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UTX > SEC Filings for UTX > Form 10-Q on 25-Jul-2014All Recent SEC Filings

Show all filings for UNITED TECHNOLOGIES CORP /DE/

Form 10-Q for UNITED TECHNOLOGIES CORP /DE/


25-Jul-2014

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 23, 2013, we announced the formation of UTC Building and Industrial Systems, a new organizational structure consisting of Otis and UTC Climate, Controls & Security. This new organizational structure is expected to enhance our ability to deliver more integrated solutions to our customers and accelerate innovation in smart building technologies and sustainable designs. Otis and UTC Climate, Controls & Security each continue to report their financial and operational results as separate segments, which is consistent with how we allocate resources and measure the financial performance of these businesses.
Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. The current status of significant factors affecting our business environment in 2014 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 2013 Annual Report, which is incorporated by reference in our 2013 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 our sales for the quarter ended June 30, 2014 grew 11% over the same quarter of the prior year. Growth in China, along with U.S. economic expansion, is expected to drive global growth throughout 2014. Consumer confidence in the U.S. reached a six-year high in June 2014, while consumer confidence and commercial construction in the U.S. remain strong. During the first six months of 2014, organic sales in Europe grew 3%. Despite elevated political tensions in Eastern Europe and the Middle East, Europe continues a slow economic recovery which we expect will accelerate modestly in the second half of the year.
U.S. Government deficit reduction measures continue to pressure U.S. Department of Defense spending and adversely affect our military businesses. Total sales to the U.S. Government were $2.2 billion and $2.4 billion, or 13% and 15% of total UTC sales in the quarters ended June 30, 2014 and 2013, respectively. The defense portion of our aerospace business is affected by changes in market demand and the global political environment. 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 2014. Disposition Activity
As previously disclosed, we disposed of a number of businesses in 2013. On February 12, 2013, we completed the disposition of UTC Power to ClearEdge Power, and on June 14, 2013, we completed the sale of substantially all operations of Pratt & Whitney Rocketdyne (Rocketdyne) to GenCorp Inc. The results from these businesses were reclassified to Discontinued Operations in our Condensed Consolidated Statements of Operations and Cash Flows. 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. Pratt & Whitney Power Systems was not 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.


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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. During the six months ended June 30, 2014, our cash investment in business acquisitions was approximately $84 million and consisted of a number of small acquisitions primarily in our commercial businesses. We expect cash investment in businesses to be less than $1 billion in 2014. 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 and political 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 2014. See Part I, Item 1A, "Risk Factors" in our 2013 Form 10-K for further discussion.
As previously reported, Sikorsky is developing the CH-148 derivative of the H-92 helicopter (the "Cyclone"), a military variant of the S-92 helicopter, for the Canadian Government. The Cyclone is being developed under a fixed-price acquisition contract (the "Acquisition Contract") that provides for a program to develop and produce 28 helicopters, and a related contract to provide in-service support (collectively, the "Arrangements"). Delivery of the final configuration aircraft, which was scheduled to begin in 2012, has not occurred due to a number of disputes between the Canadian Government and Sikorsky related to contractual requirements and contract performance.
On June 18, 2014, Sikorsky and the Canadian Government signed amendments to the Arrangements (the "Amended Arrangements"). The Amended Arrangements finalize the scope of the aircraft, change the governance of the program, and establish a phased approach to the delivery of interim and final configuration helicopters starting in 2015. The Amended Arrangements also extend the in-service support contract through approximately 2038. The contract value of the Amended Arrangements is estimated to be approximately $6.4 billion.
Prior to the amendments, sales and losses under the Acquisition Contract were recognized using an output-based method, consistent with the practices and policies the Company applies to other comparable production contracts. In light of the significant changes in program scope, governance and delivery, we have re-assessed the method we utilize in estimating the extent of progress under the Acquisition Contract. The Acquisition Contract, as amended, now reflects the significant developmental nature of the contract that has evolved over time. Under the Company's practices and policies, contracts that are comparable to the Amended Arrangements are accounted for utilizing a cost-to-cost percentage of completion method, as this best reflects the efforts expended and more appropriately aligns the sales and loss recognition with these efforts. Employing the cost-to-cost percentage of completion method, we recorded a cumulative adjustment to reflect the percentage of completion under the Amended Arrangements in the second quarter of 2014 as a change in estimate. This adjustment along with changes in the in-service support contract have resulted in the recognition in the second quarter of 2014 of $830 million in sales and $438 million in losses. Remaining losses under the Amended Arrangements of approximately $300 million will be recognized as the costs are incurred. These losses will be partially offset by the in-service support aftermarket contract with the expectation of generating positive annual margin beginning in 2018.

