EX-13 5 d477572dex13.htm EX-13 EX-13

 

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Exhibit 13

Five-Year Summary

 

 

(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)   2012     2011     2010     2009     2008  
         

For The Year

                   
Net sales   $ 57,708     $ 55,754     $ 52,275     $ 50,469     $ 56,824  
Research and development5     2,371       1,951       1,656       1,460       1,650  
Restructuring costs     590       315       387       787       328  
Net income from continuing operations     5,200       5,216       4,523       4,060       4,890  
Net income from continuing operations attributable to common shareowners     4,847       4,831       4,195       3,719       4,534  
Basic earnings per share—Net income from continuing operations attributable to common shareowners     5.41       5.41       4.62       4.05       4.83  
Diluted earnings per share—Net income from continuing operations attributable to common shareowners     5.35       5.33       4.55       4.00       4.74  
Cash dividends per common share     2.03       1.87       1.70       1.54       1.35  
Average number of shares of Common Stock outstanding:                    

Basic

    895       892       908       917       938  

Diluted

    907       907       923       929       956  
Cash flows provided by operating activities of continuing operations     6,605       6,460       5,720       5,083       5,962  
Capital expenditures     1,389       929       838       773       1,137  
Acquisitions, including debt assumed4     18,620       372       2,781       676       1,408  
Repurchases of Common Stock6           2,175       2,200       1,100       3,160  
Dividends paid on Common Stock1     1,752       1,602       1,482       1,356       1,210  
         

At Year End

                   
Working capital   $ 5,174     $ 7,142     $ 5,778     $ 5,281     $ 4,665  
Total assets     89,409       61,452       58,493       55,762       56,837  
Long-term debt, including current portion     22,718       9,630       10,173       9,490       10,453  
Total debt     23,221       10,260       10,289       9,744       11,476  

Total debt to total capitalization

    46%        31%        32%        32%        41%   
Total equity     27,069       22,820       22,323       20,999       16,681  
Number of employees3, 4       218,300         199,900         208,200         206,700         223,100  
                                         

Amounts presented for 2008-2011 have been restated to reflect results from continuing operations consistent with 2012 presentation, where applicable. Refer to “Business Overview” section for additional information.

 

Note 1 Excludes dividends paid on Employee Stock Ownership Plan Common Stock.  

 

Note 2 The decrease in the 2009 debt to total capitalization ratio, as compared to 2008, reflects the reversal of unrealized losses in our pension plans of approximately $1.1 billion, the beneficial impact of foreign exchange rate movement of approximately $1.0 billion, and the reduction of approximately $1.7 billion of total debt. The increase in the 2012 debt to total capitalization ratio, as compared to 2011, reflects the issuance of $9.8 billion in long-term debt, $1.1 billion in equity units and the assumption of approximately $3 billion in long-term debt in connection with the acquisition of Goodrich. In connection with a cash tender offer, approximately $635 million ($761 million fair value) of principal amount of legacy Goodrich debt was retired in the fourth quarter 2012.  

 

Note 3 The decrease in 2011, as compared with 2010, includes the impact of divestitures primarily within the UTC Climate, Controls & Security segment, as well as net workforce reductions associated with restructuring actions across UTC.  

 

Note 4 The increase in 2012, as compared with 2011, includes the net impact of acquisitions and divestitures across the Company, most notably the 2012 acquisition of Goodrich and divestiture of the legacy Hamilton Sundstrand Industrial business, both within the UTC Aerospace Systems segment, as well as the impact of other acquisitions and dispositions and restructuring actions across UTC.  

 

Note 5 The increase in 2012, as compared with 2011, includes approximately $250 million incremental research and development spending related to the Goodrich businesses that were acquired during 2012, and approximately $65 million at Pratt & Whitney to further advance development of multiple geared turbo fan platforms.  

 

Note 6 In connection with the acquisition of Goodrich, repurchases of common stock under our share repurchase program were suspended for 2012.  


