雷神技術公司 (RTX) 2018 Q2 法說會逐字稿

Good morning, and welcome to the United Technologies Second 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's 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 Forms 10-Q and 10-K, 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 pending 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.

Okay.

Thanks, and good morning, everyone.

As you saw in the press release, Q2, another solid quarter for UTC.

Adjusted EPS was a $1.97.

It's up 6% versus last year, and that's on top of the 20% adjusted EPS growth that we delivered in the first quarter.

So a really good start to the year.

Sales, they're up 9% organic -- or up 9%, with 6% organic growth.

That reflects the contributions from all 4 of the businesses and also marks 4 quarters in a row of organic growth of 5% or better.

Clearly, we're seeing some positive momentum in these results, driven by our investments, specifically investments in innovation.

So based on the first half performance and our expectation for the second half of the year, we're going to raise our outlook for the 2018 EPS.

So we now expect earnings of $7.10 to $7.25, and that's up from our previous guidance of $6.95 to $7.15.

And just a reminder that, that excludes the impact from Rockwell Collins.

We're also raising the low end of our sales outlook by $0.5 billion and now expect sales of somewhere between $63.5 billion and $64.5 billion.

And that includes an improved organic outlook now to 5% to 6%.

That's up from 4% to 6% previously.

Again, that's driven primarily by continued strength in our commercial aerospace aftermarket.

You saw in the press release this morning that we highlighted the expected impact to our adjusted EPS regarding the pending acquisition of Rockwell.

With regard to the closing of the transaction, let me just say that we're on track with regulatory approvals.

We believe we're down to the final stages of the process, and we expect the transaction to close here still in the third quarter.

As we look forward to the integration of Rockwell, we're clearly excited about the future and what Rockwell brings to the UTC portfolio.

Collins aerospace will give us differentiated products and services that are more intelligent and more connected than ever before and allow us to enhance customer value in the aerospace industry.

And of course, we remain confident in our ability to deliver at least $500 million of net cost synergies from the combination.

Turning back to our operating results.

As I said, we're halfway through the year, and we all remain focused on meeting our customer commitments.

So a lot of good things happened in the business with a couple of highlights to note.

Aerospace Systems, they remain on track with their cost-reduction initiatives, offsetting some of the margin impacts from all of these new programs.

Pratt & Whitney, they're continuing to ramp on new engine deliveries.

And in fact, it's the first time in several decades this quarter that Pratt delivered more than 200 large commercial engines in a single quarter.

At CCS, again continued strong organic growth, and that's driven by new product introductions.

And at Otis, they continued to execute on their service transformation initiatives, which will lead to margin growth in the future.

So overall, end markets continued to show strength.

On the other hand, there are some risks that we need to watch, particularly in terms of tariffs and their impact on product cost.

Based on what has been enacted so far -- and again, this is just the first round of tariffs, the near-term impact to UTC appears to be relatively modest.

We'll say about $0.05 a share, and that $0.05 is included in our revised EPS guidance.

As always, we're going to stay focused on what we can control.

We're feeling very good about the way the year is shaping up.

With that, let me stop and turn it over to Akhil and Carroll to take you through the results, and I'll come back with a little wrap-up and the Q&A.

Akhil?

Thanks, Greg.

And I'm on Slide 2. Reported sales for the quarter was $16.7 billion, up 9%, with 6% organic growth and 2 points of favorable foreign exchange.

The remaining 1 point of sales growth was driven by the adoption of the new revenue standard, with the largest benefit at Pratt & Whitney.

You can see the details in the appendix on Slide 19.

Adjusted EPS was $1.97, up $0.12 or 6% versus prior year.

On a GAAP basis, EPS was $2.56 or up 42% versus prior year.

This, of course, included a $0.74 gain on the sale of the Taylor Company in the quarter.

Largely offsetting this gain was $0.07 of restructuring, $0.05 of a noncash asset value adjustment and $0.02 of charges related to the Rockwell Collins transaction.

Free cash flow was $1.7 billion in the quarter, and there is no change to our full year outlook of $4.5 billion to $5 billion.

Just as a point of note, we will be absorbing over $200 million of headwind in the 2018 free cash flow from the tax payment associated with the gain on the sale of the Taylor Company.

As you probably know, cash from the divestiture is reflected as an inflow from investing activities, but the cash taxes we pay on the gain flow through the operating cash.

Also, the gain on the transaction increases our reported net income.

So for those of you who are looking at the free cash flow to net income conversion, this transaction will mathematically put some pressure on that metric.

Slide 3 shows components of our organic growth this quarter.

Overall, we continue to see strong fundamentals across our 2 end markets.

Looking at our commercial businesses.

In the Americas, sales were up 6%, with growth across both Otis and CCS.

End market activity levels remain robust as new construction continues at high levels and consumer sentiment remains strong.

Within EMEA, sales were up 3%.

In Europe, sales were up mid-single digits, with strength, again, at both Otis and CCS.

At Otis, we continue to see stabilization in maintenance revenue per unit but did see some pressure on input costs due to the increasingly tight labor market across the region.

Middle East remains a watch item.

In Asia, sales were down 1%, with Otis China down 6%.

The good news is that, in Otis China, we once again saw slightly positive price/mix in the second quarter orders.

The rest of Asia was up mid-single-digit at Otis and down 7% at CCS.

