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United Technologies Corporation (UTX)

Q42012 Earnings Call

January 23, 2013 9:00 am ET

Executives

Gregory Hayes - Chief Financial Officer, Senior Vice President

Jay Malave -Director, Investor Relations

Analysts

Jeff Sprague - Vertical Research Partners

Howard Rubel - Jefferies

Carter Copeland - Barclays

Myles Walton - Deutsche Bank

Sam Pearlstein - Wells Fargo Securities

Cai von Rumohr - Cowen & Company

Shannon O’Callaghan - Nomura Securities

David Strauss - UBS

Noah Poponak - Goldman Sachs

Julian Mitchell - Credit Suisse

Doug Harned - Sanford Bernstein

Peter Arment - Sterne, Agee

Operator

Good morning, and welcome to the United Technologies' fourth 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 permits.

Please go ahead, Mr. Hayes.

Gregory Hayes

Thank you, Stephanie. Good morning, everyone. We saw in the press release this morning no surprises. UTC closed out a transformational 2012 just as Louis laid out for you in December. Full-year sales were just under $58 billion, that was up 4% from 2011. That, of course, was driven by the Goodrich and IAE acquisitions. Earnings per share was $5.35 and that included about $0.50 of headwind from FX, pension and E&B.

For the year, Goodrich is only about $0.06 dilutive, a little better than what we had expected due to lower amortization, financing and one-time deal costs, and more importantly, better underlying performance in the Goodrich business.

Free cash flow was again strong at 108% of net income attributable to common share owners and we paid down about third of the Goodrich debt just as we had planned. As we all know, 2012 was a challenging global economic environment and while there is still plenty of uncertainty ahead for 2013 in both Europe and the U.S., we have seen signs of stabilization, particularly in Europe and we have started to see a gradual recovery in the U.S. Economy led by a rebound in housing market.

We continue to expect solid growth in emerging markets throughout the coming year. As you have come to expect from UTC, we just didn’t wait for the economy to recover. We proactively leveraged our scale and optimized our cost structure while we continue to invest in game changing technologies, all the while transforming the portfolio to take advantage of the growth opportunities over the next decade in our core markets of aerospace and commercial buildings. We also took the difficult actions this past year, reducing our structural overhead cost and focusing on global growth markets. In 2012, we invested nearly $600 million in restructuring of which $258 million was in the fourth quarter alone, as the businesses continued to find solid payback projects to reduce costs and position us for earnings growth this year and beyond.

Okay, slide two. Turning to fourth-quarter results. Total sales increased 14%, again driven by Goodrich and IAE. Organic sales were flat in the quarter, a slight improvement from our third quarter results. Segment operating profit was also flat, although Climate, Controls & Security had a very strong quarter with 17% operating profit growth on flat organic sales. As expected, Sikorsky did not ship any of the Canadian maritime helicopters in the fourth quarter but we did record a charge of $157 million related to costs associated with the program delay as we now expect. While we are continuing discussions with the Canadian government, we are also encouraged by the progress we have made since Louis spoke to you in December. There is nothing new to report today but we are cautiously optimistic and Mick will provide you with a full update in March. We are also maintaining our place order of eight aircraft deliveries for 2013 at Sikorsky and there is no change to the projected P&L impact of those deliveries. If you recall, that’s a loss of lot about $14 million per aircraft.

Right, back to Q4. Segment operating margins was down 200 basis points with a CMHP charge in Goodrich acquisition, each accounting for about 100 basis points of the headwind. Restructuring, savings and productivity benefits offset a $140 million of headwind from pension, E&D and FX.

Fourth quarter earnings per share was $1.04. That includes $0.25 of restructuring and one-time charges. The restructuring was spread across the business units, including $75 million of UTC Aerospace Systems, as they continue to make good progress with the Goodrich admiration.

Excluding restructuring, one-time items in the fourth quarter of both years' earnings per share decreased about 9%. The tax rate was 30.1%, a little better than we expected back in December, but still a $0.08 headwind versus last year. Free cash flow very strong 139% of net income, great performance especially as we contributed nearly $200 million in cash for international pension plans.

Moving to slide three, order trends. As you can see, they are showing signs of improvement. Pratt & Whitney's large commercial spares orders were up 46% in the quarter including the additional share of IAE. Excluding that incremental share, Pratt's orders were down 8%, however 21% decline in the third quarter.

Legacy Hamilton Sundstrand commercial spares orders were down 4% following a 6% decline in the third quarter, but importantly book-to-bill for both, Pratt and Aerospace Systems was over 1% for the quarter, so the rate of decline has moderated at the Aerospace Systems unit and we saw a good order growth across the commercial businesses in the fourth quarter.

UTC climate, controls and securities, North American residential HVAC orders were up 20%. Global commercial HVAC orders grew 7% in constant currency. And at Otis new equipment orders were up 13% at the same basis. And importantly, Otis saw a new equipment order in China grow 17% at constant currency as they continue to gain momentum there. Orders also grew in North America, up 18% while not surprisingly Europe was down slightly.

We also saw solid growth in emerging markets. The combined BRIC order for the commercial business units were up 11% this quarter, so order trends broadly improving, a good leading indicator for UTC's return to organic growth in 2013. I'll get back in a second to talk about 2013, but let me turn it over to Jay to take you through the business unit results.

Jay Malave

Thanks, Greg. Turning to page four, Otis operating profit was down 5% on flat sales in the quarter. Foreign currency translation reduced sales and profit by one and two points, respectively. Operating margin was 21.9%, 110 basis points lower than prior year.

At constant currency, new equipment sales were down slightly as growth in China and the Americas was offset by declines in Europe and the rest of Asia. Service was up low single-digit led by growth in modernization and contractual maintenance.

Lower volume and continued pricing pressure in Europe more than offset the benefit of ongoing cost reduction and profit growth in the rest of the world. As Greg mentioned, at constant currency, new equipment orders were up 13% with double digit growth in all areas except Europe, where orders were down slightly. China orders for the quarter were up 17%, solid improvement after being down 11% over the first three quarters of the year.

