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Executives

Gregory Hayes – Senior Vice President, Chief Financial Officer

Akhil Johri – Vice President Investor Relations

Analysts

Joseph Nadol – JP Morgan

Terry Darling – Goldman Sachs

Nigel Coe – Deutsche Bank Securities

David Strauss – UBS

Joseph Campbell – Barclays Capital

Douglas Harned – Sanford Bernstein

Jeff Sprague – Citi Investment Research

Myles Walton – Oppenheimer & Co.

Ronald Epstein – Bank of America Securities

Howard Rubel – Jefferies

Cai von Rumohr – Cowan and Company

United Technologies Corp. (UTX) Q1 2009 Earnings Call April 21, 2009 8:30 AM ET

Operator

Welcome to the United Technologies first quarter 2009 conference call. On the call today are Greg Hayes, Senior Vice President and Chief Financial Officer, and Akhil Johri, Vice President Investor Relations. This call is being carried live on the Internet and there is a presentation available for download from UTC's homepage at www.utc.com.

The company reminds listeners that the earnings and cash flow expectations and any other forward-looking statements provided in this call are subject to risk 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.

Mr. Hayes, you may begin.

Gregory Hayes

As you saw in the press release this morning, no surprises in the first quarter, the end markets were difficult, as we expected, resulting in UTC revenues of $12.2 billion and that's down $1.7 billion or 12% from last year's first quarter, 5% organically down, 6% from foreign currency translation. That divestures accounted for the remaining one point decline of revenue. However, I'll point out proactive and aggressive cost reduction actions across the businesses limited the impact of the revenue reduction. The gross margin rate adjusted for restructuring remained essentially flat. This is in spite of declines in our high margin transport refrigeration and aerospace aftermarket businesses.

SG&A, again after adjusting for restructuring, was down 20 basis points as a percentage of sales. While there's little we can do about the global economy, we are focused on the things we can control, such as overhead costs and spending, and we're continuing to invest in our products in global franchises so that we will emerge even stronger when the economy does recover.

Okay on earnings, earnings per share for the first quarter was $0.78 that's 24% lower than last year and inline with the expectations we discussed back in March. Current quarter results include $0.12 of restructuring costs and a $0.03 tax benefit. Last year's first quarter had a $0.02 charge for restructuring costs. So absent the impact of restructuring costs in both quarters and the one-time tax benefit in 2009, earnings per share were down an adjusted 17%

FX was also a big headwind in the quarter as expected. Foreign currency translation combined with Pratt & Whitney Canada's currency hedging, adversely impacted earnings per share by $0.08. From a business unit standpoint, Sikorsky was the highlight of the quarter with 30% revenue growth. It delivered 49 large helicopters and that's a 63% increase over 2008 first quarter deliveries.

Revenues were down at the other five businesses with particular weakness in our shortest cycle businesses. As expected, Carrier's revenues declined 19% on an organic basis in the quarter. At a macroeconomic level, we have not really seen any significant changes in market conditions since our investor meeting in early March.

First quarter order rates continued on the trend lines we discussed then with weakness in both commercial and aerospace orders. Akhil will take you through the detail of order rates by business in just a few minutes. The good news is that while order rates continue to be down, there are signs of stabilization in the order rates, particularly in China, which is starting to see the early benefits from the stimulus program there.

Despite this challenging environment, we did see 80 basis points of margin expansion at Otis and 70 basis points of margin expansion at both Fire & Security and Sikorsky adjusted for restructuring. This is primarily from our continued focus on restructuring and discretionary cost reduction across the businesses.

Turning to slide three on restructuring, in the quarter we spent $163 million on restructuring to deal with volume declines and to takeout structural and overhead costs. As you would expect, Carrier and Pratt Whitney Canada launched the biggest programs in the quarter as both have seen significant volume challenges.

As we announced in March, we expect to spend almost another $600 million restructuring the business throughout the rest of 2009 for a total of $750 million of restructuring. This restructuring will provide us with a $250 million benefit this year and a further $350 million of savings in 2010 and the net payback on this $750 million investment is only 1.3 years. These programs will also result in a headcount reduction of 11,600.

Expected breakdown of the $750 million by segments you can see here on slide three. About 60% of the restructuring spend will be on the commercial businesses and 40% on the aerospace side. Two thousand and nine programs will target removing overhead and simplifying structure and about two-thirds of that headcount reduction will be in the salary or indirect employee ranks making the company leaner and more cost competitive when the economy does recover.

On cash, free cash flow in the quarter was 44% of net income attributable to common share owners. While we did see some of the normal seasonality associated with Carrier's residential business, the bigger issue was at Sikorsky and Pratt Whitney, which each had a networking capital outflow of more than $300 million in the quarter.

While inventory growth was expected at Sikorsky to support the increase volumes, we also saw a significantly lower level of customer advances due to lower commercial order intake at Sikorsky. At Pratt Whitney, inventory increased as sales declined more rapidly than we were able to adjust the long lead time material inputs. Pratt also had some significant customer payments slip into early April.

On the plus side, capital expenditures decreased 30% compared to a year ago. This cash performance has the attention of everyone in the organization and it's safe to say that nobody is very happy with it. With that said, we'll focus on this and we will fix it and we remain committed to our guidance of full year free cash flow being equal to or in excess of net income attributable to common share owners.

I'll come back and talk about the outlook for the rest of 2009 and some preliminary thoughts on 2010, but for now let me turn it over to Akhil to take you through the business unit detail.

Akhil Johri

Turning to page four let me remind you that I'll talk to the segment results adjusted for restructuring and non-recurring items as we usually do. Otis had a good quarter despite the sharp global construction downturn and significant adverse foreign currency impact with operating margin expanding 80 basis points to 19.8% thanks to service business strength, as well as aggressive cost reduction actions.

Operating profit was down 9% in the quarter on 13% lower revenues with foreign currency translation accounting for approximately nine points of the profit and ten points of the revenue decline. At constant currently revenues were down 3% as continued growth in the service business was more than offset by a double-digit decline in new equipment sales with shorter cycle emerging markets, such as China and Russia seeing some of the larger declines.

