雷神技術公司 (RTX) 2017 Q4 法說會逐字稿

Good morning, and welcome to the United Technologies Fourth Quarter 2017 Conference Call.

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

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

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

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

UTC's SEC filings including its 10Q 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 proposed Rockwell Collins acquisition, UTC has filed with the SEC a registration statement, that includes a prospectus from the UTC and a proxy statement from Rockwell Collins, which is effective and which contains important information about UTC, Rockwell Collins, the transaction and related matters.

(Operator Instructions)

Please go ahead, Mr. Hayes.

Okay.

Thank you, Candace, and good early morning to everyone.

Appreciate people dialing in a little early this morning.

I know it's a busy day out there.

2017, a really good year for UTC.

We did what we said we would do, and in many cases, we did even a little bit better than what we thought.

Our financial results were above the high end of our expectations, and we grew adjusted earnings per share to $6.65, and of course, that's a small beat to the top end of our own expectations range.

Our sales also topped our expectations and we saw organic sales grow 4%, our best year of organic growth since 2014.

And importantly, each of our 4 business units saw organic growth with Pratt & Whitney leading the way at 9%.

We generated stronger-than-expected free cash flow of $3.6 billion while still making substantial strategic investments, and importantly, fully funding our U.S. domestic pension plan.

On Slide 2 on the webcast.

Operationally, we continued to execute against our growing aerospace backlog.

At Pratt & Whitney, we shipped 374 Geared Turbofan engines in 2017 and that's right in the middle of our 350 to 400 target and nearly triple our 2016 shipments.

And of course, we successfully implemented the engine improvements that we promised to customers in 2017.

In our commercial businesses where we continued to innovate for growth, our investments are producing results.

We gained share and generated solid organic growth at both Otis and in the Carrier business.

Otis delivered its best year of organic growth since 2014, and CCS generated 4% organic growth and launched over 100 new products in 2017.

As you know, we announced the Rockwell Collins acquisition late in the third quarter.

This deal will transform our Aerospace Systems business, positioning the United Technologies to enhance customer value in this high-growth end market.

We also contributed nearly $2 billion to our domestic pension plan in the third quarter, and that plan is now fully funded.

And this will significantly reduce our pension-related earnings volatility going forward.

On Slide 3. We're clearly pleased with the results we have in 2017, and we get it, you're ready to focus on 2018 and well so are we.

And I think, importantly, we're optimistic of the year ahead.

Our priorities, though, remain clear and consistent.

We're focused on growth through innovation.

We'll continue to focus on reducing costs, executing on our commitments to customers and being disciplined in our capital allocation.

We expect earnings growth in 2018 -- adjusted earnings growth of $6.85 to $7.10 and that includes the benefit of recently enacted tax reform.

More importantly, we expect each of our 4 business units to grow operating profit in 2018.

Akhil will come back and talk a lot more about the tax rate in the coming minutes here.

Let me just focus on organic sales.

Organic sales should accelerate for the fourth straight year with a range of 4% to 6%, supporting sales in the range of $62.5 billion to $64 billion excluding Rockwell Collins.

Free cash flow should be in the range of $4.5 billion to $5 billion even as we invest over $4 billion in E&D and CapEx.

Akhil will take you through the 2018 detail in a few slides, so let me just say that we feel good about the outlook.

While there will be challenges to overcome, I think we have a very bright future.

Now let me hand over to Carroll who will discuss the fourth quarter business unit results in a little more detail, and I'll come back and wrap it up and then we'll take some questions.

Carroll?

Okay.

Thanks, Greg.

I'm on Slide 4. The fourth quarter was a good one for UTC, with reported sales of $15.7 billion, up 7% including 5% organic growth and 2 points of foreign exchange.

Adjusted EPS of $1.60 was up 3% from the prior year.

On a GAAP basis, EPS was $0.50 and included $0.07 of restructuring and $1.03 of other nonrecurring items.

Nonrecurring items included $722 million for charges related to the recently enacted tax law changes, primarily in the U.S., and the $96 million charge for a product recall at CCS.

Our Q4 adjusted effective tax rate was 29%, which brought the full year to 27.8%, now that's 80 basis points above our original expectations for 2017 as that was an $0.08 headwind to our adjusted EPS results.

Fourth quarter free cash flow was strong at $1.7 billion.

That took our full year cash generation to $3.6 billion, above the high end of our expectations of $3 billion to $3.5 billion.

So with that, I'll move on to the segment results and I'll be speaking to the segments at constant currency, as we usually do.

And just as a reminder, there's an appendix on Slide 19 with additional segment data as a reference.

All right, starting with Otis.

Otis sales were $3.3 billion in the quarter, up 3% organically.

Operating profit was down 11% at constant currency.

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

Foreign exchange translation was a 3-point tailwind to sales and a 4-point tailwind to earnings.

New equipment sales grew 3%.

Mid-teens growth in North America and low double-digit growth in Europe were partially offset by an 11% decline in China where the market remains challenging.

Service sales were up 4%.

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

New equipment orders were up 1% in the quarter and grew 5% excluding China.

North America grew high teens and Europe was up mid-single digits while Asia, excluding China, was up high single digits.

This is partially offset by China orders, which were down 7% in value, but up 1% in units with continued improvement in pricing and mix trends, but fewer major project orders.

