RTX Corp quarterly report, Q2 FY2017

Business context and reporting period

This is United Technologies Corporation’s unaudited Form 10-Q for the quarter and six months ended June 30, 2017—not a filing under the RTX name. UTC reported four segments: Otis, UTC Climate, Controls & Security, Pratt & Whitney, and UTC Aerospace Systems. The interim financial statements received a limited review, not an audit.

Financial performance

Q2 sales rose 3%; operating profit declined 2%. Q2 consolidated operating margin was 15.0%, down from 15.7%; gross margin was 27.4%, down from 27.8%. For the six months, operating margin increased to 15.7% from 15.2%, while gross margin declined to 27.2% from 27.8%. Sales and operating profit figures are reported in dollars; the filing attributes total sales growth to 3% organic growth, partly offset by currency translation.

• Cash flow and investment: Six-month capital expenditures were $771M, giving operating cash flow less capital expenditures of approximately $2.368B, versus $1.957B in 2016. Investing activities used $990M; financing activities used $52M.
• Liquidity and debt: Cash and equivalents were $9.345B at June 30, 2017, versus $7.157B at year-end 2016. Total debt was $26.626B and net debt $17.281B, versus $23.901B and $16.744B, respectively. Debt to total capitalization rose to 47% from 45%. The $4.35B revolving credit facilities were undrawn; short-term borrowings were $682M.
• Capital returns: UTC repurchased $1.370B of shares and paid $1.008B of common dividends in the first half. The board declared a $0.70-per-share dividend for September 2017.

Material changes versus prior period

• Six-month diluted EPS from continuing operations increased to $3.53 from $3.12. Results included a $379M gain from sales of Watsco investments, contributing to the increase in other income to $845M from $389M. The reported six-month result also included restructuring charges and other nonrecurring items.
• Q2 segment results were mixed: Climate, Controls & Security sales increased 6% and operating profit was roughly flat; Otis sales rose 1% while profit fell 6%; Pratt & Whitney sales rose 7% and profit rose 4%; Aerospace Systems sales fell 2% and profit fell 1%.
• UTC cited price/mix pressure, especially in China at Otis, and unfavorable adjustments on a large Climate, Controls & Security project. Pratt & Whitney faced higher negative engine margins, ramp-related costs, and the absence of prior-year favorable contract settlements.
• Cash generation improved year over year, but inventories rose about $1.1B. The company said factoring activity added approximately $400M to year-over-year operating cash generation, partly reflecting temporarily extended payment terms for certain aerospace customers.

Outlook, risks, and unusual items

• Management estimated a full-year 2017 effective tax rate of approximately 27%, excluding restructuring and non-operational nonrecurring items. It expected operating cash flow less capital expenditures to approximate 90%–100% of net income from continuing operations attributable to common shareholders.
• UTC expected 2017 acquisition cash investment of $1B–$2B, share repurchases of approximately $3.5B, and restructuring costs of approximately $300M. It expected customer financing activity to use cash, with up to $0.7B of the $13.8B in commercial aerospace financing and other commitments potentially disbursed in the remainder of 2017.
• Management expected approximately $55M of annual recurring pretax savings from 2017 restructuring actions and approximately $180M from 2016 actions once implemented. Further actions remained possible; savings and costs are estimates.
• Key risks include economic and political conditions, construction and air-travel demand, airline financial health, government defense spending and contract audits, currency and commodity movements, supply disruption, execution of new aerospace programs, acquisitions, pension funding, and legal or regulatory outcomes.
• Contingencies include a government claim against Pratt & Whitney for approximately $177M plus about $67M of interest, which UTC contested; German tax litigation involving approximately €215M of claimed benefits plus estimated interest of €118M; and estimated asbestos liabilities of $370M, partly offset by a $133M insurance recovery receivable. UTC stated it did not expect the discussed matters, subject to stated exceptions and uncertainties, to materially adversely affect its financial condition or results.
• The filing noted $307M of deferred unit costs on certain new-engine contracts, expected to increase before adoption of the new revenue standard in 2018; adoption was expected to affect revenue and cost timing. UTC also said lease-standard adoption could produce material balance-sheet assets and liabilities.
• On July 13, 2017, U.S. authorities rescinded the export-related statutory debarment of Pratt & Whitney Canada and restored its export privileges. A newly filed securities class action concerning 2015 earnings expectations was at a preliminary stage; the company could not estimate any possible loss.

Important facts for investors to verify

• How much of first-half earnings growth depended on the Watsco investment gains and other nonrecurring items.
• Whether margins recover from Q2 pressure, especially at Otis and Climate, Controls & Security, and whether Pratt & Whitney can manage negative engine margins and program ramp costs.
• Whether operating cash flow remains strong after considering working-capital movements and the disclosed contribution from factoring and extended customer payment terms.
• How planned repurchases, acquisitions, pension contributions, and customer financing affect debt, liquidity, and capital returns.
• Developments in the Pratt & Whitney government claim, German tax litigation, asbestos estimates, and the securities lawsuit.