雷神技術公司 (RTX) 2006 Q2 法說會逐字稿

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

On the call today are Greg Hayes, Vice President Accounting and Control;

Ken Parks, Director Investor Relations; and Jim Geisler, Vice President Finance.

This call is being recorded and carried live on the Internet.

There is a presentation available for download at 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 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.

I'd like to turn the conference over to Mr. Hayes.

Please go ahead.

Good morning, everyone.

As you've seen many times in the past and we saw it again this quarter, balance works at UTC with strong performance from Pratt, Hamilton, Otis and UTC Fire and Security, overcoming slower growth at Carrier and the lingering impact of the Sikorsky strike to once again deliver solid earnings growth.

Ken Parks will take you through the business unit details in just a few minutes, but first I'd like to take a minute to focus on some of the positives as well as some of the challenges we faced in the quarter.

First, on EPS growth -- on a GAAP basis we saw earnings per share of $1.09 in the second quarter.

Included in these results were gains in excess of restructuring of about $0.07.

Stripping out gains and restructuring in both Q2 '06 and Q2 '05, earnings per share grew at an adjusted 19% rate in the quarter and that's on top of 19% earnings growth in the first quarter of 2006.

Given our strong first-half performance and a solid second-half outlook, we're today increasing our 2006 EPS guidance to $3.55 to $3.65 a share, that's a nickel increase to both the low and high end of the range and comes on top of a similar upward revision in the first quarter.

As you look at our 2Q results you see the benefits of continued worldwide economic expansion, but what really shines through is the strength of our portfolio of market leading businesses.

Total revenues grew by 10% in the quarter with a full 8% organic revenue growth and 2% from acquisitions.

Our businesses continue to grow at more than two times worldwide GDP thanks to innovative products, good penetration in emerging markets and a focus on satisfying customer needs.

As a result of this continued topline growth, for the year we now expect revenues of $47 billion, that's up from our previous guidance of $46 billion.

Free cash flow in the quarter was about $500 million short of net income driven almost entirely from higher outflows of working capital.

A portion of this working capital outflow is the normal seasonality of Carrier receivables; but high organic growth rates in the aerospace businesses also continued to put pressure on the supply chain resulting in temporarily higher working capital levels in those businesses.

In addition, approximately $135 million of non-cash gains set the net income bar even higher.

Despite these temporary issues we're still very confident that for the year free cash flow will again equal or exceed net income.

As we saw in the first quarter, Pratt & Whitney and Hamilton Sunstrand continued to deliver strong results.

Both businesses saw double-digit organic revenue growth reflecting increased commercial aerospace demand particularly in the commercial aftermarket which grew by almost 20% at both businesses.

As expected, the residual impact of the Sikorsky strike cost us about $0.02 of EPS in the quarter.

The good news is that Sikorsky is now producing back to pre strike levels and we look for a very strong second half as customer demand for both military and commercial helicopters continues at record levels.

On the commercial side of the business both Otis and UTC Fire and Security continue to deliver strong results.

Our biggest challenge in the quarter was the manufacture and ramp up issues in Carrier's Collierville facility both on the supplier side and in our own progress along the learning curve.

These issues resulted in approximately $35 million in higher manufacturing costs in the quarter and lower unit sales particularly of the higher margin 13 plus SEER residential air conditioners.

These ramp up issues resulted in Carrier's overall margin deteriorating by 60 basis points in the quarter.

Absent this issue Carrier's margins would have expanded and operating profit growth would have been in excess of 10% as the rest of Carrier is performing well and managing through tough issues like commodity inflation which is still outpacing pricing.

The Carrier team has been aggressively attacking these manufacturing issues and we're currently producing products in Collierville at a rate to satisfy all of our customer demand for the third quarter.

The second challenge we saw in the quarter was the continued commodity cost pressures in both the commercial and aerospace businesses.

We've been implementing price increases at Carrier to help offset the commodity cost headwind.

But pricing opportunities on the aerospace side of the business are much more limited.

The good news is that continuing strength in the commercial Aero aftermarket should help to offset pressure in the second half of 2006.

So for UTC another quarter of strong revenue and EPS growth that demonstrates, as before, that a balanced portfolio with seasoned management teams deliver excellent results even given some of the challenges we faced.

In summary, we're confident that full-year EPS will now be in the range of 14 to 17% or $3.55 to $3.65 for 2006.

With that let me hand it over to Ken to take you through some of the business unit details.

Thanks, Greg.

And I'll begin on page 3 of the webcast to take you through the businesses.

