United Technologies Corporation (UTX) Q2 2013 Earnings Call July 23, 2013 9:00 AM ET
Gregory Hayes - Chief Financial Officer, Senior Vice President
Jay Malave - Director, Investor Relations
Jeff Sprague - Vertical Research
Howard Rubel - Jefferies
Shannon O'Callaghan - Nomura Securities
Joe Nadol - JPMorgan
Ron Epstein - Bank of America/Merrill Lynch
Sam Pearlstein - Wells Fargo
Peter Arment - Sterne Agee
Cai von Rumohr - Cowen & Company
Robert Stallard - Royal Bank of Canada
Julian Mitchell - Credit Suisse
Doug Harned - Sanford Bernstein
Good morning and welcome to the United Technologies’ second quarter conference call. On the call today are Greg Hayes, Senior Vice President and Chief Financial Officer and Jay Malave, Director of 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, the company will speak to results from continuing operations, except where otherwise noted. They will also speak to segment results adjusted for restructuring and one-time items as they usually do. 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 10-Q and 10-K reports, provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements.
Once the call becomes open for questions, we ask that you limit your first round to two questions per caller to give everyone an opportunity to participate. You may ask further questions by reinserting yourself in the queue and we will answer as time permits.
Please go ahead, Mr. Hayes.
Okay, thanks, Bob, and good morning, everyone. As you saw in the press release this morning, UTC reported second quarter earnings per share of $1.70, that's up 5% versus 2012 with better than expected segment operating profit growth and higher net gains. Second half profit grew by 15% led by strong performance at Climate Controls and Security, and also with the benefit of the Goodrich and IAE acquisitions.
Gains in the quarter receded restructuring by $0.05 as compared to $0.04 last year and taxes were a $0.13 headwind to earnings growth. You recall that last year we had about 23% effective tax rate in the second quarter as compared to about 28% this quarter. So the solid first half of the year, given an uneven economic environment.
We have accelerated restructuring, positioned the business now for further growth. Additional restructuring savings, combined with good orders momentum and easier compares in the back half, give us confidence to increase the bottom end of the EPS guidance range, so you saw the press release. We now expect earnings per share of $6 to $6.15. That's growth of 12% to 15%, an increase with our prior guidance of $5.85 to $6.15.
We continue to expect double-digit earnings growth despite these uneven end markets. In the U.S., the potential fed tightening caused some volatility in the markets, but we still believe the economy is recovering and we are seeing strengthen in the leading sectors. Auto sales were up 8% in the first half and are growing at the fastest rate in five years. Housing starts are 24% higher year-to-date. And, in commercial construction, the Architectural Billing Index has shown expansion in eight of the last nine months, so good progress in the US.
Europe, of course, a little different store with unemployment now over 12% in the PMI or Purchasing Managers Index consistently below 50, and we didn't plan for much growth in 2013, but the fact of the matter is, we are actually still seeing a slight contraction in sales in Europe. Year-to-date sales are down about 3% across our commercial businesses.
On the other hand, we do see continued strength in China, and we are all cautiously watching the economic indicators coming out of China. We talked about some falling imports, exports, tightening of credit markets, lower GDP forecasts, so whether it's 7% or 7.5%, GDP growth, is still one of the fastest-growing markets. Because fixed investments has continued to grow and that's driving very strong order growth at both Otis and CCS.
Aerospace, we continue to see strong growth in the commercial aviation industry. RPM's up 5.6% in the month of May, airlines are now projected to earn over $12.7 billion for the year. While we continue to see pressure in the military, and particularly at Sikorsky, the overall aerospace industry remains very healthy.
Okay. Let's talk about orders for a second. We are on slide two for those of you following along on the webcast. I talked about economic uncertainty remains, but as you can see on slide two, overall our orders positioned us well for growth in the second half of the year. Just as a reminder, we talk orders at constant currency as we normally do.
Otis as we mentioned very strong quarter, 22% growth in new equipment orders. That was led by China with 35% growth. That's 32% growth in China year-to-date for Otis, so very strong recovery.
Climate Controls and Security global equipment orders grew for the third straight quarter. This reflects the strength in the U.S. economy where residential HVAC orders were up 19%, but partially offset by Europe, which was down about 4% across the CCS businesses.
Turning to Aerospace, a very encouraging sign of Pratt & Whitney, after five quarters of contraction, legacy Pratt & Whitney large commercial spare orders grew 15%, organically. And importantly, this included growth across all three major engine families PW2000, PW4000 and the V2500.
Aerospace Systems, we saw growth for the second straight quarter with orders up 4% on a pro forma basis. We're still looking for more recovery in the back half, but it's good to see growth of both Pratt and UTAS on the commercial spares side.
