雷神技術公司 (RTX) 2018 Q3 法說會逐字稿

Good morning, and welcome to the United Technologies Third 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 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 and the transaction and related matters.

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

Okay.

Thank you, Christy, and good morning, everyone.

As you all saw from our press release this morning, Q3 was another really solid quarter for UTC.

EPS was $1.93, that's up 12% versus last year.

It's continuing the strong performance we saw in the first half of 2018.

I think importantly, organic sales were up 8%, and that's our best quarter since 2011.

We're clearly seeing the results from our investments in innovation that we've made across the business and from our leading positions in very strong end markets.

So based on our year-to-date performance and the continued strength in aerospace, we're getting to raise our outlook for 2018.

We now expect EPS in the range of $7.20 to $7.30.

That's versus our prior outlook of $7.10 to $7.25.

We're also improving the low end of the sales outlook by about $0.5 billion.

We now expect revenues of 64 to 64.5% ( sic ) [$64 billion to $64.5 billion], and that would take organic growth to 6%.

That's up from our prior expectation of 5% to 6%.

So again, really strong top line as the markets continue to show further growth.

Before we go any further, just a couple of comments on Rockwell Collins.

Regarding the timing of the close of the transaction, as you know, we received the Department of Justice approval, a U.S. DOJ approval on about October 1. That's later than what we had anticipated.

If you'll recall, we had hoped to see that during sometime early to mid-September.

It was a little bit later.

And as a result, it has pushed out the Chinese approval date.

We always expected, I think I said this back in September, that it will be a few weeks after the U.S. DOJ approval that we would expect China to also grant their approval.

So bottom line, we're still going to expect the timing range for China.

We don't see any drama here, and we continue to expect this to happen shortly.

As far as the portfolio discussion, as I said before, the board has continued its deliberations on the strategic questions regarding the portfolio.

And I mentioned back in September, probably within about 60 days, which would be mid-November, and I still think we're right along that time line that we had talked about a month or so ago.

Okay.

Back to the business results and some outlook.

Again, we're keeping a close eye on the global economy in light of, really, it's the geopolitical environment that is our biggest concern.

To date, our end markets, of course, continue to be very strong, and growth forecast for the global economy remains strong through next year.

On the aerospace side, we're seeing particular strength.

Military programs continue to ramp up.

We're also seeing signs of recovery in the bizjets segments.

On the commercial side, global air traffic remains robust.

Year-to-date, revenue passenger miles are up about 6.8% globally.

And in July, the global passenger load factor reached an all-time high of 85.3%.

We're seeing these aerospace fundamentals translate, of course, into continued strong demand of both Pratt & Whitney and our Aerospace Systems business.

On our commercial building side, construction activity in the U.S. remains strong as does infrastructure activity in China.

And driving the strength in our orders is, of course, the growing economy and urbanization rates, which continued to be strong throughout Asia.

And as always, of course, there are some things that we're monitoring: tariffs, logistics costs, exchange rates.

Those all remains watch items.

Specifically on tariffs, no change to our previously discussed expectation of about a $0.05 headwind in 2018.

As we look to 2019, if the tariffs remain in place, we'd see about a $0.15 incremental headwind.

However, it's still early in the process.

We continue to look for ways to mitigate the impact of the tariffs as we move forward.

And as you see, we've been able to offset most of the tariff impact this year.

We'll work to do the same next year.

As always, we stay focused on what we can control, and we're confident in the investments that we've made that will position each business for sustainable long-term growth.

And that positions us to remain a leader in each of our end markets.

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

And I'll be back to wrap it up, and then we'll take the Q&A.

Akhil?

Thank you, Greg.

So I'm on Slide 2. Reported sales in the quarter of $16.5 billion were up 10% with 8% organic growth, 3 points of benefit gained from the absence of last year's nonrecurring charge at Pratt & Whitney.

And for the first time this year, foreign exchange translation was a headwind in the quarter, about 1 point.

Adjusted EPS was $1.93, up $0.20 or 12% versus prior year.

On a GAAP basis, EPS was $1.54, down 8% versus prior year.

It included $0.36 of nonrecurring charges relating to Pratt & Whitney's restructuring of a contract with Gulfstream and costs related to both the pending Rockwell Collins transaction and the ongoing UTC portfolio review.

In addition, restructuring was a $0.03 charge in the quarter.

Consistent with our expectations, free cash flow was $1.3 billion in the quarter.

And for the year, there is no change to our outlook of $4.5 billion to $5 billion of free cash flow, though likely towards the low end of the range.

Two exceptional items driving that: one, $200 million of tax payment associated with the gain on the sale of the Taylor Company.

We talked about this in Q2.

Again, the proceeds from that go to investing, but the tax outflow goes to our free cash flow.

And then secondly, approximately $300 million of net cash impact for the Pratt & Whitney contract matter I talked about earlier.

Turning to Slide 3, you will see the components of our strong organic growth.

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

Looking at our commercial businesses first.

