雷神技術公司 (RTX) 2007 Q3 法說會逐字稿

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

On the call today are Greg Hayes, Vice President, Accounting and Finance; Jim Geisler, Vice President, Finance and Ken Parks, Director, Investor Relations.

This call is being carried live on the Internet and there is a presentation available for download from UTC's homepage at www.utc.com.

The Company reminds listeners that the earnings and cash flow expectations and any other forward-looking statements provided in this call are subject to risks and uncertainties.

UTC's SEC filings include its 10-Q and its 10-K reports provide detail about important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements.

Please go ahead, Mr.

Hayes.

Thank you, Stacy and good morning, everyone.

As we typically do, we will have Ken take you through the business unit details in just a moment and then Ken, Jim and I will take your questions.

But first, let me take a few minutes and focus on some of the highlights of our third quarter.

First on revenues.

Revenues were up 14% in the third quarter with another solid quarter of 9% organic revenue growth.

You will recall the first two quarters of this year each had 10% organic revenue growth.

That is not bad for a $50 billion plus business.

The reasons for this strong growth remain the same -- innovative new products, a focus on cost reduction and cost competitiveness, a strong presence in emerging markets and robust, global, commercial aerospace and commercial construction markets.

Sikorsky continues to lead the way with 48% organic revenue growth as they execute on their $8.5 billion backlog and make progress on their supply chain and manufacturing initiatives.

Hamilton Sundstrand and Pratt & Whitney also saw strong organic growth benefiting from continued strength in the commercial aero cycle.

We also just this past week launched the Pratt & Whitney Geared Turbofan engine program on the Mitsubishi Regional Jet or MRJ.

This is the first commercial selection of the revolutionary geared fan concept, which will offer significantly improved fuel consumption along with a significantly reduced noise and NOx footprints.

On the commercial side of the business, Fire & Security led the way with 29% revenue growth.

Otis continued to gain marketshare worldwide and saw orders grow for new equipment of approximately 20% and saw revenues up a strong 14%.

Carrier, despite the continued weakness in the US housing market, still saw revenue grow by more than 5% after adjusting for last year's one-time gain.

I should also note that FX accounted for about 3% of our -- or three points of our revenue growth as the third-quarter average euro rate of $1.37 was about 8% higher than last year's average of $1.27 in the third quarter.

As a result of this continued strong organic revenue growth and with the benefit of a weak US dollar, we now see full-year revenue of $54 billion.

That is up another billion dollars from our latest revenue guidance we provided you in July.

On earnings, in the third quarter, earnings per share were $1.21, were up 22% over last year.

Now this year's third-quarter results did include $0.07 benefit from tax-related items, primarily tax and interest income adjustments related to our 2000 to 2003 federal tax examination.

Restructuring costs were $0.03 in the quarter or a net $0.04 of gain in excess of restructuring.

You will recall that last year's third quarter included a net headwind of $0.02 per share of restructuring overgains.

So when you strip out gains and restructuring from both periods, EPS was up a strong 16% in the quarter.

You will note that this net $0.04 benefit we see in this third quarter will be utilized in this year's fourth quarter to cover tax adjustments related to a recently enacted Mexican tax law change.

You will see that flow through as an increase in our effective tax rate in the fourth quarter.

Given the strong third-quarter and year-to-date earnings performance, we now see full-year EPS growth of 14% or $4.22 to $4.25 a share, towards the top of our previously disclosed range of $4.15 to $4.25.

Now before I turn it over to Ken, I would like to spend just another minute highlighting some of the results of the individual businesses.

As you will see, execution remains the hallmark of the UTC business model.

Each of our six business units reported double digit earnings growth, excluding the impact of restructuring and one-time items.

Fire & Security, one of UTC's lower margin businesses, led the way with 130 basis points to margin expansion on a 53% increase in earnings.

Sikorsky focused throughout 2007 on their production ramp-up requirements, delivered 43 helicopters and grew earnings 47%.

Otis had another excellent quarter with profits up 16% and 20 basis points of margin expansion despite the continued pressure brought on by a higher percentage of new equipment business.

In Carrier, even in the face of the weak US residential market, delivered 10% earnings growth and 40 basis points of margin improvement.

With strong performance in commercial HVAC, international/residential HVAC and the refrigeration businesses more than offsetting the weakness in the US res business.

That's how we define good execution at UTC.

Cash flow performance was solid in the quarter with free cash flow of $1.1 billion.

As you know, we have been challenged this year on free cash flow and that is a downside to the strong organic revenue growth we have seen.

Inventories are higher than we would like them to be and we will need a strong fourth-quarter inventory performance to make our cash flow target.

On balance, we would rather have strong organic growth and the inventory challenge rather than the other way around though.

On the acquisition front during the third quarter, we completed the acquisition of most of the initial Electronic Security Group, which is a division of Rentokil for just over $1 billion.

We also finalized the acquisition of Marioff, a manufacturer of water mist fire suppression systems.

Both of these deals will add meaningfully to the UTC Fire & Security portfolio.

On a year-to-date basis, acquisition spending, including acquired debt, now stands at $1.9 billion and we should end the year on or slightly above our $2 billion acquisition spending placeholder.

On share repurchase in the quarter, we repurchased another $500 million of our stock.

This brings her year-to-date total to $1.5 billion and puts us clearly on target to hit our $2 billion of share repurchase guidance.

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

Ken?

Okay, thanks, Greg and before I begin on page 3, let me remind you I'll talk to segment results with restructuring added back and excluding one-time gains just as we usually do.

Otis delivered another strong quarter with profits up 16% on revenue growth of 14%.

Favorable foreign exchange contributed more than a third of that growth.

All geographic regions experienced strong revenue growth reflecting the robust new equipment backlog and solid execution across the globe.