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 2013 Annual Report, incorporated by reference in our 2013 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, 2014.


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                             RESULTS OF OPERATIONS
                                   Net Sales
                           Quarter Ended June 30,             Six Months Ended June 30,
(Dollars in millions)         2014             2013                2014               2013
Net Sales             $     17,191           $ 16,006    $      31,936              $ 30,405


The factors contributing to the total percentage change year-over-year in total
net sales for the quarter and six months ended June 30, 2014 are as follows:
                                                    Quarter Ended                Six Months Ended
                                                    June 30, 2014                 June 30, 2014
Organic change                                                3  %                           4  %
Foreign currency translation                                  -                              -
Acquisitions and divestitures, net                           (1 )%                          (1 )%
Other                                                         5  %                           2  %
Total % Change                                                7  %                           5  %

During the quarter ended June 30, 2014, organic sales growth at UTC Aerospace Systems (9%) and Otis (7%), was partially offset by organic sales contraction at UTC Climate, Controls, & Security (1%) and Sikorsky (1%). Organic sales growth at UTC Aerospace Systems was driven by higher commercial aerospace OEM and aftermarket sales volumes, while organic growth at Otis was primarily due to higher new equipment sales volume in the U.S. and China.
During the six months ended June 30, 2014, all five business segments experienced organic sales growth, led by UTC Aerospace Systems (7%), Otis (6%), and Sikorsky (4%). Organic sales growth at UTC Aerospace Systems was driven by higher commercial aerospace OEM and aftermarket sales volumes. Organic growth at Otis was primarily due to higher new equipment sales volume in the U.S. and China, while organic growth at Sikorsky was led by higher international military and commercial aircraft sales volumes. Organic sales growth was also driven by Pratt & Whitney (2%) and UTC Climate, Controls & Security (1%). See the Segment Review section of Management's Discussion and Analysis for further discussion of segment performance.
The sales decrease from net acquisitions and divestitures for the quarter and six months ended June 30, 2014 was primarily a result of the disposition of the Pratt & Whitney Power Systems business and portfolio transformation initiatives at UTC Climate, Controls & Security in 2013. The increase in "Other" in the quarter and six months ended June 30, 2014 is attributable to the cumulative adjustment to record sales of $830 million based upon the change in estimate arising out of the Amended Arrangements signed with the Canadian Government for the Cyclone helicopter program.

Cost of Products and Services Sold
                                             Quarter Ended June 30,           Six Months Ended June 30,
(Dollars in millions)                         2014             2013            2014               2013
Cost of products sold                    $    10,182       $    8,712     $     18,263       $     16,560
Percentage of product sales                     78.2 %           74.7 %           77.0 %             75.6 %
Cost of services sold                    $     2,749       $    2,840     $      5,358       $      5,457
Percentage of service sales                     65.9 %           65.4 %           65.1 %             64.3 %
Total cost of products and services sold $    12,931       $   11,552     $     23,621       $     22,017


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The factors contributing to the percentage change year-over-year for the quarter and six months ended June 30, 2014 in total cost of products and services sold are as follows:

                                                    Quarter Ended                Six Months Ended
                                                    June 30, 2014                 June 30, 2014
Organic change                                                2  %                           3  %
Foreign currency translation                                  -                              -
Acquisitions and divestitures, net                           (1 )%                          (2 )%
Restructuring                                                 -                              -
Other                                                        11  %                           6  %
Total % Change                                               12  %                           7  %

The organic increase in total cost of products and services sold in the quarter and six months ended June 30, 2014 was driven by the organic sales increase noted above, partially offset by the benefits of previous restructuring actions and lower commodity costs, particularly within UTC Climate, Controls & Security. The decrease in "Acquisitions and divestitures, net" in the quarter and six months ended June 30, 2014 is attributable to the disposition of the Pratt & Whitney Power Systems business and portfolio transformation initiatives at UTC Climate, Controls & Security in 2013. The increase in "Other" in the quarter and six months ended June 30, 2014 is attributable to the cumulative adjustment to record costs of $1,268 million based upon the change in estimate arising out of the Amended Arrangements signed with the Canadian Government for the Cyclone helicopter program.

