雷神技術公司 (RTX) 2004 Q2 法說會逐字稿

Good morning and welcome to the United Technologies second-quarter conference call.

On the call today are Jim Geisler, Vice President, Finance;

Greg Hayes, Vice President, Accounting and Control;

Dave Porter, Director, Investor Relations; and George David, Chairman and Chief Executive Officer.

This call is being carried live on the Internet and there is a presentation available for download from UTC's home page, 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 risk and uncertainties.

UTC's SEC filings and reports, including its 10-Q and 10-K report, 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. Geisler.

Thank you, Constance (ph), and good morning.

I'm going to start the call today with some thoughts on the quarter's results, our improved 2004 earnings and cash flow guidance and a review of segment results.

Greg Hayes will then take you through cash flow and corporate items.

And finally, George David is here with us on the call today to offer his own unique perspective.

This is George's first time on the call since the events of 9/11, so George, do you want to say hello?

Good morning, everybody.

It's nice to be back with you.

Then we will take your questions along with Dave Porter, who will keep us in the right.

This was an exceptional quarter for UTC, with 32 percent reported EPS growth to $1.66 a share on revenue growth of 24 percent to $9.6 billion, as the businesses performed well in a strong economy.

As previously forecast, the results include 14 cents of EPS benefit from the second quarter settlement of some open tax years, partially offset by restructuring.

Excluding this, earnings per share grew 21 percent year-over-year, still a very good performance, and have increased 17 percent on a year-to-date basis.

In light of our strong earnings momentum, we are increasing our outlook and now expect full-year revenues of $36 billion and full-year earnings per share growth of at least 15 percent on a slightly more difficult compare in the back half of the year, or in the range of $5.40 to $5.50 per share.

This includes full-year restructuring in excess of the first-half gains of $500 million, as the almost $100 million excess in 2Q gain is more than offset with restructuring in the second half of the year.

We are also raising our free cash flow outlook today.

We expect free cash flow in 2004 equal to this higher net income, while absorbing about 500 million in voluntary pension contributions.

We achieved this standard in both of the first two quarters of the year, and we are now at 114 percent of net income year-to-date.

We are well-positioned.

Particularly notable in the quarter was 9 points of organic revenue growth.

Organic growth in the commercial businesses was 9 percent thanks to Carrier's North American HVAC operations and continued growth in transport refrigeration business, while Otis continued to achieve global new equipment and service sales growth.

Aerospace organic growth was 8 percent against an easy compare last year, as there has been a decent recovery in our commercial aerospace aftermarkets.

Worldwide revenue passenger miles are up significantly, mid-teens over last year, and finally, 6 percent above 2000 levels.

Turning to segment performance, with restructuring added back, segment operating profit grew 24 percent, with double-digit growth in all businesses, including 180 basis points' improvement in aerospace operating profit margins.

Last year was an extremely tough second quarter for commercial aviation.

You will recall that we told you Pratt & Whitney spares orders were down about 30 percent in the quarter, so we're pleased to see an improvement in these markets.

Segment operating profit margin was 14.8 percent, improving 40 basis points, including an 80 basis point drag from the roll-in impact of Chubb.

Now I will take each of the segments individually.

On slide 4, Otis operating profit was up 19 percent on 13 percent higher revenue, resulting in 1 point of margin expansion in the quarter.

Organic revenue growth at constant currency was about 5 percent, with all regions reporting year-over-year increases in the quarter, and operating profit growth was especially strong in Europe and in Asia.

About 40 percent of the revenue growth and 30 percent of the operating profit improvement were from FX.

Otis new equipment orders increased double digits in the quarter, led by continued strong growth in China, as well as in North America.

Otis also continued steady and solid growth in its aftermarket business, with service sales up about 7 percent in the quarter at constant currency.

Gen2 orders increased over 50 percent for the first half of the year, solidifying Otis's number one worldwide position in the rapidly growing machine rooms (ph) elevator market.

For the full year, we now expect Otis to grow revenues approximately 10 percent and to increase operating profit margins by about a point, consistent with our previous guidance.

On slide 5, Carrier revenue increased 14 percent in the quarter, with 12 points of organic revenue growth, and all businesses reported year-over-year revenue growth in the quarter, with double-digit growth in Europe, Asia, Transicold and North America.

Sales in Europe were especially strong, reflecting replenishment and increased demand after last year's heat wave, and in Transicold, benefiting from a recovery in the North American truck and trailer market.

Carrier's North American HVAC volume was up about 10 percent in the quarter, helped by continued strength in residential housing starts, a sell-through in the residential business and a recovering commercial market.

The weaker U.S. dollar contributed about 2 points of the quarter's reported revenue increase.

Operating profit improved 20 percent, with margins up 60 basis points from last year's second quarter.

Higher volume and productivity initiatives contributed to the solid performance in the quarter, more than offsetting headwind from steel and copper cost increases and pricing pressures.