For the full year, profit was down 7% and 3% lower sales. At constant currency, profit fell 3% on flat sales. We expect the improving new equipment order rates, especially in China in the aggressive cost reduction and restructuring actions taken over the past year to result in the return to profit growth in 2013.

On slide 5, climate, controls and security drove profits up 17% on 6% lower sales, resulting in another sharp increase in margins, up 270 basis points from prior year to 13.7%. Organic sales were flat overall with mixed results across the businesses. Mid-single digit growth in the Americas led by solid growth in residential HVAC was offset by low double-digit and mid-single digit declines in Transicold and the U.S. Security business, respectively. Asia and EMEA were flattish.

CCS had another solid quarter of earnings growth despite flat organic sales. Profit growth was driven by restructuring and productivity, including savings from the consolidation of Carrier and Fire & Security, lower commodity cost and a $22 million special dividend from a distribution partner.

Global commercial HVAC orders were up 7%, driven by a sharp uptick in China towards the end of the year. Transicold orders were flattish with container down about 10%, offset by growth in Europe and North America truck trailer.

Commercial refrigeration orders in Europe were down high single-digit given economic conditions in that region while orders for global Fire & Security products were up low single-digit.

Current order rates are consistent with our expectations for a gradual resumption of organic sales growth at CCS this year. For the full year 2012, CCS grew earnings by $116 million or 5% on flat organic sales. With operating margin at 14.1% up 190 basis points from prior year. CCS is well positioned to achieve 15% margin in 2013, two years ahead of target.

Turning to aerospace on slide six. At Pratt & Whitney, sales were up 12% in the fourth quarter driven by the consolidation of IAE and the AeroPower business. Organically, sales were down 4% year-over-year as Higher Military, Pratt & Whitney Canada and Power System sales were more than offset by lower commercial aftermarket. Large commercial spare sales were down 18% organically year-over-year.

On a reported basis, large commercial spares were up 30% including consolidated IAE sales. Operating profit in the quarter was down 25%. The impact from lower organic sales of large commercial spares, unfavorable engine mix and higher E&D and pension costs were partially offset by the benefits from the IAE consolidation and restructuring savings.

Also the prior year included the benefit of about $0.04 from a contract termination. Commercial spares orders were down 8% organically and up 46% including the benefit from the IAE consolidation. Embraer's recent selection of the GTF to power the second generation E-Jet family is another significant endorsement of the technology. Even with small incremental E&D from this win, Pratt & Whitney still expects to increase profit by 100% to 150% on mid to high single-digit sales growth in 2013.

UTC Aerospace Systems which includes the Hamilton Sundstrand business and the full quarter of Goodrich finished the year strong with sales in the quarter up $3.2 billion and operating profit of $339 million. Organic sales in the quarter were up 4% with OEM sales up high single-digit, commercial aftermarket up mid-single-digit and military aftermarket down mid single-digit.

On a pro forma basis, Goodrich sales in the quarter were flattish. Orders for commercial spares were up sequentially both at the legacy Hamilton Sundstrand and Goodrich businesses. Organic operating profit in the quarter at Aerospace Systems was flattish with the benefit of higher volume offset by higher E&D and pension costs. The EPS impact from Goodrich in the quarter was neutral to UTC's results.

Turning to Sikorsky on slide eight. Operating profit decreased 20% on 3% higher sales. During the quarter, Sikorsky shipped a total of 91 aircraft. 77 aircrafts were based on military platforms and 14 commercial. Higher sales were driven by international military and commercial aircraft volumes, partially offset by lower aftermarket sales and the absence of two Canadian maritime helicopters in 2011.

Operating profit benefited from higher international military and commercial aircraft deliveries but was more than offset by the charge taken on the CMH program. For the year, Sikorsky delivered 243 aircrafts, including the CMH charge operating profit of $765 million was down 7% on 8% lower sales. Accordingly we are updating Sikorsky's 2013 operating profit guidance. We now expect profit to be down $100 million to $150 million versus our prior guidance of about down $250 million to $300 million. Despite the earnings decline in 2013, Sikorsky is well positioned. We announced $10.9 billion of orders in 2012 and ended the year with a record backlog of over $14 billion including Denmark's selection of our MH-60R for its maritime helicopter replacement program and orders for more than 35 aircrafts in the fourth quarter.

With that, let me turn it over to Greg for wrap up.

Gregory Hayes

So close to 2012, that was essentially in line with our expectations and importantly order rates that have been coming our of the fourth quarter that give us confidence as we head into 2013. Before I talk about 2013, let me just spend a minute on some of the accomplishments for 2012 and obviously 2012 was a transformational year for UTC, as we repositioned the portfolio to focus on those key growth markets of aerospace and commercial buildings but businesses had some other big accomplishments.

Pratt & Whitney made great progress in developing the GTF and bringing this disruptive technology to market. We have now completed nearly 4,200 hours and more than 12,400 cycles of full engine testing. We recently completed the final significant tests on the C-Series engine, including the FAA mandate of 150 hour endurance test and we expect to certify this engine shortly.

As you saw, the GTF has also been selected to power Embraer's second generation E-Jet family, the fifth airframe manufacture to use our technology. This is a big win for Pratt & Whitney, and solidifies our position in the regional jet market well into the future. And with nearly 3,000 firm and option engines in backlog airline customers have embraced the lower fuel burn, emissions, noise and operating cost of the GTF technology.

At UTC Aerospace Systems, the integration of Goodrich is progressing well. We've deployed a customer-facing organization with a single point of contact for our key customers around the globe and we've conducted innovative program reviews with many of these customers. We are developing new solutions based on the best technology from each of the legacy organizations and we've achieved over $60 million in cost synergies in 2012, and we are well on pace to achieve nearly half of the $400 million in synergies by the end of this year.