As a result, the revenue mix continued to shift towards new equipment during the quarter.

Margins improved 20 basis points to 19.5% as higher volume and continued cost containment initiatives more than offset margin pressure from higher new equipment mix and headwind from commodity and labor costs.

New equipment orders continue to be exceptionally strong, up 24% year to date, with notable growth in China, the US, France, Russia and India.

As in recent quarters, we do continue to experience pricing pressure in Asia.

Otis continues to perform well.

Year-to-date revenues and profits have each grown 13% and Otis is well-positioned to meet profit growth guidance of $200 million plus.

At Carrier, operating profit increased 10% year over year on 5% higher revenues resulting in 40 basis points of margin expansion.

Favorable foreign exchange contributed approximately three points to both revenue and profit growth partially offsetting higher net commodity costs.

Carrier continues to benefit from worldwide geographic balance, a strong earnings growth in the building systems, residential/light/commercial/international and refrigeration businesses more than offset continued softness in our US residential business where revenues and earnings were down around 10% and 15% respectively.

As a result, we remain comfortable with Carrier's full-year guidance of $150 million of earnings growth despite the continued deterioration in the US residential market.

At UTC Fire & Security, performance was strong as revenue was up 29% with profits up 53% in the quarter.

Favorable foreign exchange contributed about a quarter of the revenue growth and organic growth was 4% lead by Asia, Lenel and security business in the Americas.

Operating margin expanded 130 basis points year over year driven by the continuing benefits from Kidde integration efforts, as well as other previously announced restructuring actions.

Favorable foreign exchange added about 10 points of the profit growth.

Fire & Security has delivered solid year-to-date 2007 results with revenue increases of 19% and profit improvement of $91 million or 41% resulting in margin improvement of 120 basis points.

We are confident that Fire & Security is on track with expectations of $125 million plus of operating profit growth for the full year.

Now turning to the aerospace businesses, let me start with a couple of overall comments.

First, consistent with our expectations, we have begun to see a deceleration in commercial aftermarket growth from the 20% plus rates we saw last year.

In the quarter, total commercial aftermarket growth was in the high single digits with strong growth at Sikorsky, low teens growth at Hamilton and mid single digit growth at Pratt.

Second, we now see R&D to be up approximately $150 million in 2007 compared to our earlier guidance of more than $100 million of growth.

The additional investment is driven largely by continued efforts on the 787 program at Hamilton.

Now with that, let me move to the business unit discussions.

Pratt & Whitney revenues increased $265 million or 10% in the quarter led by Pratt & Whitney Canada where new engine deliveries and aftermarket performance generated mid teens revenue growth.

Our systems business had revenues up approximately 45% in the quarter.

Large commercial aftermarket revenues were essentially flat year over year and the third-quarter book-to-bill ratio was slightly less than one.

Operating profit growth of 13% reflects the contribution from the higher third-quarter volumes along with favorable military engine delivery timing and mix partially offset by the impact of higher year-over-year commodity costs.

Operating margins increased 50 basis points in the quarter.

While E&D was essentially unchanged year over year, we do anticipate fourth quarter E&D headwind as we step up engineering investments on the Geared Turbofan.

We continue to expect Pratt & Whitney to deliver solid results for the year with high single digit revenue growth and operating profit growth of $200 million plus.

Hamilton Sundstrand's revenues grew 14% with operating profit growth of 11%.

Continuing the trend of recent quarters, performance was solid in the aerospace aftermarket and industrial segments, both with double digit revenue and profit growth.

R&D investments, principally on the 787 program, continue to be a headwind.

Given the latest program schedule, we now expect full-year 787 R&D to be up over 2006.

Better volume and mix more than offset the impact.

With strong year-to-date growth of 12% in revenues, 14% growth in profits and 30 basis points of margin expansion, Hamilton is well-positioned against guidance of $100 million plus of operating profit growth.

Sikorsky continues to increase production to meet the strong backlog for its products.

Revenue increased 51% and profits grew 47% over last year's third quarter.

3Q profit was up sequentially from the second quarter and is in line with our outlook of continuing sequential profit growth each quarter throughout 2007.

During the quarter, Sikorsky shipped 43 large helicopters, 25 military and 18 commercial.

For the year, we continue to expect over 170 large aircraft deliveries, up more than 50% from 2006.

As a result, we now estimate revenue growth of around 45%, up from our prior guidance of more than 30% growth.

Sikorsky remains on track to deliver full-year operating profit growth of $150 million plus.

Now I will turn it back over to Greg to wrap up.

Thanks, Ken.

So another solid quarter with robust organic revenue growth, double digit earnings growth across all of our businesses and solid cash flow generation.

That's a pretty good quarter.

Now with the third quarter behind us and the fourth quarter well under way, I am going to switch gears for a minute here and spend a little bit of time laying out our first thoughts on 2008.

For those of you following along on the webcast, we are now on slide number 9.

As we look towards 2008, we see the usual pluses and minuses, as well as some big uncertainties, but there is no real surprises here.

The overall commercial aerospace market looks to remain strong even as the commercial aero aftermarkets slowed to a more sustainable rate than we saw earlier in the cycle.

Emerging markets should continue to expand, although at perhaps a more modest rate than we have seen over the last few years.

As for the uncertainties, well they are pretty apparent as well.

How the US economy reacts to the current slowdown in residential housing and the recent financial market turmoil is unclear.

While we don't expect a recession in 2008, we do expect the US economy to slow further.

How much of course is the difficulty in predictions.

Commercial construction, which today remains strong around the world, may well slow into next year, especially in the US where FW Dodge now forecasts a 5% decline in nonresidential new construction starts in 2008.

