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United Technologies Corporation (UTX)

Q1 2013 Earnings Call

April 23, 2013 9:00 am ET

Executives

Gregory J. Hayes – Chief Financial Officer, Senior Vice President

Jay Malave – Director, Investor Relations

Analysts

Ronald Epstein – Bank of America Merrill Lynch.

Sam Pearlstein - Wells Fargo.

Joseph Nadol – J.P. Morgan.

Howard Rubel – Jefferies.

Carter Copeland – Barclays.

Jeff Sprague – Vertical Research.

Cai von Rumohr – Cowen and Company.

David Strauss – UBS.

Myles Walton – Deutsche Bank.

George Shapiro – Shapiro Research.

Nigel Coe – Morgan Stanley.

Julian Mitchell – Credit Suisse.

Operator

Good morning, and welcome to the United Technologies’ First 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 the 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. Then 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 also ask further questions by reinserting yourself in the queue and we will answer as time permits.

Please go ahead, Mr. Hayes.

Gregory J. Hayes

Okay, thank you [Shamie] and good morning, everyone. As you saw in the press release this morning, UTC reported first quarter earnings per share of $1.39, that’s up 6% versus 2012 and a little higher than we expected due to a little better than expected execution at Aerospace Systems and our Climate, Controls and Security business, as well at the time with some one-time gains. If you recall back in March, we were talking about a $1.30 number that we’re comfortable with. In fact on that $1.30, we had about $0.05 of gains in excess of restructuring. We ended up with $0.11. So about $0.06 of the $1.39 was a little bit more than we expected at the timing of some gains out of the portfolio that integrate the portfolio at CCS. As far as rest of the business, our integration remains on track and we continue to see strong performance in our two major acquisitions with Goodrich and IAE providing $0.21 of earnings in the quarter.

Organic sales declined 2%, partially due to tough compares in commercial aerospace aftermarket and the Transicold business. But we continue to see signs of economic recovery, especially in North America and emerging markets. Europe, however, continues to be a headwind and the legacy PW4000 commercial spares at Pratt & Whitney have yet to recover. So the past could be a bit even, but we’re confident in our full year outlook.

On slide two, on a positive note, order trends that you see on slide two indicate that the majority of our portfolio is well positioned for a resumption of top-line growth, as we progress through the remainder of the year. Just a reminder, we’ll talk to orders on a constant currency basis as we usually do. In our commercial businesses, we see good traction in North America. The housing and commercial construction markets are improving, Americans are investing in their homes again, and our North American Residential HVAC orders were up 11% versus last year. The ABI or the architecture of billing indices has now trended above 50 for the past seven months and we see that coming through in our orders and Otis new equipment orders up 21% in North America.

We did see a 12% decline on our North American Commercial HVAC orders, this is on a tough compare and we continue to expect that business to grow 2% to 4% for the year. As I mentioned, Europe remains a challenge, although we do see some bright spots. CCSs commercial refrigeration business, their orders grew 11% in Europe and Otis new equipment orders grew 21% with Russia, France and the UK more than offsetting weakness in Southern Europe. However CCSs commercial HVAC and Fire & Security products orders were down 14% and 5% respectively, so we’re not quite out of the woods in Europe yet. Otis continues to gain momentum in China, holding on the strength we saw on the fourth quarter, orders were up 27% in Q1, CCS commercial HVAC orders were down slightly, while the fire and security product orders grew 8% in China. Our position in emerging markets continues to pay off with combined BRIC orders for the commercial businesses up 22%, in the quarter.

Turning to aerospace we saw a modest improvement in our commercial aftermarket business at Aerospace Systems', spares orders were up 2% on a pro forma basis would strength primarily from the legacy Goodrich business, however we yet to see a recovery of Pratt & Whitney, legacy commercial spare orders were down 28%, continued declines in wide-body PW4000 orders were partially offset by strong growth in the V2500.

The rate of decline also reflects a tough compare to last year and a strong book-to-bill in the fourth quarter, with increasing airline traffic, record load factors, declining oil prices and airlines projected to earn more than $10 billion this year, we still expect an increase in order rates as we move through the year.

On the military side although we didn’t see a significant impact for the sequestration, we do see the impact of DOD budget cuts and reduction in flying hours, with aggregate pro forma aftermarket sales down 10% in the quarter across the Aero businesses. So we will keep a close eye on the aerospace aftermarket and look for signs of more stabilization in Europe, but order rates and macroeconomic trends broadly support our assumption for growth as we move through the year. We remain confident on our full year guidance of earnings per year of $5.85 to $6.15 and sales of $64 billion to $65 billion, that’s up 3% to 5% organically.

Okay, now onto slide three, taking a closer look at first quarter results, total sales and segment operating profit increased 16% and 15% respectively driven by the Goodrich and IAE acquisitions. Climate, Controls and Securities continues to realize savings from the integration, as they increase profit 8%, out of 3% decline in organic sales. And Otis continues to gain momentum with organic sales growth for the second consecutive quarter.

EPS of $1.39, as I said before, included a $0.11 of gains in excess of restructuring. About $0.15 of combined gains came from the tax adjustments related to the 2012 Tax Extenders, which were passed by Congress in January of 2013, and the ongoing portfolio transformation at CCS. These gains were partially offsets by $0.04 of restructuring. Excluding these items, as well as $0.21 of net gains from last year’s first quarter, an earnings per share increased 16%, again driven by the IAE and Goodrich acquisitions.

Free cash flow in the quarter was 88% of net income. CapEx was $295 million, that’s up nearly 60% versus last year, as we prepare for the ramp in commercial aerospace. We also restarted our share repurchase program in January, acquiring $335 million of our stock and we expect to buyback at similar amount here in the second quarter.

Let me stop there for now and I’ll talk more about the full-year in just a second, but first let me turn it over to Jay to take you through the segment results.

