RTX Corp quarterly report, Q3 FY2012

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United Technologies Corporation (UTC) — Q3 2012 Form 10-Q

Business context and reporting period. This is UTC’s unaudited quarterly report for the quarter and nine months ended September 30, 2012. The filing predates the company’s later name change to RTX. UTC reported five segments: Otis, UTC Climate, Controls & Security, Pratt & Whitney, UTC Aerospace Systems, and Sikorsky. Results include Goodrich only from its July 26 acquisition date; segment and discontinued-operations classifications changed during 2012, limiting some year-over-year comparisons. The interim financial statements received a review, not an audit.

Key financial results

  • Q3 revenue: $15.042 billion, up 6% from $14.235 billion. Management attributed the increase chiefly to Goodrich and IAE acquisitions; organic sales declined 2% and foreign exchange reduced sales 3%.
  • Q3 profitability: Operating profit was $2.041 billion, down from $2.151 billion; operating margin declined to 13.6% from 15.1%. Continuing-operations income attributable to common shareowners was $1.247 billion versus $1.290 billion; diluted continuing-operations EPS was $1.37 versus $1.43. Total net income attributable to common shareowners was $1.415 billion, including $168 million from discontinued operations.
  • Nine-month results: Revenue was $41.265 billion versus $41.377 billion; operating profit was $5.933 billion versus $6.001 billion, with margin of 14.4% versus 14.5%. Continuing-operations income attributable to common shareowners rose to $3.902 billion from $3.551 billion, and diluted continuing-operations EPS to $4.31 from $3.91. Total attributable income fell to $3.073 billion from $3.654 billion, principally reflecting discontinued-operations losses.
  • Discontinued operations: Nine-month results included an $823 million net loss, including $1.197 billion of disposal losses before tax, largely associated with impairment charges for Rocketdyne, Clipper Windpower, and UTC Power. Q3 discontinued-operations income included a favorable tax adjustment.
  • Cash flow: Nine-month cash from continuing operating activities was $4.651 billion, compared with $4.550 billion. Capital expenditures were $748 million, making operating cash flow less capex approximately $3.903 billion. Continuing investing activities used $17.995 billion, mainly due to acquisitions; continuing financing activities provided $13.986 billion.
  • Liquidity and debt: September 30 cash was $6.242 billion and total debt $28.700 billion, for net debt of $22.458 billion. Debt-to-total-capitalization was 52%, versus 31% at December 2011. Short-term borrowings were $5.224 billion, including a $2 billion term loan maturing December 31, 2012. UTC had $4 billion of undrawn revolving credit capacity.
  • Margins and segments: Q3 segment operating margins were 21.3% at Otis, 14.8% at Climate, Controls & Security, 11.4% at Pratt & Whitney, 10.1% at UTC Aerospace Systems, and 12.3% at Sikorsky. Pratt & Whitney and Sikorsky operating profits declined year over year; Climate, Controls & Security and UTC Aerospace Systems operating profits increased.

Material changes versus prior comparable periods

  • UTC acquired Goodrich for an enterprise value of $18.3 billion, including $1.9 billion in net debt assumed, and combined it with Hamilton Sundstrand as UTC Aerospace Systems. Goodrich contributed approximately $1.5 billion of sales and $100 million of operating profit after acquisition through September 30.
  • UTC acquired additional interests in IAE and consolidated it; the transactions included a $1.5 billion payment to Rolls-Royce and additional contingent flight-hour payments.
  • Acquisition financing drove the sharp rise in debt and interest expense. Net interest expense for Q3 was $216 million versus $139 million; for the nine months it was $513 million versus $429 million.
  • Company-funded R&D rose to $590 million in Q3 from $465 million and to $1.659 billion for the nine months from $1.427 billion, reflecting investment in aerospace programs and Goodrich.
  • Q3 gross margin was 26.9%, down from 27.4%; the nine-month margin was 27.6% in both years. Acquisition mix and higher restructuring costs weighed on Q3 margin.

Outlook, management commentary, risks and unusual items

  • Management raised its estimate for 2012 restructuring costs in continuing operations to approximately $600 million. It expected about $175 million of additional costs to complete 2012 actions, with recurring annual pretax savings expected to reach approximately $360 million over two years. Actions were expected to reduce the workforce by about 5,000 and exit about 2.2 million square feet of facilities.
  • UTC expected 2012 operating cash flow less capital expenditures to exceed continuing-operations income attributable to common shareowners. It estimated a full-year effective tax rate of approximately 29%, absent nonrecurring adjustments, and expected approximately $300 million of 2012 global defined-benefit pension contributions.
  • Non-core divestitures were expected to generate approximately $3 billion of after-tax cash proceeds, primarily for debt repayment. UTC suspended share repurchases until at least January 1, 2013 and planned significantly lower repurchases for the following two years.
  • Management cited weak or uncertain conditions in Europe, foreign-exchange headwinds, slower China growth, potential U.S. sequestration and defense-spending pressure, and softness in certain aerospace aftermarket and Sikorsky foreign-military sales. The company noted that resolution of Sikorsky’s Canadian CH-148 contract disputes could affect delivery and revenue recognition; a satisfactory resolution and 2012 revenue recognition were increasingly unlikely.
  • Key legal and compliance matters include a government claim seeking up to $661 million in the Pratt & Whitney fighter-engine case; a Sikorsky DOD claim of approximately $93 million; and a German tax dispute involving approximately $257 million of claimed benefits. UTC entered export-control agreements involving a $55 million civil penalty (up to $20 million potentially suspended for compliance investments) and an additional $13.8 million penalty under a deferred prosecution agreement. UTC said its recorded liability was sufficient and did not expect these matters to have a material adverse effect; outcomes remain uncertain.
  • Goodrich purchase accounting was preliminary, including significant customer-relationship intangible assets and approximately $2.0 billion of assumed customer contractual obligations on certain development programs. Final fair-value adjustments could be material. The filing also identified possible additional gains or losses on pending divestitures.

Important facts for investors to verify

  • Whether the Goodrich integration delivers anticipated synergies and whether preliminary acquisition valuations, customer-contract obligations, and goodwill estimates change materially.
  • Progress and proceeds from planned divestitures, and the resulting repayment of acquisition-related debt, including the near-term term-loan maturity and commercial-paper balance.
  • Whether restructuring spending, workforce reductions, and facility exits meet management’s timetable and generate the expected savings.
  • Developments in Sikorsky’s CH-148 contract, the cited government claims, German tax litigation, and export-control compliance obligations.
  • How discontinued-operations losses, tax benefits, portfolio-sale gains, and other nonrecurring items affect comparisons with ongoing earnings and cash generation.