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United Technologies Corp. (NYSE:UTX)

Q1 2010 Earnings Call

April 21, 2010 8:00 am ET

Executives

Akhil Johri - Vice President, Financial Planning and Investor Relations

Gregory Hayes – Senior Vice President, Chief Financial Officer

Analysts

Joseph Nadol - J.P. Morgan

Ron Epstein - Bank of America / Merrill Lynch

Jeff Sprague - Vertical Research Partners

Terry Darling - Goldman Sachs

Sam Pearlstein - Wells Fargo Securities

Howard Rubel - Jefferies

David Strauss - UBS (US)

Cai von Rumohr - Cowen and Company

Rob Stallard - Macquarie Research

Doug Harned - Sanford C. Bernstein

Heidi Wood - Morgan Stanley

George Shapiro – Access 342

Operator

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

The company reminds listeners that the earnings and cash flow expectations and any other forward looking statements provided in this call are subject to 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 of questions to two per caller to give everyone the opportunity to ask questions. You may ask further questions by reinserting yourself into the queue and then we will answer those questions as additional time permits.

Gregory Hayes

Thank you Tricia, and good morning everyone.

As you saw in the press release this morning, a great start to the year with strong performance across the business in a tough but improving end market environment. Some key take-away from this quarter: first, cost traction continues, resulting in margin expansion at each of the businesses. Second, we are seeing improvement in order trends and continued strength in our short-cycle business. And finally, we saw strong cash generation in the quarter.

If you recall, in our March investor meeting, we expressed confidence in our original EPS guidance provided back in December. This pressure from the euros weakness was partially offset, the benefits from pension, the early closing of the GE Security Deal, and strength in our short-cycle businesses.

Since that time, the euro has weakened a little bit more, but the continuing strength of cross-traction, and a broader improvement in order trends has increased our confidence in the outlook. As a result, we are going to raise the low end of our EPS guidance range to $4.50 from $4.40. So we now expect EPS to be in the range of $4.50 to $4.65. That's up 9% to 13% from 2009, and revenues still expected to be around $54 billion to $55 billion, up 2% to 4%.

Getting back to first quarter results, performance was solid across our businesses, with segment operating margin expansion of 180 basis points with 14.2% adjusted for restructuring.

On that same basis, total segment operating profit grew 13%, and a revenue decline of 1%. All six business units improved margins with Carrier, Otis and Sikorsky leading the way. Carrier's margin expansion of 390 basis points reflects strong progress from its restructuring actions and cost reduction initiatives, in addition to the benefits of the relatively easy compare given the very rough Q1 in 2009.

Earnings per share in the first quarter were $0.93. That's up 19%, and includes a charge of a little more than a penny of the recently enacted healthcare legislation which eliminated the Medicare Part-D tax subsidy. Restructuring costs were $67 million; that's slightly below the net $75 million that we had expected.

Excluding restructuring costs in both quarters and the one-time gain in last year's first quarter, earnings per share increased 13% on 1% lower revenue. Foreign currency was a benefit of $0.06. That's from translation and the positive impact of currency hedges at Pratt & Whitney Canada. Foreign currency translation also favorably impacted revenues by 3%.

Organic revenues declined by 4% in the quarter. That's a slight improvement from the 6% decline was saw in the fourth quarter. We expected organic revenues this quarter to be down, as last year's first quarter benefited from a strong backlog.

The best example is probably Pratt & Whitney Canada which shipped nearly 1000 engines in the first quarter of 2009, compared to 633 this quarter. That's down 35%. That's the lowest quarterly rate we expect this year at Pratt Canada, and for the full year, we still expect Pratt Canada to ship about 2800 engines.

Now on Slide 2, on orders. While first quarter organic revenues were down, first quarter order rates showed marked improvement with continued strength in most of our short-cycle businesses. Carrier’s U.S. residential shipments and Transicold orders were up year over year with strong improvement in truck, trailer, and containers.

In China, [inaudible] orders across our commercial business units grew by 40% and other emerging markets such as India and Brazil also saw strong improvements. Initially at Hamilton, we saw growth in the commercial aero aftermarket and at their industrial businesses.

Not surprisingly, commercial construction related orders, particularly in North America, remain weak. Akhil will take you through the details of orders by business unit in just a few minutes.

Now on Slide 3, in the quarter free cash flow of 116% of net income, our focus on working capital and control over CapEx continues to pay off, and we drove solid cash flow performance. Working capital terms improved to 8.3 even in the face of lower revenues. Capital expenditures to depreciation was slightly below 70% in the quarter.

Share repurchase in the quarter was $500 million; a strong start to this year's program, as we continue to believe that our shares are attractively priced. Acquisitions spend in the quarter was $2.1 billion. That's primarily from the GE Security, and Clipper Windpower transactions.

So no surprises. Just like we told you since December, the strong quarter where we saw continued market expansion and excellent cash flow in difficult but improving end markets. We'll come back and talk a little bit more about 2010, but for now let me turn it over to Akhil to take you through the business unit details.

Akhil Johri

Thanks, Greg. Turn to Page 4, let me remind you that I will talk to the segment results adjusted for restructuring and nonrecurring items, as we usually do.

Otis delivered an exceptionally strong first quarter with profit growth up 15% on 2% higher revenues. Operating margin, expanded 240 basis points to 22.2%, as the benefits of aggressive cost reduction actions over the past years and continued strength in contractual maintenance more than offset the impact of lower new equipment volume.

