They did it.

Engineering conglomerate United Technologies (NYSE:UTX) extended its string of "earnings beats" to a lucky No. 7 last week. Unfortunately for shareholders, the luck well ran dry at about the same time. Although the company walloped analyst estimates and raised its own projections for next quarter, owners today are sitting on shares worth 3% less than they were before the Q3 2006 earnings report came out. Let's find out why.

  • Quarterly revenues were up 12%.
  • Per-share profits grew 22%.
  • Free cash flow grew faster still, up 30% for the quarter, to $1.2 billion. That's a welcome change from this year's first half, in which free cash flow fell steeply in comparison to last year. Year-to-date free cash flow is now basically unchanged year over year.
  • The company expects to crack the ceiling on its projected 14%-17% annual earnings growth, and now promises between 17% and 18% ($3.65-$3.69 per share).

As you'll recall from last week's Foolish Forecast (and as already mentioned above), UTX had been having a tough time of things in the free cash flow department before this quarter. Regardless, in the Q2 earnings report, CEO George David reiterated his promise to generate free cash flow equal to net income by year's end. Based on the firm's earnings guidance, I'm guessing that UTX wants the latter number to come in around $3.7 billion this year. So with three of the year's four quarters already over, what are the chances that UTX can generate $3.7 billion in cold, hard cash profits by December?

Judging from the run-rate, it looks unlikely. UTX now has $2.5 billion in free cash flow under its belt, and another quarter looks likely to bring total free cash flow to no more than $3.4 billion. Indeed, even if next quarter's free cash flow grows at the stellar 30% rate it achieved in Q3, we're still going to end the year at "just" $3.5 billion.

The problem, in this Fool's eyes, is that UTX has failed to address the "working capital build" that David mentioned last quarter (a consequence of its building up lofty levels of inventories in aerospace businesses). Firmwide inventories that were up 17% year-over-year at the end of Q2 were up 21% in last week's report -- so we're moving in the wrong direction. Whether this is because aerospace inventories aren't getting sold down as quickly as planned, or because the self-described weaknesses at Carrier and Sikorsky added working capital woes of their own isn't clear -- because unlike last quarter, David didn't address the inventory issue at all in last week's earnings report. What is clear, though, is that the more cash the company ties up in unsold inventories, the less free cash flow it can generate -- putting David's credibility at risk ... unless he pulls a rabbit out of the inventory pile next quarter.

What did we expect out of United Technologies last quarter, and what did it produce? Find out in:

And don't forget to check out the performance of UTC's industrial peers:

  • Armor Holdings' (NYSE:AH) results are digested here.
  • General Dynamics' (NYSE:GD) are here.
  • And Embraer (NYSE:ERJ) had some interesting news lack week, too. Read it here.

Embraer is a recommendation of Motley Fool Stock Advisor , where Tom and David Gardner are always on the lookout for the market's best investments. Try it out for yourself -- it's free for 30 days .

Fool contributor Rich Smith does not own shares of any company named above. The Fool has a disclosure policy.