 

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Management’s Discussion and Analysis

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

BUSINESS OVERVIEW

We are a global provider of high technology products and services to the building systems and aerospace industries. Our operations for the periods presented herein are classified into five principal business segments: Otis, UTC Climate, Controls & Security, Pratt & Whitney, UTC Aerospace Systems and Sikorsky. Otis and UTC Climate, Controls & Security are referred to as the “commercial businesses,” while Pratt & Whitney, UTC Aerospace Systems and Sikorsky are collectively referred to as the “aerospace businesses.” Certain reclassifications have been made to the prior year amounts to conform to the current year presentation.

In 2012, we implemented a new organizational structure that allows us to better serve customers, drive growth and achieve further efficiencies through greater integration across certain product lines. As part of this new structure, effective January 1, 2012, we formed the UTC Climate, Controls & Security segment, which combines the former Carrier and UTC Fire & Security segments.

On July 26, 2012, we acquired Goodrich Corporation (Goodrich) pursuant to a merger agreement dated September 21, 2011 for approximately $18.3 billion including $1.9 billion of net debt assumed. As a result of the acquisition, Goodrich became a wholly-owned subsidiary of UTC in the largest acquisition in UTC’s history. The acquired Goodrich business and the legacy Hamilton Sundstrand business have been combined to form a new segment named UTC Aerospace Systems. This segment and our Pratt & Whitney segment are separately reportable segments although they are both included within the newly formed UTC Propulsion & Aerospace Systems organizational structure. The increased scale, financial strength and complementary products of the new combined business are expected to continue to 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. The results of the acquired Goodrich business have been included in UTC’s financial statements only for periods subsequent to the completion of the acquisition. As a result, the consolidated financial results for the year ended December 31, 2012 do not reflect a full year of legacy Goodrich operations. The acquisition resulted in the inclusion of Goodrich’s assets and liabilities as of the acquisition date at their respective fair values. Accordingly, the Goodrich acquisition materially affected UTC’s results of operations and financial position.

On 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 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 during the fifteen year period following closing of the purchase, conditional upon each hour flown by V2500-powered aircraft in service at the closing. Pratt & Whitney entered into a collaboration arrangement with MTU with respect to a portion of the collaboration interest in IAE acquired from Rolls-Royce 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, which has been consolidated by Pratt & Whitney post-transaction.

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 has been and will be used to repay the debt issued to finance the acquisition of Goodrich. These divestitures are expected to generate approximately $3 billion in net cash, on an after-tax basis, when complete. In the first quarter of 2012, the legacy 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 gains/losses expected on disposition, and the related cash flows which result from these non-core businesses have been reclassified to Discontinued Operations in our Consolidated Statements of Operations and Cash Flows for all periods presented. The sale of the legacy Hamilton Sundstrand Industrial businesses was completed in the fourth quarter of 2012, while the sale of Clipper was completed in the third quarter of 2012. On July 23, 2012, we announced an agreement to sell our Rocketdyne unit to GenCorp Inc. for $550 million. On December 22, 2012, we announced an agreement to sell our UTC Power unit to ClearEdge Power. Although the Pratt & Whitney Power Systems business was also approved for sale by the Board of Directors of the Company, it was not reclassified to Discontinued Operations due to the level of expected continuing involvement in the business post-sale. The sales of the remaining non-core businesses identified for disposition are expected to be completed in the first half of 2013.

In accordance with conditions imposed for regulatory approval of UTC’s acquisition of Goodrich, UTC must dispose of the electric power systems and the pumps and engine controls businesses of Goodrich. These businesses have been held separate from UTC’s and Goodrich’s ongoing businesses pursuant to regulatory obligations since the acquisition of Goodrich by UTC. On October 16, 2012, we announced an agreement to sell the electric power systems business for $400 million to Safran, and on January 18, 2013, we announced an agreement to sell the pumps and engine controls business to Triumph Group Inc. Closings of both sales are expected by the end of the first quarter of 2013 and are subject to regulatory approvals and other customary closing conditions.