At cost and currency, revenues went down 3% while operating profit was up 8%. New equipment sales went down 7% as a strong rebound in China was more than offset by a continued decline in North American and Europe. Service revenues went down slightly with growth in the contractual maintenance business offset by lower modernization and repair volumes.

New equipment orders resumed growth for the first time since second quarter of 2008, and went up 9% [inaudible] a year, and up 3% on cost and currency. The increase was driven by China, where orders were up close to 50% from a bleak first quarter of 2009; partially offset by a 30% decline in North America.

Orders in Europe remained flat for the second quarter in a row. While the foreign exchange benefit in the first quarter is expected to be more than offset by headwinds in the latter part of the year, based on the solid cost traction and strong orders in China, we now expect Otis fully a profit growth to be at or above the high end of our prior guidance range of $75 million to $100 million on flattish revenue.

On Slide 5, Carrier continued this transformation to a high returns business and posted another quarter of record margin expansion. Profit grew 149% on 2% lower revenues, resulting in 390 basis points of margin expansion. This was largely driven by carry-over benefits of the aggressive cost reduction and organizational restructuring, strong volume, and earnings conversion in parts of the business, and lower commodity costs.

One time impact of new divestiture related transactions reduced profit by about $20 million. Consistent with expectations, organic revenues were up 2% in the quarter, following 18 months of contraction. First quarter shipments of U.S. residential systems were up high single digits year over year; the second consecutive quarter of growth.

Although all the rates in the longer cycle commercial HVAC business in the Americas and Europe were down in the low teens at cost and currency, all of the rates in China were up mid teen. Transicold orders were up for the first time since third quarter of 2008, up over 35% at cost and currency. Container and truck filler orders nearly doubled, albeit from a low base.

I'm sure you remember these segments had significant drops in orders last year. While the cooling season is still in front of us, based on the solid start, we now expect areas of operating profit growth for the year to be at or above the higher end of our prior guidance range of $150 million to $175 million. Based on the solid stock, we now expect Carrier’s operating profit growth for the year to be at or above the higher end of our prior guidance range of $150 million to $175 million.

UTC Fire and Security delivered operating margin expansion of 110 basis points on 10% higher revenues. Organically revenues contracted 8% with double digit decline in Fire [Safety] and a mixed single digit decline in electronics security.

Net acquisitions ran [laterally] from the acquisition of GE Security on March 1 contributing 10 points of revenue growth. Foreign currency translation increased revenues eight% year over year. By first quarter orders declined organically at a low single digit rate overall.

The rate of decline continued to improve sequentially. Orders in Asia and the Fire products business increased year over year in the quarter. Operating profit grew 24% including 11 points from favorable FX and 20 points from the GE Security acquisition.

The large negative impact from low organic revenues was partially offset by the benefits of integration of field operations, restructuring and cost controls. For the full year, we continue to expect revenues to be up 20% plus and operating profit up $225 million to $215 million.

Turning to the aerospace businesses on Slide 7. At Pratt & Whitney revenues declined 9% in the quarter driven by lower overall after market volumes and significantly lower OEM shipments at both Pratt & Whitney Canada and power systems.

[Inaudible] revenues was flat while favorable currency conversion at Pratt Canada contributed three points to revenues. Large commercial engines spares revenues were down mid-teens while book to bill was slightly above 1.

As Greg said, Pratt Canada engine shipments were down 35% from a strong first quarter last year. Operating margin at 16% was 30 basis points higher than prior year. The impact from lower revenues, particularly of high margin spares was more than offset by restructuring benefits, favorable foreign currency at Pratt Canada and lower E&D.

Recent improvements in air traffic trends are consistent with our expectations of high commercial after market revenues in the back half of 2010 and for the full year we remain confident in Pratt’s operating profit increase of $75 million to $100 million on low single digit growth and revenues.

In the quarter Hamilton Sundstrand operating profit grew 6% on 3% lower revenues. aero OEM revenues were down high single digits while aerospace aftermarket and commercial spares were both up low single digits.

Industrial revenues were also up slightly. Commercial spares orders were up low double digit versus the weak first quarter 2009 levels. Book to bill was slightly above 1. Industrial orders increased mid-teens on a constant currency basis.

Orders improved across all industrial businesses with over 20% growth in the [inaudible] compressor business, a positive sign as this segment has been a leading indicator. Operating margin expanded 130 basis points, reflecting the benefits from restructuring, cost control, and lower E&D, which more than offset the impact of lower revenues.

For the full year we continue to expect Hamilton Sundstrand’s operating profit to be up $25 million to $50 million and revenue up slightly. On Slide 9 turning to Sikorsky, operating profits grew 25% on 2% higher revenues.

During the quarter Sikorsky shipped a total of 51 large helicopters, 24 based on military platforms, and 7 commercial, reflecting the continuing strength of the military business and the weakness in the commercial markets.

Operating margin expanded 190 basis points in the quarter with 10.6% from favorable mix of military and aftermarket shipments and the absence of approximately $20 million first quarter 2009 payment off a union contract ratification bonus.

The [inaudible] was slightly higher in the quarter. Final assembly on the first international Black Hawk was completed in March at [Mielec, Milicz] in Poland. This new radiant uses a global supply chain and is the first Black Hawk helicopter assembled in Europe.