Foreign exchange probably won't be as much of a tailwind in 2008 as it has been in '07 and commodity inflation, which this year has added around $300 million to our cost base, may continue as a headwind especially if the US dollar remains weak.

The [current] aerospace environment also provides plenty of opportunities for investment.

New business jet programs, the Geared Turbofan and the 787 program all look to be outstanding long-term investments for UTC.

Investments in these programs, however, will put pressure on earnings growth at Pratt & Whitney and Hamilton Sundstrand.

Lastly, I will note that for 2008, we do expect pension expense will provide additional tailwind, but a portion of this benefit will be offset by a higher effective tax rate.

So what does it all mean?

Well, moderating worldwide growth, a further slowing of the US economy as a result of the housing market and additional investments in R&D will make 2008 a challenging year.

Even in the face of these challenges and uncertainties, however, we remain confident in our future.

We have a strong, seasoned management team in place that is focused on continuing to deliver results over the long term.

While we anticipate that organic revenue growth will moderate in 2008, we still expect revenues to grow in the mid single digit range solidly ahead of worldwide GDP growth.

Also for 2008, we expect earnings per share to grow in the range of 10% to 14%.

That's continued solid execution.

We will, of course, take you through a much more detailed review of our 2008 plan at our annual year-end analyst meeting, which is scheduled for December 13 in New York City, just about eight weeks from now.

So with that, let's open up the call for questions.

(OPERATOR INSTRUCTIONS).

Joe Nadol, JPMorgan.

Thanks, good morning.

I would like to start on cash flow.

What changed in the '07 guidance?

How do you sort of bring that down to -- in line from in excess of, which I think was still your guidance last quarter?

And secondly in '08, do you anticipate cash flow at or in excess of earnings?

I think, Joe, as we have said throughout the year, cash flow in excess of net income is always the goal at UTC.

I think we have been struggling since earlier in the year when we had a couple of big one-time cash outflows to make up that shortfall and quite frankly with the higher organic revenue growth in the first three quarters, it has just become increasingly difficult to finance all that growth and still hit the cash flow target.

I'm not going to say we are giving up on it though.

I think we are still working very hard to take inventories down here, to take working capital out in the fourth quarter to hit the cash flow equal to net income.

It is just a little bit more difficult environment than we saw at the beginning of the year, but I wouldn't come off of the goal for the corporation.

And as far as next year, we are not going to forecast cash flow for next year right now, but I will say the usual goal is going to be the same and that is always trying to deliver strong cash flow at least equal to or in excess of net income.

Okay.

On the Geared Turbofan, can you remind us of what the schedule is right now in terms of flight testing -- I guess ground testing and flight testing?

And does the business plan, since now you are committing to it, does that include other platform wins or if it were just the Mitsubishi jet, would that justify your investment in the engine?

Well, first of all, on schedule, I think we are all still committed to the schedule we have been talking about all year and that is a ground run of the engine here in the fourth quarter, as well as then first flight in midyear, perhaps August of 2008.

We have made a $1 billion investment in this program so far over the last 20 years and we think it is a great engine and has got a great future.

The Mitsubishi -- the MRJ when it was big for the Pratt team, I think they did a great job convincing Mitsubishi that we had the technology that makes a difference here and I will tell you, we are not done with just Mitsubishi.

We are clearly -- we see other opportunities on the horizon with, of course, the big brass ring being the next generation single aisle at Boeing and Airbus, but we are going to continue to work all the opportunities for those programs, get launched and we see this as a great investment.

Okay.

And just one more.

At Carrier, residential, we know the market is bad obviously, but your marketshare, could you tell us what your marketshare was in the quarter and do you have an outlook for marketshare because I think you have been losing some distribution share?

Is Q3 kind of at a run rate or do you still expect some bleed-off in the next several quarters?

I think -- in fact, we did not lose additional marketshare in the third quarter.

We had a very, very strong quarter.

Marketshare is down about two points in split systems for the year, but third quarter was actually I think pretty hopeful in terms of as we look to the rest of the year.

We are not satisfied with the marketshare we have today.

We think we've got a cost advantage on the SEER 13 product and I think Geraud and team are going to be aggressive in trying to regain that marketshare over the coming years.

So we are not happy with where we are, but again I think the team at Carrier did a nice job in terms of holding onto marketshare and there is lots of upside there.

Okay.

Thanks, guys.

Myles Walton, CIBC World Markets.

Thanks, good morning.

You mentioned in your remarks and in the slides commercial aftermarket essentially flat at Pratt.

I'm just wondering could you share with us what it was at Hamilton in the Q and also what book-to-bill was like in both the commercial aero businesses?

Yes, at Hamilton, it was actually up a little bit stronger than it was at Pratt.

It was about in the mid teens growth at Hamilton.

Book-to-bill at Hamilton the last few quarters has run a little bit lighter than Pratt.

It's probably about in the -- slightly less than 90%, 0.9% and that number is actually a little bit improved third quarter to second.

Okay.

And as you look on the GTF, I think your run rate for R&D on that program has been about $100 million.

In terms of just the way we should look at the curve, should that climb considerably into next year and then follow a normal bell-shaped curve or is the climb-out really a little bit further?

I think we have been spending in excess of about $100 million a year for the last couple of years just on the basic technology and that spending will obviously continue into next year through first flight and we also would expect to ramp it obviously as we start the MRJ application next year.

And as I said, we are going to continue to look for other applications as well.

So I would expect spending at GTF will increase next year and probably for the next several years.

Okay.

And finally on Sikorsky, you have increased the sales guidance pretty considerably since the beginning of the year from high teens to 45% via the operating profit climb-out has been roughly the same story.

Have you been disappointed on the margin expansion side of things and should we look for more into next year and what has been the primary driver to holding back margins that you can overcome in the next six to 12 months?