 


 

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In addition to the divestiture of certain non-core businesses, we also issued $9.8 billion in long-term debt, $3.2 billion in commercial paper, a $2.0 billion term loan and $1.1 billion of equity units to fund the acquisition of Goodrich. As of December 31, 2012, we have repaid all of the term loan and nearly all of the commercial paper issued to finance the acquisition.

Our consolidated net sales were derived from the commercial and aerospace businesses as follows (sales from Pratt & Whitney’s industrial markets are included in “commercial and industrial”):

 

      2012      2011      2010  
Commercial and industrial      51%         57%         57%   
Military aerospace and space      21%         20%         21%   
Commercial aerospace      28%         23%         22%   
     100%         100%         100%   
                            

The significant shift in sales from Commercial and industrial to Commercial aerospace largely reflects the Goodrich and IAE transactions. In 2012, approximately 57% of our consolidated sales were original equipment and 43% were aftermarket parts and services, while in 2011 the amounts were 56% and 44%, respectively. The amounts in 2010 were 57% and 43%, respectively.

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 operations include original equipment manufacturing (OEM) and extensive related aftermarket parts and services in both our commercial and aerospace businesses. Our business mix also reflects the combination of shorter cycles at UTC Climate, Controls & Security and in our commercial aerospace aftermarket businesses, and longer cycles at Otis and in 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. The composition of net sales from outside the U.S., including U.S. export sales to these regions, in U.S. Dollars and as a percentage of total segment sales, is as follows:

 

(DOLLARS IN MILLIONS)   2012     2011     2010     2012     2011     2010  
Europe   $ 11,823     $ 12,344     $ 11,678       20%        22%        22%   
Asia Pacific     8,733       9,016       7,658       15%        16%        15%   
Other Non-U.S.     4,964       5,376       5,369       9%        10%        10%   
U.S. Exports     9,201       7,721       7,102       16%        14%        14%   
International segment sales   $   34,721     $   34,457     $   31,807       60%        62%        61%   
                                                 

As part of our growth strategy, we invest in businesses in certain countries that carry high levels of currency, political and/or

economic risk, such as Argentina, Brazil, China, India, Mexico, Russia, South Africa and countries in the Middle East. At December 31, 2012, the net assets in any one of these countries did not exceed 5% of consolidated shareowners’ equity.

As in the previous year, our short cycle shipments and order rates were mixed across our businesses. In 2012, as compared with 2011, commercial aerospace spares orders at Pratt & Whitney decreased 12%, excluding additional orders due primarily to the consolidation of IAE, and UTC Aerospace Systems’ commercial aerospace orders decreased 4%, excluding additional orders from Goodrich. Ongoing economic uncertainty and high oil prices have led to continued cash conservation and constrained spending by major airlines. Strength in UTC Aerospace Systems commercial and military aerospace OEM business and military OEM sales at Pratt & Whitney, were offset by fewer deliveries for foreign military operations at Sikorsky. Conversely, UTC Climate, Controls & Security’s North American residential HVAC orders increased approximately 8% in 2012, while Otis’ new equipment orders in 2012 were consistent with 2011 order levels. While Otis new equipment orders in China declined early in 2012, order rates increased late in the year with fourth quarter orders in China 19% higher than the fourth quarter of 2011. Although uncertainty surrounding the resolution of the fiscal debate in the U.S. and the European debt crisis, together with the slowdown in China and other emerging economies drove volatility in financial markets during 2012, the economic environment in Europe has recently begun to stabilize while the U.S. and China continue gradual recoveries. The 2013 global GDP forecast is 2.5%, with growth expected to be slower in the first half of the year and uneven across the globe. We continue to expect growth rates in emerging markets, particularly in China and India, to outpace the rest of the world. Further, the gradual commercial construction recovery in North America throughout 2012 is expected to continue in 2013.