Currency contributed about 3 points of Carrier's operating profit improvement in the quarter.

Earlier this month, you might have seen Carrier received approval from the European Competition Commission to complete the acquisition of Linde's commercial refrigeration business.

This combination will allow Carrier to provide a more comprehensive range of products and services in key markets, and with this regulatory approval, we expect to close the transaction in the second half.

Excluding Linde for the full year, we expect Carrier to grow revenues about 10 percent or a little more and expect higher second-half impact of commodity price increases to keep Carrier's margin improvement at the low end of the 50 to 100 basis points guidance range for the year.

Now, on China, both Otis and Carrier reported double-digit sales increases in China in the quarter, and we continue to see robust sales growth in this key market, despite some pricing pressure and higher material cost.

Longer-term, our products have not yet even begun to saturate the country.

China has about half an elevator per 1000 inhabitants, versus 6 per 1000 inhabitants in developed countries, and air-conditioning spend per capita in China is $5 versus $30 in the States.

So we look aggressively to grow our $1.5 billion revenues in China and Hong Kong to be more than just 4 percent of UTC's total revenues.

Operating profit at Chubb in the quarter was $35 million on revenues of $780 million.

Margins of 4.9 percent were slightly higher than the first quarter.

In constant currencies, revenues in 2Q were 5 percent higher than the first quarter, reflecting primarily customer buying patterns.

By region, Australasia and the European fire protection businesses were stronger, with some softness in the UK.

In the quarter, Chubb acquired Secure, a leading Swiss fire safety group, enhancing their already strong position in the European fire business.

For the full year, we expect Chubb will generate approximately $2.8 billion in revenues, up from previous outlook of $2.5 billion.

And consistent with our prior guidance, operating margin will be flat with 2003.

Turning to aerospace and starting with Pratt & Whitney on slide 8, revenues were up 7 percent, with large commercial engine spares and Pratt & Whitney Canada growth partially offsetting a year-over-year decline in military revenues.

This in part reflects lower development revenues and lower military shipments in the quarter, but in line with our expectations.

Operating profit was up 23 percent, resulting in a 200-basis-point improvement in operating profit margin.

Commercial spares orders were up year-over-year against a very weak quarter last year.

Recall they were down more than 30 percent in the second quarter of '03 versus the prior year.

Recall that quarter was the low point following the Iraq war and SARS.

For this year, spares orders in the second quarter improved sequentially in the high teens, and the book-to-bill was a little bit more than 1, so we have a good recovery here.

Pratt recorded a charge in the quarter totaling about 3 cents a share for estimated environmental remediation costs for an out-of-production facility in its solid propulsion rocket business.

In the quarter, IAE was awarded $600 million in V2500 contracts to power aircraft for Jet Blue and America West, as we have continued strong performance in the narrow-body market.

Also, as you may have heard earlier this week at Farnborough, IAE announced and entered into discussions with Bombardier Aerospace to offer an engine from Bombardier's new commercial aircraft.

We're working with Bombardier and our IAE partners to discuss the technical requirements of the engine, as well as our business case for this potential 100-plus passenger aircraft.

For the full year, we have raised our revenue guidance for Pratt to high single digits and margins up as much as a point, consistent with our prior guidance.

Turning to the Flight segment on slide 9, operating profit was up 25 percent, (technical difficulty) 11 percent increase in revenues, reflecting improvements in commercial aerospace aftermarket as well as the helicopter and aftermarket business at Sikorsky.

Hamilton Sundstrand's revenues were up 8 percent, led by commercial aerospace aftermarket sales and continued volume improvements in the industrial businesses.

At Sikorsky, revenues were up 17 percent, reflecting an improved mix of U.S. military and commercial aircraft deliveries and higher aftermarket volume, primarily offset by lower Comanche revenues.

Sikorsky shipped 18 helicopters in the quarter, and that is the same quantity as last year, but deliveries included higher-value Naval Hawks.

In Jones, Sikorsky successfully completed its first flight of the production S92 aircraft, with launch deliveries targeted for later in the third quarter.

Also in the quarter, the S92 became the first helicopter in the world certified by the European Aviation Safety Agency to the latest and most rigorous safety standards.

On guidance for the full year, Flight revenue growth is expected to be up in the high single digits, as we indicated in prior guidance, and margins up about 50 basis points.

Looking at our military businesses in total, in the quarter we had a slight decline in revenues, in part from the Comanche termination.

And for the full year, we continue to expect 2004 sales to be about flat or down slightly on a tough 2003 compare that saw a 50 percent increase over the prior three years.

With that, I'm going to turn it over to Greg to talk about a couple of additional items.

Thanks, Jim, and good morning.

Moving to slide 10, cash flow for the quarter.