For the full year, Otis operating profit declined $135 million at actual FX on 2% higher organic sales.

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

Operating profit grew 12%.

FX translation was a 3-point tailwind to sales and added 2 points to earnings.

Organic sales growth was 3% in Q4 including 5% growth in global commercial HVAC with gains in every region.

Transport refrigeration saw 11% growth and that was primarily driven by a strong recovery in container.

Residential HVAC was up low single digits in the quarter.

Total CCS equipment orders were strong, up 9% in the quarter.

That was driven by approximately 20% growth in both global commercial HVAC and transport refrigeration.

North American residential HVAC and fire and security orders were essentially flat.

Organic volume contribution in the quarter was offset by pricing and mix headwinds.

Productivity gains from restructuring and net favorable year-over-year impact from nonrecurring items helped drive 10% profit growth at constant currency.

For the full year, CCS operating profit grew $75 million at actual FX on 4% organic sales growth.

Shifting to Aerospace on Slide 7. Pratt & Whitney sales were strong, growing 11% organically in the quarter.

Commercial aftermarket was up 25%.

Now you'll recall, last year Q4 was down 6%.

The military business saw a mid-teens growth.

Commercial OEM sales declined 19% principally due to product mix and lower Pratt & Whitney Canada shipments.

Geared Turbofan shipments totaled 120 engines in the quarter including those allocated to the spare engine pool.

And as Greg mentioned, full year GTF shipments totaled 374 engines.

Pratt & Whitney operating profit of $437 million was down $33 million.

Higher negative engine margin and ramp-related costs were largely offset by aftermarket volume, lower unfavorable contracts adjustments as well as favorable FX and pension.

For the full year, organic sales grew 9%, while operating profit was down $90 million.

Turning to Slide 8. Aerospace Systems delivered 3% profit growth on 5% organic sales.

Commercial OEM sales were up 2% with growth on new programs more than offsetting declines in legacy program volumes in the quarter.

Now 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 sales were up 10%.

Provisioning was up approximately 20% from growth in intercompany sales to Pratt & Whitney.

Parts were up 10% and repair was up 2%.

Military sales were up 5% in the quarter and that was driven by higher F-35 volumes.

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

These benefits were partially offset by unfavorable OEM mix and higher SG&A associated with growth initiatives.

For the full year, Aerospace Systems delivered $103 million of operating profit growth on 2% higher organic sales.

So with that, let me hand it over to Akhil who's going to provide more detail on the 2018 outlook.

Akhil?

Thanks, Carroll.

Before I get into the details, a couple of points to note.

First, our 2018 outlook includes the impact of revenue recognition changes adopted prospectively on January 1. Now as we have said previously, the impact is not expected to be significant at any of the business units.

Second, the outlook is on a stand-alone basis for UTC.

It does not include any impact from the proposed Rockwell Collins transaction.

As you can see on Slide 10, the global macroeconomic environment is expected to remain robust in 2018.

In the U.S., we are expecting modest acceleration with growth above 2.5%.

Construction and housing trends still look relatively strong here.

Conditions in Western Europe have been improving and we see that in our order rates.

China reported strong fourth quarter GDP and will likely grow above 6% again in 2018.

That said, construction-related end markets in China for us will remain under price pressure, although perhaps not quite as bad as we saw in 2016 and 2017.

And we'll likely see a little tailwind from FX as the dollar has been weakening recently.

Now in the box on the lower left of that slide, you can see some of the key FX rates we have assumed in our 2018 outlook.

The macroeconomic environment and our solid backlog give us confidence in the 2018 organic sales growth outlook of 4% to 6%.

As you can see on Slide 11, for the commercial businesses in the Americas, we expect 2% to 4% organic growth for both Otis and CCS, and that's on top of a solid high base that we have seen in the recent years.

In EMEA, we anticipate 1% to 3% sales growth where we expect significant improvement in the commercial HVAC business for CCS.

And both China and Asia outside of China should see better trends compared to 2017.

On the aerospace side, we will continue to see solid growth in commercial aftermarket and military sales.

Commercial OEM sales should grow 5% to 7% in 2018, largely driven by the higher GTF deliveries.

So on Slide 12, before I get into specific segment expectations, let me talk about the impact from adoption of the new accounting standard for pension.

As you know, this change will move all pension-related income and charges except for service costs below operating profit.

Now there'll be no change to UTC's overall EPS, but segment numbers will change.

The table on the left shows you the restated 2017 results and we just are providing this so you can update your models to account for this change.

As we have said before, we expect sales and adjusted operating profit in all 4 businesses -- to grow in all 4 businesses.

Detailed assumption for the segments including the profit walks, as usual, are available in the appendix.

But let me summarize these here.

At Otis, we expect low to mid-single-digit sales growth in 2018.

New equipment will be up low single digits and service up mid-single-digit.

China new equipment will be down low single digit, an improvement compared to down 10% in 2017.

Europe service business is expected to grow again slightly with improving trends in the more profitable maintenance business.

On profits, we anticipate Otis to be flat to up $50 million at constant currency, driven by lower pricing headwind and the benefits from volume and productivity.

Translation FX should provide about $25 million of tailwind.

CCS sales will be up mid-single digits, with growth in all business units.

We will see continued strong performance in residential HVAC business, solid growth in the global commercial HVAC business, and better growth and mix in transport refrigeration.

