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Executives

Gregory J. Hayes - VP, Accounting and Finance

Akhil Johri - VP, IR

James E. Geisler - VP, Finance

Analysts

Nicole Parent - Credit Suisse

Deane Dray - Goldman Sachs

George Shapiro - Citigroup

Howard Rubel - Jefferies

Joseph Campbell - Lehman Brothers

Nigel Coe - Deutsche Bank

Cai Von Rumohr - Cowen and Company

Chris Edwards - J.P. Morgan

Doug Harned - Sanford Bernstein

United Technologies Corp. (UTX) Q2 FY08 Earnings Call July 17, 2008 10:00 AM ET

Operator

Good morning, and welcome to the United Technologies Second Quarter Conference Call. On the call today are Greg Hayes, Vice President of Accounting and Finance; Jim Geisler, Vice President of Finance; and Akhil Johri, Vice President, 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.

Please go ahead, Mr. Hayes.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks you, Nicky and good morning everyone. You saw in the press release this morning, we had anther very strong quarter driven by solid performance across the business.

Revenues were up 13%, with six points of organic revenue growth. Earnings per share in the quarter were $1.32, and that's up 14% over last year, and includes $0.06 per share of uncovered restructuring charge. Absent the impact of restructuring, and the results for both second quarter of '07 and '08, earnings per share was up 17%. Foreign exchange generated a net $0.04 benefit in the quarter, positive impact from the euro and other currencies, partially offset once again by the FX headwind that's present [ph] with these Canadian operations.

Most importantly, we remain confident about the year. Accordingly, we're taken our earnings guidance for the full year up to a range of $4.80 to $4.95 a share, and that's up 12% to 16%, $0.15 on the bottom, $0.10 on the top of the prior range. These increases are on the back of better earnings of Otis and UTC Fire & Security. Both units are now expected to the deliver operating profit guidance... or operating profits higher than the guidance already inbuilt in firm just this past February.

All the other businesses are on track with the prior profit guidance. You should note that the revised guidance does assume the year with a current spot rate of about $1.58, and you'll recall that our plan assumed the euro rate at about $1.44, a little bit of tailwind there.

We're also updating our guidance on full year revenues. We now expect it to be over $60 billion. And on restructuring spending as well, year-to-date we've incurred about $130 million in restructuring costs, all of this uncovered by gains. We do expect some gains in the second half for the year, and we are also increasing today our outlook for restructuring spending for the year to about $300 million. That's double the $150 million we forecasted at the beginning.

Now as you know, it's not unusual for us to see some lumpiness in the timings of gains and restructuring on a quarter-to-quarter basis. But, we do expect that restructuring will be significantly in excess of gains for the full year.

And free cash flow, it came in at 87% of net income, quarter-to-quarter. It's primarily due to Carrier seasonality, as you would expect, as well as slightly lower advances at Sikorsky.

We are encouraged however by inventory performance in the quarter. And the overall level of inventory remains high, especially, at the aero businesses. Although inventory was essentially flat for the quarter, improving inventory performance remains a focus; there is still a lot of work to do.

And full year cash flow, we expect the usual UTC standard of free cash flow greater than or equal to net income. Also in the quarter, we repurchased $719 million of UTC shares bringing the year-to-date total to over $1.5 billion.

In this full year, we may continue to be optimistic in our repurchases. The share repurchases will likely exceed the $2 billion guidance that we have for the year, especially, if the stock continues to trade at decade low P/E multiple.

Another key, I will take you through the business in details in just a minute, but let me talk about some of the concerns here as we have been hearing from investors over the last few months. And those concerns are of course, commercial aerospace markets, commercial construction order trends and commodity inflation. Now, with oil around $135 a barrel, we are all concerned about the impact for our airline customer's profitability, and the associated capacity reductions they'll have forecasted.

In the second quarter, large commercial engine spare parts sales at Pratt & Whitney were about flat with last year, generally in line with Pratt's expectations going into the year. And book-to-bill was marginally below one. And with concerns around its commercial spare parts and the sale... parts sales in the quarter, we were in the mid single-digit range. For the year, our outlook for spares at both of these divisions remained generally in line with where they were at the start of the year. But, we'll be watching these trends closely.

As for commercial construction activity, we continue to see very strong orders that brought us decent growth in Carrier's commercial business. In the quarter, in North America, new equipment orders were at double-digits, worldwide orders were up 23%. Carrier's commercial HVAC business, new equipment orders in North America were essentially flat in the quarter. But commercial HVAC orders worldwide were up double-digits.

In Europe, new equipment orders at both companies were strong in the quarter, with Otis up nearly 40%. Well, about half of that was from the benefit of the euro. Otis saw particularly good growth in France, Germany, Eastern Europe.

Carrier's commercial HVAC business grew about 12% in Europe in the quarter at a constant currency rate. Asian orders for both companies continued to grow at double-digit rates.

Our refrigeration orders at Carrier both in North America and Europe continued weaker in quarter as we had previously discussed. We're also mindful of the construction industry forecast for the U.S. are generally down, although our order book doesn't indicate this yet.

Given this overall environment, all of our commercial businesses are continuing to focus on cost reduction and restructuring actions.

Last issue I want to touch upon is commodity cost increases. Recall, going into the year we expect a gross commodity cost impact including energy, to be about $200 million, with about half of that offset by pricing. We now see these gross commodity costs increases of over $300 million. Pricing is still expected to offset a little more than half of the impact.

As you all know, steel prices are roughly double than past year along with the cost of oil. Some of the metals used in the aero businesses as well as copper are also up, although to a much lesser extends.

On the other hand, we are getting better pricing than anticipated. In some, higher commodity cost than anticipated at the beginning of the year, but also a better pricing environment.

UTC's response to all of these challenges of course to continue to work on cost and productivity, while we bump the year's restructuring to about $300 million, also why we continue to focus on the implementation of basic cost in all of our businesses. As a result to tight cost control, restructuring and process improvement, we saw 40 basis points of margin expansion in the quarter, adjusting for restructure.

Our portfolio of companies has allowed us to outperform in the past, we expect to continue to outperform even in the current market environment. Our target of 10% and more earnings growth annually remains unchanged. Our executive compensation incentives are all tied to this target.