Before I do I'll tell you, as I do each time, that we'll talk to the segment results with restructuring added back just as we usually do.

Otis revenues grew by 5% and margins continued to expand with another 70 basis points increase in the quarter resulting from 9% profit growth.

This margin expansion was the result of ongoing cost containment.

FX had little impact on Otis in the quarter, although still unfavorable on the year-to-date results.

Revenue growth was particularly strong in China and margin expansion was led by North America.

New equipment orders increased double-digits at Otis with growth in all regions, North America and China leading the way.

Otis has been increasing prices in key markets to cover escalating input costs, but continues to experience significant downward price pressure in Korea, China and Japan.

Otis continues to perform very well as anticipated and we still feel good about our previous guidance.

For the year we expect Otis to deliver operating profit growth of $150 million plus on mid single-digit revenue increases.

Now, at Carrier operating profit increased 4% year-over-year on 10% higher revenues.

Organic revenue growth of 8% was driven primarily by commercial and the U.S. residential shift to 13 SEER.

Earnings growth was driven by the higher commercial volume and restructuring benefits in both the commercial and refrigeration businesses.

Lower earnings in Carrier's U.S. residential business and net commodity cost headwind mitigated the growth.

As a result operating margin was down 60 basis points in the quarter.

The Collierville factory incurred significant additional expenses, mostly overtime related, as they progress along the learning curve to produce the completely new 13 SEER productline.

Commodity costs, particularly copper, continued to increase during the quarter and exceeded pricing recovery by about $30 million.

While prices are down slightly from their peek, the current spot price of copper is still about 2.5 times the level we planned for.

To offset commodity costs in the remainder of the year we followed our 5% price increase in May on U.S. residential products with an additional increase of 7% that took effect July 1st.

We expect a stronger second half at Carrier with high single-digit revenue growth on low to mid-teens earnings growth.

The drivers are straight forward -- steady improvement at the Collierville factory, recovery of commodity cost through pricing, and additional restructuring benefits including benefits from the now complete German manufacturing moves at Linde.

Despite the slower-than-expected ramp in Collierville, we feel good about our new 13 SEER productline which continues to receive high marks from the customers.

For the full year we now expect Carrier's earnings growth to be in the 125 to $150 million range on high single-digit revenue growth.

At UTC Fire and Security they continue to deliver on guidance.

Revenues were flat reflecting growth in Asia and the Americas offset by Europe's softness and a focus on higher margin businesses.

Operating profit growth was strong with profits up over 40%.

Resulting margin expansion in the quarter was 200 basis points as restructuring actions and Kidde integration efforts continue to bear fruit.

On a year-to-date basis operating profit growth has been solid with margin expansion of 140 basis points.

The UTC Fire and Security business is on track; we continue to expect that for 2006 revenues will increase over 10%, profits will be up by around $75 million, and margin expansion will be towards the high end of the 100 to 120 basis point improvement range.

Pratt & Whitney revenues increased $454 million or 20% to $2.7 billion in the quarter.

Acquisitions provided about one-quarter of the revenue increase and organic growth was led by higher aftermarket sales in the large engine business which grew by more than 20% and increased sales at Pratt Canada primarily reflecting higher new engine volumes.

The 25% operating profit growth shown excludes the favorable profit impact from last month's government contract accounting settlement and reflects the profit contribution from higher revenues partially mitigated by higher year-over-year raw material costs.

Planned increases in R&D negatively impacted operating margins by over 100 basis points in the quarter.

With continued strength in commercial aerospace we now see Pratt revenues increasing more than 10% for the year, up from our prior guidance of high single-digit growth.

Operating profit should be up $250 million plus, higher than our prior guidance of $200 million plus.

Hamilton Sundstrand delivered 18% operating profit improvement on 14% revenue growth in the quarter.

As a result operating margins expanded 70 basis points.

Strong revenue growth was seen across the portfolio in both industrial and aerospace businesses.

Operating profit growth was driven by the solid Aero aftermarket, particularly in commercial spares, as well as continuing strength in the industrial segment.

Higher program related R&D spending, principally on the 787 program, impacted operating margins by approximately 180 basis points.

As at Pratt, Hamilton continues to benefit from the strong Aero cycle.

We now see 2006 revenues up more than 10% for the year, up from our prior guidance of high single-digit, with operating profit growth now expected to be around $100 million plus.

At Sikorsky revenue was up 9% in the quarter with approximately half of the increase coming from the Keystone acquisition and the remainder driven by higher revenue on the CH 53 and Blackhawk cost reimbursable programs.