On the aerospace side, commercial aerospace sales were up 11% organically in the quarter, driven by strong GTF shipments as well as ramping up of next-generation products at Aerospace Systems.

And on the aftermarket side, we see continued high traffic demand and strong utilization of in-service products, which translated to 11% organic growth in the quarter.

Military sales were up 10% at Pratt & Whitney and up 5% at Aerospace Systems organically, driven by continued strong aftermarket demand and ramping production programs.

Lastly, just a few comments on our 2018 outlook before I hand it over to Carroll.

Within our improved outlook, you will see a few moving pieces.

At the operating level, strength at Aerospace Systems offsets the reduced outlook at Otis versus our prior expectations.

The change in outlook at CCS primarily reflects the removal of the profitable Taylor business from the second half and is offset by favorable items below the segment operating profit line.

Additionally, we now expect the adjusted tax rate in 2018 to be 24.5% compared with the prior 25.5%, and this is based on certain recent clarifications to the U.S. tax reform and higher-than-expected benefit from stock compensation-related taxes.

At the midpoint of our improved adjusted EPS range, we still have approximately $70 million of contingency.

As Greg said, we expect Rockwell Collins to close in the third quarter.

This will likely result in $0.10 to $0.15 dilution in 2018 to the adjusted EPS.

Bottom line, we feel really good about our improved EPS range of $7.10 to $7.25, excluding the dilution from the pending acquisition of Rockwell Collins.

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

Okay.

Thanks, Akhil.

I'm on Slide 4. I'll be speaking to the segments in 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 12 with additional segment data as a reference.

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

On a constant-currency basis, new equipment sales grew 2%.

High teens growth in Europe and high single-digit growth in Asia, excluding China, were partially offset by a 10% decline in China, where 2017 backlog with its embedded price headwinds continues to convert into sales.

New equipment orders were up 10% organically in the quarter, with growth in all regions.

In China, unit orders grew 2%, with their corresponding value growing 8%.

That's the first quarter since 2014 in which order growth in dollars has outpaced the growth in units.

Service sales were up 4% in the quarter.

Otis saw strong growth in modernization and mid-single-digit growth in maintenance, while repair was down slightly in the quarter after being up 13% in Q2 2017.

Otis operating profit declined 11%.

Pricing pressure and adverse mix in new equipment, largely from the backlog in China, coupled with higher input costs, more than offset contribution from higher volume.

Additionally, onetime legal charges and adverse transactional mark-to-market currency adjustments accounted for approximately $30 million of headwind.

As discussed in Q1, transactional currency adjustments can fluctuate through the year.

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

For the full year, we now expect Otis operating profit in the range of down $25 million to up $25 million at actual currency.

This largely reflects the onetime charges in Q2, the outlook for higher input costs we discussed last quarter and our updated view on foreign exchange, which is less likely to provide a favorable offset to these increased costs.

The full year outlook for organic sales at Otis continues to be low single-digit growth.

Turning to Slide 5. Climate, Controls & Security sales were up 4% organically.

Transport refrigeration sales were up 11%, driven by strong container sales, up 45%.

Residential HVAC was up 5%, in spite of trucking shortages that impacted June shipments.

Global commercial HVAC grew 3% in the quarter, and Fire & Security sales were up slightly.

In the first half, total CCS sales were up 5% organically.

Equipment orders at CCS were strong again in Q2, up 8%, and that follows 11% growth in Q2 of 2017.

Transport refrigeration orders grew 27% on top of 38% growth last year.

Residential HVAC orders were up high single digits, and global commercial HVAC orders grew 6%.

At actual currency, CCS operating profit grew 2% in the quarter as the benefits of higher volumes, improved pricing in North America and foreign currency translation were mostly offset by higher commodity and logistics costs and continued investment in new products.

Looking ahead, we can expect continued volume growth in the second half of the year, and pricing initiatives are expected to more than mitigate rising input costs.

For the full year, we now expect CCS operating profit to grow by $75 million to $125 million at actual FX.

The revision from the prior outlook of $125 million to $175 million in growth reflects the completion of the divestiture of the Taylor business as announced in June and our current view that foreign exchange is less likely to offset higher input costs.

Shifting to Pratt & Whitney on Slide 6. Sales of $4.7 billion were up 12% organically.

Including the previously discussed impact of the new revenue recognition standard, reported sales were up 16%.

Commercial OEM sales were up 20%, driven by 48% growth in large commercial engines.

Total Geared Turbofan shipments, including those to the spare engine pool, more than doubled from Q1 2018 and more than tripled from Q2 2017.

Pratt & Whitney is on track to meet its full year GTF customer delivery commitments.

Pratt & Whitney Canada shipments were up modestly, and that marks the second quarter in a row growth.

Pratt Canada OEM sales were down 3% due to mix.

Military OEM sales were up 42%, driven by F135 and tanker.

Commercial aftermarket sales were up 12% as the large engine aftermarket continues to benefit from strength in V2500 and higher content on PW4000 models.

Military aftermarket was up 3% on a tough compare and grew 9% sequentially.

That was driven by F135 and F119 programs.

Operating profit of $400 million was up 8%.

Headwinds from higher negative engine margin was more than offset by a drop-through from higher commercial aftermarket and military sales.

Based on first half results and in anticipation of negative engine margin increasing with GTF deliveries in the second half of the year, we continue to expect Pratt & Whitney to grow operating profit $25 million to $75 million.

