UTX
#Let me start and I will let <UNK> bail me out at the end.
Right now, as we look at Pratt, we wanted to be very specific.
There's $300 million of additional negative engine margin on top of probably $100 million, or half of that pension headwind that <UNK> mentioned, so a $400 million headwind.
It's just hard to see, even with better aftermarket next year and better military, hard to see how Pratt is going to grow earnings.
So we actually expect them to be down.
E&D I think is the other challenge at Pratt where we had expected it to be down next year.
With the timing of all these programs moving to the left a little bit, we are continuing to see pressure on E&D.
So one of the offsets that we are just not going to see until probably 2018 and 2019 is E&D.
As far as overall UTC, again, we are not quite ready to give guidance as you can imagine.
We are still going through the detail of the plans from all the units and there's a lot of moving pieces.
Clearly, we are going to get a benefit from share buyback, but it's probably not going to offset the negative engine margin and the big pension headwind that we have.
I think that's why, as we look at it today, it's hard to paint a picture where we could see earnings growth at UTC next year.
Right.
And my comment, <UNK>, was about EPS, not so much just about segment EBIT because obviously with the pension of $200 million, the negative engine margin <UNK> talked about; keep in mind the interest expense will be higher next year by about $100 million as well just based on the fact that we need to be in the market to borrow money to fund the share buyback.
So even the share buyback will be a significant benefit year-over-year.
In terms of lower share count, we will lose some of that through higher interest expense.
My crystal ball gets really cloudy beyond about six months.
I would tell you, <UNK>, we are on track with what we've laid out for the 2020 goals, which would show profitability starting to improve in 2018 and 2019.
And as you know then first aftermarket, or first big overhauls on the GTF are around 2020.
So we expect earnings growth to pick up in 2018.
I'm not going to give you a number here, but clearly with the aerospace ramp continuing, there's going to be some challenges, negative engine margin and the mix at UTAS, but those things should be overcome by lower E&D and higher aftermarket as well as growth on the commercial side.
Keep in mind, on the Otis side, we are also going to be investing for the next couple of years.
Philippe has laid out a plan to restore some growth to Otis, top-line growth.
That's going to require some investment in the salesforce.
It's going to require some significant investment in E&D to refresh the productline and from a system standpoint, we need to spend money on these digital initiatives.
So there is going to be headwind next year beyond just what we've laid out.
All of those things would start to pay off in 2018 and 2019.
So, again, we are trying not to surprise anybody with the 2017 outlook, but we are on track to exactly what we talked about back in March about the 2020 outlook.
Great questions, Jeff.
So, on the first one, the math for 2018, there is growth in the negative engine margin on GTFs clearly, but they will benefit from us coming down the cost curve.
But the fact which you may not be thinking about is that the CEO engines, or the V2500s, will be coming down significantly from 17 to 18 as will be the GP7000s and both of those carry negative engine margin as well.
So while GTF will grow, the others will come down and that's not something that's happening in 2017 as much.
So that's the other fact which will keep the incremental GTF incremental negative engine margin at Pratt within the $100 million range.
On the second question on working capital, again, I think we have been very clear about this.
There is probably a year or two more as we ramp up as we take the engine productions up at Pratt net-net.
There is going to be demand on inventories.
We will continue to see some improvement as the supply chain stabilizes in inventory terms, but, in absolute dollars, there will be some demand on that, as will there be demand on CapEx for another year or two where we will probably spend significantly ahead of our depreciation.
But after that, we start to feel ---+ we are back to the 100% of net income or more.
The fundamental thing, Jeff, to keep in mind is that each and every one of our business units has the structure to deliver 100% or more free cash flow to net income.
It's just this temporary phase of significant investment we are making to meet the production requirements coming up and that's keeping some pressure on it.
Otherwise we are in very good shape.
90% or close thereabouts this year, about 100% last year in face of these investments is not a bad number.
You've got a second part to it, <UNK>, or are we going (inaudible).
Yes, sure.
Well, let's start out on the North America residential.
Obviously, it was a good year.
It's interesting, the weather was very hot throughout the summer and yet we really didn't see much traction in residential until September when the dealers were forced to restock inventory.
So it was a good quarter, but I think there is still some concern out there about the legs left in the housing market.
As we look at it, household formation continues to be very, very strong at about 1.2 million a year.
That's going to grow.
If you think about 1.2 million housing starts, 20%, 25% of the resi business is for new construction and I think that should remain on track.
I think more importantly, it's the aging of the installed business out there that is going to really drive growth.
There's over 100 million split systems installed in the US.