In the Americas, sales were up 10% with solid good growth at both Otis and CCS.

End market activity continues to remain robust, and new construction and consumer sentiment remains strong.

Within EMEA, sales were up 1%.

Europe was up slightly at CCS and up 4% at Otis.

Order rates for Europe were mixed in the quarter.

Otis new equipment orders were down 10% on tough compares while at CCS, Europe equipment orders were up low single digits.

Middle East continues to be a watch item.

In Asia, sales were up 3%.

In China, Otis sales were up slightly, the first time we have seen growth there since Q1 of 2015.

More importantly, we continue to see price stabilization in new equipment orders there.

At CCS, sales in China were down low single digit, with growth in commercial HVAC, offset by declines in private security products.

Rest of Asia was up mid-single digit at both segments.

On the aerospace side, commercial sales were up 10% organically in the quarter.

OE growth was driven by strong GTF shipments at Pratt and increasing next-generation product sales at Aerospace Systems.

And on the aftermarket side, our strong OE positions, coupled with continued high traffic demand and strong utilization of in-service products, drove 10% organic growth in the quarter.

Organically, military sales were up 15% at Pratt & Whitney and up 10% at Aerospace Systems.

Now before I turn it over to Carroll, just a few comments on our improved 2018 outlook and some early thoughts on 2019.

As always, we have a few moving pieces.

First, the bad news.

Otis continues to see higher-than-expected material costs as well as increased labor costs, including in Europe.

In addition, the business has seen further deterioration in Korea, the third largest new equipment market for Otis.

On a global basis, pricing, both in new equipment and service, while showing signs of improvement, is not providing any near-term offset to cost pressures, and the stronger U.S. dollar has created additional headwind.

As a result, we now expect Otis operating profit to be down approximately $75 million year-over-year, roughly $15 million lower than before.

To address these headwinds, Otis continues to invest in digital tools to improve service productivity on a sustainable basis.

In addition, Otis is looking at structural cost-reduction actions relating to its footprint and G&A.

We expect Otis to show some earnings growth in the fourth quarter and get back on the path of sustainable and consistent earnings growth starting in 2019.

However, given its updated 2018 outlook, it is clear that Otis will not be able to make the 2020 operating profit growth range we had laid out in 2016.

On the good news side, our aerospace business has continued to perform well and should more than offset the 2018 Otis shortfall from higher-than-expected profits at Aerospace Systems and Pratt & Whitney.

Overall, we feel highly confident in our increased adjusted 2018 EPS outlook of $7.20 to $7.30.

This is, of course, before any impact from Rockwell Collins.

Looking to 2019, we continue to expect our effective tax rate to be around 25.5%, as Greg referenced last month.

Also as we have said before, we will be focused on deleveraging for the next 2, 3 years and do not anticipate any significant share buyback in 2019.

Our weighted average diluted share count should be around 808 million shares for 2019.

This is, again, before any impact from the pending Rockwell Collins acquisition.

With regard to FX, if exchange rates were to stay where they are today, we would have about $100 million of translational FX headwind to segment operating profits in 2019.

This would be principally from euro and the Chinese yuan.

As it relates to our operating performance, we expect solid growth continuing into 2019 in our end markets, particularly aerospace.

We still expect Rockwell Collins to be accretive to the adjusted EPS in 2019.

We are in the early stages of our planning process.

And just like this year, we will provide specific guidance with regard to 2019 in January at our Q4 earnings call.

With that, let me turn it over to Carroll to take us through the business unit details.

Carroll?

Okay.

Thanks, Akhil.

I'm on Slide 4, and I'll be speaking of 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 12 you can use as a reference with additional segment data.

Otis sales of $3.2 billion in the quarter were up 4% organically.

On a constant currency basis, new equipment sales grew 4%.

Low double-digit growth in Europe and mid-single-digit growth in both the Americas and Asia, excluding China, were partially offset by a low single-digit decline in China.

Service sales were up 5% in the quarter with high single-digit growth in modernization and mid-single-digit growth in both maintenance and repair sales.

New equipment orders were up 9% organically, largely driven by major projects booked in the quarter in North America and China.

Orders in the Americas were up 25%, partially offset by declines in Europe, which was down low double digits after growing 25% in the third quarter last year.

Similar to last quarter, we saw value growth of China orders outpace unit growth, with unit orders up 4% and our corresponding value growing 14%.

Major projects were almost all of the value growth.

The combination of price and mix was slightly favorable.

Otis operating profit declined 10%.

The contribution from higher volume was more than offset by higher material and labor costs as well as pricing and mix pressure from the backlog.

In addition, profitability was impacted by year-over-year headwind from transactional mark-to-market currency adjustments.

Foreign exchange translation was a 2-point headwind to sales and earnings.

As Akhil mentioned earlier, we've lowered our outlook for Otis full year operating profit based on operational challenges and the outlook for our end markets.