Helicopter shipments were relatively flat in the quarter at 25.

Profits were down $5 million year-over-year as the profit contribution from higher revenues was more than offset by anticipated incremental manufacturing costs following the labor strike.

As Greg mentioned, these were a headwind of roughly $0.02 per share.

We expect a strong second half at Sikorsky and still anticipate full-year revenue growth of midteens with operating profit growth now at $25 million plus because of the strike.

Turning to page 9, a couple of additional items in the eliminations and other line.

We have a year-over-year benefit of approximately $40 million after removing the impact of onetime items in both periods.

As we anticipated and similar to Q1, this is principally composed of lower hedging costs and higher interest income.

On cash spending, acquisition spend in the quarter was $253 million and for the year thus far is $372 million.

While our first-half run rate is short to our $2 billion target we continue to keep the placeholder for the year and have a full pipeline of deals to keep Jim busy in the second half.

Share repurchase during the second quarter was $375 million, bringing our total to $750 million through June.

This run rate is right on our target of $1.5 billion for the year.

As a result of this level of share repurchase, our diluted share count is down around 1% compared to last year's 2Q and should continue to decline throughout the remainder of the year.

Greg took you through the details of onetime items in the quarter, we continue to expect that for the full year restructuring will equal or exceed onetime favorable items.

As we look to the second half of the year we would expect to incur about $0.02 per share of net restructuring in the third quarter with the remainder falling to the fourth.

With that I'll turn it over to Jim to wrap up.

Thanks, Ken.

I was doing a little personal math the other day and I note that this is actually my 25th UTC earnings conference call.

So my time on the call stretches back now over 10 years.

So with that I want to offer a little bit of perspective looking back over the ten-year period.

In 1995 the Company's market cap was $12 billion.

And over the last 10 years UTC's portfolio has strengthened and has yielded a CAGR EPS growth rate of 16%.

Today UTC has a market cap of $60 billion; for 2006 earnings per share growth of 14 to 17%; free cash flow equal to net income; and organic revenue growth around 8% -- all strong metrics I think despite some short-term 13 SEER ramp up issues which we're getting on top of and some cash and working capital.

The record shows over this 10-year period of strength in UTC that has consistently performed, becoming one of the most stable, rapidly growing companies not only in the industrial universe, but also in the entire market.

I think this should continue and in an increasingly uncertain world UTC remains a great place to be.

So with that, let's take your questions.

(OPERATOR INSTRUCTIONS).

Howard Rubel, Jefferies & Co.

Just two questions.

One, could you add a little more color to the Collierville issues and the SEER ramp so that we can understand whether or not -- or how much more there is left in terms of risk?

Howard, this is Ken.

We always knew the ramp would take us into the second quarter, but it did progress a little bit slower more slowly than we thought.

We did retool the complete factory, as we talked about, and the fact that the new productline changed everything in the factory put some pressure on the labor force as well as our supply base.

As a result there were some bottlenecks in the process but we're working them out.

We have all the appropriate resources there to do it.

I think the good news is that output and efficiency have improved steadily over the second quarter.

We're still moving up the learning curve.

We see no hurdles that tell us that we're not going to get this ramp to where we anticipated.

And we are today producing at rates that sustain our outlook for the third quarter and fourth quarter.

So we feel good about the outlook for the second half of the year.

When you mean it sustains do you mean -- can you give us -- sort of quantify like how much is that up year on year?

I think what I would say is that the rates that we produce at today, probably somewhere in the 8,000 to 8,500 units per day sustain what we need for the third and fourth quarter.

Now at peak period the demand on a daily basis would be slightly higher than that, but we're still ramping up to that higher number and we're fine.

And then to turn to Hamilton for a moment, very nice numbers there.

You talk about the higher R&D mostly related to the 787.

Could you sort of touch base with us on the milestones and how you're doing in terms of hitting them and what's left to be done before you can say you've delivered the first [ship set].

Let me take that.

Obviously there's still a long way to go on 787 development as well as production.

Right now we are on track with Boeing for all of the major systems.

Our systems development lab in Rockford, which is the big enabler of this program, is up and running.

It started actually back early in the second quarter.

We are delivering development hardware to Boeing now.

The APU is progressing very well; the electric power system also is on track.

Right now we've got a couple of systems that appear to be maybe a month or two behind schedule, but we've got plans in place to meet all of the Boeing milestones.

So right now I would tell you the program is going very well.

We're on track for first flight next year and supporting deliveries for 2008.

Thank you, gentleman.

Joseph Campbell, Lehman Brothers.

