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UTX > SEC Filings for UTX > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for UNITED TECHNOLOGIES CORP /DE/

Form 10-Q for UNITED TECHNOLOGIES CORP /DE/


26-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

BUSINESS OVERVIEW

We are a global provider of high technology products and services to the building systems and aerospace industries. Our operations are classified into five principal business segments: Otis, UTC Climate, Controls & Security, Pratt & Whitney, UTC Aerospace Systems and Sikorsky. Otis and UTC Climate, Controls & Security are referred to as the "commercial businesses," while Pratt & Whitney, UTC Aerospace Systems and Sikorsky are collectively referred to as the "aerospace businesses."

On September 28, 2011, we announced a new organizational structure that allows us to better serve customers through greater integration across product lines. Effective January 1, 2012, we formed the UTC Climate, Controls & Security segment which combines the former Carrier and UTC Fire & Security segments.

On July 26, 2012, UTC acquired Goodrich Corporation (Goodrich) pursuant to a merger agreement dated September 21, 2011. As a result of the acquisition, Goodrich became a wholly-owned subsidiary of UTC. The acquired Goodrich business and the legacy Hamilton Sundstrand business have been combined to form a new segment named UTC Aerospace Systems. The results of the acquired Goodrich business have been included in UTC's financial statements only for periods subsequent to the completion of the acquisition. As a result, the consolidated financial results for the nine months ended September 30, 2012 do not reflect a full nine months of legacy Goodrich operations. The acquisition resulted in the inclusion of Goodrich's assets and liabilities as of the acquisition date at their respective fair values. Accordingly, the acquisition materially affected UTC's results of operations and financial position.

Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. The current status of significant factors impacting our business environment in 2012 is discussed below. For additional discussion, refer to the "Business Overview" section in Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2011 Annual Report, which is incorporated by reference in our 2011 Form 10-K.

General

Our worldwide operations can be affected by industrial, economic and political factors on both a regional and global level. To limit the impact of any one industry, or the economy of any single country on our consolidated operating results, our strategy has been, and continues to be, the maintenance of a balanced and diversified portfolio of businesses. Our businesses include both commercial and aerospace operations, original equipment manufacturing (OEM) and extensive related aftermarket parts and services businesses, as well as the combination of shorter cycles at UTC Climate, Controls & Security and at our commercial aerospace aftermarket businesses, and longer cycles at Otis and at our aerospace OEM businesses. Our customers include companies in the private sector and governments, and our businesses reflect an extensive geographic diversification that has evolved with the continued globalization of world economies.

Economic projections indicate minimal growth through 2013 within Europe as it struggles to find a permanent solution to its debt crisis. This uncertainty has adversely affected UTC sales and profit growth due to an unfavorable Euro foreign exchange rate and lower sales volumes in the region. Improvements in economic growth rates in the United States are threatened by the potential for sequestration in early 2013. Unfortunately, it remains difficult to estimate the probability of policy action in the United States, and this uncertainty contributes to lower growth rates in the United States. U.S. Government defense spending, together with the European market, represents over 40% of UTC sales. China's reported third quarter GDP growth rate was 7.4%, which while still strong was its lowest growth rate since 2009 on tightening credit conditions and decreased public investment. Despite the recent lower growth rates, China is projected to generate over one-quarter of world GDP growth in 2013. With an uneven growth outlook, we continue to take preemptive steps to position our business for future earnings growth by further reducing operating costs even as we continue to invest in new product launches and growth markets. As a result, we are increasing our 2012 full year estimate of restructuring costs in continuing operations from $500 million to $600 million.