You know, Myles, we have been talking about all year.

I think the real struggle that Sikorsky has in this ramp-up is supplier cost and we've continued to be had hampered or burdened by high supplier input costs and Jeff and team are focused on this.

I wouldn't say we're disappointed with the results.

I think the fact that they have gotten the aircraft out the door, the fact that the customer is now happy is great progress.

The real progress for the next couple of years though is going to have to come on the margin line and that, as I said last quarter, is going to take some time because most of the cost of sales that is going to be coming in for the next year is probably already on purchase order.

So we are not going to see significant margin improvement in the short term, although we will continue to see incremental improvement as we have seen this quarter.

I think we have gone from 7.3 to 7.9 margins at Sikorsky and that will continue to improve throughout this year and next.

Fair enough.

Thanks a lot.

Nicole Parent, Credit Suisse.

Good morning.

Just a follow-up on that last question.

Deliveries in both military and commercial helicopter shipments declined Q3 versus Q2.

Were you guys expecting that and how should we think about Q4?

We were expecting that.

We delivered -- well, we delivered 43 in the quarter, but in the first half, we delivered 85 and we have talked about delivering 170 for the year.

So we delivered 43.

That would put us on a 42 run rate for the fourth quarter.

I think what we are seeing though is a real mix shift at Sikorsky as we are delivering a lot fewer of the old L models and a lot more of the Ms and the Naval Hawks, which have a lot more hours in it terms of production.

So it is a mix shift and again I think that 170 is very doable and I think if you ask Jeff, he would probably tell you he is going to do more than 170.

But there are still supply chain issues out there and this is still -- it is not a done deal on these helicopters.

There is a lot of work to do down there.

Okay.

My second question -- could you just give us a little bit more granularity around Otis revenue growth equipment and service by region?

And then similarly, order growth, particularly in the construct of your commercial construction comments for '08?

Yes, overall, let's talk about -- backlog remained relatively unchanged at a very strong level in the quarter, so orders were just as strong as sales in the quarter, so let's talk about orders and the trends in the region so that will give you an idea of what is going on.

Europe was strong again, up about 10% in the quarter, maybe even a little bit stronger.

China continued strong, but I will tell you that it was a little bit less on the order pattern in the third quarter versus the second, but again still very healthy at more than 20%.

Same thing in the Americas.

We have all kind of looked at commercial construction indicators, but the order pattern in the United States was up about 28% in the quarter, so good healthy numbers there.

Korea and Japan -- Korea has shown a little bit more improvement than they had last year and Japan is still kind of flattish year over year.

Okay, great.

And then just one last one, big picture for Greg.

You talked a little bit about the challenges or question marks in the North American market, also China.

Could you give us a sense on what you guys are seeing in Europe and what you think is going to happen in 2008 overall?

Well, for Europe, I would tell you it has actually been surprisingly strong this year, stronger I think than we would have anticipated.

Growth there has not slowed down either at Carrier or at Otis this year and I think the fear as we look forward, of course, is with a $1.41 or $1.42 euro that you might see a slowdown there in the next year, but as of right now, everything looks to be on track.

Great.

Thank you.

Steve Binder, Bear Stearns.

Yes, can you maybe just touch on the commodity headwind in the quarter and how much of it was Carrier?

Yes, it was about $75 million in total for UTC.

About $30 million net at Carrier and about $30 million net at Pratt and the rest of it was spread out in little pieces all over.

Because if you back out last year's gain and restructuring charges at Carrier, it looks like, before commodity costs and before the investment you're supposed to make in the sales and distribution network, it looks like you had incremental margins well over 50%.

I am just wondering -- you kind of touched on some of the positives and negatives in the quarter and clearly you have a favorable mix, but it seems like a fairly robust incremental margin pre-commodity headwind.

I am just wondering what caused that.

I think the biggest thing, Steve, is the absence of some of the SEER 13 ramp-up costs that we saw last year in the third quarter, as well as really strong margins across the other businesses.

I think commercial construction is very good.

Refrigeration, specifically container, had a very good quarter.

So really it is all parts of the business performing, as well as Geraud and team have done a good job taking costs out on the residential side.

As the market has gone down, they have been very aggressive in trying to take G&A costs down.

So all those things contributed to what was really a very strong quarter at Carrier.

And you touched on the fact that you are going to have a Q4 tax headwind.

I am just wondering -- the plan originally, if you backed out the EU one-timers in Q1, was restructuring equal or maybe slightly higher than credits.

It looks like if you factor in that penalty in Q4, is it now that restructuring is going to be well ahead of credits or how do you bracket that?

If you think about it, we had about $0.04 of good news this quarter.

That $0.04 will go away in the fourth quarter as we have about a 2.5 point higher effective tax rate.

But in the second quarter, remember we had about $0.02 of excess restructuring.

The EU has clearly flowed through to the year.

We are not even counting that piece.

So I would tell you that for the year, we are still looking at about $0.02 of restructuring in excess of gains.

All right.

And lastly, just touching on -- this is obviously a -- it looks to me like you have had a large increase again in accrueds in the quarter to kind of pay for the blip in inventories and receivables and I imagine that's advances driving that.

Are we getting some pull forward in advances this year to pay for the inventory trapped on the balance sheet?

I wouldn't say there is pull forward, Steve.

I would just say it is normal good work.

Sikorsky has had very good luck in terms of selling helicopters internationally in Saudi Arabia, Turkey, etc.

and those orders all come with advances and those orders also come with a burden to bring inventory in.

So Sikorsky has done a nice job.

I'll tell you Pratt has done a good job and Otis' even advances are very good on this very strong order intake at Otis.

So just touching on -- I think Joe had asked the question earlier about 2008, but if we are talking about mid single digit organic growth compared to high single digit in 2007, why wouldn't we see free cash flow well in excess of net income in 2008?

