United Technologies Corp. (UTX) Q3 2013 Results Earnings Call October 22, 2013 9:00 AM ET
Greg Hayes - Senior Vice President and CFO
Jay Malave - Director, Investor Relations
Geraud Darnis - President and CEO, UTC Climate, Controls & Security
David Strauss - UBS
Carter Copeland - Barclays
Nigel Coe - Morgan Stanley
Jeff Sprague - Vertical Research Partners
Howard Guguel - Jefferies
Julian Mitchell - Credit Suisse
Myles Walton - Deutsche Bank
Joe Nadol - J.P. Morgan
Shannon O'Callaghan - Nomura
George Shapiro - Shapiro Research
Deane Dray - Citi Research
Good morning. And welcome to the United Technologies’ Third Quarter Conference Call. On the call today are Greg Hayes, Senior Vice President and Chief Financial Officer; and Jay Malave, Director, 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 the opportunity to participate. You may ask further questions by reinserting yourself into the queue and we will answer as time permit.
Please go ahead, Mr. Hayes.
Okay. Thank you. Good morning, everyone. As you saw in the press release this morning, UTC recorded third quarter earnings per share of $1.55 that’s up 13% versus 2012. We also saw a resumption of organic growth albeit modest and margin expanded to 16.6%.
There’re always a few bumps in the road such as the recent political impasse in Washington that has threatened economic recovery. But our strategy to deliver double-digit earnings growth remains in place.
Following solid year-to-date performance, we are now confident in our earnings per share range of $6.10 to $6.15 that’s growth of 14% to 15%, at the high-end of our previous expectation of $6 to $6.15, that’s despite slower top line growth.
The majority of our end markets are gradually improving but with defense down more than expected, and based on where we are year-to-date we now expect full year sales to be about $63 billion versus our prior estimate of $64 billion.
There are still a couple of puts and takes to the year, and as I said earlier this month, some headwinds at Otis and Sikorsky, but upside at the other segments. Absent this significant external event, we see in fact the high-end of earnings per share range based on our proactive and aggressive restructuring and cost reduction actions, as well as improving end markets.
As you see on slide two, organic sales grew 1% in the quarter with good growth across most of our end markets, tampered by relatively flat European markets and continued significant declines in defense.
Our commercial businesses grew a combined 3%. We saw a continued recovery in North America with sales up 3% led by residential HVAC and Otis new equipment. Europe declined 1%, China was up 11% and continues to be the bright spot in Asia, but overall sales were up only 3%.
Aerospace business continues to see good growth in commercial OEM and recovery in the commercial aftermarket. Revenue passenger miles were up 6.8% in August and were up 5% year-to-date. Oil prices have dampened profitability a bit, but the airlines are still forecasted to earn $11.7 billion this year and $16.4 billion in 2014. So a healthy industry and we see this in our business with our commercial aero sales up 7% in the third quarter. On the other hand, the military business remains a headwind with sales down 14%. We see this impact across our aero businesses, but most acutely at Sikorsky. Given the continued impasse in Washington, we don’t expect this trend to improve over the next year.
Okay, take a look at orders on Slide 3. At Otis, new equipment orders were up 4%, a solid growth off a tough compare with the third quarter of last year which had a major contract awarded in the U.K. North America and China, both saw a double digit increases. Climate, Controls and Securities global equipment orders grew 13% as strengthen in Transicold and commercial spares orders were up 17% at Pratt & Whitney and 5% at UTC Aerospace Systems on a pro forma basis.
All right, Slide 4; total sales increased 3% in the third quarter. Net acquisitions including Goodrich closed on July 26 last year contributed two points while the FX impact was negligible. Segment operating profit grew 14% and operating margins increased 160 basis points. That includes about 100 basis points from the absence of the inventory step up amortization at UTAS last year. As you heard from Geraud at our recent Investor Day in Monterrey, Mexico, CCS continues to drive synergies and leverage their global scale. Operating profit grew 10% leading to margin expansion of 170 basis points.
Pratt & Whitney also expanded margins 290 basis points, on higher commercial aftermarket and aggressive cost reduction. And Sikorsky maintained double digit margins in the face of significant headwinds from sequestration and reduced defense spending. So the third quarter earnings per share grew 13% and we initiated $103 million in restructuring actions. Excluding restructuring and gains for both periods, earnings per share grew 19%. As previously noted, we expect to invest about $500 million of restructuring this year including over a $150 million in the fourth quarter.
