雷神技術公司 (RTX) 2018 Q1 法說會逐字稿

Good morning, and welcome to the United Technologies' First Quarter 2018 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 or nonoperational nature often referred to by management as other significant items.

The company also reminds listeners that the earnings, 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 Forms 10-K and 10-Q, 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 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.

Thank you, Gigi, and good morning, everyone.

As you saw from our press release this morning, we had a very solid start to 2018.

We reported adjusted EPS of $1.77 in the quarter.

That's up 20% versus the prior year, with adjusted operating profit growth across all 4 businesses.

Sales were up 10% with organic growth of 6% and, again, contributions from each business, our best first quarter of organic growth since 2011.

And while still early in the year, our strong performance in Q1 and solid fundamentals across the business give us confidence to raise our 2018 adjusted EPS expectations.

We now expect $6.95 to $7.15 for the year versus our prior outlook of $6.85 to $7.10.

We're also taking up our sales outlook, where we now expect sales of about $63 billion to $64.5 billion.

That's up about $0.5 billion on both the bottom and top of the range.

We continue to expect 4% to 6% organic sales growth and, importantly, $4.5 billion to $5 billion of free cash flow for 2018 despite a slow start.

As I highlighted in our analyst meeting last month, we continue to focus on innovation.

That will provide us with sustained long-term growth, and you can see in our first quarter results the investments are clearly paying off.

Here are just a couple of examples.

At CCS, the team delivered 7% organic sales growth.

That's their best quarter since the business segment was formed 6 years ago.

CCS has also brought to market more than 200 new products over the last 2 years, and is targeting a record number of new product introductions again in 2018.

At Pratt & Whitney, organic sales were up 9%.

We saw robust military sales, and the Pratt Canada engine business was up in the quarter, which demonstrates that Pratt's more than just the Geared Turbofan engine.

Additionally, our large installed base of engines generated strong aftermarket sales.

We continue to grow our GTF engine order book, most recently highlighted by JetBlue's announcement that they have selected the GTF to power an additional 45 A320neo family aircraft, underpinning our confidence the value of the engine brings to our customers.

And as we said last month, we now have over 7 years of GTF backlog, and we received more than 9,000 total firm and options orders to-date for the engine.

With more than 700,000 hours of revenue service now, the GTF is flying with 21 operators to 329 destinations across 4 continents every single day.

And just today, the Embraer 190-E2 completed its first revenue flight with Widerøe.

The E190-E2 represents our third GTF-powered application now in service.

The engine also continues to provide our customers with at least 16% fuel burn, 50% lower emissions and 75% reduction in noise footprint.

That's a result of our continued investments in innovation.

As I also said last month, we're not done innovating.

The investments we'll continue to make in our business will drive both top and bottom line growth over the long term, results that we believe will outpace industry growth rates over time.

Beyond our financial results, just a word on Rockwell Collins, we continue to see a close in mid-year and are working closely with regulators to complete the remaining reviews.

We're excited to combine 2 world-class teams and accelerate our innovation in the high-growth aerospace industry.

With that, let me turn it over to Akhil and Carroll to take you through the results, and I'll be back at the end for wrap-up, and then we'll take some Q&A.

Akhil?

Thanks, Greg.

I'm on Slide 2. So Q1 was solid.

Reported sales were $15.2 billion, up 10%, 6 points organic, 3 points from favorable foreign exchange and the remaining point from the adoption of the new revenue standard.

You can see the impact of this adoption in the appendix.

The largest beneficiary was Pratt & Whitney.

At the EPS level for UTC, we saw a $0.01 benefit in the quarter from this.

Adjusted EPS of $1.77 was up 20% versus the prior year.

This was clearly better than our initial expectations for the quarter by more than $0.25.

Why?

Well, we saw stronger-than-expected CCS organic growth and aerospace aftermarket sales, both commercial and military, all with solid drop-through to the bottom line.

FX impact was more favorable than expected, and we saw a $0.05 benefit below segment operating line from a couple of insurance settlements.

Additionally, negative engine margin at Pratt & Whitney was lower than expected in the quarter due to the re-profiling of GTF engine shipments for the year.

Now some of this first quarter strength is just timing.

A few specific aftermarket transactions were planned for later in the year came through in first quarter, and the negative engine margin benefit in the quarter goes away as we catch up on deliveries.

Overall, about $0.10 of the beat will come out of the second quarter, some from the second half and some we are counting on for better full year performance.

That is why we have raised our sales and EPS outlook for the year, even though it is just April.

On a GAAP basis, EPS was $1.62, down 6% versus prior year.

You'll recall, we had a $0.29 onetime gain in Q1 of 2017.

This year, first quarter included $0.06 of restructuring and $0.09 of nonrecurring items, $0.03 of Rockwell Collins-related integration planning costs and around $0.06 of additional charges related to the recently enacted tax law changes in the U.S.

Free cash flow was only $116 million in the quarter.

That's $550 million lower than last year.