Jay Malave

Thanks, Greg. Turning to page four, Otis sales improved 2% in the quarter led by solid mid-single digit growth in new equipment and continued growth in service sales. Excluding the impact of currency, new equipment sales were up in the Americas, Europe and Asia, with North America, Russia and China leading the way. Operating profit was essentially flat at constant currency. Continued weakness in Southern Europe offset the benefits of volume growth and continued cost reduction in the rest of the world. New equipment order growth was strong, up 24% in the quarter with double-digit growth in the Americas, Europe, and Asia led by 27% improvement in China.

Order strength in Russia more than offset weakness in Southern Europe. Thanks to the growing order book and near-term completion of factory transformations around the world. Otis expects to see improving performance as the year progresses. Guidance for the full year remains unchanged with profit expected to be up $150 million on mid single-digit sales growth.

On slide 5, climate, controls & security increase profits 8% in the quarter and 7% lower sales resulting in another sharp increase in margins, up 170 basis points from prior year to 13.1%. Organic sales were down 3%, driven by a steep decline in container shipments. On a difficult prior year compare complaint with weak European markets, partially offset by high single-digit growth in the Americas residential HVAC business. China was up low single digits, while Asia overall was flattish.

CCS had another solid quarter of earnings growth, despite with the decline in order organic sales. Profit growth was driven by restructuring and productivity, including continued savings from the consolidation of Carrier and Fire & Security, lower commodity cost and the absence of ongoing losses from a business we divested in the first quarter last year.

Global commercial HVAC orders were down 8%, following 9% growth last year with double-digit declines in North America and Europe partially offset by low single-digit growth in Asia. Orders for global Fire & Security products were down low single-digit and fuel [premises] were down about 10%.

Transicold orders were up 30% and Commercial refrigeration orders in Europe were up a 11%, with solid results in the first quarter and anticipated organic improvement we continue to expect a profit growth of $150 million to $200 million on mid single-digit organic sales growth at CCS.

Turning to aerospace on slide six. At Pratt & Whitney, sales were up 11% in the first quarter, driven by the consolidation of IAE and the transfer of the AeroPower business. Organic sales were down 2% year-over-year as declines in commercial aftermarket and military businesses were partially offset by higher commercial engine OEM and Power Systems sales. Large commercial spare sales were down 19% organically over last year’s first quarter, which was the strongest of 2012. On a reported basis, large commercial spares were up 23% including consolidated IAE sales.

Operating profit in the quarter was down 3%. The impact from lower organic volume and unfavorable mix along with higher pension costs was partially offset by the benefits from the IAE consolidation, lower E&D and restructuring savings. The quarter also benefited from a partnership settlement and contract closeouts, which more than offset the absence of last year’s contract closeout benefit. For the full year, we continue to expect Pratt & Whitney’s operating profit to be up $100 million to $150 million, a mid to high single digit sales growth.

UTC Aerospace Systems delivered a solid quarter with operating profit of $509 million and sales of $3.3 billion. As Greg mentioned, Goodrich has gotten off to a better than expected start and contributed $0.18 earnings per share in the quarter. On a pro forma year-over-year basis for UTC Aerospace Systems, sales were up low single-digit with commercial OEM up high single-digit, partially offset by weakness in military aftermarket.

Commercial aftermarket sales were up low single-digit. Orders for commercial spares grew 2% on a pro forma year-over-year basis, and commercial spares book-to-bill exceeded 1 for the second straight quarter.

Compared with the fourth quarter which was a first full quarter with Goodrich Aerospace Systems' sales were up 3% and operating profit was up 50%. Operating profit growth was driven by about $90 million, purchase accounting related adjustments, conversion on higher OEM and commercial aftermarket sales volumes as well as lower E&D. With a solid start to the year we remain confident in full-year guidance with the sales of $13.5 billion, $14 billion and operating profit of $2.1 billion.

Turning to Sikorsky on slide 8, sales declined 7% driven by lower military aircraft and aftermarket volumes, partially offset by higher commercial aircraft deliveries. During the quarter, Sikorsky shipped a total of 40 aircraft including 30 military and 10 commercial. Operating profit declined 32% as a result of the lower overall sales volumes. Headwind from the Multi-Year 8 margin reset and higher pension cost.

During the quarter Sikorsky and Boeing signed a strategic teaming agreement support the U.S. Army’s Joint Multi-Role Future Vertical Lift requirements, the joint effort includes proposal to build a demonstrative aircraft based on Sikorsky’s X2 technology. For the full-year we continued to expect profit to be down $100 million to $150 million on low single-digit sales growth.

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

Gregory J. Hayes

Okay, thanks Jay. We are on slide 9 now it’s a good execution at the business units as we look to further end market recovery as the year progresses, the businesses as we said are focused on integration and execution, as we wrap up the final pieces of the portfolio transformation.

In the first quarter we closed on the sale of the two regulatory mandated divestitures from Goodrich along with our fuel cells business. We expect the last two large divestitures that’s Pratt & Whitney Power System and Rocketdyne businesses to close by the middle of the year, and CCS should have their portfolio transformation essentially complete by the end of this year. We also had several notable accomplishments in the first quarter that will drive organic growth well into the future. On our first GTF engine, the Bombardier CSeries, we achieved flight certification, while the first A320neo engine completed ground testing and will begin flight testing here in the second quarter.

We also had significant wins across the Propulsion and Aerospace Systems group in this quarter, most notably at Embraer. With the selection of the GTF to power Embraer’s second generation E-Jet, Pratt & Whitney is well-positioned on the next generation regional jets, a key growth market over the next 20 years. We also want a new position for wheels and brakes at Embraer. The combine wins across the Embraer regional jet show the value we bring to our customers and are early examples of the benefit of the Goodrich acquisition. As Jay mentioned, Sikorsky and Boeing announced the partnership to submit a joint proposal for the Army’s Joint Multi-Role, Technology Demonstrator and that’s going to be based on Sikorsky’s X2 technology, Sikorsky also took orders for 15 commercial helicopters in the quarter.