I will turn over to Akhil and have you walk through the business.

Akhil Johri - Vice President, Investor Relations

Thanks, Greg. Before I begin on page four, let me mention that I will talk to segment results with restructuring added back as we usually do.

Otis delivered another very good quarter. Revenues increased 19%, the growth in all geographic region led by double-digit growth in North America and Russia and China. This reflects the strong new equipment backlog entering the year, as well as higher modernization and the fair sales in Europe, which benefited from changes to elevator safety laws in France and Spain.

Operating profit grew 25%, as higher volume, product cost reductions and other cost containment initiatives more than offset headwinds on input cost increases. Feasible foreign exchange contributed approximately half of the improvement in revenues and profit. As a result of all of the above, operating margin expanded by 90 basis points to 19.8%.

Otis new equipment orders were up 23% in the quarter as Greg mentioned 14% at constant currency, reflecting double-digit increases in all geographic areas. In light of very strong first half performance and Otis current expectations, we are now increasing profit growth guidance for Otis from 10% plus to nearly 20% for the full year. Also we are increasing revenue growth guidance from high single-digit to low teens.

At Carrier, operating profit increased 9% on 7% higher revenue. Foreign exchange contributed about five points of revenue growth and six points of the profit growth. Operating margin expanded 10 basis points to 12.2%. Benefits from product cost reduction and prior restructuring action in the commercial HVAC and North American residential businesses more than offset $30 million of net commodity headwind in the quarter, an adverse shift towards lower margin segment in the refrigeration and international residential businesses.

The commercial HVAC business remains solid with mid single-digit revenue growth. On the negative side however, we still have the U.S. housing recession. Cooling season started poorly in Europe and commercial refrigeration markets are down both in Europe and North America.

In the face of market softness, Carrier has launched significant restructuring and other cost reduction initiatives. As a result, we remain comfortable with Carrier's full year earnings growth guidance of 10% plus on mid single-digit increase in revenue.

UTC Fire & Security performance was also strong. Revenue grew 29% with acquisitions contributing 18 points and foreign exchange seven points of this growth. Organic growth was 4% with the fire safety businesses in Europe and the Americas up mid single-digits. The security business in Europe up low single-digit and the man guarding business is down moderately in the quarter.

Operating profit increased 46% with foreign exchange contributing eight points of the growth. Benefits of restructuring actions and continuing productivity initiatives along with the profit contribution from acquisitions were partially offset by the impact of lower U.S. residential volume. Operating margin expanded 100 basis points to 8.8%.

Based on performance to date, we are increasing UTC Fire & Security full year operating profit growth guidance from 25% to 30%. We are also increasing the revenue growth guidance from high single-digit to mid teens.

Now, turning to the Aerospace businesses on slide seven, Pratt & Whitney revenues increased 6% in the quarter, led by continued engine volume growth at Pratt & Whitney Canada.

Revenues improved over 20% at Pratt Canada, revenues at Pratt & Whitney Rocketdyne and Power Systems also grew over 10%, while military revenues are essentially flat. Large commercial engine aftermarket grew low single-digit with spares [ph] about flat.

Operating profit also improved 6% in the quarter led by the military business on favorable aftermarket performance and improved engine mix. This was partially offset by adverse top visit mix in the large commercial engine aftermarket business. Profit contribution from high revenues at Pratt Canada was largely offset by the unfavorable foreign currency impact from the weaker U.S. dollar. E&D [ph] for Pratt was essentially flat in the quarter.

We continue to expect Pratt & Whitney revenues to be up mid single-digit and operating profit to be up approximately 10% for the year.

Hamilton Sundstrand revenues were up 18%, with aerospace OEM and industrial businesses up nearly 20% each.

Commercial aftermarket revenues were up double-digit, operating profit grew 11% and margin contracted in the quarter, primarily from adverse mix. Lower margin development revenues grew by about 20%, while higher margin commercial spares revenues grew only mid single-digits. Hamilton also faced pressure from commodity and input cost increases during the quarter.

For 2008, we now expect revenues at Hamilton to the higher up low teens. We continue to see operating profit up 10%, or $100 million as indicated last December.

At Sikorsky, operating profit grew 28% on 9% higher revenues. Operating margin expanded 120 basis points in the quarter to 8.5% from higher military volume and favorable mix.

During the quarter, Sikorsky shipped a total of 53 large helicopters; 37 military and 16 commercial. Sikorsky remains committed to its guidance of more than 200 large aircraft deliveries for the year. Sikorsky continues to expect mid-teens revenue growth, with operating profit up approximately 25% in 2008.

Now, let me turn it back to Greg, to wrap up.

Gregory J. Hayes - Vice President, Accounting and Finance

Okay. Thanks, Akhil. While we open the call up to questions, let me just hit on a couple of the significant new product milestones that we've achieved just this past quarter.

First on the 787 program, Boeing, as you no doubt heard, has successfully completed 787's power-on testing with the support of Hamilton Sundstrand. Next big milestone on 787 of course is its first flight which is scheduled for later this year.

Second big milestone for UTC of course is the GTF or fuel-powered W1000 as we now call it, which flew successfully for over six hours 747 tested this past week. Most importantly, engine met or exceeded all of its pre-test performance criteria [ph]. This will of course power the new Bombardier CSeries aircraft, which was formally launched earlier this week, and a letter of interest for up to 60 aircrafts from Lufthansa.

Finally, in the commercial space, UTC Powers had [ph] an order to supply 12 of our brand new 400 kilowatt fuel cells, with the Freedom Tower and three other towers at the World Trade Center site in New York.

All right, summing it all up, it's been a very good quarter, more noteworthy given the economic uncertainties that we're all dealing with. Revenues up 13%, EPS 14%, net of restructuring 17%. Increased guidance 15% on the... $0.15 rather on the bottom of the range and a dime at the top, now expect 12% to 16% EPS growth for the year. Not an unusual performance for UTC is more the same type of performance you have come to expect. Balance across geographies and product, up restructuring fast productivity mentality, especially in more challenging times.