We will continue to have organic growth that is well above GDP as you point out and with that, it will drag along some working capital.

I think at this point in time, what we'd tell you is we still target our usual standard, which is cash flow in excess of net income and to start to size the magnitude of that, we will have to get closer to the actual performance in 2008 to do it.

Clearly, Steve, there is opportunity in inventory here.

Inventory turns have been flattish for the last year or so and again driven by organic revenue growth, but that is always an opportunity.

It is something that we are working very hard on.

It is not an easy nut to crack though, but clearly as we look forward to next year, that will be something we will focus on.

Does the Company feel like they have better traction in reducing inventory levels going into 2008 than they felt earlier in the year or is it still just supply chain issues and kind of the hands-up approach on waiting until the supply chain issues moderate in the industry?

I would say the supply chain issues are really starting to moderate.

I think what we are fearful of, Steve, is the supply chain seems to have digested this last big increase in volume.

Unfortunately, if we look into next year and even the year after, we know that Boeing and Airbus are going to increase production again.

We no Sikorsky's production is going up.

So the question really is can the supply chain absorb the next 10% or 20% increase in volumes.

We are making progress I will tell you with suppliers, but it is hand to mouth still for a lot of these key commodities.

Steve, this is Jim.

Maybe if I could just add a comment on to that.

Inventory turns if you look over the last four quarters on a four-quarter average are flat and obviously that is disappointing to us and some of it, as Greg mentioned, is the supply chain as they grapple with things and some is in our own factories.

I think we don't get cash out of only one line on the cash flow statement.

So we've focused on working capital in total.

And if you look at that, working capital is up 4% third quarter to third quarter, while revenues are up 14%.

So we have had about a one turn improvement in working capital and again I think free cash flow would be equal to or above net income if we didn't have such high rates of organic revenue growth when we have used pretty good working capital performance to fund most of that organic revenue growth now.

All right.

Thanks very much.

Howard Rubel, Jefferies & Co.

Hi, I want to move in a different direction.

I want to talk for a moment about Fire & Security.

You seem very excited about the numbers, but yet it seems to me that there -- you are still having trouble getting organic growth and while profitability was better, Greg, it still seems to be a struggle to get where you need to go.

You are still doing a lot of restructuring to get there.

Could you elaborate a little bit?

We had 4% organic revenue growth and I would tell you I think Bill and the team are pretty happy about that after having 1% or 2% for the last six quarters or so out there.

But it is still a struggle especially in some key markets like Australia where we have decided to divest of our manguarding business both there and in the UK and those businesses have really been suffering and dragging down the overall organic revenue growth.

In terms of the margin expansion, I think we are right on track with where we want to be.

There is still lots of headwind out there and still on track.

We are at a 10% loss next year and it is going to come out of restructuring.

It is going to come from cost take-out.

And once I think we have our costs in line with where we need to be, Bill is going to be able to grow the top line as well, but we have got to get our costs in line first.

So I think it really has been -- it's a strong quarter for them.

I think that we are very happy with the performance.

Would like to see more organic revenue growth?

Sure.

But again I think Bill is on the plan to deliver what he is committed to and he will deliver next year as well.

And Howard, maybe just one other comment.

You have followed the Company a long time so you remember back in the mid '90s where UTC was mostly a margin expansion story and we didn't get much organic revenue growth.

But what happened in the following 10 years is all our businesses got bigger, more global and they all got better cost structures and once that happened, they all began to grow faster than their markets, which is what you see in the UTC businesses today.

So I think Fire & Security is along that same journey where the other UTC businesses are.

They are just more like 1997 than 2007.

But they will get to 2007 and grow organically just like the UTC businesses do today.

I hear you.

Thank you, Jim, for that.

The second thing is Power Systems had great numbers and can you -- is this more of the same going forward or is it just because there is -- you had the product available that that business has been that good?

Could you give us a little color on that?

We do have the product available.

I think we have seen revenues up very, very strong all year and again, is it going to continue?

I think the demand for on-site generation continues to be strong both in the US and abroad, so I think we look for this trend to continue over the next couple of years.

Do I think the revenue is going to be up another 45% next year?

I certainly wouldn't forecast that, but I still think that the current level should be sustainable.

And then finally while you have a number of notable successes at Pratt, you are seeing your F100 engines removed from the F-15s at Saudi.

Could you explain why such a long-term customer would go out of his way to replace your product?

Yes, Howard, that is obviously a very disappointing loss for not just the Pratt team, but for UTC.

We have worked very hard with the Saudi Royal Air Force to make sure that those engines stay on wing and we have had some issues in terms of the environment, in terms of the maintenance schedules and it has been a very tough road and I would say we are disappointed and we look forward to the next chance to displace GE.

Thank you, gentlemen.

Heidi Wood, Morgan Stanley.

Good morning.

Just to tag on a little bit on Howard's question about the Fire & Security growth.

I wonder if you guys have put a stake in the sand as to when we can expect more exciting revenue growth.

It doesn't sound like it is '08, but is '09 a fair expectation?

We are not going to forecast out to even '08 in detail yet, so I probably won't go into '09.

But clearly, as we have said, these businesses should grow and I think once we have the global footprint of these businesses and we are going to continue to invest as we have with the Marioff acquisition, as we have with the Rentokil business, once we have that global footprint, there is no reason these businesses can't grow in excess of worldwide GDP growth.

We love F&S where they are today.

They are on track, they are delivering as they've committed to and revenue growth will come.

It is just -- Bill is focused first and foremost on margin expansion.

It's just Greg, that that once could encompass a wide bandwidth of time so I was just wondering if you could compress that a little bit for us.

I wish I could.