You can see free cash flow in the quarter was 953 million, or 114 percent of net income, an increase of $259 million over last year.

Working capital was a $363 million use of cash, primarily the result of higher receivables from strong second-quarter sales growth, particularly at Carrier and Pratt, and slightly lower inventory, reflecting the continuing focus around inventory management we've talked about in the previous quarters.

Capital expenditures were $148 million in the quarter, and for the full year, we now expect CapEx at about 90 percent of full-year depreciation expense.

In the quarter, we had share repurchase of $264 million, bringing the year-to-date total to $480 million.

For the full year, we are raising our share repurchase target to $800 million.

Acquisition activity in the quarter was $165 million, primarily at Carrier and Chubb.

But for the full year, we continue to use the $2 billion acquisition placeholder, although we will need to see a step-up in the acquisition run rate in the second half to make this happen.

Restructuring cash outflow in the quarter was about $70 million, and for the full year, cash spend for all restructuring actions should roughly offset cash from the favorable first-half items.

Company-funded R&D spending was $313 million, up $32 million from the second quarter of last year and up about $100 million year-to-date.

The majority of this increase has been at the aerospace companies for investments on the GP7000, some small-engine programs at Pratt Canada and Hamilton's 7E7 content (ph).

We expect a similar run rate for R&D in the second half of the year, bringing full year R&D spending up approximately $200 million over last year, as we continue to make investments in the businesses.

Eliminations and other benefits from the interest income impact of the tax settlement, about $125 million in the quarter.

And the effective tax rate in the quarter was 22.5 percent, also reflecting the impact of the quarter's tax settlement.

In the second half, we expect the tax rate back at the 28 percent level before any discrete items.

Before I move on to the discussion on restructuring, I would like to give you just a quick update on the Otis EU matter.

The investigations by both the European Commission and the Company are ongoing, and we continue to cooperate fully with the Commission.

Based on the results of our investigation, we believe that some Otis employees in a limited number of European locations engaged in activities in violation of Company policies and may have violated applicable competition laws.

It is still too early in the Commission's investigation to reasonably estimate the range of civil fines to which the Company would be subject if the Commission ultimately finds that Otis employees did violate competition laws.

The fines, if ultimately imposed, could be significant.

Given the status of the investigation and the normal EU Commission processes, we don't currently anticipate that we will get to a final resolution of this matter this year, but we will keep you apprised as events warrant.

Now moving on to slide 11 and restructuring, I would like to give you a brief update of the restructuring that we covered last quarter.

In Q2, there was $156 million of restructuring charges, including $71 million on new actions and $85 million on costs related to actions launched in previous quarters.

New actions initiated during the quarter were a mix of continued factory consolidation and G&A actions across the Corporation.

Costs related to previously announced actions were primarily at Carrier, Otis and Pratt.

During the quarter, Carrier completed the transition of manufacturing work out of Syracuse and also continued to make good progress on the McMinnville factory action.

Costs at Otis related primarily to the finalization of the labor agreement at Stadthagen, Germany, and the Bloomington factory closure.

Restructuring costs at Pratt were largely attributable to the previously announced closures of its San Jose manufacturing operations.

We are also pleased to report that we finalized the settlement of the 1986 through 1993 open tax years with the IRS in June, providing roughly $250 million of pre-tax earnings benefit.

The credit to income was split fairly evenly between interest income, which is seen as a credit and (indiscernible) as another, and a reduction in tax expense.

So the net drop-through gain in excess of restructuring of approximately $100 million in the second quarter is the 14 cents a share we described to you on last quarter's call.

You should note that our outlook of $5.40 to $5.50 per share includes approximately $525 million in restructuring charges versus gains of $500 million.

Therefore, on a full-year basis, we now expect cost-reduction charges will exceed the first and second quarter favorable items by at least $25 million.

Year-to-date, we've incurred just over $410 million in restructuring and related costs, and we expect to incur $50 million to $60 million of additional restructuring costs in both the third and fourth quarters, related to these previously announced restructuring actions, both for plant closures and head count reduction.

We like this model of utilizing one-time gains to invest in our future and we will also look to make investments when the businesses are performing well.

It has worked well for us over the years, fueling margin expansion across the businesses and providing continued earnings momentum for the Company.

Now I would like to turn the call over to George David.

Okay.

Thank you, Greg.

I think this quarter looks really solid and it feels like vintage UTC to me.

I have been doing these calls on and off with you now for actually a dozen years since 1992, although not since the September 11, 2001 quarter.

This quarter, I think, is as good a one as we have ever had.

I'm not going to repeat the specifics which you have heard from Jim and Greg; you have heard lots of these.

Instead, I just though I'd offer a couple of comments giving perspective on momentum for the long term.

As I go back to these last dozen years to 1992, our total shareholder return, TSR, is over 800 percent.

That is more than three times the averages and it is way over peers, including some pretty good peers at that.