Good morning.

I wondered if you could on both the R&D and on the cash flow maybe kind of go through -- you highlighted where the R&D was up.

Presumably since it wasn't up all that much across the board there are other places where there is margin benefit from falling R&D.

And then, I don't know, we're missing 500 or $600 million of free cash flow.

Could you help us quantify where to put it sort of division by division in terms of where the shortfalls are by sort of amounts?

Sure.

Let's start with the R&D, Joe.

R&D in the quarter is up $52 million, that's about 16% on a year-over-year basis.

As Ken noted, most of that increase is at Pratt and Hamilton, Pratt up about $30 million, Hamilton up about $20 million.

Hamilton's increase is completely related to the 787 program;

Pratt's is primarily related to the Pratt Canada engine program, although there is still spending on the 6000, the GP 7000 and the new narrow body engine.

In terms of where R&D is down, Carrier is down slightly as last year we had a big ramp in spending related to the SEER 13 productline.

But that's down around $5 million or so, not a big number.

So aerospace, particularly Pratt and Hamilton the bulk of it, and nobody else really significantly changed on a year-over-year basis.

Joe, I want to talk a little bit about cash; you wanted to chat by divisions which is good.

Just a couple pieces here, I'm going to compare cash flow to net income, that's the $500 million you noted.

Carrier is seasonally weak in the first half as we build inventory and in the second half collect receivables.

So you see, and versus net income, about a $300 million outflow in receivables.

We mentioned the Sikorsky strike for a couple hundred million dollars as we ramp up for a big second half.

And then aerospace is higher $100 million or so because of organic revenue growth.

Again, I think we feel good about free cash flow for the year because Carrier's seasonality and an inevitable turnaround will occur in the second quarter as we collect receivables.

The strike is more in the rearview mirror and we'll continue to work the aerospace supply chain and get on top of that.

And those are the factors and the reasons we feel good about free cash flow equal to net income for the full year.

Jim, just on the aerospace supplier issues and (indiscernible), could you just sort of give us a sense of what's going on?

Is it that you were having difficulties with the supply chain and therefore you end up building more inventory because you're waiting for missing parts or something and therefore there's stuff you thought you might ship but you didn't?

Yes, I think that's a good summary, Joe.

There's (multiple speakers).

With sales.

There's competition for raw materials right now and in the supply base competition for machine time.

So I think as there's been volume in aerospace for several quarters now -- actually several years -- we have seen inventories at the supply chain become thinner and lead times lengthen which means we are holding parts longer and in some cases waiting for delinquent parts to arrive so we can ship the final product.

Great.

Thank you very much.

Steve Binder, Bear Stearns.

Actually this is [Steven Nissan] at [Scalvo] Research.

A couple of questions -- congratulations on a good quarter.

How are you guys better communicating with the dealer channel to be now more responsive to challenging customer and market needs?

I'm sorry, can you repeat the question?

How are you guys better communicating with the dealer channel to be more responsive to challenging customer and market needs?

I think our communication with the dealer channel is perpetual.

We're always in communication with them.

How are you better improving the process?

For example, how are you guys streamlining the buyer process to help reduce order inaccuracies so your customers get pricing to figure your products more efficiently?

Is there a particular business you're asking about?

More so the Carrier division.

I think, again, we're in constant communication with them.

I think part of the evidence you'll see of that has been in the last year and a half you've seen these price increases.

I think we had four last year and we've had two announced this year.

And I think in part our distributors' dealers have taken that because we've communicated with them very well about the higher commodity costs.

We wouldn't have been able to pass through a price increase like that two or three years ago so I think that's just one element.

It's a piece of evidence on how closely we work with our customers and they can understand our issues and we can understand their issues.

And within Carrier how are you guys streamlining the buying process to help reduce order inaccuracies so your customers can now configure their product more efficiently?

Let's do this, why don't we take that question off-line because I think it's pretty specific.

You're asking about the purchase of a single product inside a single market inside of a $13 billion company.

So why don't you give Ken Parks a call right after this -- actually he'll give you a call and you guys can follow up on this.

All right?

Thank you.

What time will you guys be over?

Thank you.

Jeffrey Hammond, KeyBanc Capital Markets.

Nicole Parent, Credit Suisse.

I guess first just on Carrier, can you give us a little bit of color as it relates to sales of refrigeration actually in the quarter versus actual Carrier HVAC units?

And then compare that with order rates and how we should think about that for the balance of the year?

Refrigeration had healthy growth overall.

I'll give you some of the components of it.

Commercial refrigeration North America was up in volume in the low teens actually in the quarter.

