雷神技術公司 (RTX) 2009 Q2 法說會逐字稿

Good day, and welcome to the United Technologies second quarter conference call.

On the call today are Greg Hayes, Senior Vice President and Chief Financial Officer, and Akhil Johri, Vice President, Financial Planning and Investor Relations.

This call is being carried live on the internet, and there is a presentation available for download from UTC's home page at www.UTC.com.

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

UTC's SEC filings including it's 10-Q and 10-K reports, provide detail on 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.

Good morning, everyone.

As you have seen from our press release this morning a tough quarter on the top line, with exceptional execution across the business.

No surprises here, just the type of execution you have come to expect from the UTC team.

Our focus on cost continues to pay off, segment operating margin reached a record high of 14.9%.

That is adjusted for restructuring and a one-time gain, with aggressive restructuring and cost reduction actions leading to 50 basis points of margin expansion.

We also saw excellent progress in driving down working capital this quarter.

As a result, free cash flow was 140% of net income, even with $400 million of contributions to our domestic pension plans.

As far as the order rates, no significant changes in the year-over-year order rates in the quarter, however, order rates do appear to be stabilizing.

Strong execution and relentless cost reduction give us confidence, even in the face of difficult markets, that we will resume earnings growth next year, while delivering on our commitments this year.

The evidence of the cost reduction is in the segment operating margins.

All were double-digit and four of six, Otis, Fire and Security, Sikorsky, and Pratt & Whitney, saw operating margin gains of 100 basis points or more, again adjusted for restructuring and a one-time gain.

Otis led the way at 21.9%.

That is 210 basis points higher than prior year.

Carrier delivered double-digit margins this quarter, as a result of a relentless focus on cost takeout, despite very difficult end markets.

This margin performance was achieved even while UTC's revenues decreased $2.7 billion, or 17% to $13.2 billion.

Revenues decreased 11% organically, and 5% from foreign currency translation.

Net divestitures accounted for remaining 1 point of the revenue decline.

Again, no surprises as we knew the comparison would be the toughest this quarter, against a very strong second quarter last year.

Earnings per share for the quarter were $1.05.

That is 20% lower than last year.

And in-line with the first half expectations we have been communicating throughout the quarter.

Current quarter results include $0.22 of restructuring costs, and a $0.06 non-taxable gain, related to acquiring a controlling interest in an Otis joint venture.

Last year's second quarter you recall had a $0.06 charge for restructuring costs.

Absent the impact of these restructuring costs in both quarter and the one-time gain this year, earnings per share was down 12%.

Approximately two-thirds of this decline, or about $0.11 was from foreign currency translation, combined with the negative impact of Pratt and Whitney Canada's currency hedging program.

On revenues, only Sikorsky saw a growth.

Revenues at the other five businesses were down, with particular weakness in our short cycle segments.

Carrier revenues declined 29% in the quarter, 21% organically.

While we would all like to say that the economy is improving, we have really seen to simply stabilization of order rates across the businesses.

Consumer confidence does show some indication of improvement, but the US housing starts outlook is more or less the same we saw in March, and the outlook for commercial construction and aerospace traffic are somewhat worse.

China, on the other hand , has started to show the positive impact of the government stimulus program.

As we have said before, we have always expected China to recover first, and we did see early signs of that in this quarter.

New equipment orders in China at Otis and Carrier commercial HVAC, were down about 18% year-over-year in the second quarter on a constant currency basis, compared with a decline of 40% in the first quarter.

Turning to Slide Three.

As a result of the continued weakness in order rates, we are revising our full year revenue guidance from 55 billion to 53 billion.

That is down 11% from last year.

We still expect to spend about $750 million on restructuring this year, and we now estimate one-time gains to be only around $200 million.

So restructuring in excess of gains looks to be around 550 million, at the high end of our prior range of 400 million to 550 million.

With the lower revenue outlook and the higher net restructuring, we are tightening our EPS guidance range with the top end at $4.20, compared with $4.50 previously.

Better than expected traction on cost reduction actions, higher savings from restructuring, and a weaker US dollar, give us confidence of the bottom end of the range at $4.00, despite the significantly lower revenues.

We are now assuming the Euro at 1.38 for the rest of 2009, versus our assumption of 1.27 going into the year.

On restructuring we spent about $300 million this quarter, that is $464 million year-to-date, to address volume declines, and to eliminate structural and overhead costs across all of the businesses.

All of 2009 programs are now expected to yield a run rate savings of $700 million.

$300 million in 2009, an incremental $300 million next year, and then another $100 million in 2011.

All of this will make the Company more cost competitive when the economy does recover.

In addition to restructuring savings we are also seeing the benefits of other cost reduction actions, in areas such as travel, furloughs, E&D, and employee attrition.

As an example, our overall head count has now gone down by more than 12,000 since December, and that excludes the net impact of acquisitions and divestitures.

About 70% of that 12,000 decrease results from the 2008 and 2009 restructuring programs.

As I noted before, free cash flow in the quarter was 140% of net income attributable to share owners at 1.4 billion, and that included 400 million of domestic pension contributions.

The solid cash flow resulted from strong working capital performance across the business, particularly in collections.

While we have made some progress reducing inventory, there is still a lot of work to do there, particularly at the aerospace businesses.

Year-to-date free cash flow is now at 99% of net income, and for the full year we continue to expect free cash flow to be equal or excess of net income.

I will come back and talk a little bit more about the outlook for the rest of 2009 in just a minute, but let me turn it over to Akhil to take you through the business unit

Thanks, Greg.

Turning to page 4, let me remind you that I talk to the segment results adjusted for restructuring and non-recurring items, as we usually do.

Otis delivered another strong quarter, as Greg said, with margin expansion of 210 basis points, to 21.9%, despite the downturn in global construction.

Operating profits in the quarter were down 6% on a 15% decline in revenue.

At constant currency, operating profits grew 5% on 6% lower revenues, as aggressive cost reductions and continued strength in the contractual maintenance business helped mitigate the impact of lower new equipment volume.

Since the beginning of the year, Otis has reduced head count by over 2,600 employees, or 4% of it's work force.

New equipment revenue was down 9% excluding currency, with mid-teen declines in Europe and North America.

Revenues in Asia were flattish with China, up mid-single-digit.

At constant currency, new equipment orders were down 38% from last year's record level, which included a large order for the World Trade Center.

