| • FORM 10-Q • STATEMENT RE: COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES • LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION • RULE 13A-14(A)/15D-14(A) CERTIFICATIONS • SECTION 1350 CERTIFICATIONS • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2012 OR
For the transition period from to Commission file number 1-812
UNITED TECHNOLOGIES CORPORATION
One Financial Plaza, Hartford, Connecticut 06103 (860) 728-7000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x. No ¨. Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x. No ¨. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨. No x. At June 30, 2012 there were 911,787,235 shares of Common Stock outstanding.
Table of ContentsUNITED TECHNOLOGIES CORPORATION AND SUBSIDIARIES CONTENTS OF QUARTERLY REPORT ON FORM 10-Q Quarter Ended June 30, 2012
United Technologies Corporation and its subsidiaries’ names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or tradenames of United Technologies Corporation and its subsidiaries. Names, abbreviations of names, logos, and products and service designators of other companies are either the registered or unregistered trademarks or tradenames of their respective owners. As used herein, the terms “we,” “us,” “our” or “UTC,” unless the context otherwise requires, mean United Technologies Corporation and its subsidiaries.
2
Table of ContentsPART I – FINANCIAL INFORMATION
UNITED TECHNOLOGIES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements
3
Table of ContentsUNITED TECHNOLOGIES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements
4
Table of ContentsUNITED TECHNOLOGIES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements
5
Table of ContentsUNITED TECHNOLOGIES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
See accompanying Notes to Condensed Consolidated Financial Statements
6
Table of ContentsUNITED TECHNOLOGIES CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The Condensed Consolidated Financial Statements at June 30, 2012 and for the quarters and six months ended June 30, 2012 and 2011 are unaudited, but in the opinion of management include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the results for the interim periods. The results reported in these Condensed Consolidated Financial Statements should not necessarily be taken as indicative of results that may be expected for the entire year. The financial information included herein should be read in conjunction with the financial statements and notes in our Annual Report to Shareowners (2011 Annual Report) incorporated by reference to our Annual Report on Form 10-K for calendar year 2011 (2011 Form 10-K). Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. 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. In 2012, the Company approved plans for the divestiture of a number of non-core businesses. The results of operations including the expected loss on disposition and the related cash flows which result from these non-core businesses have been reclassified to Discontinued Operations in our Condensed Consolidated Statement of Comprehensive Income and Condensed Consolidated Statement of Cash Flows for all periods presented. See Note 2 for further discussion. Note 1: Acquisitions, Dispositions, Goodwill and Other Intangible Assets Business Acquisitions and Dispositions. During the first six months of 2012, our investment in business acquisitions was $358 million (including debt assumed of $149 million). On September 21, 2011, we announced an agreement to acquire Goodrich Corporation (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 and interior systems, actuation and landing systems, and electronic systems. Under the terms of the agreement, Goodrich shareholders will receive $127.50 in cash for each share of Goodrich common stock they own at the time of the closing of the transaction. This equates to a total estimated enterprise value of $18.2 billion, including $1.7 billion in net debt to be assumed. In March 2012, Goodrich received shareholder approval for the transaction. The transaction is subject to customary closing conditions, including regulatory approvals. We expect that this acquisition will close in mid-2012. Once the acquisition is complete, Goodrich and Hamilton Sundstrand will be combined to form a new segment named UTC Aerospace Systems. This segment and our Pratt & Whitney segment will be separately reportable segments although they will both be included within the UTC Propulsion & Aerospace Systems organizational structure. We expect the increased scale, financial strength and complementary products of the new combined business will strengthen our position in the aerospace and defense industry. Further, we expect that this acquisition will enhance our ability to support our customers with more integrated systems. In 2012, the Company approved plans for the divestiture of a number of non-core businesses. Cash generated from these divestitures is intended to be used to repay a portion of the short-term debt we expect to incur as part of the financing for the proposed acquisition of Goodrich. See Note 2 for further discussion. In July 2012, we completed the acquisition of Goodrich and announced agreements to sell a number of non-core businesses. See Note 17 for discussion of subsequent events. On June 29, 2012, Pratt & Whitney, Rolls-Royce plc (Rolls-Royce), and MTU Aero Engines AG (MTU) and Japanese Aero Engines Corporation (JAEC), participants in the IAE International Aero Engines AG (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 a license for its V2500 intellectual property with 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 IAE as a strategic supplier for the V2500 engine and continue to perform its key responsibilities for IAE, including the manufacture of parts and assembly of 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 has 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
7
Table of Contentsvariable interest entity (VIE). IAE’s business purpose is to coordinate the design, development, and the manufacture of, and to provide product support to 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 on the remeasurement to fair value of our previously held equity interest on obtaining control of IAE. The carrying amounts and classification of assets and liabilities for IAE in our condensed consolidated balance sheet as of June 30, 2012 are as follows:
Goodwill. Changes in our goodwill balances for the first six months of 2012 were as follows:
For the six months ended June 30, 2012, Pratt & Whitney recorded $254 million of tax-deductible goodwill resulting from business combinations related to its increased ownership interest and consolidation of IAE. The approximately $2.1 billion decrease reflected under “Foreign currency translation and other” in the table above primarily reflects the decision to divest a number of non-core businesses and the resulting reclassification to Assets of discontinued operations. See Note 2 for further discussion. Intangible Assets. Identifiable intangible assets are comprised of the following:
8
Table of ContentsAmortization of intangible assets for the quarter and six months ended June 30, 2012 was $96 million and $195 million respectively, compared with $103 million and $203 million for the same periods of 2011. Average amortization of these intangible assets for 2012 through 2016 is expected to approximate $360 million per year. Note 2: Discontinued Operations In 2012, the Company approved plans for the divestiture of a number of non-core businesses. Cash generated from these divestitures is intended to be used to repay a portion of the short-term debt we expect to incur as part of the financing for the proposed 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 Hamilton Sundstrand Industrial businesses, Pratt & Whitney Rocketdyne (Rocketdyne), and Clipper Windpower (Clipper) all met the held-for-sale criteria. On June 29, 2012, management approved a plan for the divestiture of UTC Power. The operating results of Clipper and UTC Power had previously been reported within “Eliminations & other” in our segment disclosure. 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 Statement of Comprehensive Income and Condensed Consolidated Statement of Cash Flows for all periods presented. The assets and liabilities of these non-core businesses have been reclassified to Assets of discontinued operations and Liabilities of discontinued operations in our Condensed Consolidated Balance Sheet as of June 30, 2012. Cash flows from the operation of these discontinued businesses will 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 has 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 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 cost to sell the business expected to be realized upon sale and reflects the loss in value from the disposition of the business before the benefits of the technology investments could be fully realized. The fair value of these businesses has been estimated using information available in the marketplace as we market these businesses for sale. There could be gains or additional losses recorded upon final disposition of these businesses based upon the values, terms and conditions that are ultimately negotiated. The following summarized financial information related to these non-core businesses has been segregated from continuing operations and will be reported as discontinued operations through the dates of disposition:
The income tax benefit for the six months ended June 30, 2012 includes approximately $235 million of unfavorable income tax adjustments related to the recognition of a deferred tax liability on the existing difference between the accounting versus tax gain on the planned disposition of Hamilton Sundstrand’s Industrial businesses.