At Sikorsky, we secured BLACK HAWK demand for the next five years of the Multi-Year 8 contract, part of a record $10.9 billion in orders of Sikorsky in 2012. The climate, controls and security team integrated the carrier and Fire & Security businesses seamlessly. Nearly $100 million in savings in 2012, help CCS grow operating profit 5% despite flat organic sales with 14.1% operating margins, they are well ahead of the schedule on their goal to 15% by 2015, and Otis continues to regain momentum in China.

Although new equipment sales declined 2% in 2012, orders grew 17% in the fourth quarter. As orders continues to win significant projects such as the Guangzhou Fortune Center, where we're going to sell 49 elevators include Gen2 and double-deck units. Otis is well positioned in China entering 2013 with a $1.5 billion backlog, so good progress with the business units despite the challenging macroeconomic environment in 2012.

As we look at 2013, really not much change to the expectation that Louis laid out in December. We continue to expect 2013 earnings per share of $5.85 to $6.15 on sales of $64 billion to $65 billion. That's organic growth of 3% to 5%. That has some positive developments since our December meeting, the pension cost came in a little better than expected with a discount rate of 3.9 versus our plan of 3.8, and we have planned return last year the domestic plan of 14% and there are two pieces of the Tax Extenders that were passed as part of The American Taxpayer Relief Act in January, which will benefit us in 2013.

First, the benefit from the 2012 E&D extenders will provide us with the first quarter pre-tax benefit of around $100 million. This will drop the tax rate of the quarter and offset some of our restructuring investments this year. For the, we now expect $300 million of restructuring offset by one-time gains and that's up from the previous estimate 200 million. The 2012 piece of the Tax Extender, who partially offset a tough compare in the first quarter 2011, which you will recall had $0.21 of gain in excess of restructuring.

The second piece of the Tax Extender to 2013 benefit will be booked throughout the year and will reduce our 2013 tax rate to about 29%, which is our initial expectation of 29.5. We're also keeping an eye on FX. Europe remains a question mark, but we have seen some recent upside to our plan of the euro, U.S. dollar exchange rate of 128, with euro averaging about 1.32 so far, so a little bit of good news.

So, in summary, we're seeing good news on pension, FX and the Tax Extenders and that gives us some additional contingency for 2013, but I'll just remind everybody it is early and there's still a lot of uncertainty in some of our key end markets, particularly Europe and the aerospace aftermarket.

Our plan as you recall is based on 3% to 5% organic growth. Now, although order trends have been improving, commercial spares where we are yet to attain our growth assumption of mid-single digit in Pratt and about 10% in Aerospace Systems. And with the continued fiscal uncertainty in Washington and the threat of sequestration, we remain cautious early in the year.

Turning to cash flow, very strong close to 2012 with free cash flow of 108% of net income for the year, we made significant progress on debt reduction, delivered our commitment by paying down about a third of the Goodrich-related debt in 2012. We've paid down the $2 billion term loan, all of the commercial paper and about $800 million of the Goodrich debt.

In 2013, combination of solid cash flow performance in proceeds for the remaining divestitures will position us well to pay down additional debt and to fund our share repurchase program which we restarted this January. There's been an increase in investment for the aerospace OEM ramp. We expect free cash flow equal to or excess of net income.

2012 was a transformational year for UTC, and as we entered 2013 with a stronger portfolio, we are positioned to outperform. Our end markets are showing improvement and we are focused on integration, execution and delivering the EPS growth that you've come to expect from UTC.

Just one final point before I open it up for Q&A. I know there was a lot of questions and concerns about the 787. And as you guys know, we're a key supplier on the 787. Although we do not supply the lithium ion battery or the battery charger, we are supporting both, Boeing and the NTSB in their ongoing investigation. The 787 went through the most rigorous certification process in aviation history. We are highly confident in the design and the performance of the aircraft. While reviewing the ongoing review by regulatory authorities, I can't make any further comments at this time, other than to say that we don’t believe the results of these investigations will have a material impact to UTC.

So with that, let's open up the call for questions. Stephanie?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jeff Sprague from Vertical Research Partners. Your line is open.

Jeff Sprague - Vertical Research Partners

Thank you, and good morning, everyone. Greg, can you just elaborate a little bit more on Sikorsky for us. So the charge in the quarter is basically just late fees as it were because the deliveries didn’t happen?

Gregory Hayes

Yes, let me take you through it. Really, the charge was related to all the costs that we foresee related to what we believe will be later deliveries than contractually required. As you know, we are supposed to deliver all the aircraft this year, the final 19. We didn’t delivery any next year. So our expectation, our assumption now is that we will deliver the helicopters over the next three years. We put a placeholder of eight, as you know, for each of the next three, which we think is a reasonable schedule for both ourselves, from a production standpoint, and the customers, from a deliver standpoint

But having said that, we recognize that there are cost, contractual revenues that we will have to cover as it relates to the Canadian government and then we are going to also have fewer flight hours and we will probably going to have some cost on the program related to that longer time frame. So, really three pieces. There is some contractual relief cost, there is flight hour degradation and there is just some additional program cost and all that added up to the $157 million charge.

Jeff Sprague - Vertical Research Partners

So we still absorb whatever it is, $4 million a unit, as you ship those eight over the next three years. Correct?

Gregory Hayes

Yes, it's $14 million a year. Again, we should point out. We obviously can ship more than just the eight a year. We can probably deliver most of the helicopters this year. We just don’t think that that’s practical. I think Mick and the team have made some really good progress in the last month since Louis spoke. We have been discussions with the Canadian government and I think again, we will see some good news coming out of Mick in March.

Jeff Sprague - Vertical Research Partners

And just on share repurchase. You said, you started here in January. Obviously, the cash has been strong. You have a little bit more leash with the rating agencies try to at least fully arrest your creep in 2013 or potentially even go further than that?