Year-over-year, orders in China were down high teens, compared with down around 40% in Q1.

Given their first half order rates, Otis now expects full year revenues to be down near double-digits compared with 2008.

However, in light of Otis' strong operating margin performance, good traction on cost reduction actions, continued strength in the maintenance business, and improved foreign currency translation, we now expect profit for the year to decline by $50 million, a $100 million improvement from the midpoint of our previous guidance range.

On Slide Five turning to Carrier, operating margin exceeded 10% in the quarter, down 210 basis points on 29% lower revenues.

Carrier continues on the part of aggressive transformation to a simpler, more focused, higher-returns business.

Cost reduction and restructuring actions contributed more than 250 basis points of margin in the quarter, and helped mitigate the impact of the steep volume decline.

Since June of 2008, Carrier's head count has been reduced by 5,200, or 13% of the work force, before the impact of net divestitures.

Carrier's organic revenue declined 21% in the quarter, as in Q1, Carrier's most significant volume decline occurred in the higher-margin transport refrigeration business, with sales down about 40% at constant currency, driven by container and Europe truck trailer.

The commercial HVAC business was down mid-teen's organically, and we saw new equipment orders there decline about 20%, again at constant currency.

US residential was down 16%, about in-line with the market.

Carrier's prior guidance assumed an improvement in business conditions in the second half of 2009.

In light of continued weakness in order rates, Carrier now expects organic revenues in the third quarter, to be down in-line with first half, and expects profit growth to resume in the fourth quarter on the back of easier compares, and continued cost reductions.

For the full year, Carrier expects revenues down in the mid-20s, and earnings down in the range of $500 million to $550 million, with second half earnings down approximately $100 million to $150 million, versus prior guidance of flat second half earnings.

On Slide Six, UTC Fire & Security delivered a solid quarter, with operating margin expansion up 180 basis points, to 10.6% on 23% lower revenues.

Organically revenues contracted 8% with both fire safety and electronic security revenues down high single-digits in the quarter.

Unfavorable foreign currency translation reduced revenue 12%, and net M&A activity accounted for 3 points of the year-over-year revenue decline.

Operating profit decreased 8%, excluding FX profits grew 9%, reflecting the benefits of the integration of field operations, restructuring, and continuing productivity and cost control initiatives.

We remain confident in UTC Fire and Security's 2009 guidance of flat profits on revenues down mid-teens.

Turning to the Aerospace businesses on Slide Seven, revenues at Pratt and Whitney declined 13% in the quarter, driven primarily by lower overall aftermarket volume, and Pratt Canada engine shipments.

Revenues were also adversely impacted by net hedging activities at Pratt Canada.

Large commercial engines spare revenues were down in the mid-20s, and book-to-bill was slightly below one.

Engine shipments at Pratt Canada were down about 25%.

Operating profit declined 7% in the quarter.

The impact from lower revenues, adverse mix, and unfavorable foreign currency impacted at Pratt Canada, was partially offset by benefits from restructuring, productivity improvements, and fewer large commercial engine shipments.

E&D was also favorable in the quarter.

Operating margin at 16.8% was up 100 basis points.

Turning to the full year, we now expect large commercial spares revenues to be down around 20%, at Pratt Canada we expect engine shipments to be down in the high teens.

Our prior expectation for both was down double-digits.

Pratt's large engine MRO activities are also lower than expected, as airlines conserve cash in the face of lower traffic and yields.

Overall, Pratt and Whitney 2009 revenues will likely be down mid to high single-digits, operating profit is now expected to be down $100 million year-over-year, as compared with the prior guidance of down zero to 50 million.

Pratt continues to aggressively reduce operating costs, and rationalize capacity in manufacturing operations and maintenance, repair, and overhaul networks.

On Slide Eight in the quarter, Hamilton Sundstrand revenues were down 15%.

Organic revenues were down 9%, with aerospace aftermarket down double-digit.

The industrial business down 25%, and aero OEM flat.

Operating profit declined 20%, primarily from lower volume in higher-margin businesses.

Commercial spares revenues were down over 20% again.

Lower E&D, discretionary cost curtailment across the business, favorable mix in aero OEM, and productivity improvements in the repair shops, partially offset the volume impact.

Orders for the industrial business continued to reflect impact of the global economic slow-down, and were down about 35% in the quarter, including 3 points from foreign exchange.

Commercial spares book-to-bill was about 1, including a few large long lead time orders.

Depressed order rates in high margin businesses continued to put pressure on Hamilton Sundstrand's 2009 outlook.

We now expect the commercial aftermarket to be down low teens for the year, and the industrial business to be down in the mid-20s.

In total, we now expect Hamilton revenues to be down mid to high single-digits, operating profit to be down $75 million to $100 million, as compared to the prior guidance of flat.

Hamilton continues to reduce operating costs through workforce resizing, furloughs, merit furloughs, and other actions, in response to the challenging market conditions.

Turning to Sikorsky on Slide Nine, operating profit grew 26% on 6% higher revenues.

During the quarter, Sikorsky shipped a total of 50 large helicopters, 40 based on military platforms, and 10 commercial.

Sikorsky continues to target delivery of between 230 to 240 large aircraft in 2009.

Operating margin expanded 160 basis points in the quarter to 10.1%.

This improvement was primarily due to better aircraft mix, and lower manufacturing costs.

Sikorsky continues to expand it's footprint of international suppliers, during the second quarter it completed an agreement to manufacture S-92 helicopter cabins with the Tata Group in India.

Sikorsky is also making progress with the international Blackhawk in it's facility in Mielec, Poland.

While we see continued weakness in the commercial market, we expect Sikorsky to continue it's strong performance for the remainder of the year, with revenues still projected to grow in the high teens, and operating profit expected to increase approximately $125 million.

With that, let me turn it over to Greg for wrap-up.

Okay.

Looking at Slide 10 now on the webcast, a very strong quarter in terms of execution, and very strong cash performance, and very, very strong cost traction in the face of difficult end markets.

Continued focus on what we can control, resulted in over $350 million of discrete cost reductions, including restructuring savings in the quarter, and this limited the impact of the $2.7 billion revenue decline.

Just a reminder, this $350 million of savings follows $200 million of cost reductions in the first quarter, so even more traction from aggressive cost actions in the second quarter, than what we saw in the first.