Operating profit was flat at constant currency as field efficiencies and cost reduction actions offset the impact of volume decline. Otis reduced headcount by over 1,000 employees during the quarter. New equipment ordered at Otis declined 43% in the quarter from record first quarter orders in 2008. Excluding FX, orders were down 37% with significant declines across all regions.

New equipment backlog at constant currency was down 5% since the beginning of the year but still up 1% versus the first quarter of the last year. We continue to expect Otis revenues in 2009 to be down mid to high single digits and operating profit to be down $125 to $175 million principally due to adverse foreign currency translation.

On slide five turning to Carrier, consistent with the guidance given at the March investor meeting, Carrier's first quarter operating profit decreased $196 million or 76% on 27% lower revenues, including a 19% organic decline. Carrier's most significant volume decline occurred in the high margin transport refrigeration business with sales down about 14% at constant currency. The commercial HVAC business was down low teens organically as the completed projects and backlog and saw new equipment orders decline 17% at constant currency. Carrier's other businesses were down about 20% to 25%.

Operating margins contracted about 500 basis points led by the volume declines, adverse cost impact from worldwide currency shifts and lower equity income from the Toshiba joint venture in Japan. These were partially offset by deep and aggressive cost reduction and restructuring, which contributed about 200 basis points of margin in the quarter.

Carrier also reduced headcount by approximately 1,800 or 4% from December 2008 to March 2009 excluding the impact from divestures. On a similar basis, Carrier's headcount is down approximately 4,500 or over 10% since a year ago.

While the summer cooling season has yet to begin in the U.S. and Europe current order rates continue at the depressed levels Greg shared at the March meeting. Sequential volume improvements are needed in the second half for Carrier to meet its 2009 guidance of revenue decline in the low 20% range and operating profit down $375 to $425 million.

On slide 6, UPC foreign security delivered a good quarter with operating margin expansion of 70 basis points on 20% lower revenue. Unfavorable foreign currency translation reduced revenue 16% in the quarter. Net M&A activity accounted for two points of the year-over-year revenue decline and organically revenues contracted 2%.

On an organic basis, Fire & Safety was flat while security revenues were down mixing the digits in the quarter. Operating profit decreased 12%, excluding FX profits, grew 9% deflecting the benefits of restructuring, integration and continuing productivity and costs control initiatives along with net M&A activity. We remain confident in UPC foreign securities 2009 guidance of flat profits on down mixings revenue change.

Turning to aerospace businesses, before I start with Pratt & Whitney, let me note that all current and prior year revenue and margin data have been adjusted to reflect EITF 07-1 accounting for collaborative arrangements, which Greg referred to at the March meeting. Just as a reminder, this increases Pratt's revenues by $257 million in Q1 2008 from prior reported numbers and $220 million in Q1 2009. There is no impact on operating profits in either period.

On slide 7, you see revenues at Pratt & Whitney decline 8% in the quarter driven by lower overall aftermarket and military development revenues. Engine shipments were higher across the business with Pratt Canada up 10%. Now its commercial engines space revenues were down over 20% and book-to-bill was slightly below 1%. Operating profit declined 7% in the quarter. The profit impact from lower revenues and adverse mix was partially offset by benefits from restructuring and better manufacturing and SG&A cost performance.

E&D was also slightly favorable in the quarter. Operating margin at 15.7% was up ten basis points. Net hedging activities at Pratt Canada reduced revenues by approximately $125 million and combined with favorable translation of costs had minimal earnings impact. This added 70 basis points to operating margin in the quarter.

Continuing downward revisions to the production schedules by the business jet OEMs have put additional pressure on Pratt Canada. We now expect engine shipments there to be down double digits in 2009 compared with our prior expectation of flat. As a result, Pratt & Whitney will likely be at the lower end of the 2009 operating profit guidance range of $0 to negative $50 million year-over-year.

Turning to Hamilton, in the quarter revenues were down 5% with aerospace aftermarket down mid-teens and industrial businesses down low-teens. Aero OEM revenues were up mid single digits driven by space related programs and military ground vehicles. Operating profit declined 8% primarily from lower commercial space down more than 50%, lower industrial volume and higher E&D. This was partially offset by higher aero OEM volume, discretionary cost curtailment across the business and productivity improvement in the repair shops.

Orders for the industrial business continued to feel the impact of global economic slowdown and were down about 25% in the quarter, including four points from foreign exchange. Commercial space book-to-bill was also below 1% reflecting significant weakness in the orders for provisioning by the airlines as they conserve cash in these tough times.

These order rates have put greater pressure on Hamilton Sundstrand's 2009 outlook. However, more aggressive restructuring, furloughs, medical furloughs and other cost actions are anticipated to result in Hamilton's 2009 earnings being about flat for 2008. Year-to-date Hamilton has launched actions to reduce headcount by over 1,000 employees.

Turning to Sikorsky, operating profit grew 41% on 30% higher revenues. As Greg mentioned, Sikorsky shipped a total of 49 large helicopters, 38 based on military platforms and 11 commercial. Sikorsky's work force continues to improve its productivity and is on track to deliver between 230 and 240 large aircraft in 2009.

Operating profit expanded 70 basis points in the quarter to 8.7% from higher military helicopter shipments primarily Blackhawk. In February, Sikorsky signed a new first five-year contract with the union, which included the payment of a ratification bonus worth approximately $20 million in the quarter.

Sikorsky also achieved a key milestone in Q1 towards the expansion of its global low cost souring initiative. PZL Mielec, Sikorsky subsidy in Poland, completed its first cabin for the international Blackhawk. With this solid start to the year, we remain confident in 2009 guidance for Sikorsky with revenues projected to go in the high teens and operating profit expected to increase approximately $125 million.

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

Gregory Hayes

We're looking at slide ten now on the webcast. Just in summary, first quarter results were inline with the expectations we laid out at the March investor meeting. Earnings per share were down 24% due to the adverse impacts of foreign exchange, restructuring in excess of gains on a challenging end market conditions particularly in our shorter cycle businesses, so no surprises.

