RTX Corp quarterly report, Q3 FY2013

Business context and reporting period

This is United Technologies Corporation (UTC, now associated with RTX Corp), Form 10-Q for the quarter and nine months ended September 30, 2013. The company operated through Otis, UTC Climate, Controls & Security, Pratt & Whitney, UTC Aerospace Systems and Sikorsky. Results include Goodrich only after its July 2012 acquisition, so reported year-over-year growth is not wholly organic. Interim financial statements are unaudited; PwC performed a review, not an audit.

Financial performance and position

Q3 sales rose 3% (1% organic); nine-month sales rose 11%, largely reflecting Goodrich and IAE acquisitions. Q3 gross margin improved to 28.7% from 26.9%; management cited the absence of Goodrich inventory fair-value amortization, favorable Pratt & Whitney performance and restructuring/productivity benefits. Nine-month gross margin was 28.0%, versus 27.6%. Q3 diluted EPS from continuing operations increased 13%; nine-month growth was 8%. Discontinued operations materially affect comparisons: nine-month 2012 included a large loss, chiefly impairment charges.

Segment highlights: Q3 operating profit increased at Otis ($681m, +5%), Climate, Controls & Security ($696m, +10%), Pratt & Whitney ($439m, +7%) and UTC Aerospace Systems ($501m, +85%); Sikorsky fell to $159m (-22%). Aerospace Systems’ increase was substantially affected by the Goodrich acquisition and absence of acquisition inventory step-up amortization. Sikorsky faced lower military and aftermarket sales and unfavorable U.S. Government contract economics.

For the first nine months, continuing-operations operating cash flow was $4.891bn, versus $4.651bn. Capital expenditures were $1.047bn; operating cash flow less capital expenditures was approximately $3.844bn. Inventory and contracts in progress increased, contributing to working-capital cash use. Investing activities used $599m, while financing activities used $4.226bn. Cash and equivalents were $4.621bn at September 30, down from $4.819bn at year-end.

Total debt was $21.188bn and net debt $16.567bn at September 30, compared with $23.221bn and $18.402bn at year-end 2012. Debt-to-total-capitalization was 41%; net debt-to-net-capitalization was 36%. Current assets were $29.351bn and current liabilities $23.519bn. The company reported no borrowings under its $4bn revolving credit facilities and $100m of commercial paper outstanding.

Material changes, outlook and unusual items

• Portfolio actions: UTC sold Pratt & Whitney Power Systems (pre-tax gain about $193m; $432m cash proceeds plus contingent consideration valued at about $200m), Rocketdyne, UTC Power and two Goodrich businesses. Proceeds from divestitures were used in part to repay Goodrich-related debt. The company also announced a new UTC Building and Industrial Systems structure combining Otis and Climate, Controls & Security.
• Restructuring: Nine-month pre-tax charges were $343m. Management expected full-year 2013 continuing-operations restructuring costs of about $500m. It projected annual recurring pre-tax savings of about $300m from 2013 actions and $550m from 2012 actions, with most remaining actions targeted for 2013–2014.
• Management outlook: The company expected full-year operating cash flow from continuing operations, less capital expenditures, to be essentially equal to continuing-operations net income attributable to common shareowners. It expected a 2013 annual effective tax rate of about 29%, absent one-time adjustments; company-funded R&D to increase about $200m versus 2012; debt repayments of about $2.5bn in 2013 and $1bn in 2014; share repurchases of about $1.2bn in 2013; and acquisition cash investment of about $250m in 2013.
• Market and operating risks: Management cited weak European conditions, U.S. defense-spending pressure and sequestration, political and fiscal uncertainty, foreign-exchange and commodity exposure, supplier risks, commercial aerospace and construction cycles, and Goodrich integration and synergy execution. It expected U.S. Government defense measures to continue adversely affecting military aerospace into 2014.
• Litigation: A trial court entered a $664m judgment against Pratt & Whitney in the F100 engine case. UTC appealed and stated it disagreed with the ruling; if all or part were upheld, it estimated possible loss of $24m–$657m beyond amounts accrued, plus postjudgment interest. Sikorsky prevailed in a separate DOD cost-accounting case, but the government appealed.
• Tax contingencies: UTC disclosed a French tax assessment of about $320m and a German tax dispute involving about $275m of claimed benefits; it had not accrued for these matters and intended to contest them. Worldwide uncertain-tax-benefit changes over the next 12 months could range from a net increase of $45m to a net decrease of $490m, with some potential income-statement impact.
• Other notable matters: Certain Rocketdyne contract performance guarantees increased by about $124m after its sale, with no significant associated liability recorded. UTC also disclosed small Iran-related elevator-service contracts by non-U.S. affiliates; those affiliates ceased performance and UTC had made disclosures to OFAC.

Important facts for investors to verify

• Separate organic growth from acquisition, divestiture and accounting effects, particularly Goodrich-related effects on Aerospace Systems’ margins and year-over-year sales.
• Track Sikorsky’s military exposure, U.S. defense funding, Multi-year 8 contract economics and the trend in aftermarket sales.
• Assess delivery of restructuring savings against the remaining charges, workforce reductions and facility exits.
• Monitor debt repayment, cash conversion and working-capital needs against management’s full-year cash-flow expectations.
• Follow the F100 appeal and the French and German tax disputes, including potential cash, earnings and interest exposure.
• Review the full filing’s risk factors, segment disclosures and contractual commitments; the company reported approximately $11.7bn of commercial aerospace financing and other contractual commitments.