Wrapping up, our full year 2009 revenue expectation is now $53 billion, that is down 11% from last year.

And this $2 billion decrease from our prior guidance reflects the expectation of an incremental $2.5 billion decline in organic revenue, and about $500 million from recently announced divestitures, partially offset by the weaker US dollar.

The negative margin related to this volume decline is expected to be partially offset by incremental benefits of early cost reduction and restructuring actions, as well as more favorable net commodities, and the weaker US dollar also helps.

Our full-year 2009 EPS guidance, as I have said before, is a range of $4.00 to $4.20, down 14 to 18% from 2008, excluding the impact of acquisition-related costs.

Excluding restructuring expense and one-time gains, we see earnings per share down to 7 to 11% compared with 2008, on a revenue decline of 11%.

A big slice of that revenue reduction coming in our high margin aerospace spares and our transport refrigeration businesses, making the lower EPS drop through even more impressive.

As for other guidance for 2009, our expectation for free cash flow for the year remains unchanged, at equal to or in excess of net income.

Capital expenditures in the quarter were down 43%, or 37% year-to-date, and as a result, we now expect capital expenditures to be down about 30% for the full year.

Our 2009 M&A placeholder remains at $2 billion, although our acquisition spend year-to-date is only $153 million net of divestitures.

As always, deals happen when they happen.

And we will continue to be aggressive in identifying and pursuing acquisition opportunities.

We also will remain disciplined in our approach.

On share repurchase, our share repurchase guidance remains at $1 billion.

Second quarter share repurchase was $150 million, year-to-date $350 million.

Okay.

Slide 11 now, a couple of thoughts on 2010.

I have been getting a lot of questions about whether we expect earnings to grow next year.

Although there are many moving pieces at this point, I will simply remind you that the strength of UTS is in it's market-leading franchises, with geographic customer and product diversity, along with strong aftermarket businesses.

This portfolio of businesses, and the aggressive cost reduction action we are taking this year, will position the Company to resume earnings growth next year.

To be clear, we do not anticipate a significant economic recovery in 2010.

And as we begin building our detailed 2010 financial plan, the business units are developing cost-led plans, without much reliance on top-line recovery.

We will see some tailwind next year from restructuring actions taken this year, another $300 million.

While there may be some weakness in our long cycle businesses next year, such as commercial, aero EOM, Otis new equipment, and commercial HVAC, our short cycle businesses, such as the commercial aero aftermarket, residential HVAC, and transport refrigeration, should be among the first to recover, when the economy does improve.

Our continued focus on process improvement is driving the cost reductions we have seen across the businesses.

Currently 54% of our businesses are operating at the gold and silver level, well on our way that Louis laid out, of 70% by the end of this year.

Also, our ACE initiative with suppliers is gaining traction, with 44% of key suppliers spend now with gold or performing suppliers, well on track to Louis' target of 70% by 2011.

With our relentless focus on cost, seasoned management team, significant aftermarket content, and continued investment in innovative new products, we believe we are well-positioned to outperform again in 2010.

With that, Erin, let me stop here, and open up the call for questions.

Thank you.

(Operator Instructions).

And we will hear first from Nigel Coe with Deutsche Bank .

You have got Carrier in the question mark column yet.

You called out growth in 4Q EBITs, which implies that you are pretty confident in first half growth at least in 2010.

So I am just wondering why that would be in that column rather than the plus?

At Carrier, there are a lot of pieces to Carrier, I think the long cycle part of Carrier, which is the HVAC, commercial HVAC piece is a bit of a question mark for next year.

We actually would expect that to be down slightly.

I think the real question on Carrier though, goes to the nature of the economic recovery, and when we are going to see a rebound in housing, and when we are going to see a rebound in demand for the transport refrigeration products.

Again, those are very economically sensitive businesses, they have been the most, the quickest and the most, I would say.

So until we see some real signs of an economic recovery, I think Carrier remains in that kind of question mark column for next year.

Okay, fair enough.

On then on the revenues obviously taking down guidance $53 billion, that is not too much of a surprise.

Do you think that, at this point do you think revenues are becoming a bit more predictable for fiscal '09.

Is the rate of change in your projections month-to-month starting to moderate?

It has, Nigel.

If you think about it, the order rates have stabilized, as we have said, really since March we have seen the order rates fairly stable, albeit at these low rates.

As we look at the back half of the year, and we are sitting here in July, we are fairly confident in this $53 billion.

Could it be a little better or a little worse?

Yes, defending upon FX.

But for the most part, we have pretty good visibility, and I would say realistic revenue guidance here, based upon what we see today in the markets.

Great.

One more for me, a quick one.

What is the buffer right now protecting the low end of the range?

I am sorry Nigel, one more time?

What is the buffer, the contingency at the bottom end of the range right now?

At the $4 level we have about $150 million of contingency left.

You will recall back in March, at the time we talked about a $350 million contingency, that has obviously been eaten up a little bit by the revenue reduction, as well as the lower gains on restructuring, but offset by some good news on cost traction as well as FX.

150 million, it feels about like the right number as we sit here in July, again with half of the year behind us.

If that 150 is still there at the beginning of December, do you then use that for additional restructuring?

That is a great question for Louis to answer in December, but I would say probably, as we sit here today, if the business remains strong and cost traction improves, I would say there is probably more restructuring in the future.

Very helpful.

Thank you very much.

We will take our next question from Joseph Nadol with JPMorgan.

Thanks, good morning.

Greg, on the restructuring, you are well above half of your $750 million so far.

How do you think this plays out the next couple of quarters, and I mean, how much more than $750 million could you come in at, if the dollar weakens say, or something else happens in your favor?

We were a little bit above this year, this quarter I think we talked about $250 million.

We actually launched a little over $300 million, so I think $467 million year-to-date.

We feel good about the restructuring list that we have got.

It is a robust list.

It is well north of the $750 million that we have targeted.

I think the issue that we have got is, as it looks towards the back half of the year, is execution.

And all of the businesses you will see, with the exception of Sikorsky, have taken on significant restructuring activities.

So there are a lot of things going on out there.

There is pressure to probably spend more.

We will even see a little bit of restructuring follow into 2010, and we will have to play it by ear.

The number will only go up from where it is today, and certainly you can expect to see some additional next year.

Okay.