9
Table of ContentsThe assets and liabilities of discontinued operations on the Condensed Consolidated Balance Sheet as of June 30, 2012 are as follows:
We announced agreements for the sale of Rocketdyne on July 23, 2012 and for the sale of the Hamilton Sundstrand Industrial businesses on July 25, 2012. See Note 17 for discussion of subsequent events. Note 3: Earnings Per Share
The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock appreciation rights and stock options, when the average market price of the common stock is lower than the exercise price of the related stock awards during the period. These outstanding stock awards are not included in the computation of diluted earnings per
10
Table of Contentsshare because the effect would be anti-dilutive. For the quarter ended June 30, 2012, the number of stock awards excluded from the computation was 6.2 million. For the six months ended June 30, 2012, there were no anti-dilutive stock awards excluded from the computation. There were no anti-dilutive stock awards excluded from the computation for the quarter and six months ended June 30, 2011. On June 18, 2012, we issued 22,000,000 Equity Units, which did not impact diluted earnings per share in the quarter or six months ended June 30, 2012. Note 4: Inventories and Contracts in Progress
As of June 30, 2012 and December 31, 2011, the above inventory balances include capitalized contract development costs of $826 million and $776 million, respectively, related to certain aerospace programs. These capitalized costs are liquidated as production units are delivered to the customer. The capitalized contract development costs within inventory principally relate to costs capitalized on Sikorsky’s CH-148 contract with the Canadian government. The CH-148 is a derivative of the H-92, a military variant of the S-92. Note 5: Borrowings and Lines of Credit
On November 8, 2011, we entered into a bridge credit agreement with various financial institutions that provides for a $15 billion unsecured bridge loan facility available to partially fund the cash consideration of the pending acquisition of Goodrich and pay related fees, expenses and other amounts expected to become due and payable by UTC as a result of the acquisition. Any funding under the bridge credit agreement would substantially occur concurrently with the consummation of the Goodrich acquisition, subject to customary conditions for acquisition financings of this type. Any loans made pursuant to the bridge credit agreement would mature on the date that is 364 days after the funding date. We have reduced the available commitments under this bridge loan facility to $2 billion primarily as a result of the subsequent financing transactions on June 1, 2012 and June 18, 2012 as described below. On April 24, 2012, we entered into a term loan credit agreement with various financial institutions that provides for a $2 billion unsecured term loan facility, and which is available to partially fund the cash consideration of the pending acquisition of Goodrich and pay related fees, expenses and other amounts expected to become due and payable by UTC as a result of the acquisition. Any loan under the agreement would mature on December 31, 2012, and funding would occur shortly before consummation of the acquisition, subject to customary conditions for financings of this type. Funding would be conditioned on the substantially contemporaneous termination of the remaining commitments under our $15 billion bridge credit agreement executed on November 8, 2011. On June 1, 2012, we issued a total of $9.8 billion of long-term debt, which is comprised of $1.0 billion aggregate principal amount of 1.200% notes due 2015, $1.5 billion aggregate principal amount of 1.800% notes due 2017, $2.3 billion aggregate principal amount of 3.100% notes due 2022, $3.5 billion aggregate principal amount of 4.500% notes due 2042, $1.0 billion aggregate principal amount of three-month LIBOR plus 0.270% floating rate notes due 2013, and $0.5 billion aggregate principal amount of three-month LIBOR plus 0.500% floating rate notes due 2015. We expect to primarily use the net proceeds of these notes to partially fund the cash consideration for the pending acquisition of Goodrich and pay related fees, expenses and other amounts expected to become due and payable by UTC as a result of the acquisition. The remainder of the net proceeds from these notes, if any, will be used for general corporate purposes. The three-month LIBOR rate as of June 30, 2012 was approximately 0.5%.
11
Table of ContentsOn June 18, 2012, we issued 22,000,000 Equity Units. Each Equity Unit has a stated amount of $50 and initially is in the form of a corporate unit consisting of (a) a freestanding stock purchase contract under which the holder will purchase from us on August 1, 2015, a number of shares of our common stock determined pursuant to the terms of the agreement and (b) a 1/20, or 5.0%, undivided beneficial ownership interest in $1,000 principal amount on our 1.55% junior subordinated notes due 2022. Holders of the Equity Units will be entitled to receive quarterly contract adjustment payments at a rate of 5.95% per year of the stated amount of $50 per Equity Unit, subject to our right to defer such payments. We expect to primarily use the net proceeds of the Equity Units to partially fund the cash consideration of the pending acquisition of Goodrich and pay related fees, expenses and other amounts expected to become due and payable by UTC as a result of the acquisition. The remainder of the net proceeds from the Equity Units, if any, will be used for general corporate purposes. The net proceeds from the sale of the Equity Units were allocated between the purchase contracts and the notes in our financial statements based on the underlying fair value of each instrument at the time of issuance taking into consideration the contract adjustment payments. The fair value of the purchase contracts is expected to approximate the present value of the contract adjustment payments and was recorded as a reduction to Common Stock, with an offsetting credit to liabilities. This liability will be accreted over three years through interest charges to the income statement based on a constant rate calculation. The purchase contracts are reflected in our diluted earnings per share calculations using the treasury stock method. Cash generated from the issuances of long-term debt and Equity Units during June 2012 is currently designated for the Goodrich acquisition and payment of related fees, expenses and other amounts expected to become due and payable by UTC as a result of the acquisition, and has therefore been classified as “Restricted cash, current” in our Condensed Consolidated Balance Sheet as of June 30, 2012. The restricted cash balance held as of June 30, 2012 and December 31, 2011 was $10.7 billion and $37 million, respectively. At June 30, 2012, we had revolving credit agreements with various banks permitting aggregate borrowings of up to $4 billion pursuant to a $2 billion revolving credit agreement and a $2 billion multicurrency revolving credit agreement, both of which expire in November 2016. As of June 30, 2012, there were no borrowings under either of these revolving credit agreements. The undrawn portions of our revolving credit agreements are also available to serve as backup facilities for the issuance of commercial paper. As of June 30, 2012, our maximum commercial paper borrowing authority as set by our Board of Directors was $4 billion. We generally use our commercial paper borrowings for general corporate purposes, including the funding of potential acquisitions and repurchases of our common stock. Long-term debt consisted of the following:
12
Table of Contents
We have an existing universal shelf registration statement filed with the Securities and Exchange Commission (SEC) for an indeterminate amount of equity and debt securities for future issuance, subject to our internal limitations on the amount of equity and debt to be issued under this shelf registration statement. The closing of the acquisition of Goodrich on July 26, 2012 materially changed certain of the borrowings and lines of credit listed above. See Note 17 for discussion of subsequent events, including the Goodrich acquisition financing. Note 6: Income Taxes We conduct business globally and, as a result, UTC or one or more of our subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as Australia, Belgium, Canada, China, France, Germany, Hong Kong, Italy, Japan, South Korea, Singapore, Spain, the United Kingdom and the United States. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 1998. In the ordinary course of business, there is inherent uncertainty in quantifying our income tax positions. We assess our income tax positions and record tax benefits for all years subject to examination based upon management’s evaluation of the facts, circumstances, and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. Where applicable, associated interest has also been recognized; interest accrued in relation to unrecognized tax benefits is recorded in interest expense. Penalties, if incurred, would be recognized as a component of income tax expense. It is reasonably possible that over the next twelve months the amount of unrecognized tax benefits may decrease within a range of $10 million to $120 million as a result of additional worldwide uncertain tax positions, the revaluation of current uncertain tax positions arising from developments in examinations, in appeals or in the courts, or the closure of tax statutes. A portion of this net reduction may impact the Company’s 2012 or 2013 income tax expense. Not included in the range is €198 million (approximately $247 million) of tax benefits that we have claimed related to a 1998 German reorganization. A portion of these tax benefits was denied by the German Tax Office on July 5, 2012, as a result of the audit of tax years 1999 to 2000. In 2008 the German Federal Tax Court denied benefits to another taxpayer in a case involving a German tax law relevant to our reorganization. The determination of the German Federal Tax Court on this other matter was appealed to the European Court of Justice (ECJ) to determine if the underlying German tax law is violative of European Union (EU) principles. On September 17, 2009 the ECJ issued an opinion in this case that is generally favorable to the other taxpayer and referred the case back to the German Federal Tax Court for further consideration of certain related issues. In May 2010, the German Federal Tax Court released its decision, in which it resolved certain tax issues that may be relevant to our audit and remanded the case to a lower court for further development. After consideration of the ECJ decision and the latest German Federal Tax Court decision, we continue to believe that it is more likely than not that the relevant German tax law is violative of EU principles and we have not accrued tax expense for this matter. As we continue to monitor developments related to this matter, it may become necessary for us to accrue tax expense and related interest. Tax years 2004 through 2008 are currently before the Appeals Division of the Internal Revenue Service (IRS) for resolution discussions regarding certain proposed tax adjustments with which the Company does not agree. The Company expects resolution discussions relating to the 2004 and 2005 tax years to be completed within the next six months.
13
Table of ContentsNote 7: Employee Benefit Plans Pension and Postretirement Plans. We sponsor both funded and unfunded domestic and foreign defined pension and other postretirement benefit plans, and defined contribution plans. Contributions to these plans were as follows:
There were no contributions to our domestic defined benefit pension plans in the first six months of 2012 and 2011. The following tables illustrate the components of net periodic benefit cost for our defined pension and other postretirement benefit plans:
Net settlements and curtailment losses for pension benefits includes curtailment losses of approximately $3 million and $24 million related to, and recorded in, discontinued operations for the quarter and six months ended June 30, 2012, respectively.