In an unusual strong string of product launches which looked to be highly successful in the markets. Of course, cash content and net income supported increased cash returns to shareholders. It's too soon to talk about 2009 specifically. You should know that we're all focused on double-digit earnings cash flow growth.

With that, let's open up the call for questions. Nicky?

Question And Answer

Operator

Thank you. [Operator Instructions]. And we will take our first question from the Nicole Parent from Credit Suisse. Please go ahead.

Nicole Parent - Credit Suisse

Good morning

Gregory J. Hayes - Vice President, Accounting and Finance

Hey Nicole.

Akhil Johri - Vice President, Investor Relations

Hi, Nicole.

Nicole Parent - Credit Suisse

I guess first let me think about commercial, the order numbers across Otis and Carrier on the commercial side was very strong. Can you just talk, I guess a little bit about are you seeing any cancellation, where you guys see or you are in terms of the order across that, when you think about what your products are going into and kind of the comfort with the sustainability of the orders that you are seeing and I guess with respect to how do you look ahead when you just look at the backdrop of the environment and the Dow [ph] and the AVI numbers in terms of thinking going forward, do we see cancellations in some of these orders that you are getting?

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks, Nicole that's a great question. I wish I had the crystal ball to tell exactly what's going to happen --

Nicole Parent - Credit Suisse

Me too.

Gregory J. Hayes - Vice President, Accounting and Finance

Couple of quarters. You know what we can tell you, what we see out there in the market is, we have not seen order cancellations any extent. Now, there is always the odd, the one-off cancellation, but we have not seen large scale cancellations anywhere.

I think the one soft spot as we continue to note is now at about the lower end of the product lines, some of the low, low and mid rise office buildings as well as on anything that touches the retail. So, it's good malls in the retail side of order of Carrier's HVAC business here in the U.S. And China still very, very strong and Europe actually surprises I would say with the strength that we've seen there.

We all see what the indicators are out there. We all hear that things should be slowing down. We just have not yet seen any significant slowdown at any of our businesses outside of say commercial refrigeration in the U.S. and Europe. And again, I attribute that more to the retail spend than general commercial construction. So, so far so good and we're obviously watching it closely.

Nicole Parent - Credit Suisse

Okay. With respect to restructuring, you guys absorbed an enormous amount of restructuring in the quarter. When we think it's probably reasonable to think about restructuring effort at the Carrier, but you also ramped it up at Fire & Security and Pratt probably relative to my expectations in prior quarters. Could you just give us some sense on what's going on there and how we should think about that number for the full year?

Gregory J. Hayes - Vice President, Accounting and Finance

Yes, we did do as I said $130 million year-to-date. It's got a lot of restructuring at Carrier obviously in response to what's going on in the residential market there as well as on the refrigeration side of the business. I think what you're going to see for the rest of year, is just more of the same.

These actions have been... is primarily people-related, and we have closed a couple of factories and taken out about 1 million square feet. The actions to date have affected about 2500 people. It's about 1% of our worldwide workforce. I think as you go to the second half of the year, more the same, more restructuring at branch, more restructuring at Carrier, and the continued restructuring at Fire & Security.

But, I would say, no big change here. It's just a focus on taking cost out to continue to be competitive in this very difficult environment.

Nicole Parent - Credit Suisse

And one last one just on M&A, as we see the commercial airspace names get head on concerned about the end of the cycle. Could you give us a sense of what your thought is on aerospace acquisitions, then also give us an update on the Diebold?

James E. Geisler - Vice President, Finance

Yes Nicole, this is Jim. I think obviously with the decline in the market, aerospace evaluations are more attractive. Many of them know they've only been more attractive for couple of weeks, so I think it might take a while for sellers, potential sellers' expectations to reset. We're a buyer in aerospace. That's clear and hopefully that opportunity or opportunities in aerospace will arise and they will be greater than they've been in the last couple of years.

On Diebold, it's a good property. It has very good ATM share. It has a great global footprint, and obviously there is margin expansion opportunity, because it's in mid single-digits and UTC runs its businesses in double-digits. But it's never been a must half. We made our proposal back at the end of February and a lot of time has passed and there are other opportunities in the world, including buying UTX stock, so now we'll have to see.

Nicole Parent - Credit Suisse

Okay, great. Thanks. Good quarter.

James E. Geisler - Vice President, Finance

Thanks, Nicole.

Operator

And our next question comes from Deane Dray with Goldman Sachs. Please go ahead.

Deane Dray - Goldman Sachs

Thank you, good morning.

James E. Geisler - Vice President, Finance

Hi Deane.

Deane Dray - Goldman Sachs

Just to clarify on Nicole's last question, a couple of data points you used to provide in the backlog of both on the commercial side Otis and Carrier. Otis was of 18 months on the last update and six months on Carrier, where do those stand today?

Gregory J. Hayes - Vice President, Accounting and Finance

I have said that, they are just about the same. We've seen strong order growth or continued strong order growth there at Otis. Our backlog is relatively constant, so to tell you we still have about 18 months of visibility on the new equipment side. It is the same on Carrier, but just to be specific; it's Carrier BSS or commercial business that we're talking about. We've got, six months visibility. And those orders outside of U.S., it remains relatively strong, backlog was pretty good.

Deane Dray - Goldman Sachs

Okay. And then the second question relate to... I know you said that you will be light on 2009 specifics, but with regard to the press release comments and intro comments regarding the potential slowing and expected slowing in commercial aftermarket on the aero side, can you talk a bit about what the offsets might be? What would be different in '09 versus '08 in terms of your mix, let's say that powered by the hour contract, the number of deliveries side of Pratt & Whitney, Canada. So, just give us in context as we can certainly see the expectations about capacity coming out of the U.S. commercial airlines. But, how is UTC positioned differently in '09?

Gregory J. Hayes - Vice President, Accounting and Finance

You know, Deane, I'd love to get into '09 discussion, but unfortunately I think it's just a little bit premature. I'll let you, you know, we were targeting 10% plus growth as we said in the intro comments and then in the release. Obviously, commercial aero, a challenging environment and that becomes more difficult. But, I think we feel pretty good about the prospects for next year and as this year comes to a close and we see what really happens with the airlines, what happens with oil I think we will have a better feel for it. But, I'll tell you right now; we've got confidence we can continue to grow earnings no matter what the environment is.

