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United Technologies Corp. (NYSE:UTX)

Q4 2009 Earnings Call

January 27, 2010 8:30 am ET

Executives

Gregory Hayes – SVP & CFO

Akhil Johri – VP Financial Planning & IR

Analysts

Nigel Coe - Deutsche Bank

Joseph Nadol - JPMorgan

Terry Darling – Goldman Sachs

David Strauss - UBS Securities

Howard Rubel – Jeffries & Co.

Deane Dray - FBR Capital Markets

Ronald Epstein – Bank of America

Sam Pearlstein - Wells Fargo

Jeff Sprague - Citigroup

Robert Stallard – Macquarie

Cai von Rumohr - Cowen & Co.

Heidi Wood – Morgan Stanley

Myles Walton – Oppenheimer

Doug Harned - Sanford Bernstein

George Shapiro – Access 342

Operator

Good morning and welcome to the United Technologies fourth quarter conference call. On the call today are Gregory Hayes, Senior Vice President and Chief Financial Officer, and Akhil Johri, Vice President, Financial Planning and Investor Relations.

This call is being carried live on the Internet, and there's 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 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. (Operator Instructions)

Please go ahead, Mr. Hayes.

Gregory Hayes

Good morning everyone, as you saw in the press release this morning, no surprises in the fourth quarter. Three takeaways, first, solid execution with strong margin expansion on the back of sustained cost traction.

Secondly, commercial aerospace and long cycle commercial construction markets remain tough but we did see some improvement in our short cycle businesses. And finally, very strong cash flow performance as a result of our continued focus on working capital.

So the story remains the same, continuing to focus on structural cost reduction, process excellence in our factories and our supply chain and back office functions, as well as focused portfolio realignment and disciplined cash redeployment.

None of this is new. All of these actions contribute to full year segment operating margin expansion of 50 basis points to a record 14.3% adjusted for restructuring and one-time items. And we accomplished this in a declining revenue environment.

Free cash flow was 118% of net income and included $1.3 billion of global pension contributions, that’s significantly more than we anticipated. UTC also announced strategic acquisitions such as GE Security while divesting lower return non-core businesses, particularly at Carrier.

Full year revenues were $53 billion, and that’s down 11% year over year. Earnings per share were $4.12 and that’s down 16% versus 2008. Absent restructuring and one-time items, earnings were down 8%.

Fourth quarter performance was solid across our businesses despite continuing end market weakness and we returned to EPS growth excluding restructuring and one-time items. Total segment operating profit grew 8% on a revenue decline of 3%.

And nowhere was this solid performance more evident than at Carrier, where portfolio rationalization and cost actions allowed operating profit to grow 34% in the quarter on a revenue decline of 12%. Four of six business units improved margins with Otis, Carrier, and Fire & Security increasing margins by more than 100 basis points each.

Sikorsky’s 10.4% operating margin in the quarter puts it firmly on track to achieve its margin targets in 2010 and beyond. Earnings per share in the fourth quarter were $1.15 and that’s down 7%. Excluding restructuring and one-time items in both quarters, earnings per share increased 5% on 4% lower revenues.

foreign currency was a tailwind with an impact of about $0.04 from translation. Organic revenue declined 6% in the quarter with declines across all businesses except Sikorsky, which saw 22% organic revenue growth and delivered a record 84 aircraft in the quarter, brining the total to 244 large aircraft for the year.

restructuring and other charges were $135 million in the quarter, that’s $830 million for the year. We continue to drive productivity throughout our operations and UTC’s headcount is now down by nearly 18,000 since the beginning of the year before the impact of acquisitions and divestitures.

Fourth quarter order rates remained stable although continuing at the low levels we saw in the third quarter. However as I noted before trends in our short cycle commercial businesses have improved. For example US residential gas furnace and split unit shipments were up 13% in the quarter.

In addition new equipment orders in China grew about 15% for Otis and around 20% for carrier. Akhil will take you through the orders detail by business unit in a just a few minutes. In the quarter free cash flow was 107% of net income at $1.2 billion and that included $637 million of contributions to our global pension plans.

Solid cash flow resulted from good working capital performance across the business. Inventory was again a source of cash. We reduced inventory by $550 million in the quarter on top of over $450 million in the third quarter. So more than a billion dollars of inventory out in the last half of 2009.

share repurchase in the quarter was $320 million bringing the year to date total to $1.1 billion. Acquisition spend in the quarter was $146 million and just as a reminder we expect the GE Security deal to close early in the second quarter now.

We ended the year with a strong debt to capital ratio of 32% and that’s down from 41% last year. So no surprises here. Just as we told you in December, it’s a quarter where we saw continued margin expansion, excellent cash flow in a still difficult end market environment.

I’ll come back and talk a little bit about 2010, but now let me turn it over to Akhil to take you through the business unit detail.

Akhil Johri

Thanks Gregory, turning to page three of the webcast, let me remind you that I will talk to the segment results adjusted for restructuring and non-recurring items as we usually do.

Otis had another exceptional quarter with profits up 20% despite a 1% decline in revenues. Operating margin expanded 390 basis points to 22%. Excluding currency and last year’s charge for inventory and other adjustments in Brazil, profits grew 6% on 7% lower revenues due to aggressive cost reductions, lower commodity prices, and continued strength in the contractual maintenance business.

New equipment revenue was down 14% in the quarter excluding currency with declines in most major markets partially offset by a double-digit increase in China. [inaudible] revenue was about flat as continued growth in the contractual maintenance business offset declines in both modernization and repair.

New equipment orders in the quarter were down 15% at constant currency. We saw growth in China where orders were up about 15%. Orders for Europe as a whole was flat while orders in North America were down around 50%. For the full year margins expanded by 250% to 21.8%. Operating profit was up 2% despite a revenue decline of 9% from swift cost reduction actions and commodity tailwinds. At constant currency operating profit increased 7% on 5% lower revenues.