14
Table of ContentsNote 8: Restructuring Costs During the first six months of 2012, we recorded net pre-tax restructuring costs totaling $232 million for new and ongoing restructuring actions as follows:
The net costs included $110 million recorded in cost of sales, $94 million in selling, general and administrative expenses, and $28 million in discontinued operations. As described below, these costs primarily relate to actions initiated during 2012 and 2011. 2012 Actions. During the first six months of 2012, we initiated restructuring actions relating to ongoing cost reduction efforts, including workforce reductions and the consolidation of field operations. We recorded net pre-tax restructuring costs totaling $187 million, including $88 million in cost of sales, $72 million in selling, general and administrative expenses and $27 million in discontinued operations. We expect the actions initiated in the first six months of 2012 to result in net workforce reductions of approximately 2,300 hourly and salaried employees, the exiting of approximately 600,000 net square feet of facilities and the disposal of assets associated with exited facilities. As of June 30, 2012, we have completed net workforce reductions of approximately 1,300 employees and exited approximately 100,000 net square feet. We are targeting the majority of the remaining workforce and all facility related cost reduction actions for completion during 2012 and 2013. No specific plans for significant other actions have been finalized at this time. The following table summarizes the accrual balances and utilization by cost type for the 2012 restructuring actions:
The following table summarizes expected, incurred and remaining costs for the 2012 restructuring actions by type:
15
Table of ContentsThe following table summarizes expected, incurred and remaining costs for the 2012 restructuring actions by segment:
2011 Actions. During the first six months of 2012, we recorded net pre-tax restructuring costs totaling $41 million for restructuring actions initiated in 2011, including $19 million in cost of sales, $21 million in selling, general and administrative expenses and $1 million in discontinued operations. The 2011 actions relate to ongoing cost reduction efforts, including workforce reductions and the consolidation of field operations. As of June 30, 2012, we have completed net workforce reductions of approximately 4,000 employees of an expected 5,000 employees, and have exited approximately 100,000 net square feet of facilities of an expected 2 million net square feet. We are targeting the majority of the remaining workforce and facility related cost reduction actions for completion during 2012 and 2013. The following table summarizes the accrual balances and utilization by cost type for the 2011 restructuring actions:
The following table summarizes expected, incurred and remaining costs for the 2011 restructuring actions by type:
16
Table of ContentsThe following table summarizes expected, incurred and remaining costs for the 2011 restructuring actions by segment:
2010 Actions. As of June 30, 2012, we have approximately $44 million of accrual balances remaining related to 2010 actions. Note 9: Financial Instruments We enter into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments under the Derivatives and Hedging Topic of the FASB ASC and those utilized as economic hedges. We operate internationally and, in the normal course of business, are exposed to fluctuations in interest rates, foreign exchange rates and commodity prices. These fluctuations can increase the costs of financing, investing and operating the business. We have used derivative instruments, including swaps, forward contracts and options to manage certain foreign currency, interest rate and commodity price exposures. By their nature, all financial instruments involve market and credit risks. We enter into derivative and other financial instruments with major investment grade financial institutions and have policies to monitor the credit risk of those counterparties. We limit counterparty exposure and concentration of risk by diversifying counterparties. While there can be no assurance, we do not anticipate any material non-performance by any of these counterparties. Foreign Currency Forward Contracts. We manage our foreign currency transaction risks to acceptable limits through the use of derivatives that hedge forecasted cash flows associated with foreign currency transaction exposures, which are accounted for as cash flow hedges, as we deem appropriate. To the extent these derivatives are effective in offsetting the variability of the hedged cash flows, and otherwise meet the hedge accounting criteria of the Derivatives and Hedging Topic of the FASB ASC, the changes in the derivatives’ fair values are not included in current earnings but are included in “Accumulated other comprehensive loss.” These changes in fair value will subsequently be reclassified into earnings as a component of product sales or expenses, as applicable, when the forecasted transaction occurs. To the extent that a previously designated hedging transaction is no longer an effective hedge, any ineffectiveness measured in the hedging relationship is recorded currently in earnings in the period in which it occurs. To the extent the hedge accounting criteria are not met, the foreign currency forward contracts are utilized as economic hedges and changes in the fair value of these contracts are recorded currently in earnings in the period in which they occur. These include hedges that are used to reduce exchange rate risks arising from the change in fair value of certain foreign currency denominated assets and liabilities (e.g. payables, receivables) and other economic hedges where the hedge accounting criteria were not met. The four quarter rolling average of the notional amount of foreign exchange contracts hedging foreign currency transactions was $11.1 billion and $10.4 billion at June 30, 2012 and December 31, 2011, respectively.
17
Table of ContentsThe following table summarizes the fair value of derivative instruments as of June 30, 2012 and December 31, 2011 which consist solely of foreign exchange contracts:
The impact from foreign exchange derivative instruments that qualified as cash flow hedges was as follows:
Assuming current market conditions continue, a $54 million pre-tax loss is expected to be reclassified from Accumulated other comprehensive loss into Product sales to reflect the fixed prices obtained from foreign exchange hedging within the next 12 months. At June 30, 2012, all derivative contracts accounted for as cash flow hedges will mature by June 2014. The effect on the Condensed Consolidated Statement of Comprehensive Income from foreign exchange contracts not designated as hedging instruments was as follows:
Fair Value Disclosure. As of January 1, 2012, we adopted the provisions of the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU clarifies many of the existing concepts for measuring fair value and does not result in a change in our application of the Fair Value Measurements and Disclosures Topic of the FASB ASC. The guidance includes enhanced disclosure requirements about recurring Level 3 fair value measurements for each class of assets and liabilities measured at fair value in the balance sheet, which has no impact on our financial statements or disclosures as there are presently no Level 3 fair value measurements in our Condensed Consolidated Balance Sheet. This ASU also requires additional disclosures for items that are not measured at fair value in the balance sheet but for which the fair value is required to be disclosed.
18
Table of ContentsValuation Hierarchy. The following table provides the valuation hierarchy classification of assets and liabilities that are carried at fair value and measured on a recurring and nonrecurring basis in our Condensed Consolidated Balance Sheet as of June 30, 2012 and December 31, 2011:
During 2011, we recorded non-cash other-than-temporary impairment charges of $66 million within Other income, net on an equity investment. The impairment charge recorded on our investment was determined by comparing the carrying value of our investment to the closing market value of the shares on the date the investment was deemed to be impaired. Valuation Techniques. Our available-for-sale securities include equity investments that are traded in active markets, either domestically or internationally. They are measured at fair value using closing stock prices from active markets and are classified within Level 1 of the valuation hierarchy. Our derivative assets and liabilities are managed on the basis of net exposure to market and credit risks of each of the counterparties. The fair value for these derivative assets and liabilities is measured at the price that would be received on a net asset position for a particular risk or to transfer a net liability position for a particular risk in an orderly transaction between market participants at the measurement date. Our derivative assets and liabilities include foreign exchange contracts and commodity derivatives that are measured at fair value using internal models based on observable market inputs such as forward rates, interest rates, our own credit risk and our counterparties’ credit risks. Based on these inputs, the derivative assets and liabilities are classified within Level 2 of the valuation hierarchy. Based on our continued ability to trade securities and enter into forward contracts, we consider the markets for our fair value instruments to be active. As of June 30, 2012, there were no significant transfers in and out of Level 1 and Level 2. As of June 30, 2012, there has not been any significant impact to the fair value of our derivative liabilities due to our own credit risk. Similarly, there has not been any significant adverse impact to our derivative assets based on our evaluation of our counterparties’ credit risks.
19
Table of ContentsThe following table provides carrying amounts and fair values of financial instruments that are not carried at fair value in our Condensed Consolidated Balance Sheet at June 30, 2012 and December 31, 2011:
The following table provides the valuation hierarchy classification of assets and liabilities that are not carried at fair value in our Condensed Consolidated Balance Sheet as of June 30, 2012:
Valuation Techniques. Our long-term receivables and customer financing notes receivables include our commercial and aerospace long-term trade, government and other receivables, leases, and notes receivable. Our long-term receivables and customer financing notes receivables are measured at fair value using an income approach based on the present value of the contractual, promised or most likely cash flows discounted at observed or estimated market rate for comparable assets or liabilities that are traded in the market. Based on these inputs, long-term receivables and customer financing notes receivables are classified within Level 2 of the valuation hierarchy. Our short-term borrowings include commercial paper and other international credit facility agreements. Our long-term debt includes domestic and international notes. Commercial paper and domestic long-term notes are measured at fair values based on comparable transactions and current market interest rates quoted in active markets for similar assets, and are classified within Level 2 of the valuation hierarchy. Foreign short-term borrowings and foreign long-term notes are measured at fair value based on comparable transactions and rates calculated from the respective countries’ yield curves. Based on these inputs, foreign borrowings and foreign long-term notes are classified within Level 3 of the valuation hierarchy. The fair values of Accounts receivable and Accounts payable approximate the carrying amounts due to the short-term maturities of these instruments. We had commercial aerospace financing and other contractual commitments totaling approximately $2.8 billion at June 30, 2012, which now include approximately $580 million of IAE commitments, related to commercial aircraft and certain contractual rights to provide product on new aircraft platforms. We had commercial aerospace financing and other contractual commitments of approximately $2.3 billion at December 31, 2011. Risks associated with changes in interest rates on these commitments are mitigated by the fact that interest rates are variable during the commitment term, and are set at the date of funding based on current market conditions, the fair value of the underlying collateral and the credit worthiness of the customers. As a result, the fair value of these financings is expected to equal the amounts funded. The fair value of the commitment itself is not readily determinable and is not considered significant. Note 10: Credit Quality of Long-Term Receivables A long-term or financing receivable represents a contractual right to receive money on demand or on fixed and determinable dates, including trade receivable balances with maturity dates greater than one year. Our long-term and financing receivables primarily represent balances related to the aerospace businesses such as long-term trade accounts receivable, leases, and notes receivable. We also have other long-term receivables in our commercial businesses; however, both the individual and aggregate amounts are not significant.
