United Technologies Earnings Call Nuggets: Sikorsky Aircraft and Impairment Charges in CC&S

United Technologies Corp (NYSE:UTX) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Sikorsky Aircraft

Jeffrey Sprague – Vertical Research Partners: Greg, can you just elaborate a little bit more on Sikorsky for us, so the charge in the quarter is basically just late fees as it were because the deliveries didn’t happen?

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Gregory J. Hayes – SVP and CFO: Yeah. Let me take you through. Really, the charge was related to all the costs that we foresee related to what we believe will be later deliveries than contractually required. As you know, we are supposed to deliver all the aircraft this year the final 19. We didn’t deliver any next year’s. So, our expectation, our assumption now is that we will deliver the helicopter over the next three years. We’ve put a placeholder of 8, as you know, for each of the next three, which we think is a reasonable schedule for both ourselves from a production standpoint and the customers’ from a delivery standpoint. But having said that, we recognize that there are cost contractual revenues that we’ll have to cover as it relates to the Canadian government and then we’re going to also have fewer flight hours and we’re probably going to have some cost on the program related to that longer timeframe. So, really three pieces; there’s some contractual relief cost, there’s some flight hour degradation, and there’s just some additional program costs and all that added up to the $157 million charge.

Jeffrey Sprague – Vertical Research Partners: But we still absorb, whatever it is, $4 million a unit as you ship those 8 a year over the next three years, correct?

Gregory J. Hayes – SVP and CFO: Yeah, it’s $14 million a year. Again, we should point out, we obviously can ship more than just the eight a year. We can probably deliver most of the helicopters this year. We just don’t think that that’s practical. I think Mick and the team have made some really good progress in the last month since Louis spoke in having discussions with the Canadian government. And I think, again, we’ll hear some good news coming out of Mick in March.

Jeffrey Sprague – Vertical Research Partners: And just on share repurchase, you said you started here in January. Obviously the cash has been strong. Do you have a little bit more leash with the rating agencies to try to at least kind of fully arrest share creep in 2013 or potentially even go further than that?

Gregory J. Hayes – SVP and CFO: Well, I think, we’ll certainly be able to arrest share creep with the share buyback that we’ve got. As you know we’ve got a placeholder of $1 billion for share buyback this year and $1 billion for M&A. As I think about the cash, we’re still going to see about $1.5 billion of cash proceeds coming in from these divestitures that will close here in the first half. We ended the year with strong cash flow, over $5 billion on the balance sheet. We’ll have strong cash flow for the year. So, I think thinking about the (calls) on cash, we’ve got $2 billion going to dividends, we’ve got $1 billion for share buyback, we’ve got $1 billion of debt that’s due in December, that’s the 18-month floater. We’ll certainly be in position to pay that. We’ll probably pay down another $1 billion of debt, so (stuff) that’s due in ’15 or ’16, and then we’ll talk to the rating agencies about talking up the number. But I think cash flow is very strong, stronger than what we expected and, of course, (my boss) is pushing me to do a lot more than a $1 billion but it’s January, so we’ll see what happens.

Jeffrey Sprague – Vertical Research Partners: And then just finally and then I’ll move on. Just can you elaborate a little bit more on the complexion of what you’re seeing in Otis China, whether its primary cities, secondary cities, residential versus non and anything to add there about how things are playing out?

Gregory J. Hayes – SVP and CFO: I think, again, as we talked in December, where we’re seeing the growth is in the western provinces. Along the coast I think the residential investment has picked up a little bit, but the real strength we’re seeing is on the residential side in the, I’ll say, the third and fourth tier cities. This factory in Chongqing that we just opened in September of last year is probably fully utilized. I think, we will ship about 10,000 units out of there this year. So that’s really where the growth is coming. It’s from the west and nothing new. I think it’s a same phenomenon we saw last year, but we’re also seeing I think just an uptick in the overall economy in China. It wasn’t just Otis that was strong. CCS had a very good fourth quarter from an order rates perspective there.

Impairment Charges in CC&S

Howard Rubel – Jefferies: Just two questions hopefully. One is you talked about impairment charges in CC&S. Could you give us a ballpark idea of what you’re close to selling or dispensing with, so we can think about next year’s baseline in that business?

Gregory J. Hayes – SVP and CFO: I think we had a placeholder of about $800 million of divestitures. I think we’ve got, Jay, about $55 million of those?

Jay Malave – Director, IR: A little bit less than that, yeah.

Gregory J. Hayes – SVP and CFO: About $500 million of that last year. So we’ve still got a little bit to go. I think we took a $65 million impairment charge on a number of the – some of the legacy FNS businesses and I think as Louis laid all that out for you back in September in terms of the listing of those businesses, so no surprises. I suspect most of the transformational – the portfolio of transformational probably done in the first half, some of them will linger into the back half, but I think they’ve got a pretty good line of sight and that will be done this year.

Howard Rubel – Jefferies: So, you actually – if we kind of look at what you have here than just your 15% margin is almost the low hurdle not to give you too hard a time about that?

Gregory J. Hayes – SVP and CFO: You wouldn’t be giving me a hard time about that if you were to say that because I think again Carrier just based on their guidance is going to hit 15% this year, assuming their markets come back as we expect. So, the integration of Carrier in FNS is from across without a hitch, so, I think 15% ought to be very achievable, if the markets cooperate.

Howard Rubel – Jefferies: Then on Sikorsky, if we exclude all of these – I know for Canada you can’t exclude the $157 million, but for us, we can back that out and you end up with something north – something around 16% operating margins in the business unit. Was there just some (Indiscernible) and maybe some absence of R&D and I know you sort of alluded to a lower decline year-on-year in the business. Could you talk a little bit about what I’ll call core operating performance?

Gregory J. Hayes – SVP and CFO: I think core operating was actually very good at Sikorsky, we delivered 91 aircraft into the fourth quarter. It’s a huge number of aircraft. I think we delivered 242 or so for the year and 91 of that was in the fourth quarter. So, a lot of shipments again profitable, we saw good shipments on the commercial side. The S-92 is going out. We saw the S-76, I think we delivered four of those in the quarter. So, it’s really just a very strong quarter and you recall again the operating performance in terms of profit growth is not very strong throughout the year. So, all of the profit growth came in the fourth quarter.

Jay Malave – Director, IR: Howard, they had nice mix, good restructuring benefits, and also just as a reminder, strong backlog as we go into 2013.

Howard Rubel – Jefferies: But some of it is price and some of it is some permanent cost reduction?

Gregory J. Hayes – SVP and CFO: Yeah, exactly.

A Closer Look: United Technologies Earnings Cheat Sheet>>