RTX Corp quarterly report, Q2 FY2016

Business context and reporting period

United Technologies Corporation (UTC) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. The filing is for UTC, not under the RTX Corp. name. UTC reported four continuing segments: Otis, UTC Climate, Controls & Security, Pratt & Whitney, and UTC Aerospace Systems. Sikorsky was sold in November 2015; its results and cash flows are presented as discontinued operations.

Key financial metrics

Amounts are in millions of U.S. dollars except per-share data and percentages.

• Q2 gross margin declined to 27.8% from 28.7%; first-half gross margin also declined to 27.8% from 28.7%. Management attributed the main pressure to negative engine margins at Pratt & Whitney.
• Continuing-operations operating cash flow was $2,571 for the first half, versus $3,022 a year earlier. Continuing investing cash flow was negative $1,342, and continuing financing cash flow was positive $928. Discontinued operations used $2,457 of cash, primarily for Sikorsky-sale-related taxes. Cash and cash equivalents ended June at $6,785, down from $7,075 at year-end 2015.
• At June 30, total debt was $22,537 and net debt was $15,752; debt to total capitalization was 42%. Cash was $6,785, with approximately 99% held by foreign subsidiaries. UTC had $4,350 of committed revolving credit facilities undrawn, also available as backup for commercial paper.
• Cash dividends paid in the first half were $1,035. UTC repurchased $36 of shares outside the Sikorsky-related accelerated repurchase agreements in the first half.

Material changes versus the prior comparable period

• Quarterly sales rose 1%; first-half sales rose 1%. Growth in aerospace was partly offset by lower sales at Climate, Controls & Security and foreign-exchange effects.
• Q2 operating profit fell 3%, and first-half operating profit fell 7%. Pratt & Whitney operating profit declined 21% in Q2 and 12% in the first half, principally due to unfavorable commercial-engine mix and negative engine margins, lower military volume/mix, and higher R&D spending.
• First-half diluted EPS from continuing operations was $3.13 versus $3.15. Net diluted EPS was lower, in part because 2016 discontinued operations included Sikorsky-sale-related tax expense, while 2015 included Sikorsky operating income.
• First-half operating cash flow declined $451, reflecting lower earnings and a $237 Canadian government settlement payment, partly offset by lower working-capital cash use.
• Debt increased from $20,425 at December 31, 2015, with net debt increasing from $13,350. UTC issued euro-denominated debt in February 2016 for general corporate purposes.

Outlook, management commentary, risks and unusual items

• Management expected 2016 cash flow from continuing operations, less capital expenditures, to approximate 90%–100% of continuing net income attributable to common shareowners. The filing does not provide clear full-year revenue or EPS guidance.
• Management estimated a 2016 continuing-operations effective tax rate of approximately 28%, excluding restructuring and non-operational nonrecurring items; company-funded R&D was expected to be slightly above 2015.
• UTC expected approximately $400 of 2016 restructuring costs in continuing operations. It forecast approximately $1–$2 billion of 2016 acquisition cash investment and approximately $3 billion of full-year share repurchases. The remaining five Sikorsky-sale-related repurchase tranches were expected to settle in Q3 2016.
• Management projected 2016 global pension expense to be about $500 lower than in 2015, including a $215 reduction from a change in estimating pension service and interest costs. Expected 2016 global defined-benefit pension contributions were approximately $200.
• Management said the U.K. vote to leave the EU increased economic and political uncertainty but was not expected to significantly affect UTC near term; U.K. sales were less than 4% of 2015 sales. Other cited sensitivities included construction and air-travel demand, airline finances, government spending, foreign exchange, commodities, interest rates, suppliers, regulation, and restructuring and acquisition execution.
• Notable contingencies include a June 2016 $11.1 judgment against Pratt & Whitney in the long-running F100 engine case, with appeal rights; a pending U.S. government cost-accounting claim of approximately $211; and German tax litigation over claimed benefits of approximately €215 million plus estimated interest of approximately €118 million. UTC had made German tax and interest payments in 2015 while litigating. The company estimated asbestos liabilities of $378 and probable insurance recoveries of $104.
• UTC reported no material changes in risk factors, no material changes in off-balance-sheet arrangements, and effective disclosure controls. The auditor performed an interim review, not an audit, and expressed no audit opinion on the interim statements.

Important facts for investors to verify

• Whether Pratt & Whitney’s engine margins and operating performance improve, and whether aerospace aftermarket growth offsets OEM mix and military pressures.
• Whether forecast restructuring spending, savings, acquisition investment, pension expense, and cash-flow conversion develop as management expected.
• How the remaining Sikorsky-related repurchase tranches, related taxes, and future share repurchases affect cash and debt.
• Developments in the F100 appeal, the $211 government claim, German tax litigation, asbestos estimates and recoveries, and other government investigations.
• The effects of foreign cash concentration and any restrictions or tax costs associated with repatriation; and the eventual impact of new revenue and lease accounting standards.