This was almost entirely driven by higher use of working capital from strong organic growth and timing of shipments, principally at Pratt and CCS.

Cash generation will accelerate as we progress through the year.

And as Greg said, we continue to expect free cash flow of $4.5 billion to $5 billion for the year.

Now turning to Slide 3, you will see the drivers of our solid organic growth.

The macroeconomic environment continues to remain robust, and we see strong fundamentals across our 2 end markets.

For our commercial businesses, in the Americas, sales were up 8%, with solid growth across both Otis and CCS.

Activity levels remain robust.

And construction continues at high levels, and consumer sentiment remains strong.

Within EMEA, sales were up 2%.

In Europe, unemployment rates have been coming down and general economic conditions improving.

We saw CCS sales up mid-single digits, driven by the strength in commercial HVAC and Refrigeration businesses.

Middle East remains a watch item with pockets of strength in certain countries, but with slower conversion from order to completion on projects in Saudi Arabia.

In Asia, sales were up 1%.

Otis China was down mid-teens, as weak orders from late 2016 and early 2017 convert to sales.

Price-cost balance remains under pressure in China for both Otis and CCS.

The rest of Asia was up low single digits at Otis and low teens at CCS.

On the aerospace side, commercial aerospace sales were up 6% in the quarter despite the revised timing of GTF shipments.

We see continued high airline traffic and strong utilization of in-service products, which translated to 14% organic aftermarket growth in the quarter.

Military sales were up 9% at Pratt & Whitney and up 15% at Aerospace Systems, driven by strong aftermarket demand and programs that are ramping production.

Lastly, a few additional comments on Rockwell Collins.

As a result of the U.S. tax reform, we repatriated $3.8 billion of overseas cash in the quarter, which is more than $2.5 billion higher than we originally expected when we announced the deal.

So a good start to our cash mobilization efforts, and we expect to have better access to international cash going forward.

This higher available cash will reduce the debt funding requirement for the Rockwell transaction, and we anticipate going to the capital markets in the second quarter.

With that, let me turn it over to Carroll for the segment details.

Okay.

Thanks, Akhil.

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

And with the exception of organic data points, all results include the impact of the new revenue recognition accounting standard.

And as a reminder, there's an appendix on Slide 11 with additional segment data you can use as a reference.

Otis sales were $3 billion in the quarter, up 1% organically.

Operating profit was down 2% at constant currency.

Tailwinds included contribution from higher volume, productivity and transactional mark-to-market currency adjustments.

Just a note on this last item.

As in prior years, the mark-to-market adjustments can fluctuate over the balance of the year depending on currency movements.

These tailwinds were offset by continued pricing pressure and adverse mix, largely in China, as well as commodity headwinds and continued investments in the service business.

Foreign exchange translation was a 6-point tailwind to sales and a 7-point tailwind to earnings.

New equipment sales were down 2%.

Mid-single-digit growth in North America was offset by a 16% decline in China, as the lower order rates from 2016 and 2017 convert into sales.

Service sales were up 5%.

Otis saw strong growth in modernization.

Repair and maintenance were up low single-digit.

New equipment orders were down 4% organically in the quarter, off of prior-year compares that included more major projects.

Orders in Europe and Asia, excluding China, were up low single-digit.

This was more than offset by high single-digit declines in North America after being up almost 30% last year.

In China, orders were down 2% in value, with the unit orders down 1%.

So despite some tough compares impacting orders overall, Otis new equipment backlog is at record levels.

For the full year, we continue to expect Otis operating profit to be up $25 million to $75 million at actual FX.

Turning to Climate, Controls & Security.

Sales grew 12% in the quarter at actual FX.

Operating -- adjusted operating profit was up 5% at actual currency.

FX translation was a 5-point tailwind to sales and a 2-point benefit to earnings.

Organic sales at CCS were up 7% in Q1 with all major businesses contributing.

In particular, North America residential HVAC and transport refrigeration grew 11% and 18%, respectively.

Global commercial HVAC was up mid-single digits, and Fire & Security was up low single digits in the quarter.

CCS total equipment orders were also strong, up 10% in the quarter.

Transport refrigeration orders saw continued strength, up 37%, and residential HVAC grew 24%.

Global commercial HVAC and commercial refrigeration orders grew low single digits in the quarter, while Fire & Security was down 4%, driven by weakness in China and a tough compare in EMEA.

Operating profit growth due to higher organic volume and productivity gains was partially offset by commodity headwind and period expenses from the recent portable fire extinguisher recall.

Our pricing overall is slightly lower than expectations, principally in global commercial HVAC.

Recently implemented initiatives are expected to provide pricing tailwind through the balance of the year.

Looking ahead, based on strength in order rates and backlog position, we remain confident in the full year guidance for CCS.

Operating profit growth of $125 million to $175 million at actual FX on low to mid-single-digit organic growth.

Shifting to Pratt & Whitney on Slide 6. Sales of $4.3 billion were up 9% organically.