Discontinued Operations

On March 14, 2012, the Board of Directors of the Company approved a plan for the divestiture of a number of non-core businesses. Cash generated from these divestitures is intended to be used to repay debt incurred to finance the acquisition of Goodrich. These divestitures are expected to generate approximately $3 billion in net cash, on an after-tax basis. In the first quarter of 2012, the legacy Hamilton Sundstrand Industrial businesses, Pratt & Whitney Rocketdyne (Rocketdyne) and Clipper Windpower (Clipper) all met the "held-for-sale" criteria. On June 29, 2012, management of the Company approved a plan for the divestiture of UTC Power. The results of operations, including the net losses expected on disposition, and the related cash flows which result from these non-core businesses have been reclassified to Discontinued Operations in our Condensed Consolidated Statements of Comprehensive Income and Cash Flows for all periods presented. Cash flows from the operation of these discontinued businesses are expected to continue until their disposals, most of which are expected to occur in the second half of 2012. As a result of the decision to dispose of these businesses, the Company recorded pre-tax goodwill impairment charges of approximately $360 million and $590 million related to Rocketdyne and Clipper, respectively, in discontinued operations during the first quarter of 2012, and pre-tax net


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asset impairment charges of approximately $179 million related to UTC Power in discontinued operations during the second quarter of 2012. The goodwill impairment charges result from the decision to dispose of both Rocketdyne and Clipper within a relatively short period after acquiring the businesses. Consequently, there has not been sufficient opportunity for the long-term operations to recover the value implicit in goodwill at the initial date of acquisition. The impairment charge at UTC Power results from adjusting the net assets of the business to the estimated fair value less costs to sell the business expected to be realized upon sale, and further reflects the loss in value from the disposition of the business before the benefits of the technology investments could be fully realized. There could be additional gains or losses recorded upon final disposition of the businesses based upon the values, terms and conditions that are ultimately negotiated.

Acquisition and Disposition Activity

As discussed below in "Results of Operations," our results include the impact from non-recurring items such as the adverse effect of asset impairment charges, and the beneficial impact of gains from business divestiture activities, including those related to the ongoing portfolio transformation at UTC Climate, Controls & Security. Our growth strategy contemplates acquisitions. Our operations and results can be affected by the rate and extent to which appropriate acquisition opportunities are available, acquired businesses are effectively integrated, and anticipated synergies or cost savings are achieved.

During the first nine months of 2012, our investment in business acquisitions was approximately $18.6 billion (including net debt assumed of approximately $2.6 billion), and consisted primarily of our acquisition of Goodrich, an increase of our interest in IAE International Aero Engines AG (IAE) and a number of additional small acquisitions in our commercial and aerospace businesses. We recorded the excess of the purchase price over the estimated fair value of the assets acquired as an increase in goodwill. As a result of acquisition activity in the first nine months of 2012, goodwill increased $11.6 billion, of which $11.2 billion was a result of the Goodrich acquisition.

On July 26, 2012, we completed the acquisition of Goodrich, a global supplier of systems and services to the aerospace and defense industry with 2011 sales of $8.1 billion. Goodrich products include aircraft nacelles, interior, actuation, landing and electronic systems. Under the terms of the agreement, Goodrich shareholders received $127.50 in cash for each share of Goodrich common stock they owned on July 26, 2012. This equated to a total enterprise value of $18.3 billion, including $1.9 billion in net debt assumed. The acquisition of Goodrich and the formation of UTC Aerospace Systems provides increased scale, financial strength and complementary product offerings, allowing us to significantly strengthen our position in the aerospace and defense industry, create aftermarket efficiencies for our customers, accelerate our ability to drive innovation within the aerospace industry, and enhance our ability to support our customers with more integrated systems. This acquisition, coupled with our acquisition of an additional interest in IAE resulting in a controlling interest in IAE, as discussed below, further advances the Company's strategy of focusing on our core businesses.

In accordance with conditions imposed for regulatory approval of UTC's acquisition of Goodrich, UTC must dispose of two Goodrich businesses, which are the electric power systems business and the pumps and engine controls business. These businesses have been held separate from UTC's and Goodrich's ongoing businesses pursuant to regulatory obligations. On October 16, 2012, we announced an agreement to sell the electric power systems business for $400 million to Safran. Closing is expected by the end of the first quarter of 2013 and is subject to regulatory approvals and other customary closing conditions.