We now expect a range of down $75 to down $25 million and likely towards the low end of the range at actual currency, with operating profit growth returning in Q4.

The full year outlook for organic sales at Otis remains unchanged at low single-digit growth.

Turning to Slide 5, Climate, Controls & Security sales were up 7% organically.

The continued growth in refrigeration and HVAC end markets contributed to the strong performance.

Refrigeration sales were up 11% in the quarter, driven by 39% growth in container sales.

North America residential HVAC was up 9%, and global commercial HVAC grew 8% in the quarter.

Fire and security sales were up slightly.

Year-to-date, CCS sales are up 6% organically.

CCS also continued to see strong equipment orders, up 13% in the quarter.

Transport refrigeration orders grew 91%, driven by the North American truck trailer business.

Fire and security product orders were up 8%, while North America residential and global commercial HVAC were both up low single digits.

CCS operating profit grew 5%, excluding the impact of the Taylor divestiture.

Growth was driven by higher volume and the favorable year-over-year impact of a contract adjustment in the quarter.

Benefits from improved pricing realization largely offset increases in commodities and logistics costs in the quarter.

Looking at the remainder of the year, volume growth and improved pricing should continue and expected to more than offset increases in input costs, which include the recently imposed tariffs.

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

Shifting to Pratt & Whitney on Slide 6. Sales of $4.8 billion were up 13% on both an organic and adjusted basis.

Commercial OEM sales were up 18%, driven by 27% growth in large commercial engines.

Total geared turbofan shipments, including those to the spare engine pool, continued to increase sequentially and grew significantly over the prior year third quarter.

Pratt & Whitney remains on track to meet its full year customer delivery commitments and to approximately double GTF production from 2017.

Pratt & Whitney Canada OEM sales were up 9%, with shipments growing year-over-year and sequentially.

Military OEM sales were up 33%, driven by F135.

Commercial aftermarket sales were up 9% as the large engine aftermarket continues to benefit from strength in the V2500.

Military aftermarket was up 7%, driven by the F135 and F119 programs.

Adjusted operating profit of $409 million was up 7%.

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

Negative engine margin was primarily driven by higher GTF deliveries as well as delayed product cost-reduction initiatives.

Based on year-to-date performance, including continued strength in the aftermarket and despite the anticipation of negative engine margin increasing with deliveries in the remainder of the year, we now expect Pratt & Whitney to grow operating profit towards the high end of the previously communicated range of $25 million to $75 million.

Turning to Slide 7. Aerospace Systems delivered another strong quarter, with 7% profit growth on 9% higher organic sales.

Sales growth was strong across both commercial and military aerospace.

Commercial aftermarket was up 12%.

Parts and repair were up 11% and 13%, respectively; and provisioning grew by 13%.

While compares will be tougher in Q4, leading indicators remain positive.

And we now expect full year commercial aftermarket sales to be up high single digits.

Commercial OEM sales grew 6%, driven by new production programs, primarily the A320neo, partially offset by declines in legacy programs.

Military sales were up 10%, driven by higher F-35 volume and international awards.

Operating profit growth of 7% was driven by drop-through on higher commercial aftermarket and military sales and continued product cost reduction.

These benefits were partially offset by OE mix headwind, higher SG&A spend, unfavorable warranty expense and the absence of a favorable contract settlement recorded last year.

Operating profit margin of 15.9% in the quarter was down 20 basis points year-over-year.

Excluding the unfavorable warranty expense in Q3 and the favorable settlement in the prior period last year, margins expanded 140 basis points.

Based on the strong year-to-date results, we now expect full year sales to be up mid-single digits.

That compares to our prior outlook of low to mid-single digits.

And we now expect operating profit to be up $200 million to $250 million and likely towards the higher end of the range.

That's an improvement over our prior outlook of $175 million to $225 million in growth.

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

Great.

Thanks, Carroll.

So overall, UTC's performance during the quarter, I think, was very strong, you'd agree.

Obviously, we've got some work to do with Otis.

I would tell you that Judy and her team are actively working to overcome the cost issues that we encountered in Europe as well as some of the market difficulties in Korea.

We would fully expect Otis to return to operating profit growth in 2019 as the benefits from the productivity and other cost initiatives actually start to yield some positive momentum next year.

But looking at UTC overall, we're really pleased with our results and of course, the improved outlook for this year.

With organic sales growth of 8% across the board, we see strength in each of our businesses, and the leading indicators for each businesses are positive.

Orders are strong.

Backlog's continuing to grow.

On the execution side, we're well on track to our GTF production ramp targets.

And UTC Aerospace Systems continues to deliver on its cost-reduction targets, and CCS continues to invest in new products and drive growth and find ways to offset increasing costs.

Bottom line, we're confident in the improved outlook for 2018, and we see continued progress next year.

We see solid long-term fundamentals across all of our businesses, and the investments we've made give us confidence about the future.

As always, we're going to stay laser-focused on delivering to our commitments and to our customers and of course, executing on our strategic priorities.