Deane Dray - Goldman Sachs

If I ask it this way, could you tell us what the economics are as you today have... you are powered by the hour contracts, what you can do in terms of expense control and management there, and what the offset might be? Just conceptually not looking for a P&L impact.

Gregory J. Hayes - Vice President, Accounting and Finance

You know, about 40% of Pratt's aftermarket is FMP or powered by the hour type contracts is the similar number at Hamilton. So, obviously those contracts are revenues dossiers with those logarithm based upon flight hours as opposed to RPM. So, planes are still flying and revenues still is pretty good there.

In terms of cost control I think is just back to the UTC flavor. We are going to take cost out where we can or we are trying to increase productivity, use the ACE operating system to improve back office as well as factory productivity. And it's just... it's going to be the basic flavor Deane. I can't give you a lot of specifics unfortunately, but we are confident as we look forward.

Deane Dray - Goldman Sachs

Great, thank you.

Operator

And our next question is from George Shapiro with Citi. Please go ahead.

George Shapiro - Citigroup

Yes, good morning.

Gregory J. Hayes - Vice President, Accounting and Finance

Hi, George.

George Shapiro - Citigroup

Couple of quick ones. The revenue increase at Otis and Fire & Security, is that all just reflecting your currency change or is there some... is there actually some organic increase that you are seeing?

Akhil Johri - Vice President, Investor Relations

George, at Otis, about half of the revenue increase or half of the 19% approximately was currency, so about 10% organic growth there. In case of Fire & $security, about 4% organic growth?

George Shapiro - Citigroup

No, what I mean is the increased revenue guidance that you provided for the year, is that all currency-related or is it also some organic?

Akhil Johri - Vice President, Investor Relations

It's a combination of the two. There is some currency in there, but there is a lot of operating performance both in Otis and Fire & Safety.

George Shapiro - Citigroup

Okay. And then, if we look at the Hamilton Sundstrand, you mentioned small, spares up mid single-digit but the whole aftermarket up double-digits. What's the mix there between the maintenance business and the spares business?

Gregory J. Hayes - Vice President, Accounting and Finance

Well, as far as we look at Hamilton Sundstrand business, we said, commercial aftermarket was still pretty good with spares up kind of mid single-digits. The repair side was actually up almost 20% in the quarter. And we continue to see good input into the shops, which is actually, I think a good indicator as we go forward that the aerospace business is not perhaps in this dire straits as people might have thought. The input in the shops, and we actually saw the same thing at Pratt & Whitney, where we saw better inductions in the second quarter than the first quarter into the engine shops. Though again unfortunately, the problem with the repair operations is its much lower margin from what we see on spares, still indicative of a pretty robust market out there.

George Shapiro - Citigroup

And Greg, what's the rough mix between the two in the aftermarket?

Akhil Johri - Vice President, Investor Relations

The spare is up; it's slightly below 50% of the commercial aero. But they are about equal.

Gregory J. Hayes - Vice President, Accounting and Finance

Right, about equal.

George Shapiro - Citigroup

Okay. And then just back on Otis and Carrier. I found it ironic that the order growth this quarter was actually greater than the order growth that you had detailed in the first quarter. And some of it might have been a little bit extra currency. But is there any areas that you actually saw relatively better this quarter than the first quarter, to account for that?

Gregory J. Hayes - Vice President, Accounting and Finance

I think Europe was probably the surprise for us, where especially, Otis reached almost 40% growth in quarters, again half of that being currency, but still very strong underlying growth, as I said in France, Germany and Eastern Europe, and specifically in Russia.

George Shapiro - Citigroup

Okay. And maybe one last one, Greg. In Pratt & Whitney, you've done a remarkable job of holding the margins up where they are despite zero spares growth. What... from how you look at it, what would have to happen for those margins to start to come down at Pratt & Whitney?

Gregory J. Hayes - Vice President, Accounting and Finance

Obviously, if you had a significant slowdown in the spare parts sales, it is still a large percentage of Pratt & Whitney's profitability tied to spares. But as you try and size that, yes, Pratt is more than just commercial aerospace. The commercial aerospace is about $4.5 billion of Pratt's $13 billion or so of revenue. So, you'd have to have, I think, more than just commercial aerospace turned down to really see a big decline in margins at Pratt. And you've got good strength at Pratt Canada, you've got good strength in the military side, Rocketdyne is doing well. And it is a big well balanced company, just like UTC.

George Shapiro - Citigroup

Okay, very good. Thanks a lot.

Operator

And our next question is from Howard Rubel with Jefferies & Company. Please go ahead.

Howard Rubel - Jefferies

Thank you very much. First, could you talk for a moment a little bit about Sikorsky, some progress but still maybe not the margins you would like to see and then Greg, also address the MPA, the Maritime Helicopter program please?

Gregory J. Hayes - Vice President, Accounting and Finance

I guess I would, if I might take a little bit of umbrage with your first question there. I think actually, it was our pretty good performance that was supposed to be this quarter where they delivered 53 helicopters, that's up from 30 in the first quarter. They saw 120 basis points of margin expansions, 8.5%. So it's good performance. Is it where we want them to be ultimately? Absolutely not. There's still room to go there. We've talked and Jeff has talked about double-digit business here in the next couple of years, next three years I guess. But they are making progress.

We're still committed. Jeff and team are still committed to deliver over 200 large helicopters this year. There is more than just I would tell you the helicopter deliveries. That's about half of their revenue. Now they're also doing well in the development side with the CH-53 and some of their other big programs. So that's a very good quarter and again it's just indication that they are on the right track and they are on the right trajectory for this year and into the future.

As far as the Canadian Maritime program, I don't have a much of an update other than to say that, we're working very closely with the Canadian government. We will be late with the helicopter as we've talked about before, probably up to 24 months late at this time.

We're working closely though to make sure that the helicopter meets the requirements of the Canadian government, both from a schedule and a cost standpoint. And at the end of the day, it's going to be the world's best search and rescue helicopter that the Canadian government is going to be buying from Sikorsky. So, we are in is, I would say back on track. Light test will happen later this year and deliveries will start probably in and around the late or 2010 I guess at this point 2011, so little late. The first helicopters will be a little more expensive, but overall for the program standpoint it's still a great program.