We had no organic sales growth during 2012. We expect organic sales growth in 2013 to be 3% to 5%.

Although we expect an increase in organic growth, which, if realized, would contribute to operating profit growth, we also continue to invest in new platforms and new markets to position us for additional growth, while remaining focused on structural cost reduction, operational improvements and disciplined cash redeployment. These actions contributed to our earnings during 2012 and positioned us for future earnings growth as the global economy recovers. We undertook a significant restructuring initiative in 2012 to reduce structural and overhead costs across all of our businesses. Restructuring costs in continuing operations totaled $590 million, $315 million and $387 million in 2012, 2011 and 2010, respectively. Segment operating margin decreased 110 basis points from 15.1% in 2011 to 14.0% in 2012. This year-over-year decrease is primarily due to a 50 basis point adverse impact of restructuring charges and non-recurring items and a 70 basis point adverse impact from higher research and development expenses.

 


 

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As discussed below in “Results of Operations,” operating profit in both 2012 and 2011 includes 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, primarily those related to UTC Climate, Controls & Security’s ongoing portfolio transformation. Our earnings growth strategy contemplates earnings from organic sales growth, including growth from new product development and product improvements, structural cost reductions, operational improvements, and incremental earnings from our investments in acquisitions. We invested $18.6 billion (including debt assumed of $2.6 billion) and $372 million (including debt assumed of $15 million) in the acquisition of businesses across the entire company in 2012 and 2011, respectively. Our investment in businesses in 2012 principally reflected the Goodrich and IAE transactions. Acquisitions completed in 2011 consisted principally of a number of smaller acquisitions in both our aerospace and commercial businesses.

Both acquisition and restructuring costs associated with business combinations are expensed as incurred. Depending on the nature and level of acquisition activity, earnings could be adversely impacted due to acquisition and restructuring actions initiated in connection with the integration of the businesses acquired.

For additional discussion of acquisitions and restructuring, see “Liquidity and Financial Condition,” “Restructuring Costs” and Notes 2 and 13 to the Consolidated Financial Statements.

RESULTS OF OPERATIONS

Net Sales

 

(DOLLARS IN MILLIONS)    2012      2011      2010  
Net sales    $   57,708      $   55,754      $   52,275  
Percentage change year-over-year      3.5%         6.7%         3.6%   
                            

The factors contributing to the total percentage change year-over-year in total net sales are as follows:

 

        2012        2011  
Organic volume        –                5%   
Foreign currency translation        (2)%           2%   
Acquisitions and divestitures, net        6 %           –       
Total % Change        4 %           7%   
                       

Organic sales growth during 2012, at UTC Aerospace Systems (7%) and Pratt & Whitney (2%) was offset by organic sales contraction at Sikorsky (8%). The organic sales growth at UTC Aerospace Systems was primarily attributable to higher aerospace OEM volume, while the organic sales growth at Pratt & Whitney was a result of higher military engine deliveries and aftermarket sales. The organic sales contraction at Sikorsky was driven primarily by fewer aircraft deliveries to the U.S. Government and foreign military

operations. There was no organic sales growth within the commercial businesses in 2012. The sales increase from net acquisitions and divestitures is a result of Goodrich and IAE sales, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security.

All segments experienced organic sales growth during 2011, led by Sikorsky (10%), UTC Aerospace Systems (8%), and UTC Climate, Controls & Security (7%). The organic sales growth at Sikorsky was primarily attributable to higher military OEM and aftermarket sales, while the organic sales growth at UTC Aerospace Systems was a result of higher volumes in the aerospace OEM and aftermarket businesses. UTC Climate, Controls & Security’s organic sales growth was driven primarily by the recovery in the transport refrigeration market. The organic sales growth in the remaining businesses reflected higher commercial sales and aftermarket volume at Pratt & Whitney and higher new equipment volumes in emerging markets for Otis.