Including the previously discussed impact of the new revenue recognition standard, reported sales were up 15%.

Aftermarket sales were strong across the segments, with commercial up 18% and military up 13%.

Large commercial engine aftermarket continues to benefit from V2500 strength and better content on the PW4000.

Military aftermarket strength was driven by F135 and F119 programs, supporting fighter aircraft fleets.

On the OEM side of the business, military sales were up 26%, and commercial was down 2%.

In the commercial business, higher GTF shipments were offset by lower legacy program volumes.

Now as we discussed last month, Geared Turbofan shipments to Airbus resumed in late February.

Pratt & Whitney Canada OEM sales were up, driven by higher engine shipments.

That's the first time in 14 quarters that we've seen higher year-over-year shipments at Pratt Canada, so we're finally starting to see some growth in business aviation and helicopters.

Adjusted operating profit of $413 million was up 16%.

Drop-through from higher aftermarket sales more than offset headwinds from higher negative engine margin and lower OEM drop-through at Pratt Canada due to mix.

Operating profit also included higher customer support costs on the Neo knife edge seal issue, and that's consistent with what we discussed at our March analyst meeting.

Results also reflected a gain from a divestiture, which contributed $0.02 of EPS to UTC in the quarter.

Looking ahead, we continue to expect Pratt & Whitney to grow operating profit $25 million to $75 million but, as we said last month, probably closer to the low end of the range.

Turning to Slide 7. Aerospace Systems also delivered a strong quarter with 11% adjusted operating profit growth on 5% higher organic sales.

Sales growth was driven by the commercial aftermarket, which was up 16%.

Parts and repair were up 10% and 12%, respectively, and provisioning grew by 28%.

While leading indicators remain positive in commercial aftermarket, provisioning in Q1 did benefit from timing of several transactions that were anticipated to occur later in the year.

Commercial OEM sales were down 8% due to growth in new programs being more than offset by declines in legacy programs, including the absence of the Boeing 777 landing gear.

You'll recall that Q1 marks the final quarter in which the landing gear item will impact the compare.

Military sales were up 15%, driven by higher F-35 volume, customer-funded development activities, strong spares orders and the capture of several international contracts in the ISR business.

Operating profit growth was driven by drop-through on higher commercial aftermarket and military sales, lower E&D and continued product cost reduction.

These benefits were partially offset by commercial OEM mix headwind and adverse transactional foreign exchange impact.

So with a solid start to 2018, we continue to expect Aerospace Systems operating profit to be up $150 million to $200 million for the full year.

With that, I will hand it back over to Greg.

Okay.

Thanks, Carroll.

So not to beat a dead horse, but as we said several times, it's early, but we had a really good start to the year.

Despite some turbulence in the geopolitical environment, each of our businesses continues to be supported by long-term solid fundamentals, and the global macroeconomic outlook remains strong.

For us, it's about staying focused on delivering innovative products and services to our customers worldwide, and we'll do that with a continued focus on execution, innovation, structural cost reduction and disciplined capital allocation.

As I highlighted at our investor meeting last month, we continue to focus on digital initiatives to drive customer value across each of our businesses.

These initiatives include transforming our service capabilities, improving the customer experience with our products, driving smart factory optimization and developing connected products that enable real time health monitoring capabilities.

Focusing on these strategic priorities will ensure UTC delivers exceptional products and services to our customers, and creates value for our shareowners for years to come.

UTC's future has never been brighter.

And finally, as Akhil mentioned, we're focused on closing the Rockwell Collins transaction first.

And while I know many of you want to talk and ask about the UTC portfolio of discussion, I will defer any of those discussions until after the Collins transaction is completed mid-year.

So with that, let's go ahead, Gigi, and open up the call for questions.

(Operator Instructions) And our first question is from Sheila Kahyaoglu from Jefferies.

Can we delve into CCS profitability?

It came in a bit lighter than expected.

Maybe what are the moving pieces?

And how do we think about the balance for the remainder of the year?

Sure, Sheila, and thank you for the comment.

Look, the CCS thing, as Carroll pointed, 3 factors to talk about the 1 point year-over-year down op margin that, I think, you're referring to.

As Carroll said in his remarks, if you look at the FX translation, sales benefited by 5%, but profit only by 2%.

So it's a geographic mix of where the foreign earnings came from.

That was roughly 1/3 of the year-over-year issue with the ROS.

The second point was, you recall, we talked about this -- the fire extinguisher recall that we had last year.

There are some trailing costs associated with that, which hit the period Q1.

That was about 1/3 of the problem as well on the ROS side.

Thats, again, it will go away in a quarter or 2, and then we'll be back to normal.

And then the final piece is that the commodity inflation was a little higher than the price benefit that we were able to extract in the quarter.

We expect that to change as well as the year progresses.

We've got additional price increases lined up for the rest of the year.

So that dynamic primarily explained the rest of it.

So between those 3 things, 2 of which will go away is what explains the ROS.