With that, let's go ahead, Christy, and open up the call for questions.

(Operator Instructions) Our first question is from Carter Copeland with Melius Research.

Just a quick clarification or question.

The customer contract settlement, Akhil, that you mentioned, I assume that relates to Gulfstream.

I wonder if you could just verify that for us.

And then Greg, I know your comments on the Chinese approval on Rockwell Collins and waiting for that.

I realize these things can somehow or sometimes have a bit of a political aspect and drag on.

How are you thinking about how that impacts the portfolio decision?

And what should we be thinking about how that timeline is being affected?

You're right, Carter.

The charge that we talked about is entirely related to the Gulfstream and the NORDAM discussion that we've had in the past.

All right.

Let me try this one more time on the Chinese approval, just to be very clear.

We have heard nothing from the folks at SAMR, which is the regulatory agency that approves these transactions, that would cause us to believe there's any political issue that's holding up the approval of our deal.

We had a remedies package agreed to with SAMR back in August.

It was all contingent upon DOJ approval of the transaction, which didn't happen until October.

So I know people are excited.

There was a lot going on geopolitically.

There's a lot of tension between the U.S. and China.

We just don't see that as impacting the deal.

Again, we've got a very large presence in China.

We've been investing there for years and years.

We're a key part of their aerospace industry.

We've got 24,000 employees.

We just don't see UTC as being caught up in the Sino-U.

S. political issues.

So again, we're still on track.

And again, whether it takes another week or 2 weeks, I'm not all that concerned.

I think you're right, Carter, as far as the portfolio discussion, A has to happen before B, right?

So we've always said the Rockwell Collins transaction has to close before the board will make a final decision on the portfolio.

You'll recall a year ago, in September, that when we announced the Rockwell transaction, that was really the impetus to start taking a look at the UTC portfolio.

Obviously, having a very, very strong -- in fact, the #1 aerospace supplier with the addition of Rockwell Collins gives the board, I think, comfort that the aerospace business can indeed stand on its own going forward.

But we've got to close Rockwell first.

And so I think it's out there.

We expect it to happen.

I can't give you a date other than the fact that we know it will happen probably in the next, let's call, 2 to 6 weeks.

Our next question is from Julian Mitchell with Barclays.

Maybe just a question on the commercial businesses specifically.

How comfortable are you with the outlook in Europe with Otis and CC&S, given the comments from Lennox and ASSA ABLOY and so forth have been pretty tempered in the past few days?

And tied to that, do you think you need to see much more of a restructuring step-up in those businesses?

I think year-to-date, restructuring costs are about $100 million collectively in both.

You talked a little bit about Otis charges going up.

Should we see the same at CC&S?

Julian, those are all good questions.

I think as we think about the business in Europe, for a number of years, we've always been concerned about service portfolio, deterioration of pricing in Europe as it relates to the Otis business.

We've actually seen that turn the corner.

And so one of our biggest concerns has always been portfolio.

We've seen positive momentum on the portfolio.

We continue to see solid orders for both businesses in Europe.

This quarter, it was a little bit off.

I mean, I think Otis was down like 10%, but that's off of a tough compare, where they were up 25% last year in the third quarter.

So orders remains strong, the backlog remains strong.

I think the 2 watch items that I would tell you: one, our labor availability.

We have continued to see shortages of skilled labor, specifically in the U.K. and in France, which has caused some contract cost reestimates.

Again, those things are difficult to overcome in the short term.

We've also seen some other input costs that have gone up in Europe.

Now Otis, again, long-term contracts.

It's 1, 2, 3 years to execute, hard to pass on pricing in the near term.

CCS has done a much better job because of the short-cycle nature of their business and passing on some of those cost increases.

But I think both businesses have their eye on the cost lever as well.

I know both Bob and Judy are continuing to look for structural cost-reduction opportunities.

There will be, I believe, probably more restructuring dollars spent here in the fourth quarter and in the first quarter of next year.

So it's clearly something we have our eyes on.

But again, I think that overall the markets are not as awful as people might expect.

Aerospace can completely differ.

I think again, across the globe, aerospace remains strong.

The U.S., again, commercial businesses did very well.

I think we saw 9% growth in residential in the U.S. in the quarter.

We saw like 25% growth in North America in new equipment orders.

So again, Otis overall, I think, doing very well.

And Europe is just going to be a question mark.

One additional data point, Julian, that might be helpful on the Otis story is that we have -- still in our early stages of digital deployment of all the tools that we've been talking about.

There is about 20,000 technicians who now have the digital devices.

But the data point that is encouraging is that we are seeing some early impact on productivity.

The hours per unit on the service side, right, if you think about service, it's a composition of how much time you spend in servicing the unit and what is the cost, the labor cost.

That's actually down 2% year-over-year.

So we are seeing some sign of improvement from a productivity point of view.

It's just not enough to offset the higher increases we have seen on the labor side and the material side.

So the cost increase are greater.