Gregory Hayes

Well, I think we will certainly be able to arrest share creep with the share buyback that we have got. As you know, we have got a placeholder of a $1 billion for share buyback this year and $1 billion for M&A. If I think about the cash, we are still going to see about $1.5 billion of cash proceeds coming in from these divestitures that will close here in the first half. We ended the year with strong cash flow. Over $5 billion on the balance sheet. We had strong cash flow for the year. So I think, if you think of the calls on cash, we have got $2 billion going to dividends, we have got $1 billion for share buyback, we have got $1 billion of debt that due in December, that’s the 18-month flow and we will certainly be in a position to pay that. We will probably pay down another $1 billion of debt that’s due in '15 or '16. Then we will talk to the rating agencies about taking up the number but I think cash looks very strong, certainly what we expected and of course my bosses is pushing me to do a lot more than $1 billion but it’s January, so we will see what happens.

Jeff Sprague - Vertical Research Partners

Then, just finally, and then I will move on. Can you elaborate a little bit more on the complexion of what you are seeing in Otis China whether it is primary city, secondary, cities, residential versus non and anything to add there about how things are playing out?

Gregory Hayes

I think, again, as we talked in December, where we are seeing the growth is in the Western provinces. Along the coast, the residential investments have picked up a little bit but the real strength we are seeing is on the residential side and I will say, the third and the fourth tier cities. This factory in Chongqing that we just opened in September of last year is probably fully utilized. We shipped about 10,000 units out of there this year. So that’s where the growth is coming. It is from the west. It is nothing new. I think it is the same phenomenon we saw last year. But we are also seeing, I think just an uptick in the overall economy in China. It wasn’t just Otis that was strong. CCS had a very good fourth quarter from an order rates perspective there.

Operator

Our next question comes from Howard Rubel from Jefferies. Your line is open.

Howard Rubel - Jefferies

Just two questions, hopefully. One is, you talked about impairment charges in CC&S. Could you give us a ballpark idea of what you are close to selling or expensing with, so we can think about next year's base line in that business.

Gregory Hayes

(Inaudible), I think, we had a place holder of about $800 million of divestitures. I think, we got somewhere, Jay, about $550 of those?

Jay Malave

A little bit less than that. Yes.

Gregory Hayes

$500 million of that last year, so we still got a little bit to go I think, and we took a $65 million impairment charge on a number of some of the legacy F&S businesses, and I think as we laid all that out for you back in September in terms of the listing of those businesses. So, no surprises, I suspect most of the portfolio transformational probably done in the first half. Some of them will linger into the back half, but I think that they've got pretty good line of sight [all done] this year.

Howard Rubel - Jefferies

IF we kind of look at what you have here, then, your 15% margin is almost the low hurdle not to give you too hard of time about that?

Gregory Hayes

You wouldn't be giving me a hard time about that if you were to say that, because I think again Carrier just based on their guidance is going to hit 15% this year, assuming markets comeback as we expect. So, the integration Carrier and F&S has come cross without a hit, so I think 15% ought to be very achievable if the markets cooperate.

Howard Rubel - Jefferies

And then on Sikorsky, if we exclude all these, I know for accounting you can't exclude the $157 million, but for us we can back that out and you end up with something around 16% operating margins in the business unit. Was there just some catches and maybe some absence of R&D, and I know you sort of alluded to a lower decline year-on-year in the business. Could you talk a little bit about what I call core operating performance?

Gregory Hayes

I think, core operating actually very good of sequester that, 91 aircraft that we're going to look more for. It's a huge number of aircraft. I think they delivered 242 or so for the year and 91 of that was in the fourth quarter. So, lot of shipments again profitable and we saw good shipments on the commercial side, the S-92 is going out, we saw the S-76. I think, we delivered four of those in the quarter, so it's really just a very strong quarter end.

If you recall, again, the operating performance in terms of profit growth was not very strong throughout the year, so really all the profit growth came in the fourth quarter.

Jay Malave

And I would just add, sort of add nice mix, good restructuring benefits and also just as a reminder, strong backlog as we go into 2013.

Howard Rubel - Jefferies

So, some of its price and some of it is some permanent cost reduction?

Gregory Hayes

Right.

Howard Rubel - Jefferies

Thanks, gentlemen.

Operator

Our next question comes from the Joe Nadol from JPMorgan. Your line is open.

Unidentified Analyst

Okay. Good morning, guys. Actually it's [Saffran] for Joe this morning. Two quick questions. Good morning. First of all, if there's anything you can say at this point and I know it's difficult about sort of the calendarization of the improvement in the aftermarket for 2013.

Jay Malave

Yes. I wish my crystal ball was clear on how do that calendarization is going to work. Obviously, we talked about kind of mid-single digit growth at Pratt & Whitney and it's about 10% of the Aerospace Systems' business.

Obviously the order rates in the fourth quarter were still not positive, but they were a lot better. So, again, this is probably more back half than front half, but where we are seeing airline profitability continuing to improve, the trend line was good. As I said, book-to-bill was over 1%, but I am not sure if this is going to be a second quarter, or third quarter, but just given the cycles of the airlines are flying today, we know that there is going to be a recovery here some time whether it's second, third, fourth, I can't tell you.

Unidentified Analyst

Thanks. And, just as a follow-up, is there anything else you can say now about the agreement you came to with Boeing on pursuing on the helicopter work?

Jay Malave

The team here is really, it's a win-win for UTC and Boeing. It teams us with Boeing. This is on the joint multi-role helicopter program. We'll be submitting the joint bid with Boeing here in March. This is for up to 4,000 helicopters. Again, this has developed a prototype. We won't actually deliver production helicopters for 10, 15 years, but this is a great team and it puts again Sikorsky is going to lead on the aircraft, Boeing will lead on the emission system equipment really capitalize on the strength of the both companies. And recall, this is not a new thing. We teamed with Boeing back 15 years ago when Comanche program was launched and we have a very good working relationship with between the two organizations.

Unidentified Analyst

Great. Okay. Well, thanks very much.

Operator

Our next question comes from Carter Copeland from Barclays. Your line is open.