And we've taken aggressive steps to protect the P&L of the toughest economy we've seen in decades. We had about $200 million of cost reduction actions in the quarter, which mitigated the gross margin decline associated with $1.7 billion of lower revenue.

Looking forward, we continue to expect full year 2009 EPS to be in the range of 4 to 450. That's down 8% to 18% from 2008 and excludes the impact of acquisition related costs. Our full year 2009 revenue expectations continue to be approximately $55 billion. While we expect revenues to be down year-over-year in most of our businesses in the second half, we also expect that the rate of decline will be less than what we've seen here in the first quarter.

And our expectation for cash free cash flow remains the same at equal to or in excess of net income attributable to common share owners. We will continue to invest in key E&D programs in 2009 as well. Pratt & Whitney's overall E&D spend will be down a little bit, but Pratt will continue to invest in the Gear TurboFan Engine, which will exclusively power Bombardier's C-series aircraft and the Mitsubishi regional jet. We're excited about the prospects for the GTF.

One of the highlights in the first quarter was the selection of the C-series by Lufthansa and Lease Corporation International. They became the first customers for the C-series agreeing to have combined 50 firm and 50 option aircraft. Hamilton Sundstrand will also reduce its E&D primarily on the 787 as that program achieves its first flight and works toward entering the service. We are pleased to note that during the quarter Hamilton Sundstrand completed delivery of all of its equipment and software to Boeing in support of its first flight.

Our 2009 M&A placeholder remains at $2 billion, although our acquisition spend in the first quarter was light at only $122 million. As we've said many times before, we have no liquidity issues and we will be aggressive while remaining disciplined in identifying and pursuing acquisition opportunities this year. Our 2009 share repurchase guidance remains at $1 billion. First quarter share repurchases were about $200 million or less inline with the full year run rate.

Okay, turning to slide 11. I know it's still early in 2009, but let me just share a couple of thoughts about next year. There are, of course, a lot of moving pieces at this point and as you can see on page 11 we do have some known headwinds. Obviously, pension and lower large commercial aftermarket and business jet deliveries will impact us next year, as well as slowing commercial construction market.

There's also some big unknowns, including foreign exchange and the timing and magnitude of the economic recovery. The good news is balance works at UTC and we've got lots of tailwind going into 2010, as well. Sikorsky, Fire & Security and Otis should all see margins continue to expand next year. Pratt & Whitney and Hamilton's military business should remain stable, while Pratt Canada should see its 2009 FX headwind reverse.

Hamilton's positioning a new program such as the 787 should also be beneficial. Carrier short cycle refrigerator and U.S. residential businesses should also be the first to see the benefits of an economic recovery. In addition, proactive restructuring focused on high impact high payback projects will deliver $350 million of incremental savings next year.

Including 2008 and 2009 programs, we will have completed $1.1 billion of restructured actions and reduced headcount across UTC by 18,000. Collectively, these tailwinds should allow UTC to resume earnings growth in 2010. As always, our ACE operating disciplines restructuring expertise and disciplined cash redeployment and market leading products give us confidence in our ability to continue to outperform regardless of the market conditions.

So with that, let me open up the call for questions. [Tamara], if we can take the first question.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Joe Nadol – JP Morgan.

Joe Nadol – JP Morgan

Greg, on Carrier to start can you give some sense, and I don't want to parse things too much, but order trends made by months through the quarter, any perking up or just flattening out of the of the rate declines as we progress through the quarter and I'm particularly focused on Transicold.

Gregory Hayes

I think, Joe, I'm not going to quote order rates by month. I think what generally we would say is that order trends remain relatively stable throughout the first quarter as [Jerome] talked about. No surprises in really any of the businesses. I think the one bit of good news we saw was a little bit of advance activity in China. That's primarily though on the commercial side as opposed to on the Transicold business, but generally I would say order trends remain fairly stable albeit at fairly low levels.

Joe Nadol – JP Morgan

And then at Otis you had highlighted three months ago some deferral activity that really picked up. What are you seeing more recently there particularly in China?

Gregory Hayes

No big change, Joe, in deferral activity. I think we quoted 5,500 units or so at the end of the year. We’ve got some pluses and minuses to that but orders were down, obviously, in China in the first quarter a little better towards the back half of the quarter than the front half. So I think generally we feel pretty good about the outlook for China. It's going to be down for the year but I think we've seen again signs at Otis that it will start to pick up here.

Joe Nadol – JP Morgan

Just one more on Hamilton spares, obviously, Q1 was a very tough backdrop. The numbers were a little bit lower than I might have expected. Do you attribute that just to the down more than 20% just to inventory de-stocking, is it your exposure to the wide bodies, which got hit a little harder, any specific platforms?

Akhil Johri

I think, Joe, first thank you for picking up that error in my speaking because more than 20% down not 15 as I spoke, but secondly the issue is more on the provisioning side, which is more like capital for the airlines. And as you can imagine in these tough times when everybody is trying to conserve cash, the airlines were much tighter on provisioning requirements, which is what caused this disproportionate decline in the Hamilton spares.

Joe Nadol – JP Morgan

Okay, so you expect some sequential improvement there.

Akhil Johri

It will be seen how provisioning plays out, again, it's a matter of when the airlines start to feel a little better about things and so to some extent related with the general economic recovery. But, yes, over time provisioning does come back it can sometimes take a while before that happens.

Operator

Your next question comes from Terry Darling – Goldman Sachs.

Terry Darling – Goldman Sachs

Greg, I'm wondering if you could touch base on the comment on pension for 2010 and how we might handicap at this point. Do you have an update there for us?

Gregory Hayes

Let me give you what we know so far. Year-to-date I think pension returns are negative 5%, which is a heck of a lot better than what it was the beginning of March. Right now we're expecting around about $175 million of additional pension headwind next year, and that assumes just a zero return for the year and a discount rate at the same level it was last year, which I think was 6.2%.

So the discount rate could move us around, the returns could move us around a little less so, but right now I'd say between $150 and $200 million and we'll see how the year progresses.