The good thing was that they grew earnings by $31 million in the quarter, which is very much in line with our full year outlook.

Our next question is from Steve Tusa from JPMorgan.

Can you update the kind of Carrier bridge and just give us a little bit of color around, is there any updated thoughts around raw materials there?

I know you gave us like pretty recently, so -- maybe not, but aluminum's moved up a little bit.

And so I'm just curious as to -- if there's a specific update there.

Yes, sure.

I think, Steve, if you remember, we talked about $100 million positive price, partially offsetting about $50 million increase in commodities.

We think today that the commodity increase will probably be $25 million more than that for the year, partly related to the issue that you're talking about.

And just generally, we are also looking at increasing our price realization as the year goes by, so hopefully be able to offset some of that.

But if I was to put a risk or a qualifier on the CCS story, I would say that's probably where a little bit of caution might be necessary.

On the other side, we are seeing positive outlook on the FX, which will help offset that, and perhaps a little better on the volume side.

So net-net, I still feel very good about CCS guidance for the year, but there could be a little bit pressure on the price-cost.

Got it.

That's great color, as always.

I don't know if you just answered this question.

If you did, then I'll just hop back in the queue, but what was the benefit from negative engine margin in the quarter from the lack thereof?

Yes, from the lack thereof about, about $0.07 to $0.08 roughly because, if you think about it, we would have had more negative engine margins if we had not stopped shipment in the month of February.

And so that sort of goes away in the second -- in the remaining 3 quarters, which is why you don't see drop-through for the year.

Well, keep in mind, Steve, as well, there was about $50 million of onetime cost in the quarter at Pratt also associated with the knife edge deal.

So while we got good news on timing related to the lower shipments, a big -- a chunk of that was offset by the onetime cost.

That's why, again, not all this is good news, and first quarter is going to flow into the year because you are going to see that negative engine margin as we catch up on shipments here in the second quarter.

Right.

So there's $0.05 from insurance.

There's low single-digit amount of the pennies from this kind of engine thing.

There's a couple pennies from aftermarket deals, and then a couple of pennies from gain in Pratt & Whitney.

Is that kind of how you get to this around $0.10 number of stuff that is onetime in nature kind of rolls back through the course of the year?

Are those the kind of major items?

Yes, major items.

Overall, I would say, if you look at the $0.25 beat, I think I would say $0.10 out of second quarter, as I said, maybe another $0.07 or $0.08 out of the rest of the year because negative engine margin won't all come back in the second quarter.

Some of it will come in third and fourth quarter as we catch up.

Okay.

So the $0.10 in the second quarter -- okay.

Great color, as always.

You guys always make it very clear and easy to go through the results.

Our next question is from Carter Copeland from Melius Research.

Akhil, I just wondered if you could kind of give us some perspective on the re-profiling impact on cash.

And just the working capital outflow in the quarter, how much of that was related to Pratt and how should we think about that reversing itself over the course of the year?

First of all, thank you, Carter, for saving my bet because I had said that the cash question will be in the first 3. And I was surprised in the first 2 it wasn't there.

So thank you.

It's a very simple answer actually.

It's lower than what we would have expected.

But really, if you look at we stopped shipping the Pratt engines in the second month of the quarter, which meant we had more inventory and more receivables, which we could not collect because of the timing of shipments in Pratt.

The other point is, CCS, while the growth for the quarter was 7%, in the month of March, CCS growth -- organic growth was double digit.

So obviously, again, led a lot of that stuff sit in the receivables at the end of the quarter, which we will collect in the second quarter.

So no issues with regard to the full year, but those 2 exceptional items put some pressure on the first quarter cash flow.

Now for those of you who might not be familiar with the overall, why first quarter is generally low, keep in mind, CCS is a seasonal business.

Q2 and Q3 are very strong for them from a sales perspective, so you build a lot of inventory and CCS in the first quarter.

Secondly, like probably many other companies, we have a significant outflow related to incentive payments in the first quarter.

You pay the full year bonuses in the first quarter, and you accrue only one quarter worth.

And that's about $300 million for UTC overall globally, right?

So if you take those things into account, and then we had this Canadian payment in the first quarter as well, that keeps the pressure on first quarter cash flow.

So really nothing abnormal.

Nothing surprising here.

It's just the way that got profiled this time.

Well, you were clearly prepared for that one.

Our next question is from Julian Mitchell from Barclays.

Just on the EPS from Q1, and then thinking about the guidance for the year, so it sounds like all the segment profit guides are the same.

So maybe give a bit more background, I guess, as to the -- you had that EPS bridge on the Q4 call with about like 8 items in it.

Only one of them was the segment level.

So maybe give us some background as to what's changed in those other sort of 7 items.

Because I understand the timing aspect, but you're still taking up the full year guide even with that.

Sure.

So overall, you are right, Julian.

I think we feel that the business units are relatively well-calibrated for the year with regard to their EBIT bridges.

I think there are some puts and takes in each of them, and we can talk about those.

