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United Technologies Corporation (UTX)

Q4 2013 Earnings Conference Call

January 22, 2014 09:00 AM ET

Executives

Greg Hayes - SVP and CFO

Jay Malave - Director, Investor Relations

Analysts

Carter Copeland - Barclays

Samuel Pearlstein - Wells Fargo Securities

Julian Mitchell - Credit Suisse

Doug Harned - Sanford C. Bernstein

Jeff Sprague - Vertical Research Partners

Cai von Rumohr - Cowen and Company

Howard Rubel - Jefferies

Peter Arment - Sterne, Agee & Leach, Inc.

Myles Walton - Deutsche Bank

Joe Nadol - J.P. Morgan

Noah Poponak - Goldman Sachs

Nigel Coe - Morgan Stanley

Robert Stallard - Royal Bank of Canada

Operator

Good morning and welcome to the United Technologies’ Fourth Quarter Conference Call. On the call today are Greg Hayes, Senior Vice President and Chief Financial Officer; and Jay Malave, Director, Investor Relations. This call is being carried live on the internet and there is a presentation available for download from UTC’s website at www.utc.com.

Please note, the Company will speak to results from continuing operations, except where otherwise noted. They will also speak to segment results adjusted for restructuring and one-time items as they usually do.

The Company also reminds listeners that the earnings and cash flow expectations and any other forward looking statements provided in this call are subject to risks and uncertainties. UTC’s SEC filings, including its 10-Q and 10-K reports provide details on important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements.

Once the call becomes open for questions, we ask that you limit your first round to two questions per caller to give everyone the opportunity to participate. You may ask further questions by reinserting yourself into the queue and we will answer as time permit.

Please go ahead, Mr. Hayes.

Greg Hayes

Thank you, Stephanie and good morning everyone. As you saw in the press release, UTC reported 2013 earnings per share of $6.21. Our integration of the transformational deals and solid execution drove 16% earnings growth despite a slower than expected recovery in our end markets.

For the full year of Goodrich, UTC Aerospace Systems generated over $2.1 billion of operating profit. The addition of IAE or International Aero Engines along with aggressive cost reduction helped Pratt & Whitney grow earnings by a $177 million and Climate, Controls and Security, also delivered a strong 2013 with 9% earnings growth and 15.7% operating margins.

Even with the investments we’re making for the ramp in aero, we delivered strong free cash flow at a 102% of net income for the year. Gross sales for the year were $63 billion, that’s up 1% organically, and as you see on Slide 2, strong momentum as we exit the year.

Organic sales were up 4% in the fourth quarter after being flat through the first three quarters. In the commercial businesses we saw 7% growth on the Americas, driven by a continued U.S economic recovery. Europe was flat and Asia grew about 4% with ongoing strength in China, where sales were up 9% more than offsetting weaknesses in the other Asian countries.

In aerospace, continued weakness in defense was more than offset by a very strong growth in our commercial OE and aftermarket, where overall sales increased 14%. So it’s an accelerating top line to go along with improving economic environments.

In the U.S., consumer sentiment and spending continue to improve on strength in the equity and housing markets. Europe is also seeing moderate improvement with the PMI expanding for six consecutive months and return to modest economic growth. And in China construction starts and property transactions were strong for the year, giving rise to solid backlogs across our commercial businesses.

Okay, Slide 3. In addition to the accelerated organic sales growth and an improving economic outlook continued strength in orders decision us well as we enter 2014. At Otis, new equipment orders were up 8% with broad based strength around the world and the Controls and Securities global equipment orders grew 5% with double-digit growth in the Americas. In the aerospace business, commercial spare orders were up 20% in Pratt & Whitney and 19% at UTC Aerospace Systems.

Okay, taking a look at fourth quarter earnings on Slide 4 now. As always a few puts and takes as we close out the year. Earnings per share of $1.58 included a $0.11 of restructuring charges, partially offset by $0.02 of gains from tax settlements and the ongoing portfolio transformation CCS.

Absent restructuring and one-time items in both years, earnings per share increased 29% versus prior years and that was driven by a few different items. First of all, very strong performance at CCS and Pratt & Whitney and UTC Aerospace Systems which all delivered profits in excess of our guidance to you.

We also had the absence of a $100 million of inventory step-up cost that we recorded in the fourth quarter of last year related to the Goodrich acquisition. We also saw a lower tax rate this quarter. It was $0.06 better than last year and $0.04 better than what we had expected back in December. And of course lower Canadian Maritime helicopter program charges this year.

On Sikorsky, operating profit grew 10% including the absence of the 2012 charge related to the CMHP. Sikorsky shipped 77 large helicopters in the quarter and 240 for the year with 100% on time delivery to the U.S government. As we said in the press release we did not recognize revenue on any of the CMHP helicopters in 2013 resulting in a net $0.06 benefit versus our expectations. That’s $0.08 from the lack of deliveries, partially offset by a $0.02 charge for cost growth associated with the delay.

As we reported in the press, Sikorsky concluded a principles of agreement with the government of Canada on December 31. This is a positive step towards replacing the aging Sea King fleet. Preliminary pilot training is ongoing in Shearwater, Canada and it will be completed as planned this month, which will allow for the start of operational testing by the Canadian forces shortly thereafter.

The $89 million of liquidated damages associated with late deliveries were fully reserved in prior years. We continue to work with the Canadian government on a final contract amendment and we’re going to maintain our place holder of eight aircraft for 2014.

Okay, enough on Sikorsky. Let’s go back to the fourth quarter. All sales increased 2% and as I mentioned there was 4% organic growth, which is offset by two points of headwind from ongoing divestitures at CCS as well as Pratt & Whitney’s Power Systems business which was divested earlier in the year.

Free cash flow of 136% of net income in the quarter and we paid down an additional $1 billion of debt. It’s important to note in the last 18 months we’ve now paid out approximately half of the debt associated with the Goodrich acquisition. We also bought back an additional 200 million of shares in the quarter, which brought us to a $1.2 billion total for the year.