Carter Copeland - Barclays

Thanks. Good morning, Greg and Jay.

Jay Malave

Good morning, Carter.

Carter Copeland - Barclays

Just a couple of questions. First, on the Pratt spares. It looks like your compare there would have eased a lot, but obviously there was still a lot of pressure there on the revenue side. I wondered if you might speak to from a platform level where that pressure is coming from and if you are seeing it in one area more than another maybe it is PW4000s versus what you are seeing in the Vs. But any color you can provide there on that continued weakness would be helpful.

Gregory Hayes

I think it is the same trend we have been talking about for the last four or five months. We continue to see weakness of the wide-body which is the PW4000 and we continue to see strength in the narrow-body which is the Vs and with the PW2000s and 757. We thought that 75s were going to start to see some acceleration of retirements. We haven’t really sent that. In fact, they are flying more now. So, spares actually look pretty good on 75s and on the Vs and all of the weakness we are seeing, all the year-over-year decline is really in the 4000 family. So again, we know those wide-bodies are flying. Those are relatively new aircraft but we will see spares come back.

Carter Copeland - Barclays

Okay, and that 4000 weakness, would you attribute that to cargo? Can you see that in the trends?

Jay Malave

A decent size of the 94-inch fleet is is cargo, Carter, but it difficult to tell exactly where it is coming from.

Gregory Hayes

We are surprised as we also looked at this. The cycles at a cargo aircraft are not much different than the cycles on the commercial side. So although we talked about cargo versus commercial and we, from a spare parts perspective, it doesn’t make a heck of a lot of difference at the end of the day.

Carter Copeland - Barclays

Okay, and on China, in your comments there about Otis, I wondered if you might comment about the sort of implied change in market share that you are looking at there relative to 2012. I mean, assuming you lost a couple of points to share and is that the plan to regain that, all of it, part of it, some of it. Any comment you can make there?

Gregory Hayes

I can make a lot of comments. I guess I would say just a couple of things. Obviously, we did lose share earlier in the year. I think we gained a lot of momentum in the third and then even more so in the fourth quarter. (inaudible) that I just talked about, we are gaining all of our lost share by the end of '13. I think we are well on track to do that. The market is very dynamic. We are breaking it down between social housing and residential and then you have got the factories and the office but in all of those markets, we have got a pretty good share. Again, the momentum coming out of the fourth quarter ought to continue into 2013.

Carter Copeland - Barclays

Does the plan imply the Pedro hit cycle?

Gregory Hayes

Absolutely.

Operator

Our next question comes from Myles Walton from Deutsche Bank. Your line is open.

Myles Walton - Deutsche Bank

Thanks, good morning. First one, I may have missed it, but did you comment on how Pratt spares organically were sequentially, Jay?

Jay Malave

We did not. They were, spares sequentially.

Myles Walton - Deutsche Bank

I would say, Hamilton was up.

Gregory Hayes

They were down 21%, third to fourth.

Jay Malave

They were up. Are you talking about the rate of decline?

Myles Walton - Deutsche Bank

Absolute.

Jay Malave

Yes, absolute, they were up. But you would always expect them to be up because of the price type of ordering activity that happens in the quarter.

Myles Walton - Deutsche Bank

Okay, and then, Greg, on the contingency on taxes, it sounds like $0.04 that has been added to the contingency, Euro maybe $0.03 or $0.04 pension. Can you size that?

Gregory Hayes

Yes, it is another probably $0.05 or so.

Myles Walton - Deutsche Bank

Okay, is that roughly the puts that you have and then you mentioned spares as being an unknown or aftermarket as being unknown. Is there anything else that is emerging that is being a more of a put to that $0.15 or $0.16 additional contingency?

Gregory Hayes

No, in fact, I think, surprisingly, it has been a pretty good start to the year. We feel a little bit better today than we did back in December because we have got this additional goal of $0.15 or $0.16 or plus we are taking up restructuring by about $100 million. So we feel good about the guidance range and again if the business unit hit their high end of their guidance range, we will certainly see ourselves towards the top-end of that range as opposed to the mid-point but at the mid-point we did not have much contingency and now we have got calling extra $0.15, $0.16 of contingency sitting there today. So we feel pretty good.

Operator

Our next question comes from Sam Pearlstein from Wells Fargo. Your line is open.

Sam Pearlstein - Wells Fargo Securities

Good morning. Can you talk a little about aerospace systems? If I just look at the 2013's guidance of $13.5 billion, $14 billion in revenues, and the $2.1 billion in operating profit, just looking at where you were in the fourth quarter which would have had a full quarter of Goodrich, I mean, certain it seems like you need to step up the run rate on a quarterly basis. And, outside of the 87, I mean what else is really going to help move that quarterly run rate up so much over the course of the year to hit those numbers?

Jay Malave

You got really two things that are going to benefit Aerospace Systems as we move throughout the year. One of course will be additional synergies and we have recognized about $60 million of synergies last year. This year we probably had another 100 plus million in synergies, maybe $120 million of synergies, so that will help the run rate and you've got a recovery in spares.

The thing about what's holding margins down in the fourth quarter at Aerospace Systems, clearly the decline in spares year-over-year, so we if we get to that 10% spares up that we expect, plus we see the synergies. I think you will certainly an improvement in the run rate.

Sam Pearlstein - Wells Fargo Securities

Okay. Thank you. Then just CC&S, some of the other companies that have reported I guess the December quarter talked about some softening and some of the HVAC end market. I think it might have been more refrigeration, but just in general, have you seen any trends in any areas within the HVAC markets that might have been softening over the course of the quarter and into January?

