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UTX > SEC Filings for UTX > Form 10-Q on 26-Jul-2013All Recent SEC Filings

Show all filings for UNITED TECHNOLOGIES CORP /DE/

Form 10-Q for UNITED TECHNOLOGIES CORP /DE/


26-Jul-2013

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 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. 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 2013 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 2012 Annual Report, which is incorporated by reference in our 2012 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 operations include original equipment manufacturing (OEM) and extensive related aftermarket parts and services in both our commercial and aerospace businesses. Our business mix also reflects the combination of shorter cycles at UTC Climate, Controls & Security and in our commercial aerospace aftermarket businesses, and longer cycles at Otis and in 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.
Growth in emerging markets continues to be led by China where gross domestic product is expected to grow 7.5% in 2013. European economic conditions continue to stagnate with weak consumer confidence and unemployment rates over 12%. During the first six months of 2013, organic sales in Europe declined 3% across our commercial businesses. The European market, together with U.S. Government defense spending, represents over 40% of UTC sales. Despite recent volatility in the face of potential federal interest rate increases, the economic environment in the U.S. has continued to rebound on improving consumer sentiment, lower unemployment rates, an improving housing market, and increasing commercial construction.
U.S. Government deficit reduction measures are expected to continue to pressure U.S. Department of Defense spending and adversely affect our military businesses during 2013. Total sales to the U.S. Government were $2.4 billion and $2.4 billion, or 15% and 18% of total UTC sales in the second quarter of 2013 and 2012, respectively. Our participation in long-term production and development programs for the U.S. Government has, and is expected to contribute positively to our results in 2013. In July 2012, the U.S. Government and Sikorsky signed a five-year multiservice contract (Multi-year 8) for approximately 650 H-60 helicopters. Actual production quantities will be determined year-by-year over the life of the program based on funding allocations set by Congress and Pentagon acquisition priorities. Sikorsky's commercial business has benefited from increases in off-shore oil platform activity and those benefits are projected to continue throughout 2013. Although U.S. Government sequestration has not yet had a substantial effect on our military aerospace businesses, it may in future periods.
Disposition Activity
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 has been used to repay debt incurred to finance the acquisition of Goodrich. The legacy Hamilton Sundstrand Industrial businesses, as well as Clipper Windpower (Clipper), Pratt & Whitney Rocketdyne (Rocketdyne) and UTC Power all met the "held-for-sale" criteria in 2012. The results of operations, including the net realized gain and losses 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. The dispositions of Clipper and the legacy Hamilton Sundstrand Industrial businesses were completed in 2012. On February 12, 2013, we completed the disposition of UTC Power to ClearEdge Power. The UTC Power disposition resulted in payments by