Now granted, that's off of a relatively low base over the last couple of years.

But it's nice to see a little bit of health in that industry on the revenue side.

Let's look at the Transicold piece of the business for a second because that's also important.

Truck trailer both in North America and Europe, order revenue rates were up again low teens, probably 12, 13% in those businesses on both North America and European businesses.

And container, which we've talked about being a softening market, revenues were up about -- close to 10% in the quarter.

So healthy growth across the board.

Now contrast that to order rates.

I would say the order rates in the truck trailer businesses are a little bit softer now than they were a few months ago but still growing.

Container, the market overall for the year we've always said we thought would be flat to down a little bit and the backlog probably supports that number.

Commercial refrigeration probably will continue on as we've seen in the last couple of quarters.

Okay, so the change in the Carrier profitability outlook really is driven by kind of the Collierville issue?

Yes.

Okay.

Next question would just be within Pratt.

Could you give us a sense of the difference between military and commercial?

The military business at Pratt was fairly flat in the quarter.

The commercial business was up and I think Jim quoted the number around 20%, aftermarket a little bit stronger than the OEM side.

Okay.

And lastly, on Hamilton Sundstrand, can you actually give us the revenue increases commercial versus industrial?

Aero, sorry.

We can get that for you, Nicole, just one second.

I think on the industrial side we saw revenues up high double-digits -- I'm sorry -- high teens and on the commercial aerospace side we saw OEM business up over 20%.

So strong growth both on the industrial as well as on the Aero side.

And aerospace overall was up in the midteens and industrial was up a little bit more than 20% in the quarter and revenue -- stripping out the Falk divestiture.

Okay, great.

And just one last one on Otis.

Specific service growth versus equipment in the quarter?

Well, the business overall grew about 5% in revenue.

New equipment revenues were up high single-digits in the quarter, service up a little bit less than that.

Great, thank you.

Steve Binder, Bear Stearns.

Good morning, again.

You addressed the working capital issues earlier with Joe's questions with respect to the inventory build issue in aerospace and in Sikorsky due to the strike and Carrier's seasonality.

But if you go back to the first quarter those three issues kind of persisted as well in effecting the inventories, but overall working capital -- you were able to keep it fairly level from a year ago.

The usage was pretty much equal to a year ago whereas this year the second quarter you had a much bigger uptick.

So were you not able to manage the liability side as well to offset the inventory issues this quarter?

Is that the way to look at it compared to Q1?

Steve, a couple of factors.

Sikorsky inventory was higher at the end of the second quarter than the first, again, as they ramp up for the second half.

Aerospace inventory was higher, but in the past they had the benefit of timing on advances and we did not see as much advances here in the second quarter as we did in the first quarter or the second quarter last year.

All right.

And then how much of this just-in-case versus just-in-time inventory issue is truly reversible in the second half when you look at aerospace?

Because I guess the first-half drag you've had, do you think you'll be able to fully correct for it in the second half of the year?

Steve, this is Greg.

As you look at the balance sheet you can see inventory is up about $1.2 billion from the end of December to the end of June -- that's a big number for us.

Obviously not all of that is supply chain issues but a big piece of that is.

As Jim mentioned, it's Sikorsky and it's the other Aero businesses.

And there are plans in place and we feel very comfortable that that inventory is going to go down as we move through the second half of the year.

We're not going to recover the whole $1.2 billion, but we are confident we're going to take a big piece of that inventory out in the second half of the year as we work through these supply chain issues.

Supply chains -- it's a tough nut but it is getting better.

We manage to get the product out the door; it's getting out a little later than we would like, but it will get better through the second half of the year.

All right.

And then just in Fire and Security, did I hear organically you were pretty much flat for the quarter.

And if so, how did that compare to your plan?

And maybe you can just touch on Chubb versus Kidde, how the two compared for the quarter.

Or just maybe fire safety versus the monitoring business -- electronic security business?

As you look at Fire and Security for the quarter you'll see that organic revenue is essentially flat or zero growth for the quarter.

It's actually -- there are two pieces to look at there.

On the fire security side it's actually down a little bit primarily in Europe.

Electronic security is up a little bit being driven a lot by the Lenel acquisition that we made last year.

It is off plan.

Obviously we had expected mid single-digit revenue growth at Fire and Security.

But I'll tell you, Bill Brown and company had been focused on margin expansion and they have had a real effort to not take on new contracts or to renew contracts that don't have acceptable margins.

So we are walking away from some work and we're also looking to make the contracts that we do have more profitable.