Average life is somewhere between 10 and 15 years depending upon where you live and how much you use the equipment and that is again the big increases that we saw back in the early 2004, 2005 when the market was 7.5 million units a year.
Those units are approaching the end of their useful life.
So I think we should continue to see well above GDP growth in resi for a couple more years here.
So I'm not at all discouraged here.
I think it's a really ---+ we are in a very good place.
We've got great products; very high efficiency systems and there is a big push I think to continue to gain share there.
As far as the structural cost reduction, <UNK>, there's always things to do.
I think Dave Gitlin and the team down at the Aerospace Systems business in Charlotte have been focused on it.
I'm reminded, since we acquired Goodrich back in 2012, four years ago, we've realized about $600 million of synergies.
We've closed more than 30 factories.
There are still more factory consolidations to come.
I think there's also structural cost opportunities in the aftermarket down at the Aerospace Systems business.
We have a very large number of overhaul and repair shops around the world.
I think Dave is working on opportunities there.
So more to do at Aerospace Systems.
Clearly Bob McDonough and team are looking at ways to continue to reduce costs in the very competitive markets that we are.
Probably no more big plant closings there, but still executing on what they've got out there already.
And the same is true on Otis.
I think they are consolidating their engineering footprint to three major engineering centers from over 15 today.
That will help reduce structural costs.
We are also focusing on trying to consolidate the service supply chain.
We've got over 60,000 suppliers in Otis's service network and there's a huge opportunity there to reduce costs structurally.
The one place I'm not going to be reducing structure is probably Pratt over the next couple of years.
They've done a heck of a job over the last six or seven years taking overhead costs out.
Their SG&A is like 5%.
So, right now, for Pratt, it's about probably adding capacity.
But we are going to continue to look for ways to take costs out everywhere from the corporate office, to the aftermarket, to the supply chain.
Sure, <UNK>.
So I think the reported numbers would say UTAS aftermarket grew by ---+ commercial aftermarket ---+ grew by about 2%, but we had the benefit of 4 points from last year's contract closeouts.
So I think the trend rate would be about 6%, which seems more in line with the normal world.
We've always said that the long-term growth rate for commercial aftermarket in the UTC Aerospace Systems business should be mid-single digit and this quarter felt like that.
There was some benefit in provisioning that we saw with some new programs coming in, but that's in the range of a point or so.
So I think I would say very normal type of a quarter.
The trends seem reasonably okay and good.
Obviously, for the full year, we are expecting low single digit growth at UTAS and we still feel comfortable with that.
On the Pratt side, a lot of the growth has been coming on the V2500 engine.
As we've talked about before, there are two factors driving it.
One is the service bulletin, but more importantly it is about time now that the first overhauls for the V2500 select five engines start to come in.
We have seen the average age of a V2500 at about eight years, and 50% of those engines had not come for overhaul.
So they are starting to come into the shops now, which is helping on the commercial aftermarket there.
I think overall I would say it's a normal, what you would expect kind of a trend in commercial aftermarket.
Well, let's start with Pratt, <UNK>, and again, not to be more specific than we already have been, there is $400 million of headwind, but there will be growth in some of the other parts of the business to offset some of that at Pratt specifically.
So we are not going to just mail in Pratt and say they are going to be down $400 million to start.
We've got work to do there and we will continue to work through the end of the year to make sure we've wrung out every penny we can in terms of their forecast for next year.
The other headwind, the pension headwind is real, but it's real today.
We will have to see where rates are at the end of the year.
It moves us around a lot, as you can imagine.
Obviously, this pension transaction that we did earlier this quarter is just our way to start trying to reduce that big liability that we got out there.
We got $1.7 billion off the books, but, as I say, there's more to come there.
I think we are going to continue to look for ways to immunize the plan to try to avoid some of the pressure that interest rates put on us.
And interest rates, it's not just pension.
It's all the other long-term liabilities also add cost.
So we've got a long way to go on the plan.
Clearly, we should see growth at CCS.
We are pushing obviously the Aerospace Systems business to grow.
They are going to have a pension headwind though as well.
And Otis, again, probably a tough year next year as we continue to invest in E&D and systems and all of that.
But we will see.
We are going to get benefits out of share count.
We will see.
I think there's just a lot of moving pieces yet.
It's also part of that ongoing customer contract negotiations, <UNK>, so that's pretty normal for us to see that where the sales adjustment comes as part of the collaboration accounting that happens on the risk revenue sharing partners.
I won't give you a specific number.
I will tell you that we expect more than double, so probably north of 300, 350 units.
Well, I think you're right about the negative engine margin.
I'm not sure how you are calculating the fourth-quarter margin rate.
Yes.
Right, right.