20
Table of ContentsLong-term trade accounts receivable represent amounts arising from the sale of goods and services with a contractual maturity date of greater than one year and are recognized as “Other assets” in our Condensed Consolidated Balance Sheet. Notes and leases receivable represent notes and lease receivables other than receivables related to operating leases, and are recognized as “Customer financing assets” in our Condensed Consolidated Balance Sheet. The following table summarizes the balance by class of aerospace long-term receivables as of June 30, 2012 and December 31, 2011:
The increase reflected in “Notes and leases receivable” as of June 30, 2012, as compared to December 31, 2011, primarily reflects the impact of consolidating IAE. See Note 1 for further discussion. Economic conditions and air travel influence the operating environment for most airlines, and the financial performance of our aerospace businesses is directly tied to the economic conditions of the commercial aerospace and defense industries. Additionally, the value of the collateral is also closely tied to commercial airline performance and may be subject to exposure of reduced valuation as a result of market declines. We determine a receivable is impaired when, based on current information and events, it is probable that we will be unable to collect amounts due according to the contractual terms of the receivable agreement. Factors considered in assessing collectability and risk include, but are not limited to, examination of credit quality indicators and other evaluation measures, underlying value of any collateral or security interests, significant past due balances, historical losses, and existing economic conditions. Long-term receivables can be considered delinquent if payment has not been received in accordance with the underlying agreement. If determined delinquent, long-term trade accounts receivable and notes and leases receivable balances accruing interest may be placed on nonaccrual status. We record potential losses related to long-term receivables when identified. The reserve for credit losses on these receivables relates to specifically identified receivables that are evaluated individually for impairment. For notes and leases receivable, we determine a specific reserve for exposure based on the difference between the carrying value of the receivable and the estimated fair value of the related collateral in connection with the evaluation of credit risk and collectability. For long-term trade accounts receivable, we evaluate credit risk and collectability individually to determine if an allowance is necessary. Uncollectible long-term receivables are written-off when collection of the indebtedness has been pursued for a reasonable period of time without collection; the customer is no longer in operation; or judgment has been levied, but the underlying assets are not adequate to satisfy the indebtedness. At both June 30, 2012 and December 31, 2011, we do not have any significant balances that are considered to be delinquent, on non-accrual status, past due 90 days or more, or considered to be impaired. The following table provides the balance of aerospace long-term receivables and summarizes the associated changes in the reserve for estimated credit losses and exposure for the six months ended June 30, 2012 and 2011, respectively:
We determine credit ratings for each customer in the portfolio based upon public information and information obtained directly from our customers. We conduct a review of customer credit ratings, published historical credit default rates for different rating categories, and multiple third party aircraft value publications as a basis to validate the reasonableness of the allowance for losses on these balances quarterly or when events and circumstances warrant. The credit ratings listed below range from “A” which indicates an extremely strong capacity to meet financial obligations and the receivable is either collateralized or uncollateralized, to “D” which indicates that payment is in default and the receivable is uncollateralized. There can be no assurance that actual results will not differ from estimates or that consideration of these factors in the future will not result in an increase or decrease to the allowance for credit losses on long-term receivables.
21
Table of ContentsThe following table summarizes the credit risk profile by creditworthiness category for aerospace long-term receivable balances at June 30, 2012 and December 31, 2011:
Note 11: Shareowners’ Equity and Noncontrolling Interest As of January 1, 2012, we adopted the provisions of the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” As a result of this adoption, we have presented total comprehensive income for each of the periods presented within a single continuous Condensed Consolidated Statement of Comprehensive Income. A summary of the changes in shareowners’ equity and noncontrolling interest (excluding redeemable noncontrolling interest) comprising total equity for the quarters and six months ended June 30, 2012 and 2011 is provided below:
22
Table of Contents
A summary of the changes in each component of accumulated other comprehensive (loss) income for the quarter and six months ended June 30, 2012 is provided below:
All noncontrolling interests with redemption features, such as put options, that are not solely within our control (redeemable noncontrolling interests) are reported in the mezzanine section of the Condensed Consolidated Balance Sheet, between liabilities and equity, at the greater of redemption value or initial carrying value.
23
Table of ContentsA summary of the changes in redeemable noncontrolling interest recorded in the mezzanine section of the Condensed Consolidated Balance Sheet for the quarters and six months ended June 30, 2012 and 2011 is provided below:
Changes in noncontrolling interests that do not result in a change of control and where there is a difference between fair value and carrying value are accounted for as equity transactions. A summary of these changes in ownership interests in subsidiaries and the effect on shareowners’ equity for the quarters and six months ended June 30, 2012 and 2011 is provided below:
Note 12: Guarantees We extend a variety of financial, market value and product performance guarantees to third parties. As disclosed in Note 1, on June 29, 2012 Pratt & Whitney, Rolls-Royce, MTU and JAEC, completed a restructuring of their interests in IAE. This transaction has resulted in an increase in our proportionate share of IAE’s obligations from 33% to 61%. There were no material changes to IAE’s financing arrangements, which, as previously disclosed, were $989 million as of December 31, 2011. There have been no other material changes to guarantees outstanding since December 31, 2011. The changes in the carrying amount of service and product warranties and product performance guarantees for the six months ended June 30, 2012 and 2011 are as follows:
The decrease in the above table in “Other” during the six months ended June 30, 2012 primarily reflects the impact of warranty reserves reclassified to Liabilities of Discontinued Operations. See Note 2 for further discussion. The increase reflected in “Other” during the six months ended June 30, 2011 primarily reflected the impact of finalizing purchase accounting on the acquisition of Clipper.
24
Table of ContentsNote 13: Collaborative Arrangements In view of the risks and costs associated with developing new engines, Pratt & Whitney has entered into certain collaboration arrangements in which sales, costs and risks are shared. Sales generated from engine programs, spare parts, and aftermarket business under collaboration arrangements are recorded as earned in our financial statements. Amounts attributable to our collaborative partners for their share of sales are recorded as an expense in our financial statements based upon the terms and nature of the arrangement. Costs associated with engine programs under collaborative arrangements are expensed as incurred. Under these arrangements, collaborators contribute their program share of engine parts, incur their own production costs and make certain payments to Pratt & Whitney for shared or joint program costs. The reimbursement of the collaborators’ share of program costs is recorded as a reduction of the related expense item at that time. As of June 30, 2012, the collaborators’ interests in all commercial engine programs ranged from 4% to 48%, inclusive of a portion of Pratt & Whitney’s interests held by other participants. Pratt & Whitney is the principal participant in all existing collaborative arrangements. There are no individually significant collaborative arrangements and none of the partners exceed a 31% share in an individual program. See Note 1 for further discussion of changes in the IAE collaboration arrangement. Note 14: Contingent Liabilities Summarized below are the matters previously described in Note 17 of the Notes to the Consolidated Financial Statements in our 2011 Annual Report, incorporated by reference in our 2011 Form 10-K, updated as applicable. Environmental. Our operations are subject to environmental regulation by federal, state and local authorities in the United States and regulatory authorities with jurisdiction over our foreign operations. We accrue for the costs of environmental investigatory, remediation, operating and maintenance costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. The most likely cost to be incurred is accrued based on an evaluation of currently available facts with respect to each individual site, including existing technology, current laws and regulations and prior remediation experience. Where no amount within a range of estimates is more likely, we accrue the minimum. For sites with multiple responsible parties, we consider our likely proportionate share of the anticipated remediation costs and the ability of the other parties to fulfill their obligations in establishing a provision for those costs. We discount liabilities with fixed or reliably determinable future cash payments. We do not reduce accrued environmental liabilities by potential insurance reimbursements. We periodically reassess these accrued amounts. We believe that the likelihood of incurring losses materially in excess of amounts accrued is remote. Government. We are now, and believe that in light of the current U.S. government contracting environment we will continue to be, the subject of one or more U.S. government investigations. If we or one of our business units were charged with wrongdoing as a result of any of these investigations or other government investigations (including violations of certain environmental or export laws) the U.S. government could suspend us from bidding on or receiving awards of new U.S. government contracts pending the completion of legal proceedings. If convicted or found liable, the U.S. government could fine and debar us from new U.S. government contracting for a period generally not to exceed three years. The U.S. government could void any contracts found to be tainted by fraud. Our contracts with the U.S. government are also subject to audits. Like many defense contractors, we have received audit reports, which recommend that certain contract prices should be reduced to comply with various government regulations. Some of these audit reports involve substantial amounts. We have made voluntary refunds in those cases we believe appropriate, have settled some allegations and continue to litigate certain other cases. In addition, we accrue for liabilities associated with those matters that are probable and can be reasonably estimated. The most likely settlement amount to be incurred is accrued based upon a range of estimates. Where no amount within a range of estimates is more likely, then we accrue the minimum amount. As previously disclosed, the U.S. Department of Justice (DOJ) sued us in 1999 in the U.S. District Court for the Southern District of Ohio, claiming that Pratt & Whitney violated the civil False Claims Act and common law. This lawsuit relates to the “Fighter Engine Competition” between Pratt & Whitney’s F100 engine and General Electric’s F110 engine. The DOJ alleges that the government overpaid for F100 engines under contracts awarded by the U.S. Air Force in fiscal years 1985 through 1990 because Pratt & Whitney inflated its estimated costs for some purchased parts and withheld data that would have revealed the overstatements. At trial of this matter, completed in December 2004, the government claimed Pratt & Whitney’s liability to be $624 million. On August 1, 2008, the trial court judge held that the Air Force had not suffered any actual damages because Pratt & Whitney had made significant price concessions. However, the trial court judge found that Pratt & Whitney violated the False Claims Act due to inaccurate statements contained in its 1983 offer. In the absence of actual damages, the trial court judge awarded the DOJ the maximum civil penalty of $7.09 million, or $10,000 for each of the 709 invoices Pratt & Whitney submitted in 1989 and later under the contracts. In September 2008, both the DOJ and UTC appealed the decision to the Sixth Circuit Court of Appeals. In November 2010, the Sixth Circuit affirmed Pratt & Whitney’s liability under the False Claims Act and remanded the case to the trial court for further proceedings.