Terry Darling – Goldman Sachs

Okay, and then on Carrier in terms of the potential for, as Akhil indicated, some kind of recovery in the second half of the year. The down 19 organic for the quarter, I wonder if you're able to parse in any way impact from inventory de-stock and where you think you are in that process.

Akhil Johri

Terry, this is Akhil. I think what we would say is in our expectations we are not expecting a big economic recovery or a big recovery in the housing market, but sequentially as compared with say the 19% decline organically in Q1, we think the second half will be more like 10% to 15% organic decline. So still a decline, still pretty significant but less than what we have seen in the first quarter or what we might see in the second quarter.

Terry Darling – Goldman Sachs

So is the translation a differential is just we're going to get through some inventory de-stock here and that's kind of where baseline demand is running down 10 to 15.

Gregory Hayes

In fact, Terry, I think baseline demand is not down nearly as much as what orders are down, so there's obviously been some de-stocking, especially on the Transicold side where we know refrigerator transport is essentially flat from a demand standpoint, even though orders are down like in the 50% to 60% range. So we would expect people will need to start reordering and that inventory overhand, if there was any, would be used up relatively soon.

Terry Darling – Goldman Sachs

And on Carrier pricing, are you seeing any weakness there?

Akhil Johri

There is always some pressure when the volumes go down so much I think the industry in Carrier have been fairing it fairly well thus far. We, in fact, had some relative positive pricing in the first quarter but we do expect pricing pressure to continue as the year goes through if the economy does not improve quickly.

Terry Darling – Goldman Sachs

And overall for the company, Greg, any change in the price cost spread assumption for the year at this point or any biases you want to highlight for us there?

Gregory Haynes

I don't think there's anything different than what we laid out last month. Obviously, we are getting a little bit of pricing on the aero side, a little bit more difficult on the commercial business, especially in the shorter cycle businesses. On the cost side, I think that's where the traction is going to come this year. We’ve continued to take overhead costs out, reduce factory overheads, the indirect as well as the direct labor force.

So we kept margins flat in the first quarter, which when we saw the final numbers it was quite amazing that you can take out enough cost even with volumes down in those high margin businesses to keep margins flat. So I think generally speaking pricing a little bit of pressure but most of that should be overcome by cost traction.

Akhil Johri

One other point, Terry, on Carrier just to remind, I think what we are seeing at Carrier is a move towards the higher products in the U.S. residential business and you recall that the stimulus package had a $1,500 rebate, which is now available for 16 [tier] products or above, and I think that's helping a little bit as well as we saw some of the benefits of that coming to in the April orders. That helps pricing.

Operator

Your next question comes from Nigel Coe – Deutsche Bank Securities.

Nigel Coe – Deutsche Bank Securities

Just wanted to clarify, when you talk about stabilization in orders are you talking about the rate of decline in orders or are you talking about the absolute total level of order intake?

Gregory Hayes

We're talking about the absolute order level here. I mean orders have declined absolutely, as we've talked about. What we're talking about here is they have not continued to decline more during the course of the quarter so they've stabilized at this rate that we're talking about here across the business.

Nigel Coe – Deutsche Bank Securities

Okay, and then moving on to Pratt and Hamilton, I guess given the extent of the spares declines I'm just surprised you're not seeing a bit more pressure on margins that margin performance is extremely good. Can you just maybe isolate in a bit more detail the impact of mix that you saw during the quarter in both Pratt and Hamilton and maybe the offsets in terms of price inflation productivity, etc?

Akhil Johri

The answer, Nigel, is more cost really it's not so much mix as you would imagine with the higher margin spares down both at Hamilton and Pratt, the mix was adverse, if anything. It's the significant restructuring actions that Pratt took the number of hedges that started earlier took out last year, and the improvement they've seen through ACE in the manufacturing side are starting to bear fruit. And certainly all of that is helping preserve the margins to some extent in these tough times.

Nigel Coe – Deutsche Bank Securities

But what was the actual impact of this mix of all these spares during quarter? Do you have that number?

Akhil Johri

Yes I don't know whether I can quote a number on that for you. I can certainly back to you. We can look at that, too, later on.

Gregory Hayes

It's clear obviously spares are much higher margin on the OEM side both at Hamilton and Pratt. It has put significant pressure on the margins. I think what you have seen with both businesses, again as Akhil is talking about, is just a huge focus on taking costs out.

We also, again, we saw a little bit of good news on the military OEM side at Pratt on the engine deliveries. Pratt Canada still had a pretty good quarter despite the fact that volumes are coming down up there. All those things, I would say, combined to keep margins where they were just up ten basis points at Pratt.

And quite frankly after 70 basis points of benefit in the Pratt numbers from hedging activities at Pratt Canada so margins would have been down, let's call it, 60 basis points versus 40 at Hamilton. But still I think a pretty good performance in terms of just taking costs out across all the businesses to try and keep margins where they were.

Akhil Johri

As we look ahead, Nigel, you'll recall last year we saw significant decline in the space starting the third quarter at Pratt and so we don't expect this 20% rate on spares to sustain. What we have seen is some change in the build standards by the airlines. There is lighter business coming through right now but that will reverse at some point as well. And so hopefully the mix, the tough mix that Pratt saw in first quarter will improve as the year progresses.

Nigel Coe – Deutsche Bank Securities

So it looks like one more quarter of big declines then we see some elements of [inaudible].

Akhil Johri

Certainly on the spares we would expect.

Nigel Coe – Deutsche Bank Securities

And then could you just maybe call out the difference in what you're seeing on the JT8s and the new engine such as the V2500s?

Gregory Hayes

Yes, I think the JT8, JT9 which were the old legacy Pratt engines have seen the biggest decline. In fact we actually saw a little bit of uptick on the V2500, which is the new IAE engine that we sell to Airbus for the A320 family that spares were actually up in the quarter versus down big for the legacy JT8, JT9s.

You'll recall, Nigel, that that was a $1 billion business back in 2001. Last year that was less than $300 million and I suspect it'll be down significantly from even that level this year. Not a huge piece of the aftermarket at Pratt, but still obviously important from a margin standpoint.