With regard to your calandarization question, right now we are putting about $200 million for third quarter, and the balance in Q4, to go up to the $750 million.

Okay.

In China, that is where you are seeing the best results in the Company, and of course, that is where the GDP looks by far the best.

How sustainable your people there, particularly in Otis, think that this recovery is?

Well, what we have seen in the last quarter, Joe, is really a recovery at the low end of the market, in terms of order rates, our XOEC business orders I think are actually up about 15% or so.

The low end is where the government stimulus is helping the most, this is on the residential construction market.

That looks to be sustainable.

The 7.9 or 8% GDP growth is all very good.

We have also seen foreign direct investment start to come back to last year's level.

Still down year-over-year, but as foreign direct investment picks up, and I think the compounding effect of the stimulus picks up, we have got a lot of confidence we are going to see a good back half for Otis in China, as well as Carrier, and even a strong 2010.

Okay.

And then just two more quick number questions, what is your commercial HVAC backlog down year-to-date, first of all?

And secondly, could you just discuss your Hamilton E&D spending, and where you are running versus where you thought you would be?

Hamilton E&D was a little bit of a reduction in second quarter, Joe, on a year-over-year basis.

Overall, as you know, we had E&D down about $50 million this quarter, and Hamilton was roughly 40% of that, in terms of year-over-year decline.

We do expect continued decline in the second half there, primarily as the 787 spend comes down.

You can imagine with the delay in the first flight, there is some pressure on that.

With regard to commercial HVAC, I think the orders have been worse than these revenues that we have generated.

So backlog is down.

The orders have been down roughly 20%-plus for the first half, while the revenues have been down organically in the low teens.

So you can do the math.

It is down slightly, not huge.

Okay.

Thank you.

Thanks, Joe.

And we will take our next question from David Strauss with UBS.

Good morning, thanks.

Greg, could you maybe touch on the outlook for Otis new equipment shipments, as you think about 2010?

I think you had previously guided, originally we started thinking about flat, then I think you talked about down 5 to 10.

Just given the order rates you are seeing now, how do you think about Otis new equipment in 2010?

I think for this year we expect Otis new equipment to be down kind of in that 10-ish percent range.

It was down 9% in the quarter.

And certainly with orders down around 40% on the new equipment side, that 9 or 10% down will play out next year.

So I think again, another 5% down next year is probably in the realm of reasonableness.

I think part of the question here is how quickly China recovers.

China accounts for a third of the new equipment business at Otis.

So even though we have got these big order rates coming down, China is recovering, as well as there were a lot of deferrals at the end of this year, that will probably play out next year.

So as we are thinking about it, I think there is obviously pressure on new equipment next year.

I would say 5%, but it is a little early, and we will come back obviously at the end of the year with some better visibility there.

And then on the revenue side overall for this year, order rates are relatively stable sequentially, yet you are looking at, I guess, in the second half of the year, that revenues are going to actually increase I think 10 or so percent sequentially, second half versus first half of the year in total.

What specifically, other than a little bit of a benefit of the FX side.

What else is going to be driving that, what kind of gets better on the revenue side in the back half of the year versus the first half of the year?

FX clearly is a big driver as you pointed out, David.

The other factor is that there were, sequentially we do have some improvement in the second half, particularly in our commercial construction-related industries every year, because more projects get completed in Q4, as people are running to complete their budgets, if you will.

There is some seasonality which we see every year in our business in the second half versus first half sequentially.

On a year-over-year basis I would point out that the benefit from easier compares, if you recall Pratt spares were down mid-teens in third quarter, similarly Carrier organic revenue was down 7% in fourth quarter.

So we are coming off of some easier compares, better FX, and just the normal seasonality of the businesses.

Okay.

And the last one, Greg , what was the net pricing benefit if you had one on the quarter, how much was it in

Yes, there was a small net pricing benefit.

It was about $40 million for the quarter across the business.

Great.

Thanks, guys.

Thanks, David.

And next we will hear from Jeff Sprague with Citigroup.

Thank you, good morning.

I would like to get into the restructuring a little bit more.

Greg, you mentioned kind of furloughing, and other actions kind of driving the 350 in Q2, versus the 200 in Q1.

I just wonder if you can kind of separate what is going on, in terms of kind of structural cost reductions, relative to things that will eventually kind of swing back the other way, when we do get a volume turn.

If you think about it, the $350 million of savings we talked about in the quarter, about a little less than $150 million of that came from actual restructuring, which I would consider to be structural type of cost takeout.

We have also, of course, had a lot of just cost control, cost containment.

We have seen, for instance, travel, that is down more than $50 million in the quarter.

We have seen the benefits of furlough across all of our businesses, and furloughs, simply people taking days off without pay.

I think every one of our businesses have done that.

We are also seeing the benefit of net attrition.

In fact, attrition is more than 3,000 people in the quarter, year-to-date rather, and we are just not backfilling those jobs.

We have also deferred merit increases out of the year.

So if you think about it, some of that will obviously come back.

I would say, two-thirds of our savings is probably, two-thirds of the savings, rather is structural, and one-third is probably timing that will come back.

You also have to point out I think that the employees have been remarkably good about all of the cost takeout.

There has been a lot of sacrifice across all of the businesses, from the furloughs, flying coach to Singapore is no fun thing to do, but all of that is part of what we have been doing here to contain costs.

So again, it is good traction.

Of that 350 we will get a little bit of that back, because we will have merit increases, we won't have furloughs forever.

But I would say, roughly two-thirds probably structurally out of the business.

And then if I think about this 700 that you rolled up 300 this year, 300 next, and 100 left in '11, those are all structural cost takeouts, right?

That is correct, those are run rate savings that will repeat year-over-year.

And then kind of changing gears a little bit, I wonder if you could just give us a little more granularity on Carrier, as it kind of relates on the price and cost dynamics in that business.

Jeff, we still saw some pricing benefits in Carrier this year, although we would say, you recall in third quarter last year, US residential Carrier raised prices up to 6% for it's various products, and we are continuing to see some benefits off of that.

The Carrier team will tell you though, that there is increasing pressure, and you would see probably, particularly on US residential side, and on the commercial HVAC side, increasing price pressure in the back half.

However, on the opposite side we would see increasing benefits on the commodities.

As you know, they have a rolling blocking practice with the copper consumption that they have, so the back half benefits on the commodities side, will be greater than they have seen in the first half.