On the CMH program, we continue to have discussions with our customers, but there is really nothing new to report at this time. We remain committed to the program and are already to begin pilot training and we’re going to maintain our place holder, eight aircraft deliveries for 2013. In the commercial businesses, we continue to win orders in key emerging markets. Otis’s 27% order growth in China, including order for a 151 elevators in a high-end luxury residential complex near Shanghai, and CCS was awarded a contract to provide two datacenters in China with HVAC, fire suppression and chiller control systems. So just as you heard from the presence in March, each of our businesses is well-positioned on our core markets and continued innovation will allow us to drive long-term organic growth.

Okay, taking a look at the rest of 2013, no real changes from what we told you last month. We remain confident in our guidance range of $5.85 to $6.15, despite the potential $0.10 impact for the sequestration. The order rates in our commercial businesses are good leading indicators for resumption of organic growth and we will keep a close eye on commercial spares as well as the European market.

We’ll also see some easier comparison over the course of the year. If you recall that the last year Pratt & Whitney’s organic spare sales were down only 4% in the first quarter versus 19% decline over the rest of the year. And Transicold entered 2012 with a very strong backlog in the container business, which they burn down in last year’s first quarter and this was followed by double-digit sales declines in each of the next three quarters.

So you should see CCS revert to organic growth here in Q2. A, and we’re going to continue to invest in restructuring, with visibility, some additional gains and good payback restructuring factors across the business. We now expect to spend about $350 million on restructuring this year, all of which will be offset by one-time gains. We spent $52 million on restructuring in the first quarter and we would expect that to be level loaded with about a $100 million of restructuring in each of the next three quarters. Remaining gains however should come largely in the second quarter, so on top of the $185 million of gains you saw on Q1, we’ll see about a $150 million to $160 million of gains here in the second quarter.

Also strong cash flow remains a hallmark of UTC and we continue to expect free cash flow will equal or exceeds net income for the year. In the first quarter, we paid down almost $400 million of debt and we bought back $335 million of shares on maintaining the cash balance of $4.8 billion. We will continue to delever and we now expect to paid down about $2 billion of debt this year, $1 billion that we will target for here in the second quarter and the other $1 billion which is due in the fourth quarter. We’re also going to maintain for the time being our placed order of $1 billion each for share repurchase and M&A, so, no surprises. The UTC portfolio is well positioned to take advantage of the megatrends of urbanization in commercial aerospace growth over the next decade. As always we’re going to remain focused on integration and execution in 2013 and on your strategy to deliver long-term sustainable earnings growth.

With that let me stop. We’ll open up the call for questions. Shamie?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Ron Epstein of Bank of America Merrill Lynch. Your line is now open.

Ronald Epstein – Bank of America Merrill Lynch

Hey, good morning guys.

Gregory J. Hayes

Hey, Ron, how are doing?

Jay Malave

Good morning, Ron.

Ronald Epstein – Bank of America Merrill Lynch

Good, quick question on the PW4000. I would say they were down I guess organically a bunch in the quarter. Why would they come back? I mean are the (inaudible)? What do you expect to see to have that actually come back?

Gregory J. Hayes

What, we know you’re going to ask that question, Ron. Yeah, look it’s a complicated story, let me try and take you through some of the pieces as we see it today. Right now, there’s about 2500 PW4000 engines in services. And over the last five years that’s come down in total about 3%. And we expect that that’s going to continue to come down 1% or 2% a year for the next five years. So you’re actually going to see some attrition in the portfolio, but at the same time, the average age of these engines is only 14 years. We fully expect these things to have a normal lifecycle of 25 years to 30 years, so at some point they will come back.

There is some excess material out there in the, of engines obviously from some of the retirements, but just not significant enough, so they will come back for LLCs, we will start to see a more normal run rate here as we go throughout the year, so pretty confident, the other thing just to put it in perspective, so there is 2,500 4000s out there. Today there are 5,000 V2500s out there. We are going to sell another 3,000 engines over the next five years or so. So the Vs are really going to be the story going forward and we saw that in the quarter, if you dissect that 28% down, what you see is that the 4000s were down about just under 40% maybe they were down about 39%, but the Vs on the other hand were up about 34% on the legacy piece. So again I think we’ve made this bet on narrow-body it’s going to pay-off, and again I think it’s all manageable in terms of what we are seeing on the 4000s in over the course of the year.

Ronald Epstein – Bank of America Merrill Lynch

Okay. Okay and then maybe if I can just a follow-on that same question. So are you seeing I mean relatively young or engines would not [have] many hours on them, relatively speaking coming off airplanes that are getting retired computing with your own spares, maybe about kind of part of the issue?

Gregory J. Hayes

Not really. In fact, what we are seeing again, these engines have been out there, I think there is some engines that are 25 years old and the PW4 is in fact more than that, probably from the almost 30 years old, from the early 4000 so, sort of the older engines are coming off which is providing service to the material, we also see the airlines continuing to try and take spare engines and use them and not induct them into the overhaul shaft, so inductions actually on the 4000 are lighter than what we had expected just because the airlines are trying to do what they can to conserve cash, so oil prices at $90 a barrel, I think the airline traffic is still very high, capacity very high, you really think that we are going to see kind of return to normal on the 4000s, it’s just not enough engines out there in the fleet that have been retired to provide enough spares to support the fleet that’s out there.

Ronald Epstein – Bank of America Merrill Lynch

Okay, great. Thank you.

Gregory J. Hayes

Ron thanks.

Operator

Thank you. Our next question comes from Sam Pearlstein of Wells Fargo. Your line is now open.

Sam Pearlstein – Wells Fargo Securities

Good morning.

Gregory J. Hayes

Hi Sam.

Sam Pearlstein – Wells Fargo Securities

The first thing is can you just quantify the partnership settlement and contract closeouts in Pratt and how much that helped?