Operating profit will be up $125 million to $175 million at actual FX with the improved volume, mix and pricing more than offsetting commodities pressure and investments in E&D and sales force to support growth.

At Pratt & Whitney, sales will be up low teens.

GTF volumes will ramp again significantly and we expect to see higher shipments at Pratt Canada.

Commercial aftermarket should grow around 10%, primarily driven by higher V2500 shop visits.

The military business will also see benefits from higher Joint Strike Fighter engine shipments.

On the profit side, the growth in GTF shipments will result in additional negative engine margin headwind, as we have previously discussed.

That will be more than offset by solid growth in commercial aftermarket and military.

Overall, we expect Pratt operating profit to increase between $25 million to $75 million.

Aerospace Systems will grow the top line low single digits with commercial OE up low single digits including one quarter of impact from the loss of the Boeing 777 landing gear business that we have talked about in 2017.

The aftermarket and the military businesses will be up low to mid-single digits.

On the profit side, lower commercial OEM mix headwind net of cost reductions, combined with solid conversion on commercial aftermarket and military sales, should result in strong operating profit growth of $150 million to $200 million.

Collectively, the 4 segments will grow earnings between 4% to 6% over the pension-adjusted 2017 results, a positive change from the last couple of years.

On Slide 13, you'll see our EPS walk for 2018.

The segments will contribute $0.39 at the midpoint of their outlook range.

The new tax changes are expected to lower our effective tax rate to 25.5% versus the 27.8% in 2017.

And I know that's one of the key questions on your mind, so why 25.5%?

Well, as you know, about 60% of our earnings come from overseas.

With the U.S. federal tax rate at 35%, our blended global rate was about 30%.

We used to get a couple of points of credits that got us down to the 28% effective tax rate that you've been seeing for the past few years.

These credits go away under the new rules, so you're starting from a 30% blended rate.

Now the benefit from recent U.S. tax law changes is a federal rate reduction of 14 points, from 35% to 21% and that is on 40% of our earnings.

So given no other changes, simple math would suggest our new rate should be 24.5%.

However, under the new tax laws, there are some provisions that add another point for base broadening and that is how we get to 25.5%.

As we all know, new notifications and clarifications are still being written and we will continue to monitor these for any potential benefits that can help drive the ongoing tax rate lower.

On the other hand, these notifications and other refinements in the calculations will likely increase the tax-related onetime charge that we took in fourth quarter over the next 4 quarters.

Finally, the tax law changes will result in a net $1.5 billion estimated cumulative cash payment on previously earned foreign income.

This amount will be paid through 2026.

That's probably enough on taxes, right?

Getting back to the rest of the EPS walk.

Pension will be a $0.19 tailwind, mainly due to our 2017 voluntary contribution.

On the other side, interest expense will be an $0.11 headwind due to the full year impact of Q2 '17 borrowings as well as higher interest rates.

And again, as a reminder, we are not including any expense for Collins-related debt.

In terms of other big items below the segment profit.

Corporate expense, eliminations and others will be an $0.18 headwind.

And on the slide, you can see the contributors such as change in the mark-to-market accounting that we have talked about, higher intercompany eliminations and some settlements and other credits we got in 2017.

As usual, our EPS range of $6.85 to $7.10 includes contingency to account for the unexpected, it's $120 million at the midpoint.

In summary, we feel good about EPS growth outlook with all 4 business units contributing.

As in the prior years, our earnings growth will be weighted more towards the back half of the year as we get the benefit of cost reduction efforts.

We expect Q1 EPS to be basically flat to 2017, primarily driven by the profile of the commercial businesses.

With that, let me hand it back over to Greg.

Okay.

Thanks, Akhil.

I hope you guys got all that.

The good news is, of course, Carroll and his team will be around later to help take you through all of the detail on taxes and pensions and all the other good stuff.

But let me just say I feel good about the quarter that just ended, but I feel even better as we look forward into 2018 because those investments that we've been making, the strategic investments at Otis, the big R&D investments on the aerospace businesses, the new product development at CCS, all of that is actually paying off.

And not only will they pay off in 2018, but they'll pay off well into the future.

A year ago, I told you we were excited about where we were, that we were on the cusp of seeing returns on the investments.

Well, those returns are happening in 2018 and we expect accelerating organic sales and earnings growth with strong cash flows.

At Rockwell Collins, we continue to expect the transaction to close around the middle of the year.

Of course, it's pending regulatory approvals.

As you saw, Rockwell Collins shareowners overwhelmingly approved the deal a couple of weeks ago, and Dave Gitlin, Kelly Ortberg and the team are preparing to execute a successful integration that will create value not only for customers, but also for shareowners.

Bottom line, though, on 2020 growth objectives is we remain confident.

The business unit presidents will actually get a chance, in March we're going to have everybody stand up to take you back through their 2020 objectives, both the top and the bottom line at our annual Investor Day.

I think it's important to remember that each of us at United Technologies is focused on a shared set of priorities and that's, first of all, delivering on our commitments, innovating for growth and driving to long-term shareowner value.

So with that, I'm mindful of the time, let's open up the call for questions, Candace.

See what's on everybody's mind.

Thanks.

(Operator Instructions) And our first question comes from Steve Tusa of JPMorgan.

On CCS, yes, obviously, pretty good orders on the commercial front.

I think you're guiding positive price costs in the bridge, if I'm right about that.