For the year, we continue to expect restructuring to be offset by onetime items. Free cash on the quarter was 82% of net income. This was unfavorably impacted by an increase in inventory over $500 million primarily at Pratt & Whitney and Sikorsky as each ramps up their shipments in the fourth quarter. While we continue to see progress on the CMHP with the commencement of pilot training and we’re maintaining our [place order] [ph] eight aircraft in the fourth quarter. In addition to the four aircrafts at the training facility in Shearwater, Canada, we have six aircraft, fully assembled and flight tested at the [Pittsford] [ph], New York storage facility.
Seven are undergoing flight testing at our West Palm Beach facility. The balance of the 20 aircraft are in production. As the program continues to advance, we’ll provide updates as more progress is made.
The quarter capital expenditures were $383 million, a little more than $1 billion year-to-date as we invest with the aero ramp up at both Pratt & Whitney and UTC Aerospace Systems. For the year, we expect CapEx to be in the range of $1.6 billion to $1.7 billion as we noted before. Also in the third quarter we brought back $330 million of stock and we expect to buy back about $200 million in the fourth quarter.
We remain confident that cash flow will equal net income in 2013 and we increased our dividend to $0.59 per share in the quarter a 10.3% increase. I’ll be back to talk about 2014 in just a second, but let me stop there and turn it over to Jay, as he takes you through the business unit results.
Thanks Greg. Turning to Page 5, 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, Russia and the Americas. Operating profit was flat at constant currency, but operating margins remained solid at 22%. Continued growth in China was largely offset by transition costs associated with the factory transformation in North America. In developed Europe, the rate of profit decline is slowing, the sequential growth in northern and Central Europe offsetting the continued weakness in Southern Europe.
New equipment order growth was up 4% at constant currency with mid-teens growth in Americas and Asia with continued double-digit expansion in China. Orders in Europe were down high single digits as the prior-year benefited from our major contract award in the U.K. Excluding this award as well as a significant order this quarter, Europe new equipment orders grew 12%.
Given the headwind from the manufacturing and supply chain transition from the Nogales, Mexico to South Carolina and continued weakness in Southern Europe, Otis now expects full-year profits to be up around $25 million, from up $75 million to $100 million and mid-single digit sales growth.
On Slide 6, Climate, Controls and Security increased profits 10% in the quarter on flattish sales, resulting in another sharp increase in margins, up 170 basis points from prior year to 17.1%. CCS is continuing to see slow but steady improvement in organic growth as Q1 was down 3%, Q2 was up 1% and now Q3 is up 2%.
As you have seen all year, organic growth is mixed across geographies. Europe was down low single digit. China was up mid single digit while Asia overall was down about 1% driven by a decline in Australia. Americas was up low single digit driven by 9% growth in the residential HVAC business.
Transicold was up 22% on a robust recovery in the container market after an exceptionally weak period last year. On profit, CCS had another solid quarter of earnings growth, driven by strong conversion on organic sales, restructuring and productivity including continued savings from the consolidation of Carrier and Fire and Security, and lower commodity costs.
Global commercial HVAC equipment orders were up high single digit with growth in Asia and Europe more than offsetting flat orders in North America. Orders for global Fire and Security products were up mid single digit while the field businesses were down high single digit.
Commercial refrigeration orders in Europe were up 2% while Transicold was up 17%, driven by Container and an easy compare over last year. With continued solid results through three quarters and steady sequential organic improvement, we expect profit growth to be around $200 million, the high end of the prior guidance range of $175 million to $200 million and 1% organic sales growth, all resulting in operating margin above 15%, two years ahead of target.
Turning to aerospace on slide 7. Pratt & Whitney delivered solid results with 18% profit growth and 5% lower sales, resulting in margin expansion of 290 basis points. Organically, sales were flat as 22% growth in commercial spares was offset by lower military engine sales.
Reported sales were down due to the power systems business divestiture. Profit growth in the quarter was driven by higher commercial spares volume and restructuring benefits, partially offset by pension headwinds and lower military volume.
As you recall, last year we had the benefit of a supplier settlement that was largely offset by the benefit from licensing agreements this year. In full year, we now expect Pratt & Whitney operating profit grow $150 million on low single digits sales growth.
We expect profit growth to be at the high end of the prior profit range as large commercial after market has stabilized and the benefits of proactive cost actions are realized.
UTC Aerospace Systems delivered another solid quarter with operating profit of $525 million and sales of $3.3 billion. On a pro forma year-over-year basis, sales were up low-single digit with mid single digit growth in both commercial OE and after market, partially offset by low single digit declines in both military OE and aftermarket.