Turning to Slide 7. Aerospace Systems delivered another strong quarter with 17% profit growth on 8% higher organic sales.

Sales growth was driven by the commercial aftermarket, which was up 12%.

Parts and repair were up 4% and 12%, respectively, and provisioning grew by 20%.

The provisioning included 15 points of growth related to the Pratt & Whitney spare engine pool, and these intercompany sales are expected to be a headwind for Aerospace Systems in the back half of this year, given the significant shipments made to the Pratt spare pool in the second half of 2017.

While compares will be tougher in the back half, leading indicators remain positive, and we now expect full year commercial aftermarket sales to be up mid- to high single digits.

Commercial OEM sales grew 8%, driven by new production programs, primarily the A320neo, and is partially offset by declines in legacy programs.

Military sales were up 5%, driven by continued F-35 volume growth and strong spares.

Operating profit growth of 17% was driven by a drop-through on higher commercial aftermarket and military sales, lower E&D and continued product cost reduction.

These benefits were partially offset by OE mix headwind, higher SG&A spend and adverse foreign exchange impact.

Based on first half results, we now expect full year sales to be up low to mid-single digits versus our prior outlook of low single-digit growth.

That's driven by strength in commercial aftermarket.

The projected drop-through from these sales allows us to raise the full year outlook for operating profit growth to $175 million to $225 million and likely towards the high end of the range.

That's up from our prior expectation of $150 million to $200 million.

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

Okay.

Thanks, Carroll.

So look, it's a lot of moving pieces in the quarter, as is typical, but I think there's some really key things to highlight.

And I would start out with the organic growth that we saw at 6%.

But I think maybe, most importantly, each of the businesses saw a growth in orders, we take a look at the 12% aftermarket growth on the aerospace side, new equipment orders up 10% at Otis.

The end markets are delivering, and we're very, very confident about the, not just 2018, but as we move into the future.

I think the one point, again, worth repeating from what Carroll said, if you think about the GTF and the ramp and all the issues that we've had, I would tell you that the Pratt team has done been a tremendous job.

And if you look at the deliveries in the second quarter, doubling what we did in the first quarter and tripling what we did just a year ago, phenomenal, phenomenal results for the year for the Pratt team and, again, keeping pace with what is a growing aerospace market across the world.

So again, very, very confident about the future of the portfolio in UTC.

Regarding the question on the portfolio, I know it's on everybody's mind everywhere.

Let me just say that there's nothing more to report today.

We continue to do the work with our Board of Directors, and we continue to believe that we will have a decision here in the fourth quarter that we'll share with everybody, but nothing new to report other than the fact that we continue to do the analysis and continue to work through that process.

So with that, we're happy to answer whatever other questions you have, so let's open up the call for questions, if we could.

(Operator Instructions) Our first question is from Julian Mitchell with Barclays.

I just wanted to circle back to Otis.

I understand that there's the legal charge weighing on the second quarter profits.

But one of your competitors last week was talking about a prolonged headwind from price-cost into next year.

Obviously, looking at your medium-term guide implies decent profit recovery in Otis.

So I just wondered how you were assessing the likelihood of that today and if the business is really progressing as you thought or every quarter we get sort of an extra headwind or 2.

Great question, Julian.

So I think, let's -- the 230 basis points margin drop at Otis is a startling number, and everybody is probably focused on that.

So let me just break it down for you quickly.

As you said, about 90 basis points of the 230 essentially is the $30 million that Carroll talked about, which are onetime exceptional charges.

We didn't pull them out in the segment as is our normal practice since they were not large enough, but they are all onetime type of things and doesn't happen very often.

So hopefully, that's just behind us.

The second item is the price cost, price/mix issue that you've talked about, and that's largely driven by the backlog in China.

That was another 90 basis points in the quarter.

So if you take that, the trend there that is encouraging is for 3 quarters in a row now, we have seen price/mix being positive, slightly positive in the China orders.

So as we then pull the backlog of 2017 badness, I -- when I look at 2019, hopefully, that number starts to become a little bit better as opposed to continuing headwind that we have.

The final piece is obviously the increase in inflation, increase in the cost that we have seen.

Some of it in the case of Otis is a little more difficult to pass on as price increases right away because there is a backlog that is there.

You've got to take the cost increase and adjust it against the backlog margins, unfortunately.

But that again, the intent on the Otis team is to try and increase prices going forward so that we can offset some of these input cost inflations.

Yes, Julian.

Let me just pile in there.

So I think this whole issue of input costs, it's a recurring theme that we'll be talking about as it relates to the commercial businesses.

And the input costs are really a couple of things.

Obviously, commodities, we've seen a little bit of headwind, although not that much this year, but steel is up 25% in the last year.

Aluminum is up, and copper is up about 14%, 15%.

So input costs are up.

And the other place where costs are up is at labor cost, and there really is a labor shortage here in the U.S. and in Europe.

And as a result of that, we're seeing some cost pressures that we need to deal with.

I'm not going to just say we're going to surrender and the margins are what they're going to be.

We're obviously taking actions to reduce costs, to look for ways to resource products.

But input cost inflation is a real issue that, I think, is something new for us.

And again, tariffs don't help.

Again, another $50 million of cost input on top of what's happening with the basic commodities and labor costs.

But look, the future of Otis is about selling new equipment.

And I think if you look at the quarter where you saw a 10% growth in new equipment at Otis, that's solid, right?