We remain confident in our growth outlook and we announced a dividend increase of 10.3% in October. The businesses continue to reduce their cost structure in 2013 and identified solid payback restructuring projects, totaling almost $500 million for the year. Restructuring was offset by one-time gains and spread across the business units. Pratt & Whitney led the way with over $150 million of restructuring. UTC Aerospace Systems, CCS and Otis each spent close to $100 million. And we continue to see pull from the businesses for additional restructuring as we entered 2014.

So strong close to what was a good year at UTC. I will be back to talk about 2014 in a few minutes, but first let me turn it over to Jay to take you through the segment results. Jay?

Jay Malave

Thanks Greg. Turning to Page 5, Otis sales improved 4% organically in the quarter with new equipment sales up 10%, including double-digit growth in China and the Americas and modest growth in service. Operating profit was flat to constant currency with profit growth in Asia led by China is largely offset by continued factory transition costs in North America.

Profit in Europe is stabilizing. New equipment order growth remains robust, up 8% to constant currency with mid teens growth in China and the Americas and strength in the Middle East. New equipment backlog ended the year up double digit versus the prior year. For the full year, operating profit was flat at 4% higher sales.

On Slide 6; climate, controls and security increased profits 12% in the quarter and a 1% increase in sales, resulting in another sharp increase in margins of 150 basis points from prior year of 15.2%. Organic sales continue to steadily improve and were up 4% in the quarter.

The geographic mix was consistent with recent trends. Europe was flat, China was up high single digit while Asia overall was flat though mainly by a decline in Australia. Americas was up mid single digit driven by 18% growth in the residential HVAC business. Transicold was up 22% with solid growth in Eastern European truck and trailer business and a robust recovery in the container market after a weak quarter last year.

Profit growth in the quarter was driven by strong conversion on organic sales, restructuring savings and net productivity, which more than offset headwind from divested earnings. Orders for global commercial HVAC equipment were up low single digit in the quarter. Orders for global fire and security products were up 10%, although that was largely offset by a decline in the fire and security field businesses.

Global commercial refrigeration orders were flattish while Transicold was down mid single digit following a 70% increase in the third quarter. For the full year, CCS grew earnings by 221 million or 9% and a 1% organic sales increase. Operating margin of 15.7% was up 160 basis points from the prior year and comfortably above the 50% margin target set for 2015.

Turning to aerospace on Slide 7, Pratt & Whitney delivered strong results with 23% profit growth and 5% higher sales, resulting in margin expansion of 170 basis points. Organically, sales were up 14% reflecting growth across the businesses led by high teens growth in the large commercial engine business where aftermarket was up over 20%. The military engine business was up low double digits driven by a higher JSF program sales while Pratt & Whitney Canada was up mid single digits.

On a reported basis, sales were up 5% as the organic sales growth was partially offset by the power systems business divestiture. Profit growth in the quarter was driven by the benefits from higher organic sales and restructuring savings as well as lower E&D which more than offset headwinds and adverse large commercial OE mix, power systems divestiture and higher pension costs.

For the year, Pratt & Whitney delivered profit growth of 177 million exceeding its prior expectation of 150 million based on a seamless integration of IAE, solid execution of cost reduction and restructuring and improvement in the commercial aftermarket.

On Slide 8, UTC Aerospace Systems delivered a strongest quarter of the year with operating profit of 544 million and sales of 3.5 billion. Sales were up high single digit with commercial aftermarket up high teens and commercial OEM up 10%. Overall, military sales were flat to the prior year with mid single digit growth in military aftermarket, offset by a low single digit decline in military OEM.

Year-on-year profit growth was driven by the absence of last year's inventory step-up costs, higher aftermarket volume and continued synergy traction. As Greg mentioned, orders for commercial spares grew 19% on a year-over-year basis.

UTC Aerospace Systems delivered strong results in its first full year with operating profit slightly above to 2.1 billion and integration remains on track towards delivering solid growth in 2014 and beyond.

Turning to Sikorsky on Slide 9, operating profit increased 10% and 13% lower sales. The sales decline was driven by lower international military OEM, the military aftermarket volumes, which were partially offset by higher commercial shipments. During the quarter, Sikorsky shipped a total of 77 aircraft including 58 based on military platforms and 19 commercial.

On profit; lower overall sales volumes, the unfavorable mix of aircraft and headwind from higher pension and compliance costs were more than offset by lower year-over-year CMHP charges. During the quarter, Sikorsky delivered its first fully configured S-76D aircraft into service. Customer interest in the S-76D is strong with backlog in access of 600 million.

For the full year, Sikorsky delivered 240 aircraft. Operating profit of 644 million was down 16% and 8% lower sales. Based on 2013 results, we are updating our 2014 expectations to flattish operating profit and high single digit sales growth.

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

Greg Hayes

Okay. Thanks, Jay. So a good year for UTC. In aggregate, the business units delivered solid margin expansions of 15.7% and EPS grew 16% despite a slower than expected global economic recovery. On top of the solid financial results, we continue to achieve significant milestones on development programs and security wins for the future.

At Pratt, 31 GTF engines have now completed more than 7,000 hours and 16,000 cycles of full engine testing including 750 hours of flight time. The C Series engine achieved certification in February of 2013 and successfully powered the maiden flight of the C Series aircraft this past September. The A320neo engine is on track for certification at the back half of 2014 and our customers recognize the value of the GTF and have now ordered over 5,000 engines including options.

We also quickly realized the benefits of the Goodrich acquisition. In our Propulsion & Aerospace Systems organizational structure in 2013 when Embraer selected UTC to derive a fully integrated propulsion system, that is the engine and the cell and the controls along with the electric system and wheels and brakes for its second-generation E-Jets. These combined wins highlight our ability to leverage our technology across our aerospace businesses to win more content on new aircraft while providing greater customer value with more integrated systems.