Operator

Your next question comes from David Strauss – UBS.

David Strauss – UBS

Greg, you talked or I guess Akhil talked a little bit about Otis on the aftermarket side what you're seeing there. Can you flush it out a little bit more and then also talk about Carrier on the aftermarket side that we're seeing.

Akhil Johri

For Otis aftermarket we saw some growth in the low single digits roughly, David. I think what we saw was some decline as you would expect in the early parts of this kind of economic cycle on the modernization revenues they were down year-over-year, not surprisingly. But the maintenance contracts continue to grow at the normal rate of around 4% overall for Otis. And the repairs were up slightly but not as much as we have seen in the past, so tougher compares in March, but overall service continuing to grow at the rate that you would expect regardless of the economy.

David Strauss – UBS

And then I, Akhil, I think you said new equipment sales at Otis were down double digits. Was that including FX or was that, what basis was that?

Akhil Johri

That was constant currency.

David Strauss – UBS

Constant currency, okay, and I think that's steeper than I would have thought this early on. I think you've guided to Otis new equipment sales flat to down mid single digits 2009, 2010 and we really haven't seen the impact go down for commercial constructions, so kind of how did that jive with what you saw in the quarter?

Akhil Johri

I think that the issue, David, as we talked in March both [inaudible] did, we are seeing some quick impact in the shorter cycle emerging markets like China and Russia, which were down a lot more. So even though the backlog is there, the deferral of projects or some slowdown in activities, they have saw significant impact on new equipment revenues in those markets.

We expect, as Greg said, the China stimulus to start working sooner rather than later and that should give us some easier compares in the second half in China, which is a big market for new equipment as you know. So we are watching it closely and we still think there is a possibility that it could be down in the minus 5% range for the new equipment. But depending on how the second quarter goes, we will come back and talk to you if we need to change or re-look at that.

David Strauss – UBS

And then back to aerospace on the aftermarket side, obviously with order rates worse than expected on the spares side I think you had talked about Pratt commercial spares down low teens for the year and Hamilton aftermarket flat to down low single digits. Are you revising that forecast or you kind of on that range or what should we think about as far as the forecast?

Gregory Hayes

Well, I don't think we want to revise the forecast just based on the first three months of order data. I think, again, you've got to look at the specifics of what's happening with the spares at both businesses. Pratt, Akhil alluded to the fact that on the repair side we've seen a much lower engine build standard from the airlines.

They have been trying to conserve cash, not just on the provisioning side, but also on the repair side. So when they have a lower build standard, although it still meets FAA requirements and is still a safe engine, at the end of the day it speeds up the repair cycle so we'll see those engines back sooner, and we'll put more parts in later.

I think it's just one of these things where everybody is in cash conservation mode on the airlines side as you can imagine they're losing a lot of money. But for the full year, I would still expect spares will come back from the levels that we've seen. The fact is the airlines can't continue to fly the aircraft without buying more spare parts than what we've seen here in the first quarter. In fact on the newer engines we've seen spares are still pretty good. So I don't think it's time to revise down the forecast.

The same at Hamilton, provisioning it's a big deal. It's a very profitable business for us but it's also, as Akhil said, it's a capital item for the airlines and they're conserving cash but eventually they will need the equipment. Our PMs will be down for the year. We still think probably down in the 4%, maybe more range. I think down more than that obviously in the half, down 7%, 8%, maybe 9% here. But for the full year, we still expect a better back half.

Operator

Your next question comes from Joseph Campbell – Barclays Capital.

Joseph Campbell – Barclays Capital

I have two things. The first is what are we talking about exactly if the provisioning at Hamilton Standard? I mean if this is old, existing airplanes and the airlines buying their very A320 or something or whatever, or is this related to 787 lay in of initial spares and provisioning? I mean what exactly is going on when you say provisioning?

Gregory Hayes

Provisioning is a term of ours that we have at Hamilton Sundstrand. I think Hamilton Standard went away about ten years ago, Joe, but I always say that because I came from Sundstrand. Provisioning though is really what we consider to be line replaceable units, LRUs and these can be anything from a generator to a full APU system. And typically when an airline takes a new type of aircraft they lay in initial provisioning in all of their line stations so they can replace the LRUs as –

Joseph Campbell – Barclays Capital

Yes, but usually that's when they're changing if you had one kind of equipment and you're getting another kind of equipment. So I'm just wondering what is it that is going on because if it's you're adding three or four more planes to an existing set of spares that you already own, then the provisioning isn't really a big deal, while if you're getting a whole new line of equipment the provisioning lay ins are very big.

Gregory Hayes

You're exactly right, so for instance, next year one of the big benefits that we see the 787 going into commercial services there will be a large amount of provisioning associated with all of those airlines.

Joseph Campbell – Barclays Capital

But is that's what's missing that you had in there for this year and now it's not or what though, because it's hard to see provisioning on standard stuff that's been shipping for ten years.

Gregory Hayes

Yes, provisioning is one of those things that obviously it's impacted by new aircraft type going into service. So 787 will be a big, big impact next year, but we still have a typical normal provisioning level, which is down significantly I'm talking more than 50% here in the first quarter from what we saw last year. And part of that, too, is just airlines deferring airlines in India, airlines in China not taking new aircraft and so there is a typical kind of replacement of these LRUs as they're used. But this is not a big, new program we're talking about like the 787.

Joseph Campbell – Barclays Capital

The other thing that I wanted to ask about is just this sort of general feel that says well, Pratt could be at the low end of the guidance and Hamilton could be at the low end of the guidance and Carrier could be at the low end of the guidance unless things happen. And I'm trying to get a sense for the extent to which in order for, I mean you've given yourself on some huge companies some miniscule ranges at Pratt minus 50 to 0 and 0 to 25.

Pretty small numbers really but I'm trying to get a sense of whether what happens in the back half of the year is just the comparison of weak numbers in '09 to weak numbers in '08 because we've run into the weak part of the last year, and therefore the compares are better, or whether you're actually saying United Tech is hoping that the economy and therefore our businesses get better and if it happens great and if it doesn't well we'll miss the numbers.