So the margin expansion story is on track.

We're very comfortable with the margin and the EBIT guidance for the year.

Revenue is going to be a little light though.

Because I notice in the official guidance you didn't say greater than 10% -- (indiscernible) you were greater than 10%, but I thought you said in your MD&A discussion here today that it was going to be roughly 10%?

That's correct.

And lastly, can you maybe just touch over on the -- you said aftermarket collectively -- commercial aftermarket for aerospace was up 20%, did I hear that correctly, Pratt and Hamilton?

That's right.

Is that a sales or orders comment?

It's a sales comment.

So what did orders do year-over-year in the second quarter for both businesses and aftermarket?

Orders were up; book to bill was above 1 for the quarter at both Hamilton and at Otis.

So again, strong orders, backlog is good and the sales remain strong.

All right.

And lastly, should R&D -- because you were up over R100 million in the first half of the year.

R&D second half of the year should be flat, is that correct, for the Company?

If you remember, Steve, in the second half of last year we had a big run-up in R&D.

So the compares will be pretty similar.

We'll see probably a leveling of R&D in the second half, but again, up on a run rate basis from last year.

And Jim, we're going to miss the Investor Relations process, I just want to tell you that.

I'm sure Greg will do a good job, but we'll miss you.

We won't miss him.

Thanks a lot.

Jeffrey Hammond, KeyBanc Capital Markets.

I just wanted to get a little more color on the residential HVAC business.

Can you give us a little granularity on what the units were down, what you saw on price mix versus maybe what you had indicated in December?

And then where do you stand with your inventory levels and how are you thinking about hedging?

Let's talk about the units first.

Our estimate of the market in the second quarter was that it was down in units around 15%.

Year-to-date let me quote a number that we think the market is relatively flat based upon our estimate.

And it's pretty much within a few points in line with what we thought as we went into the year.

We still hold to our year-over-year full-year decreased estimate of volume in the market about 15%.

So the first quarter or a little bit stronger in units than we thought; the second quarter a little bit lighter in units than we thought; but year-to-date we're pretty much online with our initial planning estimates.

You asked about price, I would say we told you at the beginning of the year that the average mix of the units that we would be selling post transition would be about 18% higher in price than the mix of units we sold before, and that was kind of a key assumption going into the year.

That's pretty well stuck and in fact we've seen the price increases, the one we launched in May of 5% come on top of that.

And then we are looking out to the second half, as Greg mentioned and I mentioned, at the 7% price increase to help us offset more of the commodity cost.

Okay.

And then just in clarification on the units, you said market down 15% in the second quarter.

Where were you relative to that?

We were down a little bit more than that in the quarter.

And obviously that's driven by the Collierville ramp.

But not significantly different and we felt that the units are coming out now.

We built a little bit of a backlog at the end of the quarter, but we were down a little bit more than the industry.

And then can you just mention where you're at in terms of hedging?

Hedging we look out at about the next six months and we're hedging about 75% of our needs -- copper need specifically.

You also asked about inventory.

I'd like to throw out there the comment that at this point in time in the year our inventory levels and the channel inventory as well as we can tell for the industry is actually down year-over-year from both where we expected and just on an absolute basis.

So it looks clean as we go into the second half.

Okay, perfect.

Thanks.

George Shapiro, Citigroup.

Good morning.

At Pratt, if you look at the incremental margins in trying to adjust for the R&D, they were somewhere, 26-27% in the quarter, clearly reflecting a stronger aftermarket versus OE.

I was wondering if you could provide the percentage of the business that's aftermarket this year versus what it was last year.

George, I think -- we've talked in the past that Pratt has been about 50% aftermarket and we've seen very strong growth both in aftermarket and in OEM particularly out of Pratt & Whitney Canada this year.

And I think when you see the good margins ex R&D; it's just a result of good execution at Pratt.

Okay.

And then in general, spares growth up over 20% at both Pratt and Hamilton, traffic growth in the second quarter was up around 6%.

So where are you continuing to benefit so much above what the traffic numbers are?

That's a good question, George, and I want to put some perspective on that.

If I go back to 911 and look at RPM growth since then, it's been about 4% CAGR.

Our aftermarket over that period of time has grown about 7% -- and we're growing of course faster than the market because it's a focus of our business.

We're executing, delivering and winning new customers.

Over the long period of time though our growth is tracking I think, again, just a little bit ahead of the industry.

I think we've probably turned down more than the market around the time of SARS and the Iraq war, and now off that lower base we show a stronger recovery with these numbers like 20%.

That's good and marvelous.