We do believe that as these tools gain traction and as we continue to deploy a global service system in Otis, the productivity number will continue to rise.

There is significant opportunity there, but that is still to come.

So keep in mind, we spend about $3 billion a year on service technicians, 33,000 service technicians.

You get a 1% improvement in productivity that Akhil is talking about, that translates into $30 million of profit on an annual basis.

Now we're not quite there.

We've only got 20,000 of the mechanics equipped with these digital devices.

But as I talked in my closing comments, we start to think next year, the investments in digital will indeed pay off.

We'll see that in the bottom line.

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

Greg, I just wanted to come back just to China again.

Perfunctory is probably too strong a word, right, but it kind of sounded like the Chinese approval was viewed as relatively perfunctory once the U.S. kind of signed off.

I'm just curious though, have they actually asked for anything else?

Is there additional discussions?

Are there remedies that they are looking for beyond what the U.S. sort of lust here?

Nope.

I don't mean to be flippant, but the answer is no.

I think we had a complete package here for them back in August, a complete remedies package.

Right now, it's just -- they told us it was going to be put on hold until we saw DOJ approval.

That happened on the first of October.

Of course, they had the Golden Week, so they were off for a week.

So it really -- this is just the second week that they've been back since the holiday.

And again, I don't ever actually think anything as perfunctory because you never know.

But there has been no additional discussions, no additional requests.

This is just simply the administrative process that SAMR has to go through.

Great.

And then just back to Otis.

So I think I heard that Europe service margins are stabilizing.

Is that correct?

And the bigger question now is just now as you look out to 2020, how do you see the margin trajectory of Otis playing out and kind of what are the big moving pieces to get there?

Yes.

Just to clarify, Jeff, the revenue per unit on Otis service in Europe is stabilizing.

That's the point that Greg made earlier.

Margins are still trending down, although at a lower rate than before, and that's just because the cost increases had been greater than the productivity offsets, right.

So revenue is stabilizing, good sign.

After many, many years of decline, revenue per unit is now starting to stabilize in Europe.

That's a very positive sign.

As our productivity initiatives take hold and start to more than offset the cost, that's when you will see the margin expansion, right?

So not yet there.

With regard to 2020, obviously we've got to go through our planning process for '19.

That will inform the expectations of our outlook for 2020.

So we'll give you an updated look at that in January.

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

Greg, can you just walk us through Otis, Otis in China?

We've seen -- Akhil remarks said that you're starting to see a little bit of a turnaround there.

Where are you seeing that strength?

And kind of what's going on there?

And then the second question would be the middle of the market airplane.

Do you look at it as an opportunity for both Pratt & Whitney and UTAS?

Or are you kind of more focused on just UTAS?

Okay.

I'll start with Otis China first.

Just to give maybe the numbers for the quarter, just to remind you.

We saw 14% growth in orders in China on a dollar basis, only 4% growth on a unit basis.

So clearly bigger projects.

And where we're seeing the strength is in the infrastructure side and the infrastructure spending that the Chinese have been doing to try and offset some of the other headwinds that they have in the economy.

So clearly, Otis is benefiting from that.

I think service was up big as well in China in the quarter, so we're starting to see some momentum on service.

Margins still aren't great, but at least we're starting to see growth in service, which is, I think, something we have been expecting for quite some time.

So yes, we still view China as a very, very strong long-term market.

Again, the fundamentals remain strong.

There's still a big push on urbanization.

And to the extent that you're not going to see growth in residential construction, the Chinese have shown a willingness to spend on infrastructure.

So I think that's the story at Otis.

Obviously, the quarter, there are still some hangover from the backlog that were playing out.

And so earnings were down in the quarter a little bit in China.

But -- it was flat rather.

But it's still a good news story, I think.

On the middle of the market aircraft, again, we see this as a -- it's a viable aircraft we believe.

I think that Boeing company is continuing to work with customers.

I know there's a lot of demand from especially some U.S. carriers for this aircraft.

We've had some conversations with those customers as well.

And we obviously would like to have a position on the aircraft going forward.

But it has to make sense.

I think the investments have to have a pay off and based upon what we think the market size is.

And so we're continuing to work with the Boeing company, both on the engine side as well as on the systems side.

They've got some pretty tough cost targets out there.

But they're optimistic about the market size.

So continuing to work there.

I don't think we see any announcements from us this year, probably not until the first part of next year.

Okay.

And then maybe just one quick follow-on if I may.

Can you dig deeper into the Otis operating outlook in 2019?

I mean, is there something structurally wrong with the business?

Has the competitive environment just changed?

I guess I was kind of surprised in kind of the outlook for 2019.

Yes.

The only new thing, Ron, that we may not have talked about before was Korea.

It just happens to be a large market for Otis, their largest equipment and new equipment market.

And that's seen a significant deterioration both in price as well as from a volume perspective.

So that's probably, I would say, $25 million change in our outlook versus what we were thinking in January.