On June 29, 2012, Pratt & Whitney, Rolls-Royce plc (Rolls-Royce), MTU Aero Engines AG (MTU), and Japanese Aero Engines Corporation (JAEC) participants in the IAE collaboration, completed a restructuring of their interests in IAE. Under the terms of the agreement, Rolls-Royce sold its ownership and collaboration interests in IAE to Pratt & Whitney, while also entering into an agreement to license its V2500 intellectual property to Pratt & Whitney. In exchange for the increased ownership and collaboration interests and intellectual property license, Pratt & Whitney paid Rolls-Royce $1.5 billion at closing with additional payments due to Rolls-Royce conditional upon each hour flown by V2500-powered aircraft in service at the closing date of the purchase from Rolls-Royce during the fifteen year period following closing of the purchase. The collaboration interest and intellectual property licenses are reflected as intangible assets and will be amortized in relation to the economic benefits received over the remaining estimated 30 year life of the V2500 program. Rolls-Royce will continue to support the program as a strategic supplier for the V2500 engine and continue to manufacture parts and assemble engines. Pratt & Whitney entered into a collaboration arrangement with MTU with respect to a portion of the acquired collaboration interest in IAE for consideration of approximately $233 million with additional payments due to Pratt & Whitney in the future. As a result of these transactions, Pratt & Whitney holds a 61% net interest in the collaboration and a 49.5% ownership interest in IAE. Based on the criteria set forth in the Consolidation Topic of the FASB Accounting Standards Codification (ASC), we have determined that IAE is a variable interest entity (VIE). IAE's business purpose is to coordinate the design, development, manufacturing and product support of, the V2500 program through involvement with the collaborators. IAE retains limited equity with the primary economics of the V2500 program passed to the participants in the separate collaboration arrangement. As such, UTC is determined to be the primary beneficiary of IAE as it absorbs the significant economics of IAE and has the power to direct the activities that are considered most significant to IAE. The consolidation of IAE resulted in a gain of $21 million recognized during the second quarter of 2012 on the re-measurement to fair value of our previously held equity interest on obtaining control of IAE.


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We now expect to invest approximately $300 million in acquisitions in 2012, excluding spending for the acquisition of Goodrich and Rolls-Royce's interests in IAE. However, actual acquisition spending may vary depending upon the timing, availability and appropriate value of acquisition opportunities.

Other

Government legislation, policies and regulations can have a negative impact on our worldwide operations. Government regulation of refrigerants and energy efficiency standards, elevator safety codes and fire protection regulations are important to our commercial businesses. Government and market-driven safety and performance regulations, restrictions on aircraft engine noise and emissions, and government procurement practices can impact our aerospace and defense businesses.

Commercial airline financial distress and consolidation, global economic conditions, changes in raw material and commodity prices, interest rates, foreign currency exchange rates, energy costs, and the impact from natural disasters and weather conditions create uncertainties that could impact our earnings outlook for the remainder of 2012. See Part II, Item 1A, "Risk Factors" in this Form 10-Q for further discussion.

CRITICAL ACCOUNTING ESTIMATES

Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses. We believe the most complex and sensitive judgments, because of their significance to the Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain. Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1 to the Consolidated Financial Statements in our 2011 Annual Report, incorporated by reference in our 2011 Form 10-K, describe the significant accounting estimates and policies used in preparation of the Consolidated Financial Statements. Actual results in these areas could differ from management's estimates. There have been no significant changes in our critical accounting estimates during the first nine months of 2012. During the third quarter of 2012, we have conformed Goodrich's accounting policies to UTC's accounting policies.

RESULTS OF OPERATIONS

Net Sales

Quarter Ended September 30, Nine Months Ended September 30, (Dollars in millions) 2012 2011 2012 2011 Net Sales $ 15,042 $ 14,235 $ 41,265 $ 41,377

The 6% increase in net sales for the third quarter of 2012 primarily reflects the impact of net acquisitions (11%), the adverse impact of foreign currency translation (3%) and organic sales decline (2%). The sales increase from acquisitions was primarily a result of Goodrich and IAE sales, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. During the third quarter of 2012, UTC Aerospace Systems experienced organic sales growth (6%) driven by higher aerospace OEM sales. This was more than offset by a contraction in Sikorsky organic sales (12%), driven by reduced aircraft deliveries from foreign military operations (12%). Sikorsky's organic sales decline in the third quarter of 2012 follows organic growth of 21% in the third quarter of 2011. Our remaining business segments, Otis (1%), UTC Climate, Controls & Security (2%) and Pratt & Whitney (1%) each experienced organic sales declines in the third quarter.