Net/net, I think the first and second half are balanced, the dynamics are just different.

Pricing more in first half, less in second, gross commodities less in first, and more in second.

Finally, Greg, when do you pull the lever a little harder on share repurchase, if the deals don't start to materialize?

Hey, guys, that is clearly a second half action for us.

You can see we are really pretty light to the $1 billion guidance right here.

Quite frankly, we have been conserving cash in the first half of the year.

Cash was very, very light, as you remember back in the first quarter.

I would expect you see share repurchase run rate ramp up here in the third and the fourth quarter.

Just actually one more quick one if I could.

Given the growing importance of Chinese new equipment as it relates to Otis, any update on kind of service attachment rates there?

Are you making any better progress on the market side?

Yes, service has been growing at a slightly faster rate than new equipment.

But this is a long-term opportunity for us.

It is not something which will happen in a quarter, or a year even.

We think the installed base that we are creating in China, will help Otis over the long time over many, many years.

Thank you very much.

And moving on we will hear from Deane Dray with FBR Capital Markets.

Thank you, good morning.

Greg, if we compare your commentary back in march about M&A, there are expectations that you might seem a bit more aggressive going after deals.

And since then, the tone has gone back to a little bit more of the placeholder comments, staying disciplined.

Give us a sense of what the pipeline looks like, were there deals closer that you thought you might get in the beginning of the year, and how do you expect that to play out?

I don't know that we have been any less disciplined, or more disciplined.

I think it is just typical UTC acquisition reviews.

We were hopeful I think earlier back in March when we saw equity prices so low, that there would be opportunities for us to do some deal,s that quite frankly would be very accretive to the business.

But it is taking time, and quite frankly, it may take some more time.

I think people's expectations of price have not really come down to what the level of their stock price is, and so we are just going to wait this out I think again.

We don't expect the economy to recover any time soon.

We expect as these 52-week highs go into the rear-view mirror, people will become more receptive to some of the discussions.

It is a very full pipeline.

I think we have got a lot of good targets out there.

But it just takes time.

So I wouldn't say that we have toned down the aggressive nature of the pursuit.

It is just simply a realization as we get here in July.

It is going to be probably tough to get a lot of things done yet this year.

That is helpful.

If I could just go back to Otis for a moment, the 8% decline in backlog, how do you measure that in months, versus where we were in the beginning of the year?

Given the decline being of about 9 to 10% in new equipment revenues, I would say the 8% decline, the backlog is still about 12 months' worth of revenues expected, based on the 8 to 10% decline we talked about on new equipment.

Still about 12 months worth of backlog.

Great.

Any commentary regarding quote activity , and then obviously it doesn't look like you have seen a lot in the way of push-outs or deferrals, but any comments there would be

I think it is clearly, in China there is clearly a lot more interest, lot more dialog with the customers, project developers, et cetera.

I would say geographically Europe has been pretty consistent at a low level.

And same in the case of US, which had very, very tough compares in the second quarter, but the activity level is pretty stable at low levels there.

But China and Asia is showing some increasing signs of discussions with customers.

Great.

Thank you.

Next we will hear from Cal von Rumohr with Cowen & Company.

Your R&D, are you still looking for it down $100 million for the year, given that it was down as much, it was kind of as low as it was in this quarter?

We were down $50 million or so, and $53 million year-to-date.

You will remember first quarter was essentially flat.

We still expect down $100 million or so for the year.

So probably the third and fourth won't be as dramatic as what you saw in Q2.

But we will also see a ramp up on spending on the back half of the year on the C-series, as well as the MRJ.

That will be good news.

We will see a little bit of a ramp down on 787, which will offset some of that.

So I think the other piece is probably Columbus, with that being deferred by Cessna, will also take some of the back half pressure down.

So 100 million still seems about right.

You would still see a sequential build as we go through the year?

Yes, absolutely.

It is a normal seasonality guide in the engineering spend.

Okay.

Okay.

And do you have any recovery from Textron for the cancellation of Columbus?

I believe the program has been deferred as opposed to cancelled, and as a result, we are actually continuing to work on the core of that engine, because the core to the Columbus is the same core as we are using on the MRJ, so it is not as much of a savings as you otherwise think from the deferral of that platform.

Okay.

And you talked to Jeff's question about one-third of the savings were kind of timing related things, like merit deferrals, so that is basically, what like $110 million or $120 million, something like that.

Should we expect that timing impact to continue at that level in the third and the fourth quarters?

And you mentioned it is probably going to come back at some point, how should we think about it coming back next year?

Clearly, I think the pressure on cost is not going to let up this year, and I would even tell you into next year as what he don't see a recovery in the markets, there is going to be this continuing focus on cost.

It is really nothing new to UTC.

We have been doing this stuff for a long time.

We have done $3 billion of restructuring over the last 10 years.

The furloughs and the merit deferrals, those are a little bit tougher, but you may see some furlough activity next year if the aerospace markets don't recover.

Merits, obviously that will come back a little bit next year, for headwind.

But I would actually, I wouldn't think all of that is going to come back next year.

You may see a piece of it obviously, but not the whole 30% or so.

Okay.

And the last one, I mean, you have this huge cash flow in the quarter, and yet you didn't buy very much stock.

Was that just timing that the cash flow came in the back part of the quarter, and you were blocked out, because of reporting the earnings early on when the price was so low?

How come you were so cautious on share buy-back?

I would tell you that we entered the quarter after the kind of the disappointing first quarter cash flow performance, and we were a little bit leery of ramping up share repurchase right away, until we saw what the markets were going to do.

Obviously as the quarter progressed we started taking up share repurchase, as the price is hovering there in the kind of low 50, high 40's.

Also a big piece of the cash flow in this quarter came from collection activity.

That is something that really because back half of the quarter loaded.

So back half cash wasn't very strong.

And we also took the opportunity to fund the pension plan by that 400 million, and we had planned to do 400 million for the year, but only going to do a couple of hundred million in the quarter.

We saw the strong cash coming in.

The best thing to get behind us was that pension contribution, that earns us 8.5%.

Share repurchase, we will be aggressive in the back half of the year, with the price remaining in this mid-50's range, it is still a very, very good deal for us.

I would expect to see that much more aggressive back half.

Thank you very much.

We will take our next question from Doug Harned with Sanford Bernstein.

Good morning.