The other parts have been essentially increases in costs, which have been much greater than what we had anticipated coming into the year.

So I won't say necessarily that there is something fundamentally wrong.

The business still remains a very, very solid business with a great cash profile.

It's just that some circumstances had created greater headwinds, particularly when you add on the FX headwinds as well that have come on, on top of that, that have made the trajectory worse.

We were expecting profit growth this year.

Unfortunately, it's not likely to happen.

But we do feel that Otis is on the right track.

With stabilization in China that Greg talked about, the services revenue per unit starting to stabilize in Europe, those are the 2 big drivers that will help.

And then these structural cost actions that Otis and Judy and team are looking at to relook at how the digital tools may change the nature of how we go to market in terms of whether we need all the branches that we have today, do we need the manufacturing footprint that we have today.

So continuing to evaluate the structural costs from that perspective and seeing whether the use of digital tools in this digital age can actually help us take our cost down in a more fundamental manner than what we had traditionally done at Otis is what the next step is going to be, right?

But I think that we are on the right track.

The 2 big problem areas are stabilizing, and we are seeing some traction from our tools, early stages but some traction from the tools.

I'd also just remind you, while there were some issues short-term at Otis, Otis because again the long-term nature of those contracts, they just don't have the ability to increase prices to cover costs in the short run.

It's not to say they're not taking prices up on the long term.

So I would expect again some of these cost increases that we're seeing this year will start to see some recovery next year and even more in the following year.

You juxtapose the efforts of CCS where we saw very strong pricing recovery, even with logistics cost up and with tariff costs, pricing pretty much offset those increased costs.

Again, just the nature of the short-cycle versus the long-cycle nature of the business.

So this is not a structural issue at Otis to Akhil's point.

Yes, we'll deal with structural costs to the extent that we can or we need to.

But I think it's just short-term perturbation associated with the fact you've got long-term contracts and short-term cost pressure, specifically around labor.

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

I have one question in 5 parts, just kidding.

On the -- you mentioned the spares impact for GTF.

What was kind of the percentage of your kind of total GTF deliveries that were spares?

And when you get into kind of a more normal run rate on that, what percentage is kind of a normal percentage in any given quarter of engines going into kind of the spares pool?

Steve, we're not getting into the breakdown on installs versus spares in too much detail.

But obviously last year, we pulled forward a good number of spare engines on GTF.

When you look at a normalized fleet, you might have spare ratios around 10% to the installed fleet.

But we're ways off from that.

On a ramping program, you clearly need to have more spares delivered as a percentage of the fleet, just so there is really liquidity in that marketplace of engines so you can move those engines around.

So we'll do certainly fewer spares as a percentage of total this year than last.

And I expect that to decline as we go forward.

Yes.

But then those are relatively higher margin, right, engines than -- just on a booking basis than the new ones, than the kind of ones that are going straight to the OE?

Well, keep in mind that the spare engines, the GTF spares that we're building these days, we're keeping in the spare engine pool.

So those are capitalized.

At some point in time, you may have the option to transact those engines.

And you're right, the pricing dynamics on those sales are different than on OEM installation.

Yes.

That's a good question, Steve, from a V2500 perspective.

But really at GTF, it's more of a lease-pool asset freeze-up as opposed to a sale of spares with a high margin.

Okay.

And then one last follow-up on that, what is the -- what do you expect for kind of Pratt aftermarket in 4Q?

You said something about the annual number being up high single digit.

What does that kind of imply for the fourth quarter?

Probably still in this sort of high single-digit range, mid- to high single-digit range, because the underlying fundamentals are still pretty strong.

There is increasing sharp visits happening with the V2500s.

There is still demand for the legacy spare parts.

We've been pleasantly surprised on the PW4000, for example, as opposed to the decline that we had been expecting there.

And then the Pratt Canada aftermarket remains reasonably robust as well.

So I think overall, no change in trends there.

I think the aftermarket will be lower in the case of UTAS in the fourth quarter relative to what they have seen earlier.

And that's a function of the timing of some provisioning items that we know.

Yes.

But Pratt is slower is what you're saying?

It's just not -- it's just a little bit slower than the annual -- slows down in the fourth quarter.

Just slightly slower, but I think it's more in line with our total -- our annual growth rate of 10% still feels pretty good.

Our next question is from Sheila Kahyaoglu with Jefferies.

Just following up on the pricing questions earlier.

Maybe you could talk about pricing across the portfolio, given tariffs are -- it seems an incremental headwind, I think you mentioned, Greg, in your prepared remarks.

How are you thinking about mitigating that headwind across the board and as it relates to maybe pricing step-ups in '19 or productivity?

Well, let me start, and I'll let Akhil kind of fill in the blanks.

But if we think about $0.15 of headwind next year after $0.05 of headwind this year, we have been able to more than offset the tariff impacts through pricing this year.

I would expect pricing will also have to increase next year if these tariffs remain in place.