On slide four turning to Carrier, consistent with guidance Carrier returned to profit growth in the quarter with operating profit up 34% on 12% lower revenues. This translates into 230 basis points of margin expansion bringing the margin to 6.7% for the quarter, the second highest Q4 margin in this last decade.

Carrier continues on the path of aggressive transformation to a simpler, more focused higher returns business. In Q4 the benefits of ongoing aggressive cost reduction and organizational restructuring combined with lower commodity costs, more than offset the impact of lower revenues. While organic revenues were still down 8% in the quarter, we are seeing improvement in the rate of revenue decline at Carrier.

In fact volume is up in the US residential HVAC and truck trailer businesses. Q4 shipments of US residential split and gas furnaces combined were up year over year for the first time since Q1 of 2006. For Carrier Transicold, in total orders were down only a little over 10% at constant currency, an improvement from the nearly 40% decline in the first three quarters of 2009.

On the other hand, there was no meaningful change in the rate of decline of longer cycle commercial HVAC business where revenues were down mid teens organically and we saw new equipment orders there fall by about 20% at constant currency.

For the year Carrier results were in line with guidance with adjusted earnings down $523 million on 24% lower revenues. Operating margin for the year was down 170 basis points, however proactive cost reduction and restructuring actions contributed more than 275 basis points of margin and partially mitigated the impact of the steep volume decline.

UTC Fire & Security delivered another solid quarter with operating margin expansion of 130 basis points to a record 13.1% on 2% higher revenues. Organically revenues contracted 9% with high single-digit declines in both Fire Safety and Electronic Security. Foreign currency translation and net acquisitions increased revenue by 8% and 3% respectively.

Operating profit was up 14%. Excluding the impact of FX profits grew 5%. Fire & Security continues to realize the benefits of integration of the field operations, organizational [inaudible], restructuring, and cost controls. Despite the lower revenues productivity initiatives drove down overhead by more than 100 basis points in the quarter from a year ago.

Consistent with our guidance Fire & Security held profits flat year over year while revenues declined 14% resulting in 150 basis points of margin expansion for the year. Now turning to aerospace, on slide six, at Pratt & Whitney, revenues declined 9% in the quarter driven primarily by the lower overall after market volume and Pratt & Whitney Canada engine shipments.

Engine shipments were down at Pratt Canada over 30% from last year’s strong fourth quarter. Large commercial engine spares were also down over 30% partly due to tougher compares as 2008 Q4 included the benefit from a [JB 90] distribution agreement. Book to bill in the quarter was about one.

Military revenues were up mid teens on higher engine deliveries. Operating profit at Pratt declined 9% in the quarter. The impact from lower revenues particularly of higher margin spares and unfavorable foreign currency at Pratt Canada was partially offset by fewer large commercial engine shipments, lower E&D and restructuring benefits.

Also you will recall that in the fourth quarter of 2008 Pratt & Whitney had recorded a favorable adjustment to a commercial engine program worth less than $0.02 of EPS. For the full year Pratt & Whitney operating profit declined 8% on 10% lower revenues. Operating margin at 16.1% was up 40 basis points for the year in spite of 25% decline in higher margin large commercial engine spares.

On slide seven in the quarter Hamilton Sundstrand revenues were down 8% with Aero OEM down high single-digits, industrial businesses down low teens, and Aero aftermarket down slightly. Commercial spares revenues were down high teens with book to bill of about one. [inaudible] order rates remain depressed and were down over 35% as airlines continue to conserve cash.

Industrial orders were down slightly over 10% in the quarter on constant currency. However they were slightly higher on a sequential basis from Q3. Operating profit declined 14% primarily from greater volume reductions in the higher margin businesses and the absence of an acquisition related liability adjustment last year.

The decline was partially offset by lower E&D expenses primarily on the 787 program as expected. We continue to invest in the program although at a lower rate as Boeing moves towards certification and entering the service of the 787.

For the year Hamilton Sundstrand revenues were down 9% with operating profit down 13% from the decline in higher margin commercial spares and industrial businesses partially offset by benefits from restructuring and cost reduction actions.

Turning to Sikorsky, record levels were achieved in Q4 where revenue, operating profit, and aircraft deliveries. Operating profits grew 33% on 22% higher revenues. During the quarter Sikorsky shipped a total of 84 large helicopters, 57 based on military platform and 27 commercial.

Operating margin expanded 90 basis points to 10.4% from higher helicopter shipments and product cost reductions. During the quarter Sikorsky’s Black Hawk helicopter fleet surpassed one million flight hours in Iraq and Afghanistan without a single significant failure.

For the year Sikorsky delivered a record 244 aircraft, above the high end of its commitment of 230 to 240 aircraft deliveries. Consistent with the guidance last December operating profits grew 29% on 18% higher revenues.

Operating margin of 9.7% for 2009 is up 80 basis points year over year and as Gregory said, puts Sikorsky firmly on track to achieve its margin targets in 2010 and beyond. With that let me turn it over to Gregory for wrap up.

Gregory Hayes

Thanks Akhil, just on slide nine on the webcast, just to summarize 2009, excellent execution through structural cost reduction and portfolio realignment along with strong cash performance in a difficult end market environment.

Margins improved despite lower volumes and we positioned the business for continued margin expansion when volume does return. This is evident in our earnings per share conversion. Excluding restructuring and one-time items, EPS declined 8% on a revenue decline of 11%.

Free cash flow was 118% of net income and that included $1.3 billion of global pension contributions. We drove down working capital by over $1 billion and inventory was down 8% for the year on an organic revenue decline of 7%.

We also returned about $2.5 billion to shareholders in the form of share repurchase and dividends during the year. although 2009 was a tough year there was a lot of good progress made across our businesses. Otis improved its industry leading operating margins with best in class products, service, and operating performance.

Carrier completed two thirds of its portfolio realignment agenda with simpler more focused higher returns business. Fire & Security significantly enhanced its geographic and product breadth with the GE Security and GST acquisitions. Pratt & Whitney launched testing of a full-scale GTE engine core and delivered its final development JSF CTOL engine as it readies for decades of production.