And what drove that TSR was segment op margin expansion from 5 to 14 percent, and also starting about 5 years ago, deployment of free cash flow for acquisitions.

There were some acquisition bumps in the road along the way, as there always are, but we broadly really like these acquisitions and what they have brought to us.

You know, the 1999 ones were amazing, absolutely amazing.

Think about UT Automotive out and Sundstrand in.

What a day that was in my life!

ICP, International Comfort Products -- that's North American HVAC and the Lucky Goldstar, LG Korea elevator acquisition, both of them provided big lifts for market share and for op income to Carrier and to Otis.

We think Chubb and follow-on acquisitions in security and fire protection will do the same for that business.

And we will do the same thing with Linde, the European commercial refrigeration market leader.

Our cost reduction productivity and restructuring disciplines are mature, with lots of momentum.

They will take segment op margin higher in the future no doubt, and the $0.5 billion we're taking in restructure this year from the two big one-time items and from operating income above expectations sets us up, I believe, well for 2005 and 2006.

Balance is a tremendous force for us.

It is what gave us the highest EPS growth rate achieved among all of our peer companies over the 5 years since 1999, and obviously overcoming the really bad impacts of 9/11, Iraq, SARS and the commercial aviation meltdown.

When I think about profit dependence, going back, say, to 1990 for UTC, when we had two-thirds of our profit op income coming from Pratt & Whitney, and today 25 percent, I think the case for balance is absolutely made.

We like a lot the 61 commercial content and 51 percent international content in our revenues that we have today.

This is why this whole balance things works in good times and it works in tough times.

So our story is 100 percent in tact.

We have a now very seasoned, mature team to deliver it.

This Company feels really great.

Let me stop there, actually, with just those few brief comments and turn the call back to Dave and Greg and Jim, and we will take your questions and comments.

(OPERATOR INSTRUCTIONS) Steve Binder of Bear Stearns.

Good quarter.

A couple things.

Number one was, Jim, maybe you can highlight -- talk about pricing, what kind of price increase did you actually see across Carrier year-over-year in the quarter?

And can you quantify the headwind on commodity prices, and also touch on pricing with respect to new equipment orders at Otis, maybe for the quarter or year-to-date, compared to a year ago?

Steve, at Carrier, we put through, towards the end of the second quarter, starting in the third, a price increase in North America.

It is small.

It is 2 to 4 percent across the product line.

It doesn't begin to offset the commodity price impact that we're seeing globally.

The commodity price impact is really taking us from the high end of the guidance range towards the low end of the guidance range.

Pricing won't make that -- price, although there's kind of temporal power on that at the moment, pricing doesn't offset all of that.

At Otis, there's pricing pressure in Asia, but I would say overall, there's always a little bit of pricing pressure in the Otis new equipment market, and we haven't seen a major change there outside of Asia.

So you're saying that the quality of pricing for new equipment orders maybe year-to-date is similar to what it was a year ago?

I don't think it's dramatically different, except in China, where we have seen a fair amount of pricing pressures.

We talked about before, there are a lot of new entrants there and the market is growing, so it attracts a lot of attention.

If you go over to Pratt and you back out the charge you took this quarter, you have -- it looks like a good incremental margin of like 60 percent year-over-year; and you had higher R&D in the quarter as well.

It looks like -- I'm guessing spare parts sales were more than half of the increase year-over-year in sales growth, so that you saw extremely high conversion rates on the spare parts sales.

Spare sales were very good in the quarter.

Again, easy compare, but very good, as we have had a decent recovery in the aerospace aftermarket.

All rights, and then two last things.

George, since you're on the call, can you maybe discuss -- Greg talked about the acquisition pipeline, or at least what acquisitions have done year-to-date and your goal for the year.

Can you maybe touch on what kind of opportunities you're seeing out there and do you think the actual expenditures will come in less than planned for the year?

Of course, the acquisitions are always event-specific.

It takes willing buyer, willing seller to make a deal go ahead, and we have our (ph) usual pipeline.

There are a bunch of things that are out there.

We obviously have to step the run rate up, as Greg said, to get to the 2 billion for the year.

That has been about our global average over the last now 8 years since we resumed acquisitions out of free cash flow in 1996.

And I guess I am going to duck predicting whether we will get there or not.

We would like to, but again, it is very event-specific.

And you can get a good-sized deal for 0.5 billion or even a billion that moves it around.

And whether it happens in this year or falls into 1 or 2Q next year, I think it's hard to forecast.

By their very nature they're very lumpy.

All right.

And Jim, the FX assumptions for the year, have you raised that now from the 115 range or where is that now?

You're right, Steve.

We started the year at the 1.15 range, and I guess proven that we couldn't forecast FX for the year, because I don't know that it's touched 1.15.

So for the remaining six months, we are going to use the spot rate, which is around $1.22, $1.23, and that is embedded in the 5.40 to 5.50 guidance.