Sikorsky continues to see strong civil demand from deepwater oil and gas exploration around the world and has a total commercial backload now of nearly $3 billion. And the investment in X2 Technology has paved the way for our agreement with Boeing to co-develop a demonstrator for the next generation of multi-role helicopters.

New three and four-year labor contracts were also ratified by the union membership at Pratt & Whitney and Sikorsky, respectively, and these agreements had a good result for both the company and our employees.

On the commercial side of the business, climate, controls and security continued to see successful leveraging in combination of our carrier and fire and security businesses and delivered a record 15.7% operating margin. Going forward, we'll leverage the combined capability of CCS and Otis in the new building and industrial systems organization to accelerate top line growth.

Otis had several key wins in 2013 including the Tianjin 117 and the Abu Dhabi Airport. Worldwide, Otis new equipment orders were up 14% from 2013 including 22% growth in China. It's a good momentum that will allow us to deliver solid growth in 2014, and really no changes to the expectations that we laid out in December.

The solid organic growth in backlog exiting the year gives us confidence in our sales assumption of 3% to 4% organic growth in 2014 and we expect continued recovery in our North American markets, slight growth in Europe and solid growth in China.

Okay, looking at the DoD budget, the developments in Washington are encouraging but it's still a little early to determine the impact on our businesses for 2014. We're still planning for a 3% to 5% decline on our U.S. government aerospace sales which we mentioned in December, but that will be more than offset by strong growth in our commercial aerospace businesses.

Overall, we continue to respect total sales of around $64 billion this year including almost $1 billion of headwind from divestitures. As always, we remain relentlessly focused on cost reduction on leveraging our global scale. Last year we invested nearly $500 million in restructuring and for this year we expect about 300 million, all offset by one-time gains.

Restructuring spending in 2014 should be evenly distributed across the quarter, so expect about $75 million of restructuring charges each quarter, while the gains are probably going to some in the middle of the year. Strong operating leverage across the business should allow us to deliver earnings of 655 to 685 this year.

We remain confident in that guidance range with earnings growth accelerating during the year. Specifically in the first quarter, we had about $0.22 of headwind year-over-year. We recall that last year's first quarter had $0.11 of net gains while this year we expect $0.06 of net restructuring. We also had about $0.05 of good news at Pratt & Whitney last year which is not going to repeat in this year’s first quarter.

So wrapping up with cash flow we expect to invest about $2 billion in CapEx this year after investing $1.7 billion in 2013, and that $2 billion should be the peak. The timing of course will be dictated by program schedules. These are critical investments for our commercial aerospace business as we prepare for an unprecedented ramp in production. And while these investments of the non-cash pension tailwind creates some pressure on cash flow we continue to target free cash flow equal to net income for the year.

So in conclusion solid year for UTC and the momentum we have actually in the year gives us confidence in 2014. We got the right strategy and the right portfolio in both the developing growth markets along with an organizational structure and experienced management team that will capitalize on the continued global economic recovery and deliver sustainable earnings growth both in 2014 and into the future.

So with that, Stephanie, let’s open up the call for questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Carter Copeland with Barclays. Your line is open.

Carter Copeland - Barclays

Hey, good morning guys.

Greg Hayes

Good morning, Carter.

Jay Malave

Good morning.

Carter Copeland - Barclays

Just I wondered if you could give us a little bit more granularity on the commercial aftermarket order numbers and kind of parse that out maybe at Pratt what you’re seeing, on the large commercial side for the PW4000s versus the V’s; any differences in the trends there. And then broadly speaking maybe UTAS differences in military versus commercial and the outlook there?

Greg Hayes

Sure. That’s all pretty good news as you would expect on the commercial side. And spares orders were up at Pratt about 20% beside a UTAS or Aerospace just improved 19%. But I think what was most encouraging for us is what we saw on the services side. This is in our shops around the world where we saw sales up over 40% in the quarter and we then finally started to see the airline switch from these light overhauls we’ve been talking about for the last couple of years to more heavy overhauls and that really drove the tremendous amount of volume in the shops and then drove the order rates as well. So airlines are making money, and things look pretty good that we saw the delinquency and the receivables down because the airlines are making money. We saw spares, we saw heavy overhauls. It was all pretty good on the commercial side of the business. As far as the split, Jay in terms of the Vs and the…

Jay Malave

Sure the -- Carter, the V2500 was up high single-digits in the quarter, PW4000 was up high teens, and the PW2000 was very, very strong and there was an order there for delivery in 2014, but our models did pretty well in the quarter. On the aerospace system side, the provisioning was strong in the quarter and again that was narrow body growth as well as some 787 provisioning. Again as Greg mentioned we’re seeing these higher or stronger overhauls, heavy overhauls with profitability getting better, traffic continuing to grow, cycles in the hours with air sort of trends all the fundamentals as we’ve been saying all along really we’ve seen that in the quarter.

Carter Copeland - Barclays

And what about on the Sikorsky side in terms of the orders there, I mean obviously the spares were off a lot, the orders were off a lot. Have you seen any reversal in that trend?

Jay Malave

We saw just on the sales, military aftermarket was a little bit better, it was down low teens. However that was on an easier compare. Last year military was down high single digits in the after market. So not all that much better.

Greg Hayes

Yeah, I mean I would just tell you, we think we’ve kind of bottomed out from the impacts of sequestration at Sikorsky in terms of the aftermarket. As you guys have, that we’ve all seen, it looks like the defense budget for ’14 will be the same as it was for ’13 when they restore that $20 billion of cut. So, we don't expect much further deterioration at Sikorsky in terms of the order rates, but clearly the backlog is going to be down going into ’14 which is why we think military spares or sales will be down again about 3% to 5%.

Carter Copeland - Barclays

All right. Thanks guys.

Greg Hayes

Thanks, Carter.

Operator

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

Samuel Pearlstein - Wells Fargo Securities

Good morning.

Jay Malave

Good morning, Sam.