Hamilton Sundstrand systems successfully supported the 787 first flight and Sikorsky continued to increase its production velocity with record aircraft deliveries in the fourth quarter and for the year. On ACE we achieved Louis’ goal of 70% ACE gold and silver sights across the business by year-end 2009.

We also made significant progress towards deploying ACE at our key suppliers. In fact 50% of key supplier spend was at ACE gold and performing sites at the end of 2009. This is the type of performance that you’ve come to expect from UTC and gives us confidence that we have positioned the company for earnings growth in 2010 and beyond.

Now turning to 2010, in December Louis provided EPS guidance range for 2010 of $4.40 to $4.65, that’s growth of 7% to 13% on revenues of $54 to $55 billion. And we are affirming that guidance today.

Okay so let’s take just a couple of minutes to talk about calendarization, first on organic revenue growth, while we still expect to see full year growth of zero to 2%, organic growth in the first half of the year could be flat to slightly down and we’ll likely see a decline of 2% to 3% in the first quarter.

And while that is down that is still a significant improvement from the 6% organic revenue decline we saw in the fourth quarter. The pressure on growth come from the fact that we saw good backlog conversion into revenues in early 2009.

As an example Pratt & Whitney Canada shipped almost a thousand engines in the first quarter of 2009 and that dropped to about 700 by the fourth quarter and that’s the rate we expect will remain through most of this year.

Otis new equipment backlog is also down about 15% from last year and commercial Aero after market activity is only expected to pick up as the year progresses. In spite of these headwinds we expect restructuring benefits, a continuing focus on cost control, and favorable currency translation to provide earnings growth in the first half consistent with our full year earnings growth expectation of 7% to 13% growth.

On cash flow we continue to expect free cash flow equal to or in excess of net income. As Louis stated in December the acquisition placeholder is $3 billion and that includes the GE Security transaction. Share repurchase guidance is $1.5 billion for the year.

With our seasoned management team, structural cost reductions and significant after market content, we are well positioned to resume earnings growth and outperform in 2010. So let’s stop there and open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Nigel Coe - Deutsche Bank

Nigel Coe - Deutsche Bank

Just to pick up where you left off can you just talk about how you expect restructuring net of gains to pace for the year.

Gregory Hayes

For the full year we’re expecting about $350 million of restructuring, about $200 million in the first half probably spread evenly across those two quarters. We also expect gains for the year of about $100 million and I think we’ll see about $25 million of gains here in the first quarter and then $75 sometime in the third and fourth quarter. So $250 net.

Nigel Coe - Deutsche Bank

And then turning to Otis margins, can you maybe just talk about what you see on the OE pricing and maybe if you just throw in the OE margins, are you seeing any pressure on the OE margins within Otis and then if you adjust for mix normal mix of between OE and after market, where do you think the margins for Otis are, is this now a low 20’s business.

Gregory Hayes

Let’s start with the last part of that question, absolutely we think is a 20% plus margin business going forward. I think with the cost that the team have taken out over this past year and with the strong after market franchise, 20% is a goal that ought to be achievable not just for one year but on a continuing basis.

As far as pricing, pricing has been difficult. As you would expect with new equipment orders down 50% here in North America, we’ve seen some very difficult pricing. And as a result I think you’re going to see a little bit of pressure on new equipment margins coming into 2010. Saw pricing pressure in China, that’s a continuing thing. Even in Europe we saw pricing pressure and in fact I think we have been, the team has been very disciplined. We lost a little bit of share in 2010 at Otis but I think we did not give up on pricing.

And that cost of share, but I think its good discipline for us to keep pricing where it is.

Nigel Coe - Deutsche Bank

Can you just remind us on the other temporary cost reductions in 2009, how much of that is coming back in 2010.

Gregory Hayes

Its about, there’s about $750 million of call it temporary cost reductions, that’s furloughs, merit deferrals, probably see about half of that come back in 2010.

Operator

Your next question comes from the line of Joseph Nadol - JPMorgan

Joseph Nadol - JPMorgan

Just first of all on the calendarization of the sales, is that different than six weeks ago or are you just giving a little bit more color on that now.

Gregory Hayes

No I think its exactly as Louis had explained, its just as we started to look, revenues have been getting better although still down throughout 2009 and that trend is going to continue where you’re going to see slower growth in the first half than the back half.

We’ve always talked about kind of a back half recovery in the economy so nothing new, just trying to get a little bit of specificity out there so we don’t surprise people if we see earnings, but revenues down. Earnings will certainly be up in the first half but revenues could well be down especially in the first quarter.

Joseph Nadol - JPMorgan

Is there anything that’s changed, what would you highlight across all the businesses from when you gave your guidance six weeks ago.

Gregory Hayes

I think what’s changed in my mind is really some of the performance we saw at Carrier short cycle businesses where we saw really good traction I think in the US res business. We also saw good traction at Transicold in the truck trailer business in fourth quarter.

Joseph Nadol - JPMorgan

And then just finally US res turned for the first time as you mentioned in I guess almost four years, do you think that’s sustainable, do you think you’ll be in the black every quarter in terms of growth rate in 2010.

Gregory Hayes

I don’t know that I want to comment or predict quarterly growth rates, but yes we do see growth throughout 2010 at Carrier in the res business. Its going to be on the back of housing and an economic recovery.

Akhil Johri

And certainly we can give more color on that certainly at the March meeting when we are together with you.

Operator

Your next question comes from the line of Terry Darling – Goldman Sachs

Terry Darling – Goldman Sachs

Just on this phasing discussion, make sure I’m clear, you’re saying you would expect the 7% to 13% EPS growth for the full year to be consistent throughout the year and just to make sure we’re on the right starting point, $0.78 Q1 2009 so we’re sort of implying a range of $0.83 to $0.88 for the first quarter.