Hey, Doug.

On the overall restructuring gains, when you went to the lower end of the range, the 200 million to 350 million down to 200 million, what led to that?

Is this just taking longer?

Is the opportunity less?

Yes, we actually we had seen, or had visibility to, I will say a sizeable back half gain, that looks like it is just going to get pushed out into 2010.

And because we had given the forecast of 200 to 350, as we were going to close out the quarter here, it really became apparent we weren't going to get this last transaction done this year.

So it is just a timing issue.

What is pushing that back?

Just the completion of the deal, and I really can't be more specific, Doug, other than to say it is a deal that we looked to close sometime in the back half of the year, but probably won't see the gain until some time next year.

Okay.

Okay.

And then on pricing you described the pricing benefit, and then I would assume at Carrier you are getting some benefit from efficiency incentives related to residential.

If you look overall at Carrier and I would say Fire & Security and Otis, what are you seeing as the pricing trends in the market, and how are you responding to those trends today, in terms of your aggressiveness on pricing?

Pricing has become very difficult, I would tell you, at Otis in the new equipment.

It is always difficult in China.

I would say there has been no let up there.

We have also seen pricing pressure in North America and in Europe, and again, as the volumes have come down, the competition has of course ratcheted up the price pressure.

So we are seeing pressure there.

Really no different at Carrier on the commercial side, again we are still seeing price pressure there.

As far as the efficiency from the stimulus program, we are actually seeing a big increase in our SEER 15-plus product, more than 30% increase year-over-year in volume there.

That has actually been a plus for us.

Obviously the higher-tier SEER product is higher margins for us, so not as much price pressure there.

Still a lot of price pressure at the low end, as you can imagine, with the amount of excess capacity in the residential HVAC here in the US.

One thing on Hamilton Sundstrand, this is the unit that, other than Sikorsky, you talked about the least amount of restructuring effort, but it looked like there was a fair amount in Q2.

What specifically are you going after in Hamilton Sundstrand in the restructuring area?

Well, I think there are really two areas.

One is on the industrial side.

They have been very aggressive in terms of taking out capacity on the industrial side, and taking out people, as well as Elaine Belmar has just been taking out overhead costs.

I think they are reducing overhead, or G&A type positions by 17 or 18% up there.

We are talking about structural takeout, that is exactly what they are doing up there.

I think they have spent over 50 million year-to-date up there on restructuring, and I would expect more in the back half of the year, as well.

Great.

Thank you.

And next we will hear from Howard Rubel with Jefferies.

Thank you very much.

I want to go first to restructuring for a moment.

When we look at the natural class statement, Greg, when we look at SG&A as a percentage of sales, it is 11.9% in the second quarter, versus 11.1 in the year ago numbers.

I know a chunk of it is the restructuring items in there.

Can you give us a sense of what you would like to target for SG&A going forward, so that we can actually get a tangible sense of the improvement?

I think what you see in the quarter, if you back out restructuring for both this year and last, you will actually see that SG&A as a percentage of sales is down to about 11.1 from 11.2 year-over-year.

That is what you are going to continue to see, is that trend of holding SG&A as a percentage of sales down slightly quarter-over-quarter.

The thing about taking out 17% of your revenues, and holding SG&A flat to slightly down, that means we are taking out a huge amount of SG&A.

And I think that trend is going to continue here in the back half of the year.

And so the goal really is that when volume comes back, it will just drop to the bottom line?

That is the idea.

And then to talk about inventories, this is always the promise, and never quite the result.

It always seems to be one area or another that is not.

Could you sort of talk through some of the business units where, I mean you talked about aerospace still being a challenge.

What is it in particular?

We have seen this destocking at the back end of the channel fairly substantially.

Why can't you get ahead of the curve?

I think we in fact the businesses, especially Carrier and Otis, have gotten ahead of the curve.

I look at Carrier performance year-over-year their inventory is down over $600 million.

Obviously the market is down, but even sequentially Carrier was down almost $200 million.

Otis took inventory down, F&S took inventory down, both sequentially and year-over-year.

The real challenge remains on the long lead aerospace side.

I think that is the continuing frustration of inventory here.

And Pratt has been working very hard on it, but they still saw inventory go up sequentially just a little bit.

And Sikorsky saw more than $200 million of growth on inventory.

Really good work by Ari and his team on the commercial side, in terms of getting inventory down.

And Jeff down at Sikorsky is faced with a different problem, and that is a good problem of having a lot more volume.

So his inventory continues to go up.

His turns are nothing special.

They are aware of that, and they are continuing to work on it.

And then just a follow-up on Carrier, the fact that you were down sequentially 200 million with the usual seasonal build, means the turns were up fairly sharply then.

Yes.

And then last, could you just talk about transportation a little bit?

I mean, I remember at the Analyst Meeting, the surprise by Geraud, at just how bad the numbers were.

Could you talk about the environment, and what you have done to improve it?

I know those run sustainably low levels.

The numbers that Geraud talked about back in March, he talked about truck trailer and container being down 70 or 80%.

Obviously they have recovered from that level.

I think Transicold for the quarter was down for the quarter, was down just about 40% or so.

A little less, about 35 or 40% in terms of orders.

And we still see container being very, very weak.

Truck trailer North America has gotten a little bit better, and even in Europe truck trailer, we are start to go see some signs of activity in that market.

You have got to remember the underlying demand for refrigerated transport, as best we can tell is only down 2 or 3% around the world.

So the fact that we have seen this remarkable reduction in order rates, in my mind it is a temporary thing, because if demand is there, eventually we will see orders come back.

Part of it is of course the credit markets.

We have been talking about this for the last few months, the unavailability of credit is really what is hurting that business.

The shipping business, of course, is in trouble.

There is lots of excess capacity out there.

Everybody is constrained by capital.

But until the credit markets really free up, and our customers have access to credit again, I think we are going to see a pretty tough market there.

Again that will come back.

Underlying demand has not evaporated for refrigerated transport, that is foods and medicines being moved around the world.

We like the business long-term, it is just a very tough year.

One last thing, is if you were to kind of look at all of your businesses, are there any managers that are coming to you, and saying I would like to either add some hours on direct labor, or hire some people in direct labor?

I know I am being optimistic, but I am sorry.

You are being.

I am sorry, this is one area you might see it first, or in service at Otis?