Gregory J. Hayes

Yeah. So, last year, there was a, I guess, some contract closeouts that gave us a benefit of about $0.02. This year, we’ve got contract closeouts and a couple of other things which benefit us between $0.04 and $0.05, let’s say, so kind of a net $0.03 year-over-year benefit at Pratt.

Sam Pearlstein – Wells Fargo Securities

Okay. And then just talk about lower E&D of Pratt and also UTC Aerospace Systems. E&D is coming down. And so I’m just trying to just understand how come R&D is up year-over-year from $5.44 to $6.10? Where is that additional spending going?

Jay Malave

Well and that’s the just function of Goodrich, I mean, sorry, Sam that’s just the function of the Goodrich acquisition year-over-year, just consolidating the results versus last year they weren’t in the results in the first quarter.

Gregory J. Hayes

And that was about a $100 million of that. So Pratt at least come down, I think $34 million of is well on track, it come down to $75 million to $100 million. The CSeries, as we said that’s certified, in neo is going to flight test here shortly. So, you will see a real ramp down in the E&D and Pratt as we move through the year.

Sam Pearlstein – Wells Fargo Securities

Okay, thank you.

Gregory J. Hayes

Thanks Sam.

Operator

Thank you. Our next question comes from Joe Nadol of JPMorgan. Your line is now open.

Joseph Nadol – JPMorgan

Thanks. Good morning.

Gregory J. Hayes

Hi, Joe.

Joseph Nadol – JPMorgan

The first question is just back on the Pratt spares. I heard everything you said. Could you quantify, I mean your confidences are going to come back. Are you able to quantify what would you believe is the new normal level for this and where are we relative to that? So how much under the long run level of PW4000 do you think we’re running?

Gregory J. Hayes

Well, obviously, we are down 40% this year in the first quarter to 39% and that will get better. Again we had a very tough compare last year and some strong sales of the 4000 and some LLCs that the drop of last year’s first quarter. I think that rate that we saw its down 15% last year, we think that kind of the normalized rate that we saw in the third and the fourth quarter of last years the same rate that we saw this year in the first quarter and that rate should pick up again, we still have the airlines out differ in maintenance and just not to the indications over the shaft, so at some point these are going to come back.

Joseph Nadol – JPMorgan

And do you think you’re still on track for overall 5% organic growth in Pratt spares?

Gregory J. Hayes

Yeah, but I think the mix is going to be different, I think the 2000s have held up pretty well, we saw good orders there the Vs have been better than what we expected on the legacy side and the 4000s are little weaker, but I still think, with the price increase and everything else that we see out there, we can still get to that 5%, we might be a little late to that if the 4000s don’t come back at all, but if you see strength in the rest of the portfolio there.

Joseph Nadol – JPMorgan

Okay and then just one more Greg, overall organic growth you’re still saying 3% to 5%, you are minus 2% in Q1. What do you think the profile will like over the rest of the year and did you expect Q1 to be minus 2% or are you thinking more like flat before?

Gregory J. Hayes

No, I think when we were, as we were looking at the year back in December, I think we saw kind of a flattish first quarter came in a little bit late there, again I think CCS we knew that the issues that we’re going to see there because of the big compare issue on container, we knew Sikorsky was going to be down and we didn’t expect spares of Pratt to be down as much as they were in the quarter. So that’s a little bit of it, but again, I think it’s generally you are going to see a gradual recovery, we’ll see organic growth in the second quarter and it will pickup through the course of the year end, again and what I am looking at is order intake, especially at the commercial businesses as we saw very strong growth in China but we also saw a growth in Europe that obviously up 21% and North America is pretty good. So again, there is momentum with a backlog it’s growing and we should see that play out in the higher sales as we move through the year.

Jay Malave

Yeah, Joseph, when we did see sequential growth in the backlog at both CCS and Otis new equipment, so that gives us some confidence as we go throughout the year, besides just the compare is getting easier.

Joseph Nadol – JPMorgan

Thanks.

Gregory J. Hayes

Okay, Joe.

Operator

Thank you. Our next question comes from Howard Rubel of Jefferies. Your line is now open.

Howard Rubel – Jefferies

Thank you very much.

Gregory J. Hayes

Good morning, Howard.

Howard Rubel – Jefferies

Good morning gentlemen.

Jay Malave

Good morning.

Howard Rubel – Jefferies

For a moment just to follow a little bit more on Joe’s question with the diversified business the way you have, you always have some puts and takes. Where else did you see some things outside of the 4,000 that surprised you on the downside and where we’re maybe some strength that you hadn’t planned for?

Gregory J. Hayes

Yeah, I think there is a one thing I would say; it’s hard to say it surprises us. We knew Europe was going to be weak. The order rates at CCS on the commercial leaseback side were probably a little weaker and we didn’t see any real traction of a service side of the business from the F&S business in Europe either but I would say that’s a real surprise maybe we have hoped, I think as [Geraud] had talked about kind of 1% to 3% growth in Europe this year has markets. Again, I think we did see good growth in truck trailer in Europe and we’ll saw a good growth in truck trailer in North America. But so there are pockets of goodness in Europe, it’s not as dire as people might think. I mean we’ve get good balance across the portfolio. So even if service of CCS has down, I think with truck trailer up. If there is nothing really out there, then I would say it’s a big, big concern as we move through the year.

Howard Rubel – Jefferies

And then you’ve outlined to some degree what you think the gains and also where the restructuring is going to be? Could you provide a little more color on that or a little granularity?

Gregory J. Hayes

Sure, of the restructuring actions?

Howard Rubel – Jefferies

Yes, please.