25
Table of ContentsOn June 18, 2012, the trial court found that Pratt & Whitney had breached other obligations imposed by common law based on the same conduct with respect to which the court previously found liability under the False Claims Act. Under the common law claims, the U.S. Air Force may seek damages for events occurring before March 3, 1989, which are not recoverable under the False Claims Act. Further proceedings at the trial court will determine the damages, if any, relating to the False Claims Act and common law claims. The government is expected to continue to seek damages of $624 million, plus interest. Pratt & Whitney continues to contend that the government suffered no actual damages. Should the government ultimately prevail, the outcome of this matter could result in a material adverse effect on our results of operations in the period in which a liability would be recognized or cash flows for the period in which damages would be paid. As previously disclosed, in December 2008, the Department of Defense (DOD) issued a contract claim against Sikorsky to recover overpayments the DOD alleges it has incurred since January 2003 in connection with cost accounting changes approved by the DOD and implemented by Sikorsky in 1999 and 2006. These changes relate to the calculation of material overhead rates in government contracts. The DOD claims that Sikorsky’s liability is approximately $93 million (including interest through June 2012). We believe this claim is without merit and Sikorsky filed an appeal in December 2009 with the U.S. Court of Federal Claims. Trial in the matter is scheduled to commence later this year. We do not believe the resolution of this matter will have a material adverse effect on our competitive position, results of operations, cash flows or financial condition. A significant portion of our activities are subject to export control regulation by the U.S. Department of State (State Department) under the U.S. Arms Export Control Act and International Traffic in Arms Regulations (ITAR). From time to time, we identify, investigate, remediate and voluntarily disclose to the State Department’s Office of Defense Trade Controls Compliance (DTCC) potential violations of the ITAR. DTCC administers the State Department’s authority under the ITAR to impose civil penalties and other administrative sanctions for violations, including debarment from engaging in the export of defense articles or defense services. Most of our voluntary disclosures are resolved without the imposition of penalties or other sanctions. However, as previously disclosed, in November 2011, DTCC informed us that it considers certain of our voluntary disclosures filed since 2005 to reflect deficiencies warranting penalties and sanctions. On June 28, 2012, we entered into a Consent Agreement (CA) with DTCC to resolve a Proposed Charging Letter that references approximately 45 of our previous disclosures. The CA has a four-year term, and provides that we will: (1) pay a civil penalty of $55 million, up to $20 million of which can be suspended based on qualifying compliance investments made by us prior to or during the term of the CA; (2) appoint, subject to DTCC approval, an outside Special Compliance Official (SCO) to oversee our compliance with the CA and the ITAR; (3) continue and undertake additional remedial actions to strengthen ITAR compliance, with emphasis on human resources and organization, training, automation, and security of electronic data; and (4) sponsor two company-wide outside compliance audits during the term of the CA. The voluntary disclosures addressed in the CA include disclosures made in 2006 and 2007 regarding the export by Hamilton Sundstrand to Pratt & Whitney Canada (P&WC) of certain modifications to dual-use electronic engine control software, and the re-export by P&WC of those software modifications and subsequent P&WC-developed modifications to China during the period 2002-2004 for use in the development of the Z-10 Chinese military helicopter. As previously disclosed, the DOJ separately conducted a criminal investigation of the matters addressed in these disclosures, as well as the accuracy, adequacy, and timeliness of the disclosures. We cooperated with the DOJ’s investigation. On June 28, 2012, the U.S. Attorney for the District of Connecticut filed a three-count criminal information alleging: (1) that in 2002-2003, P&WC caused Hamilton Sundstrand to export ITAR-controlled software modifications to Canada and re-exported them to China without the required license; (2) that in 2006, P&WC, Hamilton Sundstrand and UTC made false statements in disclosures to DTCC regarding these ITAR violations; and (3) that P&WC and Hamilton Sundstrand violated a separate provision of the ITAR by failing timely to notify DTCC of the unlicensed software shipments to China, an embargoed country. P&WC pleaded guilty to violating the ITAR and making false statements as alleged, and was sentenced to probation and to pay fines and forfeitures totaling $6.9 million. P&WC, Hamilton Sundstrand and UTC (the UTC Entities) entered into a Deferred Prosecution Agreement (DPA) regarding the remaining offenses charged with respect to each UTC Entity. The DPA has a two-year term, and provides that the UTC Entities will: (1) pay an additional penalty of $13.8 million; (2) appoint, subject to DOJ approval, an independent monitor (who may be the same person as the SCO appointed under the CA) to oversee compliance with the DPA; (3) provide annual senior officer certifications that all known violations of the ITAR, Export Administration Regulations and sanctions regimes implemented under the International Emergency Economic Powers Act occurring after the execution date of the DPA have been reported by UTC, its subsidiaries, and its majority-owned or controlled affiliates to the appropriate official(s) of the U.S. government; (4) cooperate with law enforcement in specified areas; and (5) implement specified compliance training initiatives. We believe the previously disclosed potential liability recognized at March 31, 2012 of $55 million will be sufficient to discharge all amounts due under the CA and DPA. By reason of P&WC’s guilty plea to a criminal violation of the ITAR, DTCC imposed a partial statutory debarment on P&WC with respect to obtaining new or renewed ITAR license privileges. The debarment does not affect existing ITAR licenses/authorities, nor does it extend to programs supporting: (1) the U.S. government; (2) NATO allies; or (3) “major non-NATO allies” (as defined in the ITAR). P&WC may seek “transaction exception” approvals on a case-by-case basis for new or renewed ITAR licensing in other cases during the period of debarment. P&WC may apply for full reinstatement of ITAR privileges after one year. Various military
26
Table of Contentsdepartment and defense agency officials are also reviewing the UTC Entities’ present responsibility under the Federal Acquisition Regulation and P&WC’s eligibility to receive funds appropriated for fiscal year 2012 under the National Defense Appropriations Act. We do not believe the ultimate resolution of these matters, individually or collectively, will have a material adverse effect on our competitive position, results of operations, cash flows or financial condition. Other. We extend performance and operating cost guarantees beyond our normal warranty and service policies for extended periods on some of our products. We have accrued our estimate of the liability that may result under these guarantees and for service costs that are probable and can be reasonably estimated. We have identified the potential for additional warranty costs associated with certain components within the wind turbines previously installed by our Clipper business. During the second quarter of 2012, we evaluated likely sources of underlying quality issues on a portion of the affected wind turbines and recorded a $91 million reserve in discontinued operations for potential warranty costs. We continue to research the source of the remaining underlying quality issues and are unable to determine an estimate of reasonably possible additional warranty costs at this time. Depending upon the nature of the warranty actions required and the number of installed turbines that may be affected, the outcome of this matter could result in a material effect on our results of operations in the period in which a warranty liability would be recognized or cash flows for the period in which warranty remediation is performed. We are involved in a number of other legal proceedings, investigations and other contingency matters, including government audit matters, environmental investigatory, remediation, operating and maintenance costs, performance guarantees, self-insurance programs and matters arising out of the normal course of business. We are also subject to a number of routine lawsuits, investigations and claims (some of which involve substantial amounts) arising out of the ordinary course of our business. Many of these proceedings are at preliminary stages, and many of these cases seek an indeterminate amount of damages. We regularly evaluate the status of legal proceedings in which we are involved, to assess whether a loss is probable or there is a reasonable possibility that a loss or additional loss may have been incurred and determine if accruals and related disclosures are appropriate. The Company has established reserves for several hundred of its legal proceedings and other matters. We accrue contingencies based upon a range of possible outcomes. If no amount within this range is a better estimate than any other, then we accrue the minimum amount. With respect to any additional losses that may be incurred in excess of those accrued, either they are considered not material or we do not believe that a range of reasonably possible losses (defined by the relevant accounting literature to include all potential losses other than those deemed “remote”) can be determined. We do not believe that these matters will have a material adverse effect upon our competitive position, results of operations, cash flows or financial condition. All forward-looking statements concerning the possible or anticipated outcome of environmental, investigatory, litigation proceedings and other contingency matters involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. For further information as to these risks and uncertainties, see “Cautionary Note Concerning Factors That May Affect Future Results” and Part II, Item 1A, “Risk Factors” in this Form 10-Q. Note 15: Segment Financial Data Our operations are classified into five principal segments: Otis, UTC Climate, Controls & Security, Pratt & Whitney, Hamilton Sundstrand and Sikorsky. The segments are generally based on the management structure of the businesses and the grouping of similar operating companies, where each management organization has general operating autonomy over diversified products and services. 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.