And that will deliver in the long term.

It takes a couple of years to play out, obviously, before we install all those elevators and start servicing them.

But it is that growth in new equipment that people should be focused on as it relates to Otis and growth in the service portfolio.

And again, as I highlighted before, the service initiatives, what we can do from a productivity standpoint, will also help drive Otis profit growth over the long term.

So look, the headwinds that we have are the same as everybody else.

The way you deal with them is the same as everybody else.

Obviously, we need to be more aggressive on pricing, which we will do.

Easier on CCS than it is at Otis, obviously, because of the short-term versus long-term nature of the contracts, but the folks are on top of it.

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

If we could just maybe dig in more into the aerospace aftermarket, I mean, the growth there was really good, right?

I mean, above global air traffic, maybe 2x global air traffic.

What's underlying that?

Is it -- one of your smaller competitors mentioned that they're seeing the pool of serviceable used spare parts really kind of fading away, and that's driving some aftermarket growth.

But just in your case, I mean, what's driving that aftermarket growth?

Yes.

I think there is -- as always, there is no one simple answer here.

I think if you think about the Aerospace Systems business, where we have really seen growth beyond our expectation, it's been on the repair side of the businesses.

The repair shops have done a much better job.

And I think we've got about 74 repair operations around the world, but they have really focused over the last couple of years on improving turn time, improving customer responsiveness.

And we're starting to see that market share gain.

So that's very positive.

I think, on the Pratt side, we continue to see very, very strong growth on the V2500.

That's not unusual.

We also still are seeing some of the PW4000 aftermarket being a little bit stronger than what we expected.

Look, this trend line won't continue at 12%.

I think we all recognize that.

But right now, as you pointed out, there has been a consumption of spares out there and spare parts airlines have to reorder.

You can't continue to take things off the shelf.

And so we're benefiting a little bit from this.

So look, our traffic will probably be up 5.5%, 6% again this year, and I think that's kind of the long-term trend that we're looking at, which is where aftermarket should grow.

But clearly, there's a little bit of catch-up this year, but we feel pretty good about it.

Carroll?

Yes, Ron.

And Pratt, it's really a continuation of what we've talked about in Q1.

So we've got strong content on V2500.

We expect V2500 shop visits will be -- there's demand for more than 1,000 of those worldwide this year, and no change to that view.

And then on the 4000s, while shop visits will be down, the mix is favorable.

The PW4000 112-inch, powering 777 fleets, we're seeing operators recapitalize some of those engines, and it speaks to the demand for a lift out there in the marketplace.

So really, just a continuation of what we saw in Q1, and we'll take it.

Yes.

The fundamentals, remain really strong, Ron.

The fundamentals really, remain strong.

And I think the promise of the aerospace industry is if you get on new platforms, you have good content on them, aftermarket follows.

And that's what we are starting to see with the V2500 engine, with the continuation of the PW4000 on the Aerospace System side.

So I think we are in a good spot, given the OEM growth, which will again translate into aftermarket for many, many decades to come.

Okay.

Great.

And then maybe just a follow-on, why wouldn't you expect, maybe not 12%, but continued growth kind of at the higher end of the range, something above global air traffic growth?

Yeah no.

I think we should expect that.

And I know what -- Greg said, you shouldn't expect 12% every quarter, maybe high single digit in some cases.

Or it could be mid- to high single digit as we have upgraded the -- or increased the Aerospace Systems guidance, as you noticed in our outlook change.

So could it be higher than traffic growth?

There would be periods when it could be.

But over the long term, it's probably closer to approximately traffic growth than double-digit growth forever.

You also got to keep in mind, Ron, that Pratt, again, with its reentry into the commercial business with the GTF, they should see outsized growth in the aftermarket in the next 10 years.

And just like the V2500, it's kind of in that sweet spot that Carroll is talking about for repairs and demand for overhaul visits.

As we think about it, as Pratt delivers what is now what did we say, 10,000 orders we've had for GTF engines now, that -- those 10,000 orders will play out over the next 10 years and generate a huge increase in the aftermarket with Pratt.

Our next question is from Rajeev Lalwani with Morgan Stanley.

Greg, if I could ask you a question on the strategic -- I appreciate that there isn't a whole lot to add, and the process is underway.

But I guess, I just wanted to clarify some of the comments you've made publicly already.

I think previously you've highlighted sort of looking at splitting the company into 3 pieces.

Does that preclude any other sort of alternatives that you would maybe pursue?

I mean, I'd imagine there's lots of permutations in there.

Taking a look at what you did with Taylor, I think that was well received.

I mean, why can't you do more or evaluate more than just a simple breakup or staying together, if that makes sense?

Yes, Rajeev.

Let me just say, there's nothing simple about a breakup.

But as you think about what's going to create the most value for shareowners long term, I think all options are on the table with the board.

And that's the -- I think, the key message if you want to take one away here is that it's not just about splitting the company up 3 ways.

We're evaluating other potential options that could create value, be it acquisitions or be it divestitures as part of this strategic portfolio review.

So again, like we did with Sikorsky, initially, it was going to be a spin.

We ended up finding a great home for Sikorsky in Lockheed Martin.

We'll look for ways to maximize value long term, whether that's together as the entire UTC portfolio or apart.

I think all options are on the table.

And clearly, there are alternatives that may be attractive in the long term, and we're going to continue to pursue those.