Gregory J. Hayes

So, again, we have identified about – but we probably identified more than $350 million of potential actions. And we’re going to see that as you would expect both at CSS, at Otis, we’re going to see some more at Pratt. In the Aerospace Systems group, we have the Goodrich integration, is going well, but there is a about a $100 million of restructuring we’ll do there, even Sikorsky is, as they see volumes down on military, you’ll see some restructuring. For the most part, the programs that we’re looking at today are paybacks between one and two year. So as they do that, as they take out their restructuring to $350 million that actually gives us a little bit of cushion this year, as well as a runway next year. So, again I think, there will be the typical actions, we’re looking to move to low cost sourcing, we’re looking to make sure that we will right size the business. And we know cuts are coming on the military side, we’ve seen that already in the after market. So we’re going to right size the business for what we see as the market demand, especially on the military aerospace side.

Howard Rubel – Jefferies

And then your gains you said, can you just qualify them?

Gregory J. Hayes

The gains, I think we had a $185 million in the first quarter, a biggest piece I think. It’s funny to call it a gain, but that was from the Tax Extenders package, that was the R&D tax credit for 2012 that got passed in 2013. But I’m sure there’s great policy to them, instead of us to spend in 2012 and 2013, that’s another story. The other piece of that was portfolio transformation. We sold the Hong Kong guarding business at CCS. Those are the two gains. And in the second quarter we see gains on the divestitures that we’ve got out there as well as a little bit of additional good news on taxes.

Howard Rubel – Jefferies

Thank you, Greg.

Gregory J. Hayes

Thanks, Howard. (Inaudible).

Operator

Thank you. Our next question comes from Carter Copeland of Barclays. Your line is now open.

Carter Copeland - Barclays

Hi, good morning guys.

Jay Malave

Hi, Carter.

Carter Copeland – Barclays

Just a couple quick ones, one, I wondered if you might expand a bit on Europe and maybe quantify how much Europe was down on the quarter in the commercial businesses and just what you saw in terms of the progression of orders over the quarter you know, March relative to February relative to January, this seems to be a pretty significant slowdown there. So, I wondered if you might be able to provide some color on that.

Jay Malave

Sales, I’ll start with sales Carter and I’ll get into orders, sales at Otis were up low single digit, sales at CCS were down high single digit. It was pretty much across the board we had the clients at commercial HVAC, we had the high single digits clients at commercial refrigeration, and we have declines in the fire and security businesses. And the orders as we said Otis was up 20% in the quarter and CCS was a little bit mix as Gregg said or as I said before commercial refrigeration was up 11%. Transport refrigeration in Europe was up over 20% HVAC was down mid teens and F&S that was also down, I think in around mid single digit.

But again, none of this was a surprise we have build this and we’re, we’ve had Europe as pretty much the headwind go for the rest of the year and I think said it already in the guidance.

Gregory J. Hayes

Yeah, and we also said there was no big trend change during the quarter, we’re all of a sudden things just went to hell in a handbasket and we think it was simply kind of a continuation of what we saw throughout all of last year. Southern Europe reaming weaker than Northern Europe and emerging Europe especially Russia, being a lot better in probably the biggest growth opportunity, but we saw growth in the U.K. We saw growth in Germany it was not just across the board bad news.

Carter Copeland – Barclays

That’s great color, thanks, and just a quick follow up on the Goodrich increase you call about $0.18 in the quarter obviously that tracks to a bigger accretion number than you were outlining for the year at $0.60, you also called out a $90 million in purchase accounting adjustments did that impact Q1 in particular way that may that larger or how should we be thinking about Goodrich accretion over the course of the year relative to what your figures guide towards?

Gregory J. Hayes

Yeah. I think yeah Goodrich did do a little bit better than what we had expected, and that’s surprising trying to under promising over deliver here on the biggest acquisition we’ve ever done, but Goodrich is been nothing but good news for us. And again I contribute that really to the Aerospace Systems team down they’ve been doing a great job integrating the business and got great people. And again taking care of the problems as they find them and that having any big surprise and so again a little bit better in first quarter and I would hope that trend would continue to again, just thinking about this balance works team here again a little bit of upside on Aerospace Systems this year could offset a little bit weakness on the commercial spares, so on the latest business the Propulsion and Aerospace Systems did pretty good about the guidance we’ve got.

Carter Copeland -- Barclays

That’s great. Thanks guys.

Operator

Thank you. Our next question comes from the Jeff Sprague of Vertical Research. Your line is now open.

Jeffrey Sprague – Vertical Research

Thank you good morning gents, just…

Gregory J. Hayes

Good morning, brother.

Jeffrey Sprague – Vertical Research

Couple of other follow ups. Just back to Otis the strength in both Europe and China I guess in both cases do you think there is some share gain going on there or the markets really that strong, and I guess in China. If could provide some color on what’s going on in the pricing environment?

Gregory J. Hayes

Yeah, so in China I think the market is very, very strong I don’t want to think that there is been were actually big gain in share because as we saw Conair reported this morning they’ve also had very good results in China. And the market in China is very strong, I think property transactions in the first quarter we’re up 60% in China. So again the markets are lot better than what we had anticipated. We saw that starting in the fourth quarter. We’re also getting traction I think in China with the new products, we’ve got the new low cost Gen2 for social housing. We’ve tailored the products to that market. So again we’re getting good traction but I wouldn’t say we’re gaining share necessarily, but it certainly feels pretty good when you have orders up 27%. As for Europe, again, it was a mixed bag against strength in the UK, strength in Russia, I think we’re obviously, we’re probably gaining share there, also strengthen in the Middle East, but Southern Europe continues to be kind of a drag and that’s really more about the service side than it is new equipment. There really isn’t much of a new equipment market in Southern Europe today.

Jeffrey Sprague – Vertical Research

And I just didn’t totally understand what Jay said, when he was talking about container orders. I wasn’t sure if he said offer up. Were container orders up in the first quarter?

Jay Malave

Container orders were up over 40% in the first quarter.

Gregory J. Hayes

Yeah, so you remember last year in the first quarter, we came in with this big backlog of containers and so sales at CCS were very strong in the first quarter, but the order rates started to decline and then we didn’t really see any orders in container until mostly in about September and then it started to pick up and the trend that we saw in the fourth quarter is just accelerated here in the first quarter. So and containers are short cycle business but the leasing companies are buying and that looks like they’re going to have a pretty good year, I think Jay already talked about 15% for that market for the year.