Samuel Pearlstein - Wells Fargo Securities

Can you share a little bit more about the Canadian helicopter in terms of this potential agreement? You said you’re still going to assume eight deliveries this year; is this going to give you any ability to treat the production and service differently and maybe be able to write off any of the production cost. Anything else you can share along the lines of that agreement?

Greg Hayes

Yeah, I think -- again as POA or this principles of agreement that was signed on December 31 really is a milestone for us. I think we had a path forward with the customer to deliver aircraft now. We got a lot of the bad news behind us I think on the program. We weren’t able to revenue recognize any of the helicopters, but again I think as we go forward we’ve got a clear path this year to revenue recognize eight the contract or the amendment should be finalized by the 31st of March and hopefully by the time we stand up in front of investors in March we’ll have some more details in terms of that contract amendment. But right now it looks like we’ve got the ability to deliver out through ’18. Our goal is to get those things delivered all by 2016. So we think eight this year, eight next year, and eight the following year. And I think importantly the customer recognizes the value of the aircraft. There was talk in the Canadian press about termination of all that. They need these helicopters; these are the best damn military helicopters out there. So, I think it's all very positive for Sikorsky. As for the accounting, while I wish we could get this behind us, Sam I just -- I don’t see a way based upon the structure of the contract that we’re negotiating today to do that. So, again I don’t see any more bad news beyond that which we’ve expected today. We’re going to lose about $14 million of helicopter going forward. So unfortunately I can’t get that behind us. If I had a way to do it I would but, at least for right now we’ll just assume that’s the plan.

Samuel Pearlstein - Wells Fargo Securities

Okay, and then the change in the segments for Sikorsky is not going to be flat in terms of the profit year-over-year instead of up 0 to 50. It doesn’t look like the other segments change, so really where is the offset if the tax rate interest share count, where do you offset that?

Jay Malave

If you look at -- it's just a change from where they ended, Sam. If you look at based on our guidance the absolute number for Sikorsky’s expectation is the same, and so at our midpoint the bottom line number for Sikorsky is really the same number it was before. It's just the change is different.

Samuel Pearlstein - Wells Fargo Securities

Okay, and if I could squeeze one more in; Greg back at the third quarter call I think you talked about, I thought a tax rate somewhere close to 29%, that would seem like a little bit more than the few cents you mentioned in terms of the variants. What was in this quarter that was different in terms of the tax rate?

Greg Hayes

There was couple of different pieces in here. There was a small settlement with the IRS which gave us a couple of pennies of benefit which we hadn’t expected in the rate. I think we call that out as part of the gains math. And then we had a little bit better year end rate because of some planning that we had put in place earlier in the year. I think the operational rate would have been about $28.6 million, so we picked up about $40 million or $0.04 operationally because of the tax rate benefit in the quarter.

Samuel Pearlstein - Wells Fargo Securities

Thank you.

Operator

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

Julian Mitchell - Credit Suisse

Great, thanks. I had a couple of questions on Otis. First of all looking at your China OE business there; based on the order backlog and the order trends you had through 2013, I guess is it fair to assume that your OE deliveries in China, the growth rate should be pretty similar this year as what you had in ’13?

Greg Hayes

Yeah, we’re expecting about 15% sales growth there this year based upon the backlog.

Julian Mitchell - Credit Suisse

Great. And then within the U.S. part of Otis; do you still have a drag in the first half of the year from the factory relocation, so that’s mostly finished in Q4?

Greg Hayes

No, there’ll still be a little bit of a drag probably through the middle of the year. I think we had on a little less than $20 million of headwind in Q4. That will step down a little bit each in the next two quarters and I think the plan right now is by the third quarter that should be generating tailwind as opposed to headwind. So, a little bit of drag here in the first few quarters.

Julian Mitchell - Credit Suisse

Got it. And then lastly just within Pratt; you’re getting close enough just starting to ship for commercial use the GTF, any change in your thoughts on the kind of headwind within Pratt that you’ll see to earnings from that ramp up?

Greg Hayes

Well, I think it's the same thing we talked about in December. We will be losing money especially on the early delivery. So there will be a headwind from negative engine margin and that’s going to accelerate as the ramp goes. So you’re going to see, we got a little bit of headwind this year, little more in ’15 and then ’16, ’17 some significant negative engine margin. Obviously we’re working the product cost, piece of that equation. It's a great engine and this is a headwind that we’re going to have to deal with which offsets of course. I think we’ve got E&D should be coming down and you’ve got the rest of the business which we expect to recover. The Vs, of course, as those go away, so will the negative engine margin on the Vs which will help offset a little bit of this and the aftermarket should also continue to grow. So, it's headwinds but we know about it, we're working it and we'll tell you more about it as we go through the year.

Julian Mitchell - Credit Suisse

All right, thanks.

Greg Hayes

Thanks, Julian.

Operator

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

Doug Harned - Sanford C. Bernstein

Good morning.

Greg Hayes

Good morning, Doug.

Doug Harned - Sanford C. Bernstein

On Otis, you said that new equipment was up 10% but sales were only up 4%. Can you talk about what came down? Is this repairs and modifications or contract services, what happened there in the quarter?

Greg Hayes

It really is just mix service revenue. We're only up about 1%. That's 60% of the business. That's what got the overall sales only up 4%.

Doug Harned - Sanford C. Bernstein

And then on Pratt, the C Series Bombardier is now talking about this being delayed going into service until the back half of '15. What's the impact of that on you all?

Greg Hayes

Well, it's good news in terms of we had talked about some negative engine margin and both that Pratt is the negative margin that you test for the year on deliveries that we're starting to ramp, and it wasn't a big number. But fortunately, the good news associated with not shipping is it's mostly going to be offset by the fact that the program is going to be out there longer, so the R&D build is going to go up. It was a small net benefit but not big.