Gregory Hayes

That’s how the math would work out but yes I think, what we’re trying to do is just make sure everybody understands, first quarter is going to be a very tough compare versus last year on the revenue line because again we came out of 2008 with very strong backlog and still good production out of Pratt, so revenues are going to be a little challenged.

I think you’re going to see good cost traction the first quarter, Sikorsky is going to have a good first quarter because they’re not going to have the settlement costs from the union negotiation. We’re getting good cost traction so yes, I think, I’m not going to give quarterly guidance. I just want to make sure everybody understands, its just a tough compare.

But yes, 75 to 13% each quarter.

Terry Darling – Goldman Sachs

And then on the commercial spares at Pratt, just wondering if you can calibrate what happened sequentially there and what you are expecting in the first quarter there. The down 30% was down more sequentially on a year over year basis but did the spares number go down sequentially as well and would you expect we’re sort of running along the bottom here in the first half or could there be another leg down there.

Akhil Johri

We typically see a pick up in the fourth quarter of spares that is just the normal calendarization we saw that again this year. The reason why year over year compares were tougher was because of this agreement we had last year on JD90 which propped up these spares last year in fourth quarter. So if you adjust for that the year over year run rate would be about 25% which is consistent with what we have seen through the rest of the year.

And at some point the airlines will have to buy these spares, the question is when does that happen as traffic improves probably first half may be a little difficult but I think second half should be strong.

Gregory Hayes

We don’t expect to see another leg down here in commercial air, I think its been, what we saw last year we think was the bottom. Airline profitability is still a challenge going into 2010 but we are seeing better inductions into the engine centers and we would expect to see spare pick up kind of gradually through the year.

Terry Darling – Goldman Sachs

And just to be clear, there really is nothing changed on your commercial after market view overall for Pratt and Hamilton relative to December, is that correct.

Gregory Hayes

That’s right we still think they’re kind of up 6%, 7% for the year about half of that on RPM growth and the other half on pricing.

Terry Darling – Goldman Sachs

And then on China you had talked about China running a little bit better in December and the order rate that you called out on the commercial side certainly reinforced that, I’m just wondering your take on the tightening efforts and what impact that might have on China in the second half of your 2010 year at this point in terms of what you’re field people are telling you in terms of conversations with customers and so forth there. Do you think that we’re going to see a little bit of a moderation in growth in some of those numbers in the second half or how are you looking at that now.

Gregory Hayes

What we are hearing from our folks in China is that the bank lending is starting to tighten. I think we’ve seen that across the headlines here for the last couple of weeks and that’s really focused on trying to keep some of the economic growth, the factories, and some of the residential housing prices in check to eliminate the possibility of an asset bubble there.

We’re still seeing good order intake though on the infrastructure and on the low end housing market which is where Otis plays primarily as well as Carrier so, we’re still expecting a good full year 2010. In fact, they’re still going to spend $250 billion of stimulus in China this year on the infrastructure projects on that low end residential housing so again, the idea there is you’ve got to keep growth from getting out of control, but I think we still are expecting 9% to 10% GDP growth evenly throughout the year there.

Terry Darling – Goldman Sachs

At the total commercial level, is there a way, can you call out what growth in China was overall in 2009 and maybe what you would think is a reasonable range for 2010 to calibrate us there.

Akhil Johri

I can give you the specific details later on. I think for the fourth quarter we saw it roughly 15% to 20% kind of growth in the order rates across all our commercial businesses and I think in terms of revenues because there’s a little bit of a lag probably a little less than that but still pretty good growth, double-digit growth in China across in revenues and 15% to 20% on orders.

Gregory Hayes

Just to be clear orders were down for the year. Otis orders in China were down about 15% for the full year. For Carrier it was down almost say about 10% to 12% for the year so it was a very tough first half. We saw good traction in the back half and that traction is really going to continue throughout 2010.

Operator

Your next question comes from the line of David Strauss - UBS Securities

David Strauss - UBS Securities

Your flattish revenue forecast for Carrier for the year, can you just walk through all the different moving pieces there between what you’re expecting specifically out of res and commercial and Transicold and then the offset with the divested revenues.

Akhil Johri

I think, let’s start with divested revenues first, there is about $500 million of divested revenue impact next year, that’s just for the annualized effect of divestitures done in 2009. There is organic growth of low single-digit, call it 3% or so in the assumptions overall and the breakdown of that would be double-digit growth in US residential, 10 to 20% sort of level for transport refrigeration, offset by a decline in commercial HVAC.

David Strauss - UBS Securities

And at Otis are you still thinking on the new equipment side down mid to high single-digits.

Gregory Hayes

Yes I think given where we ended the year with orders down and backlog down about 15% it will probably be towards the higher end of that range on the downside, probably closer to 9% or so down for the year.

David Strauss - UBS Securities

And the guidance you gave for 2010 back at the investor conference I think you talked about $0.20 to $0.25 contingency at the mid point obviously the dollar has moved a little bit against you since then, is there anything that’s made up for that move in the dollar or have you [inaudible] into your contingency a little bit.

Gregory Hayes

When Louis stood up we talked about a contingency at the mid point which is about 10% growth where we had about $275 million of contingency. I think the euro this morning is about 141 versus our guidance of 148 and that’s cost us let’s call it $75 million but we had to have some good news on the pension plan, the discount rate on the pension we had assumed 5.7 back in December ended up being around 6% for the US plan.

We also had a little bit of returns, we did a little bit more funding for the pension plan so add all that up and it gives us about $50 million of benefit versus the guidance that we gave you in December, so that’s a long way of saying contingency is probably about 250 today at the mid point.

Operator

Your next question comes from the line of Howard Rubel – Jeffries & Co.

Howard Rubel – Jeffries & Co.

Could you talk for a minute about foreign military sales for Sikorsky, I know that’s going to be part of what happens going forward, the opportunities.