George, your mantra used to be earnings growth of 15 percent.

I noticed in the release today you said earnings should grow at least 15 percent in 2004.

Is that a number you would like to be targeting down the road again, or can you maybe just give some color on what you would like to see in the future?

Double-digit forever.

All right.

Thanks a lot.

Nicole Parent from Credit Suisse.

Good quarter.

George, I was wondering if you could elaborate a little bit more on the big picture globally.

Jim alluded to the strength of China.

Could you talk about what you're seeing there more specifically in terms of the slowdown that they are seeing, hard or soft landing.

And then also on nonresidential North American construction, if you are seeing any pickup there.

Well, Nicole, the economy worldwide feels pretty good to me.

Of course, the big bang is in the U.S.

Tax cuts last year were a strong stimulus, and of course we have other things going on.

We have the natural force of an ebbing recession.

We still have record or near record low cost of money.

We have good stimulus from a weaker dollar and strong impact on exports and also on FX in translation for the Company.

So there's a lot of power coming out of the U.S. economy.

But also, we have strength across the board in countries all over the world.

Japan is getting a little better.

I feel like what's said in the media maybe is more robust than what is actually there or going to be there, since I'm fairly pessimistic on the demographic case in Japan.

China is very good.

I think the talk about hard landing or soft landing in China maybe is a little bit overdone.

I go back to Jim's earlier comments about half an elevator per 1000 people in China versus 6 per 1000 in the world, and $5 for air-conditioning versus 30 in United States.

These are big numbers on saturation, and we may see a pause in these really torrid growth rates in China for a while; (indiscernible) economy needs to recover.

But long-term, I think there's a lot of stuff that's left there.

I think the whole Asian case -- we've been talking about globalization forever in UTC -- huge impact of urbanization, the fact that more and more percent of world GDP is going to come from the emerging markets as they outgrow the advanced economies in the U.S., Europe, and Japan.

All of that is intact; all of that is good.

And I think we've got a period here for the next 18 months, in my judgment, where we are going to have good economies worldwide.

Great.

And more specifically on the businesses, Jim, at Hamilton, I'm not sure if you said how much commercial aftermarket was up in the quarter.

It was up, again, off an easy compare of last year -- not quite as much as Pratt, but not quite as easy compare.

But again, we are seeing that recovery in the aerospace aftermarket that began in the third quarter of last year.

Did it increase sequentially versus the first quarter?

It was about flat sequentially, whereas, again, Pratt was up sequentially, as I noted.

And I wouldn't read too much into that.

I think that's just the fact that we are looking at short periods of time.

I would just go back to the fact the last four quarters, we have seen increases essentially in every quarter certainly no declines in any quarter during that time.

Lastly, on Linde, now that you got the approval to a proceed ahead, could you talk a little bit about the integration, the restructuring plans that you have underway there?

They are extensive plans.

As you know, we bought that business, and I think as George said once, that Linde has very, very, very low margins, and as we have talked, that is essentially zero.

So we have -- it's a good $1 billion business to pick up.

What you get out of that is the brand name in Europe and leading share, and we love that position because it is what has propelled so much of the other businesses in UTC.

The restructuring is significant.

It will occur over the next two and three years, with plant closures and restructuring the operation.

And as Jeraud has talked, we've dedicated 80 people full-time to the integration.

So the resources are there and I think the energy is there, and this will be a good deal.

It is a deal we like because it gives us that share in Europe and a brand name.

Could you compare and contrast that versus Transicold?

I guess the integration that you had there and kind of the pace of the margin expansion you saw there was probably a little bit slower.

I would like to take that.

The whole goal with Linde and the other commercial refrigeration acquisitions we had in the United States earlier is to build a business just like Carrier Transicold.

Carrier Transicold is a jewel business.

It has really strong world market leadership.

It is -- more than 60 percent, even two-thirds, of the world container fleet is Carrier Transicold.

Almost half of the truck trailer refrigeration supply in the entire world is Carrier Transicold.

Strong double-digit margins.

It has been that way for a long time.

I mean, realize that Carrier Transicold has been what is has been for a couple decades, and it's just a jewel of a business.

It's got some capital good cycle, risks up and down, but over the cycles it's a really, really great business, and we think we can do exactly the same thing with the commercial refrigeration business.

I feel like Linde, which we have looked at now for a decade, a long, long time.

While it's got some operating challenges, there's no doubt about that, and it's got a high German cost base.

We'll have to deal with that.

There is restructuring, lots of integration plans.

We are going to end up here in several years time, and it may take longer than all of us would like it, but it's just the nature of things.

But we want a business exactly like Carrier Transicold, and we think we can do it and we've got the world market share today.

Great, thank you.

I will pass the baton.

Tony Boase with AG Edwards.

Thanks.