Year-on-year profit growth was driven by the absence of last year’s inventory step-up cost, additional market of Goodrich and continued synergies realization. UTC Aerospace Systems expects to deliver around $250 million in synergies for the year and is well on track towards achieving the $500 million synergies target by 2016.
Orders for commercial spares grew 5% on a pro forma year-over-year basis with improvement in both parts and provisioning. With approximately $1.6 billion of operating profit generated year-to-date, we’re confident in the full-year operating profit outlook of $2.1 billion and sales of around $13.5 billion.
Turning to Sikorsky, operate profit decreased by 21% on 7% lower sales. During the quarter Sikorsky shipped a total of 61 aircrafts including 42 based on military platforms and 19 commercial. The sales decline was driven by lower military OEM and aftermarket volumes, partially offset by strong growth in commercial shipments. The lower overall sales volumes as well as headwinds from higher pension and compliance costs contributed to the operating profit decline.
Sikorsky continues to see robust demand for its commercial product line with orders this quarter of over $400 million, a strong backlog in excess of $2.5 billion, including approximately $350 million to customers in China as at quarter-end. For the full year based on continued pressure in military aftermarkets, we now expect profit to be down around $150 million, the low end of our prior guiding strange and the low sale digit sales to client versus upload single digits previously.
With that, let me turn it over to Gregg for wrap up.
Okay, thanks Jay. Before we take over to 2014 just some of the key items to note in the quarter. In late September we announced the creation of our new buildings and industrial systems organizations under the leadership of Urel Denise. Although it will remain separate reporting segments this will strategically to unite orders and climate controls and security. This will create the leading commercial building organization in the industry and will allow us to accelerate growth by fully utilizing our unmatched capabilities and scale.
Building on the success of combining our HVAC and plant security platforms under CCS two years ago, this new organization creates opportunities to unlock further synergies and leverage each organization’s field network to service customers in a wider geography and with 30% of revenues in emerging markets we will focus our innovation on our next generation buildings and integrating systems where we see opportunities to create value for our customers.
Also in the quarter Pratt & Whitney and UTC aerospace systems supported the main flight of Bombardier C Series aircraft on September 16th in Mirabel, Canada. A PurePower performed [fan engine] performed flawlessly on this historic flight on the course of next generation narrow body aircraft. We are confident that the flight test program will further validate the performance characteristics, its noise, low emissions, significantly better fuel efficiency.
Although we always like to focus on them for a few broad of the GTF designs, just as importantly the GTF noise propeller is up to 70% smaller than today’s engine. And this creates opportunities to fly more direct routes into congested noise controlled airports. Smaller noise engine also allows streamlining airport operations to expanded runway usage as well as expanding current operational curfews at airports and heavily populated areas. This will [realize] the opportunity to work with airports to generate more revenue by opening additional take-off and landing slots. A good example of value creation that are game changing technologies bring to the table.
Pratt & Whitney’s performance, its best in class technology readiness and program execution is the reason why the GTF has captured orders for more than 4700 engines. We also saw the first flight of Boeing 787-9 in the quarter as UTC aerospace systems continues to support Boeing in the development of this next generation family of aircraft, so, a busy quarter and several significant milestones at UTC.
Let’s change gears for a second here and take a look at 2014. We had not surprises that compared to what we talked about just a couple of weeks back. Our strategy remains in place that we continue to target double digit earnings throughout the 2014. We expect solid growth in the commercial air space and the commercial construction markets in North America and Asia to more than offset declines in our military aerospace business.
As you all know Europe remains a question mark. We will take a cautious approach that we’re not planning for growth in Europe as we sit here today. The good news is that we finally seem some tailwind from pension next year. There were approximately 800million of pension expense flowing through the P&L this year and it will be a welcome relief to see some benefits for lower organization strategies and higher discount rates.
On the other side of the ledger we do have about $0.30 of headwinds from three significant items. It’s obviously continued reduction in defense spending both sequestration as well as the overseas contingency spend.
There is also pressure on the tax rate primarily from the expiration of the tax extenders and lastly we will see some headwind from the initial GTF engine deliveries. It will improve as the technology matures but we will face some negative engine margin on deliveries of each platform over the next several years. These are great long-term programs that point towards bright future for Pratt & Whitney, but we will need to work down the learning curve as these aircraft enter service.
So as always some pluses, some minuses and question marks as we look towards next year. We continued to leverage our industry-leading franchisees in global scale. We have a great strategy in place and we remain committed to delivering double-digit earnings growth once again next year.
So with that let’s open up the call for questions.
Earnings Call Part 2:
- Company Earnings