Gregory Hayes

I think the biggest opportunity in front of us right now is with the international Black Hawk and I think the biggest opportunity on that program is going to be in Turkey in the near-term. That’s a very large contract that’s up for bid right now. We’re competing with [Augusta Westland] so I think we’ll hear on that contract shortly.

But the key for us on the international Black Hawk is low cost sourcing and low cost manufacturing and we’re gearing up in Poland to build the international Black Hawk there. Significantly lower cost obviously than Stratford so we think there’s a huge market out there. The US market, the European market is pretty well spoken for but international Black Hawk still opportunities we think in Taiwan, and Singapore.

Howard Rubel – Jeffries & Co.

From time to time the JSF has been a topic and this might be a good opportunity for you to sort of give us an update on the progress on the engine and how well its going so that you kind of eliminate some of the confusion.

Gregory Hayes

I don't think there’s any, there shouldn’t be any confusion on the development of the engine, the engine has performed beautifully in the flight test program. We had a little hiccup about a year ago with a blade but I think all of that is behind us and we are on track. We are delivering engines under the [L rip] program right now. The [Stouvall] version is in test. That’s also performing very well so we see nothing but upside on that program right now from an engine standpoint.

Howard Rubel – Jeffries & Co.

And then second, when you look at your outlook for Carrier how are you weighing the risks of the stimulus for housing abating and maybe the market petering out, how are you balancing that risk versus the 550,000 units a year.

Gregory Hayes

The 550,000 was obviously a low point and we do expect modest growth I would tell you in housing this year but if you think about US res its really becoming add on replacement market, over 80% of the revenues in res now come from add on replacement so new housing starts make up a very small percentage of total revenue there.

Again AOR as we would call it is really more dependent upon overall economic growth as opposed to growth in housing so housing price stabilization is important I think for consumer confidence and we expect all of that to be positive this year but not in a big way.

Howard Rubel – Jeffries & Co.

So you’re sort of sizing for, I know you, modest growth but you kind of looked at the downside and feel like some of this stimulus is, are you just being careful that if some of the stimulus has a transitory effect it won’t impact your business plans.

Gregory Hayes

Yes, I think Carrier is pretty calibrated on the res side. We don’t expect much impact from the elimination of the housing tax credit here. I think that happens in March or April but quite frankly with 550,000 starts its hard to imagine a lower 2010.

Operator

Your next question comes from the line of Deane Dray - FBR Capital Markets

Deane Dray - FBR Capital Markets

Can we get an update on Transicold, it looks like that you recovered nicely from last quarter the order fall off, is that, do you have some visibility on that business now, do you think the worst is behind you.

Akhil Johri

I think the truck trailer business clearly seeing improvement, North America more than Europe but both grew in terms of orders year over year. The container business is still down year over year in orders but a lot better than the 80% number that we quoted in the past. So clearly some signs of improvement there.

Like the US HVAC residential market, I think we believe transport refrigeration is probably an early indicator and that’s an encouraging sign.

Deane Dray - FBR Capital Markets

And then the other early indicators you say are the residential [A track] business of Carrier, we’ve got a different dynamic this year with the [Watts Co] joint venture is there anything in terms of how we’ll be watching inventories in the channel, will it be more difficult for us to track that and what is the assessment of inventories today.

Gregory Hayes

I think our visibility in inventories remains the same. Remember this is a joint venture we have with [Watts Co] called Carrier Enterprises, so we still see what’s going on in the marketplace and as we continue to divest out of some of the distribution we’ll continue to have equity stakes in these ventures to give us visibility.

Inventory is down across the channel and I think that’s actually an encouraging sign for us because when we see any pick up in economic activity we’re going to have our factories back up and running to support that. So I think its down in line with the market but upside for us for the year.

Deane Dray - FBR Capital Markets

And then just to clarify you updated the numbers on restructuring expectations for 2010 and can you just reaffirm on the saving for expected incremental savings on the carryover from 2009 and then the new restructuring initiatives on 2010.

Akhil Johri

We have about $350 million of savings in 2010 from the restructuring actions taken in 2009 and a little bit from the 2010 program that we have on the [inaudible]. Keep in mind that those savings will come more early in the year and then a little bit less as we got some good savings last year as well.

Deane Dray - FBR Capital Markets

So the 350 is what you talked about in December and can you calibrate the expected on 2010 yet.

Gregory Hayes

I think 2010 you’re looking at probably less than $50 million of incremental savings this year. Most of that payback is going to really come in 2011 and 2012 as we’re taking on some of the longer restructuring sort of the more structural things like factories and such that you don’t see the payback right away but its still maybe about $50-ish million this year.

Akhil Johri

And just to be clear the 350 we said in December contemplated that [inaudible]. If you recall the 2009 restructuring savings were profiled at 300 in 2009, 300 in 2010 and another 100 in 2011.

Operator

Your next question comes from the line of Ronald Epstein – Bank of America

Ronald Epstein – Bank of America

What are you seeing on the M&A front, how is pricing in M&A markets and can you give us some color there.

Gregory Hayes

You see the equity markets every day, you know. The fact is prices have recovered and I think that’s maybe the message of the day as we think about the M&A pipeline. There’s still a lot of targets out there but pricing has certainly firmed up from what it was a year ago when we talked about being aggressive on the acquisition front.

There’s really nothing to talk about in terms of the pipeline except to say that its full. We’re going to be disciplined and we’re not going to do a big deal. We’re not looking to do a big deal. What we’re looking for are more deals like [inaudible] Wind Power where we can add to some of our capabilities and take advantage of some good valuations and you may see more smaller deals like that during the course of the year but more in the core, we’re not looking for the big deal.

Ronald Epstein – Bank of America

And then maybe on the GTF can you give us an update what’s going on with that in terms of the testing and then for the various programs that its on.

Gregory Hayes

The engine is on test, it started in mid December or so on full scale testing up in Canada. Its performing as we expected. The program, the C Series program continues on track, lots of talk out there in the market about the C Series. MRJ, that program has slipped a little bit as you know but the engine continues to work. And we’re working with the other OEMs as well on potential re-engining opportunities and I think there’s lots of pull from airline customers for what the GTF has to offer which is 10% to 15% better fuel burn and lower noise, lower emissions, and all those good things.