Sales in the first nine months of 2012 are consistent with sales levels in the prior year with the impact of net acquisitions (2%) offset by the adverse impact of foreign currency translation (2%). During the first nine months of 2012, two of the five business segments experienced organic sales growth: UTC Aerospace Systems (8%) and Pratt & Whitney (3%). The organic growth at UTC Aerospace Systems is driven by higher aerospace OEM (6%) and aerospace aftermarket (1%) volumes. Pratt & Whitney's organic growth is primarily a result of higher military engine and aftermarket sales (6%), partially offset by declines in Commercial spares sales (3%). Sikorsky organic sales contracted 12%, in the first nine months of 2012, following 13% organic growth in the first nine months of 2011, driven by reduced aircraft deliveries from foreign military operations (10%) in 2012.


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                       Cost of Products and Services Sold



                                                 Quarter Ended September 30,                Nine Months Ended September 30,
(Dollars in millions)                            2012                   2011                  2012                    2011
Cost of products sold                        $       8,278          $       7,519        $       21,724          $       21,650
Percentage of product sales                           76.4 %                 75.3 %                75.3 %                  74.9 %
Cost of services sold                        $       2,725          $       2,819        $        8,143          $        8,308
Percentage of service sales                           64.8 %                 66.4 %                65.6 %                  66.6 %
Total cost of products and services sold     $      11,003          $      10,338        $       29,867          $       29,958

The factors contributing to the total percentage change year-over-year for the quarter and nine months ended September 30, 2012 in total cost of products and services sold are as follows:

                                        Quarter Ended            Nine Months Ended
                                      September 30, 2012        September 30, 2012
Organic volume                                         (2 )%                     -
Foreign currency translation                           (3 )%                     (2 )%
Acquisitions and divestitures, net                    11  %                      2  %
Other                                                  -                         -

Total % Change                                         6  %                      -

The organic decrease in total cost of products and services sold (2%) in the third quarter of 2012 corresponded to the organic sales decline (2%) noted above. The increase in "Acquisitions and divestitures, net" (11%) is largely attributable to the acquisitions of Goodrich and IAE, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. The year-over-year increase in cost of products sold, as a percentage of product sales, reflects the higher proportion of commercial aerospace OEM sales as a result of lower commercial aerospace spares sales volume during the third quarter of 2012, partially offset by adverse impact of Goodrich and IAE.

Cost of sales in the first nine months of 2012 are consistent with levels in the prior year with the impact of net acquisitions (2%) offset by the favorable impact of foreign currency translation (2%). The 2% increase in "Acquisitions and divestitures, net" is attributable the acquisitions of Goodrich and IAE, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. The year-over-year decrease in cost of services sold, as a percentage of service sales, reflects favorable aftermarket service performance within the aerospace businesses.

                                  Gross Margin



                                             Quarter Ended September 30,               Nine Months Ended September 30,
(Dollars in millions)                         2012                  2011                 2012                    2011
Gross margin                              $      4,039          $      3,897        $       11,398          $       11,419
Percentage of net sales                           26.9 %                27.4 %                27.6 %                  27.6 %

The 50 basis point decline in gross margin as a percentage of sales for the third quarter of 2012 is due to the adverse impact of the acquisitions of Goodrich and IAE (70 basis points) as well as higher restructuring expense recorded in the third quarter relative to the same period of the prior year (20 basis points), partially offset by the disposition of lower margin businesses in connection with the UTC Climate, Controls & Security portfolio transformation (40 basis points).

Gross margin as a percentage of sales for the first nine months of 2012 is consistent with the prior year. The benefit from the disposition of lower margin businesses in connection with the UTC Climate, Controls & Security portfolio transformation (40 basis points) was offset by the adverse impact of the acquisitions of Goodrich and IAE (20 basis points) and higher restructuring expense in 2012 (20 basis points).