Jeffrey Sprague – Vertical Research

And just one last one and then I will pass. That if you can speak to resi HVAC price costs and what’s going on there? Are you feeling cost of lease given what’s going on with raw math so you are getting kind of an associated drag down on selling prices as the raw math come down?

Gregory J. Hayes

No, in fact, I think we feel pretty good about cost price. There was a price increase as obviously drift back in effective January 1 so far so good there. Some of the commodity benefits that we see again, its short cycle, it’s been up and it’s down, it’s been as high as about 390 last year, we are pretty well locked in on copper for the year, little bit of above what the current price is. But again, copper is a commodity that continues to come down, an importance of CCS as we move to, especially on the commercial side, some more of the aluminium plate and heat exchangers. So again, I think generally, we feel pretty good. It’s never an easy pricing environment, but I would tell you that CCS is making some good strides to get a great distribution here in the U.S. and good product innovation and that’s helping a lot.

Jeffrey Sprague – Vertical Research

Perfect, thanks a lot.

Gregory J. Hayes

Thanks, Jeff.

Operator

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

Cai von Rumohr – Cowen & Company

Thanks so much. So your release refers to defense impact at Sikorsky in the first quarter. Could you kind of explain that and maybe give us some color on what you’re seeing in terms of sequester impact on the total business?

Gregory J. Hayes

Let me have Jay take you through Sikorsky and I’ll take a shot at the sequester question.

Jay Malave

Cai, Sikorsky, we had lower deliveries on military aircraft. The after market was down – the military after market was down little bit over 20%. So that’s really where you saw the big impact. The deliveries we knew about, but those were partially offset by some strong growth in commercial aircraft deliveries, and I think this quarter, we have 40 deliveries. We are expecting north of 240 deliveries for the full year. So you would expect that volume to increase on as we go throughout the year. So, partly, it was just timing of deliveries, partly it was particularly in the after market, was due to cuts.

Gregory J. Hayes

As far as the sequester impact, I’d love to tell you that we can quantify at any better than what we did 30 days ago, but unfortunately the customers aren’t sending us invoices with a 10% reduction for sequester – sequestration. So, we’re hearing about it, we are starting to see a little bit of it in terms of the order intake. I think, Jay talked about the aftermarket was down 10% across aerospace, commercial aerospace in the quarter. And that’s really just a reflection, again reduced off tempo in Afghanistan, but also reduced flying hours here. We see some of the fighter wings being stood down for the remainder of the year, cancelling some of the exhibitions. And again, all of this is going to have an impact on us. It’s just going to take a while for us to play out. So we continue to say it’s probably about a $0.10 impact, but again, it’s hard to see it beyond that. I think the bigger concern is on these furloughs of the FAA, if they start driving the higher cost on the commercial airlines, but that could do the spares, but again I think that should be a relatively small impact for us.

Cai von Rumohr – Cowen & Company

You mentioned the military aftermarket down 10% and seeing some cutback in the flying hours. I think in December, you were still kind of asserting at least in March still asserting military aftermarket would be half at Pratt. It looks like it was down. So where do you now expect military aftermarket to be for the year at Pratt?

Jay Malave

At Pratt, we were expecting it to be flat to slightly up, not much growth there. In the quarter, we actually saw growth in military aftermarket at Pratt really on the back of F100, F119 and F135 spares, and that was the F100 and F119 was really more of a reflection of the strong order of sales in 2012, just built a backlog we delivered here in the first quarter. And the F135 was more a pop-up function of disprovisioning and we have over 80 engines that’s been delivered program to date, and so it’s just a matter of provisioning start to accelerate.

Cai von Rumohr – Cowen & Company

And so do you expect the military aftermarket still to be flat to up for the year, Pratt?

Gregory J. Hayes

At Pratt, we do. I think we’re talking about that 10% what you really saw was at Sikorsky and at the Aerospace System, we had military aftermarket down about 20%. So good news at Pratt in the quarter but offsets by bad news at Sikorsky and at UTAS. I think again the Sikorsky numbers are little bit worse than what we had expected. On the OEM side, we know exactly what we’re going to be from a military delivery side but spares we’ve got a little worse than what we expected in Sikorsky. So need to keep an eye on that as move through the year.

Cai von Rumohr – Cowen & Company

Okay. And you mentioned you still have the placeholder for CMH deliveries. Could you give us an update on your progress are out there Canadians? And you know I mean if you don’t have, you can’t say when you’re going to have a settlement, I mean I assume that the age is going to be a zero until you have an settlement for us?

Gregory J. Hayes

Yeah, like we’re expecting that we’re going to shift those need in the back half of the year. But I wouldn’t say we’re not making progress. We continue to have discussions, good discussions with the customer in Canada. Again, this is a very complicated procurement program in Canada with different public works and the department of the defense. We’re working with both sides of the Canadian Government. We’re trying to get through a win-win solution here. And it’s just taking a longer than anybody wants in to and obviously we’re ready to begin pilot training. There is four aircrafts up in Shearwater. I think number 26 of the 28 is on the production line down in the West Palm Beach. So we’re building them and we’re still not done with some of the mission software but we are making very good progress with that. So again we’ll get pass this. I can’t tell you whether its next week or next month or the month after, but I still think we have a pathway to deliver additional helicopters and the key for us is to get the pilots training to begin and we’re pretty close to that.

Cai von Rumohr – Cowen & Company

Okay, thank you.

Operator

Thank you. Our next question comes from David Strauss of UBS. Your line is now open.

David Strauss – UBS

Good morning

Gregory J. Hayes

Hi, Dave

Jay Malave

Good morning, Dave

David Strauss – UBS

Greg, just following up on Cai’s question the CMH. The charge that you guys took in the fourth quarter does that reflect delivering the interim configuration aircraft or does it reflect you know not delivering the interim configuration aircraft and waiting till final configuration?