Can you talk about what's happening on commodities and then pricing in commercial HVAC as well as residential HVAC?

Sure.

So I think for next year, Steve, as you can -- as we've talked about before, commodities is going to be a headwind, copper, steel, all those important inputs had been going up in price, and there's about a $50 million headwind at CCS next year.

CCS has put through some price increases as have some of the other players in the industry.

Certainly, on the residential HVAC side in North America, we see a little better traction in terms of the prices being passed through to the consumers.

Ultimately, we'll see how that all plays out when the season comes in on the cooling side, so that's still a bit of a wild card.

But I think the discipline appears to be there and we feel good about that.

Commercial HVAC is a little bit more challenging.

We are expecting that trend to change and improve and the plan assumes a change in the trend there.

Again, prices have been increased.

The big markets where we have seen the pressure have been China and Middle East and we are seeing a little bit of moderation, but not much.

I would say you're actually pushing on the right button here.

The key assumption in CCS is our ability to get pricing next year.

We have assumed a net $50 million benefit, but that, I would say, is the one watch item to still observe as the year progresses.

So are you assuming any price in commercial globally?

We are assuming some price increase in 2018, yes.

A modest amount.

And our next question comes from Matt McConnell of RBC Capital Markets.

So on free cash flow, I'm calculating a conversion of something in the mid-80% range for 2018.

First, does that sound right?

And could you talk through some of the drivers?

I know there might be more cash tax for foreign earnings.

And are there other working capital requirements?

Or was 2017 a CapEx peak?

Just help us walk through some of those drivers.

Sure.

I think the math you're doing, Matt, is based off the adjusted net income.

I think what you need to look at is the reported net income because obviously you have -- the cash number that we talked to you guys about is the reported cash number.

It's not for adjusted.

So then you take into account things like the restructuring cash expenses that will be there.

Also even though we have not included anything for Rockwell Collins post close, the first part of the year we have some expenses associated with the integration work of Rockwell Collins, that comes in with about a charge, which will again flow through our cash flow.

Not included in our adjusted earnings, but flows through our cash flow.

So when you adjust for all that, we have between 90% to 95% conversion is where I would put us at with, again, significant items that we have talked about.

CapEx will still remain high at about 170% of depreciation, $2 billion.

Also, we have the roughly $200 million to $250 million of payment to the Canadian government for the royalties that we had in Canada.

The reality is with all that pressure, we feel pretty good about our cash performance.

Actually, just for kicks, we did this math -- I had the guys do this math for 2017.

When you adjust all the noise out, pension, the Canadian royalty, et cetera, we actually ended up with 99% of adjusted free cash flow to net income.

Not a bad performance given that our CapEx was $2 billion, which will not stay at that level forever and given that we are still investing in our inventory for -- to support our high organic growth expectations.

So that's -- it's a pretty good performance in cash flow, same thing for '18.

And I do expect for the metrics to truly convert back to over 100% by 2020 when the CapEx starts to go down a little bit.

And our next question comes from Carter Copeland of Melius Research.

Just a quick elaboration question.

I wondered, Akhil, if you could tell us -- just elaborate on the lower unfavorable cumulative adjustments in Pratt that was in the release, just what that related to?

And Greg, you hinted at still being optimistic about Collins.

I wondered if you could just give us an update, obviously some moving things there in terms of potentially funding and costs, but as well as the more you get the chance to look at it, Dave and Kelly and the guys, how are you feeling about the synergy target and the accretion targets you guys laid out?

And any update there that you can give us?

Sure.

Carter, I'll do the easy one first and let Greg answer the Collins one.

But I think the Pratt one is a simple thing.

If you go back and look at our script from last year fourth quarter, there was a significant charge that -- or adjustment that we had booked at Pratt for some unfavorable EACs and all we are talking about is the benefit this year that Pratt saw from lower negative adjustments this year.

So it's just a favorable year-over-year compare.

That's all.

Akhil, can you remind us what program that was on?

Was that V2500?

It was PW4000 principally, but a little bit of V2500 as well, yes.

Okay.

Carter, on Rockwell Collins, I think a couple of important points to make.

We still do expect to close sometime here in midyear.

We're working through the second request with the DOJ right now.

And nothing has really come up from a regulatory standpoint that surprises us here, so we feel really good about getting this done.

I think, importantly -- or more importantly, though, is the cash aspect of the deal where we had originally expected to fund part of this through foreign cash, we're going to bring back about $1 billion a year to pay down the debt.

We now see a line of sight to bring back at least $3 billion this year, maybe a tiny bit more and a lot more than $1 billion a year for the next couple of years.

So I think we'll be able to pay off the Rockwell Collins debt a lot faster.

The deal obviously looks a lot better, too, from an NPV basis because of the lower tax rate.

As you know, Rockwell Collins is primarily U.S. domestic income and so at a 35% rate that we assumed in the model, that 21% rate looks pretty doggone good.

So feel good about that.

I spent some time 2 weeks ago with Kelly Ortberg and Dave Gitlin.

I think we've got a line of sight to what the organization should look like post merger.

But more importantly, I think the guys have a really good handle on the integration opportunities and the synergy opportunities.

We're going to push for $500 million of net synergies.

I know the list is a lot bigger, it'll shrink over time, but we are clearly on a path to get those synergies over the next few years.