Gregory Hayes

Well, let me go through it piece-by-piece, because obviously there's puts and takes in the CCS portfolio, but res as we mentioned ended very strongly 20% order up 10% in sales. Commercial HVAC globally was up about 7%, again, strong in North America, strong in Asia, not so good in Europe. I think, the one kind of governor of the year is going to be Transicold specifically, the container business which was still down in the fourth quarter and it's not clear that we are going to see a big recovery although we're certainly hopeful on the container market. Now, looking at the goods [indices] obviously that's still down at a relatively low level and it doesn't bode well for the containers, but it's a very cyclical business. So, containers were down and commercial refrigeration in Europe was also down year-over-year. Again, not much going on there in Europe, we are of course very strong there.

Sam Pearlstein - Wells Fargo Securities

What is interest guidance in terms of the container assumption for this year?

Jay Malave

Container is up, I believe about 15%.

Sam Pearlstein - Wells Fargo Securities

Okay. Thank you.

Operator

Our next question comes from Cai von Rumohr from Cowen & Company. Your line is open.

Cai von Rumohr - Cowen & Company

Yes. Thank you very much. On the Canadian Maritime Helicopter, where are we in negotiations with the Canadian government. Are you in talks?

Jay Malave

Let me be very clear about this guy. I think we are in discussions with the Canadians. We have not entered into a renegotiation of the contract yet. We are in discussions to get to that point where we can restructure the deliveries of the IMH, which is the interim configuration of the helicopter. We started those discussions last year. I think they are going very well, but we are not at the point yet where we're ready to pencil to paper.

Cai von Rumohr - Cowen & Company

Okay. So, I mean obviously you've kind of had a lower number than expected at Sikorsky last year, but you bought the decline down a little bit, so I mean you feel better than you did in December about those discussions.

Jay Malave

I think, yes. Generally, we feel better in general about the relationship. I think we are making progress everyday up there. Mick and his team have been working very closely with the customer. It just takes time to work through all this.

Cai von Rumohr - Cowen & Company

Okay. Then help us understand maybe the tax rate, you took it down 50 bips, but you said what? There's 100 million plus from the R&D credit in the first quarter for 2012?

Jay Malave

Yes.

Cai von Rumohr - Cowen & Company

Another $100 million, so by $200 million benefit shouldn't that be a little bit more than 50 bips?

Jay Malave

Yes. In fact the benefit will be a little bit more in 2013 than we saw in 2012. Again, we've taken the rate down by a half of point, probably wanted to come down four-point, but this actually gives us an opportunity to make sure we actually hit that rate. And though, we have to do some tax planning to get from the statutory rate down to that target rate of 29.5%. This takes some pressure off of that and we'll see how the year goes. There's obviously a little, it helps a lot by having that R&D tax credit out there.

Jay Malave

Cai, the 2012 piece that we booked in the first quarter will reduce the reported rate. We've [inferred]the 29%, we're talking about the operational rate. And in that $100 million as Greg spoke to basically could be to offset the incremental restructuring against the $300 million. So, you are correct the reported rate will be lower than 29%.

Cai von Rumohr - Cowen & Company

I guess, I didn't get that, so the reported rate will be lower than 29?

Jay Malave

Yes. The operator effective rate will be 29%, but because this 2012 extenders, it will be booked in the first quarter actually.

Cai von Rumohr - Cowen & Company

No, I get that. Maybe you could also help us show where the rate to be in the first quarter and assuming the 2013 is equally spread, where should it be for the last nine months, approximately.

Gregory Hayes

In fact, what will happen is, to Jay's point, you are going to get this $100 million benefit on R&D in the first quarter. So the rate normally is going to be about 31% in the first quarter and it declines throughout the year as we implement tax plans and strategy. So this $100 million will help in the first quarter. I don’t have an exact number. We will get back you on that. In fact, when we update you, I think sometime here coming up in February, when we can give you probably a better look at what that rate is going to be quarter-by-quarter.

Operator

Our next question comes from Shannon O’Callaghan from Nomura. Your line is open.

Shannon O’Callaghan - Nomura Securities

Good morning, Greg and Jay. Just a couple of things on cash flow. So CapEx jumped up in the fourth quarter. Can you talk about what the focus there is, where they are and should we assume this kind of percentage of sales close to 4% as a run rate?

Gregory Hayes

Yes, let's talk a little bit about CapEx. I think we spent $641 million or $642 million on CapEx in the quarter and almost $1.4 billion for the year. That was up like $500 million, year-over-year. So, we saw that spending all over, but really it's on the aerospace side. As Pratt gears up for production of the GTF and as Hamilton Sundstrand, Goodrich businesses, as they gear up for this big increase in OEM production, we are seeing a lot of pressure on CapEx.

At the same time, we also had spending on the commercial side of the business, I think Otis was up to $142 million. So that’s up about $70 million year-over-year. So we are making investments around the business. I think we will continue to see pressure on CapEx that number wants to be higher in 2013 where we obviously have got a little work to do to hold that to a more reasonable level, but that $1.4 billion could well go up to $1.5 billion this year.

Shannon O'Callaghan - Nomura Securities

Okay, so a little bit of an increase year-over-year but fourth quarter was a heavy quarter?

Gregory Hayes

Yes, in fact we didn’t actually believe the forecast. It got rolled up because we have never seen a quarter that big before but the ramp is real. 787 production is going to go from seven to 10. You got A380 production increase. Really, across the aerospace platforms, you are seeing big increases and that just leaves the CapEx.

Shannon O'Callaghan - Nomura Securities

Okay, and then just, where did you end the year on the funded status in terms of pension? You put in a $200 million in the international plans in the quarter. Any plans to contribute in 2013?

Gregory Hayes

We ended up about 85% funded. Again, we have had a very good year on the pension side. The returns were around 14% on the domestic side. We did put of a $200 million into international plans in the late December. We will probably put a similar number in this year. There is no U.S. contributions this year. None required this year and probably none for next year.

So, again, the funded status, again, we have a good run-up but like we did last year it will correct itself plus and discounted rate helped us a little bit at the end at 3.9 versus the 3.8. So, still long way to go from where it’s been historically, but I think all those factors point to the need for very little funding.

Operator

Our next question comes from David Strauss from UBS. Your line is open.