27
Table of ContentsResults for the quarters and six months ended June 30, 2012 and 2011 are as follows:
See Note 8 to the Condensed Consolidated Financial Statements for a discussion of restructuring costs included in segment operating results. Note 16: Accounting Pronouncements In December 2011, the FASB issued ASU No. 2011-11, “Disclosures about Offsetting Assets and Liabilities.” This ASU is intended to enhance a financial statement user’s ability to understand the effects of netting arrangements on an entity’s financial statements, including financial instruments and derivative instruments that are either offset or subject to an enforceable master netting or similar arrangement. The scope of this ASU includes derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. This ASU includes enhanced disclosure requirements, including both gross and net information about instruments and transactions eligible for offset or subject to an agreement similar to a master netting arrangement. The provisions of this ASU will be applied retrospectively for interim and annual periods beginning on or after January 1, 2013. We are currently evaluating the impact of this new ASU. Note 17: Subsequent Events On July 23, 2012, we announced an agreement to sell Rocketdyne to GenCorp for $550 million. The transaction is expected to close in the first quarter of 2013. Proceeds from the sale will be used to repay a portion of the short-term debt incurred to finance the acquisition of Goodrich. The sale is subject to customary closing conditions, including regulatory approvals. On July 25, 2012, we announced an agreement to sell the Hamilton Sundstrand Industrial businesses to BC Partners and The Carlyle Group for $3.46 billion. The sale is expected to close before the end of the year and the proceeds from the sale will be used to repay a portion of the short-term debt incurred to finance the acquisition of Goodrich. The sale is subject to customary closing conditions, including regulatory approvals. 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 and interior systems, actuation and landing systems, and electronic systems. Under the terms of the agreement, Goodrich shareholders received $127.50 in cash for each
28
Table of Contentsshare of Goodrich common stock they owned on July 26, 2012. This equates to a total estimated enterprise value of $18.2 billion, including $1.7 billion in net debt assumed. Goodrich will be combined with Hamilton Sundstrand to form a new segment named UTC Aerospace Systems. This segment and our Pratt & Whitney segment will be separately reportable segments although they will both be included within the UTC Propulsion & Aerospace Systems organizational structure. Additional disclosures relating to the purchase price allocation will be provided in our third quarter Form 10-Q. To finance the cash consideration for the Goodrich acquisition and pay related fees, expenses and other amounts due and payable, we utilized the previously disclosed net proceeds of approximately $9.7 billion from the $9.8 billion of long-term notes issued on June 1, 2012 and the net proceeds of approximately $1.1 billion from the Equity Units issued on June 18, 2012, as well as $3.2 billion from the issuance of commercial paper during July 2012 and $2.0 billion of proceeds borrowed on our April 24, 2012 term loan credit agreement on July 26, 2012. For the remainder of the cash consideration, we also utilized approximately $0.5 billion of cash and cash equivalents generated from operating activities. On July 26, 2012 we terminated our bridge credit agreement entered into on November 8, 2011 after completing the Goodrich acquisition financing. Since these transactions occurred subsequent to the end of the second quarter of 2012, the effects of these transactions are not reflected in the condensed consolidated statement of comprehensive income, statement of cash flows, or balance sheet as of or for the quarter or six months ended June 30, 2012.
29
Table of ContentsWith respect to the unaudited condensed consolidated financial information of UTC for the quarters and six months ended June 30, 2012 and 2011, PricewaterhouseCoopers LLP (PricewaterhouseCoopers) reported that it has applied limited procedures in accordance with professional standards for a review of such information. However, its report dated July 30, 2012, appearing below, states that the firm did not audit and does not express an opinion on that unaudited condensed consolidated financial information. PricewaterhouseCoopers has not carried out any significant or additional audit tests beyond those that would have been necessary if their report had not been included. Accordingly, the degree of reliance on its report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers is not subject to the liability provisions of Section 11 of the Securities Act of 1933 (the Act) for its report on the unaudited condensed consolidated financial information because that report is not a “report” or a “part” of a registration statement prepared or certified by PricewaterhouseCoopers within the meaning of Sections 7 and 11 of the Act. Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareowners of United Technologies Corporation We have reviewed the accompanying condensed consolidated balance sheet of United Technologies Corporation and its subsidiaries as of June 30, 2012 and the related condensed consolidated statement of comprehensive income for the three-month and six-month periods ended June 30, 2012 and 2011 and the condensed consolidated statement of cash flows for the six-month periods ended June 30, 2012 and 2011. This interim financial information is the responsibility of the Corporation’s management. We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America. We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2011, and the related consolidated statements of operations, of cash flows, and of changes in equity for the year then ended (not presented herein), and in our report dated February 9, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2011, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived. /s/ PricewaterhouseCoopers LLP Hartford, Connecticut July 30, 2012
30
Table of Contents
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, Hamilton Sundstrand and Sikorsky. Otis and UTC Climate, Controls & Security are referred to as the “commercial businesses,” while Pratt & Whitney, Hamilton Sundstrand 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. 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. Subsequent Events On July 23, 2012, we announced an agreement to sell Rocketdyne to GenCorp for $550 million. The transaction is expected to close in the first quarter of 2013. Proceeds from the sale will be used to repay a portion of the short-term debt incurred to finance the acquisition of Goodrich. The sale is subject to customary closing conditions, including regulatory approvals. On July 25, 2012, we announced an agreement to sell the Hamilton Sundstrand Industrial businesses to BC Partners and The Carlyle Group for $3.46 billion. The sale is expected to close before the end of the year and the proceeds from the sale will be used to repay a portion of the short-term debt incurred to finance the acquisition of Goodrich. The sale is subject to customary closing conditions, including regulatory approvals. 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 and interior systems, actuation and landing systems, 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 equates to a total estimated enterprise value of $18.2 billion, including $1.7 billion in net debt assumed. Goodrich will be combined with Hamilton Sundstrand to form a new segment named UTC Aerospace Systems. This segment and our Pratt & Whitney segment will be separately reportable segments although they will both be included within the UTC Propulsion & Aerospace Systems organizational structure. Additional disclosures relating to the purchase price allocation will be provided in our third quarter Form 10-Q. To finance the cash consideration for the Goodrich acquisition and pay related fees, expenses and other amounts due and payable, we utilized the previously disclosed net proceeds of approximately $9.7 billion from the $9.8 billion of long-term notes issued on June 1, 2012 and the net proceeds of approximately $1.1 billion from the Equity Units issued on June 18, 2012, as well as $3.2 billion from the issuance of commercial paper during July 2012 and $2.0 billion of proceeds borrowed on our April 24, 2012 term loan credit agreement on July 26, 2012. For the remainder of the cash consideration, we also utilized approximately $0.5 billion of cash and cash equivalents generated from operating activities. On July 26, 2012 we terminated our bridge credit agreement entered into on November 8, 2011 after completing the Goodrich acquisition financing. Since these transactions occurred subsequent to the end of the second quarter of 2012, the effects of these transactions are not reflected in the condensed consolidated statement of comprehensive income, statement of cash flows, or balance sheet as of or for the quarter or six months ended June 30, 2012 or in the remainder of Management’s Discussion and Analysis of Financial Condition and Results of Operations below. 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.