But broadly speaking, the commercial businesses benefit from FX, and they have some risks associated with commodity inflation and/or some price -- so the price-cost balance effectively there.

On the aerospace side, I think we have -- we feel pretty good about the benefits from the aftermarket.

Hopefully, some of that will fall through for the year, above what we were originally expecting.

And then on negative side, we had this higher retrofit cost that we talked about -- that Bob Leduc talked about, $50 million associated with the knife edge seal issues.

So net-net, business unit's about on track.

The reason why we raised the guidance at this stage is the $0.05 of insurance settlement, that comes in above what we were expecting.

That was not in our plan clearly, so that kind of flows through to the bottom line.

We think because of timing of the debt issuance, we probably have $0.01 or $0.02 on the interest line and just the continuing focus on the cost side for the corporate expenses.

So I think net-net, we feel good.

I would say that there may be a little bit more upside on the business units overall as the year goes by, but at this point, it's too early.

We still have a contingency of $120 million at the midpoint of $7.05.

So feeling good about the year, which is why you saw the untraditional raise in April.

Now Greg is looking at me like...

Who is this person sitting next to me?

But I think, Akhil, hit it on the head, I think there's probably a little bit more upside to the year, although this is very unusual for us to have an April raise to guidance.

I've been doing this, I told you, guys, yesterday for 15 years, and I've never remembered, even with really good first quarters, us doing this.

So it just goes to the strength of the businesses as well as some of those macro things, like currency, that's helping us and a very, very strong aftermarket on the commercial side, commercial aero.

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

When we look at the China -- potential China trade tariffs and some of the tension going on right now between the U.S. and China, has that had any impact on your China operations in Otis or CCS?

And then, I guess, as a follow-on to that, do you expect that to have any impact on the Chinese approval of the Collins deal?

You know Ron, that's a great question.

We've been asking that question ourselves of the business.

In fact, Judy Marks and her team just got back from China over the weekend.

And what looks like to us is the Chinese property market continues to be slow because of some of the cooling measures that have been applied to try and keep property prices in check.

But we have seen no impact on any of the businesses, CCS or Otis, in terms of potential tariffs.

And keep in mind, we manufacture in China for the Chinese market, right?

We're not a big exporter out of China back to the U.S. And so any of this tariff -- these discussions back and forth really don't have a terribly big impact on the business.

As far as the Rockwell Collins approval goes, we have seen no change in behavior from the Chinese regulators.

So all still very professional asking all the questions that we would expect.

And we remain on track to, we think, second -- late second quarter, early third quarter to close on Collins.

And we just don't see an issue out there.

Our next question is from Jeffrey Sprague from Vertical Research PA.

One -- just 2 quick things, really.

I just wanted to confirm on Pratt the negative engine margin for the year.

Are we still using roughly $1.2 billion?

And then my main question really was on Resi HVAC and what looks like extraordinary strength here exiting the quarter and into the second quarter.

I know you and others are out with another round of pricing.

Do you think there's some kind of pre-buy going on?

Or what additional color could you give us on just the tone in Resi HVAC?

Yes.

Well, just on the negative engine margin, Jeff, we remain on track, I think, at that $1.2 billion that we have been talking about over the last couple of months.

So no change there.

Still peak year for negative engine margin should turn over next year a little bit.

As far as the Resi market in North America, obviously, there must have been a little bit of pre-buy.

We think we took a little bit of share, but we saw sales up 11%.

Our order's up a lot higher than that.

And that would have seemed to indicate that people are trying to stock for what should be a very good season.

Look, new home sales are still moving really nicely.

Existing home sales are moving.

Product is moving.

And I think as a result of that, we have been able to see some pricing benefit.

And frankly, it's pricing based upon cost inputs, right?

Copper has gone up.

Aluminum's gone up.

Steel's gone up.

Second tier supply has gone up.

So I think it's all just natural that you're going to see a little push here on pricing.

But I think it surprised all of us in terms of the real strength that we saw.

But again, this is a seasonal business, so there's a little pre-buy here in Q1, that's great, but we'll see what happens at the end of June.

That will tell you what the season really looks like.

Yes.

I think as Bob McDonough said at the March meeting, Jeff, the fundamentals for the North American residential HVAC market remained really, really strong, right?

I mean, the housing starts are going up.

There is a pent-up demand from that perspective, but the bigger thing is the replacement market.

There is 100 million split air conditioners installed in the U.S., and a lot of that was -- got installed during the previous boom, which is the early 2000s, right?

And with the life cycle of 15 to 18 years, that's coming up for replacement now.

So there is a strong robust replacement market also helped by the housing starts.

So a combination of those give us high confidence that mid-single-digit growth for the year should be easily doable there in that market.

Our next question is from Steven Winoker from UBS.

Just on Otis, maybe talking a little bit about the order and price trends there, and particularly kind of China impact, what's going on, and then also on the material inflation side what you're seeing there?

Sure.

So I think the good news there, Steve, is that for the second quarter in a row now, at least we saw price mix in China in the positive territory.