Doug Harned - Sanford C. Bernstein

And then just on the other side of that, now that you're starting to see the F-35 growth beginning to kick in, how do you see that going forward in terms of margins? I mean it's a good thing that you're seeing this grow but I would assume there should be some dilution on margin as it becomes bigger?

Greg Hayes

Yes, again those are – now I think we're in Lot 6. Those were all firm fixed price at this point. So as we go forward here, I think, and we will take cost out. We're still coming down the learning curve pretty rapidly on that but it will be slightly dilutive to margin but not a huge impact really across Pratt. The fact is the demand for these engines in these aircraft are much stronger internationally than we expected, so we expect this ramp to be pretty strong over the next two years.

Doug Harned - Sanford C. Bernstein

Okay, very good. Thank you.

Greg Hayes

Thanks, Doug.

Operator

Our next question comes from Jeff Sprague with Vertical Research Partners. Your line is open.

Jeff Sprague - Vertical Research Partners

Thank you. Good morning, everyone.

Greg Hayes

Morning, Jeff.

Jay Malave

Good morning.

Jeff Sprague - Vertical Research Partners

I was wondering if we could just drill into Otis service a little bit, the 1% growth kind of geographically where you're seeing pressure maybe just kind of what's going on in Europe in particular, I guess, and maybe that ties to your stabilization comment.

Greg Hayes

Yes. I think again in the Americas we saw modest growth. I think it was up about 4% service overall and Europe was down about 1%. So the good news here is in China, service is actually up 10%. Again, it's off of a low base. The good news in Europe, if you will, is we have not seen the big continued deterioration that we had been seeing for the last couple of years, so while it's not exactly stabilized since it's still down 1%, at least there's some – there's some light at the end of the tunnel as the economy has improved. I'll tell you this is probably the biggest focus of Geraud Darnis and the whole team at BIS organization today is making sure that the risk portfolio in Europe continues to returns to growth and profitable growth.

Jeff Sprague - Vertical Research Partners

On China, as you said, it's a low base but is there a visible turn in your service capture in that business? Is that on a clear upward trajectory?

Greg Hayes

It is going up. I think, again, we're seeing – I think OCL, the Otis China Limited brand where conversions are right around 60% on all of our direct sales, overall still about 25%. Obviously that's a big focus that we have going forward as we grow that business. The new equipment business is wonderful today, but we all know the ultimate price in China will be service and we're focused on it. The whole team really is in China.

Jeff Sprague - Vertical Research Partners

And then just finally from me and I'll move on, pension, how did that actually end? Did you pick up a little bit of cushion relative to your guide in the year relative to where discount rates ended?

Greg Hayes

Yes, we did. It was – the discount rate I think when Louis stood up, we had expected a 4.8% discount rate and I think that's exactly where it ended up for us. But I think overall, the plan was up about 10.8% in terms of performance for the year, really solid performance. Right now, the U.S. plan is about 98% funded on a PBO basis where we were short $4 billion three years ago, today the shortfall is only about 500 million in the pension plan. So we'll see probably about $100 million of additional good news on pension this year beyond that which Louis had talked about in December. So it adds to that cushion that we talked about at the midpoint. You're also getting a little bit of benefit on the currencies, where I think we had forecast the euro at 1.33 for the year, today it's 1.36-ish. So you pick up three pennies there. So, we feel pretty good about the midpoint as compared to where we were just six weeks ago.

Jeff Sprague - Vertical Research Partners

All right, thank you.

Greg Hayes

Thanks, Jeff.

Operator

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

Cai von Rumohr - Cowen and Company

Yes, thanks so much. So the very, very strong commercial spares orders and the MRO activity in the fourth quarter, any sense whether that might have been driven by your relatively large price hike announcements for 2014? What are you seeing in terms of color in those areas in the early weeks of January?

Greg Hayes

Well, I might push back a little, Cai, on your characterization of unusually high price increases. I think this is typical normal increases that we see almost every year. I think what was important is we didn't see a lot of discounting in the fourth quarter this year. We saw really solid order intake. And was there a little bit of beat the price? There may have been, but quite frankly that wasn't a big driver of the increase. I think it really is just pent-up demand. And again as we've talked about more heavy overhauls in the shop which drive a tremendous amount of spare parts.

Jay Malave

Yes, Cai, remember the fourth quarter is typically the highest. It's seasonally that beat the price activity occurs. So the compares are pretty clean. It's not like this year is much greater than last year.

Cai von Rumohr - Cowen and Company

Right. And so was the activity flow over end of the first quarter, so what you've seen in January looks about what it looked like last year in terms of percentage changes?

Jay Malave

Yes, well, book to bill is above 1, Cai, so there will be – some of that flows over into the first quarter.

Greg Hayes

Yes, the fundamentals haven't really changed. I think the airlines are still flying these planes full. They're still flying a lot of hours. Some of this pent-up demand that we've been talking about is continuing to play out, we expect here in the first half. Obviously, we're not going to get 20% aftermarket growth for the full year at Pratt this year. We're thinking it's going to be…

Jay Malave

Mid single digits in the…

Greg Hayes

Mid single digits. So if we hit 20%, things will be really good but it will slow down a little bit again as the compares get tougher in the back half of the year, but I think so far so good.

Jay Malave

Yes. As I've said, Cai, there was one large order in PW2000 that was for delivery in 2014. So the 20% was a little high related to that one order.

Cai von Rumohr - Cowen and Company

Got it. And then we now know that the FY '14 DoD appropriation. You're still looking for down 3 to 5, and then kind of when you take together the budget agreement plus the DoD, is there any potential for favorable results relative to your expectation?

Greg Hayes

Yes, I think they are, Cai. But again, most of that benefit is probably going to flow to next year. But if you think about it, the CRH, the combat rescue helicopter was fully funded. The VXX, the Presidential was fully funded. If we're fortunate and get awarded those two contracts, you would expect to see some additional revenues this year, not much on the bottom line obviously because they are developing contracts in the first couple of years, but I would expect a bigger impact to be next year. I think the good news on sequestration is at least everybody knows what it is now. So we have a baseline. So people aren't scrambling and moving money around in a dis-economic fashion. I think the DoD has been building out a plan for next fiscal year. It was a two-year budget deal. And so we expect some stability and not as many surprises going into the year on the downside as we saw last year on the military.