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UTC totaling $48 million, which included capitalization of the business prior to the sale and interim funding of operations as the buyer took control of a loss generating business. We have no continuing involvement with the UTC Power business.
On June 14, 2013, we completed the sale of substantially all operations of Rocketdyne to GenCorp Inc. for $411 million. The sale generated a pre-tax loss of approximately $17 million ($10 million after tax) which has been included in discontinued operations in the accompanying Condensed Consolidated Statement of Comprehensive Income. On May 17, 2013, we completed the sale of the Pratt & Whitney Power Systems business to Mitsubishi Heavy Industries (MHI) and entered into a long-term engineering and manufacturing agreement with MHI. The sale generated a pre-tax gain of approximately $193 million ($132 million after tax). Cash received in connection with the sale was $432 million, and excludes contingent consideration valued at approximately $200 million. Pratt & Whitney Power Systems has not been reclassified to Discontinued Operations due to our level of continuing involvement in the business post-sale.
In connection with regulatory approval of the Goodrich acquisition, regulatory authorities required UTC to dispose of the Goodrich electric power systems and the pumps and engine controls businesses. Pursuant to these regulatory obligations, these businesses had been held separately from UTC's and Goodrich's ongoing businesses since the acquisition of Goodrich by UTC. On March 18, 2013, we completed the sale of the Goodrich pumps and engine controls business to Triumph Group, Inc., and on March 26, 2013, we completed the sale of the Goodrich electric power systems business to Safran S.A. Combined proceeds from the sales of the two businesses were approximately $600 million.
As discussed below in "Results of Operations," our results include the impact from non-recurring items such as the beneficial impact of gains from business divestiture activities, including those related to the ongoing portfolio transformation at UTC Climate, Controls & Security. Acquisition Activity
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. On February 7, 2013, we completed the acquisition of Grupo Ascensores Enor, S.A. (Enor), a privately held company headquartered in Spain with operations in Spain and Portugal, which designs, manufactures, installs and services elevators. Enor's 2012 sales were approximately $50 million. Under the terms of the transaction, Zardoya Otis, S.A. (ZOSA), a non-wholly owned subsidiary of the Company, exchanged publicly traded shares of ZOSA with a fair value of approximately $240 million as of the transaction completion date for all of the shares of Enor.
During the six months ended June 30, 2013, our cash investment in business acquisitions was approximately $66 million and consisted of a number of additional small acquisitions primarily in our commercial businesses. We expect cash investment in businesses of approximately $1 billion in 2013. However, actual acquisition spending may vary depending upon the timing, availability and 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 2013. See Part II, Item 1A, "Risk Factors" in this Form 10-Q for further discussion.
The following activities are disclosed as required by Section 13(r)(1)(D)(iii) of the Securities Exchange Act of 1934, as amended (Exchange Act), as transactions or dealings with the government of Iran that have not been specifically authorized by a U.S. federal department or agency:
In 2012 and 2013, Delta Security Solutions S.A., a company organized under the laws of France and an indirect wholly-owned non-U.S. subsidiary (part of United Technologies Climate, Controls & Security group of companies), provided alarm monitoring services and on-site maintenance inspections to the Paris branch of Bank Melli Iran. The Paris branch of Bank Melli Iran has been a customer of Delta Security Solutions (and its predecessors) since at least 2000. Bank Melli Iran is an entity identified by the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) on the Specially Designated Nationals and Blocked Persons List pursuant to Executive Order 13382.


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In August 2010, Delta Security Solutions entered into two service contracts with the Paris branch of Bank Melli Iran. Pursuant to those contracts, Delta Security Solutions provided remote monitoring of the Paris branch's electronic alarm system as well as related maintenance services to verify the proper functioning of the branch's intrusion detection equipment. In 2012, Delta Security Solutions received total payments and net profit of $3,747 and $2,323, respectively, under these contracts. In 2013, Delta Security Solutions received total payments and net profit of $3,835 and $2,378, respectively, under these contracts. Neither these contracts nor the services to be provided thereunder were prohibited by applicable law when the contracts were executed. However, a portion of the services performed by Delta Security Solutions took place after the President issued Executive Order 13628 on October 9, 2012, which implemented
Section 218 of the Iran Threat Reduction and Syria Human Rights Act by prohibiting any entity owned or controlled by a U.S. person and established or maintained outside the U.S. from knowingly engaging in any transaction, directly or indirectly, with the Government of Iran. Accordingly, UTC Climate, Controls & Security has filed an appropriate disclosure with OFAC. Delta Security Solutions has notified the Paris branch of Bank Melli Iran that the two contracts have been terminated. Delta Security Solutions does not intend to do any further business with Bank Melli Iran.
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 2012 Annual Report, incorporated by reference in our 2012 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 six months ended June 30, 2013.

                             RESULTS OF OPERATIONS
                                   Net Sales
                           Quarter Ended June 30,             Six Months Ended June 30,
(Dollars in millions)         2013             2012                2013               2012
Net Sales             $     16,006           $ 13,807    $      30,405              $ 26,223


The factors contributing to the total percentage change year-over-year in total
net sales for the quarter and six months ended June 30, 2013 are as follows:
                                                 Quarter Ended            Six Months Ended
                                                 June 30, 2013              June 30, 2013
Organic change                                            -                           (1 )%
Foreign currency translation                              -                            -
Acquisitions and divestitures, net                       16 %                         17  %
Other                                                     -                            -
Total % Change                                           16 %                         16  %