Howard Rubel - Jefferies

No, I hear you, and that's encouraging and I appreciate that. And yes, I guess I can see, clearly move in the right direction. You didn't talk about industrial and Hamilton Sundtrand. My guess is elements of that business continued to be very strong and could you just talk for a moment on that and then I have one another item.

Gregory J. Hayes - Vice President, Accounting and Finance

Yes, it was actually a very strong quarter in industrial and the revenue is up about 28%. And as we would expect, they are the businesses that are impacted by growth in China and Asia are very, very strong. So a little bit of slowdown in some of the U.S. centric construction businesses and any of the hydrocarbon processing work there, primarily Sundyne and Milton Roy. All those businesses continue be very strong. Order growth was a little less than the 20%, but still strong and I think we're going to have a pretty good year.

Howard Rubel - Jefferies

And then Greg finally, one of the challenges is always trying to figure out how Fire & Security organic growth is being measured in? Could you or may be Akhil, because he is so familiar with that business, address, good hand off right. But, seriously some of the metrics, which you could talk about either customer adds or other things that you couldn't point to whether there is organic growth?

Akhil Johri - Vice President, Investor Relations

I said both good growth Howard in the Fire & Safety side of the business. As you recall, Fire Safety is about twp-thirds of 60% of the total revenue base for Fire & Security and that grew in mid single-digit, which was good to see both in North America and Europe. In fact inside of North America, the reservation business which we had talked about last time in first quarter, is being down 30%, was down 16% this quarter as well, yet the overall Fire Safety business in North America grew mid single-digit. So, very encouraged with all the focus and effort that Bill and team are putting on the organic growth side. Security EMEA, which... it was a little bit down also in first quarter, is about up low single-digit. So again, encouraging times there. I think the team is focusing on organic growth and hopefully, we will report better numbers going forward on that.

Howard Rubel - Jefferies

Thank you, gentlemen.

Gregory J. Hayes - Vice President, Accounting and Finance

Thank you, Howard.

Operator

And our next question comes from Joe Campbell with Lehman Brothers. Please go ahead.

Joseph Campbell - Lehman Brothers

Hi. Good morning, Greg, Jim and Akhil.

Gregory J. Hayes - Vice President, Accounting and Finance

Hi Joe.

Akhil Johri - Vice President, Investor Relations

Hi Joe.

Joseph Campbell - Lehman Brothers

Could you just... I have just two things. One, as you've given us a lot of information, most of which is reasonably constructive about order rates in the various businesses in the various global market. But rather than kind of business-wise, is it possible to keep together sort of Europe, Eastern Europe, Asia, China and so on. Just kind of go around the world. I am struck for example that you've got such strength in Otis, but then you are off to a slow cooling market in Europe and then you've got weak refrigeration. Is there a way that's kind of pull this together region-by-region so that we can see whether your views of what seems to be going on taking in a aggregate is really that different from what we read in papers and so on.

And then the second question I just give it to you right now, is whether or not we think we can, you know can we achieve kind of 10% margin in Fire & Security, are we backing off from that strength in the revenue growth?

Gregory J. Hayes - Vice President, Accounting and Finance

Okay. Let me start Joe on the kind of the geographical overview, if you will. I think there is any surprise as we look at the... where we were strong and where there is a little bit slowness. As you think about the U.S. overall from the UTC perspective now, growth there is kind of mid single-digits in terms of revenues for the quarter. And obviously, the weakness in the U.S. residential market is a big piece of that slow down. I think we actually saw some encouraging signs I think in the residential market today where housing starts actually were up in June and Carrier's resi business is actually getting a little bit of traction, I would tell you in a down market, mostly on the back of cost reduction.

But, the U.S. kind of mid single-digit growth, it was the slowest growing area around the world. Europe, I think may be that's the surprise to everybody here. Again, we saw very strong growth at Otis as well as Carrier. I think that is mostly I would say France, Germany and Eastern Europe. There is a still have lot of slowness in the UK, Spain, Italy also in the cooling market as well as the elevator business. So, again no surprises, I think it coincides pretty well with what you guys probably see in the paper.

Asia; yes, very, very strong; I am talking about double-digit growth there. And you know I had to differentiate. China, continues, more than 20% kind go growth rates across our businesses in China. Japan that slow, Korea is slow but Asia in general and total including India, up strong double-digits. So, nothing to do with the economy here in terms of what we are seeing versus what you are reading, it is just that we have been very successful in those markets that are expanding especially in the emerging markets.

James E. Geisler - Vice President, Finance

Joe, on Fire & Security, you will see very strong profit growth for the year, but I think 10% of margin will come up just shy of that. And there is no shame in being a little bit short at 10% margins for the year. We wanted to sell and announce the sale of some of the low margin, man guarding businesses. But the valuation wasn't fair in the tough markets. We've decided to retain some of those business and they have margins that are low to mid single-digits. So, it just dilutes the margin. But you still get the same earnings growth that we talked about early in the year and actually with the more with the foreign exchange.

Joseph Campbell - Lehman Brothers

So Jim, that change in the resulting margin, the earlier guidance assumed that you will be able to get rid of some of those. And so, really the business is a stronger extract rather than weaker and it's just some of them, if I understand it correctly, that's up pulling the average margin down?

James E. Geisler - Vice President, Finance

Joe, you said it better than I said it.

Joseph Campbell - Lehman Brothers

I know I did. All right, thanks so much, Jim. Thanks guys.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks, Joe.

Operator

And our next question is from Nigel Coe with Deutsche Bank. Please go ahead.

Nigel Coe - Deutsche Bank

Good morning. So, Otis margins 19% to 20% I think that's a record up 19% year-on-year. So it's last year was mix is offsetting the top line growth and that's keeping the margin leverage below trend. But we have not seen that now. I am just wondering, are we starting to see the impact of operating leverage on the volume growth offsetting that mix impact and may be if you could just comment on what the OE margin is doing right now?

Akhil Johri - Vice President, Investor Relations

Nigel, firstly, the mix in the quarter was not... did not change unfavorably and that's because the service revenues grew at almost as fast as the OEM revenues grew for the quarter. That was certainly not a headwind as we've talked about in the past.