Cost of Products and Services Sold

 

(DOLLARS IN MILLIONS)   2012     2011     2010  
Cost of products sold   $   31,094     $   29,252     $   27,513  
Percentage of product sales     76.3%        75.2%        75.1%   
Cost of services sold   $ 11,059     $ 11,117     $ 10,441  
Percentage of service sales     65.1%        65.9%        66.7%   
Total cost of products and services sold   $ 42,153     $ 40,369     $ 37,954  
Percentage change year-over-year     4.4%        6.4%        1.5%   
                         

The factors contributing to the total percentage change year-over-year in total cost of products and services sold are as follows:

 

        2012        2011  
Organic volume        –                5 %   
Foreign currency translation        (2)%           2 %   
Acquisitions and divestitures, net        6 %           (1)%   
Total % Change        4 %           6 %   
                       

Total cost of products and services sold increased (4%) at a rate consistent with sales growth (4%) in 2012 as compared with 2011. The increase in cost of products and services sold is a result of the Goodrich and IAE transactions (8%) partially offset by lower cost of products and services sold as a result of the UTC Climate, Controls & Security portfolio transformation (3%) and the beneficial impact of foreign currency exchange translation (2%).

Total cost of products and services sold increased organically (5%) at a rate consistent with organic sales growth (5%) in 2011 as compared with 2010. The beneficial impact of cost reductions and productivity gains were partially offset by higher commodity, pension, and warranty costs in 2011.

Gross Margin

 

(DOLLARS IN MILLIONS)    2012      2011      2010  
Gross margin    $   15,555      $   15,385      $   14,321  
Percentage of net sales      27.0%         27.6%         27.4%   
                            
 


 

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Gross margin as a percentage of sales decreased 60 basis points, in 2012 as compared with 2011, driven primarily by the adverse impact of the Goodrich and IAE transactions (40 basis points), higher restructuring expense in 2012 (30 basis points), and a loss provision recorded by Sikorsky for a contract with the Canadian Government (30 basis points), all of which was partially offset by benefits from the disposition of lower margin businesses in connection with the UTC Climate, Controls & Security portfolio transformation (30 basis points).

Gross margin as a percentage of sales increased 20 basis points, in 2011 as compared with 2010, driven primarily by increased volumes and lower cost of sales resulting from continued focus on cost reductions, savings from previously initiated restructuring actions and net operational efficiencies. The beneficial impacts of the absence of asset impairment charges (10 basis points) recorded at UTC Climate, Controls & Security and UTC Aerospace Systems in 2010 and lower year-over-year restructuring charges (20 basis points) were partially offset by higher warranty costs at UTC Aerospace Systems in 2011.

Research and Development

 

(DOLLARS IN MILLIONS)    2012      2011      2010  
Company-funded    $   2,371      $   1,951      $   1,656  
Percentage of net sales      4.1%         3.5%         3.2%   
     
Customer-funded    $ 1,670      $ 1,419      $ 1,460  
Percentage of net sales      2.9%         2.5%         2.8%   
                            

Research and development spending is subject to the variable nature of program development schedules and, therefore, year-over-year variations in spending levels are expected. The majority of the company-funded spending is incurred by the aerospace businesses and relates largely to the next generation product family at Pratt & Whitney, the C-Series, Airbus A350, and Boeing 787 programs at UTC Aerospace Systems, and various programs at Sikorsky. The year-over-year increase in company-funded research and development in 2012, compared with 2011, primarily reflects increases at UTC Aerospace Systems as a result of incremental research and development spending related to the Goodrich businesses (13%) and at Pratt & Whitney to further advance development of multiple geared turbo fan platforms and military engines (5%). The increase in company-funded research and development in 2011, compared with 2010, primarily reflects increases at Pratt & Whitney associated with the next generation product family.

Company-funded research and development spending for 2013 is expected to increase by approximately $225 million over 2012 levels primarily due to the added spending as a result of the Goodrich acquisition.