And this is going to be a great deal for customers as well as shareowners when this whole thing is done, so feel really good about it today.

And our next question comes from Noah Poponak of Goldman Sachs.

Greg and Akhil, so you've got a 2016 to 2020 organic revenue CAGR outlook that, depending on exactly where you pick to land in the range of each business, and I guess exactly how you define 10%-plus at Pratt, looks like it averages kind of 6.5%, maybe even 7% organic revenue growth '16 to '20.

And you just put up 4% for '17.

Your guidance for '18 at the midpoint is 5%.

So in order to get to that, just mathematically, 2019 and 2020 would need to average something in the zone of 8%.

Is that what you're saying?

Is that what you're standing by today?

And if so, how much of that is the 10%-plus at Pratt just having a big year or two because of GTF versus how much of it is meaningful acceleration in the rest of the business?

Yes.

Noah, I think you're right on in terms of the Pratt when we point that 10%-plus.

Obviously, Pratt, huge Q4 here, a great year in 2017 and growth will accelerate at Pratt this year.

GTF deliveries were 374 last year and we'll almost double that again this year.

So think about production going up quite a bit in '18 and then it will go up again in '19.

And keep in mind, there's 8,000 engines in backlog.

So the preponderance of the growth will come from Pratt & Whitney in terms of overall UTC.

The Aerospace Systems guys, they've got a good shot, but probably towards the lower end of the range there in terms of organic growth that we laid out.

Obviously, the loss of the 777 landing gear was important in '17, that cost them 4 points of growth.

But they see growth accelerating.

They've got the headwinds behind them.

And importantly, I think they've got a lot of new programs that are coming online, which is going to help.

In Pratt, keep in mind, too, it's not just GTF, it's also JSF.

We also have the PW800 up at Pratt Canada, the new Gulfstream engine.

So there is real growth out there.

This is not just pie-in-the-sky on the aerospace side.

And the Aerospace Systems guys benefit from all that Pratt growth as well because they have the engine controls and accessories on all their engines.

On the commercial side, it'll be a little bit more challenging.

I think, Otis, pretty good line of sight there, but it will depend on China.

Yes, we're expecting China to stabilize.

Clearly, we saw good growth throughout Asia last year ex-China, still strong growth in North America and a really strong recovery in Europe.

So again, I think you'll see accelerating growth.

Backlog is way up at Otis in new equipment.

Service is coming back.

So yes, I think we can get there.

And then, CCS, again, I think the biggest question mark, and a little disappointed in fourth quarter performance at CCS.

But importantly, they put 130 new products out in the field last year.

They got another 100 coming this year.

The E&D investments are starting to pay off and that's what, I know, Bob McDonough and team are banking on in terms of what's going to accelerate growth for them.

Yes.

And even on CCS, Noah, keep in mind, I mean, their backlog is good.

They've had great order growth on the equipment side, 9% organic order growth on the equipment side in fourth quarter, pretty strong, pretty solid.

So I think we do feel the comment about Greg's disappointment with CCS on fourth quarter was more related to the drop-through, not so much the top line.

I think we do feel very, very strong and very good about their ability to continue to get results from their investment in innovation and the new products that they're bringing to the marketplace.

So things feel okay as well.

But you'll have a chance to ask the presidents these questions in detail when they stand up in March as well.

And your next question comes from Ron Epstein of Bank of America.

Can you walk through Pratt in a little more color?

It was a pleasant surprise to see the uplift in the underlying earnings at Pratt next year.

And is that V2500, is that PW4000 because, for sure, we're seeing a pickup in the freighter markets and you guys have a lot of engines in that market.

Or is that GTF related?

Sure, Ron.

I think, yes, the big driver for the commercial aftermarket, which is probably what you are referring to, the 10% growth, right, I mean, the GTF and the military engine business not really surprising just given the outlook for the engine shipments that we have.

On the commercial aftermarket side, clearly, it's V2500.

They are entering into the sweet spot, as we have talked about for a few years now, right?

I mean, a lot of them, the average age of the fleet is a little over -- is about 9 years or so.

First overhauls are coming in for a lot of those engines.

We expect worldwide shop visits to be around 10% growth in 2018.

And that's what drives a lot of that commercial aftermarket assumption.

On the OE side, I would tell you this.

I think it's -- Pratt is finally back in the large commercial engine business.

If you look at overall production for next year, I think, finally, we will be over 1,000 large engines.

This was last achieved by Pratt in the early 1980s.

So it's a long time coming, but we are finally there and that number will only continue to grow as we look forward.

So we feel really good about it.

And then the third element of Pratt is the Pratt Canada business.

And not just because of the PW800 that Greg referred to, we expect to see engine shipments to start growing in the other small engine segments as well.

The helicopter market is bottoming out and hopefully starts to improve.

There is an improving sentiment about the business jet market.

We'll see whether that turns around or not, but we certainly have a market share gain with the Gulfstream.

So I think it's all feeling like it's coming together, and this is an often used phrase, but it feels like Pratt is firing on all cylinders.

And at Pratt, I mean, is this year going to be the peak in the headwind for the GTF?

Is that how we should be thinking about it?

And what will that headwind be?

Yes, we've talked about the 2018 as the headwind -- as the peak year for negative engine margin headwind on a year-over-year basis and in terms of absolute numbers and that number is going to be approximately $1.1 billion, as we have said before, right?