We remain confident in Sikorsky’s 2010 guidance with deliveries of 250 to 260 large helicopters. Revenues up high single digits and operating profit up $100 million to $125 million. With that let me turn it over to Greg for wrap up.

Gregory Hayes

Okay, thanks Akhil. Well, a very solid quarter. Great cost performance, great margin expansion and all of that came with good cash conversion as well. And [size of life] in the end markets.

Some other highlights from the quarter, I think most importantly we closed out the GE security acquisition. The F&S team is now focused on the hard work of integration of this really wonderful property into the F&S family.

Carrier continues to implement its portfolio transformation agenda as well. Since the beginning of the year, Carrier has announced new divestitures for joint ventures for about $200 million in annualized revenue, and that’s in addition to the $1.7 billion previously completed.

On the aero side, Pratt Whitney’s engine continues to gain momentum in the market with the Bombardier C series order for 40 firm and 40 option aircraft from Republic Airways. And Hamilton Sundstrand were recognized as Supplier of the Year by the Boeing company for its performance on the 787 program.

Okay, as for the outlook for all of 2010, while there is still some uncertainty regarding the pace of global economic recovery, and foreign currency continues to be a forecasting challenge, we are very confident in our revised EPS guidance of $4.50 to $4.65 a share.

As I said before, we continue to expect revenues of $54 billion to $55 billion, that’s up 2% to 4% from last year. And as I stated earlier, order trends are improving, and that’s all in line with our expectations for organic growth to resume in the second half of the year.

Our full year expectation for organic growth remains in the range of 0% to 2%. No other changes to guidance for 2010. Still expect $350 million of gross restructuring, partially offset by one-time gains of about $100 million.

Our restructure in the first quarter was lower than we expected due to the timing of some of the projects. We continue to expect gross restructuring charges of $200 million and about $25 million of one-time gains in the first half of the year. So that’s about $0.08 of net restructuring in the second quarter if I can do the math for you.

E&D was down slightly in the first quarter, but we still expect the full year to be up about $150 million due primarily to [GTF] development and the acquisition of GE Security. And of course we continue to expect free cash will be equal or be in excess of net income.

On share repurchase our guidance remains at $1.5 billion for the full year. And we’re keeping our $3 billion placeholder for acquisitions for 2010 of which $2.1 billion was used in the first quarter.

While the world feels much better than it did three months ago, keep in mind that it is still April and our guidance relies on organic growth in the back half of the year, particular in the high margin commercial aero after market.

As always, we remain confident but cautious. We also remain focused on what we control and we continue to position UTC to outperform. By the end of this year we will have invested over $1.5 billion since the beginning of 2008 in restructuring to rationalize our cost structure.

At the same time, we continue to focus on low-cost sources, and we’re reshaping business unit portfolios to become simpler and more focused to deliver consistently higher returns. And on the top line, we continue to invest in game changing technologies and to enhance our presence in growth markets and fuel sustainable top line growth in excess of global GDP growth.

In closing we’re confident in delivering our 2010 commitments, and the leadership team is committed to generating double digits earnings growth in 2011 and beyond. Let me stop there, and Operator let’s open it up for questions if we could.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joe Nadol - JP Morgan.

Joseph Nadol - J.P. Morgan

Greg, just on organic growth company wide, you had said 2% to 3% down for Q1 and you came in -4 and my sense is that Q2 might me a little lower than you were thinking a couple months ago.

Where are you seeing – is it in aerospace that you’re seeing the weakness? And what’s your confidence level on that full year guidance which you didn’t change?

Gregory Hayes

I think organic growth did come in a little bit lighter than what we expected. I think there you know really three places that I would point to. You know F&S was down organically about 8%, and that was a little bit lower than what we had expected.

The orders have started to pick up there sequentially but still a pretty tough environment on the F&S side. Also you saw you were down 9% organically at Pratt, that was a big number for us. But of course that was really pretty much in line with expectations given the big back log that burned down in last year’s first quarter. And the other place I would say is probably Sikorsky came in a little bit light on the F&S side.

Also you say you were down 9% organically at Pratt that was a big number for us but of course that was really pretty much in line with expectations given the big back-log that burned out in last year’s first quarter. And the other place that I would say is probably Sikorsky came in a little bit light. They delivered only two more helicopters this year than last year and part of that is just the nature of the commercial business or we had a little problem with some of the customers where we didn’t get some things delivered that we probably could have. I expect again, second quarter will be a better story then first quarter.

Joseph Nadol - J.P. Morgan

Okay and then Pratt & Whitney Canada, spares you gave us the big Pratt but how did that you look in the quarter?

Akhil Johri

Buick was down in like mid to high teens level excluding FX.

Joseph Nadol - J.P. Morgan

And how does that compare to what you saw late last year and what do you think is going to happen in the next couple of quarters there?

Akhil Johri

I think a little worse then we saw last year but we do believe fully because of the improvement of the traffic we are seeing in the customers’ use of the business jet, that number should improve as it goes through the year. So we do believe this quarter was probably the lowest compares that Pratt would see all of this year.

Joseph Nadol - J.P. Morgan

Okay, on the first question I asked on the organic growth, I just want to get back to that for one second. The Fire and Security at negative 8%, where was the weakness organically because that’s been a pretty stable business historically. Was it fire or security and any details you can give?