Our next question is from Jeffrey Sprague with Vertical Research Partners.

Just on Collins, the fact that you're giving us a sense of the dilution here today, a, does reflect your confidence, I guess, in closing.

But b, would also seem to suggest you do have a little bit of certainty now on just some of the accounting machinations of conforming accounting and what the amortization may look like and such.

If that's the case, could you give us your early thought on what the accretion/dilution picture looks like for 2019 based on Q3 '18 growth ticket rate?

Precisely, Jeff.

I mean, really, that's a nice soliloquy that will lead into guidance on '19, but we're not going to do that.

No.

The reality, Jeff, is that we are still working through the intangibles amortization calculation.

We have now -- again, I have not seen the data because we cannot see it legally.

But we have an accounting firm, which has got the data from Collins and is evaluating the cash flow streams of the future, which, as you know, is the basis of determining the intangibles amortization.

So that work is going on.

I think the preliminary estimates are that we are probably not too far off from the numbers that you've seen in the S-4 on that, but there's still a lot more work to be done.

I think the next couple of weeks is probably what is needed to get that -- get to a firmer answer.

Obviously, as you know, assuming we close in third quarter, we will have to book something in the quarter with regard to those intangibles.

And so we are working very hard to make sure we get a number, which we don't have to change or update in the future.

So that work is still going on, which is why you see the range.

We do feel we are in the closing stages of the approvals and, therefore, feel a lot more confident about being able to do that this quarter.

And we will tell you more as that transaction closes.

Yes.

I think the best thing to say is no surprises here.

So if we look at the amortization, what we had expected it to be, there's no real surprises from what we had originally estimated.

So look, we'll talk about this in September probably in terms of what we think 2019 looks like.

But obviously, it's going to be accretive to earnings.

We're just -- we just need to work through what that number is.

And just one other one -- and I appreciate the compliment on the articulate soliloquy, by the way.

I haven't gotten that often.

Just could you give us a little bit of update in general on aero's supply chain?

And in particular, looking at this NORDAM bankruptcy, anything to be concerned about here in the near term and managing your way through all that sort of thing?

Yes.

I would tell you, let's take NORDAM as a separate issue because I think that's kind of a one-off.

Because as far as the aero supply chain goes, I think we've got pretty good visibility.

In fact, we've got very good visibility into the supply chain for all of the key components on the GTF engines.

And we're working through that same process on the Aerospace Systems side.

So I don't see any big bottlenecks other than the continuing challenge that we have with the ramp.

Look, there's always going to be castings and forgings and things like that, that are difficult to do.

But again, no shortage per se that would say that we can't meet the contractual commitments that we have.

I think I said this earlier, this was just last week in Farnborough, we continue to work with Airbus and continue to work with the supply chain to see if we can ramp up even more quickly, but that will take additional capital and additional time, but we'll work through that.

So I -- today, I don't see an issue.

I think if there's another big ramp up in production beyond what we see today, it will be a challenge, but we'll work through that as the year progresses.

As it relates to NORDAM -- NORDAM, for those of you that are familiar with it, it is a small supplier out of Tulsa that does nacelles primarily.

They're -- took on a contract with us back in 2010 to do the nacelle for the Pratt & Whitney 815, which is the engine that goes on the new Gulfstream aircraft.

We've had some challenges.

They've had some challenges in terms of getting that product certified, and the cost has been a challenge for them as well.

Unfortunately, they had to enter bankruptcy proceedings this week.

We're continuing to work closely with the bankruptcy court, with the lenders and with the folks at NORDAM to try and find a solution here.

And I think there will ultimately be a solution that ensures continued production of the nacelles as well as a good resolution, I would say, for all the parties involved here.

So it's not great anytime you see one of your key suppliers going to bankruptcy, but it didn't come as a surprise.

We've been working with them very closely for the last 6 months, and I think it will be a pretty -- not easily managed, but at least a good outcome here in the not-too-distant future.

Our next question is from Carter Copeland with Melius Research.

Just a quick question on CCS.

I mean, I know for the remainder of the year, Akhil, you highlighted the Taylor impact.

But when you just look at the order flow you had in Q1, and you guys had talked about having some pricing tailwinds that you expected to come through, when you look at the conversion of orders into sales and maybe a potential pricing tailwind, it just didn't seem to come through in Q2.

I wondered if there was something in there that we were -- that we're missing or it's just -- takes time for that to get in.

Any color would be helpful.

Sure, Carter.

So I think the good news in Q2 was that the price cost -- price cost.

And when I talk about price cost, it's commodity's cost versus the price increases that we have.

It was slightly positive in Q2.

As you recall, in Q1, it was still slightly negative.

We have had additional price increases going to affect in early July, which are in the market now and seem to be having traction.

So we feel good about our ability at CCS to continue to see improvement in the price/cost dynamic as we go forward.

So that's certainly an encouraging thing.

The other encouraging part is the strength in the orders that they have had, those orders are certainly going to translate.

I mean, if you look at the residential business in North America by itself, both in Q1 and Q2, the orders that we booked were greater than the shipments that we made in those quarters.

So backlog is pretty healthy coming into the third quarter.

We feel, again, good about the ability of CCS to convert that.

And as the price-cost mix continues -- price-cost equation continues to improve, we should see better conversion in -- later in this year.

Okay thanks.