So it will be the peak.

In 2019, the volume increases will be there, but that'll be offset by the cost reduction benefits.

And our next question comes from Sheila Kahyaoglu of Jefferies.

Just on the portfolio update.

As you think about the Collins transaction nearing and tax reform changes, how do you think about the portfolio from here?

Any divestments needed to delever?

If you could give some color there.

Yes.

We've talked about we'll look at the portfolio post Rockwell Collins and our thinking really hasn't changed there.

I would tell you, with tax reform, the ability to delever is significantly enhanced just with having access to our foreign cash without having to pay a second toll tax on it.

So I wouldn't think there is anything out there that we have to divest as a part of our deleveraging scheme.

At the same time, I would tell you we're continuing to look at the entire portfolio, things that makes sense, things that don't make sense and we'll continue to evaluate what we're going to do longer term.

Right now, of course, the focus is on getting it closed, getting it financed and then we'll come back to you guys with, I think, a more detailed look at everything.

And our next question comes from Jeff Sprague of Vertical Research.

Just a couple of quick things here for me.

Just first on Otis, China, particularly.

I guess it still isn't really clear if pricing has stabilized there.

But can you give a little bit of color of how you see the year playing out, Otis China price specifically?

And then I was also wondering, on CCS, it looks like there was a recall in the fourth quarter.

What does that relate to?

Is that some legacy products or something new?

Any color there would be helpful.

So on the Otis part, Otis China, again, I think you are referring to the disconnect between the dollar value in orders of down 7% and units up 1 point.

That's -- the 8-point difference is very consistent with what we have reported the last couple of quarters.

The difference, Jeff, this time was that when we look -- when we typically break that gap between 3 pieces, price, mix and major projects, right, because major projects can have a significant impact.

They come with higher dollar value with fewer units.

This quarter, for the first time, major projects more than explained the entire 8-point disconnect.

So price/mix was actually slightly positive for the first time in many, many quarters that we have seen that.

That's a change in trend that we are hoping will continue.

Now one quarter doesn't make a trend, you'll remind me, but it's the beginning, and we hope that continues.

That's what the assumption is in the plan, that pricing stabilizes and becomes slightly positive as we go forward for China.

Obviously, because of the negative price/mix in the backlog, the sales in '18 will still have some negative impacts coming through as well the margins, which is why we have forecasted China to be down slightly low single digit in the new equipment sales next year.

But the order trends are more encouraging in Q4 even in China than what we have seen historically.

On the CCS side, Jeff, that's the fire extinguisher, the Kidde U.S. fire extinguisher recall.

You'll recall that we started talking about this in the third quarter.

We took a small charge at CCS for what we thought was the amount of the recall.

But as the quarter progressed, what we saw was a much higher return rate than we have seen historically.

A lot of these fire extinguishers are not just sold to consumers, but also to businesses and the businesses, be it the Coast Guard or the police, have a much higher return rate than what consumers typically do.

And so as the quarter progressed and we saw the return rates spiking significantly, we took another look at the reserve for that and we booked what we think is an adequate reserve we'll see over time here.

But hopefully, this is behind us now in terms of the financial impact of this fire extinguisher recall.

Remember, these go back 20-some years.

So while it's a big number in the context of the business, over some 20 years of production, it's not that significant.

It's still a very profitable business long term.

And we did the right thing here in terms of the product recall with the Consumer Product Safety Commission.

We've gone out, we've advertised to get these things back and just trying to correct what was unfortunately a manufacturing error.

And our next question comes from Sam Pearlstein of Wells Fargo.

Greg, you had talked a little bit about the Rockwell Collins transaction and the discussions with the regulators.

When this was first announced, certainly the large OEMs were saying they didn't see a lot of benefit from it, which clearly was a negotiating tactic.

They haven't been talking a lot about that, so can we read that as you've come to some agreement in terms of concessions?

And anything you can add about how the OEMs are viewing the transaction now?

Well, Sam, we have clearly been talking to both the OEMs as well as to the airlines about the benefits of the deal.

It's no surprise, I think the big OEMs are skeptical just in terms of what they perceive to be market power of a combined Rockwell Collins and the Aerospace Systems business.

But our message has been clear since day 1, which was we think this will add value to the customers over the long term.

We're working with the OEMs now to get this thing finalized and hopefully we're not going to see big objections.

But in terms of settlements and all that, I'm not going to comment on that other than to say that we're talking to folks on a daily basis and we don't see anything that's going to prevent this deal from getting done.

And our next question comes from Peter Arment of Baird.

Greg, I'm sure we'll get a lot of details of GTF in March.

But maybe you could just give us some additional color of how you're seeing the production going, the fixes that are being put in place and obviously thoughts on maybe spare engine volume in 2018.

Yes, it's good question and I'm noting this is, I think, the ninth question and the first one on GTF, so that's a significant improvement as we've seen in the field on the GTF, I might add.

So just to put it in context, we've got about 500,000 hours today on the GTF.

Dispatch reliability is 99.88%.

That's all pretty good.

And importantly, the number of AOGs or aircraft on ground waiting for spares is less than a handful.

And in fact, we've got more spares than we need today, which is fine because as we've talked before, we'll be retrofitting a number of these engines to incorporate the fixes for engines that were produced last year.

Every engine that's going out the door today has the 2 big fixes in it, that is for the number 3 seal as well as for the improved combustor liner.