The second thing is, we truly are seeing tremendous operating leverage with high volumes in OEMs, our product cost reduction actions, and other cost actions that Harry and now the EA and team are taking in Otis. It's just great execution there. And we're seeing the benefits of OEM margins expanding, and the mix really not changing, as service revenues grow about at the same rate as OEM.

Nigel Coe - Deutsche Bank

Okay. I am surprised that service revenues grew at the same level as the OEs, is that sustainable?

Akhil Johri - Vice President, Investor Relations

Yes, keep in the mind that Europe is where we have a larger proportion of service revenues, as a percentage of total revenues. And then we have the currency benefits in euro like we've seen, have helped the actual currency, the mix part a little bit.

Nigel Coe - Deutsche Bank

Okay, understand. And then Greg mentioned little bit of traction in the resi market is U.S., which is on your treaties, which is interesting. I just wondered if you could just expand on that. And on the pricing side for residential, obviously, you announced the price increases last quarter. Trying to see some good pricing coming through in the PPI numbers, the air conditioning, I'm just wondering are you seeing that pricing actions sticking?

Gregory J. Hayes - Vice President, Accounting and Finance

Let me start firstly maybe on the overall market. We saw some preliminary statistics which would say that the market was down about 9% or 10%, as overall split systems market in the U.S. in the second quarter, preliminary numbers. Our revenues were about flat year-over-year. So, that would tell us that we're gaining a little bit of traction in the market. Actually, continuing the trend that we saw in the first quarter. So, again, I think they're addressing some of the concerns that were out there in distribution and in the cost side, and they're doing a lot of things to try and take back a little bit of share, that's been going quite well.

As far as the pricing, we did announce a price increase last month, which is effective actually July 15th. And we're getting a little bit of traction with pricing, which is good news. I think you've seen pricing from the competitors as well. But, in this environment where we see input cost going up, we're actually getting I would say better pricing than we have historically seen in that side.

Nigel Coe - Deutsche Bank

Okay. And then just one final one, I think you talked about some gains of certain restructuring [ph] in the second half for the year. Can you just give us a little bit more color on that?

Gregory J. Hayes - Vice President, Accounting and Finance

So, we're got few gains, although I can't give you a specific number on them today. We've got a small business that Pratt just disclosed here in the beginning of the third quarter, which will generate a small gain. We've also working on a tax settlement related to 2003. I can't really be very specific, because I just don't have that finalized yet with our friends at the Internal Revenue Service. But we expect that will be resolved by the end of the year. We expected that will... there'll be a fairly sizable reversal there, but I just can't give you a specific number on it.

What I do know is that restructuring is going to be very strong in the back half of the year. Obviously, we've got $130 million so far, we see at least another $170 million, and the gains could be up to that level or may be even a little higher. We'll have to just wait and see what happens.

Nigel Coe - Deutsche Bank

Okay and then just... I was a little surprised that the Pratt restructuring wasn't a little bit higher given that's where a lot of the pressure is going to felt in '09, I presume. Can you just maybe comment on that?

Gregory J. Hayes - Vice President, Accounting and Finance

I think as always, I think all the units, our team out there restructuring as they think about 2009 and Pratt certainly has been focused on this and I think as you go into the third quarter, the $170 million that we just mentioned, you will see Pratt be a fairly large participant in that pool.

Nigel Coe - Deutsche Bank

Okay. Thanks Greg.

Operator

And our next question is from Cai Von Rumohr with Cowen and Company. Please go ahead.

Cai Von Rumohr - Cowen and Company

Yes, thank you. It looks like if you kind of hit your target that you'll see a pickup in commercial helicopter deliveries in the second half and I believe those are of lower margins than the military. Can you improve your margins at Sikorsky from where you were in the second quarter?

Gregory J. Hayes - Vice President, Accounting and Finance

Yeah, obviously, Cai. I think we saw a very good progress, 120 basis points. I think we'll continue to see margin traction there throughout the year, I am not going to say 120 basis points, but we should... we need to see costs come down especially on the helicopter production line. Hours have to continue to come down. They have to come down not just from a cost standpoint, but also from the delivery standpoint so that we have the capacity to deliver these 120 helicopters or so in the second half.

Cai Von Rumohr - Cowen and Company

So sequentially, you should be able to improve the margin from the 8.5 year-over-year obviously for the fourth quarter?

Gregory J. Hayes - Vice President, Accounting and Finance

Yes, I think that's right.

Cai Von Rumohr - Cowen and Company

Okay, great. And then could you give us the number of industrial gas turbines that you shipped in the quarter and give us some color that market appears to be relatively strong. Talk about order intake, what you expect for the year and the kind of momentum you might have going forward?

Gregory J. Hayes - Vice President, Accounting and Finance

Well, we actually shipped about 20 of the industrial gas turbines. That's actually up 100% from what we saw last year in the second quarter and that market continues to be very robust around the globe as people are looking for the peaking engine standby energy. Now that we have, I'm just looking to, here you will see we have the order intake for industrial. It's not, may be we can get that... we'll get back to you with a call if that will be helpful.

Cai Von Rumohr - Cowen and Company

And then what do you expect to do... what's the plans for the years?

Gregory J. Hayes - Vice President, Accounting and Finance

I don't know, but I have a forecast for the year for industrial gas turbine shipment. Again, what I will do is I will ask Akhil or Maria to try and get that data for you.

Cai Von Rumohr - Cowen and Company

Okay. And then the last one, Greg. You mentioned that the non-recurring gains in the second half could equal or exceed the $170 million, which means, as opposed to being a headwind though; $128 million in the first half restructuring would be essentially neutralized in the second half to the extent kind of business goes well. What's your information in term like if you have a figure of non-referring game? What's your information in terms of even pushing that restructuring higher, because you really implying at the time and the run rates where you were in the second quarter versus letting more in your earnings, so?