                                  Gross Margin
                           Quarter Ended June 30,          Six Months Ended June 30,
(Dollars in millions)        2014            2013           2014               2013
Gross margin            $     4,260       $  4,454     $      8,315       $      8,388
Percentage of net sales        24.8 %         27.8 %           26.0 %             27.6 %

The 300 basis point decline in gross margin as a percentage of sales for the quarter ended June 30, 2014 is primarily due to the cumulative adjustment to record $830 million in sales and $1,268 million in cost of sales based upon the change in estimate arising out of the Amended Arrangements signed with the Canadian Government for the Cyclone helicopter program (390 basis points). This was partially offset by lower restructuring costs (40 basis points) and the benefits of previous restructuring actions and lower commodity costs and productivity gains at UTC Climate, Controls & Security (30 basis points). The 160 basis point decline in gross margin as a percentage of sales for the six months ended June 30, 2014 is primarily due to the previously noted cumulative adjustment to record $830 million in sales and $1,268 million in cost of sales on the Cyclone helicopter program (210 basis points). This was partially offset by the benefits of previous restructuring actions and lower commodity costs and productivity gains at UTC Climate, Controls & Security (30 basis points).

                           Research and Development
                           Quarter Ended June 30,          Six Months Ended June 30,
(Dollars in millions)       2014            2013            2014               2013
Company-funded          $     666       $     631      $      1,290       $      1,241
Percentage of net sales       3.9 %           3.9 %             4.0 %              4.1 %
Customer-funded         $     641       $     550      $      1,164       $      1,093
Percentage of net sales       3.7 %           3.4 %             3.6 %              3.6 %

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 (6%) for the quarter ended June 30, 2014 is primarily related to higher research and development within the UTC Aerospace Systems segment related to several commercial aerospace programs. Customer-funded research and development increased (17%) primarily due to higher customer-funded spending at Pratt & Whitney on military (11%) and commercial (6%) programs.


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The year-over-year increase in company-funded research and development (4%) for the six months ended June 30, 2014 is primarily related to higher research and development within the UTC Aerospace Systems segment related to several commercial aerospace programs. Customer-funded research and development increased (6%) primarily due to higher customer-funded spending at Pratt & Whitney on military (8%) and commercial (6%) programs, partially offset by lower customer-funded spending at UTC Aerospace Systems, primarily on U.S. military and space programs (3%) and within U.S. Government programs at Sikorsky (5%). We expect company-funded research and development for the full year 2014 to remain consistent with 2013 levels.

Selling, General and Administrative
                                           Quarter Ended June 30,            Six Months Ended June 30,
(Dollars in millions)                       2014             2013             2014               2013
Selling, general and administrative
expenses                               $     1,623       $     1,737     $      3,219       $      3,364
Percentage of net sales                        9.4 %            10.9 %           10.1 %             11.1 %

Selling, general and administrative expenses declined 7% in the quarter ended June 30, 2014 due to lower restructuring costs (5%) and lower divestiture costs (1%). The benefit from savings from previous restructuring actions was partially offset by an increase in overhead expenses at Otis due primarily to continued investment in emerging markets. The 150 basis point year-over-year decrease as a percentage of sales reflects higher sales volume, lower restructuring costs and benefits from previous restructuring actions.
Selling, general and administrative expenses declined 4% in the six months ended June 30, 2014 due to lower restructuring costs (2%) and lower divestiture costs (1%). The benefit from savings from previous restructuring actions was partially offset by higher overhead expenses at Otis.