And then just a quick -- just clarification on the comment you made around provisioning.

Can you guys quantify what sort of pressure you expect in the back half on the inter segment sales on UTAS?

Sure.

So I think the back end, you'd probably see if you go back to look at the numbers for last year.

Very strong aftermarket at UTAS, and some of that had to do with the data -- the engine build units that UTAS provides to Pratt or -- and that goes into the lease pool engines.

In the second half, you will probably see reductions to the tune of about $10 million to $80 million across the 2 quarters, so somewhere between $50 million to $100 million in the second half versus what they saw last year.

So that still is all factored into our thinking when we said that UTAS will grow aftermarket by mid- to high single-digit.

So that's all being factored into our thinking about the guidance.

Our next question is from Sheila Kahyaoglu with Jefferies.

Just going back to Otis.

Can you talk a little bit about the service portfolio, in particular, and just price increases?

Is it a matter of time where pricing should start to improve?

Or is it something structural within the industry itself?

And if you could just comment on maybe what you saw on a regional basis for pricing within the service portfolio.

Sure.

So the good news on the service side at Otis is -- I kind of look at it in 2 ways.

One is, is the portfolio growing by itself?

And I think that the good news is the portfolio at Otis did grow in terms of the number of units under maintenance in the second quarter compared to the first quarter or compared to the last year.

So that's a positive sign.

The biggest element from a regional perspective, Sheila, as you know, is Europe.

And after several years of decline in the revenue per unit line item, which drives -- which is an indicator -- indication of the pricing, we have seen now in the first half revenue per unit stabilize for the maintenance portfolio in Europe.

So it's been flattish, which is again a good sign.

As you know, we are working on all these service transformation initiatives.

So right now, because of the investments we are making, we have this dynamic of cost, not -- cost growing, not being fully offset by our productivity.

But as these initiatives take traction and the new tools become prevalent all across the world, you will see productivity gains starting to offset some of the cost inflation that is there in that line.

So looking forward, we feel a lot more positive about the trends that are there.

Other places, North America service still doing well.

And in China, we continue to make progress with regard to growth in the service business as a percentage of the total.

Great.

Thank you for the color.

And then just one more, if you don't mind.

On Pratt, military continues to be very strong.

How long do you think that growth is sustainable?

Pratt is going -- it seems to be -- Joint Strike Fighter is continuing to grow, as you know, right?

The number of engines -- the number of aircraft required will continue to grow.

The engines that we are supplying and all the components that UTAS is supplying to them also continue to grow.

So Joint Strike Fighter is the big driver of the growth in military engine business.

We also have great strength in the aftermarket side of the business as these assets continue to fly a lot.

So I think, overall, we do expect to see -- our guidance for this year is 20% OE growth in military engine side.

And that's -- we feel very good about our ability to hit that.

Aftermarket growth is expected to be around 10% for the year, and that also feels very doable.

So it's a pretty good story, and I think there is several years of legs on that.

Yes.

And Sheila, if you think about the fleets, the F100 fleet is still massive out there, flying a lot of hours.

F119 fleet generating a lot of flight hours.

And then F135, we're not just delivering it, but we're also equipping the fleets worldwide to sustain themselves.

So you start to see the aftermarket in that program as well as we progress out here in the next few years.

(Operator Instructions) Our next question comes from Steve Tusa with JPMorgan.

Our next question is from Sam Pearlstein with Wells Fargo.

And I know you just said one question, but just a quick -- the first one on just NORDAM.

Is there any sort of impact to receivables?

It was just a quick question.

But then I was wondering if you could talk a little bit more about just the Rockwell Collins dilution and help us just to understand what's in and what's out.

And I'm thinking about the cost to extract the synergies versus the synergy savings, kind of the onetime closing cost around the transaction.

I'm just trying to understand what's in and what's out of that in terms of the adjusted earnings.

Sure.

So on NORDAM, there is no receivables impact.

They were a supplier to us, so there is no impact from that side.

There is obviously going to be some impact on the cost side, which we talked about, as things progress there and as we have a greater understanding of the solution to that outcome.

On the Rockwell Collins number, as we've always said, I think the number that we talked about on adjusted EPS is consistent with our definition of adjusted EPS, which means we exclude any restructuring costs, we exclude any onetime step-up inventory amortization or any integration cost for the first 6 months to a year, if you will, which are exceptional in nature.

But going forward, any intangibles amortization of a normal recurring nature on customer relationships, trade name, et cetera, that will be part of the adjusted EPS.

For the reference to those who care, we will provide an extra data point, which is on the cash accretion, if you will.

We will provide that, so you can see on a cash basis, clearly, the transaction is going to be greatly accretive.

And our commitment was that even on -- even with taking into account a large significant intangibles amortization, the transaction will be accretive in 2019, and we still believe that will be the case.

Our next question is from Peter Arment with Robert Baird.

Akhil, just -- you mentioned, I believe, that the China pricing in backlog at Otis that lingers into '19.

Can you clarify like how -- if that goes throughout '19?

How should we be thinking about that?

And then just, Greg, just related to this, you mentioned $0.05 of risk from tariffs.

Maybe you could just walk us through how you're thinking about that just in general.

Sure.

So the price/mix point I was making is that Otis is starting to see improvement in that, Peter.

So last 3 quarters now, price/mix has been slightly positive in Otis China orders.

And as you know, it takes about 9 to 12 months for those orders to convert into sales.