Cai von Rumohr - Cowen and Company

Okay. And last one, you had mentioned in response to Doug's question that a little more E&D as a result of the C Series, but what are we looking for, for E&D now for the year?

Jay Malave

Cai, we're still flattish. It may go up – a little uptick from here but generally flattish is still the expectation.

Greg Hayes

And you're probably talking about $10 million of pressure on E&D from the C Series delay at Pratt, and that's a little bit smaller number at the Aerospace Systems business. So we're not talking huge numbers here.

Cai von Rumohr - Cowen and Company

Great. Thanks so much.

Greg Hayes

Thanks, Cai.

Operator

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

Howard Rubel - Jefferies

Thank you very much. I might pick up a little bit where Cai left off on the military. If I recall correctly last year you were down over 20% military spares in the first quarter or so. Do you see that sort of playing out or do you see something better there, Greg?

Greg Hayes

Are you talking specifically at Sikorsky, Howard or you’re talking…

Howard Rubel - Jefferies & Co. Inc.

No, I believe it was at Pratt.

Greg Hayes

No, I think again Pratt, we saw actually I think spares at Pratt, let me just take a look here.

Jay Malave

Pratt were up in the first quarter.

Howard Rubel - Jefferies & Co. Inc.

So you’re going to have some positive comparisons there right?

Greg Hayes

Yeah. Should be positive, yeah.

Howard Rubel - Jefferies & Co. Inc.

So how else do you, you kind of are saying to us be careful in the first quarter because of the gains and some of the other items. What else on an operating basis might help you lift the number?

Greg Hayes

Well, I think…

Howard Rubel - Jefferies & Co. Inc.

I mean, we’re thinking at a bottom line that going to be a tough compare, but I am sure there’s operating performance that will make a difference.

Greg Hayes

Yeah, I think again what you’re going to see because of the accelerating organic growth is coming out of the fourth quarter backlogs were up. So I think you’re going to see a good top line growth and I would expect decent conversion out of that top line growth. The thing about it for the year we’re forecasting organic growth of 3% to 4% that will give us $2 billion to $2.5 billion. We should see some organic growth here in the first quarter which is going to help, gain you’ll see it in Otis because of the backlog I think is seen at CCS, and you’ll certainly see that in the Aerospace OEM side. The only weak point you’ll probably see in the first quarter is Sikorsky which again is still looking at reduced Black Hawk production this year. Recall we’ve been talking about a 20% reduction of Black Hawk sales year-over-year, so that’s probably the biggest pressure point in the first quarter.

Howard Rubel - Jefferies & Co. Inc.

And so a tax rate normalized going forward is like 28.5% Greg, is that sort of where you’re thinking about in…

Greg Hayes

Yeah, I wish it were 28.5%. I think again we had some employment opportunities in the fourth quarter and last years rate you’ll recall benefited from the tax extenders which got fast back in January of ’13. So, we loose that benefit which was a full point on the rate. So from a planning standpoint we’re expecting about a 30% rate going into the year now. If that gets better because of extenders getting past, again there’s about a point of good news there and we’ll look for some planning opportunities, but right now we’ve got visibility to a 30% rate and that’s the planning assumption at least going in.

Howard Rubel - Jefferies & Co. Inc.

I mean then just two more items, one of CCS. Can you -- have you gone to the point where you feel very comfortable with the portfolio or are there still some other divestitures that are teed up and does that reflect part of what you think will be the gains?

Greg Hayes

Yeah, probably not gains associated with the portfolio transformation. If you think about as Geraud has been talking about $850 million of portfolio reductions or transformation at the legacy F&S business. As we sit here today, I think he would tell you, it's more like about $1.2 billion. So, if you think about the revenues this year, I think CCS is going to see about $500 million of headwinds between divestitures we did during last year including like the Australia cash-in-transit business and some of the other businesses we’ve divested and what's on the block still for 2014.

Howard Rubel - Jefferies & Co. Inc.

And you had a very nice call on saying at the bottom that Carrier was going to show some leverage and that housing wasn’t going to go to zero. Can you put on your forecast thought for a moment and sort of tell us how you continue to see residential and do we see any commercial improvement at Carrier to share.

Greg Hayes

Yeah, in fact I think that’s -- the resi story I think is pretty well known, I mean we finished the year very strong with sales up about 18% in the residential. We saw that in heating, we saw it in small package; we saw it in cooling as well. So I’d expect that that momentum continues. But I think the better news if you will really goes on the non-resi side. We saw Otis orders in North America up almost 13% in the fourth quarter and the CCS, the commercial business orders were up about 5% even though sales were down 5%. So we’re starting to see that recovery that we have been talking about in non-res and again -- and we’d always say Otis is the leader and then CCS is a little bit later in the cycle. But it feels pretty good on the non-resi side as we exit the year in the U.S.

Howard Rubel - Jefferies & Co. Inc.

Okay.

Greg Hayes

Thanks, Howard.

Operator

Our next question comes from Peter Arment with Sterne, Agee. Your line is open.

Peter Arment - Sterne, Agee & Leach, Inc.

Hi, yes thanks. Good morning Greg and Jay. If I can just circle back quickly on the aftermarket; Greg you talked a lot about the heavy overhauls for a while and it's nice to start seeing that. What’s the expectations on how long this can persist or the pent-up demand, is this a six months phenomenon or is this something we could see throughout the year?