Gregory J. Hayes - Vice President, Accounting and Finance

I think as you think about the year 2008, we've taken the guidance up to at the top end about 495 and we've contemplated in that the restructuring up to $300 million. I would tell you, given what we see for '09 today, I would suspect that we would probably want to do more restructuring as opposed to flowing it through the earnings at this point. And I think we saw that here in the first half of the year and I think we will have that point broken in the second half of the year is if there is appetite for restructuring, we want to make investments for the long-term here. We are going to do what's right for the business over the long term.

Cai Von Rumohr - Cowen and Company

Okay. And the last one in terms of the timing of the non-recurring item, can you give us an instance if it's like a 150 or kind of whatever is, what are the key items which could attribute to that and when might be all in the third and fourth quarter?

Gregory J. Hayes - Vice President, Accounting and Finance

You know Cai, really, again we've got one small gain that we know it's already close to in the third quarter, Pratt disposition. But in terms of the larger gain as it relates to the tax or few of the other things that we are working on, I can't tell you whether that's third quarter or fourth quarter today. I will certainly let you know as we know about those things. So, there is no surprises here.

Cai Von Rumohr - Cowen and Company

But it should be one big lump in the third or the fourth?

Gregory J. Hayes - Vice President, Accounting and Finance

Well, yes, it could be one big lump or it could be some other things as well. I just can't give you a specific in terms of timing today.

Cai Von Rumohr - Cowen and Company

Okay. That's great. Thanks a lot.

James E. Geisler - Vice President, Finance

I just chose to look on the industrial gas turbine forecast, I think, that's, you've had about 35 shipped in the first and second quarter. And we had full year forecast is between 55 and 60.

Cai Von Rumohr - Cowen and Company

Thank you.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks, Cai.

Operator

Our next question is from Chris Edwards with J.P. Morgan. Please go ahead.

Chris Edwards - J.P. Morgan

Good morning, guys. Congratulations on a good quarter.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks, Chris.

Chris Edwards - J.P. Morgan

Joe wanting me to say hi too. He's on the flight back.

James E. Geisler - Vice President, Finance

Hi.

Chris Edwards - J.P. Morgan

Just a couple of quick questions, because most of mine have been answered. You referred earlier to some of the capacity reduction announcements that the airlines have announced. And a lot of those planes are... had engines MD-80s, and we were just curious to see what percentage of the Pratt installed base, you expect might be parked over the next year or so?

Gregory J. Hayes - Vice President, Accounting and Finance

Look Chris, I don't know that I would have a percentage. As you think about the announcements that have happened so far, I think American has talked about taking 50 or 60 MD-80s and reducing that capacity here in the third or fourth quarter. I mean, the bigger capacity reductions actually been announced I believe at United, where they are talking about taking old 737s which were actually CFM powered as opposed to the Pratt powered aircraft.

As you think about Pratt's aftermarket, commercial aftermarket is about $3.5 billion. We've given these numbers before, about 10% of that is kind of the older model engine JT8s, the JT9s. And, I think what's important is to keep it in perspective is, five years ago that business was about double the size it is today. So, we've already seen a fairly large reduction in spare sales related to the older model. So, again, there could be some further capacity reductions beyond which has been announced and it is painful to the extent it impacts spares. But it's not catastrophic in any way. I think it's just something we'll have to manage with Pratt.

Chris Edwards - J.P. Morgan

Right. No, that sounds good. Thank you. And then shifting gears a little bit, commercial refrigeration has been relatively weaker in the first half of the year. How do you think about that going forward for the rest of the year, and maybe into next year?

Gregory J. Hayes - Vice President, Accounting and Finance

In terms of commercial refrigeration, we have seen some weakness both in the U.S. as well as in Europe. Again, that's really more retail spending related so I don't know that I'd call a rebound in that market in the near term. I think again, it will depend upon what happens in the U.S. economy as well as the broader European economy. It position still well.

Chris Edwards - J.P. Morgan

Is that refrigeration weakness where it probably, can it be kind of like the store based sort of products and containers or is it more one or the other?

Akhil Johri - Vice President, Investor Relations

Yes, I think what Greg was talking about is more of the display kits business, which is the store based product as you are calling it.

Chris Edwards - J.P. Morgan

Okay. But container remains good?

Gregory J. Hayes - Vice President, Accounting and Finance

Actually, container was down in the quarter. We actually saw the weakness in the container shipments for the quarter versus last year. Again, inside the call that we look at the containers are pretty lumpy business. So, a down in the quarter but I think for the year we're still pretty optimistic that containers are going to come back.

Chris Edwards - J.P. Morgan

Okay. And then you've spoken about I guess truck trailer before, how was that going in the U.S. and Europe?

Gregory J. Hayes - Vice President, Accounting and Finance

The U.S. truck trailer has been very strong; come back quite a bit from last year's depressed levels. So we're seeing good growth there. Europe has actually started to moderate and that's, it has a bigger business in the U.S. truck trailer. It is also very profitable business. So, that is... that was actually down a little bit in the quarter.

Chris Edwards - J.P. Morgan

Okay. Thank you very much.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks, Chris.

Operator

Our next question is from Doug Harned with Sanford Bernstein. Please go ahead.

Doug Harned - Sanford Bernstein

Good morning.

Gregory J. Hayes - Vice President, Accounting and Finance

Good morning.

James E. Geisler - Vice President, Finance

Hi,Doug.

Doug Harned - Sanford Bernstein

On commercial construction and I'd say both Otis and Carrier commercial. When you talked about the growth you are seeing in orders, can you characterize that versus market growth and obviously that depends on geography, but I am trying to understand, are you seeing growth in the market or you are capturing share gain?

James E. Geisler - Vice President, Finance

Hi Doug, this is Jim. I think we are seeing both, I think we are seeing the market continues to grow, I think we have good products both with Gen2 at Otis and some of the Carrier commercial projects, products allowing us to take share gain. I would note as we talked a lot about it this morning though that, we had good backlog growth and particularly Otis have been given pricing in this market, we have being executing, probably the reason why you see higher margins. But as we look for architectural billings are down and we have seen a little bit lower quoting activity. And that usually precedes orders. So, I think we had very good backlog growth. I don't think we are going to sustain is very high growth rates, the backlog growth rates into the future.

Doug Harned - Sanford Bernstein

And what I was getting at is outside of the U.S. are you able to compensate some for any slowing we may see by some share gain in some of these other markets?