David Strauss - UBS

Good morning, Jay and Greg. On Goodrich, it came in a little bit better than you guys forecast, $0.06 dilution. It looks like synergies were a little bit better. It also sounds like, in response to Sam's question, you are now forecasting a little bit higher synergy number for '13. Did anything else for the Goodrich forecast in terms of accretion change for '13?

Gregory Hayes

Yes, we are still looking at $0.60 of accretion year-over-year. You would get about $1.2 billion of EBIT and you get the synergies and offset that and then you get $90 million or so of amortization. So, none of that has really changed the restructuring. It is still about $100 million. Maybe the one nuance in this is that $0.60 of accretion includes a $100 million of restructuring, and we will cover that $100 million of restructuring at the top level. So, the real number you are going to see is probably more like $0.68 of accretion year-on-year.

David Strauss - UBS

Okay, and then CCS. Given what you are seeing today, back at the meeting in December, you had talked about the underlying assumptions there being about mid-single digit growth in resi volumes and mid-single digit growth on the commercial side. Does that still hold today?

Gregory Hayes

Yes. I think so. But again, order rate would seem to support those numbers coming into the year and I don’t think there has been any change to those base assumptions.

Operator

Our next question comes from Noah Poponak from Goldman Sachs.

Noah Poponak - Goldman Sachs

Good morning, gentlemen.

Jay Malave

Hello.

Noah Poponak - Goldman Sachs

Just wanted to try to dig into the commercial aftermarket broadly again. It looks like we could see airlines de-stocking inventory throughout 2012. You guys have talked about this dollar cost per shop visit being under pressure. It sounds like things are getting a little better there, but that behavior isn't really changing. And, Greg, you mentioned, flight hours are growing in a nice clip. Airline profitability is pretty solid relative to prior cycles. Can you just sort of elaborate on when you are talking to the customer, why are they behaving that way? What's making them do that? It seems like often times to answer that question is just broader macro and broader uncertainty, but that was true. That's been true for four year now and there have been pockets of inventory restock and destock, and why are they doing that now and then what is that that will make them stop so that they try and reverse this?

Jay Malave

Yes. I think what will make them stop is the shelves barely won't be able to dispatch aircraft, so it is a very cyclical business. You go back to 2009 and we saw spares down 25%. It came back in '10 and '11 and like last year again there was a lot of uncertainty from a macro standpoint. What's going in Europe, we saw a big reduction in the European airlines order rates, U.S. uncertainty. Again, a slowdown in China, all of those macro factors I think impacts the airlines' perception of how much do I need to order, how much stock do I need to have. It will come back. I mean, it is a very cyclical business. And, as I said earlier, I am not sure if this is first quarter, second quarter, third quarter, fourth quarter, but we know typically these cycles run 12 to 18 months, where they have to come in and buy parts.

The good news is as we go to this next generation of aircraft, more than 80% of our customers are electing to go on some type of an FMP, so it will take the volatility out of this eventually, but today that number is less than 40%, so we are still seeing revenues today, we're just not seeing an incremental piece from all of these flight hours that are out there.

Noah Poponak - Goldman Sachs

And you don't have the data on what the customer holds to give you a little bit more precision on when they do have the shelves bare and need to start restocking?

Jay Malave

Well, keep in mind, there's a couple of different phenomenon. Here at Pratt, we know pretty is going into the which engines are going to come off wing and which for overhaul and how many inductions we should be seeing in our shop and we'll know that within 10%. What we don't know when we do that forecast is what level of overhaul the customer is going to ask for order is it light or heavy. So, the scope again that's just short of the interval between overhaul cycles.

Now the Hamilton and Goodrich size is little different. Those are primarily on condition repairs, where something breaks they have to fix it, but there is no time based overhaul, so that’s another business. I think that's why the Hamilton business is down nearly as much as the Pratt business, because again as things break on plant they have to fix them, but they still have some ability to work out or to use up the spears that they have in stock.

Noah Poponak - Goldman Sachs

Okay. That's very helpful. And just one other question on the separate topic, Otis margins, can you just elaborate on whether or not the margin in the quarter, or how the margin in the quarter compared to what you thought it would be. And, I know you have 2013 guidance that shows a little bit of improvement there. Is there any change to the longer term a few years down the road thought on what the right margin is in that segment, particularly as you start to take that market share back?

Gregory Hayes

Obviously, there is no surprises in terms of the fourth quarter. We knew margins will come down about 110 basis points, I guess, which is just where I think Pedro had calibrated us for the fourth quarter. And this year margins will go up a little bit again what we expect to see a recovery in equipment sales and we expect to see stabilization in Europe.

I think the margins are 23%, we probably aren't going to see those again anytime soon. And that was really because new equipment sales were down so much in the aftermath of this great recession, so as new equipment comes back to kind of more normal 55% and 60% of revenue. If it goes back to 55%. We should see again probably those margins maybe 20% to 21% range long-term.

Noah Poponak - Goldman Sachs

Great. Thanks very much.

Operator

Our next question comes from Julian Mitchell from Credit Suisse. Your line is open.

Julian Mitchell - Credit Suisse

Thanks a lot. Yes. So, my first question is just on the overall UTC-wide organic sales growth. It's flat in Q4, flat in 2012. The midpoint is up 4% for 2013. We are looking at the four main order numbers that you always call out, half were down, half are up. So without getting to sort of bulk down a little, if we are getting commercial aftermarket forecasting, when do you think the overall UTC-wide entity will start to see decent organic sales growth? Will we have to wait till Q2 or Q3, or you think Q1 will start to see some growth again?

Gregory Hayes

I would expect you will see modest growth in the first quarter and then it should accelerate as the year progresses. Again if you think about the CCS business, it's obviously seasonal as well. So second and third quarters are typically stronger than first quarter, but what you will see is a gradual resumption in organic revenue growth. Last year was clearly an anomaly for UTX. It's been a dozen years since we have seen sales growth at that level.