Gregory J. Hayes

All right, so the charge that we took $157 million I think it was in the fourth quarter that assume that we weren’t going deliver any aircraft until 2015, with all the machine system software would be done. So, it didn’t anticipate a interim solution even though we think ultimately that’s the best for both ourselves as well as for the customer to head start delivering these interim aircraft get them flying, but the charge was a more conservative view of the fact that we’re going to be able to deliver anything until 2015.

David Strauss – UBS

Okay. So, if we get to some sort of agreement that reflects the move towards taking the (inaudible) again the interim configuration aircraft potentially it could some good news.

Gregory J. Hayes

Yeah, but I wouldn’t, yeah, there might be a little bit of good news, you are right, again, this is, but again I wouldn’t think it’s going to be a big number.

David Strauss – UBS

Okay. And then China, I know you talked about the strength in China overall in Q1, but can you talk about maybe what you saw as we went through the quarter, it looks like you know, January and February start up very strong but then, else we’ve done in the March and April things might have gone up a little bit. And I think your guidance for China overall reflects about 7.5% to 8% GDP growth this year, you still feel that’s the right place to be?

Gregory J. Hayes

Yeah, we do. In fact, you see it was a weird compare because the Chinese New Year was in January last year, February this year, so January start about game busters, then February was slow and then March was even better than I think would anybody had expected, again, we’re, you know, the units were up significantly, good order intake and even in April, I think we continue to see a solid order intake, we just did the operating review last week with Otis they were very confident in the China story for the year.

David Strauss – UBS

Thanks.

Gregory J. Hayes

Sure.

Operator

Thank you. Our next question comes from Myles Walton of Deutsche Bank. Your line is now open.

Myles Walton – Deutsche Bank

Thanks, good morning. I just wanted to go back to the aero systems margins for a second, the implied guidance I think it’s around 15.6% or even slightly below. So, I’m curious is there, usually that, historically both Goodrich legacy and Hamilton legacy got better the year progress on the margin side and I guess that 90 million purchase accounting that’s something that hit you in the first quarter or to your early point Gregg, how much conservatives in this way to the aerospace systems?

Jay Malave

Myles, the 90 million is simply, charge that was taking in the fourth quarter related to the inventory step-up it just, it doesn’t repeat because it got the inventories that have got fully liquidated in the fourth quarter. So, what we are dealing here, now we just, it is recurring earnings, which is consistent with our guidance of $2.1 billion. We based some of what we forecast, we expect it to be fairly flat level loaded as far as operating margins throughout the year, but as Gregg said, it’s possibly could be some upside it’s a little early to make that call.

Myles Walton – Deutsche Bank

Yeah, as you think…

Gregory J. Hayes

We had about just under $50 million of net synergy benefit in the first quarter, when talking about $200 million for the year obviously those synergy benefits continue to pick up that’s going to accretive to margins and again I think there’s probably a little bit of good news, but it’s just, it’s April so we are going to wait another quarter here before we decided that it’s actually that what the upside might be

Myles Walton – Deutsche Bank

Okay, I mean, it just seems like the aftermarket we get better historically those margins expand through the course of the year so I’m just trying get out…

Gregory J. Hayes

Yeah.

Myles Walton – Deutsche Bank

Anything in the first quarter but it sounds like there wasn’t?

Gregory J. Hayes

No I don’t disagree with your [thesis] still Myles.

Myles Walton – Deutsche Bank

Okay and the other question kind of clean up, it’s on discontinued operations cash, it looks like there was a big use in the quarter and I guess I don’t know what the cause of that was?

Gregory J. Hayes

Unfortunately the Federal government requires us to pay taxes when we make the gain, so the gain on the sale of the industrials which closed in December 15 as we paid the taxes here on the first quarter, so that was the big cash outflow.

Myles Walton – Deutsche Bank

Okay. That makes sense. Thanks.

Operator

Thank you. Our next question comes from George Shapiro, Shapiro Research. Your line is now open.

George Shapiro – Shapiro Research

Yes. Good morning.

Gregory J. Hayes

Good morning.

George Shapiro – Shapiro Research

Greg, Hamilton Sundstrand had no organic growth in the quarter, is that a combination of OE growth, after market growth offset by military being down?

Gregory J. Hayes

Yeah, I think the commercial after market was essentially flat at the legacy Hamilton business. Military, as I said, was down significantly. And then commercial OE was up, I think 8% to 9% in the quarter.

Jay Malave

Yeah

George Shapiro – Shapiro Research

Okay. And then at Otis, the margin this quarter was a little bit less than I thought. Is that still a mix issue and where OE was a little bit worse than service and is that change going forward or we still seeing a lot of pressure from the after market renegotiations?

Gregory J. Hayes

I think, yeah. We have – margins were down. This actually should be the low-point for the year in terms of Otis margins, but a big chunk of this was as we – we picked up about a point of mix in the new equipment versus service. So that’s actually detrimental, as you know service margins are obviously better than the OE side. So that was a piece of it. Again, pricing tough around the world, tough in China, but we’re holding the margins, I think and we should continue to see benefits. The other thing to keep in mind at Otis or the process is some of this plant transformation. We’re closing our Nogales plant and opening up the facility in Florence, South Carolina. We’ve got the new Chongqing plant and there are some expenses in the first half of the year, which were actually holding margins down a little bit. It should get better as we complete those transfers.

George Shapiro – Shapiro Research

Okay. Thanks, very much.

Gregory J. Hayes

Thank you.

Operator

Thank you. Our next question comes from Nigel Coe of Morgan Stanley. Your line is now open.

Nigel Coe – Morgan Stanley

Yeah. Thanks. Good morning, gents.

Gregory J. Hayes

Nigel.

Nigel Coe – Morgan Stanley

So, I hate to ask you this question but where is the contingency now at the midpoint, given the sequester et cetera?