And I think all of those are contributing to the success or the reliability that the airlines are seeing today.

The challenge in 2018 is we'll have to do a number of overhauls for those engines that are already shipped.

That's in the plan.

We think we've got adequate capacity to do that and adequate spares.

We had more than 40 extra spares -- 40 spares at the end of the year.

We'll make more this year, but we certainly won't make them at the same ratio that we did last year as you're doubling production.

You're going to see a huge ramp-up in -- at Airbus as well as an increase at Bombardier.

So I feel pretty good about the GTF today.

Yes.

And keep in mind, with the fuel burn benefit that GTF provides, which is substantial, I mean, the airlines are seeing significant benefit.

And with the fuel prices rising, which is a concern that we keep reading about nowadays, I think that's -- even makes it an even more attractive engine to have on the aircraft.

So I think it's all helped.

Yes, I think the one word that I would say summarizes the success of the GTF is Delta.

The fact is Delta showed high confidence in Bob Leduc and the Pratt team in selecting the engine in December to power their A321 fleet.

Delta is a very sophisticated customer with Delta TechOps.

They wouldn't have selected it if they didn't think it was the right engine with all the attributes that we've been talking about with fuel burn and noise and reliability.

And our next question comes from Steven Winoker of UBS.

Greg, love to get a sense for where service attachment rates are for Otis these days in China and where you see that trending.

And then if you could also kind of clarify your comment or Akhil's comment that your disappointment on CCS in the drop-through, was that mostly the product recall related?

Was it priced raws, time frame and lag or factory absorption?

What were your concerns there, too?

So first one, Steve, on the China conversion rates, we saw some improvement there.

The rate now -- as you know, it, for a long time had been in the low 30s.

We ended 2017 with a 39% conversion rate, which was encouraging.

But that's, for a long time, we have said, look, it'll be a slow progress.

It is not going to overnight go back to the Western phenomena of above 80% conversion.

And what we mean by conversion is new equipment coming off warranty and getting into a service contract.

So an encouraging sign of progress, but it is going to be that level of progress every year as we continue to focus on more and more service in China.

With regard to CCS, I think the comment Greg made, the disappointment, it was largely the mix factor that we didn't see can change that dramatically.

There were also a couple of issues with our new products in the commercial refrigeration space where we were expecting cost reductions to come in at a faster rate, but unfortunately the factory performance was a little short of our expectations and we ended up having -- not seeing the level of cost reduction that had been anticipated in that business.

But it was more about that and a little less improvement in pricing, particularly on commercial HVAC.

So I think those 3 factors are what ended up to the disappointment in the CCS numbers, as Greg referred to earlier.

And was that specifically Linde factories on the commercial refrigerator or was it someplace else?

Or it wasn't on the transport side, right?

No, it was primarily the old Linde business and it was just additional volume coming through the factories.

We just couldn't get folks -- not surprisingly, we moved the factories to Czech Republic a number of years ago and unemployment there is about 2%.

We had a hard time getting people into the factories to build the product, and as a result, the costs were just higher than what we expected.

On the container side, I think we had some adverse mix, but really it was the commercial refrigeration, the factory performance, that really wasn't up to expectations.

Right.

And keep in mind, commercial refrigeration in Europe, the Linde business you talk about, Steve, is just about $1 billion of the total $17 billion, $18 billion that CCS has.

So other factory performance, whether it's Mexico or Collierville or Indianapolis, all going extremely well.

So it's not a systemic issue, it was just a lot of orders coming in and new products and that cost reduction not happening at the pace we expected or wanted.

And our next question comes from Cai Von Rumohr of Cowen and Company.

So Akhil, you did a great job of explaining the difference in the tax rate.

Given that, presumably, you have to pay something for repatriation 8%, you get bonus depreciation, what is the all-in cash flow impact of the tax law change on 2018?

Not a huge number, Cai, for a variety of reasons, right, in 2018.

For the entire period over through 2026, we will have a $1.5 billion net payment that we have talked about.

But a small portion of that -- as you know, there is a graded payment that the government has allowed.

And net of any credits that we get, the impact in 2018 is not meaningful, not that significant.

Got it.

And then you said you were going to bring $3-plus billion back.

I mean, given that you have $7.5 billion to $8 billion abroad, how come not bring back more so you can whack more of the Collins debt?

And given that you are bringing some back and can do that, does this bring you closer to the point at which, I think you guys once said, you might consider breaking up the company?

Well, let me answer the first one.

The $8 billion of cash that you referred to, keep in mind that a lot of that is related to our partners that we have, particularly in China, that Otis and Carrier has.

So not that entire amount of cash, even though it shows up on our balance sheet, is not our cash per se.

There is minority partner share in that cash, which belongs to them obviously.

Also, through the Pratt joint ventures or collaboration agreements that we have, there is a significant amount of cash that is due to our collaboration partners that is sitting overseas as well.

And then there are constraints that we have to look at such as withholding taxes in foreign jurisdictions, et cetera.

So our tax and treasury guys work very closely together to try and optimize the most cost-effective way of bringing the cash back.

At this point, we believe we can do $3 billion out of the $8 billion.

Now we'll continue to push that and hopefully we can do more than that.

But at this point, it's safe to assume $3 billion, at least that's the good news of the tax reform.