You make the point, I think fairly, that there's an inconsistency between 20 and 6% was your number in the second-quarter which I wouldn't dispute, so as much as we like this aftermarket growth that's near 20%, I don't think we can count on it in perpetuity.

And then Jim, if you just go on you have got 250 million or a little more than that maybe profit guidance for Pratt, you did about 180 in the first-half and you have got a strong book to bill suggesting strong Q3, so do you expect to see slowing in the fourth-quarter or where is the slowing going to start to come or are you just too low in your estimate?

George, George.

I am going to go back to perspective here in a moment with you but first recall in the Pratt numbers year-to-date there is a M Piaggio partnership gain in the first-quarter that is a good $30 million of that and I guess I would say, how is our outlook for the second-quarter?

It is very good.

Pratt has had a very good first-half I think given the backlog and their ability to execute we feel very good about the second half.

But I would caution you, I think this is appropriate offer some perspective that we need to be cautious about the aerospace aftermarket.

You shouldn't bake that in now; we are confident but let's not get ahead of ourselves.

Okay.

Then just in general if you look at your change in operating profit growth numbers from the first-quarter to the second-quarter, I mean, Carrier you lowered by 25 to 50 million, you increased Pratt by 50 and lowered Sikorsky by 50.

So effectively overall you are down like 25 to 50 yet the guidance went up a nickel.

Is this just kind of tightening the ranges?

Because, obviously, if you had added up everything you had before you would have been well above what your guidance was?

I think all that math is right and it's evidence of the fact that we are executing across the businesses and feel good about our outlook with half the year under our belts.

Okay.

Then one last one.

If Linde had about a 5% margin this quarter versus losing $10 million last year then it would have made the weakness due to the residential side margin even greater.

So I just wanted to clarify that.

Linde numbers -- the $10 million was a first-quarter number of last year -- they showed a little improvement in the second quarter of last year.

But I'll tell you just to give the number, year-over-year Linde improved its operating profit by about $5 million in the second quarter.

Second quarter versus the second quarter last year?

Correct.

Okay, thanks a lot.

Cai von Rumohr, Cowen & Co.

If you could give us a little more color on the aftermarket at Pratt.

You said up 20%; how much were you up in spare parts and how much of that is overhaul and repair?

I think both spares and aftermarket in total are up over 20%.

So we saw good penetration on the service side with the new global service providers and also, again, strong orders for spare parts.

So it's really across the whole aftermarket at Pratt.

Okay.

And could you comment on the book to bill in the quarter for spares both at Pratt as well as Hamilton Sundstrand?

Yes.

As I mentioned before, Cai, it's above one a little bit for both of the businesses this quarter.

Okay.

And turning to Carrier, you mentioned $35 million hit from Collierville in the second quarter.

Where would you expect that to be in the third quarter?

The $35 million that we talked about, it really split between two pieces.

One is the excess production cost which was primarily overtime cost; and the second piece of that, about 40% of those costs related to lost sales and the margin on those lost sales.

Some of the overtime cost will continue into the third quarter as we continue to try and meet the production requirements.

We're currently at the run rate we need, but it is coming at a cost of somewhat higher overtime.

In terms of the lost sales, I think that is behind us.

Since we're meeting customer demand we don't anticipate that that piece will repeat.

So there will be some drag from Collierville, but I would say it would be less than $10 million in the third quarter.

Okay.

And then turning to commodities, you mentioned $30 million net headwind year-over-year and that you're hedging, but with a 7% price hike effective July 1st and copper prices, spot market at least, starting to turn down, where does that number -- does that number turn into a positive in the second quarter -- in the third quarter?

We think the pricing actions that we've put out there, specifically the 7%, will help us make significant headway towards recovering the commodities in the second half.

Yes.

I think the thing to keep in mind, Cai, is that only half of the commodity cost impact that we saw in the quarter was on the Carrier side.

The other half was on the Aero side, particularly at Pratt.

As you think about our second half, again, very strong spares run rate going into the second half, but we're also seeing a lot of pressure from higher titanium and some of the other specialty metals in the aerospace side which caused us almost $30 million of commodity headwind in the second quarter and that will probably continue into the second half of the year.

Okay, last question.

Given the very hot weather we've had in July, can you comment, even if only qualitatively, on the sell through at Carrier and U.S. res?

So far year-to-date as we commented the inventory channel is even cleaner than we thought it was going to be.

I am saying just any sense in late June, early July qualitatively, I mean I would assume the sales would be very strong but --.

People want the production and we are busily improving our ability to make the product.