During the second quarter of 2013, organic sales growth at Otis (4%), UTC Climate, Controls & Security (1%) and UTC Aerospace Systems (1%), was offset by organic sales contraction at Pratt & Whitney (5%) and Sikorsky (3%). Organic sales growth at Otis was led by higher new equipment sales volume in China and Russia, while the organic sales decline at Pratt & Whitney was driven by lower military engine sales.
During the six months ended June 30, 2013, Otis experienced organic sales growth of 3% driven by higher new equipment sales, while UTC Aerospace Systems realized organic sales growth of 1% on higher commercial aerospace OEM volume. These increases were more than offset by a contraction in Sikorsky organic sales (5%) driven by lower aftermarket sales to the U.S. Government, organic sales contraction at Pratt & Whitney (4%) driven by lower commercial spares and military business volume, and organic sales contraction at UTC Climate, Controls & Security (1%).
The sales increase from acquisitions for the quarter and six months ended June 30, 2013 was primarily a result of the acquisitions of Goodrich and IAE, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security.


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Cost of Products and Services Sold
                                             Quarter Ended June 30,            Six Months Ended June 30,
(Dollars in millions)                         2013              2012            2013               2012
Cost of products sold                    $      8,712       $    7,123     $     16,560       $     13,446
Percentage of product sales                      74.7 %           74.3 %           75.6 %             74.7 %
Cost of services sold                    $      2,840       $    2,811     $      5,457       $      5,418
Percentage of service sales                      65.4 %           66.6 %           64.3 %             65.9 %
Total cost of products and services sold $     11,552       $    9,934     $     22,017       $     18,864

The factors contributing to the total percentage change year-over-year for the quarter and six months ended June 30, 2013 in total cost of products and services sold are as follows:

                                                 Quarter Ended June            Six Months Ended
                                                      30, 2013                   June 30, 2013
Organic change                                               (1 )%                         (1 )%
Foreign currency translation                                  -                             -
Acquisitions and divestitures, net                           17  %                         18  %
Restructuring                                                 -                             -
Other                                                         -                             -
Total % Change                                               16  %                         17  %

The organic decline in cost of sales was driven by lower commodity costs and factory productivity, particularly within UTC Climate, Controls & Security. The increase in "Acquisitions and divestitures, net" (17%) is largely attributable to the acquisitions of Goodrich and IAE, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. The organic decrease in total cost of products and services sold (1%) in the first six months of 2013 corresponded to the organic sales decline (1%) noted above. The increase in "Acquisitions and divestitures, net" (18%) 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 first six months of 2013.

                                  Gross Margin
                           Quarter Ended June 30,          Six Months Ended June 30,
(Dollars in millions)        2013            2012           2013               2012
Gross margin            $     4,454       $  3,873     $      8,388       $      7,359
Percentage of net sales        27.8 %         28.1 %           27.6 %             28.1 %

The 30 basis point decline in gross margin as a percentage of sales for the second quarter of 2013 is due to the adverse gross margin impact of a higher proportion of commercial aerospace OEM sales as a result of lower military engine sales volume at Pratt & Whitney, the adverse impact of the Multi-year 8 pricing and reset provisions at Sikorsky, and pricing pressure at Otis, primarily in Europe and China, during the second quarter of 2013. The 50 basis point decline in gross margin as a percentage of sales for the first six months of 2013 is largely due to the adverse gross margin impact of a higher proportion of commercial and military aerospace OEM sales at Pratt & Whitney and Sikorsky during the first six months of 2013.


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                           Research and Development
                           Quarter Ended June 30,          Six Months Ended June 30,
(Dollars in millions)       2013            2012            2013               2012
Company-funded          $     631       $     525      $      1,241       $      1,069
Percentage of net sales       3.9 %           3.8 %             4.1 %              4.1 %
Customer-funded         $     550       $     313      $      1,093       $        637
Percentage of net sales       3.4 %           2.3 %             3.6 %              2.4 %

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 (20%) in the second quarter of 2013 primarily reflects an increase at UTC Aerospace Systems as a result of incremental research and development spending related to the Goodrich businesses (23%), partially offset by lower research and development spending at Pratt & Whitney (3%) primarily related to the development of multiple geared turbofan platforms. The increase in customer-funded research and development (76%) is due to incremental customer-funded spending related to the Goodrich businesses (57%) and at Pratt & Whitney on military (7%) and commercial (5%) programs.
The year-over-year increase in company-funded research and development (16%) in the first six months of 2013 primarily reflects an increase at UTC Aerospace Systems as a result of incremental research and development spending related to the Goodrich businesses (23%), partially offset by lower research and development spending at Pratt & Whitney related to the development of multiple geared turbofan platforms (4%). The increase in customer-funded research and development (72%) is due to incremental customer-funded spending related to the Goodrich businesses (53%) and at Pratt & Whitney on military programs (12%). We expect company-funded research and development for the full year 2013 to increase approximately $225 million, as compared with 2012.