I wonder if I could just get some of your shipment data for Pratt & Whitney and also Sikorsky.

Sure, Tony.

It's Dave.

Why don't I start with Pratt from the large commercial side. 86 engines 2Q this year, up pretty good sequentially and over the prior year as well.

From a military standpoint, 40 engines again up sequentially.

Pratt Canada, really, really good growth there, up over 50 percent year-over-year, 425 engines and you'll recall the real strong first quarter from a shipment point of you that Pratt Canada posted as well.

Then, as I think Jim mentioned, 18 helicopters this quarter at Sikorsky, consistent with last year but a little bit better mix in terms of Naval Hawk aircraft.

Then just on Comanche, you mentioned the announced -- the facility closed.

Would you say that you ended up whole on that?

How would you say that that has been wrapped up?

Tony, this is Greg.

I guess I would say that we are still in the process of wrapping up the termination claim.

We have about a year to get that completed.

We're working very closely with our customer and our partner, Boeing, on the termination claim, and we would like to get it wrapped up as soon as possible.

We believe that all the costs that we have incurred related to the termination we will recover in due course from the U.S. government, but these things just take time.

So I wouldn't expect resolution of that this year.

Probably some time late next year.

I apologize if you touched on this earlier in the call, but how much benefit did you derive from planes coming out of the desert this quarter?

It seemed that Honeywell got quite a big boost from that.

Tony, I wouldn't say there's really much benefit from that.

Those planes coming out of the desert is a small percentage of the total overall Pratt & Whitney fleet, and a lot of those engines coming out of the desert are 8 and 9D (ph), for which there are already surplus parts, and cannibalization has largely occurred.

So I think what you're seeing driving our aerospace aftermarket recovery is just the fact that there has been pent-up demand and deferred maintenance for a period of time, that engines are now coming in for overhaul and spare parts are being procured.

But I don't think the engines in the desert is a very big driver for UTC.

What about for Hamilton Sundstrand?

I would say same phenomenon.

The engines coming out of the desert as a percentage of the overall installed fleet are very, very small.

Great, thanks very much.

Don MacDougall of Banc of America.

Good morning, gentlemen.

I had a question on Otis.

I was just wondering if you could maybe characterize the order activity by geography.

And if we were to assume that China slowed, how long would it take before that would show up in your revenues, given that that is a backlog business?

Why don't I take you through what was a real nice order quarter at Otis -- North America in particular, with strong new equipment orders up over 20 percent in the quarter; good performance in Asia on new equipment as well, mid-teens. 10 percent in Europe and overall mid-teens for Otis on the new equipment side.

I think Jim mentioned service up about 7 percent in the quarter for total order growth at Otis at about 10 percent.

Okay.

And if we were to assume China slowed, with the backlog that you have, how long would it take that to show up in the results?

I think we are pretty set with the backlog through this year. so I think you would have to get out into next year to see the impact of that and again (ph).

So we are six months plus here.

And again, we've heard a lot of talk about it; although we haven't started to see any slowdown, we've heard a lot of talk about it, just like you.

If it comes, I think is manageable inside of both Otis and UTC's business, and given the overall growth profile in China, we would look to increase our investments.

Next question would be at Hamilton Sundstrand.

With the recent contract wins that you've had there, can you give us a sense for what the anticipated R&D investment 7E7-related is at Hamilton Sundstrand?

We think with the 7 programs that we have won, John -- this is Greg -- we anticipate our R&D spending at Hamilton will probably still remain flat over the next few years.

Again, we've got programs winding down like the A-380 and the ERJ-170 program.

The total investment profile is not much different than any of the other platforms that we've seen.

Although we have won 7 programs, we have partners in several of the programs.

So we don't anticipate a big tick-up in R&D spending as a percentage of sales at Hamilton over the next couple of years as a result of the 7E7 wins.

Final question, maybe this one is for George.

With respect to your earnings outlook, if I go back a quarter or two, the general sense that you left us was that upside to earnings from operations was more likely to be plowed back into the business in enhanced restructuring and in growth investments.

Can you give us a sense for what your thoughts are on that and maybe where that has gone?

And is it just that things are that much better that you wanted to take the number up as much as you did?

Don, we always say that.

We said it before and I'll say it again.

I feel like this is 5.40 to 5.50 range, that's 15 to 17 percent growth -- that is a truckload.

And there is just a lot of punch in the P&L.

You can feel it in the business.

We have very good earnings momentum, and if we do a little better than we anticipate, well, we might do a little bit more restructure, and we will have to see.

We are in this game for the long-term.

Let's always keep that in mind.

And I think that has been UTC's hallmark now for a dozen years, is when we have extra strength, we tend to put it in the future, because we're interested in EPS in 2005, 2006, 2007.

This is not like letting it all out now and then we will worry about later when later arrives.

We are into later already.