Service at Otis continues on the maintenance side to be a strong business.

But even at Otis we are taking head count out, as we continue to drive productivity in that business.

It is not the time to be adding direct labor, or any kind of overhead right now to the business, and obviously the idea here is to get productivity as the markets improve, and not bring back all of the people that are being let go now.

I would tell you around the business, we are not adding much if any, anywhere.

Thanks, Greg.

Thanks.

And we will take our next question from Joseph Campbell with Barclays Capital.

Hi, good morning, Greg, Akhil, and Maria.

I wonder if you could talk a little bit about Europe?

You have talked about China coming back.

What is happening in the developed economies of Europe, and say northern Asia for you?

I think Europe has been very slow.

We look at both at Otis and at Carrier, and we are not seeing many signs of life in any of the European markets.

I think Spain has been particularly bad.

Italy not much better.

Ireland, of course, has been down because of the housing bubble there.

Eastern Europe still looks to be promising, although Russia with the commodity meltdown we have seen over the last 12 months, we have seen a fairly large contraction in order activity.

So I think our own view is Europe is probably behind the US, in terms of the timing of the recovery.

And we would expect to see it here first, so I just don't have much good things to say about Europe.

I guess the Tour de France is going on, so we can say that.

But other than that, not much good activity.

And on northern Asia?

Korea actually has come back a little bit.

Otis saw some good traction there in Korea in the quarter.

Japan not so much.

Japan was down significantly, but as far as China, we already talked about China, but those are really the two other big markets for us in northern Asia.

And then just switching to aerospace, Boeing and Airbus, perhaps surprising to many, continue to stick to their no cuts, or if any modest cuts.

Are you thinking along the same lines, if you revise your OE outlook upward, other than 787 shipments, or are you still thinking that Airbus and Boeing will probably have to make some cuts?

We are continuing to work with both Boeing and Airbus on the long lead production items.

I think we all realize that with air traffic down 7 or 8% this year, there is probably a lot of excess capacity, and at some point, we believe that volumes will have to come down.

At the same time, you still look at the backlog I think there is almost 7,000 aircraft in backlog between the two.

So long-term demand remains strong, but we would not be surprised in fact if we saw a cut in production next year, or at the latest 2011.

But right now we are working very closely with them.

I know they are both concerned about suppliers making cuts in productions, so they can't be supported, so we are making sure we have got the long lead items in place, but I think from a financial planning standpoint, we are pretty cautious about the near-term outlook, I would say, for production.

And on the small engines, Greg, there is a lot that has been announced.

Are you thinking that we have kind of seen it, and we get down to these new lower, much lower run rates, and then we kind of hang out there?

Or is the small engine business a place where there is another round of output?

I am not talking any one guide, but just collectively across the board here?

I think what we would fully expect is another down year next year.

But you would get that if you just see, the back half of the year is just down from the front half and from Q4 last year.

And what I am asking is, now that you are down there, does it sort of hang out at those rates, or does it take another notch down from sort of the Q4 levels?

I think what you are going to see is a continued reduction in the run rate of engine production at Pratt Canada.

What is driving the biz jet market is what is driving our transport refrigeration business, and that is customers can't get credit.

On top of that, the corporate profitability is a great precursor, in terms of when business jet production will increase.

We wouldn't expect that to increase in 2011, or maybe even 2012.

You have also got of course a lot of used planes on the market.

So it is a tough market.

I would not be surprised to see run rates come down again, even into next year as the OEMs build out their backlog this year, and try and pull airplanes into this year for delivery, to fill slots that they are building.

So it is a pretty tough market, and I would not expect it to be any better next year, probably a little worse.

Great.

Thanks very much, Greg.

And we will take our next question from Myles Walton with Oppenheimer & Company.

Thanks, good morning.

I was wondering if we could focus on Otis a bit, in terms of the EPS guidance revision there.

Nice upside to prior expectation, obviously the top line coming in lower than previously expected.

I know one of the moving parts would be FX, but can you walk us through that 75 million to 125 million, improved outlook at Otis on the EBIT side, how much of that is FX?

Actually, Myles, if you look at it, their revenue decline would result in some margin impact as well, and that has been pretty much more or less offset by the strong execution on the cost side and the restructuring, and other actions that they are doing on the field performance.

So big strong cost reduction benefits offset pretty much entirely the negative impact from volumes, and then the improvement is pretty much all FX, if you look at it.

So benefits of cost reduction and field performance offsetting volume decline, FX improvement flowing through to be improved guidance.

Got it.

Okay, perfect.

Greg, to put in context about OE Otis being down 5% maybe next year, in a constant FX environment, even under that scenario, could you see Otis up?

Oh, absolutely.

I think again just because OE production is down, doesn't mean we are going to stop driving costs out of the business.

You also got to remember, 55% of that business comes from the service side, which traditionally continues to grow.

You have got 1.6 million elevators under service contract around the world, and that population continues to grow at 2 to 4% every single year.

So between productivity improvements, cost reduction in our factories, and the service side of the business, we would certainly expect Otis to grow earnings next year.

And could you give us a little bit of color on the portfolio shaping you are doing at Carrier, both from a standpoint of how much of these businesses that you are shedding or spinning into JVs where sources of restructuring spend in the past, that won't be there on an ongoing basis, and also kind of the size of the further portfolio shaping to come?

We have taken about $1.1 billion of revenue out of Carrier on a run rate basis so far.

That includes the transaction we did earlier this year with GL Byer, to get rid of our European commercial parts refrigeration distribution business.

That includes the part that we joint-ventured with Watsco, and also the exiting of the commercial refrigeration business here in the US.

In terms of restructuring we have done some restructuring as part of the exit of those activities.

It has not been a source I would say in the past of huge restructuring spend though.

So I wouldn't expect that to be any kind of year-over-year change in restructuring.

What we said all along is that there is probably another $1 billion of additional revenues to take out, and Geraud and Ari have been working on that.

They have talked about that plan at length.

It takes time to execute.

But I would think over the next 12, 18, 24 months, you would see that continuation of the more focussed Carrier start to emerge, and again, it is not magic; it is just a lot of hard work and focus.

All right.

That is great.

Thanks.

And next we will hear from Ron Epstein with Bank of America.

Hey, good morning, guys.

Morning, Ron.

Greg, you have been I guess very cautious about the economy, in terms of talking about stabilization.