The increase in customer-funded research and development in 2012, as compared with the prior year, reflects spending related to the Goodrich businesses (24%) partially offset by a

decrease at Sikorsky (4%) related to a reduction in development spending on U.S. Government military platforms. The decrease in customer-funded research and development in 2011, as compared with 2010, was primarily driven by a decrease at Pratt & Whitney related to a reduction in development spending on the Joint Strike Fighter program.

Selling, General and Administrative

 

(DOLLARS IN MILLIONS)    2012      2011      2010  
Selling, general and administrative    $   6,452      $   6,161      $   5,798  
Percentage of net sales      11.2%         11.1%         11.1%   
                            

The increase in selling, general and administrative expenses in 2012, as compared with 2011, is due primarily to the impact of acquisitions, net of divestitures, completed over the preceding twelve months (3%) and higher restructuring costs (2%). Higher pension costs (1%) were offset by favorable foreign exchange translation.

The increase in selling, general and administrative expenses in 2011, as compared with 2010, is due primarily to the impact of acquisitions completed over the year, including the acquisition of the GE Security business in March 2010, adverse foreign exchange translation, and higher pension related costs.

Other Income, Net

 

(DOLLARS IN MILLIONS)    2012      2011      2010  
Other income, net    $   952      $   573      $   31  
                            

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 change in other income, net in 2012, as compared with 2011, largely reflects an approximately $46 million net year-over-year increased gain resulting from UTC Climate, Controls & Security’s ongoing portfolio transformation, a $34 million gain on the fair value re-measurement of the Company’s previously held shares of Goodrich, a $46 million gain resulting from the effective settlement of a pre-existing claim in connection with the acquisition of Goodrich, an $81 million increase in income from joint ventures, as well as the absence of both a $66 million other-than-temporary impairment charge on an equity investment at UTC Climate, Controls & Security, and $45 million of reserves established for legal matters. The remaining increase in other income, net is attributable to net gains recognized on miscellaneous asset sales and normal recurring operational activity as disclosed above.

The year-over-year change in other income, net in 2011, as compared with 2010, largely reflects an approximately $55 million net year-over-year increased gain resulting from UTC Climate, Controls & Security’s ongoing portfolio transformation, a $41 million gain from the sale of an equity investment at Pratt & Whitney, a $73 million gain on the contribution of a Sikorsky business into a new

 


 

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venture in the United Arab Emirates, a $122 million increase in income from joint ventures, and $79 million in other, net gains from divestitures, all of which was partially offset by a $66 million other-than-temporary impairment charge on an equity investment at UTC Climate, Controls & Security, and $45 million of reserves established for legal matters.

Interest Expense, Net

 

(DOLLARS IN MILLIONS)   2012     2011     2010  
Interest expense   $    893     $    673     $    751  
Interest income     (120     (177     (101
Interest expense, net   $ 773     $ 496     $ 650  
Average interest expense rate during the year on:            

Short-term borrowings

    0.9%        2.0%        1.8%   

Total debt

    4.1%        5.6%        5.6%   
                         

Interest expense increased in 2012, as compared with 2011, primarily as a result of higher average debt balances in 2012 associated with the financing of our acquisition of Goodrich. Financing for the Goodrich acquisition included a total of $9.8 billion of long-term debt, $1.1 billion of equity units which bear contract adjustment payments at a rate of 5.95% per year, and $3.2 billion from the issuance of commercial paper. We also entered into a term loan credit agreement for $2 billion and borrowed the full amount available under this facility. In connection with the acquisition of Goodrich, we assumed long term debt of approximately $3.0 billion, which bears interest at rates ranging from 3.6% to 7.1%. Subsequent to the acquisition in 2012, we repaid approximately $635 million of principal ($761 million fair value) of the assumed Goodrich debt, the entire $2.0 billion term loan, and nearly all of the commercial paper issued to finance the acquisition.