31
Table of ContentsEurope continues to struggle with a debt crisis, and no clear solution is yet in place. An unfavorable Euro foreign exchange rate, combined with the continued economic slowdown in the region, has adversely affected sales and profit growth. China’s reported second quarter GDP growth rate was 7.6%, which while still strong, was the lowest growth rate since 2009. The Chinese government has begun easing fiscal policies in support of economic growth, including interest rate reductions. Despite the recent lower growth rates, urbanization and long-term economic fundamentals support continued growth in China, and we remain confident in China’s long-term growth prospects. Most indicators point towards modest growth in the U.S. in 2012. However, the political debate in Washington D.C. surrounding the “fiscal cliff” arising from scheduled spending cuts and tax increases could dampen growth prospects for 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 cost in continuing operations from $450 million to $500 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 a portion of the short-term debt we expect to incur as part of the financing for the proposed acquisition of Goodrich Corporation (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 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 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 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 six months of 2012, our investment in business acquisitions was $358 million (including debt assumed of $149 million), and consisted primarily of an increase of our ownership interest in IAE International Aero Engines AG (IAE) and a number of small acquisitions in our commercial 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 six months of 2012, goodwill increased $298 million. On September 21, 2011, we announced an agreement to acquire 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 and interior systems, actuation and landing systems, and electronic systems. Under the terms of the agreement, Goodrich shareholders will receive $127.50 in cash for each share of Goodrich common stock they own at the time of the closing of the transaction. This equates to a total estimated enterprise value of $18.2 billion, including $1.7 billion in net debt to be assumed. In March 2012, Goodrich received shareholder approval for the transaction. The transaction is subject to customary closing conditions, including regulatory approvals. We expect that this acquisition will close in mid-2012. Once the acquisition is complete, Goodrich and Hamilton Sundstrand will be combined to form a new segment named UTC Aerospace Systems. This segment and our Pratt & Whitney segment will be separately reportable segments although they will both be included within the UTC Propulsion & Aerospace Systems organizational structure. We expect the increased scale, financial strength and complementary products of the new combined business will strengthen our position in the aerospace and defense industry. Further, we expect that this acquisition will enhance our ability to support our customers with more integrated systems.
32
Table of ContentsOn 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 a license for its V2500 intellectual property with 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 IAE as a strategic supplier for the V2500 engine and continue to perform its key responsibilities for IAE, including the manufacture of parts and assembly of 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% 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 and manufacture of, and to provide product support to, 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 on the remeasurement to fair value of our previously held equity interest on obtaining control of IAE. On October 12, 2011, Pratt & Whitney and Rolls-Royce announced an agreement to form a new joint venture to develop new engines to power the next generation of mid-size aircraft that will replace the existing fleet of mid-size aircraft currently in service or in development. With this new joint venture, Pratt & Whitney and Rolls-Royce will focus on high-bypass ratio geared turbofan technology as well as collaborate on future studies of next generation propulsion systems. Pursuant to the agreement, the formation of this new joint venture is subject to regulatory approvals and other closing conditions. The completion of the restructuring of the parties’ interests in IAE on June 29, 2012 satisfied one of these closing conditions. The formation of the new joint venture may not occur for a substantial period of time. We expect to invest approximately $500 million in acquisitions in 2012, excluding spending for the acquisitions 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 six months of 2012.
33
Table of ContentsRESULTS OF OPERATIONS Net Sales
The 5% decrease in net sales for the second quarter of 2012 primarily reflects the impact of net dispositions (3%) and the adverse impact of foreign currency translation (3%). Organic sales growth was 1% for the quarter. During the second quarter of 2012, two of the five business segments experienced organic sales growth: Hamilton Sundstrand (9%) and Pratt & Whitney (6%). The organic growth at Hamilton Sundstrand is driven by higher aerospace OEM sales (9%), while organic growth at Pratt & Whitney is primarily a result of higher military engine and aftermarket sales (6%). Sikorsky organic sales contracted 9%, following 5% organic growth in the second quarter of 2011, driven by reduced aircraft deliveries from foreign military operations (6%) and fewer deliveries to the U.S. government (4%) in 2012. The 3% decrease in net sales in the first six months of 2012 reflects organic sales growth (1%), which was more than offset by the impact of net dispositions (2%) and the adverse impact of foreign currency translation (2%). During the first six months of 2012, two of the five business segments experienced organic sales growth: Hamilton Sundstrand (10%) and Pratt & Whitney (7%). The organic growth at Hamilton Sundstrand is driven by higher aerospace OEM (7%) and aerospace aftermarket (3%) volumes. Pratt & Whitney’s organic growth is primarily a result of higher military engine and aftermarket sales (6%). Sikorsky organic sales contracted 12%, following 9% organic growth in the first six months of 2011, driven by reduced aircraft deliveries from foreign military operations (9%) in 2012. Cost of Products and Services Sold
The factors contributing to the total percentage change year-over-year for the quarter and six months ended June 30, 2012 in total cost of products and services sold are as follows:
The organic increase in total cost of products and services sold (1%) in the second quarter of 2012 corresponded to the organic sales growth (1%) noted above. The 3% decline attributable to “Acquisitions and divestitures, net” is largely attributable to the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. The year-over-year decrease in cost of products sold, as a percentage of product sales, reflects the absence of losses associated with international development aircraft at Sikorsky, which were recognized in the second quarter of the prior year. The organic increase in total cost of products and services sold (1%) in the first six months of 2012 corresponded to the organic sales growth (1%) noted above. The 3% decline attributable to “Acquisitions and divestitures, net” is largely attributable to 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.
34
Table of ContentsGross Margin
The 40 basis point increase in gross margin as a percentage of sales for the second quarter of 2012 is due to the absence of losses associated with international development aircraft sales at Sikorsky, which were recognized in the second quarter of the prior year (20 basis points), lower year over year warranty costs at UTC Climate, Controls & Security (10 basis points) and the benefit of higher margin service sales (10 basis points) in the second quarter of 2012. The 40 basis point increase in gross margin as a percentage of sales for the first six months of 2012 is due to the absence of losses associated with international development aircraft sales at Sikorsky, which were recognized in the six months of the prior year (30 basis points) and benefit of higher margin service sales (10 basis points) in the first six months of 2012. Research and Development
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%) in the second quarter of 2012 primarily reflects an increase at Pratt & Whitney (3%) to further advance development primarily of multiple geared turbo fan platforms. Lower expenditures on the Boeing 787 program at Hamilton Sundstrand (1%) partially offset higher research and development spending on other aerospace programs (3%). The increase in company-funded research and development expenses for the first six months of 2012 (11%) primarily reflects an increase at Pratt & Whitney (7%) to further advance development primarily of multiple geared turbo fan platforms, and at Sikorsky (2%) primarily in support of military programs. We continue to expect company-funded research and development for the full year 2012 to increase about $150 million, as compared with 2011, in support of multiple next generation aerospace platforms. Selling, General and Administrative
Selling, general and administrative expenses decreased 4% in the second quarter of 2012, due primarily to the impact of favorable foreign exchange translation (4%) and dispositions completed over the preceding twelve months (3%), partially offset by higher restructuring costs (2%) and costs related to the proposed acquisition of Goodrich (1%). Selling, general and administrative expenses increased less than 1% in the first six months of 2012, due primarily to the impact of favorable foreign exchange translation (2%) and dispositions completed over the preceding twelve months (2%), partially offset by higher restructuring costs (2%) and costs related to the proposed acquisition of Goodrich (2%). The 50 basis point year-over-year increase as a percent of sales also reflects these higher acquisition related and restructuring costs.
35
Table of ContentsOther Income, Net
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 increase in other income, net in the second quarter of 2012, is largely due to an approximately $142 million net gain from the sale of a controlling interest in a Canadian distribution business, partially offset by a $32 million loss on the disposition of the U.S. fire and security branch operations, both of which are related to the ongoing UTC Climate, Controls & Security portfolio transformation. The remaining increase in other income, net is attributable primarily to net gains recognized on miscellaneous asset sales ($49 million) and normal recurring operational activity as disclosed above. The year-over-year increase in other income, net in the first six 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. fire and security branch operations, all of which are related to the ongoing UTC Climate, Controls & Security portfolio transformation. The remaining increase in other income, net is attributable primarily to net gains recognized on miscellaneous asset sales ($91 million) and normal recurring operational activity as disclosed above. Interest Expense, Net
The increase in interest expense in the second quarter and for the first six months of 2012 is a result of higher average long-term debt balances associated with the financing of our proposed acquisition of Goodrich. The increase in interest income in the first six months of 2012, as compared with the same period of 2011, reflects approximately $15 million of favorable pre-tax interest adjustments related to the conclusion of the IRS’s examination of our 2006 – 2008 tax years. Income Taxes
The decrease in the effective tax rate for the quarter ended June 30, 2012, reflects the favorable income tax impact of $168 million related to the release of valuation allowances resulting from internal legal entity reorganizations. The decrease is also the result of favorable tax impacts related to the net gains associated with the UTC Climate, Controls & Security ongoing portfolio transformation. The decrease in the effective tax rate for the first six months of 2012, primarily reflects the items noted above. This decrease is also the result of the favorable non-cash income tax impact of $203 million in the first quarter of 2012 related to the conclusion of the IRS’s examination of our 2006 – 2008 tax years. We estimate our full year annual effective income tax rate in 2012, excluding the impact of the acquisition of Goodrich, to be approximately 29.5%, absent non-recurring adjustments.