I really -- I can't give you a lot more color other than to say that I think that all the pieces are in place at Fire & Security both from a marketing standpoint, cost standpoint that we should see organic revenue growth accelerate in the future.

I wish I could be more specific but I just I can't pick a date when that is going to happen.

I guess actually, Greg, we should probably be flattered that people seem to question 4% organic revenue growth.

I am going to ask a question on 787.

Can you talk to us a little bit about -- remind us what happens on accounts receivable now in '08 with this delay?

And is there any change in how their handling of the payments to Hamilton Sundstrand in '08?

I mean are you in discussions with Boeing of maybe getting some amount of payment next year?

And also you have been saying you are consistently on track on the 787 and now there is a $50 million increase in R&D.

I wonder if you could explain that a little bit and tell us where R&D on the 787 goes in '08.

Those are all really good questions.

I will say first of all on the accounts receivable, they are still out there and right now the contract is actually pretty clear that we will get paid for those receivables right after that plane gets delivered to the first customer.

So we all know that's probably not going to be now until late 2008.

So there is a bit of pressure on Hamilton's cash flow and they will continue to fund those receivables all the way through '08 and probably actually won't see first cash until '09.

So that is a bit of a headwind and again it is something manageable.

It is not huge numbers.

We have got about $2.5 million a ship set in costs, about 40 aircraft first year.

So you are talking about $100 million in receivables, but headwind nonetheless.

As far as the program spending, as you know, we have taken out a much bigger role in the integration of the aircraft and we have signaled all year that we are going to stay on track with Boeing, we're going to continue to support Boeing and as they have slipped the schedule, we have continued to support Boeing and quite frankly we are going to continue to support them into next year.

I have mentioned earlier in the year that we are spending about $4 million a week supporting this program.

That rate is now continuing and will continue up through first flight, which will happen sometime in the first quarter we think and the spending will come down a little bit, but we still expect significant spending next year through entry into service and that is a big change for us and I think that is one of the things that we would point to in '08 is probably one of the headwinds which we hadn't anticipated and that is a six-month delay, which will add significantly to Hamilton's E&D bill next year.

So should we expect that R&D there will be sort of flattish in '08 versus '07 then?

I think yes.

It'd probably be flattish to even potentially up depending upon what happens on the A350.

All right.

Great.

Thanks very much.

Ron Epstein, Merrill Lynch.

Good morning, guys.

Can I just follow up on your comments on the A350?

When do you expect to hear more awards, particularly on the stuff that you guys bid coming out of Airbus?

We are hoping actually some time here even into the fourth quarter.

We are not on all of the same systems on the A350 that we are on the 787, but we still have a couple of key programs that we certainly hope to win, but I expect we will see that here in the fourth quarter, maybe the latest early into the first quarter, but spending will ramp up relatively quickly in '08.

Okay.

And then kind of changing gears here a little bit, when you look out in terms of M&A opportunities, have you seen any changes in that marketplace with the changes in the debt market?

Have you seen some of the bids come off some of the properties out there with financing arguably a little harder to get for the private guys?

This is Jim.

What we have seen in that market is that financial sponsors have withdrawn as it is tough for them to raise much money right now.

But strategics still have a lot of money and good balance sheets, so I don't think the pricing dynamic has changed yet and I think you also have to remember that it takes a while for seller's expectations to reset.

So they remember what the price was, not necessarily what it is today and it will take them maybe six or 12 months to reset their pricing expectations.

So I don't think we have really seen a change in that market yet.

We may in the future if this persists.

But I don't want to give a forecast.

We use a typical $2 billion placeholder at UTC for M&A spending and it doesn't take more than really one or two deals to put you at or above that.

So no forecasts here today, but I would confirm what we've read in the paper, which is that financials are having a tough time raising money, but auctions continue.

And Jim, I guess one more question, changing gears a little bit again.

If we go back to the balance sheet, we were talking a little bit about inventory turns.

How much better do you think they can get?

If you were to put sort of a target inventory turn level out there, where could we expect it to go realistically?

I would like to think all of us at UTC would like it to get much higher and when we can benchmark peers that would say we get it up into the high single digits, but frankly I would tell you I'd like to get to six before I go off and forecast something much higher than that.

So I think we would like to see it move up and get some momentum behind it and then we will come back to you with a hard target.

Okay.

Great.

Thank you.

Deane Dray, Goldman Sachs.

Thank you, good morning.

If we could just go back to the 787 R&D expenditure just to make sure I am clear, is that -- when you talk about supporting the program, are you -- does this really concentrate towards the integration issues and the delays and helping Boeing out there versus increased spending on any new model development?

Yes, we are really talking about just the current models under development and it is not the hardware.

The hardware is done.

It's delivered and it is certified.

What we are talking about now is the actual integration of all of the systems and that is primarily software engineering and that is really what is going to drive this cost up until entering into services.

Whatever changes happen to that aircraft have to flow through our systems and we have to continue to support that, so we are not talking about new models yet.

That is probably an '09 and out kind of discussion.

And when you talk about software integration, because that was a big role for Hamilton and the [win], are we talking about software integration issues that have come up that you have been asked to take care of that you were not anticipating or is this -- are there delays on programs or modules that you were already committed to?

Clearly there has been some scope creep and the other -- but I wouldn't lay it all off on that.

I think there's also been just schedule delays, other suppliers have been late to Boeing and we are just at the very tail end of the development process here, which is really new to us.

We knew when we took this on we were taking on some significant risk, but even with this additional spending, the program returns still look to be outstanding.

Great.

And then a question on the Geared Turbofan and the win at Mitsubishi, were there any changes coming down to the wire in terms of how you were looking at the features of the engine with regard to maintenance, fuel efficiency, noise, any tweaks at the end that was really -- made the deal for you?