So, we think 2010 will be a very good year for the GTF. We see lots of opportunities and we’ll just update you as we go along.

Operator

Your next question comes from the line of Sam Pearlstein - Wells Fargo

Sam Pearlstein - Wells Fargo

I just wanted to follow-up on the comment you made about the spares and if you ex out the JT 90 comparison pricing usually changes on Jan 1 and I guess I’m wondering, one, did you see a pre buy in December ahead of that, and can you talk about what the realized price actually was for spares in 2010 versus 2009.

Akhil Johri

We typically see the pre buy and this year was no different then that. The level I would say is also consistent with what we’ve seen in the past years and the pricing realization is also consistent with what we see every year so no new news there, no surprises, everything as you would expect.

Sam Pearlstein - Wells Fargo

And then the $577 million reduction in inventories in the fourth quarter can you talk about where that mostly came out of and as we think about a recovery in the businesses during 2010 are you going to be able to hold inventories at these levels or should we start to see that growth in 2010 versus 2009.

Gregory Hayes

That’s clearly the challenge is to keep inventories in check and to improve turns as we see some of the demand come back. In terms of the reduction for the fourth quarter about $450 million of that let’s call it 550 ex acquisitions and all that, 450 came from Carrier, Pratt, and Sikorsky. That’s good news at Sikorsky, and you would expect that on those high shipments.

Otis also had a good quarter taking out almost $90 million of inventory so really good in fact each one of the businesses actually took out inventory during the fourth quarter so good performance across all the businesses.

Sam Pearlstein - Wells Fargo

The deferred income tax line of the $415 million or so in terms of the cash, what is that related to in the fourth quarter.

Gregory Hayes

That’s really related to the pension contributions that we made primarily.

Operator

Your next question comes from the line of Jeff Sprague - Citigroup

Jeff Sprague - Citigroup

Just on the inventory both for the quarter and the year, did that end up being a net negative or positive to the P&L, in other words you had absorption issues as a result of that but you also probably cut into some LIFO layers along the way. How do you think that shook out.

Gregory Hayes

I think in total it was a net negative to the year. We had big absorption across most of the businesses as you can imagine with Carrier’s volume down as much as it was. At Hamilton I think the absorption impact was over $100 million alone and there was a little bit of benefit in the fourth quarter from LIFO that came partially from divesting of some of those Carrier distribution businesses but also just on the lower volume.

So on a net basis I would tell you it was a big negative.

Jeff Sprague - Citigroup

The flipside of Howard’s question on stimulus, stimulus for energy retrofit on commercial has been AWOL, have you seen any uptick in energy performance contracting or anything on the commercial side that mutes the negative headwinds in 2010 on commercial OE.

Gregory Hayes

We’ve certainly seen some good traction at the [Norersco] business which is the energy services contracting business that we bought in late 2008. They’ve got a very strong backlog. The problem there is it’s a $200 million or so business as compared to the total totality of the commercial HVAC business so its going to be improving this year.

We have seen good traction on the government side which is where they focus. But in terms of stimulus impacting or energy efficiency impacting the rest of the PSS, its really pretty moderate.

Akhil Johri

The only real benefit has been in the US residential business where the mix is better because of the rebate for [15 inaudible] equipment. That has driven the mix up which has helped the margin a little bit, again not meaningful but has certainly been the most positive impact.

Jeff Sprague - Citigroup

And then on Carrier resi in particular can you give us a little color on how price cost dynamics are playing out. Obviously everybody is hearing some footsteps on cost and we’re running at real low utilization rates, what do you think is the shape of pricing as the year unfolds here, what’s going on in the channels right now.

Gregory Hayes

I think pricing is probably the one question mark we have and maybe the biggest risk as we think about Carrier for the year. As volumes pick up we know that there’s excess capacity in the channel out there. I think the good news from a Carrier perspective on a cost side over the last year and a half Carrier has actually reduced the break-even point of the big res factory in Tennessee from about a 50% volume to 25%.

So we think we’ve got a cost advantage out there. Obviously copper could be a headwind if we see that start to pick up here as we have in the last quarter but from a cost perspective I think we feel pretty good. Pricing is the great unknown and again we have to stay disciplined, just like Otis stayed disciplined last year. I think Carrier is going to have to remain disciplined and not give up on pricing.

Jeff Sprague - Citigroup

And on GTF, obviously there’s been a lot of development dollars expended along the way here for years as you work on this, but if one of the big commercial OE actually hits the bit if you will on a re engining program, what kind of inflection in E&D spending would that trigger as it relates to the GTF.

Gregory Hayes

Obviously there would be a big bill associated with any re engining of one of the large commercial transport, be it the 737 or A320, the good news of course is we have partners out there that would absorb a big chunk of that but you would see and inflection. You probably wouldn’t see it in 2010, its probably more a 2011 phenomenon because even if something that was selected this year, to ramp up spending, I don’t think you’re going to see it until 2011 and really probably even 2012, 2013 before you get to the bigger dollars.

Jeff Sprague - Citigroup

Can you give us an idea though of order of magnitude even after once you dish off pieces to partners and the like.

Gregory Hayes

It’s a big number. I think the question is how much of it goes to the partner share and how much of it ends up on our P&L but if you think about it Pratt spends about $700 million a year on E&D now so obviously other programs will go down. This will replace a piece of that spending but you’ll probably still see an incremental number, but you’re not talking about $ 2 or $300 million a year.

Operator

Your next question comes from the line of Robert Stallard – Macquarie

Robert Stallard – Macquarie

Going back to the aerospace after market on the commercial side, I was wondering if you could give us an idea of how orders in this area have progressed over the last quarter and if possible into this year.