36
Table of ContentsNet Income Attributable to Common Shareowners from Continuing Operations
Diluted earnings per share from continuing operations for the second quarter of 2012 includes a net $0.10 per share benefit from non-recurring items, partially offset by $0.06 per share of restructuring charges. The results for the second quarter of 2011 included a net $0.05 per share benefit from non-recurring items, partially offset by a restructuring charge of $0.04 per share. For the first six months of 2012, diluted earnings per share from continuing operations includes a net $0.40 per share benefit from non-recurring items, partially offset by $0.15 per share of restructuring charges. The results for the first six months of 2011 included a net $0.05 per share benefit from non-recurring items, partially offset by a restructuring charge of $0.06 per share. The impact of foreign currency generated an adverse impact of $0.05 and $0.07 per diluted share on our operational performance in the second quarter and first six months of 2012, respectively. This year-over-year impact also includes the net adverse foreign currency translation impact at Pratt & Whitney Canada (P&WC). At P&WC, strength in the U.S. Dollar in 2012 generated a benefit from foreign currency translation as the majority of P&WC’s sales are denominated in U.S. Dollars, while a significant portion of its costs are incurred in local currencies. To help mitigate the volatility of foreign currency exchange rates on our operating results, we maintain foreign currency hedging programs, the majority of which are entered into by P&WC. As a result of hedging programs currently in place, P&WC’s 2012 full year operating results are expected to include a net adverse impact of foreign currency translation and hedging of approximately $50 million. The net impact of foreign currency translation and hedging was a favorable impact of $6 million and an adverse impact of $10 million in the quarter and first six months of 2012, respectively. For additional discussion of hedging, refer to Note 9 to the Condensed Consolidated Financial Statements. Net (Loss) Income Attributable to Common Shareowners from Discontinued Operations
Diluted loss per share from discontinued operations for the second quarter of 2012 includes $0.12 per share of net asset impairment charges at UTC Power. A warranty charge of $0.07 per share for potential costs associated with certain components of wind turbines previously installed by our Clipper business offset a $0.07 per share benefit from the results of operations of discontinued entities in the quarter. Diluted loss per share from discontinued operations for the first six months of 2012 includes $0.82 per share of goodwill impairment charges related to Rocketdyne and Clipper and net asset impairment charges at UTC Power, and $0.26 per share unfavorable income tax adjustments related to the recognition of a deferred tax liability on the existing difference between the accounting versus tax gain on the planned disposition of Hamilton Sundstrand’s Industrial Businesses. A $0.09 per share benefit from the results of operations of discontinued entities was partially offset by the $0.07 per share Clipper warranty charge noted above.
37
Table of ContentsRestructuring Costs We recorded net pre-tax restructuring costs for new and ongoing restructuring actions as follows:
The net costs included $110 million recorded in cost of sales, $94 million in selling, general and administrative expenses and $28 million in discontinued operations. As described below, these costs primarily relate to actions initiated during 2012 and 2011. 2012 Actions. During the first six months of 2012, we initiated restructuring actions relating to ongoing cost reduction efforts, including workforce reductions and the consolidation of field operations. We incurred net pre-tax restructuring costs totaling $187 million as follows:
The charges included $88 million in cost of sales, $72 million in selling, general and administrative expenses and $27 million in discontinued operations. These costs include $155 million for severance and related employee termination costs, $13 million for asset write-downs and $19 million for facility exit, lease termination costs and other related costs. We expect the 2012 actions that were initiated in the first six months to result in net workforce reductions of approximately 2,300 hourly and salaried employees, the exiting of approximately 600,000 net square feet and the disposal of assets associated with exited facilities. As of June 30, 2012, we have completed net workforce reductions of approximately 1,300 employees and exited approximately 100,000 net square feet. We are targeting the majority of the remaining workforce and all facility related cost reduction actions for completion during 2012 and 2013. Approximately 75% of the total pre-tax charge will require cash payments, which we will fund with cash generated from operations. During the first six months of 2012, we had cash outflows of approximately $62 million related to the 2012 actions. We expect to incur additional restructuring costs of $69 million to complete these actions. We expect recurring pre-tax savings to increase over the two-year period subsequent to initiating these actions to approximately $200 million annually.
38
Table of Contents2011 Actions. During the first six months of 2012, we recorded net pre-tax restructuring costs totaling $41 million for restructuring actions initiated in 2011. The 2011 actions relate to ongoing cost reduction efforts, including workforce reductions and the consolidation of field operations. We incurred net pre-tax restructuring costs for the first six months of 2012 as follows:
The charges included $19 million in cost of sales, $21 million in selling, general and administrative expenses and $1 million in discontinued operations. Those costs included $28 million for severance and related employee termination costs and $13 million for facility exit, lease termination costs and other related costs. We expect the 2011 actions to result in net workforce reductions of approximately 5,000 hourly and salaried employees, the exiting of approximately 2 million net square feet of facilities and the disposal of assets associated with the exited facilities. As of June 30, 2012, we completed net workforce reductions of approximately 4,000 employees and exited approximately 100,000 net square feet of facilities. We are targeting the majority of the remaining workforce and facility related cost reduction actions for completion during 2012 and 2013. Approximately 75% of the total pre-tax charge will require cash payments, which we will fund with cash generated from operations. During the first six months of 2012, we had cash outflows of approximately $104 million related to the 2011 actions. We expect to incur additional restructuring costs of $50 million to complete these actions. We expect recurring pre-tax savings to increase over the two-year period subsequent to initiating these actions to approximately $300 million annually. Additional 2012 Actions. We expect to initiate additional restructuring actions during the remainder of 2012. Including trailing costs related to previously initiated actions, we now expect full year 2012 restructuring costs from continuing operations of approximately $500 million, including the $204 million of charges incurred during the first six months of 2012. The expected adverse impact on full year earnings in 2012 from anticipated restructuring costs is expected to be offset by the beneficial impact from net non-recurring items. Except for those actions described above, no specific plans for significant other actions have been finalized at this time. Segment Review Segments are generally based on the management structure of the businesses and the grouping of similar operating companies, where each management organization has general operating autonomy over diversified products and services. Effective January 1, 2012, we formed the UTC Climate, Controls & Security segment, which combines the former Carrier and UTC Fire & Security segments. Adjustments to reconcile segment reporting to the consolidated results for the quarters and six months ended June 30, 2012 and 2011 are included in “Eliminations and other” below, which also includes certain smaller subsidiaries. We attempt to quantify material cited factors within our discussion of the results of each segment whenever those factors are determinable. However, in some instances, the factors we cite within our segment discussion are based upon input measures or qualitative information that does not lend itself to quantification when discussed in the context of the financial results measured on an output basis and are not, therefore, quantified in the below discussions. Commercial Businesses Our commercial businesses generally serve customers in the worldwide commercial and residential property industries, although UTC Climate, Controls & Security also serves customers in the commercial and transport refrigeration industries. Sales in the commercial businesses are influenced by a number of external factors, including fluctuations in residential and commercial construction activity, regulatory changes, interest rates, labor costs, foreign currency exchange rates, customer attrition, raw material
39
Table of Contentsand energy costs, credit markets and other global and political factors. UTC Climate, Controls & Security’s financial performance can also be influenced by production and utilization of transport equipment, and, in the case of its residential business, weather conditions. To ensure adequate supply of products in the distribution channel, UTC Climate, Controls & Security customarily offers its customers incentives to purchase products. The principal incentive program provides reimbursements to distributors for offering promotional pricing on UTC Climate, Controls & Security products. We account for incentive payments made as a reduction to sales. Within the Otis segment, new equipment orders were down 7% in the second quarter of 2012 (including 3% attributable to foreign exchange) due primarily to a decline in China (11%). The ongoing Chinese government effort to reduce housing prices has had an adverse impact on the high-end residential market, which has negatively impacted Otis’ China sales. However, the new equipment order rate in China improved during the second quarter in comparison to the first quarter of 2012. U.S. residential HVAC orders continued to grow through the second quarter and increased 4% compared to the second quarter of 2011, as UTC Climate, Controls & Security benefited from warmer than normal temperatures across most of the U.S. As begun in 2008 for the legacy Carrier business, we will continue the process of evaluating and transforming the UTC Climate, Controls & Security portfolio. Summary performance for each of the commercial businesses for the quarters ended June 30, 2012 and 2011 are as follows:
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||