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                            Research and Development



                                            Quarter Ended September 30,                   Nine Months Ended September 30,
(Dollars in millions)                       2012                    2011                  2012                       2011
Company-funded                          $        590            $        465         $         1,659            $         1,427
Percentage of net sales                          3.9 %                   3.3 %                   4.0 %                      3.4 %
Customer-funded                         $        508            $        397         $         1,146            $         1,066
Percentage of net sales                          3.4 %                   2.8 %                   2.8 %                      2.6 %

Research and development spending is subject to the variable nature of program development schedules and, therefore, year-over-year fluctuations in spending levels are expected. The majority of the company-funded spending is incurred by the aerospace businesses. The year-over-year increase in company-funded research and development (27%) in the third quarter of 2012 primarily reflects an increase at UTC Aerospace Systems as a result of incremental research and development spending related to the Goodrich businesses (23%). Company-funded research and development spending also increased at Pratt & Whitney (6%) to further advance development primarily on military and commercial platforms.

The increase in company-funded research and development expenses for the first nine months of 2012 (16%) primarily reflects an increase at UTC Aerospace Systems (8%) as a result of spending by the Goodrich businesses and at Pratt & Whitney (7%) to further advance development of multiple geared turbo fan platforms and military engines. The remaining increase in company-funded research and development expenses is primarily in support of military programs at Sikorsky (1%). We continue to expect company-funded research and development for the full year 2012, excluding spending related to the former Goodrich businesses, to increase about $150 million, as compared with 2011, in support of multiple next generation aerospace platforms.

                      Selling, General and Administrative



                                             Quarter Ended September 30,                 Nine Months Ended September 30,
(Dollars in millions)                         2012                  2011                 2012                      2011
Selling, general and administrative
expenses                                  $      1,619          $      1,512        $         4,657           $         4,538
Percentage of net sales                           10.8 %                10.6 %                 11.3 %                    11.0 %

Selling, general and administrative expenses increased 7% in the third quarter of 2012 due primarily to additional expenses related to the former Goodrich and IAE businesses (9%), higher pension and other employee related expenses (2%) and higher restructuring costs (1%), partially offset by the impact of favorable foreign exchange translation (4%).

Selling, general and administrative expenses increased 3% in the first nine months of 2012, due primarily to additional expenses related to acquisitions, net of divestitures completed over the preceding twelve months (3%), higher restructuring costs (2%), and higher pension and other employee related expenses (1%), all of which were partially offset by the impact of favorable foreign exchange translation (3%). The 30 basis point year-over-year increase as a percent of sales also reflects these higher acquisition related and restructuring costs.

Other Income, Net

Quarter Ended September 30, Nine Months Ended September 30, (Dollars in millions) 2012 2011 2012 2011 Other income, net $ 211 $ 231 $ 851 $ 547

Other income, net includes the operational impact of equity earnings in unconsolidated entities, royalty income, foreign exchange gains and losses as well as other ongoing and non-recurring items. The year-over-year decrease in other income, net in the third quarter of 2012, is largely due to the absence of a $41 million gain recognized at Pratt & Whitney from the sale of an investment, and the absence of a $28 million gain resulting from dispositions associated with UTC Climate, Controls & Security's ongoing portfolio transformation, both of which were recorded in the third quarter of 2011. Gains recognized within other income, net in the third quarter of 2012 include $34 million on the fair value re-measurement of the Company's previously held shares of Goodrich and a $46 million gain as a result of the effective settlement of a pre-existing claim in connection with the acquisition of Goodrich. The remaining change in other income, net is attributable primarily to other normal recurring operational activity as disclosed above.


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The year-over-year increase in other income, net in the first nine months of 2012, largely reflects an approximately $215 million net gain from the sale of a controlling interest in a manufacturing and distribution joint venture in Asia and an approximately $142 million net gain from the sale of a controlling interest in a Canadian distribution business, partially offset by $103 million of impairment charges related to planned business dispositions and a $32 million loss on the disposition of the U.S. UTC Fire & Security branch operations, all of which are related to the ongoing UTC Climate, Controls & Security portfolio transformation. Gains recognized within other income, net in the first nine months of 2012 include $34 million on the fair value re-measurement of the . . .

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