So, we are well positioned in the emerging markets. I think China is going to come back strong this year, after a weak last year. We have seen that in the order rates at both CCS and Otis. Again, commercial OEM will be strong. We know that the backlog is very strong there. Sikorsky, again down a little bit on the Black Hawks, but commercial business is doing well. So, spares is probably the big question mark in terms of whether that's a first, second or third quarter recovery, but I would expect just a gradual recovery in organic growth, but we should see some in the first quarter.

Julian Mitchell - Credit Suisse

Got it, thanks. Then just to circle back quickly on Otis. You mentioned earlier in the call that Europe, in some areas, was stabilizing. It doesn't sound like that had happened in HVAC or in Aerospace. So does that mean you have already seen some stabilization in Otis Europe?

Gregory Hayes

Again, you have to look at it almost country-by-country as we go across Europe. Obviously Spain was down big, Italy was down big, France was relatively flat. Then we saw decent growth in Russia and the emerging Europe. So again, parts of Europe are okay. Other parts are, I would say, still in the doldrums. But again Spain has stabilized. It's not getting worse. Italy has stabilized, not getting worse. So, it's at low level and we should see a gradual recovery. We are not expecting much this year. Remember we are talking two or three points of growth out of Europe after a down two years.

Julian Mitchell - Credit Suisse

Got it, and pricing in Otis. Obviously you had some changes in strategy in China in the spring of last year. So now Otis sort of region by region the pricing strategy is unchanged?

Gregory Hayes

Again, there is a pricing pressure across the globe in the Otis business. We see it especially in China and we also see it in Europe. We are actually seeing pricing get a little bit better here in North America, but it's a fight every day.

Operator

Our next question comes from Doug Harned from Sanford Bernstein. Your line is open.

Doug Harned - Sanford Bernstein

Good morning. I was interested if you could give a little insight into the CC&S margins. Good margins, but if you were to separate what's caused the improvement in terms of, say, mix, commodity cost, and the benefits of the integration, exit from lower performing businesses, and you did give us a special dividend. How would you give those puts and takes?

Jay Malave

Let me just talk about the growth, because the growth in the quarter was essentially, as we said, the restructuring benefits, you had some improvement in commodities, and then you had the dividends. As far as the operating margin, you do get some, and we have talked in the past, about a third of the benefit comes from the portfolio transformation. But again a lot of that is the heavy lifting that they have done related to the consolidation and the restructuring that they have done and continue to do over the past number of years. So that's mainly the big drivers of their operating margin expansion.

Doug Harned - Sanford Bernstein

And how much was it in reduced commodity cost?

Jay Malave

Commodities wasn't much, Doug, but I can get back to you on that.

Gregory Hayes

It wasn't the biggest driver. If you think about it, restructuring is probably the biggest, followed by special dividend out there and then we would get down to commodity pricing.

Doug Harned - Sanford Bernstein

Okay, that’s helpful and then on Otis, now that orders, you have seen some pickup in orders, in terms of lead time today, what do you see in terms of when that would turn into sales?

Jay Malave

Yes. Market-by-market, it will vary. Typically, in China, we are seeing about a six to nine month lead time from order to delivery. The U.S., especially some of the big megaprojects or even in the U.K. like this cross-rail project, we won't be delivering those for a couple of years. So, again, the U.S. orders are all 18 to 24 months as opposed to Asia which is typically a much shorter cycle.

Doug Harned - Sanford Bernstein

And then have you seen any changes in the competitive behavior here with regard to pricing?

Gregory Hayes

Yes. I think again as I mentioned before, pricing is difficult in all of the markets. I don't think that we are seeing any changes per se, but it is a very difficult pricing environment in all of these markets. Again, as orders pickup, obviously some of that pressure abates, but it is still a very, very competitive market out there.

Doug Harned - Sanford Bernstein

Okay, very good. Thank you.

Operator

And our final question comes from Peter Arment from Sterne, Agee. Your line is open.

Peter Arment - Sterne, Agee

Yes. Thank you. Good morning, Greg and Jay. Just more of a clarification on the restructuring, Greg, the additional $100 million that you picked up here where exactly is that going to fall? Is it in the Goodrich comments that you've mentioned earlier about covering the restructuring costs there, or is it placed in CC&S?

Gregory Hayes

I think, in fact, what you'll see is that $100 million of restructuring that we had at UTAS or at the Aerospace Systems, that is unchanged from December. What we've seen is really both at Otis and at Pratt & Whitney is a desire for more restructuring dollars. They've got projects that they're working on both, domestically and internationally where there are looking for some restructuring dollars.

Again, we see really good payback. This is one to two year payback kind of projects and the list is longer than my funding ability right now, so again I think you'll see it just like you did last year across each of the businesses.

Peter Arment - Sterne, Agee

Okay. Then just for clarification going back to your EPS kind of walk that you laid out in December. It sounds like we are going to have a little bit less the headwind here for Sikorsky given the charge and pension came in a little better in a slightly lower tax rate is the midpoint still is intact because of the additional restructuring? Is that a fair way to look at it?

Gregory Hayes

No. I think the midpoint is intact and we've got a little more contingency. The $100 million of additional restructuring is actually covered by the tax extenders from 2012. Because we got them in January, they come through in the first quarter of this year, so I'm going to take that $100 million of kind of good news and we are just going to use it to fund additional restructuring.

The other good news like the tax rate from the 2013 extenders, plus the good news on pension, FX and all that, that just really gives us more contingency at the midpoint and we are not going to take the guidance up, because of that good news today but certainly we feel better about where we are than we did even a month ago.

Peter Arment - Sterne, Agee

Okay. Understood. Thank you.

Gregory Hayes

All right. Thank you, everyone. I appreciate you guys listening in on the call. We'll see everybody in March at our Annual Investor Meeting [your presence] and look forward to talking to all of you. Thank you.

Operator

Ladies and gentlemen, that does conclude today's conference. You may all disconnect and have a wonderful day.

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