So, in summary, despite the uneven end markets strength in the U.S. emerging markets in commercial aerospace are going to offset the softness that we are seeing in Europe and defense. Our orders momentum still points towards recovery in the back half, but as I said in June, with year-to-date. organic sales down slightly we are now probably going to see organic revenue growth of about 3% for the full year, which is at the low end of our prior range, so total sales are now expected to be just around $64 billion for the year.
Turning back to Q2 results and on slide three, total sales and segment profit increased 16% and 15%, respectively. That's driven of course by Goodrich and IAE acquisitions and the strong operating performance of CCS.
Organically, sales were flat versus prior year following a 2% decline in the first quarter. CCS had another strong quarter, 7% operating profit growth and margin expanded to 120 basis points as they continue to realize savings from the integration of carrier in FNS and capitalize on their operating leverage.
Overall, segment operating margins at UTC declined 20 basis points with the strength at CCS more offset by headwind from pension and the decline in the military business at Sikorsky.
Goodrich and IAE acquisitions continue to exceed our expectations and contributed $0.20 of earnings in the quarter. As I mentioned, earnings per share of $1.70 include $0.05 gains in excess of restructuring. $0.19 of the gains in the quarter came from the sale of the Pratt & Whitney Power Systems business and some small tax settlements. These are more than offset by $190 million we invested in restructuring, including $93 million at Pratt & Whitney as we continue to reduce the cost base there.
Foreign currency, small impact of about $0.01 in the quarter. Free cash flow, 101% of net income. We repurchased an additional $335 million of stock and we expect to buyback a similar amount here early in the third quarter.
So I will stop here for a second and let Jay take you through the segment results, looking back and talk about full year. Jay?
Thanks, Greg. Turning to Page four. Otis sales improved 4% at constant currency in the quarter led by solid high-single digit growth in new equipment and continued growth in service sales. New equipment sales were up in all regions led by double-digit growth in China and Russia. Operating profit was up 1% at constant currency. Solid growth in China and other emerging markets was offset by continued weakness in developed Europe and transition costs associated with the factory transformation in North America.
New equipment order growth was strong, up 22% at constant currency with double digit growth in Americas and Asia led by a 35% improvement in China. Orders in Europe were down mid-single digit. Given continued pressure in Europe and a significantly weaker Yen, we now expect full year profit growth at Otis of $75 million to $100 million versus the prior range of $100 million to $150 million. We expect profit improvement to come in the second half based on conversion of a higher new equipment backlog, especially in China, continued savings from restructuring and completion of the factory transformations in North America.
On slide five. Climate Controls and Security increased profits to 7% in the quarter on 1% lower sales, resulting in another sharp increase in margins, up 120 basis points from prior year to 16.9%. Organic sales were up 1% with mixed results across geographies. Europe was down mid-single digit amid continued economic weakness in the region, while Americas was up low single-digit, driven by 13% growth in the residential HVAC business. China was also up mid-single digit, while Asia overall was flattish, driven by a decline in Australia. Transicold was up 11%. While the organic growth in the quarter was modest, this was the first quarter of growth in over a year and we anticipate acceleration through the remainder of the year.
On profit, CCS had another solid quarter of earnings growth driven by strong conversion on the higher organic sales, restructuring and productivity, including continued savings from the consolidation of carrier and fire and security and lower commodity cost. Global commercial HVAC orders were flattish with 10% growth in Asia offsetting declines in North America and Europe.
Orders for global fire and security products were up mid-single digit while the fuel businesses were down a similar amount. Transicold orders were up 5% and commercial refrigeration orders in Europe were down 5%. With solid results in the first half and anticipated organic improvement, we now expect profit growth to be in the range of $175 million to $200 million, up from $150 million to $200 million on low-single digit organic sales growth at CCS.
Turning to aerospace on slide six. At Pratt & Whitney, sales and profit increased 5% in the second quarter. Higher sales were driven by the consolidation of IAE and transfer of the AeroPower business. Organically, sales were down 6% year-over-year due to lower military engine shipments, partially offset by higher large commercial engine OEM sales. Large commercial spare sales were up 2% organically over last year's second quarter. On a pro forma basis, including consolidated IAE sales in both quarters, large commercial spare sales were up 5%. Profit growth was driven by the benefits from the IAE consolidation, restructuring savings, and lower E&D, partially offset by lower organic sales and higher pension costs. In addition, the absence of favorable one-time items in last year's second quarter offset the benefit of a commercial contract closeout this quarter
As Greg mentioned, Pratt & Whitney, large commercial spares orders were up 15% organically. Based on year-to-date sales however, we now expect large commercial spares to be flattish for the year organically from up mid-single digits.
