs versus the old OEM programs.

I would tell you, Boeing got a benefit from the acquisition.

And look, we're 6 to 9 to 12 months away from closing on the Rockwell Collins deal, so I can't comment specifically on where the savings will come from, but I know that Kelly Ortberg and Dave Gitlin have been working, thinking about from an innovation standpoint what can we do together, where can we take cost out, where can we take weight out, where can we add value across the connected airplanes.

So look, it's too early to say -- to point specifically to where the benefits will come from, but it's one of the things that we're going to commit to the airlines and to the airframers, is we will provide value to you guys because of this.

And let me just get one follow-up probably for Akhil.

To get a low single-digit growth at Aero, we need a step-up of a couple hundred million dollars in revenues in the fourth quarter.

Can you just tell us where that may be coming from?

Yes.

So George, year-to-date they're about 1% up.

You're talking about UTC Aerospace Systems organic growth.

1% is low single digit.

And so all they need to do is fourth quarter of something similar.

And I think what we -- where we see the change happening is the military business, which was down, slightly down in the third quarter is expected to be up a decent amount in the fourth quarter.

That's based on the timing of some of the programs that shifted from third to fourth quarter.

So we feel the ability for UTAS to get the 1% to 2% type of growth in fourth quarter is pretty real, and hopefully we get there.

There are no further questions in the queue at this time.

I'd like to turn the call back over to Mr. Hayes for closing remarks.

Okay.

Thank you, Latoya.

So again, a really solid third quarter, good results year-to-date, high confidence in the year.

I think that's reflected in the uptick that we gave in the full year guidance.

Carroll Lane and the team will be here, along with Akhil, the rest of the day to answer any questions you might have.

So I thank you all for listening, and have a great day.

Take care.

Thank you.

Ladies and gentlemen, this concludes today's conference.

You may now disconnect.

Good day, everyone.