Gregory Hayes

We’re not going to get down to daily and weekly order rates discussion here. I think the market is trending as we expect it. I think that’s probably the best way to put it. Obviously fourth quarter was pretty similar to the third quarter when you adjust out everything so we didn’t see a big change sequentially from the third quarter to the fourth quarter but the market is really progressing as we would expect.

That’s kind of this slow gradual recovery that we’ve talked about earlier.

Robert Stallard – Macquarie

And as you talk to your airline customers do you get the sense that this destocking trend is coming to an end or is there further to go.

Gregory Hayes

I think again 2009 was all about cash conservation. I think the airlines will probably lose money globally again in 2010 but they are still flying and I think as we see in the reported results of especially the US majors, it looks better. They’ve done a great job on cost, they’re raising revenues, and I would expect as they continue to fly these aircraft they’re going to need parts.

And we expect RPMs to probably be up about 35 this year and as long as they fly, they’re flying our engines. We haven’t seen a big uptick in parked aircraft. Again, I think that all bodes well for a recovery here in 2010.

Robert Stallard – Macquarie

And then on the acquisitions you said GE Security was going to close slightly earlier than you expected, is that going to have a material impact.

Gregory Hayes

No I think as you think about, we’ve talked about first half, we just got US and Canadian antitrust approval. We’re in the queue in the EU to have approval in late February so we’ll probably close 30 days or so after that. Think about it for the whole year, we’re not expecting any type of net pick up in terms of accretion dilution.

We’re going to issue some debt to pay for the deal. We’ll do that right around the close time so we think interest expense, it really offsets what we expect to be about $80 million or so of profit that we’re going to see for the year from the acquisition.

Akhil Johri

Just as a reminder I think when Louis said in December its consistent with that, our guidance assumed about a April close at that time with $800 million of revenue and $75 to $100 of earnings. That was part of our guidance in December and this is consistent with that.

Operator

Your next question comes from the line of Cai von Rumohr - Cowen & Co.

Cai von Rumohr - Cowen & Co.

Good quarter, so R&D looked a little bit light in the fourth quarter where do you expect R&D for the year to be in 2010.

Gregory Hayes

I think when Louis gave guidance back in December we said up about $75 million, given that A&D came in a little light in Q4, we would now expect E&D to be up about $100 million for the year and most of that is going to be at Pratt with a little bit at Sikorsky. I think you’re seeing E&D flattish at Hamilton where you’ve got news off 787 spend coming down but really replaced by C Series and the A350.

Cai von Rumohr - Cowen & Co.

And the follow-up to Jeff’s question what sort of progress have you made in terms of integrating the GTF into the international Aero partnership given that that’s something that Airbus views as important.

Gregory Hayes

I think it has always been our goal to have the GTF be a part of the IAE joint venture and to go to market through IAE. Obviously that’s all subject to approval by our partners and we’re still working through that and I think we’re going to continue to work through that with Airbus during the first half of the year.

Cai von Rumohr - Cowen & Co.

And what’s the impact looking out, you had mentioned that the JFS engine is all upside and yet the rumors that the DoD is going to cut by 20% F35 production through 2015, and the F16 it looks like the 2012, 2013 customers, Turkey and Egypt are brand X’s engine versus today you’ve got the production. Should we worry about Pratt a little bit more as we look out there in terms of what’s happening to the military engines or do you still think the after market and biz jet can outweigh that.

Gregory Hayes

Are you specifically concerned about JSF production in the next couple of years, is that—

Cai von Rumohr - Cowen & Co.

It would be, so as we get out to 2012-ish, 2013 before we have GTF contributing if there’s less JSF engines if the F16 is going down, C17 is going down, and you have R&D at a relatively high level for the GTF, is there a growing concern that Pratt would be flat or do you think that Pratt Canada and after market and restructuring can still give you growth during that period.

Gregory Hayes

There’s no doubt I think 2011 will be kind of a low point on the military engine business, you’re going to see the engines for the F22, they start to go away after this year. JSF does not ramp up to replace all of that until 2013, 2014. I think Pratt is going to be challenged next year but to your point, we’re going to see benefits from restructuring next year.

You’re going to see a little bit of recovery in spares continue and you’re going to see better outlooks from Pratt Canada. So again it’s a little early to give guidance out of 2010 but I think Pratt understands the challenge and the military is certainly going to be a headwind for them in the next couple of years.

Operator

Your next question comes from the line of Heidi Wood – Morgan Stanley

Heidi Wood – Morgan Stanley

Question on Hamilton Sundstrand, if you could give me a little bit more color I know we saw a 10% decline in revenues and a 32% decline in profits, clearly weaker in spares and you gave us color on industrial and commercial but can you add even more color on what we saw and talk about the sustainable margins in 2010.

Akhil Johri

I think for Hamilton the numbers you quoted were reported numbers so when you adjust for restructuring and Hamilton did a lot of restructuring as you would expect in this environment, I think the numbers are closer to down 13% for the year on earnings. That primarily is because of the, both their spares business and their industrial business were down about 20% for the year, year over year on revenues.

That’s a big decline on their highest margin businesses. So that put a lot of pressure on it. They did do a lot of cost actions like everybody else, furloughs, travel restrictions, and restructuring, all that gave them about $200 million of good news in the year but that wasn’t enough to offset the declines from the higher margin businesses.

Heidi Wood – Morgan Stanley

I’m sorry those numbers I quoted I backed out the restructuring and I still found that it fell short but it was just the significant weakness more in the commercial side.

Akhil Johri

Commercial spares and industrial.

Heidi Wood – Morgan Stanley

And then what about what we should think about then about margins in 2010 and also touch on when will we see provisioning spares on the 787 ramp up, does that happen in 2010.

Gregory Hayes

No I don’t think so, I think margins ought to be up at Hamilton this year just on the back of the cost reduction that Akhil talked about. Revenues will be challenged there again primarily because of the regional jets going down as well as some of the military vehicles that have been a big piece of the revenue for the last couple of years.