So what you are seeing in our P&L this year is in effect the margin that was booked in the backlog in 2017, which had pretty high negative price/mix.

So as we get into 2019, we should start to see an improvement in that metric, not lingering impacts.

There will be some impact of that, but not by a large amount.

So I expect that to see -- to get a little bit better.

With regard to the tariffs, 50 -- the roughly $50 million or $0.05, as Greg mentioned, that's included in our outlook.

About half of that is at CCS.

Another $10 million or so would be at Otis, and then the rest is between the aerospace companies.

And that's got to do with the -- not just the steel and aluminum, it is also the List 1 of the tariffs that came from -- the $50 billion list that had...

Given that the Section 301.

Yes.

And Peter, one thing to keep in mind is as is our normal practice, we lock in most steel, aluminum, most of the commodities out for 6 to 9 months.

So we're actually not seeing the full impact in '18 of what the steel and aluminum tariffs are.

And as anybody's guess, how long those are staying in place, I think if you think about next year, obviously, you can see a much bigger impact from all of these tariffs, not -- right now, we've only got a half year impact on the 301.

But the full year impact there, plus potentially some higher steel and aluminum tariffs, is -- as well as copper input cost higher.

So we've got a lot of work to do to try and offset that.

I think the key will be our ability to continue to push price in the marketplace as these input costs go up.

Of course, that's going to lead to a little bit of inflation and hopefully, not so much that it's going to curtail demand.

But we are always mindful of that trade-off.

So again, it's -- these tariffs aren't helpful to anybody, but we're going to have to deal with them.

Our next question is from Steven Winoker with UBS.

Could you just maybe give us a little more color on that strong working capital number in the quarter?

Is it sort of a liquidation of deliveries despite ramps on the GTF?

Or what are some of the dynamics back and forth there?

And can we expect that to continue?

Well, some of it was the bad Q1 we had, Steve, right?

I mean, I think you saw that we had that shortfall in our cash in Q1.

And as a result, there was significantly higher receivables that came into Q2, which we were able to collect upon, and that's helped the working capital number.

The area, which we still have work to do, which is the long-term opportunity for our cash flow metric, is inventory.

We've seen continued growth in inventory to support the ramp that is there.

The supply chain stability, that will come in that area over the next few years as production rates start to stabilize, as supply chain gets more stable.

I think all that is the upside that is still ahead of UTC with regard to the cash flow metric and the working capital turns.

As I've said before, I think our aerospace businesses have seen inventory turns decline over the last several years.

This year, I expect the turns to start to improve, and then cash flow benefit starts to come in, in the forthcoming years.

But a lot of opportunity ahead of us.

Okay.

So that's -- you expect it to basically normalize, stabilize in the back half of the year?

Back half and going forward.

I think the supply chain stability will probably take longer than just the next 6 months, Steve.

These are not easy things to do.

By the time we are able to get some of the safety stock reductions in our inventories, it will probably be a few more years.

But I think the good news is that it's a multiyear, good news self-help story that is ahead of us that we can take advantage of.

Okay.

And Akhil, just a point of clarification, the $70 million of contingency that you mentioned, that's at the midpoint of guidance?

Yes, it is.

In the updated guidance, which is at $7.18, effectively, $70 million.

Our next question is from Steve Tusa with JPMorgan.

Sorry about that.

Some technical difficulties.

Just on CC&S, can you maybe just more specifically update us on that profit bridge?

And what kind of the moving pieces are now with the reduction in the guide than you gave earlier in the year in March?

Sure.

So if you look at that specific profit bridge, in the other line, there was a negative $50 million.

That is where we've got the Taylor divestiture impact.

So in an updated bridge, that number will be closer to about somewhere between $75 to $100 million, let's say, maybe closer to $100 million, as Taylor comes out of the second half, and it's a -- it was a profitable business.

In the other pieces, I would say, we had $50 million of good news between price cost.

That number looks more like $25 million positive now.

We still believe it's $25 million for the first half.

We were pretty much neutral.

All that goodness is going to come in the second half, and we have price increases in there.

The offsets to those sort of negatives is on the higher volume.

So organic growth has been doing reasonably well.

So to the extent that there is any offset needed to those specific numbers, it will come through the volume line.

So overall, we feel very good.

The FX number has now -- it was looking stronger, Steve, at the end of first quarter, but it's probably back to the $25 million bridge that we've taken in the January guidance.

Okay.

And then just on -- to follow up on Steve's question on free cash flow.

So can your actual cash generation at Pratt be up next year in 2019?

I would certainly hope so.

Pratt should continue to grow cash going forward.

The other element is CapEx, Steve, where we have been spending a lot of money in standing up the production facilities to support the ramp.

The OE side of the ramp-related CapEx is going to be pretty much behind us or become de minimis, but there is still aftermarket ramp-related capital expenditure, which is still ahead of us at Pratt and to some extent at UTAS.

But those numbers are probably going to start -- I think after '19, we would start to see CapEx at Pratt and UTAS start to decline a little bit, and that should help overall cash flow for both those businesses as well as UTC overall.

And are they up this year at Pratt?

Pratt, the CapEx is -- yes.

Pratt, the CapEx is flat to slightly up this year.

Overall, for UTC, as you know, we have talked about CapEx being flattish, and that's probably effective across the businesses.

But cash -- free cash flow is what I meant at Pratt this year.