This year is done from our point of view in terms of the P&L.

We are way into '05/'06.

Thank you.

Good-looking quarter.

Jeff Hammond with Key Banc Capital Markets.

Good morning.

I wanted to get a better sense, I guess, of the momentum you're seeing exiting the quarter in June and into July on the commercial spares and aftermarkets side, both in Pratt and Hamilton Sundstrand.

A month in a business that can be lumpy like that is really too short a time to talk about.

I think we don't read much into it.

And I just go back over the longer period, which is obviously we saw a ramp-down in advance of the Iraqi war, and we have seen an improvement pretty steady ever since then.

And admittedly, the airlines' overall financial condition is weak, so I wouldn't by any means call this a strong recovery.

It is a good recovery, but tentative.

We don't see any change to that at the moment.

Okay.

And then on Carrier, I guess you talked about some pricing pressure.

It sounds like your price increases are just being implemented.

Can you talk about where specifically -- within that business, where you are seeing more or less pricing pressure?

And can you also give us a sense of how your commercial unitary business looked versus commercial applied?

The pricing pressure at Carrier is more acute in the commercial side of the business.

And I think that just stems from the market condition of we had three years of downmarket in commercial HVAC, which was unprecedented in the industry.

And so you've got a recovery beginning now, but nobody has a full factory, so you see a lot of pricing pressure there.

Accordingly, on the flipside, where are you more likely to get price?

It's in the residential market right now, where you have continuing strong volume and market support.

So price increase across the board are probably more likely to hold in residential.

Unitary, you asked specifically how does that do versus the bigger business.

That has had less pricing pressure and better growth than the big commercial business.

And from a demand standpoint, unitary versus applied in the quarter?

I would say, as well, better demand in the unitary than the commercial applied.

Good, thank you.

George Shapiro with Smith Barney.

Good morning.

Nice numbers.

I want to pursue a little bit in the commercial spares business at Pratt, you mentioned you're up a lot from last year.

How would it compare to the 2002 quarter?

It would be up versus 2002 as well.

And could you give an order of magnitude?

It was pretty healthy increase, but again, I would go to that it's a 90-day period, and I look over the longer term, almost more like a 12-month roll, where we continue to see kind of a line going up here.

Okay.

And at Carrier, American Standard had mentioned that they thought the residential market was up by 15 percent and they were gaining market share domestic.

Can you comment on where you think your domestic residential was this quarter and how it would compare, or whether you would agree with what American Standard said about the market?

I guess I would make the same comment I just made on spares, which is 12-month roll is kind of a nice way to look at these things.

So you can't read too much into any quarter.

I think we had good performance in residential.

We grew along with the market and up over 10 percent, and we similarly had very good performance in the first quarter.

So over the longer term, our performance in res has been very good and we are growing along with the market and executing well.

George, actually, I think we also need to remind ourselves that Carrier Corporation goes to market with two-step distribution.

And so whatever the revenues are that we have, that drops into field inventories and you've got to worry about movement out of those into dealers in the residences.

So I think any one quarter is not -- we can't conclude totally from one quarter.

We feel like Carrier's got great products, has a very low-cost.

It's always been the cost leader in North America.

Tremendous productivity and throughput out of Carrier Collierville, and we feel real good about the North American res business.

While you're on the phone, George, one overall question.

Right now, the aerospace to your commercial mix is maybe 40 percent aero and trending down, certainly, if you add more to Chubb.

If you go back over the years, you have kind of said you're comfortable with that mix being 40/60.

As it looks like it's going to become less than 40, do have any kind of new perspective on where you might expect it to be in 5 years or 7 years out?

I think I wouldn't move off the 60/40.

Actually today, it's 61/39.

But I think right around that area is where it ought to stay.

There could be some acquisitions in commercial security, fire protection.

Also, there could be some acquisitions in aero components and systems out of Hamilton Sundstrand.

There could be some acquisitions in aero aftermarket, both at Pratt, Hamilton Sunstrand and Sikorsky Aircraft.

I feel like the 60/40 is a good placeholder number to carry into the future.

Okay.

Maybe one last one.

You mentioned there was strong industrial growth at Sundstrand's industrial businesses.

Could you just break out which of those businesses you might have seen higher growth versus some of the other areas?

The pump business and compressor businesses have shown the greatest growth tied to construction and mining industries.

I think they are just moving with the general overall economy, and those are good industrial businesses for us, good niche players.

Okay, thanks very much.

Cai Von Rumohr with SG Cowen.

Let me reiterate good quarter.

Flight Systems was the only one of your businesses where the margins really were not as great;

I guess they were the weakest of the last four quarters.

Could you comment on the impact of the 7E7 in R&D and was there anything else holding those margins back?

Flight margins, I think we had good improvement there as well, I would say.

Not really impacted yet by much 7E7 spending at Hamilton.