The other point is that not only about the cash that is on the balance sheet today, but the access to cash as we generate going forward and being able to bring that back is what will help us delever faster than what we had originally anticipated.

So we'll be able to access cash.

We generate over $3 billion internationally every year and that -- having the ability to bring some of that cash back would be very meaningful from that perspective.

With regard to the portfolio question, look, nothing has changed with regard to our thinking that we have discussed with you guys periodically and often.

We will continue to look at all the options.

We'll continue to look at that.

But the first priority is to close Rockwell Collins, get the synergies, get the integration done and delever so we can get back to our A rating before we have any conversation of any meaning on portfolio.

And our next question comes from Doug Harned of Bernstein.

I wanted to go back to the GTF, a second question on it.

Now that you're getting the fixes in place and you look forward, obviously the instance has been a challenging start.

When you think about the aftermarket going forward, can you talk about how you see the profitability of that aftermarket over the next couple of years relative to your expectations?

And given that these are going to be heavily on fleet management programs, when should we start seeing a material positive cash impact coming off of the aftermarket for the GTF?

First of all, Doug, I think the GTF aftermarket, right, these engines will be out there for 20 or 25 years.

Almost all of 80% of the engines today are going out under some type of an FMP or Fleet Management Program.

A portion of those are actually paying cash on an hourly basis, the other at first shop overhaul.

But again, these first visits that we're going to see this year, we won't see any additional cash for those because this is really under warranty as we put the fixes into the fleet.

So realistically, you're talking 2020, 2021 when we really start to see the aftermarket from the GTF start to be a meaningful part of the Pratt story.

The good news, of course, is, in the interim, you've got the V2500, which, as Akhil mentioned, probably over 1,000 shop visits this year and probably next and it still is in that kind of sweet spot.

So our GTF is still a few years out, the V is exactly where we had expected it to be and the aftermarket is as strong as we could have hoped there.

So I don't see any big changes there, it just takes time.

So presumably, in a fleet management program, obviously you're making estimates on risks and costs and so forth and that's all in your pricing.

So you haven't seen any changes to your expectations based on some of the early challenges the engines had in terms of what you expect that profitability to be?

No.

I think, overall, it is about as we had expected.

Obviously, we don't specifically plan for these 2 issues that we had.

But given the nature of -- the long-term nature of the contracts and the costs of the overhauls and the work because this is not a significant impact to the overall fleet profitability as you think about what is about 8,000 engines that we've sold so far.

I think the best thing to think about that, Doug, going forward, there are still 3,000 Airbus aircraft out there that haven't had an engine selection on it yet.

And I think given the success we had in the fourth quarter and what we're seeing from the operators today, we think we'll get our fair share of those.

So hopefully, it'll be better even than what we're currently anticipating.

Yes.

The good news, Doug, if any, is that in these problems, I mean, with every engine that we have out there, sometimes we do encounter problems which require costs to be incurred on the FMP programs, the good news is having caught the problems early, we have fewer engines to worry about with regard to that incremental cost, if any.

And over the years, our experience has been that the engineering teams, along with the manufacturing teams, continue to work on improving the quality and the performance of the engines through cost reduction efforts and others, which will then help improve the projections that we might have at this point of time.

It goes both ways, but overall I think we feel good about where things are.

And our next question comes from George Shapiro of Shapiro Research.

Yes.

A question on Pratt's margin.

First, it seems like you must have shipped maybe another 30 or 40 spare GTFs in the quarter.

I just want to know whether that was accurate statement and that's a big part of the reason you had the 25% sales growth in aftermarket.

And the second is, which seemed to me, with the aftermarket up that high, that Pratt's margin should have been higher than what you reported.

So I just wondered if you could provide some added color on that.

George, first of all, any spare engines sold don't go through the aftermarket numbers.

That generally goes into our OE count itself if there are spare engines sold as part of the overall campaigns.

Secondly, the conversion point, I think one of the things we have talked about -- you and I talked about a little bit, is that the traditional old margin rates on aftermarket that we used to get on JT8Ds, JT9Ds or PW4000s was much higher than what we expect to get on V2500, first of all, because there is the payment to Rolls-Royce that we have for buying over their portion of the business, that comes with higher intangible amortization associated with that transaction and there is a significant amount of more engine services model that we have.

So our net conversion or drop-through on commercial aftermarket under the new programs is a little lower than what was traditional old margin expectations that you've seen on the Pratt engine models.

So both those things actually explain the conversion.

The conversion we are seeing is not different than what we expected.

The higher growth rate was from V2500.

And some of it also comes from our -- from the engine services we provide on some of the other engine models, which does not come through with great drop-through like we have for China Eastern.

We have CFM engines that we service in our Shanghai engine center and that, as you can imagine, comes with very little conversion, right?

So it's a combination of those factors is what explains the Pratt aftermarket.

Okay.

And can you validate, Akhil, whether I'm at all in the ballpark in terms of the spare engines in the quarter?

No, I don't think we have given that and we don't want to get into that, George.

And that concludes our question-and-answer session for today.

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

Thanks, Candace.

And I want to thank everybody for listening.

I know it's a busy day for you, guys.

But Carroll and Nathan and Devin will be here all day to answer any questions you guys have, so feel free to give us a call.

And have a great day.

Thanks, all.

Bye-bye.

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

This does conclude the program and you may all disconnect.

Everyone, have a great day.