We can talk more off line, <UNK>, on that one, but I think there is ---+ you know the factors which are going to impact Pratt in the fourth quarter.
The negative engine margin is one.
We don't see E&D coming down that much in the fourth quarter.
There is obviously some benefit at Pratt Canada.
We continue to see FX good news, pension good news.
Net-net the math would get you to the fourth-quarter number, which is easy to calculate now.
Yes.
It is net, <UNK>.
It was supposed to decline by $100 million, not $150 million.
I think we talked about that before.
So this is the net because ---+ just the discount rate change in UK and US is pretty significant, as you know.
It's not just US.
UK has seen significant reduction in discount rates as well and we have a pretty significant pension liability in the UK markets as well.
So it's a combination of that.
The $200 million is the net number based on discount rates today.
As <UNK> said, that can change, again, depending on what happens with the Fed and what happens on December 31.
So in terms of marketshare, the key thing, <UNK>, there is ---+ the biggest market, as you know, is China.
We see China is about 50% of the new equipment market still.
In terms of units, it's even larger and there, based on the data that we have talked about for the three quarters, our unit orders have been up 3% where we firmly believe the market has been down 5% or more.
So, clearly, we are seeing some benefits in the marketshare in the China business.
I would say even though the data is not quite there from industry overall, but given the strength we have been seeing in our orders in Americas, we have been doing extremely well there and I would venture that we are gaining significant share in Americas.
And then in Europe, the order rates are up 21% this quarter, which suggests that, again, we are probably doing better than market.
So net-net, the initiatives that Philippe has laid out, particularly on the new equipment side, are starting to show up this year.
Yes, I think pricing has been very, very difficult for the last couple of years in China.
We've been talking about that.
We actually started to see some stability here in the third quarter on pricing as the market continues to be relatively robust, especially in the tier 1 and tier 2 cities.
Pricing is an issue really across the Otis portfolio, but is obviously most acute in China.
US, I think we are doing a little bit better.
Pricing in Europe continues to be tough and I think we continue to lose a little bit of pricing on the service portfolio every quarter.
So the key for us and for Otis to turn this around is to make sure we get that service stickiness, so we see the cancellation rates come down, and we also improve the productivity of the field workforce.
So there's a lot to do at Otis.
It's not just about pricing.
There's some structural things we need to do, but I think Philippe and team are on the right track.
And keep in mind, <UNK>, that the China team for Otis, particularly, is very good at taking cost out from the supply chain as well.
While we see pricing pressure every year, they have also been able to extract cost reductions from supply chain.
So they will continue to do that.
They continue to push productivity in the factories there and they will offset at least part of the pricing pressure that we have seen.
Q3 pricing was not any worse than what we had seen year-to-date, so it seems to be stabilizing a little bit.
Still much higher than what we saw last year, but down 7% to 9% as opposed to the 4% to 5% that we used to see before.
So, great question, <UNK>.
We've always said that, for Aerospace Systems, the adverse mix would be the biggest headwind in 2017.
It starts to become better from 2018 onwards, but the UTAS team is also working very aggressively on cost reductions.
You can see it from this year's performance.
They are doing extremely well with regard to the plan that Dave Gitlin laid out.
They are very much on track with it, and I think the same thing will hold for next year.
They will be offsetting a large part of this adverse mix issue that they have with the changeover from legacy platforms to the new generation aircraft with the lower margin products replacing high-margin legacy products.
But we do expect UTAS to do very well in terms of being able to offset a large part of that mix in 2017.
No, I think it's more of what you said first, which is easier comps in fourth quarter.
If you remember this quarter, we had the negative adverse impact of the FX mark-to-market adjustments.
Last year in fourth quarter it had gone the other way.
So, therefore, we get some easier compares, which are relatively easy to forecast and that's why we feel comfortable with the Otis guidance for the year.
And I think just to add just a bit of color there, <UNK>.
The fact is these fixes that we are talking about at Otis, this is nothing you are going to see come through in the P&L right away.
Even if we improve on the new equipment side, it takes us 18 months to install the elevators.
We give free service for a year.
You are really talking two to three years out before you really start to see big traction on the new equipment side.
Service productivity will be a little bit faster, but again we are making more investments than we are seeing on the productivity site initially.
So a little bit of patience on the Otis side, I think, but on the right track.
All right, I want to thank everybody for listening in today.
I appreciate that.
As always, <UNK> and the investor relations team will be available all day to answer your calls.
I would ask that you go easy on our new guy, Carroll Lane, as he comes up to speed, but I'm sure he's looking forward to meeting with each and every one of you.
So thank you very much and have a wonderful day.
Take care.