                               Other Income, Net
                                          Quarter Ended June 30,         Six Months Ended June 30,
(Dollars in millions)                       2014            2013            2014             2013
Other income, net                      $        384     $      421     $         647     $      730

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 decrease in other income, net in the quarter ended June 30, 2014 (9%) is a result of a charge to adjust the fair value of a Pratt & Whitney joint venture (14%), an impairment loss on a Sikorsky joint venture investment (6%) and the absence of a gain on the sale of Pratt & Whitney Power Systems (46%) recognized in the second quarter of 2013. These factors were partially offset by a gain on an agreement with a state taxing authority for the monetization of tax credits (53%), a gain on the sale of a Pratt & Whitney product line (4%), and by normal recurring operational activity. The year-over-year decrease in other income, net in the six months ended June 30, 2014 (11%) is a result of a charge to adjust the fair value of a Pratt & Whitney joint venture (8%); an impairment loss on a Sikorsky joint venture investment (4%); and the absence of: the gain on the sale of Pratt & Whitney Power Systems (26%) recognized in the second quarter of 2013, a gain on a settlement with an engine program partner (5%) recognized in the first quarter of 2013, and net gains related to the UTC Climate, Controls & Security portfolio transformation (5%). These factors were partially offset by a gain on an agreement with a state taxing authority for the monetization of tax credits (30%), higher licensing income (5%), a gain on the sale of a Pratt & Whitney product line (2%), and other normal recurring operational activity.

                             Interest Expense, Net
                                 Quarter Ended June 30,          Six Months Ended June 30,
(Dollars in millions)             2014            2013            2014               2013
Interest expense              $     245       $     272      $       488         $       527
Interest income                     (39 )           (55 )            (57 )               (74 )
Interest expense, net         $     206       $     217      $       431         $       453
Average interest expense rate       4.3 %           4.5 %            4.3 %               4.2 %


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The decrease in interest expense in the quarter and six months ended June 30, 2014 is a result of lower average debt balances as a result of debt repayments made since June 30, 2013. The decrease in interest income in the quarter and six months ended June 30, 2014 reflects the absence of $36 million of favorable pre-tax interest adjustments related to settlements of the company's tax years prior to 2006 as well as the conclusion of certain IRS examinations of the 2009 and 2010 tax years that were recorded during the second quarter of 2013, which were partially offset by $21 million of favorable pre-tax interest adjustments, primarily related to the conclusion of the IRS's examination of the Company's 2009 and 2010 tax years recorded during the quarter ended June 30, 2014.

                                  Income Taxes
                     Quarter Ended June 30,        Six Months Ended June 30,
                      2014           2013            2014              2013
Effective tax rate     16.7 %         28.2 %          23.0 %             26.2 %

The decrease in the effective tax rate for the quarter ended June 30, 2014, primarily reflects the favorable non-cash income tax impact of $253 million related to the conclusion of the IRS's examination of the Company's 2009 - 2010 tax years, as well as the conclusion of the State of Connecticut's examination of the Company's 2010 - 2012 tax years, both of which were recorded in the second quarter of 2014.
The decrease in the effective tax rate for the six months ended June 30, 2014 includes the items noted above, and is partially offset by the absence of the favorable tax impact of $95 million recorded in the first quarter of 2013, associated with the legislative corporate tax extenders enacted in January 2013, as part of the American Taxpayer Relief Act of 2012.
We estimate our full year annual effective income tax rate in 2014 to be approximately 30%, absent one-time adjustments. We anticipate some variability in the tax rate for the remainder of 2014.
Net Income Attributable to Common Shareowners from Continuing Operations

                                          Quarter Ended June 30,         Six Months Ended June 30,
(Dollars in millions, except per share
amounts)                                    2014            2013            2014             2013
Income from continuing operations
attributable to common shareowners     $      1,680     $    1,552     $       2,893     $    2,822
Diluted earnings per share from
continuing operations attributable to
common shareowners                     $       1.84     $     1.70     $        3.16     $     3.09

Net income attributable to common shareowners from continuing operations for the quarter ended June 30, 2014 includes restructuring charges, net of tax benefit, of $38 million as well as a net benefit from non-recurring items, net of tax expense of $37 million. The effect on diluted earnings per share for the quarter ended June 30, 2014 of restructuring charges was $0.04 per share, offset by a net $0.04 benefit from non-recurring items. The impact of foreign currency translation and hedging generated a favorable effect of $0.03 per diluted share on our operational performance in the quarter ended June 30, 2014.
Net income attributable to common shareowners from continuing operations for the six months ended June 30, 2014 includes restructuring charges, net of tax benefit, of $121 million as well as a net benefit from non-recurring items, net . . .

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