I think it's more a matter of mix issue at Sikorsky.

As I referenced earlier, we had some higher-valued helicopters that (indiscernible) sales value of a little bit lower or didn't have the same margin content.

But mix, and I think, again, what you're seeing in the segment overall is an aerospace recovery and continued good military business at Sikorsky in their aftermarket.

Okay, and your R&D was up sequentially, but a little lower as a percent of sales, really a function of your great sales.

As we look at the year, what should we look for for R&D for the year?

An absolute number is probably the better way to talk about it.

George, this is Greg.

I think we did about $1 billion last year.

We are talking a $200 million year-over-year increase, so I think about 1.2 billion, which equates to about 3.3 percent on $36 billion dollars in revenue.

That would imply some deceleration in the second half, which doesn't seem to fit with the build we have had, any sequential build in the last couple of quarters, nor with the fact that you are just gating into the 7E7.

Is that a number that is probably low?

Maybe we'll have to go through the numbers off-line on that.

I think we feel pretty good about the 1.2 billion.

And as you mentioned, it's kind of hard to look at this on a percentage of revenue basis, because you've got this FX benefit and the Chubb roll-through and growth in commercial, which tends to drag that number down.

But we can go through the calendarization of the R&D with you off-line if you like.

Okay, that's great.

And last question, you still have your target of 2 billion in acquisitions, and yet, unless we do something fairly soon, we basically would be lucky to get over 500 through the end of the third quarter.

Do you really think you're going to get to the 2 billion, and if you don't, where does the incremental cash go?

I'll take that.

We said before a couple times it takes a step-up in the run rate to get from here to there, and I said acquisitions are intrinsically lumpy and they are event-specific and you can't be sure.

The goal remains 2 billion.

The fact is that our cash position and liquidity is real solid today.

We are at 2 billion in cash on the balance sheet, a 28 percent gross debt-to-cap ratio, which is as low as it has ever been, a 19 percent debt-to-cap ratio.

There's a lot of power in the balance sheet for UTC.

And the problem is these things are always event-specific.

And if we don't do it in 3Q, 4Q, we will do it in 1Q, 2Q, 3Q next year.

I think that this placeholder of 2 billion out of free cash flow is a good number over the long-term.

That is what we have averaged for years and we will keep on doing it.

We like these acquisitions a lot.

They provide top-line growth.

They are typically into adjacent businesses or piling right on top of our current core businesses, like ICP and L.G, as I mentioned earlier.

These are great things.

They extend the franchise.

Linde does that.

They reset the margin run rate (ph).

This is an integral part of the operating story for UTC, and it is what I think gives assurance to investors -- like I said before, double-digit forever.

By the way, thank you for the good quarter comment, but I thought you might even say great.

Well, I guess you could.

Last question, on the acquisitions, is your pipeline looking fuller where you have good opportunities?

Is it fairly skimpy?

Can you give us some color in terms of your thought process?

I would say that the pipeline is solid.

But the problem is we look at 100 deals at a time.

It is a lot.

And those deals come in sizes from 100 million to several billion, and the question is which one comes in in any given quarter or period.

I feel like the pipeline is good and I feel very confident that we will stay on this 2 billion a year run rate for the next several years.

What will happen next, actually, is we will step the run rate up because we are going to have higher free cash flow in a couple, three years and that will give more money for acquisitions.

This number used to be $1 billion placeholder and then we made it $1.5 billion placeholder, then we made a 2 billion placeholder.

And over the long-term, we have spent the money that we said we had set aside for the placeholder.

Great, thank you very much.

I think we have time for one more question this morning.

David Bleustein with UBS.

Good morning.

On page 11, you mentioned a $250 million pretax equivalent for the tax settlement.

What was the actual number?

David, this is Greg.

I think the tax settlement actually came in two pieces.

One was an interest income component, which was about $125 million.

The second component was a reversal for reserves that we have established in prior years, and that was about $80 million, which is in the tax line.

Terrific.

Do you have the revenue contributed by acquisitions in the quarter for each of the businesses?

Dave, why don't we talk about that later today?

I don't have that in front of me.

George, at EPG (ph), you provided some thoughts on exchange rates.

Has anything changed or do you still expect a major re-valuation of the Chinese currency?

I think -- I will repeat my EPG comment, which is that the Chinese economy at purchasing power parity is roughly 2X what it is at exchange rate parity.

And it is the real strong currency and I think there is long-term pressure.

It is going to revalue and the question is when, how much, all it once, a piece at a time.

My guess is that we will just see slow upward pressure and it will move in a little while and it will move a little bit and it will keep on moving.

Thanks so much.

Thank you, Dave, and thanks all of you.

We appreciate your participation today.

And as always, Rick and Myra (ph) and myself will be available for your calls over the balance of the day.

Thank you.

This concludes today's conference call.

You may now disconnect at this time.