James E. Geisler - Vice President, Finance

I think one have to see, but to date we had both. We've had growing share in robust markets.

Doug Harned - Sanford Bernstein

And then on Fire & Security, you talked about organic growth and the FX effect. Could you talk a little bit more specifically about the part, the piece that acquisition and non-organic part of this and then what the actions you're taking that lead the restructuring charges? In other words, what are you doing there that's leading to probably substantial restructuring charges?

Akhil Johri - Vice President, Investor Relations

With regard to acquisition actually, both questions are related to some extend because the acquisitions of Initial, which we've announced in the third quarter of last year is driving part of the restructuring charges as well. And what is happening there is that was more of a density play. If we recall, we had a position in UK, France, and Netherlands and that initial coming on top of that it gives us an opportunity to try same the combined revenue to a lower infrastructure in terms of lower number of branches, head office et cetera. And so that's driving some other restructuring.

The integration of Initial is going very, very well. We seem to be on track with that and that's part of the reason why Bill is expecting some margin expansion in the second half at the rate larger than what you seen thus far. The other acquisition of significance was Marioff, which was fourth quarter last year and again the order rate there continued to be very strong. The business is doing extremely well and we're very, very happy with those plays were made in Fire & Security.

Doug Harned - Sanford Bernstein

So when you look forward and you talked about 10% margin this year, and I was assuming that that was 10% including restructuring before. Are you on the track for something like that and then when you look long-term at the 15% goal that you're described, is that all pretty much intact or long-term could it even be stronger given what you've done?

Akhil Johri - Vice President, Investor Relations

Its very much on track is what I would say Doug at this point. I think when we did half margin guidance; it's always adjusted for restructuring costs. Certainly, we have benefit of restructuring in those guidance number and that continues to be the reason why we feel they have a good path to get through with the 15%.

Doug Harned - Sanford Bernstein

Okay, good. All right, thank you.

Akhil Johri - Vice President, Investor Relations

Thanks.

Gregory J. Hayes - Vice President, Accounting and Finance

One more question.

Operator

And due to time restraints, our final question comes from the Lee Rowling [ph] from Morgan Stanley. Please go ahead

Unidentified Analyst

Good morning.

James E. Geisler - Vice President, Finance

Good morning, Lee.

Unidentified Analyst

Nice quarter. Just a few questions. Can you talk about your new equipment order growth and taking us in dollars, could you characterize that in units overall and I think you stated as 40% in Europe. Did you have that for us?

Akhil Johri - Vice President, Investor Relations

It's tough to talk about unit Lee, only because unit is made up of so many different sizes and types and performance, it becomes difficult for us to characterize that. But clearly the way to look at it is the FX which we talked about, 50% of the 40% is roughly FX. If you adjust for that, at constant currency they are about 19%, 20%. And I think on a unit basis, again, Otis placed very well in the higher end. So, the dollars per unit per for Otis wins are typically larger than the market in some cases. So... but, to give you an exact number on units, that's tough for us to do.

Unidentified Analyst

Okay. Fair enough. And then in the U.S., could you tell us just may be regionally where the strength is coming from and maybe in Europe, maybe country-by-country for Otis?

Akhil Johri - Vice President, Investor Relations

As Europe is easier to talk about, let me start with that I think that one is more I think as Greg said, France certainly for Otis has been strength in France, Germany, Eastern Europe particularly Russia. Weaknesses on the other hand have been basically you said to some extend Italy and Spain for a smaller extend. With regard to U.S., I think that's a little something maybe I can take it later on on the call, I'll talk to you about that.

Gregory J. Hayes - Vice President, Accounting and Finance

They will try and get you some more detail here but we'd be on the call.

Unidentified Analyst

Okay. I mean just to switch it up a bit, I know for going into power on, I think Hamilton had a few outstanding items that were necessary as to be complete for power on, just so wondering could you give us an update there and just what's going on with the program, what you guys are working on, I mean any surprises positive or negative?

Gregory J. Hayes - Vice President, Accounting and Finance

I wouldn't characterize any... that we had any real surprises at the development program. So, you always have things that you may have to reward is part of the process. But I would tell you the power on process from a Hamilton perspective was good as we could have ever expected. And we are obviously supporting First Flight certification hardware. We've got a couple of outstanding items there. I expect all of that will be done by the end of this month, end of July, to support First Flight or support won't happen until some time towards the end of the year. So, feel very good about the program. I think Dave Hess and team and Tim Morris, they all have done just a great job supporting Boeing through this very long and difficult development process. But they are not done yet, and still spending money but I feel also very good about the program.

Unidentified Analyst

Great. What are the systems that are outstanding for First Flight?

Gregory J. Hayes - Vice President, Accounting and Finance

Again Lee, I don't know that I have those specifics. I know again a lot of it has to do with the certification of software and the start primarily going to be related to electric power distribution systems. But I'm sure there is more kind of mix and matchs that has to be completed as well. I just don't have it on hand for you here.

Unidentified Analyst

Sure. And then, I think Nicole asked about an update on Diebold. I don't remember the answer, the question being addressed. So, if you did, I apologize for it, could you give us some update there?

James E. Geisler - Vice President, Finance

Yeah. Actually, I will give an update, I did speak about and about 15 minutes ago and actually my response is going to be similar to what it was 15 minutes ago but, the same...

Unidentified Analyst

I apologize.

James E. Geisler - Vice President, Finance

That's all right. I was going to say actually the response will be the same as it was an hour ago and it was four months ago, which is, we really like the property. But, it's not a must have, there are other opportunities in the world and we will have to see how it goes.

Unidentified Analyst

Got it. Thanks.

Gregory J. Hayes - Vice President, Accounting and Finance

Thanks, Lee. Okay. Well, just want to thank everybody for dialing in and listening in this morning. Obviously, a very strong quarter, and we've got a lot of confidence in the year. The focus right now as we've mentioned many times on this call is about preparing for '09, given there'll be economic uncertainties we all face. But, I feel very good about where we are, we've got great products, great people and think we're going to have a great year. Thank you very much.

Operator

Ladies and gentleman, this does conclude today's conference. Thank you for your participation. You may now disconnect.

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