Selling, General and Administrative
                                           Quarter Ended June 30,            Six Months Ended June 30,
(Dollars in millions)                       2013             2012             2013               2012
Selling, general and administrative
expenses                               $     1,737       $     1,509     $      3,364       $      3,038
Percentage of net sales                       10.9 %            10.9 %           11.1 %             11.6 %

Selling, general and administrative expenses increased 15% in the second quarter of 2013 due to the impact of acquisitions, net of divestitures, completed over the preceding twelve months (9%) and higher restructuring costs (5%). Higher pension costs were offset by savings from previous restructuring actions. Selling, general and administrative expenses as a percentage of sales in the second quarter of 2013 is consistent with the prior year.
Selling, general and administrative expenses increased 11% in the first six months of 2013 due primarily to the impact of acquisitions, net of divestitures, completed over the preceding twelve months (9%), and higher restructuring costs (2%). Higher pension and export compliance costs (combined 1%) were largely offset by savings from previous restructuring actions. The 50 basis point year-over-year decrease as a percentage of sales reflects higher sales volume as a result of the Goodrich acquisition and the benefits from previous restructuring actions.

                               Other Income, Net
                                          Quarter Ended June 30,         Six Months Ended June 30,
(Dollars in millions)                       2013            2012            2013             2012
Other income, net                      $        421     $      340     $         730     $      640

Other income, net includes 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 increase in other income, net in the second quarter of 2013, is a result of the gain on the sale of Pratt & Whitney Power Systems (57%), offset by the absence of net gains present in the prior year related to the ongoing UTC Climate, Controls & Security portfolio transformation (32%). The remaining increase in other income, net is attributable to normal recurring operational activity as disclosed above. The year-over-year increase in other income, net in the first six months of 2013, is a result of a gain on the sale of Pratt & Whitney Power Systems (30%), the benefit of a settlement with an engine program partner (6%), and lower acquisitions and


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divestiture costs (5%). This was partially offset by a decline in net gains related to the ongoing UTC Climate, Controls & Security portfolio transformation (29%), which included a net gain in the first quarter of 2013 of $38 million primarily from the sale of a business in Hong Kong, compared to a net gain of $222 million during the first six months of 2012. The remaining increase in other income, net is attributable primarily to higher equity earnings in unconsolidated entities (3%) and normal recurring operational activity as disclosed above.

                             Interest Expense, Net
                                 Quarter Ended June 30,          Six Months Ended June 30,
(Dollars in millions)             2013            2012            2013               2012
Interest expense              $     272       $     190      $       527         $       354
Interest income                     (55 )           (22 )            (74 )               (57 )
Interest expense, net         $     217       $     168      $       453         $       297
Average interest expense rate       4.5 %           5.5 %            4.5 %               5.6 %

The increase in interest expense in the second quarter of 2013 is a result of higher average debt balances associated with the financing of our acquisition of Goodrich. The increase in interest income in the second quarter of 2013 reflects $36 million of favorable pre-tax interest adjustments related to settlements for the Company's tax years prior to 2006, as well as the conclusion of certain IRS examinations of the 2009 and 2010 tax years.
The increase in interest expense in the first six months of 2013 is a result of higher average debt balances associated with the financing of our acquisition of Goodrich. The increase in interest income in the first six months of 2013 reflects $36 million of favorable pre-tax interest adjustments related to settlements for the Company's tax years prior to 2006, as well as the conclusion of certain IRS examinations of the 2009 and 2010 tax years, all of which was partially offset by the absence of approximately $15 million of favorable pre-tax interest adjustments related to the conclusion of the IRS's examination of our tax returns for the years 2006 to 2008, which were recognized in the first six months of 2012.

                                  Income Taxes
                     Quarter Ended June 30,        Six Months Ended June 30,
                      2013           2012            2013              2012
Effective tax rate     28.2 %         22.5 %          26.2 %             21.5 %

The increase in the effective tax rate for the quarter ended June 30, 2013, . . .

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