The challenge is that the material productivity/commodity inflation is still outpacing the price increases.

So the good news is that price is stabilizing.

The bad news is that there is still negative pressure on the margin because the cost increases are greater than the price increases that we can get on the market.

So given the flattish sort of market outlook, we think that dynamic will continue, and we will just need to keep watching that as the year progresses.

Okay.

And any improvement at service attachment over there?

The service attachment has been decent.

I think our conversion rate in the -- in 2017 were up about 4 points from the year before.

They were close to 39%, which has been -- it's a slow progress, but again, it's progress, and it's a movement in the right direction.

So seeing that happen, but it will take a long time before we get to the Western world rates of 80% conversion, as we call it, the attachment rate.

Just trying to make sure it's headed in the right direction.

Our next question is from Peter Arment from Baird.

Greg, just a quick one on Pratt & Whitney Canada, just, obviously, you're probably keeping the cork on the champagne bottle here about volume expectations improving first time in 14 quarters.

What is -- can you remind us just normally the visibility in terms of shipments of what kind of time line you usually deal with in terms of lead times?

So yes, a typical lead time, you're talking 12 to 18 months for engines, be it helicopter engines or biz jets.

So the strength that we saw is not really a surprise.

It could be because it was both on the helicopter side as well as on biz jets.

But we have seen more order cancellations of the last few years, and we've seen people taking everything to PO.

So this was really a very pleasant surprise to see, both helicopter and biz jet.

And again, I think as we think for the guidance for Pratt, and I mentioned this, Pratt's a lot more than just GTF.

And while there was strength at Pratt Canada, there was real solid strength for the military side at Pratt.

And I know we overlook that a lot because of the GTF, but Pratt is really -- is doing very well across all 3 of its segments.

Our next question is from Matt McConnell from RBC Capital Markets.

I'd be interested to hear your view on just status of your aero supply chain, and there's certainly upward pressure on narrow-body rates.

So how do you feel UTC and your suppliers are kind of positioned or prepared for potential further rate increases, whether that's 2019 or beyond?

Matt, that's another really, really excellent question.

And I think that is something that we are struggling with today.

As I'm thinking Pratt & Whitney today, on the GTF, we're at about rate 55 for engines today.

We have spoken to Airbus.

We know that there's a desire to increase that.

And we are committed to take that rate up over the next couple of years, but I think there's a question beyond that, whether or not the sub-tier suppliers really have the capacity.

And that's what we're working through with Airbus and the Boeing company is, is there enough capacity in the supply chain that you're not going to see big bottlenecks?

And having been around long enough, I've seen this a couple of times, is to say, as we've ramped up production, the supply chain just can't keep up.

And I think a very slow-measured increase in output is probably fine, but if we're going to see big jumps, that's going to be a problem.

So look, we're -- it's a high-quality problem.

We're working it.

The bottleneck's not in our assembly and test facilities.

It really goes in out of the supply chain, and not even the first tier suppliers.

You're talking second, third tier suppliers.

And one of the biggest shortages we're seeing is not material, but workers.

And I think that's a global issue that we've got.

And it's not just in aerospace, we see it on the commercial side of our business as well as having trained workers available, as unemployment is low, that's going to be a challenge, I think, in the supply chain.

So look, we're on top of it.

We're working it, but I think that's a question that we're going have to be answering very deliberately over the next couple of years.

Our next question is from Sam Pearlstein from Wells Fargo.

Akhil, you talked a little bit about the Otis and pricing in terms of new equipment.

Can you just help us in terms of how long does this poorly priced product in the backlog take to work its way through in terms of when we start to see improvement with an Otis on a quarterly basis?

Yes.

So I think we've talked about 12 to 18 months before the backlog converts into sales.

China is typically a little shorter than that, but one of the issues we have been monitoring is a reduction or a slowdown in the conversion of their backlog into sales.

That has been slowing down as the China market overall is dealing with consolidation in the developers there and some liquidity concerns or cause of slowed investments or availability of financing.

So I think all that is slowing down a little bit of that conversion of backlog into sales.

The first quarter mid-teen reduction in the new equipment sales were essentially driven by all the backlog that had been booked in the late '16 -- 2016 and early 2017.

So I think we see that for another quarter or 2, and then the benefit or the benefit of better price mix that we started seeing in the fourth quarter of '17 starts to show up in the numbers, either late this year or definitely in '19.

And just following up just separately.

R&D was down $30 million year-over-year in the quarter.

Is that trend -- should that continue through the year?

Is there anything that's unusual in terms of this quarter from an R&D perspective?

No, there was -- I don't see that trend continuing.

Actually, within that, there is a couple of things.

The commercial companies did increase their R&D, as you would expect.

Both Bob and Judy have been pushing to increase investments in innovation.

And so their R&D went up.

We got about a $19 million benefit from the new revenue standard, which allows us to capitalize a portion of the R&D at Pratt and UTAS.