What would you have to see to become more positive?

Well, that is a great question, Ron, because I think we are all looking for the positives in the economy.

Clearly consumer confidence, and the leading economic indicators are pointing upward.

Unfortunately what is happening is that consumer spending, or savings I should say, continues to soak up some of that good news out there on the economy.

I think when we start seeing credit return to more normal levels, and when our customers aren't saying that, look, we would love to place an order, but we can't have access to credit, that will be the real sign for us.

And we will see it in some of our short cycle businesses.

We will see it at Transicold, because again, underlying demand is there.

I think we will see it obviously in the housing market as well, and mortgage rates are at record lows here, and we are still only talking about 550,000 or 560,000 new housing starts this year.

So again, we hear some good news, there are some things out there that might give us confidence that things will get better.

But quite frankly, as we look at the order rates today, and we look at the underlying in availability or unavailability of credit, I think we are still very cautious about any type of return to growth next year.

Okay.

And then maybe just one follow-on quickly.

The geared turbo fan, can you just give an update on how that program is going, and how the test went at Airbus, and what we should think about it?

The tests last fall at Airbus, I think we gotten all of the data back, and the test program exceeded everybody's expectations, in terms of the fuel burn, and in terms of the noise levels of the engine.

I think everybody was very excited about those results.

Right now we don't have an engine on test for the C-Series.

We won't have an engine on test for either the C-series or MRJ until next year.

But we are continuing with the development program.

We have about 20,000 cycles of testing now done on the gear set, which is of course the heart of the geared turbo fan.

As we have taken that apart after those tests it all looks excellent, in terms of the predictability of the wear on the unit.

So making progress, the spending will ramp up the back half of the year, it will increase again next year as we get first engine to test.

I tell you right now we are all on track, and there has been no show stoppers in terms of technology development.

Great.

Thank you.

Thanks, Ron.

We will take our last question, please.

Our final question will come from Heidi Wood from Morgan Stanley.

Good morning.

Greg, I actually want to get your thoughts on sort of a bigger picture item on Pratt.

Can you talk a little bit about what you see as sort of the long-term margin potential structurally there?

I mean, as we look at the puts and takes, I am just wondering about the feasibility of the high teens margins at Pratt.

I know it has been something that you guys have long had a goal on, and there is always something that interrupts it, and every year you take restructuring charges, and I know R&D is coming down, but if we think over the next several years with the installed base continuing to decline, and it looks like the CFM engine venture really hasn't panned out, Pratt and Whitney Canada is coming down, your military engines volumes are probably flat to up, but do you have the structural underpinnings to get to those eventual high-teen margins?

Yes.

(laugher).

My second question is--

Heidi, come on, I think if you take a look even at this quarter, over 100 basis points of margin expansion in a market where you see Pratt Canada down 25%, spares down 25%, those are high-margin businesses, and we still had margin expansion.

Dave Hess and the whole team over at Pratt are focused on this 20%.

I think it is realistic.

You have cost takeout and cost potential, from low cost sourcing on the engineering side.

You have got low-cost manufacturing that we have done in Poland.

You have also got a very strong future because of the JSF, remember, that is a huge program.

We are not going to see a big benefit until probably 2013, but clearly there is margin upside to the 20%.

Pratt's military engine business is great.

The small-engine business is wonderful.

And even the commercial business with the GTF, it will return to high levels of profitability in the future.

So 20% is not out of the question, and Dave is not letting his foot off the gas there.

They will get to it.

Can you refresh us as to what your installed fleet of large commercial aircraft engines is today, and what it will be in the next couple of years by your estimates?

About 16,000 engines today.

That includes a few that of course have been parked, but about 16,000 out in the fleet.

That is obviously declining every year, as some of the old JT8s and JT9s get retired.

I don't know that we have an actual forecast of fleet size, but we can get back to you with that.

Basically you are saying that the low-cost sourcing and the manufacturing changes in Poland, and the growing volumes in military, are going to help more than offset the change in the installed, the decline in the installed engines that you have now?

If you think about it, Heidi, and we have seen a dramatic decrease in profitability associated with a big piece of that installed base, that is the JT8s and JT9s, a couple of years ago, in 2001 that was $1 billion of revenue.

Two years ago that was 350 million.

This year it will be less than 200 million.

I would tell you that most of that, which you would be concerned about, has already happened, and Pratt has been able to overcome it.

The V2500, parts continue to be very strong on that program.

And you have got enough other things in the hopper to offset this.

They have done a good job over time.

It is not just something that will just fall off the cliff right away.

No, I don't say fall off the cliff, but it is interest to go see what has happened between Hamilton Sundstrand in 2001, and Pratt and Whitney where margins just continue to be, I mean you are fighting a good fight at Pratt, but it seems it is always hard to get above a sustainable 16% and higher, and volumes doubled at Hamilton, and gone from sort of 13, 14% on to 17, whereas Pratt Whitney in early 2000 and 2001 is doing 16 and 18, and now we are looking at 14, 15.

Again, with sales just about doubling.

So I am wondering, we think about the global recovery, and aftermarket demand picking up, whether Pratt Whitney was going to see the benefit, as well as whether that benefit was going to be feasible.

Come on, we like this challenge.

This is what we come to work for to do every single day, is to drive margin improvement at each of the businesses.

Obviously Hamilton is maybe, they have had a little bit better recovery over the last five or six years, they are on more aircraft around the world.

Pratt has done a tremendous job in terms of offsetting the decline in that old installed base, and driving cost reduction.

You think about low cost sourcing that Pratt has done, it has been tremendous, both on the engineering side and the factory side.

And there is more of that to come.

So 20%, Dave is going to get there.

Heidi, also remember that collaboration accounting drives margins down effective this year by almost 100 basis basis points for Pratt.

That is just an accounting change, that is not in operational.

That is fair.

Greg, will you give us a sense as to how many years from now we could look for that 20%?

That a great question to ask Dave when you see him next March.

All right.

Thanks very much.

All right .

I want to thank everybody for listening into the earnings call today.

Obviously a tough market out there, but I think what you have seen here is tremendous execution across all of the businesses, and 50 basis points of margin expansion in this market is really something remarkable.

I thank everyone for listening, and we will be in touch over the next couple of weeks.

Thank

Once again, ladies and gentlemen, that concludes our conference today.

Thank you all for your participation.