Greg Hayes

Yes, it’s a great question, Peter. I think again it caught us a little bit by surprise in terms of how strong the services business or the MRO business was at Pratt in the fourth quarter. But clearly if you think about it, over time with the airlines flying the hours that they’ve been flying and the dip that we’ve seen in spares over the last couple of years, you would expect this recovery to last at least go into the first half of this year. But I don’t want to get ahead of ourselves either I think, you’re going to -- we still think 5% is probably a reasonable expectation for the aftermarket to grow at Pratt & Whitney this year. Could it be better? It could, but I would actually like to see another quarter or so of this under our belt before we declare victory.

Peter Arment - Sterne, Agee & Leach, Inc.

Okay. And Jay just could you remind us what’s the aftermarket assumption for the year for UTAS?

Jay Malave

UTAS, its high single-digit.

Peter Arment - Sterne, Agee & Leach, Inc.

Okay. That’s great. That’s all from me. Thank you.

Greg Hayes

Thank you.

Operator

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

Myles Walton - Deutsche Bank

Thanks. Good morning. I just had two quick ones. One on the EPS guidance for ’14, I think you had negative contingency at the high end and I think Greg you mentioned a couple of things on pension currency. Maybe a little bit benefit from the $100 million high restructuring. Have you now established some positive contingency at the high end of the EPS guidance?

Greg Hayes

Well let me -- let’s talk at the midpoint and you can do the math. We think there is probably about 200 million to 250 million of contingency at the midpoint at 6.70. So there is a path to that high end today, that’s a little bit more certain than it was six weeks ago really because of pension and currency here. So the restructuring gives us a little bit of opportunity, but it is January. So let’s not get too excited about it. Bad things can and will happen.

Myles Walton - Deutsche Bank

I will restrain myself, Greg. The 15% China Otis growth, you’ve baked into the guidance. Can you remind us the dynamics of backlog visibility for China versus the rest of Otis; is it kind of six months that you kind of have a 90% certainty on and then tails off in the second half?

Greg Hayes

Yes, Peter six to nine months is a typical rule of thumb that we use. Some do go longer, but six to nine months is a typical visibility.

Myles Walton - Deutsche Bank

In similar in China to the rest of the business?

Greg Hayes

The rest of the business will be longer than China.

Jay Malave

Yes, the longer cycle projects, talking more like 12 to 18 months Myles.

Myles Walton - Deutsche Bank

Okay, great. Thanks again.

Operator

Our next question comes from Joe Nadol with J.P. Morgan. Your line is open.

Joe Nadol - J.P. Morgan

Thanks. Good morning,

Greg Hayes

Hi, Joe.

Joe Nadol - J.P. Morgan

So organic growth perked up finally in Q4 to the 4% level and just wondering as you look to…

Joe Nadol - J.P. Morgan

[Technical Difficulty] to be specific.

Joe Nadol - J.P. Morgan

I'm sorry?

Greg Hayes

4.5% if you want to be specific. Go ahead.

Joe Nadol - J.P. Morgan

Right, okay. Well, as we look into 2014, just thinking through the quarters here, is this level sustainable in the early part of the year or how do you see that playing out?

Greg Hayes

Yes. I think again, the order rate that we saw exiting the year gives us confidence in the organic growth. Obviously, backlog at Otis gives you -- I'm very confident Otis we’ve got 6% growth forecast for Otis this year. I think that’s almost like in the bag, because you still have to deliver it and you still have to see service recover a little bit, but high confidence there. I think on the CCS side, we are forecasting 4% organic growth for the year. Again, good backlog around the business on the non-resi side. The resi business looks to be good. Transicold looks to be okay and as long as Europe remains stable and does not surprise us on the downside, I feel pretty good about that as well. So again, commercial OE, that all looks pretty solid for the year. So I’m expecting a pretty good growth throughout the year.

Joe Nadol - J.P. Morgan

The challenges you are facing on the EPS line in Q1 are pretty much all restructuring and earnings related, EBIT related, but not really sales related at all?

Greg Hayes

Exactly. It really just is one-time. Pratt had a little bit of good news last year; $0.05 (indiscernible) quarter from a couple of contracts and then you had, of course, the gains last year versus the restructuring headwind this year. So I just want to give you guys a heads up and it makes, personally the IR team to rest easy when we got that out there, they can talk about it. But there is $0.20 plus of headwind going into the first quarter.

Joe Nadol - J.P. Morgan

Okay. And then just, my other question is on Goodrich. Could you give us an update on how you finished the year in terms of synergies and what you’re seeing, I guess, in real-time on the deal? What you’re expecting now in terms of the trajectory in 2014 and 2015 in terms of an update?

Greg Hayes

Yes, so synergies, we're well on track. I think we ended the year, cumulative synergies at about $270 million I think. So about $20 million ahead of what we had expected even in the middle of the year when we updated it last; so a good synergy traction. We'll see another $100 million or so this year. I'll just remind you the next tranche of synergies becomes more difficult because it relates to moving facilities, product cost reduction and all of those things. So, Alain and team have got their arms around this and I'm pretty confident we're going to see another $100 million. And then you'll see another almost $100 million in the next couple of years beyond that.

Joe Nadol - J.P. Morgan

Okay. Thank you.

Greg Hayes

Thanks, Joe.

Operator

Our next question comes from Noah Poponak with Goldman Sachs. Your line is open.

Noah Poponak - Goldman Sachs

Hi. Good morning, guys.

Greg Hayes

Good morning.

Noah Poponak - Goldman Sachs

On the growth you've seen in Otis China on the original equipment side, is it possible to parse out how much of that is market share gain versus just the underlying market?

Greg Hayes

Yes, I don't know that I have that breakdown, Noah. I think clearly the market share in China has stabilized through the course of the year. We think our share is somewhere around 15% or so, maybe 16%. But the market grew a lot stronger than what we had expected in 2013. So a lot of that growth is just the market acceleration.

Noah Poponak - Goldman Sachs

Okay, that's helpful. And then just one follow-up on cash deployment. I know there are placeholders, but the placeholders you have would generate a pretty large increase in the cash balance through the year. And Greg, you mentioned in the prepared remarks how much you've paid down debt since Goodrich. Can you just sort of update us all on which buckets are most likely to see upside in terms of cash deployment this year?