Gregory Hayes

Yes, you know really we saw weakness around the globe particularly in the US, Austro-Asia. I tell you the one bright spot in the quarter was Asia itself but for the rest of the markets it was really pretty much down across the board.

Akhil Johri

One of the things you would find, if I might add, is to it’s not a huge, it was a little lower than we expected. The orders in the third quarter last year for F&S were down 14%. They were down 8% in the third and they are now down 3 in the first quarter. So we have seen an improving trend and again, like Pratt, we do believe that the organic compares would start to get better for F&S as well going forward.

Operator

Your next question comes from Ron Epstein - Bank of America.

Ron Epstein - Bank of America

Good morning. When we think about volume coming back through the business, how much of the cost take-out do you expect to be sticky? I mean how much of it is going to go away when volume comes back to the business?

Gregory Hayes

I think the place over there that we have been talking about for the last year or so, is about two-thirds of the cost that we have been taking out are structural and should not come back when volume comes back. A third of the costs are just related to the volume reductions that we’ve seen so head count has been taken down sharply at Pratt & Whitney Canada. Obviously it’s come down sharply at Carrier with the volumes coming down. The BL piece will come back. But as far as the other cost savings, those things ought to stick.

Ron Epstein - Bank of America

Okay then we’re thinking that’s what – $500 million or $600 million of cost to go, ballpark?

Gregory Hayes

Yes, that’s probably a good ballpark.

Ron Epstein - Bank of America

And then maybe one other question. On the geared fan, if we were to see a re-engining announcement from Airbus or Boeing this year and it did involved geared turbo fan architecture engine, what kind of investment would you expect that would be in terms of R&D for Pratt?

Gregory Hayes

Well again, I think every time you look at a large commercial engine, you’re talking about an investment somewhere in the neighborhood of a $1 billion but you’ve got to keep in mind that that’s over probably a 4 to 5 year period and there’s lots of partners involved. The clear preference of course is to offer GTF through the IAE joint venture. Again, that takes a big burden of the E&D to the partners. Even if we don’t end up going through IAE, you can be assured that we will have lots of partners willing to sign up for that so at least half of the engine would probably be partnered out regardless. So, again, all kind of manageable within the context of UTX.

Ron Epstein - Bank of America

You think it would be $150 million to $200 million a year, something like that?

Gregory Hayes

Well, it could take, yes, $1 billion over five years is $200 million a year and you know half of that would be on our nickel so $100 million a year, rough numbers.

Operator

Your next question comes from Jeff Sprague - Vertical Research Partners.

Jeff Sprague - Vertical Research Partners

Greg, I was wondering if you could provide a little bit more color on where the cash flow upside is coming from and specifically I’m wondering, given the actions you’ve taken at Carrier are you seeing, although you’re in kind of your seasonal low ebb, are you seeing better cash performance there?

Gregory Hayes

If Carrier was probably I think the most pleasant surprise in the quarter. Not just for margin expansion but also they had a positive free cash flow which considering it is their big inventory billed quarter. It was a remarkable performance. Carrier’s inventory was up a couple hundred billion in the quarter but their returns were up over a point.

So working capital I think last year was an outflow of about $700 million, this year only about $200 million. So that’s really where the strength came in. If you parse that down and inventory was up in the quarter but not up as much as it probably otherwise would have been, so turns have actually improved across UTC working capital terms have improved.

Jeff Sprague - Vertical Research Partners

So I would bet that typically Carrier’s negative cash flow in Q1 going back forever, do you think that’s a permanent structural change in the business that you’re going to, I mean it’s going to be seasonally weighted still to the middle of the year but the working capital and other changes have inherently changed the cash flow of Carrier for the good?

Gregory Hayes

Well I think it certainly changed it for the good. Obviously as we get out of distribution, we’re not just sitting there with all that inventory that gets shipped from the factories into distribution. We still have the receivables, however. And Carrier’s always going to be light cash first half of the year because of the big impact of the summer cooling. But again, structurally having gotten rid of the or divested of a big piece to the distribution businesses so far, it’s taking a big piece of working capital and put it on somebody else’s balance sheet.

Jeff Sprague - Vertical Research Partners

Now you did indicate that that raw mats were a favorable in the quarter and I’m sure that that helped Carrier. I just wonder how the channel is acting relative to price with potentially hearing negative footsteps on cost as we progress through the back half of the year?

Gregory Hayes

Yes, I think it was about a little less than, or about a penny I would say of headwind at Carrier in the quarter, so, I’m sorry, tailwind, associated with raw materials. Copper was lower this year than last year. If copper has gone up, we’ve seen around $3.60, I think when [inaudible] gave guidance last month we were talking about a $3 average price. It’s probably going to be more like $3.15 now.

Pricing is obviously very difficult in the market. Channel inventory is actually down we think year over year. And I think it’s going to be tough to push price in the back half of the year even with raw materials going up because there is so much excess capacity. At the same time everybody else has essentially the same cost structure as we do in terms of inputs. So given Carrier’s scale, I think we’re in a better position to take advantage of the market then many of the others.

Jeff Sprague - Vertical Research Partners

And if you have the data, do you know how GE Security performed organically in the quarter if you look at it on a pro forma basis?

Gregory Hayes

I don’t know that we have that data. We can probably get that for you but I don’t know that we have that handy here.

Operator

Your next question comes from Terry Darling - Goldman Sachs.

Terry Darling - Goldman Sachs

Hey Greg I wonder if we can talk about some of the pieces in Otis, the China orders very, very strong. The profit forecast kind of buys to the upside but revenues are unchanged. First question is sort of the way to put those pieces together just mix? And secondly, can you address the question a lot of people are wondering about here in terms of a China property bubble.

Gregory Hayes

China property, let’s get to that one last. Because I don’t have an answer for you. I think the Otis story in the first quarter was really on the cost performance side. New equipment was down 7% and even service was down slightly. But overall really it was a great quarter because they took out a lot of cost. They have 240 basis points of margin expansion, about 50 basis points of that just came from mix.

I’d also tell you though, they’ve got a big piece of benefit from currency obviously. That’s actually going to be a headwind for them as they go throughout the year and we don’t expect this kind of performance to continue throughout the year. Obviously they’ve had a big piece of their guidance here in the first quarter but for the full year we still expect new equipment down 5-10%.

Service has to come back from the first quarter levels before going to be able to take their guidance up. Now as far as China, orders were up just about 50% there but again, that’s off of a very low compare. Last year’s first quarter was down 40%. So you do the math and we’re still not back to where we were in the 2008 levels even thought the headline 50% sounds really, really good.

Clearly the Chinese government is concerned about a property bubble. We’ve seen some of the actions they’ve taken here in the last couple of weeks in terms of trying to limit the property sales and increasing down payments and such. But quite frankly, we haven’t been very much impacted by that. Most of the growth we’ve seen has come into the social housing and in some of the western provinces where the housing bubble isn’t nearly as apparent as what we see out of the east side.

Terry Darling - Goldman Sachs

Okay, very helpful there. And then on the confidence in the second half Pratt commercial spares improvement, you mentioned, referenced some of the macro factors out there that also all of us are seeing. I’m wondering if there’s anything more on the micro level at this point or customer indications or anything along those lines that you can point to that reinforce your confidence on that?

Gregory Hayes

I’d love to be able to point to inductions into the engine centers or customers telling us that they’re going to be able to send a bunch of engines in, but quite frankly it really goes back to the macro view that as RPM’s increase, and we saw them up double-digits here in February, I think we’re going to continue to see engines come back. Right now as we look at why are spares down so much at Pratt, it’s truly because the overhaul continues to be these light overhauls instead of the regular heavy overhauls in the engine centers.

So every spare part are down some 30% on some of these repairs of engines going through the shop. So again, we expect as traffic picks up, the airlines become more profitable during the course of the year we’re going to see a return to more normal levels of repair activity and spare sales. Obviously this problem with the volcano in Iceland isn’t helping matters and the industry probably lost a couple billion dollars of revenue. But, despite that I still think we’re pretty confident we’re going to see a lot of engines come back, we’re going to have to see parts come back relatively robustly.

Terry Darling - Goldman Sachs

Lastly, on M&A I’m wondering still around $1 billion on the placeholder for this year– how you’re thinking about public vs. private opportunities out there. I guess if you look at the valuations in the public market moving up, does that shift your focus to the private side more or not necessarily?

Gregory Hayes

Not necessarily. I think we remain open to deals, both public or private. Obviously as valuations pick up and it becomes more difficult to do a deal we like to buy for value. I think GE Securities is a great example of that. And as we sit here today, we don’t see any big deals on the horizon, but we sat here at the end of the first quarter last year and we didn’t know about GE Security either. You know deals happen when they happen and we continue to evaluate a lot of different things and we’ll just have to see how they all develop.

Operator

Your next question comes from Sam Pearlstein - Wells Fargo Securities.

Sam Pearlstein - Wells Fargo Securities

Good morning. Greg I just wanted to go back to one thing you just said so the engine shop visits right now as the works go unchanged, you’re not seeing people moving back towards a normal work scope in terms of the shop visit?

Gregory Hayes

That is exactly right. That’s one of those things that I think as we think about what’s going to change in the course of the year, the airlines again as they have more cash as they work these bigger repair bills, we’re going to see this naturally pick up.

Sam Pearlstein - Wells Fargo Securities

This would be the time on Carrier, especially on the residential side, when you would be building inventory for the cooling season. Can you talk at all about what your production schedules look like now as in April and May vs. a year ago?

Gregory Hayes

As we start to look at the beginning of April orders are certainly trending up on the cooling side. We’re running a full shift in Collierville, right now. We’re not working the second shift. We didn’t work any overtime last year. I tell you the production is ramping up in Collierville though. We expect really good growth for the cooling season here coming up.

Sam Pearlstein - Wells Fargo Securities

And then on F&S I guess the comment was February was the first positive organic growth in I think it was 18 months something of that sort. Did that continue into March and April or is the discussion about the organic growth being a little less a sign that perhaps it didn’t continue?

Akhil Johri

I think the reference, Sam, was to the orders, organic orders were up in February. We saw the improvement in orders for the quarter. It was only down 3% compared with down 8% and down 14% in the prior 2 quarters. We still expect some negative organic quarters of 1 or 2 just given the lead time of the conversion of those orders, but we do expect that to turn around and be positive in the second half of the year.

Operator

Your next question comes from Howard Rubel – Jefferies.

Howard Rubel - Jefferies

Greg, you pointed out about the volcano so some of your eco-wash I’m sure is up here. But you talked about working capital improvement, could you address a little bit why that’s happened especially at Carrier. You talked about distribution but that’s not really all of it.

Gregory Hayes

Should we comment on eco-wash? Obviously it’s the probably biggest growth opportunity we have right now is washing engines in Europe but I don’t think that’s probably not across second quarter.

Howard Rubel - Jefferies

I know that.

Gregory Hayes

As far as working capital at Carrier, inventory was up a couple of hundred billion dollars but that is much less than we had seen in previous years. Again I think there’s not a lot of inventory out in the channel right now, but Carrier has taken out so much structural cost and they have such a focus on cash, Cap Ex and the whole working capital area, I think that they’ve really been able to turn the corner. Cash has been strong at Carrier really since the last half of last year going into the first quarter. And as you take the residential distribution business out it takes a lot of that cash capital out. We don’t have to carry that inventory we previously did.

Howard Rubel - Jefferies

You’ve done a nice job with the numbers at Carrier in the aggregate. Is there still some more trimming around the edges or are there still a few things you need to do to strengthen the franchise as you reposition it from here?

Gregory Hayes

I think we’ve announced a couple billion dollars in positions. In California that’s going to go into a joint venture shortly. We’re still working on some of the other distribution here in the States. I think we’ve got the northeast and Canada left. We’re also probably looking at investing or joint venturing some of our other European and South American residential HVAC. So again, that’s all part of this ongoing. We think we’re going to get to $2.5 billion of net revenue divestitures so we’re probably about 75% of the way there.

Howard Rubel - Jefferies

Just to follow up on one other thing. Research and development is obviously a function of projects and timing and other things. Could you address where you are with the runoff on the 787 at Hamilton? I mean the numbers really were a nice improvement year-over-year in terms of profitability.

Gregory Hayes

Hamilton did see a big improvement year-over-year. In the 787 there were down about $15 million. Still a little higher than the run rate we expect for the year there. That’s not unusual in this space of the flight test program. For the full year we still expect about $100 million or so of spend in the 787 program. The first quarter was probably about 35% or so of that total.

Operator

Your next question comes from David Strauss – UBS.

David Strauss - UBS

I apologize if this has been asked as I joined late. Greg, were there any changes to your underlying assumptions to Carrier for the year by market whether it be res, commercial, trust, trailer, container, any of the guidance points that you gave at the investor conference.

Gregory Hayes

Obviously the order rates are up wonderfully at Transicold, and probably a little stronger than we had anticipated. You think about truck trailer North America is up. Truck Trailer Europe combined, those are up over 80% in orders in the quarter. We’re very low base. On the commercial side, commercial HVAC, still down around the world ex-Asia, but again trend line is improving there. I think overall we just feel better about the year. For the year still only expecting about 2% organic revenue growth there. We haven’t really forecasted a big increase. Orders are better, we feel a lot more confidence in the guidance, but a lot of that guidance is simply coming from the cost traction that we’ve seen in the business.

David Strauss - UBS

Nothing really changed in the underlying assumption by market.

Akhil Johri

It’s probably a better conversation to have as the cooling season…maybe we can have this again in a couple of months, may have better information.

David Strauss - UBS

Looking up to 2011 in terms of headwind, how should we think about in terms of quantifying F22 and D17 and then shuttle, can you give us an idea of what each of those headwinds might look like?

Gregory Hayes

I don’t know if I can quantify the exact dollar amount. We know that production on the F22 is going to end after the first quarter of next year. C17 we think production will go down and we think there will be 8 aircraft with the DOT budget versus 16 this year. And obviously the space shuttle going away is impacting rocket time this year. So those are known headwinds. On the upside you’re going to see a recovery at Pratt Canada next year and I think spares are going to come back relatively strong. The back half of this year and into next year to kind of offset a big piece of that headwind at Pratt.

Operator

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

Cai von Rumohr - Cowen and Company

Could you give us some color on the sequential monthly trends in the commercial aftermarket at both Pratt and Hamilton Sunstrand?

Akhil Johri

We typically guide… We don’t talk about monthly data as such, but I think the point to make probably would be that there is improvement in Hamilton that we’ve been seeing as evidenced in our overall quarterly numbers and it’s not surprising given the broader base that they have across the aircrafts around the world, so Hamilton is the first one to see the improvement. They also saw the improvement in the provisioning side which is also encouraging to see.

On Pratt, I think that gets [back in mode] by the fleets that they are on and the [inaudible]. Also to remind you, Pratt’s [inaudible] for first quarter last year was the strongest quarter of the year for last year. So I think to talk about significant decline year-over-year, we still believe that it’s due to tough compares and that should get easier as the year goes around in addition to the improving traffic and the phenomena that Greg talked about of maybe higher, heavier build schedules as the engines come back the later half of this year.

Cai von Rumohr - Cowen and Company

I didn’t really want specific, we were up 10% or whatever by month, but just any general color as you went through the quarter. Was January the worst, did things get a little bit better in general? Was it about level? Any kind of color to that extent would be very helpful.

Gregory Hayes

We look at things on like a three month rolling average here. Things are very lumpy day to day, week to week, and month to month. January – really the whole quarter was just about on forecast where we had expected it to be. There were no surprises either positively or negatively in the quarter on spare run rates at Pratt.

Cai von Rumohr - Cowen and Company

Also could you kind of walk us through [inaudible] Transicold, clearly truck trailer was strong, the orders were strong, when do you expect that to kind of translate into volume and kind of… Do you have any sequential color? Are things really starting to pick up or… Was it even throughout the quarter? Any color there would be greatly appreciated.

Akhil Johri

Bear in mind Cai that the order compares could be slightly different than revenues because orders in first quarter for last year, Transicold were down over 60% so [inaudible] up a lot while the revenues were not down as much. So I think because of the backlog, sometimes you have slightly different compares on orders versus the revenues. In terms of translating the orders regarding Q1, I think we should expect to see that at Carrier in the next three to six months. We still believe as we said in March that container and truck trailer should see somewhere in the neighborhood of 20% or so increase year-over-year. That’s what we expect the market to do. One or two of the quarters might be different but that’s what the full year outlook still remains.

Operator

Your next question comes from Rob Stallard - Macquarie Research.

Rob Stallard - Macquarie Research

Just a couple of quick ones on the aftermarket. Greg, you did note that Hamilton Sundstrand saw the aero aftermarket up low single digit and the commercial spare orders up low double digit. Does it imply a little bit of conservative about how the aftermarket is going to track this year at HS? Are you confident that your supply chain is ready for this pickup in aftermarket demand through 2010?

Gregory Hayes

I can’t believe you’re accusing us of being conservative. It was a good quarter. In fact, I think it was a little bit of a positive surprise for us because for the year we had expected aftermarket to be up high single digits at Hamilton. Obviously when orders are up in excess of that, that’s always good news. As far as the supply chain goes, we have not seen any real issue with supply chain. Keep in mind, supply chain problems of 2 and 3 years ago were on record volumes and we’ve come off of those and pretty much adjusted to that so right now I think we could clearly handle 10% or 15% increase in sales without any disruption to the supply chain or bumps from the supply chain.

Rob Stallard - Macquarie Research

Just quickly, did you get your normal price increases in the spare parts aftermarket in the start of the year?

Gregory Hayes

Yes, both Pratt and Hamilton published catalogs back in the first of October. I think spare parts price increases were averaged around 5%.

Operator

Your next question comes from Doug Harned - Sanford C. Bernstein

Doug Harned - Sanford C. Bernstein

Going back to the gear turbo fan, you refer to $1 billion of investment if Airbus or Boeing decided to re-engine with it and that’s a typical cost for a new engine. But what I’m trying to understand, if you’re already developing a similar thrust class engine for the MS21, doesn’t that imply that you’d be spending that money anyway and also, wouldn’t that have implications for how you would structure investment in something like an IAE structure?

Gregory Hayes

You’re exactly right. Obviously if you build an engine for the A320 family which is going to be very similar to the MC21 that we’re building, there’s obviously big synergies on the core side. You still have obviously specific testing that you have to do, certification testing and all that, but that $1 billion comes down materially if you’re able to use the same core from plane to plane.

Doug Harned - Sanford C. Bernstein

I would expect you to be able to do that given what the aircraft looked like and if you go that way, you envision… let’s say you sold it through IAE. Wouldn’t you envision having a much larger share in terms of revenues coming out of IAE given your investment and your intellectual property, you’d be contributing.

Gregory Hayes

Those are all things that we’re talking to the partners about today. Obviously we very much want to do the Airbus re-enginging through the IAE joint venture. Most of the partners are aligned with us. One of them is not. That’s part of the problem, one of the reasons why this is more difficult than it otherwise would be to forecast for you guys.

But we’re working on every possible scenario with Airbus with IAE and with our partners. I think if we can’t come to conclusion with Rolls Royce on this on how IAE goes forward, clearly Pratt’s going to go it alone and I say go it alone, that means we’ll still have partners, so to your point, we’ll get a lot more than a third of the revenues in a geared turbo fan engine program than we see on the V-2500 today.

Akhil Johri

As you well know, it’s still all hypothetical discussion. There’s still a lot to happen between now and before Airbus decides to re-engine and put GTF on, so better guidance, better direction as we always provide, we will give all this data to you once those decisions are made and be further along.

Doug Harned - Sanford C. Bernstein

Then if I can quickly, decline in service revenues at Otis, typically Otis is something that service tends to improve year-over-year in good times and bad times. Why do you think service is down and what’s your thinking on that for the rest of the year?

Gregory Hayes

Service was down in the first quarter but just slightly. You’re talking about 1% or so and as you’re looking at the three pieces of service, the biggest piece of the service revenue comes out of the contractual maintenance. That’s about two-thirds of the revenue. That was actually up as it normally is. That just keeps growing every single year as the number of units under a service contract grow.

What was down in the quarter was repair and modernization, and they’re probably equal in terms of their weighting in the revenues. Modernization was down the most though. That’s one of the things we think will come back strongly in the back half of the year. There’s still a requirement in Europe to modernize all of the older elevators so we expect as we typically do that repair and mod will pick up as the year goes on. It’s just a natural tendency. Our guys are out there, they’re selling this and building owners have to get things done by the end of the year. So it’s just kind of a… It was a bad first quarter but again, it doesn’t really cause us concern for the year yet.

Operator

Your next question comes from Heidi Wood - Morgan Stanley.

Heidi Wood - Morgan Stanley

A question on Otis as well. On the new equipment orders, can you break those out in terms of geography? Was largely all the strength from orders in China or was there strength elsewhere?

Gregory Hayes

As you think about it, North America was down about 30% on new equipment. Like Akhil said, Europe was flat which is the second quarter in a row that’s Europe has been flat. In China we saw orders up nearly 50% so again, keep in mind, as we said before, that’s off of a very easy compare when orders were down 40% last year, but the strength is really in Asia right now.

Commercial construction continues to be a problem here in North America. I think the only good news we saw today, I think ABI finally came out and its trending positively, still not at 50% level, but again we’re going to have a tough year in new equipment in North America and it’s probably not going to be great in Europe either, but that trend will reverse. Again, one of the reasons we’re confident next year is going to be so much better is we’re going to see a rebound at Otis new equipment next year.

Heidi Wood - Morgan Stanley

Another question on M&A. You answered it from one angle, but I wanted to take it from another which is we haven’t seen strategic M&A in commercial aerospace from you guys since I think Hamilton Sundstrand in the late 90s. Can you talk a little bit about sort of where you see opportunities in that arena and how you address kind of gaining share with Comac given their long-term ambitions in China. Are we going to see more joint ventures out in Asia as a consequence of that?

Gregory Hayes

That would be just exactly right idea. What you’re going to see Comac is an important customer that both marketed in Pratt and Hamilton and had been working with the [Avec] companies for a number of years. I think we view this, the Comac opportunity is unique and we’ll be able to look at it from the Hamilton Sundstrand side to develop a joint ventures to supply the Comac aircraft within China and also to use those joint ventures as low cost sources for the rest of the products that we deliver. That’s the, I think that’s the good news.

As well on the engine although we did not win the initial competition on the engine, we’re still talking to the Comac folks about potential for the GTS on the next generation or the next version of that aircraft so, lots of opportunity in China and commercial aviation. And most of this is going to happen through joint venturing.

Heidi Wood - Morgan Stanley

But does this interest you in being larger in commercial air from an M&A standpoint. I mean are there more things that you think you ought to be buying to expand this new entrant. We have a duopoly market that some day over the decade is going to be an oligopoly and how are you positioning for that?

Gregory Hayes

I think as we look at commercial aero opportunities it’s primarily the aftermarket space and you’ve seen Pratt Whitney has been doing this for a number of years. We just opened up the China Eastern joint venture to overhaul CFM engines. We opened up the Turkish engine overhaul center again, the CFM overhaul shop and as we think about M&A opportunities it’s really in the aftermarket area.

There are three engine manufacturers out there, three big engine manufacturers out there. It’s kind of hard to do consolidation there. Obviously there’s opportunity on the Hamilton side from a systems perspective to go down the wire [spirter] to offer more systems, but some of the big aero sub system suppliers are very expensive. I think our money is better spent and aftermarket where the margins are better and the opportunities are greater.

Operator

(Operator Instructions) We’ll take our next question from George Shapiro – Access 342

George Shapiro – Access 342

Hi Greg, if you go through Hamilton Sundstrand’s aftermarket and break it up by the provisioning, the piece part and the maintenance so, is there much difference in any of those categories?

Akhil Johri

The provisioning orders came back a little stronger as you would imagine because they had fallen off a lot in first quarter last year so then easier to base that these parts were up so, both were up in terms of orders provisioning probably a little more than these parts. And then in terms of revenues I think it was about the same. Provisioning was still a little down but these parts were up.

George Shapiro – Access 342

Okay and then, if you look at Carrier you got almost $100 million dollar increase in profit in the quarter so why weren’t the 175 for the year be conservative and then if you can just comment on how much of that carrier profit if at all significant, came from the Watsco joint venture?

Gregory Hayes

Yes, first quarter of it was very strong, you’re absolutely right there George, but if you take a look we did get a big benefit in the quarter in a very strong summer selling season down in South American in Brazil and in Argentina. We also had tailwind from commodities that’s not going to repeat. It’s actually going to be headwind in the back half of the year. But to your point I think as look at the guidance for Carrier we are very confident that they’re going to be at the top end and perhaps above that.

That based again on revenues but just on the very strong cost traction that we’ve seen in the business.

George Shapiro – Access 342

Okay and then Greg, the Watsco, is there a significant number you get there from the way you accrue the joint venture profit in carrier?

Gregory Hayes

No, it’s not a big number especially in the first quarter, George. We’ve got 40% of that joint venture so we’re picking up a pro-rata share of the earnings but it’s just not significant in the first quarter.

George Shapiro – Access 342

And let me sneak in on more Greg, almost $700 million increase in inventories. You mention a couple of hundred was probably carrier. Can you break out where the rest is from?

Gregory Hayes

Yes, to think about that, about $200 million of that came from the GE Security transaction. And another $230 million or so was at Sikorsky and again that’s just part of the issue that we talked about in terms of some of the commercial aircraft not getting shift in the quarter is going to go out here in the second quarter so… Most of the other units had very very small increases if at all.

With that Patricia, let’s conclude the call if we can.

I want to thank everybody for dialing in and listening. Real strong quarter obviously. We’re confident in the improved full year outlook so thanks for listening and the Akhil and team will be around to answer your questions throughout the day.

Thank you.

Operator

Thank you ladies and gentlemen for your participation. This will conclude to this conference call.

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Source: United Technologies Corp. (UTX) Q1 2010 Earnings Call Transcript
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