So, they’re going to be challenged on the top line but cost reduction will actually give them some margin expansion this year. As far as provisioning, provisioning was as big piece of the after market. We saw that down significantly last year and don’t expect it to pick up much this year and specifically on the 787 with entry into service probably here towards the end of 2010 we wouldn’t expect a big uptick in provisioning orders in 2010 especially since the first customer which is ANA, they’re actually on our long-term, we call it a care program, where they don’t actually provision but they just pay us a fee for the provisioning.

Heidi Wood – Morgan Stanley

Okay so that’s something we can anticipate for next year.

Gregory Hayes

Yes.

Heidi Wood – Morgan Stanley

And then on GTF another way that I’m wondering about is how do we think about the risk to the C Series given that Boeing and Airbus have lodged complaints on [inaudible] subsidies even though that is a little like calling the kettle black.

Gregory Hayes

I think its actually a great testimony to how good the GTF is that Boeing and Airbus are concerned about the C Series. So I think again it’s a good aircraft. Bombardier is going to have it to market ahead of any re engine A320 or 737 and we think there’s nothing but upside with GTF.

Operator

Your next question comes from the line of Myles Walton – Oppenheimer

Myles Walton – Oppenheimer

Good quarter, question for you on the cash side of the house, you obviously added another $500 million on the, I think you had placeholder for 2010 of $400 domestic $200 million international, I assume the international hasn’t changed. Has the domestic.

Gregory Hayes

We did a lot of prefunding in December as you noted, we still have a $400 million placeholder out there and I think again cash ought to be strong again this year so we’re still anticipating another $400 million but it really depends I think on the market and cash but $400 is a good placeholder for now.

Myles Walton – Oppenheimer

And the other cash item was on CapEx, obviously you pulled back the reins pretty hard in 2009 on CapEx do you go back in 2010 to more of the $1.2 or equal to D&A kind of rate.

Gregory Hayes

No I think, CapEx was down a little over 30% last year. obviously all the businesses, we saw the economic environment they tightened up and Louis put out an [inaudible] out there to cut back on CapEx. The guys executed on that. You’re going to see a little bit of an increase this year, not back to the levels that we saw in 2008 but you’re going to see a little bit of uptick in CapEx year over year.

Akhil Johri

There are a few program related investment that need to be made, for example in Pratt you see the setting up of the Turkish and the Shanghai engine centers, so there is some CapEx which got pushed out from 2009 into 2010 which will put a little pressure but we don’t expect it to be any where close to the $1.2 billion. It will maybe be a double-digit increase but not much more than that.

Operator

Your next question comes from the line of Doug Harned - Sanford Bernstein

Doug Harned - Sanford Bernstein

Could you on Carrier walk through some of the actions that have been taken, I know you’ve done a lot on headcount reduction, you’ve talked about R&D consolidation, exiting underperforming businesses, I’m trying to get a sense of where you are right now in terms of actions that have pretty much been completed and what you have ahead of you in the next year or so.

Gregory Hayes

As we said in the opening comments we think we’re about two thirds of the structural work has been done at Carrier. The other third is still to come. I think the key and Geraud will take you through this in more detail in March is you’re going to see some more on the international res, we’ll be exiting some of those, and of course just continuing down the path on the US distribution business and we’ll probably see more of that here in the first half.

But the big tough things have been done. I would say the heavy lifting is behind us but still some more, and again Geraud can give you a lot of detail here and he’ll spend some time in March on that.

Doug Harned - Sanford Bernstein

And then similarly on Fire & Security, I know one of the things that [inaudible] has emphasized was the need to do consolidation around service centers, where are you on that, is this at a point where its being implemented or are you still in the planning stages for that work.

Gregory Hayes

No we’re going full tilt there. We started last year in France, we’ve got some more teed up around Europe this year. You’re going to see in fact a big piece of the restructuring cost this year are going to be at Fire & Security not just for GE Security but also to continue on the branch office consolidation. That ought to be wrapped up by the end of 2010 or so.

Doug Harned - Sanford Bernstein

So we should actually see savings impact from that in 2010.

Akhil Johri

Some savings from the actions, as you can imagine this is a geographic business so we started actions in Australia, we’ve seen benefits from that. There are actions in France as Gregory talked about we’re just starting to see some benefits in 2010. Bulk of the benefits will come in 2011 and 2012.

Operator

Your final question comes from the line of George Shapiro – Access 342

George Shapiro – Access 342

I wanted you to run through sequentially both at Pratt and Hamilton Sundstrand the margin was down despite revenues being up and I thought I heard you say that normal seasonality is that the spares are up a little bit sequentially in Q4 versus Q3, so I’m just looking for the reason for the margin decline. My guess is maybe its more OE zero margin engine deliveries but if you could provide the color.

Akhil Johri

Let’s take Pratt first, the normal seasonality on the spares is also followed by seasonality in E&D where E&D ramps up in fourth quarter typically so we saw from Q3 to Q4 an increase of approximately $50 million in the Pratt E&D number. The second thing to keep in mind there is if you go back to our third quarter call we mentioned a one-time benefit in Pratt numbers associated with several contract adjustments.

We talked about a $35 million number there which was on a year over year basis, in the quarter the number was more $50 plus so if you take those two factors into account, higher E&D and the one-timer in Q3, you pretty much explain the margin change there.

And for Hamilton actually sequentially there is really no change in the margin. the margin is pretty consistent, about similar level of profit on similar level of sales. The little decline there is also a function of E&D being higher in Q4 as compared with Q3.

Gregory Hayes

Maybe just to close, just a final word on 2009, a great year for execution. Its positioned UTC for earnings growth in 2010 and beyond. Thanks for listening today. We appreciate your time. We look forward to seeing everybody in March at our annual investor meeting. Its going to be on March 12 in New York City and Akhil and the team will be happy to take your calls throughout the day. So thank you.

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Source: United Technologies Corp. Q4 2009 Earnings Call Transcript
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