Gregory J. Hayes

Well, it’s actually – if you remember back in March, we said that we were comfortable with analyst’s consensus, which at the time was 610 with about a $0.10 impact from sequestration. So, again, there was no contingency at 610. Again, if you go back down to the midpoint to $6, obviously we’ve got a little bit of good news. And again, as a closeout to quarter – again no surprises here, so, really there is some puts and takes, may be (inaudible) a little better, try it a little worse in terms of spares. But, I think overall, feel pretty good. We got benefit from the euro. Again, we’re seeing that a 128 it’s been 132, 133. So, right now, I would just tell you in around 610, there is no contingency, but that includes an impact from sequestration. And we will expect, we’ll see over the course of the year.

Nigel Coe – Morgan Stanley

Okay. So, no change, that’s great. And then switching to Otis, obviously, you have great backlog performance this quarter, but how does margin look on that backlog?

Gregory J. Hayes

Actually, margin doesn’t look bad. I mean here, again, pricing is tough in China, so the margins there are going to be a little bit under pressure. But, again, as we fill up the factories with all of these orders going through that’s going to help overall margins there. So, even though new equipment, the sold margins are a little late, I think we can pick that up. And then in North America, we’re actually seeing much stronger, better, stronger margins in the new equipment. Pricing has stabilized. We’re not seeing, again, all of the, say, cuts or competition that we had. And again, the market is picking up. So that’s good news on new equipment margins.

Nigel Coe – Morgan Stanley

Yeah. Otis continues to take out cost, they’ve done a great job of taking out cost of the elevator unit cost, sorry, page will show that in the March meeting and that’s going to continue. So feel confident that margins will remain and we’ll leverage the volume going forward.

Nigel Coe – Morgan Stanley

Okay. And then just going back to Jeff’s question on the CCS, copper prices, obviously down, that’s similar pricing holds on the equipments, why won’t steel or copper price benefit the second half of the year, as you go through this own hedges?

Gregory J. Hayes

Mostly because we’ve got the year locked in at a price of little bit above what the current market is so the market is I think around 320 today, because of concerns over China, we could see that $320 moved to $360 or $370 I think pretty quickly, but we are locked in for the year so the CCS guidance as soon as locked in copper, no real benefits from further commodity cost reductions, again that benefit, again we’ll see it, next year, as we will start to lock in buys for next year in today’s lower prices.

Nigel Coe – Morgan Stanley

I see. And then just one quick one, obviously container was down this quarter, but orders suggest that’s going to come back strongly in 2Q and beyond, how much mix headwind did you have from container this quarter?

Gregory J. Hayes

Well, in terms of…

Nigel Coe – Morgan Stanley

On CCS margins?

Gregory J. Hayes

I don’t know whether I got that number off to the top of my head.

Jay Malave

Yeah, we don’t I mean again one thing I would say about CCS is there, operating margins across the board are fairly even so we got much more balanced, and I am not sure, that it had a huge impact, we will take a double to look at it again and I think we will get back to you on that.

Nigel Coe – Morgan Stanley

Okay, that would be great. Thanks.

Operator

Thank you. Our final question comes from Julian Mitchell of Credit Suisse. Your line is now open.

Julian Mitchell – Credit Suisse

Thanks a lot. Yeah, so I guess my first question is within CCS. You’ve had a bunch of companies Ingersoll, Schneider and so on complaining about how weak foreign security is as an end market right now. Could you just remind us how much of CCS post all these divestments is foreign security and what your sort of expectations off for the year in that business?

Gregory J. Hayes

Just one second, Julian and I will give it that for you. So I think, see here, as I would think about Fire & Security, again, the products piece of the Fire & Security business has actually done quite well. You see pretty good strength here in North America. It’s been a little bit weaker in Europe. We’re really seeing kind of the headwind has been on the service side in Europe and that’s been really a result of just what’s going on economically here in some of the services businesses, but margins have not been very good. We’re trying to be a little bit more selective there. But in China for instance, I think securities are up very strong. We had a good traction with the GSP business. Correct, I don’t know Jay do you have the exact...

Jay Malave

Just rough order of magnitude here Julian out of the $17 billion portfolio about $6 billion is Fire & Security.

Julian Mitchell – Credit Suisse

Got it. And you’re expecting that to be kind of flattish or up inline with CCS overall for the year?

Gregory J. Hayes

Yeah I think on the product side, you’d expected to be up inline and then on the service side a little bit light to that overall kind of 5% growth.

Jay Malave

It varies regionally, in Europe the expectation again were flattish and maybe up slightly.

Julian Mitchell – Credit Suisse

Sure, thanks. And then just my follow up would be, again just circling back to the Otis margins. As you said Q1 you had, you didn’t have sort of the operational leverage showing up because of the mix of OE versus services. I guess it’s likely that European service stays weak and the Otis suggests the OE growth in terms of revenue should accelerate. So you’re probably dealing with that mix hit for the balance of the year. Do you therefore expecting an offset to come from a lot more restructuring savings coming through already, just the falling out of those costs around the plants transformation?

Gregory J. Hayes

It’s obviously a combination of both. Otis is pretty aggressive with restructuring last year. They’ve got more restructuring to do this year. We should be accretive to margins and then you got the factory transformation, which get done really by mid-year. So, that’s all going to be help I think on the margin mix side.

Julian Mitchell – Credit Suisse

Okay. The Q2, you already see the margins going up sequentially and may be year-on-year?

Gregory J. Hayes

Yeah, they’re positioned…

Jay Malave

Yes.

Gregory J. Hayes

Yes, absolutely.

Julian Mitchell – Credit Suisse

Okay, thank you.

Gregory J. Hayes

All right, Julian. Thank you, much.

I will thank everyone for listening today. We look forward to seeing you on the road this quarter and the Investor Relations team is standing by to take your questions. So, thanks very much and have a wonderful day.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Have a great day.

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