There is a limit, however, in terms of how far pricing can go.

Keep in mind, we've had, I think, 3 price increases so far this year in the U.S. resi business.

Ultimately, these tariffs can get all passed on to the consumer in one form or another.

It's just a tax on the consumer in another way to think about it.

So on the extent that the pricing is not going to be adequate, I know Bob is thinking about ways to take some costs out to do some additional restructuring this year and early next year to try and mitigate a piece of this.

But again, at $0.15, it's not a huge number, but it is something that we're going to have to deal with, primarily through pricing.

Yes.

Just to add a little bit more to that, Sheila, as you know, CCS has the biggest burden of our tariff increases.

So of the total roughly $200 million of tariffs we are talking about for next year, 60% of that is at CCS.

And some of that relates to really life-saving products, such as carbon monoxide alarms, et cetera.

And one of the mitigation actions that Greg didn't talk about is also we're trying to look at and see if we can get exclusion to those products, which are life-saving devices from the list from the administration, so that they can award the tariffs on that.

So there is obviously actions on the price side.

There's actions on exclusion, trying to get exclusions.

There is also actions on looking at supply chain and trying to see if we can in the short term, without having major disruptions, look at alternate sources to the extent we can.

Our next question is from Myles Walton with UBS.

Akhil, I know I heard you say that you expect UTAS to slow down on the aftermarket side in the fourth quarter.

But obviously, there can be any expectations through the course of the year, and it sounds like you're talking about provisioning.

Is it kind of one-off provisioning that you're just not expecting to repeat?

Or is this plain vanilla strength that you don't expect to remain as strong?

So I think the fourth quarter implied would be like no growth year-on-year.

Yes.

It's a combination, Myles.

I think if you go back and look at our data for last year, the fourth quarter was significantly stronger for provisioning.

It was almost 20% more than any -- the best quarter before that last year.

So it's a very, very tough compare.

Part of that is just the engine per unit that they supply to Pratt, but there is also timing of some parts associated with 787 and other legacy provisioning that we have seen early takeup from airlines.

And while it's still the demand, excluding the EBUs, that's going to be up, but it's at a much lower rate than what we have seen earlier in the year.

So would you describe the -- you started the year at up low single digits, you're now at up high single digits.

Is it because of provisioning?

Or is it because of plain vanilla that you have seen kind of the upside for the year?

It's both, Myles.

So provisioning is up.

I think that at this point, we are thinking provisioning will probably be high single digit up for the year as opposed to our flat to maybe slightly down when we came into the year.

So that's certainly been a big help.

But we have also seen good strength out of just the plain-vanilla parts.

And the most encouraging part from my perspective has been the good growth that UTAS has seen on the repair side of the equation there.

And to me, that is actually a sign of our lean initiative and all the work that Dave and his team has been doing in the repair shops, in the MRO shops, which are allowing them to improve their turnaround times and satisfy the customers faster, as a result, probably gaining a little bit of market share in that space.

So that's been also an encouraging part, which is largely driven by our own execution and the capabilities in our MRO shops.

Our next question is from Peter Arment with Baird.

Akhil, maybe just a modeling question.

What are some of the bigger puts and takes implied for 4Q, just given the range for the annual EPS?

If we look at that for 4Q, it looks like it's the lowest for the year.

Yes.

I think partly it is because of the GTF, the profile of the negative engine margin.

That's generally -- we expect that to be the highest year-over-year headwind in the fourth quarter based on the delivery profile.

That's number one.

Number two is as you know, carriers is, generally, CCS is by seasonality-wise.

It's the weakest -- it's one of the weaker quarters.

And last year, we had a very significant growth in the container business, which is one of our bigger margin businesses in that portfolio.

So tougher compares inside that on the CCS side.

And then there are some nitty-gritties below the line as well.

The tax rate, for it to be 24.5% for the full year, would suggest that the rate will be closer to 26% for the fourth quarter.

It's just the timing of how some of the items play out there.

Our corporate expenses typically are highest in the fourth quarter.

So it's a combination of things.

But it's not inconsistent with the way we were expecting the year to play out.

And that's just more or less math as opposed to any real hidden agenda here.

Our next question is from Sam Pearlstein with Wells Fargo.

Can you talk a little bit more about the GTF and just the supply chain?

And how it's executing today?

And maybe what's inside Pratt versus outside Pratt in terms of your ability to just deliver engines?

Well, I think, Sam, the good news is we've got pretty good visibility in the supply chain out to a full 24 months.

And we have -- while it's still early, I would say a handful of parts that cause us some consternation on a regular basis.

For the most part of those -- there's 8,000 parts of the engine, 1,100 of them are highly engineered.

Of those highly engineered parts, there are really no hiccups in the supply chain that we can see today.

In fact, as I said, we're on track to just about double production of GTF this year.

It will be up nearly 50% again next year.

And so far, the supply chain has been able to keep up with us.

So the difference between today and 10 years ago is we actually have visibility into the supply chain.