Gregory Hayes

Joe, let me just be very clear. We stand by the guidance that we gave last March and we stand by it again today. Obviously, if the order rates continue at what we've seen in the first quarter, it would be difficult to make guidance. But having said that, orders don't have to go back to where they were last year. We still have adequate contingency. We talked about a $350 million contingency. That equates to about $1 billion of revenue that we could miss at the back half of the year and still make the earnings guidance range.

On top of that you've got better compares on FX, you've got restructuring savings that gain momentum during the course of the year, you've got commodities, and E&D the timing of that you'll see will even benefit the back half of the year. So all of those things are what give us confidence to re-confirm the guidance. Even with these awful order rates that we've seen in the first quarter, I still think, we still think and are committed to these numbers.

And I will tell you, Dave Hess, [Elaine Belmar], [Gerod Darnee], are committed to making the guidance numbers and they are doing dramatic things on the cost side to make sure that they can indeed make those numbers. It is tough out there there's no doubt about it, but they're going to make it.

Joseph Campbell – Barclays Capital

That was exactly what I wanted to hear you say. Somehow the comments left me worried a little bit that maybe there was something that was up in the air. And I appreciate the definitive kind of answer and the reminding of the FX and the E&D and the other things in the back half that help make the compares easier, not just a wish for improving or a cessation in the declines.

Operator

Your next question comes from Doug Harned - Sanford Bernstein.

Douglas Harned – Sanford Bernstein

On Carrier, you've taken a lot of people out already. Have you at the same time also made changes to the reporting structure or the organization in doing that?

Gregory Hayes

Absolutely and [Gerod] is in the process of doing that as we speak. And I think trying to simplify as Johri talked about, the overall structure of Carrier is one of the priorities that we have for the year. And trying to make the reporting lines leaner, [Gerod] does have more direct reports than he did a year ago. But I think, again, that's the whole idea is to be empowering to people that are on the line running the businesses.

Douglas Harned – Sanford Bernstein

Has this changed though, or has it yet or do you expect it soon to change the way Carrier operates. In other words, are you doing anything, let me back up a second. You laid out a picture of the portfolio, Carrier's portfolio, at the industrial conference with a triage of businesses that included some fixed and assets and some very significant changes that it looked like you may be heading toward. Have you made progress in that direction to changing the portfolio, how it reports those sorts of things?

Gregory Hayes

Absolutely. We're not going to make any announcements on this call, but I would tell you that [Gerod] and Johri are making very good progress on that, I call it portfolio rationalization. The whole idea, of course, is to get a leaner more focused organization and to be in markets where we know we can be successful over the long-term. I think you'll be pleasantly surprised over the next couple of quarters at the progress that they make.

Douglas Harned – Sanford Bernstein

So you're expecting this to be over the next two to three quarters that we'll see something substantially different in terms of what Carrier looks like.

Gregory Hayes

Well, again, I think depends on how you define substantial. I would tell you that they will be making progress each quarter going forward. Is Carrier going to be a $5 billion business? Absolutely not. But will it be a leaner, more focused organization? Absolutely. And the whole idea here is to get accountability at the business unit level within Carrier. To have those general managers be successful and to have the focus on cost and I think that's what this whole organizational structure and realignment is all about.

Douglas Harned – Sanford Bernstein

And then one last thing, on Carrier, what are your assumptions now in guidance with respect to benefits from commodity pricing for the year?

Akhil Johri

Overall, we have about 100 million for the year.

Gregory Hayes

Right. They saw about $30 million of benefit here in the first quarter, about $100 million full year. Copper has kind of moved around a little bit on us. First quarter copper, I think, was just under $3 average price, but for the full year, we're thinking it's going to be about $2.30 or so. So they'll still see some back half benefit from copper.

Operator

Your next question comes from Jeff Sprague - Citi Investment Research.

Jeff Sprague – Citi Investment Research

Greg, just on acquisitions you remarked that the company will continue to aggressively pursue acquisition opportunities, but could you actually speak to the landscape of opportunities that you see, obviously not naming names, but some color on the pipeline and what the tempo is in the pipeline.

Gregory Hayes

I think the pipeline is full as it typically is. But I think the difference today and the reason we continue to use the word aggressive is we see valuations that are very attractive, and I think especially on the aerospace side we see some very compelling types of valuations and some businesses where we see some synergy opportunities between ourselves and the target company.

Obviously, you've got to remain disciplined you can't chase these things and overpay in this market. I think the problem, as we talked about even in March, is you need a willing seller along with a willing buyer. We've got the ability, we've got a great balance sheet, we've got typically strong cash flows, we can afford to do a lot of things, but you still need to have somebody out there that's still willing to sell their business. And right now with valuations down where they are, it's becoming more difficult.

The other point to mention, of course, is we're talking about things in the core here whether it's aerospace or whether it's commercial. And we want to stick to things that we know how to fix and things that we know where we can get true hard cost synergies in those businesses. Other than that I know it's frustratingly slow sometimes, but it's just a process that, again, you have to stay disciplined and these things will happen.

Jeff Sprague – Citi Investment Research

And as we think about the placeholder construct, if the year continues to unfold and the deals are not materializing, would we expect some pickup in share repurchase or do you just let the dry powder mount here?

Gregory Hayes

No, I think we'll probably take up share repurchase. Right now we only did $200 million in the first quarter. We've got $1 billion placeholder with $2 billion of M&A. I'd expect that we would see higher share repurchase in the back half of the year, if we don't think we're going to see a significant type of acquisition.

Jeff Sprague – Citi Investment Research

And then just on the cash flow question, your comment about Sikorsky and Pratt using cash was pretty clear. But if you think about the remainder of the year, do those businesses actually generate cash this year in excess of net income? Or is there just some normalization in those businesses and the cash performance ultimately comes from Otis and elsewhere in the portfolio?