Maybe just to take -- as we are getting near the call here, maybe just to make a comment as I have listened to the last several questions here.

We pointed to a lot of tailwind that we get in the second half, not only on our R&D but we talked about pricing.

And although we've raised prices and it looks like the price may come on top of commodity, I will remind you that each time we think that's going to happen over the last several quarter prices go back up and we end up with commodity in excess of pricing.

So it think we've passed through price increases to get on top of that, but it's yet to be seen and we like that for the second half.

We also talked about an aerospace aftermarket that continues to move forward with big growth rates; but again, I'd say we're going to move into tougher compares in the second half and we can't depend on the 20% forever.

And the economy I think is less certain than it was six months ago with $78 oil.

So I think it is a little bit more uncertain.

We are very confident about our future, but with that confidence it's not the time to get ahead of ourselves here.

Terrific, thank you.

Tony Boase, A.G. Edward.

Kind of a qualitative question on Carrier.

You decided to do a complete revamp on your residential line in addition to taking on the conversion of 13 SEER.

In retrospect, is that something you would do again?

Yes.

We think the product that we designed is going to be the best product in the marketplace with the best cost and we're working through the ramp up at this point in time.

We see no reason to do anything other than what we planned to do in the first place.

And then Jim made a comment about spares and 911 and where you are.

Did you say that on growth in spares from 911 you've pretty much caught up with what RPM's growth has been or ADM growth has been?

I said actually our aftermarket growth which has been about 7% CAGR since 2001 is ahead of RPM growth which has been about 4% CAGR.

So we're caught up and ahead and, again, I think it's natural that we would be ahead given the focus of our business and the customers that we've won.

And is that on spares as well or are you just talking -- it sounds like you're just talking about total aftermarket?

Spares is included in that.

And then, sorry if I missed it, but did you give delivery numbers for large commercial engines, military engines, Pratt and -- well, I guess you gave helicopters?

I'll give them to you.

We gave you the macro level helicopter number.

I'll give them to you here.

Commercial engines second quarter 96; military 41;

Pratt Canada 593; and then we gave you the total helicopters of 25, it was 12 commercial and 13 military.

And just one last question on cash flow.

Does your full-year cash flow expectation net income -- or free cash flow equaling net income, does that include a pension contribution in the second half?

There will be a pension contribution in the second half.

The original guidance we had said up to $500 million of pension in the year.

That will probably be lower than the $500 million.

Again, returns have been good and with interest rates going up we're fully funded on a PBO basis, Tony.

So really the need to fund in the states is pretty well behind us, although there are still some plans internationally that will need some funding.

But the funding should be less than $500 million -- I won't give you an estimate exactly today; we'll see where the markets end up.

But our plan is to have lower than $500 million.

Okay, thanks very much.

Nigel Coe, Deutsche Bank.

You talked about the deal pipeline and it seems that there's a bit of a backlog build in there.

Can you talk in a very general sense about how that fits between aerospace and industrial?

I'd say assets are plentiful in the pipeline, probably more on the commercial side than aerospace.

The issue around deals then is not the availability even in aerospace, it's all-around valuations.

Valuations have been tough for a while now, that has not changed here in the second quarter.

And at UTC we pay strict attention to valuation and purchase on an opportunistic basis.

So we're just going to -- if valuations remain high we're just going to have to ride this out and that's fine because we're a buyer for the long-term.

So you haven't seen multiples come down over the last couple months?

No, they will at some point.

We're optimistic, but they have not yet.

Okay.

And second question, talking about the 7% price increase in July.

What sort of reaction have you had from the channel and do you expect to fully absorb that 7%?

We're obviously working hard to get as much of that to stick as possible, but there has been push a little bit from the channel.

Copper prices have moderated a little bit from their peak, but as I pointed out, they're still 2.5 times higher than we planned for.

A little bit more pushback on the 7% than we've seen on some of the other ones, but we're certainly working to get it all.

Okay, thanks a lot.

Okay.

Nigel's first question there on valuations is a good segue into my final comment which is really to thank Jim Geisler who will be taking on responsibility for corporate strategy including M&A affective last week.

I'll be transitioning into the IR roll and I certainly have appreciated Jim's help and guidance over these last two and a half years and I look forward to working with all of you, getting a chance to come out and talk to many of you in the coming weeks and months.

Ken Parks and team will be available later this afternoon to take your calls and look forward to the coming weeks.

Thank you.

Thank you.

Once again, ladies and gentlemen, that concludes today's call.

Thank you for your participation, you may disconnect at this time.