No, I think this is just a unique opportunity that we had with Mitsubishi to launch the Geared Turbofan.

We sold it on the technology.

We sold it on the total value package, which is 10% plus fuel burn improvement, noise footprint, the NOx emissions, all of those things, that whole package which convinced Mitsubishi to take a chance on the GTF.

It really will differentiate that aircraft.

Is there anything -- it might be too early to ask this -- about the maintenance agreement for the engines with Mitsubishi?

Deane, I am not really sure I could comment specifically on that.

We can certainly follow up, but the program has not yet officially launched even at Mitsubishi so I know there is lots of things -- lots of details on that that will emerge over the coming few months, so we will be talking about that I am sure.

Sure.

And then last question just relates to your outlook on '08 and you typically all have had a history of fairly conservative guidance at the outset.

When we went back and looked a year ago, you talked about '07 as being a 10% plus earnings growth opportunity and it looks like you will be at 15% plus there.

If you look back at where we were a year ago versus today, is there any differences in visibility, backlogs, the infrastructure cycle that would be different as to why you would be bracketing at a 10% to 14% growth?

I think maybe the one difference that we see or maybe two differences I would point out this year versus last is we really thought the housing market was going to recover at the end of '07 and give us some nice tailwind as we went into '08 and that obviously is not going to happen and quite frankly it is probably not even going to happen in 2008.

And the second thing is it's these investments in the programs that have really caused us to take a step back and say we have got some headwind out there.

It is really kind of early to give you a specific number on any of this E&D, but I will point out, as we always do UTC style, we will underpromise and always, always attempt to overdeliver, but this is just where we see it today.

And we will stay tuned for December.

Exactly.

Thank you.

Jeff Hammond, KeyBanc Capital Markets.

Hi, good morning.

Just a question on I guess US commercial construction.

You cited that you expected that to be more difficult.

You cited the Dodge data, which we have seen as well.

But as you talk about commercial HVAC and you talk about the order rates, which were exceptional (inaudible) in the US, can you maybe point to what your customers are saying in terms of visibility or is the conservatism really just around some of the macro data points?

I think the conservatism starts with the macro environment and that is -- we know interest rates -- borrowing costs are going up.

There is more risk obviously from the lender's perspective on some of these new products.

We have not -- I would tell you today, we have not seen a slowdown in the US.

Dodge is predicting this 5% drop and quite frankly the first half of '08 should probably be pretty strong just on the backlog that both Otis and Carrier have today.

The real concern is, as you get into the second half of '08, will there be a real slowdown in the US economy, will that flow all the way through to commercial construction.

Has there been any change in quoting or bidding activity near term?

Not -- again, we asked this question of all the units here just a couple of days ago and I think, to a person, they would tell you that there has not been a real change in quoting activity.

People are concerned as they look out, but right now today, I would tell you there has not yet been a slowdown.

Okay.

Then moving over to Carrier, how would you characterize inventories, pricing within Carrier and if you can just maybe talk about what you are doing strategically to drive some of that share recapture going forward?

We'll talk about inventories first.

The inventories look pretty good actually.

They are down year over year in the channel.

We think they are down about double digits.

So it is pretty clean and we have known that we've had a pretty tough market in front of us.

So that has been good work both on Carrier's part, as well as the distributors.

The pricing environment is certainly a very tough market to try to get positive pricing.

We know that; you know that as well as we do.

The good news is, especially on the US, we haven't seen much decline in pricing.

In fact, I would say we didn't see any decline in pricing year over year.

What we are doing to make sure that we are appropriately placed for share gain is, first of all, we think the value of the product is something we need to get in front of the customers appropriately.

Secondly, we are looking at each one of the markets and looking at the pricing dynamic with other players in there, making sure that we are properly positioned.

Okay, great.

And then final, just in terms of the '08 outlook, some of the non-operating items, can you quantify what you think the pension tailwind will be and what specifically you are looking for from an effective tax rate standpoint?

Pension tailwind, I think you can kind of look back and see that we had some losses in the early part of the decade and those -- we had one year dropping off next year, but it is a little bit early to lock down the discount rate and what has happened actually to our pension asset this year, so we just know there is tailwind there for us.

The tax rate based upon the changes to the tax laws that we know are coming, the ETI, we see a little bit of upward pressure on that rate.

Again, we always work to try to keep that as low as possible, but we know there is going to be a little bit of upward pressure on the 28%.

Yes, there is really no surprise on the tax rate.

We have been targeting 28% for a number of years now and as the business has grown, especially as it has grown internationally, it is just much, much more difficult to maintain that 28% effective tax rate.

As Ken said, the ETI benefit is now gone.

We are not sure what is going to happen with the R&D credit in Congress today.

That still has not been renewed.

So there is again just general pressure on the tax rate and we are working on that very hard, but it will tick up next year.

Okay.

Thanks, guys.

Cai von Rumohr, Cowen & Company.

Yes, thanks an awful lot.

Your large commercial engine aftermarket was flat in this quarter.

My notes showed you said it was up 14% to 15% in the second quarter.

How much of the deceleration is spares as opposed to overhaul and given you said I think that book-to-bill was less than one should we assume this business to go to a decline in the fourth quarter year over year?

Cai, I think as we look at that, the primary driver is really a drop-off in spares in the third quarter and again we are coming off a very high run rate from last year and we also -- we are still seeing good input into the shops and I think we're still struggling to get engines out of the shop.

And so part of this is a little bit of timing.

I think we would not forecast this decrease as we look into the fourth quarter.

Okay, great.

And if we look at R&D, Hamilton Sundstrand looks like it is flattish, maybe up, but you haven't won the A350 and the 787 should come down unless Boeing really boots badly on first flight and I would assume that the Mitsubishi build would happen more in the second half, something like $50 million to $100 million.