Gregory Hayes

Well, let me make it clear. We expect all of our businesses to generate cash flow equal to or greater than net income. I think the challenge is probably bigger at Sikorsky than it is at Pratt &Whitney. I would tell you most of the issues at Pratt & Whitney were timing. Obviously inventories, although they were up in the quarter at Pratt, inventories in March were actually down.

And unfortunately those inventories went down in March, accounts payables went down and that hurt their working capital, and they also had a few payments that slipped out. I don't think there's anything structural at Pratt that's going to prevent them from hitting 100% or free cash flow to net income.

The challenge on Sikorsky, again, is they're going to see a 20% plus increase in the top line and that means more inventory. I think the challenge for them is inventory turns have to improve. Inventory was up probably $250 million in the first quarter at Sikorsky that's half of the total inventory increase across UTC. Now, again, most of that was planned but turns have to get better.

And I think inventory turns are one of those things that as you know we struggle with sometimes because in a growing business like Sikorsky, it's hard to get turns to improve. But, Jeff, the teams have a plan to get cash flow back to equal the net income for the year. Part of that will be reducing capital expenditures, but also just being aggressive on the inventory reduction front.

Jeff Sprague – Citi Investment Research

And then just finally for me on China's stimulus, do you feel that you can actually kind of draw a line so to speak from kind of the theory of the stimulus to what's on the drawing board as it relates to commercial construction opportunities in the country, or is there maybe some risk that those dollars are flowing into other infrastructure type projects that maybe don't play directly to Otis.

Akhil Johri

Well, I think we do, even though Otis, Jeff, is our largest business, we do claim the infrastructure side through Fire & Security and that business is seeing some benefits from the stimulus already in terms of the dollars which are flowing through the infrastructure. We are seeing both at Carrier and Otis, even though it's not translated into orders yet, but increased level of interest, increased level of coordination activities, increased interaction with the builders in China. So we think some that will ultimately flow through and hopefully sooner rather than later.

Operator

Your next question comes from Myles Walton - Oppenheimer.

Myles Walton – Oppenheimer & Co.

Just a quick question on Pratt Canada, I know that you've lowered the expected engine shipments since March, which was down since December, and I also note you had previously cited in Analyst Day that only about 35% of that was corporate, so I'm just curious what's driving the magnitude of that reduction?

Obviously, there have been business jet makers cutting forecast but, again, that 35% figure you threw out would seem to mute that to some extent. So what's driving the sequential change to guidance, and also is that the kind of pressure you're seeing at Sikorsky's commercial helicopter business?

Akhil Johri

Well, let me take the Pratt Canada question first, Myles. I think the decline, even though overall we are talking about double-digit decline for engine shipments, I think the corporate segment, which by the way is closer to 50% of the total aircraft for the Pratt Canada, and the shipments is more likely to be down over 30%, which is more inline with the reductions we a have seen from the customer base.

So inside of that double-digit decline of engine shipments overall, the corporate is down over 30% and that's probably most consistent with what you would expect. The other parts of the business, which is the utility, the regionals and the aftermarket engine shipments, are flat to up and that what gives the total double-digit decline.

On the Sikorsky side, obviously, first quarter was a little tough on the commercial side. We had no orders there on the commercial aircraft, but that is going to over time I think as things stabilize and things change, hopefully, that will start to see some recovery as well.

Myles Walton – Oppenheimer & Co.

Did you see any cancellations at Sikorsky on the commercial side, and also did you see any lack of acceptance of built aircraft.

Gregory Hayes

No, we did not see any cancellations. I think the one thing I would point out we had a couple of contracts that were deferred on the commercial side but no cancellations.

Myles Walton – Oppenheimer & Co.

Okay. And then last one for me, do you have any clarity yet on Secretary Gates' position with respect to the second engine on JSF and his new go forward plan?

Gregory Hayes

It's interesting, Myles. He actually didn't mention the second engine as part of his overall budget cut, but we took that to mean that he wasn’t' going to support it. We'll have to see how that moves through Congress. I think, obviously, accelerating the JSF program was positive and we're still on track in terms of the overall engine testing program, which I think we start [Stovall] testing here in July.

Operator

Your next question comes from Ronald Epstein - Bank of America Securities.

Ronald Epstein – Bank of America Securities

When I look at the numbers on the quarter, it looks like Otis and Fire & Security didn't have any decremental margins. Is that right? I mean did you guys just take out cost quicker than the revenues fell or was there any one-time things in the quarter?

Gregory Hayes

I'm sorry, that was at Otis and…

Ronald Epstein – Bank of America Securities

Fire and Securities.

Gregory Hayes

Yes, I think it really was just a cost takeout. I think on the Otis side, they also benefited from the fact that new equipment was down significantly, as we said about 10% or so. And as new equipment goes down and you've got more service, obviously, that helps on the margin side.

Ronald Epstein – Bank of America Securities

Okay, great. And then can you give us some color on, I know Airbus was doing some tests with the geared fan on one of their platforms. Can you give us any color on that? How'd that go? And when will we hear more about it.

Gregory Hayes

Yes, the program was actually completed back in the fourth quarter. We flew the GTF on the A340 flying test bed. We're still waiting, I think, for the final test reports out of Airbus, but our own data and what we have heard from the team over there was that the engine performed to its expectations or better in most cases, including fuel burn, noise and emissions. So I think everybody was very pleased with the test program.

That really, quite frankly, is probably the last you'll hear about the GTF test program until we actually start first flights on the C series here with the new GTF, and again that's a whole new core for the C series and the Mitsubishi regional jet as opposed to the engine that we flew on the test bed. So I think the testing is over and now it's just about development.

Operator

Your next question comes from Howard Rubel - Jeffries.

Howard Rubel – Jeffries

A couple of things, did you provide some aircraft financing in the quarter, Greg, and how do you sort of see your position in that market over the next 6 to 12 months?

Gregory Hayes

We didn't provide any net financing in the first quarter. As you know, we do occasionally provide some backstop financing at Pratt Whitney for some of the engine campaigns, but typically that is backstop and we have not generally been called upon to finance a lot of aircraft. I think we've got a placeholder $250 million for the year, last year it was a little light of that, but it's not a big number. We manage that very closely. We don't want to be in the financing business. I think [Louis] has said that about 10,000 times and we'll reiterate it today. We do not want to be in the financing business.