Free cash flow for -- free cash flow for Pratt is slightly down this year compared to last year at this point, but that can...

Our next question is from Nigel Coe with Wolfe Research.

I just wanted to pick up on the Otis China pricing commentary, the backlog kind of conversion in the 9 to 12 months.

That implies -- have we now seen peak pressure from pricing in the first half of the year, and therefore, we start seeing a moderation of that pinch?

And then maybe just then broaden that out to Europe, what are you seeing in European service pricing?

So the price/mix in China should -- I think your assertion is right, Nigel.

We should probably start to see a pinch improvement, and pinch is probably the right word.

Improvement in the second half in the price/mix going to the backlog.

The backlog still has some negative pricing in there.

With regard to service, Europe service, the revenue per unit is starting to stabilize.

As I said earlier, I think first half of this year is the first time in many years that Otis business had seen revenue per unit for maintenance contracts in Europe be flat to slightly positive.

And we do expect to see that turn.

And again, it's not broad-based at this time, Nigel.

So within Europe, there are different countries you would see pressures continuing still in places like France and Spain, where we have a pretty high installed base.

But there are also, on the other hand, improvements in other markets within Europe.

So it's a mixed story there.

But overall, at least, for the first time in many years, we are seeing flattish revenue per unit year-over-year.

Great.

And then just quickly on the 301s, I think you said that the $50 million is solely List 1. Have you done any work in terms of trying to quantify List 2 and List 3 impacts?

No.

There is still more work to be done there, Nigel.

I think, as you know, until those things get firmed up and we know exactly what -- I mean, the good thing is it's not a finished product issue because we generally make product for the local markets, so most of the China production in China is for that market.

It's -- we don't export too much out of it to U.S. specifically, but there are components.

There are drives, there are motors, there are all kinds of small components that we do buy, which get -- probably get impacted by these tariffs.

So the ultimate solution, as Greg said, is unfortunately going to result in higher inflation, where we and others will attempt to pass all of that to the consumers.

So over the long term, you and I pay for this stuff, but that's the way business works.

Our next question is from Doug Harned with Bernstein.

I wanted to see if you could give us a little more of an update on the GTF.

It's -- I mean, you've had some very good delivery ramp so far this year now.

How are you looking at the rest of the year in terms of the number of deliveries, the kind of cadence?

And really, when do you see production proceeding in a way that it's more stable, that we're not dealing with the kinds of back-end loading that we had last year?

Yes.

So if you think about total production of GTF this year, it will be a little bit more than double what we saw last year.

Obviously, the cadence of deliveries in the second quarter was making up for a little bit of the first quarter issue that we had with the seal.

But having said that, we're back on track, and we're meeting all of the delivery milestones.

The engine itself -- and I'll speak to the neo specifically, it's got about 800,000 hours on it right now.

So we're approaching that point where we always say about 1 million hours.

Most of the teething problems have at least been identified.

So we will clearly get there before year-end.

I think the good news is, in the last year, we've got over 2,000 orders for the GTF.

And as you think about all the issues everybody has been concerned about, the fact is this motor really works and really delivers on the fuel burn, on the emissions and on the noise signature.

So the airlines are confident.

We've got the hours.

We continue to build hours every single day.

We're still dealing with some of the issues.

You'll recall, we had the combustor issue on the -- on some of the early units.

So we continue to see those come off wing, about on schedule.

So it creates a bit of a challenge to some of the operators.

But for the most part, there's enough spares now out there to deal with that.

And I think everybody is pretty happy with the performance.

I think, on time, we're -- I think, we're 99.89% on time right now in terms of availability of the engines.

So again, we're not causing delays at the operators, and people are generally very, very happy with us.

But I think you'd say the same thing at Bombardier or now, I guess, Airbus with the A220.

That engine continues to perform very well, and we're just starting to see some early introductions of the E2.

So again, all very, very positive and, I think, really a tribute to the Pratt local production team and the engineering team for getting some of these issues dealt with very, very quickly and effectively.

Is it fair to say that since you resolved the seal problem earlier and you're continuing to make progress on the combustor, do you see any other issues that are out there, that appear to be any significant hurdle to getting this ramp continuing to go up?

Well, I don't see any issue today.

But like I said, we still -- we haven't hit that 1-million-hour mark.

Keep in mind, with these engines, even on the V2500, which has been out there for 25 years and delivered over 7,000, we continue to find ways to improve the performance, to improve durability.

And we will continue to find ways to do that on the GTF.

As you know, we still have a long way to go on the cost-reduction curve on GTF.

So we'll be introducing some cost-reduced components.

But as we do that, we'll also be looking to improve the durability of the components that we're putting on the wing.

So this is -- you're never done in the engine business, right?

This is a constant evolution of the engine to try and get to the best possible configuration you can.

And we're continuing to work that.

But today, I don't see -- there's no showstopper out.

There is no new drama that I'm aware of today that will cause us any concerns.

And I'm showing no further questions.

I would now like to turn the call back to Mr. Hayes for any further remarks.

Okay.

So I thank everyone for listening in today.

A really solid quarter again and, I think, more importantly, a really solid outlook for 2017 -- or 2018, that's for the year this is, and beyond.

As always, Carroll and the team are available to take your calls, and we look forward to seeing you all in the coming weeks and months.

Take care.

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

You may now disconnect.

Everyone, have a great day.