Pratt & Whitney's proactive cost reduction and restructuring measures give us confidence in its full year profit growth outlook of $100 million to $150 million and mid-single digit sales growth.
UTC Aerospace Systems delivered another solid quarter with operating profit of $532 million and sales of $3.3 billion. On a pro forma year-over-year basis, sales were up mid-single digit with commercial OEM, up double digits and commercial aftermarket, up mid-single digit, partially offset by declines in military OEM and military aftermarket of mid-single digit and low-single digit, respectively.
Orders for commercial spares grew 4% on a pro forma year-over-year basis. Compared with the first quarter, profit was up 4% on 2% higher sales, driven by solid conversion on sales growth and continued synergies capture.
With the first half of the year complete, we now expect full year sales to be around $13.5 billion, the low end of our previous guidance range of $13.5 billion to $14 billion. We continue to expect operating profit of around $2.1 billion in spite of lower sales due to continued cost containment and better than expected synergy traction.
Turning to Sikorsky on slide eight, operating profit decreased 24% and 3% lower sales. During the quarter, Sikorsky shipped a total of 62 aircraft, including 47 based on military platforms and 15 commercial. Sales decrease was driven by lower military aftermarket volumes as well as unfavorable military aircraft mix, partially offset by higher commercial volumes.
The profit decline was driven by lower sales as well as headwinds from the multi-year 8 margin reset and higher pension and export compliance costs. For the full year, we continue to expect profit to be down $100 million $150 million and low single digit sales growth. We expect profit improvement in the second half and benefits of higher aircraft volumes and restructuring savings.
With that, let me turn it over to Greg to wrap up.
Okay. Thanks, Jay. So, I am happy to report that with the completion of the Rocketdyne divestiture in June, we are now done with the major portfolio transformation. Entire organization took on a huge task over the last two years, complete two significant acquisitions, integrate new organizations, divest over $4 billion worth of businesses and paid down $7 billion of debt.
I'll tell you that team executed flawlessly. We now have a portfolio that's well-positioned for long-term growth and we've capitalized on the big the urbanization and commercial [aerospace].
Some other highlights in the quarter, we announced significant wins across our aerospace businesses at the Paris Air Show. Pratt & Whitney announced orders for over 1,000 engines and claim orders for the launch of the second-generation Embraer regional jet. Customers see the advantage of our engine and have placed firm and option orders now for over 4,500 engines.
UTAS Aerospace Systems business is also well positioned with the electric system, cell, wheels and brakes and other systems at Embraer. They also secured new long-term MRO contracts from several airlines and supported Airbus in the certification A400M.
Sikorsky continues to see strong international demand announcing orders for 11 S-76D search and rescue helicopters for Japan, and 6 additional S-92 for the Chinese oil and gas market.
On the commercial side, our business has continued to win key orders. Otis was awarded the largest elevator contract ever in India. We sold 670 elevators and escalators for the Hyderabad Metro. Otis also won a contract to install 255-unit at Tianjin 117, which is nearly 600 meters, will be one of the tallest buildings in China.
CCS was rewarded the contract in the quarter with China resources land to provide HVAC, fire detection system in residential and commercial buildings across China over the next two years. So, the investment in innovative products is paying off. We are delivering real value to our customers and securing keywords that will drive top line growth well into the future.
Okay. Let's take a look at rest of 2013. As I mentioned, we now see earnings of $6 to $6.15. That's the top end of our prior range and represents earnings growth of 12% to 15%. Our relentless focus on cost reduction will allow us to delivery double-digit earnings growth. We continue to invest in restructuring as well. We spent about $240 million in the first half of the year and the businesses have good payback projects in the pipeline.
With almost $435 million of one time gains realized to-date on a pretax basis, we now expect about $450 million of both gains and restructuring for the full year. That’s up from our prior estimate of $350 million each. So you can expect about $100 million of restructuring in each of the next two quarters.
Strong cash flow, of course, remains the hallmark of UTC and we continue to expect free cash flow to equal or exceed net income for the year. We paid down $1.2 billion of debt in the second quarter. That’s almost $1.6 billion in the first half and we have an additional $1 billion due in the fourth quarter. So we will pay down about $2.5 billion of debt this year.
We are also buying back shares. The remaining $335 million in our original share repurchase plan will be completed here early in the third quarter and we expect to do a little bit more towards the end of the third quarter or early fourth quarter assuming cash flow remains strong.
So portfolio transformations behind us, we are focused on integration and execution and we are seeing a gradual recovery in our end markets. The order book supports a resumption of organic growth in the back half and we are confident in the revised EPS guidance.
So with that, Bob, let's open up the call for questions, if we can.
Earnings Call Part 2: