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United Technologies Corporation (NYSE:UTX)

Q4 FY07 Earnings Call

January 23, 2008, 9:30 AM ET

Executives

Gregory J. Hayes - VP, Accounting and Finance

Ken Parks - Director of IR

James E. Geisler - VP, Finance

Analysts

Heidi Wood - Morgan Stanley

Deane Dray - Goldman Sachs

Steve Binder - Bear Stearns

Joseph Campbell - Lehman Brothers

George Shapiro - CitiGroup

Cai Von Rumohr - Cowen and Company

Ron Epstein - Merrill Lynch

Nicole Parent - Credit Suisse

Howard Rubel - Jefferies

Nigel Coe - Deutsche Bank

Myles Walton - Oppenheimer & Co., Inc.

Joseph Nadol - J.P. Morgan

Operator

Good morning and welcome to the United Technology's Fourth Quarter Conference Call. Today's call is being recorded. On the call today are Greg Hayes, Vice President, Accounting and Finance; Jim Geisler, Vice President, Finance; and Ken Parks, Director of 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.

At this time I would like to turn the call over to Mr. Hayes. Mr. Hayes, please go ahead, sir.

Gregory J. Hayes - Vice President, Accounting and Finance

Thank you Rufus and good morning, everyone. As you saw the press release this morning, UTC ended 2007 with a strong fourth quarter with each of our six business units delivering double-digit earnings growth and exceptionally good cash flow. More revenues of the UTC operating model with its focus on top line growth, margin expansion and cash generation delivers consistently for shareholders.

And it is that operating model along with a strong management team that gives us confidence of another good year in 2008 despite the economic headwinds that we read about everyday. I’ll let Ken take you through the Q4 detail in just a minute, but let me just hit a couple of the highlights of the quarter.

In the fourth quarter, earnings per share were $1.08. That's up 24% over last year. Revenues were up 15%, including 8% organic growth. That follows 10% organic growth in Q1, 10% in Q2 and 9% in Q3. Free cash flow was $1.6 billion or 150% of net income. It was driven by working capital reductions, primarily inventory reductions of a little over $500 million as well as solid collections. Included in the fourth quarter results is a net $0.04 a share charge driven by non-U.S. tax law changes, restructuring and a few other one-time items and Ken will take you through those details in just a minute. But no surprises here, as this net $0.04 impact is consistent with what we told you back in the fourth quarter and third quarter conference call.

As we look across the businesses, we see continued examples of solid execution, a very good top line growth at the aero units, strong margin expansion at Sikorsky and Fire & Security, a solid operating performance, performance at Otis and at Carrier, and despite of the significant drag in the U.S. housing market. We had a major milestone in the quarter as well with Geared Turbofan, which successfully completed almost 70 hours of ground testing, demonstrating about the validity and robustness of the engine's design. The rollout of ACE UTC's operating system continues, ending the year with 30% of sites at gold or silver level, nearly doubled from the beginning of the year. Our goal remains 70% by 2009. ACE is a proven operating system with a rigorous focus on the customer and process. These provide benefits not just in the factory but in all the customer-facing and back office functions that can drive value creation across the company. So, strong finish to 2007, that more importantly underscores the importance and success of operational excellence at UTC. And it’s this operational excellence that gives us confidence that 2008 would be another good year for UTC. I will come back and talk a little bit more about the outlook for '08 at the end. But first let me hand it over to Ken to take you through the details.

Ken Parks - Director of Investor Relations

Thank you Greg. And as Greg said fourth quarter earnings per share were a $1.08, less than 24% over the last year including $0.04 of restructuring and charges in excess of gains. Recall that last year's fourth quarter included $0.05 of restructuring in excess of gains. Now let me go through the non-recurring items in the quarter as shown, the sale of two non-core businesses generated $83 million of gains. In addition to restructuring charges, following $63 million we settled the litigation matter at Carrier. Finally, our effective tax rate in the quarter was higher primarily as a result of non-U.S. tax law changes. As you recall, we had $0.04 of net gains in our third quarter results and told you to expect the same amount of net charges in the fourth quarter.

As tax accounted for 5 points of our revenue growth and 2 points of our EPS growth, as the 4Q average Euro rate of $1.45 was significantly higher than last year's average rate of $1.27 and consistent with our assumption for 2008.

Moving on to page four and turning to the business unit details, I’ll remind you that I will talk to segment results adjusted for restructuring and these non-recurring items that I just went through. Otis finished the year with a strong fourth quarter. Profits up 22% on revenue growth of 17%, revenues grew in all geographic regions including double-digit growth in Asia and North America as Otis continues to execute on a robust new equipment backlog. While revenue mix continued to shift towards new equipment, margins expanded by 60 basis points by 18.9%. Favorable foreign exchange contributed just under half of the revenue and profit growth in the quarter. New equipment orders remained strong in the fourth quarter with an increase of 20%.

For the year, Otis delivered a 15% increase in operating profit on 14% revenue growth. Margins expanded to 19%, a 20 basis point improvement as ongoing cost containment and efficiency action mitigated commodity and labor cost headwinds, continued pricing pressures and the shift in Otis revenue towards more new equipment. Favorable foreign exchange contributed approximately 40% of the revenue growth and 45% of the profit growth. Otis ended the year with a new equipment backlog 27% higher than the prior year. The robust new equipment backlog positions 2008 to be another good year for Otis with guidance of high single digit revenue growth and profit growth of 10% or more.

At Carrier, fourth quarter operating profit increased 20% year-over-year on 14% higher revenues, translating into 30 basis points of margin expansion. As in recent quarters, strength in the building systems, international, residential and light commercial, and refrigeration businesses more than offset housing-related weakness in North America.

Favorable foreign exchange contributed about six points to revenue growth and about half of the earnings growth slightly exceeding the net commodity headwind in the quarter. For the year, Carrier earnings grew 12% on 9% higher revenues, margins expanded 20 basis points to 9.5%.

Earnings growth was consistent with our initial guidance despite a continued deterioration of the U.S. housing market, while currency translation contributed about $50 million of the earnings growth, it was more than offset by net commodity headwind of about $80 million. We continue to expect Carrier to grow earnings by at least 10% on mid-single digit revenue growth in 2008.

UTC Fire & Security continued its strong performance as revenue growth of 27%, generated profit growth of 38% in the quarter. Revenue growth was substantially driven by acquisitions as well as 9 points of favorable foreign exchange. Foreign exchange also added about 10 points of the profit growth.

Continuing benefits from previously announced restructuring actions as well as ongoing pricing and supply chain initiatives resulted in margin improvement of 80 basis points year-over-year. In December, we completed the purchase of Rentokil's Initial Electronic Security Group as we closed on our French piece of the business. This followed our acquisition of the U.K., Netherlands and U.S. businesses in the third quarter.

Fire & Security delivered full-year profit growth of 40% on revenue increase of 21% resulting in margin improvement of 110-basis points for the year.

For 2008, Fire & Security will continue to focus on margin expansion and profitable revenue growth. We expect revenues will grow mid-single digits with operating profit growth of 25%.

Now turning to the aerospace businesses, Pratt & Whitney revenues increased to $172 million or 6% in the quarter led by 20% growth at Pratt & Whitney, Canada and 80% growth at Power Systems.

Operating profit improved 16% in the quarter reflecting the higher revenues, the absence of unfavorable adjustments in last year's fourth quarter and the favorable impact on completion of contractual milestones on a commercial engine program. Partially offsetting this growth were higher commodity and R&D costs, which each negatively impacted fourth quarter operating margins. For the full year, Pratt & Whitney increased operating profit 14% on revenue growth of 9% driven primarily by Pratt & Whitney Canada, a large commercial engine asset market and Power Systems. We anticipate the solid performance at Pratt to continue into 2008 expecting mid-single digit revenue growth with operating profit growth of approximately $175 million to $200 million depending on the GTF program. Spending on the GTF will approach $125 million, which is about 60% of UTC's total expected E&D increase of $200 million in 2008.

In the quarter, Hamilton Sundstrand revenues grew 15% with operating profit growth of 12%. Similar to recent quarters, performance was solid in the aerospace aftermarket and industrial segments, both delivering double-digit revenue and operating profit growth.

R&D investments principally on the 787 program continued to be a headwind, accounting for more than 100 basis points of operating margin in both the quarter and the year. Even with these investments, Hamilton delivered a solid year with revenue growth of 13%, profit growth of 14% and 10 basis points of operating margin expansion. For 2008, we continue to expect Hamilton revenues to grow at high single-digit rates and operating profit to increase 10%.

Revenues at Sikorsky grew 18% in the quarter as they continue to increase production to deliver the record helicopter backlog. Operating profit grew about 80% over last year's fourth quarter and was up sequentially from the third, in line with our guidance of sequential profit growth each quarter around [ph] 2007.

Sikorsky operating profit for the year was $370 million as compared to our guidance a year ago of $340 million. During the quarter, Sikorsky shipped 46 large helicopters, 22 military and 24 commercial. For the year, that is a total of 174 large aircraft deliveries, up almost 60% from 2006 exceeding the guidance of 160, we started the year with.

In December, Sikorsky won the largest contract in UTC's history, a $7.4 billion five-year production contract for 537 U-860 helicopters for the U.S. Army and Navy. As a result, ending backlog at Sikorsky reached $11.4 billion, up 30% from December 2006 and includes the $3.1 billion appropriated portion of this new contract.

For 2008, we expect revenues to increase mid-teens on 200 plus large aircraft deliveries, generating operating profit growth of approximately 25%.

Now I'll turn it over to Greg to wrap up.

Gregory J. Hayes - Vice President, Accounting and Finance

Okay, thanks Ken. Before turning to the 2008, just a few final thoughts on 2007. It was another strong year of both revenue and earnings growth for UTC. Revenues for the year ended at just under $55 billion and that's up 14% from 2006, and the full 9% of that growth organic. It is the fourth consecutive year of solid organic growth coming on top of 9% organic growth in '06, 7% in 2005 and 8% in 2004. Earnings per share for the full-year were $4.27, that's up 15% over 2006. This is also the fourth consecutive year of solid double-digit EPS growth following 19% in '06, 18% in '05 and 19% in 2004. And don't forget that the 2000 EPS includes a net $0.07 drag associated with the resolution of the Otis EU matter back in the first quarter.

Free cash flow for the year ended at essentially 100% of net income, [inaudible] growth of 1.4 billion and the headwind of the Otis EU and Canadian tax payments back in the first quarter, which totaled almost $0.5 billion.

Although we saw significant improvement of working capital throughout the year, inventory and more specifically inventory returns was disappointing. No is the answer here, but we can fix this through focus and by continuing to use the ACE tools in our own factories as well as at our suppliers to improve inventory velocity across the entire supply chain. On perhaps a happier note, in 2007 we returned 75% of our free cash flow to shareholders in the form of share repurchase and dividends, the second consecutive year, which we returned over $3 billion of free cash flow to shareholders. Acquisition spending, including acquired debt for the full-year was $2.3 billion, slightly higher than our guidance for the year. A full $1.8 billion of this spending was allocated to our Fire & Security business as we continue to build the scale in our newest segments. So another excellent quarter and year for UTC, double digit earnings growth across all of our business, robust organic revenue growth and solid cash flow generation. And just as importantly, solid execution by our experienced management team, all of which gives us confidence as we look towards 2008.

On 2008 first of all, no changes from what we told you in December. Although 2008 may be a tougher economic environment, we continue to see another year, solid year ahead given UTC's geographic balance, a continued worldwide infrastructure build-out, our emerging market presence and our solid execution capability. On emerging markets, we expect these markets to continue to expand at roughly 2x those of the developed markets, albeit not clear to the pace we've seen over the last few years.

Commercial aerospace OEM markets remained strong, due to continuing growth in revenue passenger miles worldwide and in spite of record-high fuel prices. We currently see good order and quota activity in our commercial construction markets, however, we remain alert to the impact of the credit crisis and its essential spillover impact on these markets. And although the North American residential market remains sluggish, it still represents only 5% with overall UTC revenues, balance those work.

Overall, the strengths of macroeconomic certainly on the horizon, we are confident in our ability to once again deliver strong results that our investors have come to expect from UTC. For the year we see revenues of approximately $59 billion on mid single-digit organic growth consistent with what we said in December and we expect EPS to be in the range of $4.65 to $4.85 and free cash flow to equal or exceed net income, our usual standard.

So with that, let me open up the call to questions. Rufus?

Question and Answer

Operator

Thank you Sir. Ladies and gentlemen our question-and-answer session will be conducted electronically. [Operator Instructions] And for our first question we go to Heidi Wood with Morgan Stanley.

Gregory J. Hayes - Vice President, Accounting and Finance

Hello Heidi. Good morning.

Operator

Ms. Wood your line is open please go ahead.

Heidi Wood - Morgan Stanley

Okay sorry...there was some problem. Can you guys talk a little bit about what you are seeing in commercial aftermarket? How much did they grow in 2007 and what are you expecting in 2008? I'm just wondering if you can give an update on what are the most recent trends you're seeing there?

Gregory J. Hayes - Vice President, Accounting and Finance

I think, Heidi, as we look across the business, what we saw, it was very, very strong aftermarket growth at Hamilton, 20% kind of growth. Pratt & Whitney actually had a... for fourth quarter that was a little bit flattish again coming off of a very strong compare. And Sirkosky, which it's rolled up and is actually was down just a little bit off of very strong deliveries back in 2006. But I think the overall trends we see remain very, very strong and we would expect high single-digit kind of growth in the aftermarket for 2008. Our RPMs continued strong, yields are very good at the airlines. And despite these record high oil prices, people are still flying out there. So we don't see any slowdown especially as the OEMs continue this build out of the record backlog.

Heidi Wood - Morgan Stanley

All right thank you, and then on Carrier how much was North American residential down in 2007 and tell us what you're expecting in 2008?

Ken Parks - Director of Investor Relations

The market for North America was down for systems a little bit more than 10% and remember that's a mix of residential new construction, as well as AOR. So, you’ve got the… residential construction piece was [inaudible] based on housing starts down more than 20%, probably closer to 25%. AOR was a little bit better than that and probably closer to just right at double digits down. Rents followed along with that. As you know, we talked earlier in the year that we had lost a couple of points in market share in the second quarter and we basically held that position through the remainder of the year. So, that's kind of a look at '07. One we are expecting for '08, when we look at housing starts like you guys do and we are still saying a number of that looks like another 24%, 25% drop in '08, maybe AOR is a little bit better than this year, but we are really just counting on a market that continues to be down year-over-year and probably doesn't start to show any favorable comparison on a quarterly basis until we get very late in the year or probably even into early '09.

Heidi Wood - Morgan Stanley

All right. Great. Thanks so much.

Ken Parks - Director of Investor Relations

Thanks, Heidi.

Operator

We go next to Deane Dray with Goldman Sachs.

Deane Dray - Goldman Sachs

Thank you. Good morning.

Gregory J. Hayes - Vice President, Accounting and Finance

Good morning, Deane.

Deane Dray - Goldman Sachs

I can hear you expand, if you could, on your comments on commercial construction. And very specific, it looks like you are entering '08 with pretty sizable backlog. So, could you touch on the backlog and true up the numbers? You said Otis at one time was 18 months of backlog and Carrier around six months. So how do those backlogs look? Any risk and what has been the code activity in those businesses?

Gregory J. Hayes - Vice President, Accounting and Finance

Yes, Deane, this is Greg. If you look at the backlog at Otis, Otis is going to end the year with about $14 billion backlog. That's up about $2.5 billion over last year. Otis continues to see very, very strong activity, especially in North America but even in Asia. In North America, we had about 30% order growth here in the fourth quarter and even in Asia it was 20%. Europe was even kind of I think mid single digits to high single digits. So, strong order growth around the entire geography for Otis. So, backlog is strong there. And you think about, that it is a little over a year sort of the sales at Otis. But it’s actually more than that because of the service element. And at Carrier, at the end of the year, a little over $2 billion of backlog, that's up a little more than 10% year-over-year. And I would tell you that the code activity at Carrier also remains fairly strong. We have not seen yet a slowdown in any of the commercial construction markets that would give us an indication that we are going to see a big problem here, at least in the first half of the year.

Deane Dray - Goldman Sachs

Greg, did I hear in your prepared remarks you mentioned pricing pressure at Otis and has that changed at the margin and what does that look like for '08?

Gregory J. Hayes - Vice President, Accounting and Finance

No, I think if you think about pricing pressure, really is in China specifically, it was comment. North America pricing looks actually fairly robust, but the pricing pressure in China will continue. I think it has been world's biggest elevator market, but it is the world's biggest elevator market, lots of competition and we don't expect that the pricing pressure will oblate any time soon.

Deane Dray - Goldman Sachs

Great. Thank you.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks, Deane.

Operator

We go next to Steve Binder with Bear Stearns.

Steve Binder - Bear Stearns

Yeah, Greg, you touched on the fact that there is no change in December 13… in the guidance from December 13. I am just wondering if you look at your short cycle, long cycle, more short cycle commercial end markets, and not just the short cycle business, but also long cycle at Otis, you obviously had some front-end signals. I am just wondering over the last month, month and a half you seasonally adjusted for, have you seen any real change in those end markets?

Gregory J. Hayes - Vice President, Accounting and Finance

Steve, we really have not and believe me we are asking that question every week, because as we read the headlines I think everybody is concerned that there is a slowdown out there. We have not seen it. And I think that's the best news that we can convey to everyone.

Steve Binder - Bear Stearns

Right. And secondly with respect to R&D, obviously Pratt is a big chunk of the increase in '08, just wondering given the uncertainty of that consolidation the economy in North America in the air line business, since one of your large customers potentially is the U.S. Airline, it has been talked about. Coupled just with global concern, can you see a possibility in '08 whether that $200 million number turns out to be high and just discuss the [inaudible] of 787 could be a headwind obviously relative to that plan, but is there a chance of $200 million comes in wider than that?

Gregory J. Hayes - Vice President, Accounting and Finance

Maybe just to dissect that $200 million for you, we think $100 million to $125 million of that spending is going to be at Pratt & Whitney. And that is primarily going to be on the GTF. And I don't see anyway that that is going to slow down or update in any way during the course of the year. It’s... we are committed to those programs, we're committed to the flight test in the middle of the year. We are still looking for partners. Obviously we have signed up one partner for 15% that is MTU. We are working with other partners. But I think the 125 or so at Pratt is pretty solid. The rest of the increase in spending is really about 30 million at Carrier, about the same amount at Otis and the same amount at Sikorsky. If you think about the 787 program specifically at Hamilton we are actually going to see a little bit of a decrease in spending, although it’s certainly not at what we had hoped in the middle of last year, given the way the schedules looked at Boeing. I think there is always risk on the 787 as the programs continues to slide, but right now we actually see a little bit of good news coming out of Hamilton on the E&D line.

Steve Binder - Bear Stearns

And lastly, Fire & Security I mean the growth rate… the organic growth rate spending was lighter than it has been first nine months of the year. Is that just comparisons, tougher comparisons, any change in their environment?

James E. Geisler - Vice President, Finance

Steve, this is Jim. The organic revenue growth rate in the fourth quarter was lowish, but I think it goes back to the base premise that our focus is on margin. I will give you the example of that. If you look into Europe, in securing Europe in this quarter we had a slight decline in organic revenue growth, but that's also where we have done the Initial Rentokil acquisition. And so the focus of the organization has been in driving margins and getting synergies out of the deal because their maintenance, their call centers and their branches sit right on top of ours. So, we continue to drive the cost reduction and sometimes that has resulted in revenue growth that's not very high. But, I think as the business gets its cost base in line then you will see revenue start to move up.

Steve Binder - Bear Stearns

All right. Thank you.

James E. Geisler - Vice President, Finance

Thank you.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks Steve.

Operator

We'll go next to Joe Campbell with Lehman Brothers.

Joseph Campbell - Lehman Brothers

Hi. Good morning. There has been a lot of talk about whether the international markets and the emerging markets are coupled. They are not coupled with but perceived a real weakness in the U.S. economy. And I wondered if would just kind of walk around the various overseas UTC businesses and comment on how you see them. You mentioned, you see the developed... the emerging markets running twice the developed markets, but maybe just kind of walk around and then if you could just give us the kind of year end FX numbers for each of the businesses. You gave it for fourth quarter and I know you have given them to us over the course of the year, but just perhaps remind us of the overall contribution of FX to the businesses. Thanks very much.

Gregory J. Hayes - Vice President, Accounting and Finance

Okay Joe, well, it can’t be to FX numbers as I try to address the first part of your question. And as we look around the world, specifically Asia, I think what we would tell you is that the trends that are driving growth in Asia do not look to slow down in the near term. And that is really the continued migration of people from the farms to the factories. 17 million people a year coming in China from the farms to the factories, 30 million people across Asia and then it is driving the infrastructure build up. And we don't see anything that's really going to slow that down in the near-term. Urbanization, it's a powerful force and this was driving the business really for the last five years and driving organic growth at Otis and Carrier, as well as in the aerospace business as we've seen record orders in India and China for new aircraft. So, Asia looks to remain solid. I think Europe, the question there is what happens is the… with the Euro at 144 or 145, we have not seen any particular slowdown in Europe. It certainly is not going to have the kind of growth rates that Asia does, but we would expect that it still has kind of mid single-digit growth in 2008. In North America, again I think you got to go back to the individual businesses, res, as Ken said, it's going to be a tough market this year, we think the market for new home construction could be down 25%, but residential... I am sorry non-residential construction we still think... it may moderate a little bit from last year's growth, it's still fairly strong. And of course, the aero businesses, I think, all remain strong. And both Boeing and Airbus have record backlogs. Sikorsky has got a great backlog, they're going to build over 200 helicopters this year and you're going to see strong revenue growth out of Sikorsky. So, we don't see any big bumps on the horizon here.

Ken Parks - Director of Investor Relations

Maybe one other comment on that Joe, just to offer a little bit of perspective and that is I think as Greg said, we haven't seen any slowdowns. However, we are very cognizant that other things are happening in other sectors that may come to effect in our markets. So, while we haven't seen anything yet we have to open our minds to the fact that something in time may come to affect our businesses. All that being said, we feel very good about our positions, 62% of the revenues outside the States really great mix of short and long cycle businesses and frankly company that has performed well in adverse times.

James E. Geisler - Vice President, Finance

All right Joe let me give you the FX numbers that you were asking about. For the year, for UTC overall, it contributed a couple of points of the EPS. Now the main place where it plays obviously is on the commercial side of business. So, Otis, their profit growth for the year it contributed about 7 points of growth. For Carrier, it's around 4 and Fire & Security is around 9, aero business is a small number. But all that sum together will give you a couple of points of EPS growth for UTC.

Joseph Campbell - Lehman Brothers

Thank you very much.

James E. Geisler - Vice President, Finance

Thanks Joe.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks Joe.

Operator

Our next question, we go to George Shapiro with Citi.

Ken Parks - Director of Investor Relations

Good morning George.

Gregory J. Hayes - Vice President, Accounting and Finance

George?

Operator

One moment please. Mr. Shapiro, would you please resignal?

Gregory J. Hayes - Vice President, Accounting and Finance

Rufus while we are waiting, is there someone we can go next on the list and then come back to George.

Operator

Mr. Shapiro, your line is open.

George Shapiro - CitiGroup

Okay.

Gregory J. Hayes - Vice President, Accounting and Finance

Good morning George.

George Shapiro - CitiGroup

Okay. I don't know what happened but my question is given that this is the second quarter in a row that we've seen like zero spares growth at Pratt and 20% this quarter and 15% last quarter at Hamilton Sundstrand. Have you gone back and looked at why the discrepancy is so large, I mean does it relate to lack of narrow body share at Carrier versus Hamilton or what did you come up with?

Gregory J. Hayes - Vice President, Accounting and Finance

I think actually we have obviously taken a look at this because it's not… it is unusual I would say for there to be such a divergence between the quarter growth rate at Hamilton Sundstrand versus Pratt & Whitney. But, as we look at Pratt & Whitney, we saw a fairly big increase in inductions into the engine shop, about a 9% increase into the overhaul shop. We didn't get all of those engines out and I think had we actually seen that kind of... or had we really get those engines out, we would have seen probably much better growth in spare part because obviously the big part of the revenue there is spares. Also you pointed the fact that Hamilton is on every aircraft out there. So obviously they have a larger base on which to grow but I don't think there is anything that would tell us that Pratt is going to grow anymore slowly than Hamilton over the long-term in terms of its installed based for aftermarket.

Ken Parks - Director of Investor Relations

And remember one other thing we talked about George, as we moved through 2006 was that spare parts and aftermarket ramps up as we move throughout the year based on airline profitability and so we saw some tougher compares on the second half. Just to supplement a little bit what Greg was saying was, compared to the second half of this year, have been awfully tough compared to the second half of last year.

George Shapiro - CitiGroup

So why would it be that much tougher at Pratt and Hamilton?

Ken Parks - Director of Investor Relations

It’s just based upon the timing of how the engines come out.

Gregory J. Hayes - Vice President, Accounting and Finance

I think it really goes back to the engine inductions. I think also to look back at 2006, there was a little bit of an influx of engines as we completed some of the ring casework on the Pratt 4000. So that drilled a little bit of the timing here, but in long-term we do not see a divergence in order rates.

George Shapiro - CitiGroup

Okay. Then Ken, could you just provide deliveries or if you wanted to do it offline I will wait for offline at Pratt?

Ken Parks - Director of Investor Relations

I can give you deliveries while we are here. Commercial engine shipments in the fourth quarter were 111, military were 40, Pratt Canada was 922 and industrial were 19.

George Shapiro - CitiGroup

Okay, thanks a lot.

Ken Parks - Director of Investor Relations

Thank you.

Operator

For our next question we go to Cai Von Rumohr with Cowen and Company.

Cai Von Rumohr - Cowen and Company

Yes. Like many other companies you have good results, you haven't seen any slowdown and yet the markets continue to tank. You're sitting there with very good financial position, how do you react with that financial firepower? At what point do you go into the market and buy in your own shares, at what point do you say, now I'm going to make another acquisition?

James E. Geisler - Vice President, Finance

Cai, this is Jim. We agree the stock is practically trough price right now and we already committed to $2 billion of share repurchase. So we look to buy, we will continue to look to buy and frankly while the stock is very attractively priced for us, there may be other opportunities as well. So again, I mentioned earlier, that this is an environment, I think where UTC typically does well and may have the opportunity to take advantage where others cannot take advantage. So stay tuned.

Cai Von Rumohr - Cowen and Company

So what you're telling me is that you're more likely to get kind of redeploy cash if we see... what we see in the last couple of weeks we are more likely to see you take more aggressive initiatives either in terms of M&A or share repurchase than you did in the fourth quarter?

James E. Geisler - Vice President, Finance

I would say right now we feel very good about having a strong balance sheet and the opportunity it gives us.

Cai Von Rumohr - Cowen and Company

Okay, terrific. And just one follow up to George. Could you give us the split at Pratt in terms of year-over-year change in large engine spares and large engines MRO and at Pratt Canada?

Gregory J. Hayes - Vice President, Accounting and Finance

Well I think we would… we don't typically give the spares changes but I'll tell you that the book-to-bill in the quarter was right around one. As Pratt Canada growth we quoted as about 20% and that business has had good growth both on the OEM and aftermarket side, I think it's fairly comparable.

Cai Von Rumohr - Cowen and Company

Okay, terrific thank you.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks Cai.

Operator

[Operator Instructions] We go next to Ronald Epstein with Merrill Lynch.

Ron Epstein - Merrill Lynch

Good morning guys.

Ken Parks - Director of Investor Relations

Good morning Ron.

Gregory J. Hayes - Vice President, Accounting and Finance

Good morning Ron.

Ron Epstein - Merrill Lynch

When we think about the GTF program, what milestone should we be looking for, when we look out over the next 12 months?

Gregory J. Hayes - Vice President, Accounting and Finance

I think the key milestone is we have gotten past the full power testing of the ground run here in the fourth quarter. The next key milestone we are going to be talking about is flight test, which will happen in mid-year. I think the other milestones, keep in mind, the actual launch of both Mitsubishi and the Bombardier CSeries aircraft. Those are still not officially launched yet. But those will be big milestones for us because that is when the spending will begin to ramp up on those programs.

Ron Epstein - Merrill Lynch

And you are spending on those programs is by continuing on some sales figure of those programs right? I mean it doesn't... Mitsubishi has to sell certain number of airplanes before you guys?

Gregory J. Hayes - Vice President, Accounting and Finance

There are certain launch conditions obviously in both contracts. So, we have to be satisfied that we have a good customer base, that's going to be a successful launch. But we are confident about Mitsubishi and the Bombardier are going to get those commitments from customers.

Ron Epstein - Merrill Lynch

Okay. And then just a financial question. If you look at the run-rate of CapEx in the first three quarters of the year and then in the fourth quarter, fourth quarter was kind of well above trend. Why was that?

Ken Parks - Director of Investor Relations

It was concentrated more at Sikorsky and at Pratt and I think that just comes along with the fact that the capital cycle tends to be heavier in the fourth quarter of the year.

Gregory J. Hayes - Vice President, Accounting and Finance

It’s really related to volumes. So, you think about Sikorsky is there is continuing ramp up the volume down in Stratford, as well as at some of the supply base as well as at Pratt Canada as we are ramping up volume on the small engines. We shipped almost 3000 engines out of Pratt Canada, this year and that obviously is going to take more capital as we continue to increase the volumes of theirs, so a little bit higher than we would have expected but still in line with what we are seeing in terms of revenue growth in those businesses.

Ron Epstein - Merrill Lynch

Okay and then just one last quick question. Otis aftermarket in China, what kind of conversion are you are seeing from the OE equipment you have put in place to the aftermarket?

Ken Parks - Director of Investor Relations

I think it hasn't changed significantly since we talked last. We are seeing conversion. There is a long pathway. With that conversion rates in the team, I mean it’s not high yet.

Gregory J. Hayes - Vice President, Accounting and Finance

We have talked about this a lot. The fact is that we do not have a large service portfolio yet in China but it gives the opportunity as we look forward as all of these elevators that we are delivering in, probably delivered more than 50,000 elevators in 2008 in China. It will eventually be a huge market for service and we would expect it over the long-term that the service portfolio would generate more than half of the revenue in China as it does throughout the rest of the Otis world.

Ron Epstein - Merrill Lynch

Okay. Great. Thank you.

Gregory J. Hayes - Vice President, Accounting and Finance

Thank you.

Operator

We go next to Nicole Parent with credit Suisse.

Nicole Parent - Credit Suisse

Good morning.

Gregory J. Hayes - Vice President, Accounting and Finance

Hi Nicole.

Nicole Parent - Credit Suisse

And just one follow-up on M&A. Could you just talk a little bit about kind of what you're seeing with the private equity bid gone and you're seeing a lot more favorable pricing and then I guess maybe a little bit more granularity when you look at the portfolio. Should we expect bolt-ons or are there any large thing for unrelated new businesses that might be of interest given where prices are?

James E. Geisler - Vice President, Finance

Private equity is not very active in the M&A markets right now. I don’t think I am talking anything new by restating that. But we still see that price can be a little bit sticky. So people remember what their price was three or six months ago as opposed to what it is exactly today and strategy is to have money. But all that being said, I think, over time prices will reset and again there may be opportunity for us that wouldn't be possible or available to others. Where we grow, we will look everywhere. But I think last year was a good indicator that there is good opportunity in Fire & Security and you will continue to see acquisitions there for sure.

Nicole Parent - Credit Suisse

Great. And then Greg, could you elaborate on A, which businesses had the biggest contribution in the improvement in silver and gold in '07 and what do you view as the biggest opportunity in '08?

Gregory J. Hayes - Vice President, Accounting and Finance

I will start with biggest opportunity. I would say that the business that is probably further behind because it is the newest business is Fire & Security, which only has about 10% of its businesses at silver and gold today. And I think Bill Brown and the team are focused to drive that business to higher returns through the implementation of ACE. So, that will be a key. We also saw a good growth at Sikorsky and also at Carrier during the year. Pratt is of course I think farthest along. We've talked about that, but Sikorsky is quickly catching up and I think you see that in their results where they've got the fairly strong margin expansion here in the quarter. And we are going to see more of that next year.

Nicole Parent - Credit Suisse

Great. Thanks.

Ken Parks - Director of Investor Relations

Thanks, Nicole.

Operator

And we go next to Howard Rubel with Jefferies.

Howard Rubel - Jefferies

Thank you. Good morning, gentlemen.

Gregory J. Hayes - Vice President, Accounting and Finance

Hi, Howard.

Ken Parks - Director of Investor Relations

Good morning, Howard.

Howard Rubel - Jefferies

Will this be the last quarter we hear that commodity headwinds have bothered the business and how fast do you think you can take advantage of lower commodity prices?

Gregory J. Hayes - Vice President, Accounting and Finance

If we could actually accurately forecast commodity prices we would probably be doing something else. The fact is, commodities have mitigated considerably. We only saw about $40 million of headwind here in the fourth quarter. A big piece of that at Pratt and a little bit less at Carrier. As we look at the market today, obviously copper looks to be at a price much lower, not much, 10%, 15% lower than what our average price was for 2007. And some of the specialty metals, the titaniums, the nickels, those have really moderated from what we saw in the middle of last year. So, I think we will se some opportunity there if they continue down, but again I think we are not ready to call the market in terms of where commodity prices are going.

Howard Rubel - Jefferies

So, you’ve left unhedged a fair amount of your copper exposures?

Gregory J. Hayes - Vice President, Accounting and Finance

Yeah, we in fact are not hedging any of the copper exposure today.

Howard Rubel - Jefferies

To follow up on a separate issue, what did... what were the two businesses you sold at Otis and Carrier respectively?

Ken Parks - Director of Investor Relations

At Carrier, it was the Fincoil, which is a Finnish commercial refrigeration business. And at Otis it was a Korean business, a motor business, non-core.

Gregory J. Hayes - Vice President, Accounting and Finance

Small motor business in Korea.

Howard Rubel - Jefferies

And just two other things. One is, if I am not mistaken, you probably were able to benefit slightly from the expansion in the spreads over treasuries for a pension discount rate. Is that fair?

Gregory J. Hayes - Vice President, Accounting and Finance

We have set the rate for 2008 and I think you will see that coming up it will be a little bit above 6%, I think about 6.2% in fact is the discount rate. So, a little bit better than what we had for 2007. Not materially different though in terms of the overall impact on the pension plan because there are other things that were going against us like salary growth. Thank you.

Howard Rubel - Jefferies

And Fire & Security still had a charge. I think that was your largest charge you had for small business. It's also sort of the one that has had the most M&A. Could you sort of reconcile a little bit of how come you have not been able to totally capture the expected restructuring in the original purchase prices and or is this just some other things that are going on for an advantage?

Ken Parks - Director of Investor Relations

Howard, we did have restructuring charges in Fire & Security. First chance really is just cross takeout throughout the business. Second is, sometimes in these deals... or I should say not sometimes, all the times, when you buy a company and you undertake restructuring you can put under the current accounting, you can put the cost proposing their operations up in purchase accounting while the cost across your legacy operations will go to the P&L. So, in the case of, for instance, initial rent scale in Europe we had a little bit of both of those kind of costs.

Howard Rubel - Jefferies

Thank you very much.

Ken Parks - Director of Investor Relations

Thanks, Howard.

Operator

And we go next to Nigel Coe with Deutsche Bank.

Nigel Coe - Deutsche Bank

Thanks. Good morning. Just to follow up on Howard’s question on commodity prices, it sounds like the answer is no, but fuel prices obviously looking to be much higher in 2008. You're buying more steel and copper and significantly more in steel than copper in Carrier. Is that a risk to 2008 margins?

Ken Parks - Director of Investor Relations

Well I think, as we look into 2008, we will tell you that we do see some commodity headwind when you look at the year-over-year prices, it is much less as we look out now than we've seen in the last couple of years. If it stays where it is you might hear us talk about it about that less because the numbers are actually significantly down.

Nigel Coe - Deutsche Bank

Okay, okay. And then looking at Otis margin this quarter, you still got some significant OE mix issues but the margins are significantly better year-on-year and anything to talk about there, you talked about productivity but any step on productivity that we are talking about here?

Gregory J. Hayes - Vice President, Accounting and Finance

I think where it really goes to Nigel is simply factory cost productivity. We saw very, very good traction in the factories, good cost reduction both in the supply base as well as in the factories. That really was driving a big piece of the growth at Otis is a continued factory productivity.

Nigel Coe - Deutsche Bank

So that’s… that flows through into 2008. So, we maybe we should see better margin expansion we saw in 2007?

Gregory J. Hayes - Vice President, Accounting and Finance

Certainly the volumes continue to pick up, you're going to get absorption in the factories, which also helps on product cost but I think overall it is doing a much better job in the factories.

Nigel Coe - Deutsche Bank

Okay. Great. And then just one final quick question on organic growth, you guided for mid single-digit next year, you are tapering down from 10 to nine to eight in the last couple of quarters. Should we expect that general decline to continue or do we see a step down to mid-single digit from here?

James E. Geisler - Vice President, Finance

I think organic for the year we feel good about mid single digits, we're not going to forecast it for the... by quarter. Again we are in uncertain times and we have to keep our minds open to the possibility that we haven't seen slow down, we could see well in the future, but right now we are not expecting anything to fall off the cliff, just to move down organic revenue growth from high single digits to the mid-single digit.

Nigel Coe - Deutsche Bank

Okay. That's fair. Thanks a lot.

James E. Geisler - Vice President, Finance

Thanks Nigel.

Operator

And we go next to Myles Walton with Oppenheimer & Co.

Myles Walton - Oppenheimer & Co., Inc.

Thanks. Good morning. And we talked about the business backlog in a lot of the businesses, one of ones you didn't mention was Pratt & Whitney, could you give us that number as well as the overall corporate at year end?

Gregory J. Hayes - Vice President, Accounting and Finance

Sure. Pratt & Whitney ended the year with about $23.5 billion of backlog. That is up over $6 billion. So very, very strong backlog growth at Pratt. About half of that was really related to one contract, it was a northwest long-term service contract that we have to provide the engine maintenance, so a very strong backlog there. Overall for the corporation, we ended the year at about $57 billion of backlog and that's up just about $13 billion year-over-year. So, really there was strong backlog growth across all the businesses as we ended the year.

Myles Walton - Oppenheimer & Co., Inc.

All right. Great. So it’s about 30% year-over-year, book-to-bill 1.24 and kind of just as I look, it looks like kind of the best book-to-bill that you've had at least in terms of numbers I have. And so I guess a lot of these contracts that came through in '07 are longer lead times than usual, and that's what's driving to the only modest mid-single digit?

Gregory J. Hayes - Vice President, Accounting and Finance

Certainly on the aero side where we have got these longer-term contracts like Pratt & Whitney as well as at Sikorsky where we have got larger, long-term deliveries to large parts of U.S. Military. Always I think you have the backlog there that typically builds out in 12 to 18 months.

Myles Walton - Oppenheimer & Co., Inc.

Okay. Great. And then maybe last one on Otis. I think you had about 1.5 of shift towards OEM in '07. What is the trend line in '08, are we going even more in that direction?

Gregory J. Hayes - Vice President, Accounting and Finance

We reached 48% in new equipment, a little bit more than that in the fourth quarter and that was as you said, up a point year-over-year at 1.5 sequentially. With the backlog we at, we’re seeing a very strong backlog and the growth that we are seeing in the markets. I wouldn’t expect that trend to reverse.

Myles Walton - Oppenheimer & Co., Inc.

Okay. Thanks.

Ken Parks - Director of Investor Relations

And let's take our final call Rufus.

Operator

And that final question will be from Joe Nadol with JP Morgan.

Joseph Nadol - J.P. Morgan

Hi. Good morning, everyone.

Gregory J. Hayes - Vice President, Accounting and Finance

Hi, Joe.

Joseph Nadol - J.P. Morgan

First question is I just want to hound on specifically on spares at Pratt, so I think you gave overall aftermarket, but there has been some divergence between services and spares in the past. Wondering what you saw for spares in Q4 and what you are looking at for '08?

Ken Parks - Director of Investor Relations

Well, let's start with the '08 because it's always better to look forward at the longer term, which is we have said that the aftermarket at Pratt including spares are going to decelerate from what we saw in the last couple of years that are… where they were going at about 20%. Something more like an RPM growth rate plus the annual price increase would put that right at double digits. We are not coming off of that. That's what we think for the next year. What we saw in the fourth quarter was the spares part of that market did grow slower than the overall side of the business.

Joseph Nadol - J.P. Morgan

Which means it was down, no?

Ken Parks - Director of Investor Relations

Excuse me.

Joseph Nadol - J.P. Morgan

Which means it was down in the quarter.

Ken Parks - Director of Investor Relations

It was basically flattish. Yeah. That’s right [inaudible] call it down.

Joseph Nadol - J.P. Morgan

Okay.

Ken Parks - Director of Investor Relations

Okay. So, that's what we saw in the quarter, but keep in mind we had that conversation a little while ago about the tougher compares year-over-year. So, I will also give you one other data point that sequentially, we actually saw spares in the fourth quarter a little bit stronger than the absolute number of spares in the third. So, nothing out there concerning us significantly.

Joseph Nadol - J.P. Morgan

Okay. Secondly, just on the Carrier residential business. You just gave pretty dire outlook and we all know housing is terrible but there have been some positive comps, I think in the last three months industry-wide according to ARI, and I am just wondering if that's not what you are seeing? The second part of the question is in terms of the margins, at this point, we all know things are terrible. At what point will you be able to cut enough cost out of the business to maybe get over the margin boost even with the top line that's not doing anything or still declining?

James E. Geisler - Vice President, Finance

Joe, this is Jim. It's really frankly just too early to say anything good about the U.S. housing market, comparison or otherwise, because that market is in tough shape right now and again we should be clear on the fact that that market is very tough.

Gregory J. Hayes - Vice President, Accounting and Finance

I'd also point out Joe, that we are not just sitting back waiting for the market to deteriorate. We are actually taking very aggressive cost reduction actions across that business. I think [inaudible] and team are focused on taking significant cost up both through restructuring and just weaning out the factory and the supply chain. So, there is still opportunity in that business even in a down market for profit growth this year.

Joseph Nadol - J.P. Morgan

Yeah, that's where I was getting at. Okay and then finally, just sort of a balance sheet question and this is little bit theoretical, but you put out you have a strong balance sheet as opportunities to buy back stock, obviously the M&A opportunities are really lighting it up compared to any time in the last few years. How aggressive are you willing to get with the balance sheet to really to take advantage of the opportunities out there?

Ken Parks - Director of Investor Relations

Joe, we have a little of flexibility in the balance sheet. Obviously we value our credit rating. It comes in might handy at times like this when the rest of the world struggles. So, I think we can afford to be a little bit more aggressive but it is all going to come down to what opportunities are out there that present themselves so that we can go get. So there is no forecast today on what's is going to happen with either M&A or share repurchase. It's just to find us a more favorable environment with that kind of stuff than it was six months ago.

Joseph Nadol - J.P. Morgan

Can you specify how much of capacity you have to keep your credit rating?

Ken Parks - Director of Investor Relations

I think, again at times like this and times that are changing it is best to retain flexibility. So, I don't want to give a number today. We will just... we are mindful of our rating and continue to grow the company.

Joseph Nadol - J.P. Morgan

Okay. All right. Thanks, guys.

Ken Parks - Director of Investor Relations

Thanks Joe.

Gregory J. Hayes - Vice President, Accounting and Finance

Thank you, Nadol. Okay. With this I think that's all for the questions. I will just take one second to summarize and first of all thank you all for listening in. I think as you have heard this morning a very, very strong close to 2007. I think you are all pleased with the way that each of the business delivered both on the earnings and the cash flow side. I would also say that as we look at 2008, we do not see kind of the dire economic circumstances that we read about everyday. The order backlog looks very strong. The business will do well this year and we will do well in any environment, and we are built to outperform and I think that's the key message here. You read a lot of bad things out there, but we will outperform and we will continue to deliver.

Operator

And ladies and gentlemen this....

Gregory J. Hayes - Vice President, Accounting and Finance

That's it. Thank you.

Operator

And ladies and gentlemen this does conclude the United Technologies’ fourth quarter conference call. We do appreciate your participation and you may disconnect at this time.

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Source: United Technologies Corp. Q4 2007 Earnings Call Transcript
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