So we can see when the parts are getting started, what the yields are, what the quality escapes might be.

All of that visibility on a real-time basis, and we've got folks at all the key suppliers today.

So while there's always a watch item, there can always be an escape, there can always be an issue, I think today we've got a lot more visibility.

And keep in mind, we have dual sourcing for almost every part out there.

Most -- the preponderance of the volume goes to the lowest-cost supplier, but we keep a second source there just in case.

And I think that's a good strategy that Pratt has employed on this.

So I think about 75%, 80% of this engine is actually produced in the supply chain.

So it's imperative that we have our arms around this.

And I think Leduc and team have done a great job, and I really shout-out to the team back there.

And operations have done a great job on the supply chain monitoring.

And presuming you actually stay on schedule through next year, is the new engine margin loss flat next year?

Or does it actually start to go down next year?

I think because of the volume increases, it's probably in absolute terms.

It will be flattish.

But on a per-unit basis, obviously it will be coming down the learning curve that we've talked about.

Our next question is from Rajeev Lalwani with Morgan Stanley.

Greg, I wanted to come back to some of the comments you made around strategic review and so on.

Can you just walk us through just so that we've got the right expectation as to what are the parameters for what we're going to hear in November, obviously assuming Rockwell Collins closes?

And then just can you remind us of your approach for just entertaining a third-party interest in assets and that sort of thing?

And how that relates to what you may or may not say in November?

Look, I think what you'll -- what we'll say in November will not surprise anyone.

But having said that, there is always the ability of the board to make a different decision.

But right now, we're on track.

We've looked at this question for well over a year.

I mean, I have made my views pretty clear.

I think focused businesses do better over the long term.

But the board has an obligation to evaluate all of the issues regarding the potential separation of these businesses.

And there are a lot of questions that we continue to answer with the board.

But I would tell you, I feel confident that the board will come to a final decision shortly.

And that decision will simply be to probably explore all of these options.

I think as you think about potential M&A opportunities, value-creating M&A, there's always that possibility, although I would tell you both at the CCS business and Otis businesses, business combinations are hard to do because of antitrust.

When you have market-leading positions like we do in HVAC, market-leading positions like we have in elevators, it's hard to think about big, big transactions that would pass antitrust scrutiny today.

But having said that, I think we will, the board will be open to all potential opportunities along those lines, and we'll continue to work that.

Our next question is from Jon Raviv with Citi.

Greg, just philosophically, I was wondering if you could talk a little bit about just how does a company as large and as varied as yours adjust to just the higher-cost, higher-rate and potentially higher-growth environment?

Is there some sort of playbook that you can reach back to the last time we saw inflation pick up and rates pick up as well?

Yes.

That's -- it's a good question.

And I think each of the businesses has their own methodology for coping with cost increases.

If you think about the aerospace side, we have -- most of the products that we buy are under long-term agreements.

That provides some level of price adjustment based upon inflationary index, again, not in that big price increases.

The beautiful thing about the aerospace business though is you have the ability to pass those increases on as part of the annual catalog increase in the aftermarket.

And many of our OEM contracts have the same type of cost adjustment for inflation or increases in these indices.

So that's the aerospace side.

Again, it continues to look for ways to pass along these cost increases as well as the ability to look for second sources and to move to lower-cost supply to the extent that inflation becomes unmanageable.

On the commercial side, the playbook is pretty simple.

It's constantly keeping an eye on structural overhead costs.

But it's also using the pricing lever where we do see inflation, using the inflation as a method to increase pricing.

And that's not a bad answer, a little bit of inflation is not bad.

I think it's just a question of being able to manage it, being able to forecast accurately where your cost increases are coming, so you don't get surprised.

Yes.

And just to, I mean, give further data point.

If you look at the number of facilities that UTAS has structurally addressed since the acquisition of Goodrich, it's almost 40 facilities that they have closed or consolidated.

And that's the type of playbook that carriers have used historically where the number of factories have come down significantly.

So it's about scale, it's about trying to make sure that you are constantly looking at structural costs.

This is something that UTC is very good at.

And that's also a part of the playbook in addition to looking at pricing and strategically positioning ourselves in high-growth markets such as aerospace.

I would tell you though, I mean, the playbook here really revolves around the operating system.

And that's the ace, an implementing ace in each one of the factories and pushing that down into the supply chain, such that everything we do is focused on process excellence and how do you reduce cost in every step of the production, every step of the supply chain.

So again, the playbook is pretty well understood.

And I think to the most part, the guys have been executing on that.

And our final question is from Deane Dray with RBC Capital Markets.

Okay.

Well, I guess Deane is not on the call.

But with that, let me take the opportunity to thank everybody for listening in today.

We are at the bottom of the hour.

Just to remind everybody, Carroll and team are available all day today, as they always are, to answer any further questions.

And we appreciate you guys listening in.

Take care.

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

This does conclude today's program, and you may now disconnect.

Everyone, have a great day.