Greg Hayes

I think, again, you got the placeholder for $1 billion of share buyback and placeholder of $1 billion for M&A, placeholder of $1 billion for debt pay down, dividends will be another call, about $2 billion. As we see it today, I would tell you the $1 billion of M&A is probably the squishiest number we have out there just because the pipeline today is not terribly robust. But that can change. I think again, you never know what opportunity might avail itself during the course of the year. So we'll see what happens there. I'd just remind you that the color of money for M&A is primarily outside of the U.S. because of the $2 billion CapEx spend this year, a big chunk of which is here in the U.S. That's a big consumer of U.S. cash. Again, the opportunity for us is working capital reduction. If we see a turn in inventory starting to come down, we generate a little more cash. Clearly, we'd like to see that share buyback number go north of $1 billion again, and we'll just have to see how that plays out during the year. But we don't want to see share growth again this year, although there is a little tiny bit forecast just with the $1 billion of share buyback and the stock price where it is. We're still going to get a little dilution from higher shares.

Noah Poponak - Goldman Sachs

Is that less robust M&A pipeline, just plain old lack of availability of assets or is it more a – that the assets are there and there is an issue with pricing expectations?

Greg Hayes

There are lots of things out there for sale. But again, the focus really for this year from last year has been on execution. So we haven't been really, I'd say, pushing very hard on the M&A front. Obviously, we're always looking but the focus is going to be again on execution this year. So if something comes up, I would tell you. Prices have obviously accelerated dramatically in the M&A space. And we're going to focus in the core here. So if something avails itself to us, we'll certainly be in a position to do something. But I'm not hopeful you're going to see a big M&A number this year. Not to say we're not looking though.

Noah Poponak - Goldman Sachs

Okay. Thank you.

Operator

Our next question comes from Nigel Coe with Morgan Stanley. Your line is open.

Nigel Coe - Morgan Stanley

Good morning. So obviously we've covered a lot of ground already but just going back to the 2014 bridge, you've got $0.08 for commercial OE mix. I'm just wondering does the Bombardier C Series push out. Does that make like $0.08 a bit more – maybe you do it squishy?

Greg Hayes

Squishy? I guess I did use that word. Obviously, it gives you a little bit of upside. I think we talked about, as we said $0.08 or about $100 million of negative engine margin. We'll pick up a little bit of that. Again, it just adds to that contingency that we talked about at the midpoint, but it's not 100 million. It might be a couple of pennies as we're going to pick up. We're still going to be shipping hardware this year. I think the Bombardier continues to build aircraft. We're just not going to be shipping at the same rate that we had expected.

Jay Malave

Yes, both UTC Aerospace Systems and Pratt, both have upticks in commercial OE. UTC Aerospace Systems has higher volume on 787 as well as A350. They're going to delivering and that's still going to drive some negative margin and Pratt just has higher commercial shipments. It really doesn't change that number meaningfully at all.

Nigel Coe - Morgan Stanley

Okay, got it. That's clear. And then the 80 bips at Otis, I'm assuming 50 bips on mix and up 30 bips for the factory transition, but I'm just wondering are the service margins pretty stable year-over-year?

Greg Hayes

I think we would say they're down slightly for the year and that's again pricing pressure that we saw in Europe.

Nigel Coe - Morgan Stanley

Okay. And then just finally you mentioned 2 billion on the CapEx is the peak for 2014. Beyond 2014 Greg, do you think it sort of stabilizes at this level or do we come back down to a more normalized 1.6, 1.7?

Greg Hayes

No, it should come down. This is really the year of the ramp. If you think about it, we have to have the CapEx in place, the facilities in place this year because we start delivering neo engines next year. So this is really the biggest year and we should see it, I would hope, come down $300 million, $400 million next year although, don't – I guess, you can quote me at it, but we'll see what happens.

Nigel Coe - Morgan Stanley

Okay. Thanks guys.

Operator

Our final question comes from Robert Stallard with Royal Bank of Canada. Your line is open.

Robert Stallard - Royal Bank of Canada

Thanks so much. Good morning.

Greg Hayes

Good morning, Robert.

Robert Stallard - Royal Bank of Canada

Greg, just on your Aerospace Systems looking at Aerospace OEM, that wasn't bowing [ph] out pretty much at full rate on everything really this quarter with only the A350 yet to go. Is there an opportunity to take out some of your inventory or working capital here now that we know with at a fairly stable rate?

Greg Hayes

Yes, I think it's probably – as you look back on 2013, one of the – I would say disappointments is the inventory turns did not increase. As production rates ramp up, we would certainly expect to see the velocity, if not the actual amount of inventory increase. So that's one of the focuses that Louis has this year is inventory – again not reduction, but turn rate improvement.

Robert Stallard - Royal Bank of Canada

Okay. And then maybe just secondly on the engine side of things, you commented about the technological progress on the geared turbofan, but I was wondering if you can comment on the market share in the competitive situation of how it's held in versus the alternative engine on the A320?

Greg Hayes

Yes, I think across the A320 family, I think its a little bit north of 15%. On the A321s, I think the market share is much better than that; a little less on the A321 and – I'm sorry the A319 family. So it really varies by thrust class. But I think the GTF clearly has been the winner on the longer range, higher thrust variance.

Robert Stallard - Royal Bank of Canada

All right, thanks, Greg.

Greg Hayes

Okay. So I think we'll end it there as we approach the top of the hour. Just to remind everybody, a good year, 16% EPS growth, good fourth quarter organic growth; 4% and strong cash. So making great investments in E&D. We've got a great backlog going into the year and it should be a very solid year for UTC. I want to thank everyone for listening. We look forward to seeing you at our Annual Investor Analyst Meeting, and we're going to do it here at Hartford this year. So we look forward to seeing you on March 13. Thanks very much.

Operator

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect and have a wonderful day.

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