So if we guess $100 million or so in R&D, flattish about as a percent of sales, is that realistic or is there more upward pressure on the GTF?

I think the issue on the GTF is other opportunities that are out there.

Clearly the size of your numbers is not out of line at Pratt, but again there could be upward pressure on that depending upon other potential applications and not just on the GTF, but other on the [biz] jet side up at Pratt Canada.

As far as Hamilton goes, you're right.

The A350 has not started yet and I think that is a question mark for next year.

We will have a lot more visibility on this when Louis presents the '08 plan in December.

So I guess I would just ask for your patience here for a couple of weeks and we will get back to you when we have better visibility on it.

Okay.

And at Sikorsky, your deliveries were down sequentially, but your volume was up.

I assume that was mix-related and given that it looks deliveries are higher in the fourth quarter, why would Sikorsky's volume be a little bit higher in the fourth quarter and therefore higher than you say and shouldn't that run rate next year given the higher ASP kind of kick those numbers up and do we also look for the sequential margin improvement quarterly to continue from the fourth to the first and on through '08?

Those are a lot of good questions.

Let me just take it, first of all -- I think the guidance we have given you from Sikorsky, we feel very comfortable with that for the fourth quarter.

As I said before, I think our guidance would indicate only 42 helicopters and we think -- which would be 170 for the year.

Obviously that number could go up a little bit.

Margins, they should continue to improve into the fourth quarter from the third quarter and they should continue to improve next year.

I don't want to give you a quarter-by-quarter sequential growth because obviously the calendarization hasn't been really studied very hard as we sit here in October, but clearly margin expansion next year is on the agenda.

Okay.

The last one is your shipments were down, so should fourth-quarter volume equal the third quarter if your shipments are basically flat to up?

No, I think you'll continue to see volume up in the fourth quarter a little bit.

Again, it is part of that, as you mentioned, it is mix.

We are shipping fewer of the low dollar L models and more of the Naval Hawks and the Ms.

Terrific.

Thank you very much.

Joseph Campbell, Lehman Brothers.

Good morning.

Could you talk a little bit about what is happening in Power both in terms of the specifics of the results and the outlook for the year?

And then just remind us again about what is happening for the longer-term future?

That is not a question about '08, but just sort of -- there has been an awful lot of talk about alternative power and fuel and green and so on, just refresh us on what is happening in UTC Power along those lines.

UT Power, they are continuing to make investments as we have talked about all year.

They are developing a new 400kW machine, which hopefully will be ready for delivery towards the end of '08 or into '09 and we still see lots and lots of runway with that business.

The green initiatives are not diminishing in any respect and there is just more and more pressure around the world for distributed clean green power.

I think if you talk to Jan van Dokkum, he would tell you that $1 billion in revenue is not an unattainable goal in the not too distant future at UT Power and again we're making investments today to have the products to do that and launching some innovative things with geothermal power, as well as using our alliance with Capstone on the new 200kW machine to offer some unique solutions here in the US.

So it is a good business for the long term, but I will tell you, it is not going to make a big dent in UTC's results at least for the next year or so.

Great.

Thanks very much.

Stacy, why don't we take one last question.

Nigel Coe, Deutsche Bank.

Thanks, good morning.

So the uncertainty on commercial construction, is that purely confined to North America or do you have any concerns about trends in Europe or maybe even China going into 2008?

No, we continue to see the same thing that we have seen all year long, which is robust order activity in those markets especially in the emerging markets.

Okay.

And just thinking about the possibility of deceleration in North America next year, what sort of time lag do you tend to see between actual dollar spend or projects and the actual equipment orders for yourself?

It is different between Otis and Carrier.

The timeline is a little bit longer at Otis depending on the size of the projects and we play on some of the very big luxury products and high-rise buildings obviously.

That can be anywhere from a year on the short end to a very big project would be a couple of years timeline.

On Carrier, it is a little bit shorter.

It's probably more like a nine-month kind of average between booking and shipping.

Okay.

And then move on to Carrier.

Just a pretty good margin performance there.

Did that include the costs related to the Californian distributor set-up and also if you could just maybe talk about how you are thinking about marketshare in residential next year versus margins and how do you manage that balance?

It absolutely did include the cost of setting up distribution in California and as Greg said earlier, we are certainly focused on not only regaining the share that we have lost in the first part of this year, but we want to go higher than that.

Okay.

And how do you manage that against improving margins?

Say that again, Nigel.

Just the question was how do you manage that balance between margins -- maintaining margins or improving margins of Carrier.

Geraud and the team always, as we do with everything, we have to look at all sides of the equation and we don't just gain margin -- share of market at the expense of margins.

We are always looking at the pricing in the markets for appropriateness.

Okay and the costs on the California, that was $25 million also?

It's probably less than that.

I think we thought it would be a little bit more in the third quarter.

It was probably somewhere around $0.01 or so of EPS.

Okay.

Thanks a lot.

I want to thank everyone for participation in today's conference call.

Maybe just a couple of wrap-up comments here.

I know we spent a lot of time talking about 2008 here and clearly as we look forward, '08 looks to be a more difficult environment and no surprises.

It is about housing and it is about a slowing US economy and it is really coming off of the very high growth rates that we have seen.

Growth will slow a little bit, but we remain very confident in the future of UTC and we remain confident in delivering earnings next year, earnings growth in the range that we have laid out and it will be a good year in 2008 and we have had a good year so far and I think we shouldn't forget the third-quarter performance was really quite good.

Anyways, thank you all for that -- for your time today and we will be available to answer questions all day with Ken and his crew.

So thank you.

Thank you.

Ladies and gentlemen, that will conclude today's conference.

We thank you for your participation and you may disconnect at this time.