That number is probably going to stay at that level, not likely to grow through the year, because that does vary based on the input and activities.

So we think overall, E&D will not see the kind of reduction we saw in the first quarter.

The only place where we have some reduction in E&D actually is UTAS for the year, as Dave talked about in March, maybe $40 million-or-so.

Our next question is from Noah Poponak from Goldman Sachs.

I was hoping to dive a little further into the drivers behind the strength in both aerospace and military aftermarket.

So first one, just to make sure I have the numbers right.

So it sounded like in the prepared remarks, we should be thinking about the Pratt, up 18%, as a relatively clean number; and the UTAS, up 16%, as about 10% of underlying business and 6% of provisioning.

Are those numbers correct?

Well, firstly, in the 18% of Pratt, there is about 5 points of benefit from the revenue standard adoption, because on the engines which go through our shops now, you go from completed contract to percentage of completion.

So that gave a benefit of about 5 points on that.

That, again, number will probably stay constant for the rest of the year, may go down a little bit, but that's sort of a benefit that we saw.

On the UTAS side, overall, the numbers are correct.

16% growth was driven by -- I didn't quite do the math the way you just did, Noah, but provisioning was very strong.

As Carroll said, it's, what, close to 30%, up 28% or something year-over-year.

Some of the provisioning included some transactions that we were expecting to happen later in the year.

A couple of airlines took deliveries earlier than we expected.

So it was part of the year, but came through in first quarter.

So I don't know whether provisioning will stay at that high level, compares get more difficult for them in the third and fourth quarter, where we saw really good numbers last year, but overall still very happy with where the trends are.

Carroll, do you want to add anything?

Well, just, Noah, in terms of what's going on over at the Pratt aftermarket, the fundamentals are strong.

And really, in the quarter, what you saw was the benefit of stronger content.

V2500 content was up, and PW4000 was pretty interesting actually.

The content there reflected better mix than we've seen in prior quarters.

So more of the engines coming through the shop, where PW4000 112-inch, which from a content standpoint carry multiples of the 94-inch, which powers the 767, 747 fleets.

So in terms of what the fleets are doing, we still feel like the V2500 is going to see more than 1,000 shop visits worldwide in 2018.

PW4000, definitely still in attrition mode, but it's interesting to see operators recapitalize some of these engines.

And we saw the benefit to that in Q1.

There was a relatively long period of time where you guys were saying that the airlines were sort of deferring maintenance and delaying engine shop visits.

It sounds like by need or more from having to that that's finally reversing.

Is that correct?

Yes.

Look, I think the fundamentals of the aftermarket are really pretty simple.

It's driven by RPM growth, first and foremost.

And today, you're looking at almost 6% RPM growth.

And in Asia, China, you're talking 10% or 11% RPM growth.

So airlines need the lift.

In order to get the lift, they're going to -- they've got to keep these planes in service.

There's a reason there's a 7-year backlog for narrow-bodies.

Today's airlines are short of lift.

Again, I think that all drives a very robust aftermarket here.

The other thing is -- a little bit of this, I'd say, is life cycle of the Vs, right?

We're about the eighth or ninth year of V average life, and this is where the heavy maintenance overhauls are coming in.

So yes, that's also driving part of this.

But I think really it's airline profitability remains strong.

RPM growth remains strong.

And oil prices, although up a little bit, still relatively moderate impact on the bottom line.

So the -- I think all of that points to a very robust aftermarket, not just in the first quarter, but probably for this year and into next.

Our next question is from Doug Harned from Bernstein.

And if we look at UTAS, aside from the Rockwell Collins deal, there's long been a goal to push margins higher.

And I'm interested, when you look forward for that unit over the next 2 to 3 years, what do you see is the opportunity?

And are the opportunities most in cost reduction, product mix, growing the aftermarket?

Where do you see the opportunity at UTAS?

Yeah Doug, it's a good question.

I think Dave has laid this out over the last couple of years.

We've seen a tremendous shift from kind of the older variance of aircraft to the newer generation.

And that shift has had a huge impact on margins -- OE margins at UTAS.

And I think the UTAS organization, Dave and team have done a really good job of taking product costs down, taking structural costs down.

And that is going to have to continue.

You'll see Dave continue to do restructuring this year, and next, you'll continue to see other product cost reductions.

They're very focused on lean in the factories and doing lean events to continually look for ways to take costs out.

So this is -- I go back to blocking and tackling in terms of how to raise margins there.

But again, some of the older-generation aircraft will all be gone here and will be newer-generation lower-margin.

We'll work it back up over the next couple of years, but a lot of it is just going to come from just nuts and bolts cost reduction.

Yes.

They have got -- I think Dave talked a lot about this in March.

I mean, his focus on cost reduction is never-ending.

You saw that with Goodrich, they were almost 185, 190 facilities, I forget the exact number.

Now they're down to about 135.

So significant consolidation, significant cost reductions with lean events, as Greg talked about.

The other area of focus for them is increasing focus on margin upgrades.