Howard Rubel – Jeffries

Well that's encouraging. On CapEx the number was sharply lower than I might have expected. What sort of, I mean are we going to see $800 million in CapEx for the year or will it be lower than that?

Gregory Hayes

Well, we talked about a number down 20%, and I think what you're seeing here is the business unit presidents just clamping down on CapEx just to make sure that we hit free cash flow. I don't know whether I want to quote a new number. Last year we spent 1.2 billion or so on CapEx. We expect that number to be less than a billion. Could it be 800? I don't know. I think it's, there's obviously pressure out there for some of the longer term development programs to facilitize and things, but all the businesses are rationing capital as you would expect in this market.

Howard Rubel – Jeffries

Just two more, one sort of staying with capital, on the R&D side, also that looked like that was a $200 million benefit year-on-year and you did indicate most, it sounded like most of that was at Pratt. Is that correct?

Gregory Hayes

Well, R&D was not much of I don't know $200 million where you're getting that number.

Howard Rubel – Jeffries

I may have misread the income statement and if I did I'm sorry.

Gregory Hayes

I think E&D in total is almost flat at about $409 million.

Howard Rubel – Jeffries

Oh, yes. I read the wrong line. I apologize. Yes, but still in all, I mean are you still sort of seeing it flat for the year or are you going to be looking at that?

Gregory Hayes

It is going to go down, E&D, I think. We talked about a $100 million decrease. I think you'll see Pratt take E&D down in the back half of the year, most of that, just as customers have slid programs to the right. You're also going to see, I think, a fairly big reduction at Hamilton as 787 goes to first flight here in the second quarter. You'll see just a natural reduction in spending there. I think that should be down up to $50 million for the year.

Howard Rubel – Jeffries

And then the last thing is supplier health, I know you've been monitoring that very carefully. Are there some suppliers that you're at a position where you need to take them over or make sure that you're protecting your security interest in the business. Would you elaborate on what you're doing there?

Gregory Hayes

Yes, we've got a watch list that our corporate supply management team puts together. We review it every single week. I think right now we've got about, in fact, I know we have exactly 31 key product suppliers on that list, and there in varying levels of I'd say financial distress. In some cases, we have moved work out of suppliers if we don't think they're going to make it.

A couple have asked for increased or decreased payment terms, I guess, but we're managing that very well, as you would expect. It's just one of the things that Joe [inaudible] and his team do on a daily basis with the business unit just manage that supply base, and that's 31 out of 1,500 key suppliers. It's not a huge number, but we try to stay on top of that to avoid any surprises.

Howard Rubel – Jeffries

And if I'm not mistaken, that's really not changed very much.

Gregory Hayes

It has not. The list stays relatively constant. We have one or two moving in or out but it stays just around that 30-ish level.

Gregory Hayes

Okay. Now if we could take our last question, please.

Operator

Sure. Your next question comes from Cai von Rumohr - Cowan and Company.

Cai von Rumohr – Cowan and Company

Could you fill in the spares orders? You didn't give like commercial large engine MRO, Hamilton MRO, and Pratt Canada?

Akhil Johri

I think we talked about the fact that large commercial engines spares orders were down 28%.

Cai von Rumohr – Cowan and Company

No, no I meant MRO, just are you talking spares plus MRO or just spares?

Akhil Johri

Yes, that was spares.

Gregory Hayes

Just spares.

Akhil Johri

Right. The MRO is down sort of mid-teens for Pratt at total aftermarket, so I think MRO is slightly less than that. And on the Hamilton side, it's a similar story where you have total aftermarket down sort of mid teens. The spare is down over 20%.

Cai von Rumohr – Cowan and Company

And then at Pratt Canada, what did the spares do?

Akhil Johri

Excluding FX, high single-digit down.

Cai von Rumohr – Cowan and Company

Okay. And you mentioned that you took a $20 million union payment bonus at Sikorsky. If we add that back, that would imply that margins were over 10%. Was there anything abnormal on the plus side there?

Gregory Hayes

I think you did the math exactly correct. I think the other thing that benefited Sikorsky in the quarter was just the mix of the helicopters that went out. We had some foreign military in there that had a little bit better margin than the typical Blackhawk deliveries, and so that's what drove margin up for the year. We still expect margins to go up at Sikorsky this year but we're not forecasting 10% for the year. I think that's a 2010 target.

Cai von Rumohr – Cowan and Company

Okay. And then the last one you mentioned kind of, customer delays because of provisioning and tight finances of the airline customers. Was that situation getting worse as you exited the year and what are you kind of seeing in early April?

Gregory Hayes

Well, I think it was absolutely getting worse as we exited the year. I think as the economy has continued to slow down into the first quarter, provisioning and order rates were worse in the first quarter than what we saw in the fourth quarter. Spares did start to slow down at Pratt I think last year in the third quarter.

Cai von Rumohr – Cowan and Company

I guess really was it exiting March and April? Was that continuing to get worse or is that too starting to stabilize?

Gregory Hayes

No. I don't know whether I want to forecast the first two weeks of April, Cai. I would say that what we saw in the order rates during the course of the quarter is they were fairly stable, again, albeit at the lower rates that we saw. So it got progressively worse from Q4 into Q1, but during the quarter it kind of remained at this lowish rate that we've seen. We just didn't see the bump in the March timeframe that we might have expected.

Okay. Thank you very much everyone. Just to wrap up here, appreciate everybody's time on the call. It was, I think, a very good quarter for UTC, despite 1.7 billion of revenues down. Cost control across the business is taking hold. There's a lot more cost to take out and the business units are focused on it. The guidance is secure. We still stand by $4.00 to $4.50 for the full year in free cash flow equal to net income. And like I said earlier on, we're going to focus on the things that we control, the costs in the business, and with that, I thank everyone. Take care.

Operator

Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. You may disconnect at this time.

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Source: United Technologies Corp. Q1 2009 Earnings Call Transcript
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