And with the Rockwell coming into -- Rockwell Collins coming into the fold soon, the joint efforts in that area will, again, help us mix better in the aftermarket side through better margin in repairs.

So I think that's going to be another area of focus.

And is the portion of this -- you talked about facilities.

Is this still an ongoing consolidating effort, and also potentially moving more work to low-cost locations?

Is that an important part going forward from here?

It's part of the calculus every day, high cost to low cost.

We continue to look for opportunities.

Again, I think the good news is with the deployment situation in the U.S, even though we may be moving factories, there's not a lot -- not talking about huge job losses here.

Pratt continues to try and hire people, and we're actually struggling to hire enough people.

I think there's a huge hiring program in the background that we don't talk a lot about.

And I think that's all positive here.

So I don't see political pressure that's going to impact this.

This is just what we do every day.

Our next question is from George Shapiro from Shapiro.

Yes, a couple of quick things.

Can you give us the exact number of GTF deliveries?

I mean, I figure maybe about 75 in the quarter.

And then second, can you discuss a little bit where we stand on the G500, G600 engine deliveries to Gulfstream?

And then last, if you update what you expect the aftermarket growth for the year to be?

That's more than one question, George, but anyway, I'll try.

So on the first one, I think, GTF, as Bob said, we are not going to give exact numbers because of what Bob described, certainly Airbus desire as well as competitive reasons.

Both with the combination of negative engine margin and the number of engines creates a dynamic which is probably not good from a competitive point of view.

So as Carroll said, the number -- the GTF deliveries in the quarter were higher than last year.

They were lower than what we expected, and we are on track to deliver our full year.

That's about as much as what I will probably say on GTF.

On the G500, 600, we're still looking to be on track to assist with the program and have the...

Yes, the certification program continues to progress.

We're very, very close, I think.

The engine, of course, is certified.

We're still doing some work down in the nacelle as we figure the name of that's very close.

And I think we're fully ready to support entry into service later this summer.

So I don't think there's any drama there.

And then it will all be about production.

And as you know, production will ramp up, and I think that's all good news for Pratt Canada for the next 2 or 3 years, although not from a margin standpoint, at least top line.

And sorry, George, the last question was...

Did you change your aftermarket growth prospects for Aero and Pratt based on the quarter?

Yes.

I think, again, it's only one quarter.

So it's probably early to declare a new number.

But I would think based on what we are seeing in the marketplace, I would bet that probably both Pratt and UTAS will see a little upward pressure on the full year aftermarket.

I don't know exactly how much.

Let's wait to -- wait and get through the second quarter.

Compares do get more difficult in the second half.

But if the second quarter remains strong, then we'll be able to update to a more precise number at the end of the first -- at the end of the second quarter.

Our next question is from Cai Von Rumohr from Cowen and Company.

So first quarter, if we take the $0.07 to $0.08 GTF slip, and it looks like that's some $30 million to $40 million higher than the knife edge charge, you have super mix with commercial aftermarket, R&D was down, how come the number wasn't better?

And the other confusing thing is, if you're on track for the GTF, and you're going to have higher commercial aftermarket, and it sounds like lower R&D and the $0.02 divestiture gain, how come you're guiding to the low end of Pratt's guidance?

You sort of emphasized that for Pratt, but not for the other ops.

Sure.

So I think for -- just to be clear on Q1, first of all, the mix, even though the negative engine margin was better than what we expected or less than what we expected in absolute terms, it was still significantly higher year-over-year.

Keep in mind that our production rates had gone up significantly in the third and fourth quarter last year.

And so we were looking for a significantly higher number of GTF deliveries in first quarter versus first quarter of last year.

So that's one key part of the -- what you are missing.

The second thing is, even though the engine shipments within Pratt Canada were higher, the mix within that portfolio was unfavorable.

So that impacted Pratt a little bit in the first quarter as well.

The gain of $0.02 that Carroll referred to was contemplated in the guidance.

It was part of what was already included.

So that was not a surprise.

We just pointed it out, so you could have visibility to that, as we always do.

But that was not a surprise, and nothing new there.

So net-net, we still think the overall situation for Pratt hasn't changed that dramatically.

The commercial aftermarket, if that does come in stronger than what we expected for the full year, they're already looking at 10% growth for the year.

If it comes in stronger than 10%, then that will help offset the retrofit cost, and maybe Pratt goes back towards the middle or the higher end of the range depending on how strong the aftermarket is.

But at this stage, it's too early to say that their commercial aftermarket will be more than 10% for the year, right?

So that's the reason why, Cai, we are being a little cautious, I guess.

At this time, I am showing no further questions.

I would like to turn the call back over to Greg Hayes, Chairman and Chief Executive Officer, for closing remarks.

All right.

Well, thanks, Gigi, and thank you all for listening today.

As always, Carroll Lane and the team will be around the next couple of days to answer any questions that you may have.

I just want to thank you again for listening, and have a great day.

Take care.

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

This concludes the program.

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