Interest expense on our long-term debt decreased in 2011 as a result of the repayment at maturity in May 2010 of our $600 million of 4.375% notes due 2010, the early redemption in June 2010 of the entire $500 million outstanding principal amount of our 7.125% notes that would have otherwise been due November 2010, the early redemption in September 2010 of the entire $500 million outstanding principal amount of our 6.350% notes that would have otherwise been due March 2011, and as a result of the early redemption in December 2011 of the entire $500 million outstanding principal amount of our 6.100% notes that would otherwise have been due May 15, 2012. This impact was partially offset by the full year impact from the issuance of two series of fixed rate long-term notes totaling $2.25 billion in February 2010. Lower interest charges related to our deferred compensation plan and lower interest accrued on unrecognized tax benefits also contributed to the overall interest expense decline. Interest income increased in 2011, as compared with 2010, as a result of favorable pre-tax interest adjustments of approximately $89 million related to the settlement of U.S. federal income tax refund claims for years

prior to 2004, partially offset by the absence of a favorable pre-tax interest adjustment of approximately $24 million associated with the resolution of an uncertain temporary tax item in the second quarter of 2010.

The decline in the weighted-average interest rates for short-term borrowings was due to the mix of our borrowings with a greater percentage of short-term borrowings at lower interest rates in 2012 than the percentage of short-term borrowings in 2011. At December 31, 2012 and 2011, we had commercial paper borrowings outstanding of $320 million and $455 million, respectively. The three month LIBOR rate as of December 31, 2012, 2011 and 2010 was 0.3%, 0.6% and 0.3%, respectively. The decline in the average interest rate on total debt is due to the redemptions of higher rate debt as discussed above and the low interest rates obtained on the debt issued to fund the Goodrich acquisition.

Income Taxes

 

      2012      2011      2010  
Effective income tax rate      24.8%         29.0%         27.6%   
                            

The effective income tax rates for 2012, 2011 and 2010 reflect tax benefits associated with lower tax rates on international earnings, which we intend to permanently reinvest outside the United States. The 2012 effective tax rate reflects a favorable non-cash income tax adjustment of approximately $203 million related to the conclusion of the IRS’s examination of the Company’s 2006 – 2008 tax years, as well as a reduction in tax expense of $34 million related to the favorable resolution of disputed tax matters with the Appeals division of the IRS for the tax years 2004 and 2005. Also included in the 2012 effective tax rate is the favorable income tax impact of $225 million related to the release of non-U.S. valuation allowances resulting from internal legal entity reorganizations.

The 2011 effective tax rate reflects approximately $63 million of favorable income tax adjustments related to the settlement of two refund claims for years prior to 2004, as well as a favorable tax impact of $17 million related to a U.K. tax rate reduction enacted in 2011. These favorable tax adjustments are partially offset by non-deductible charges accrued in 2011.

The 2010 effective income tax rate reflects a non-recurring tax expense reduction associated with management’s decision to repatriate additional high tax dividends from 2010 earnings to the U.S. as a result of U.S. tax legislation enacted in 2010. This was partially offset by the non-deductibility of impairment charges, the adverse impact from the health care legislation related to the Medicare Part D program and other increases to UTC’s effective income tax rate.

We estimate our full year annual effective income tax rate in 2013 to be approximately 29%, absent one-time adjustments. We anticipate some variability in the tax rate quarter to quarter in 2013. In addition, the Company expects to record a one-time favorable tax adjustment of $80 million in the first quarter of 2013 related to

 


 

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the legislative corporate tax extenders enacted in January 2013, as part of the American Taxpayer Relief Act of 2012. This adjustment relates to the 2012 retroactive impact of the new law.

For additional discussion of income taxes, see “Critical Accounting Estimates—Income Taxes” and Note 11 to the Consolidated Financial Statements.

Net Income Attributable to Common Shareowners from Continuing Operations

 

(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)    2012      2011      2010  
Net income attributable to common shareowners from continuing operations    $   4,847      $   4,831      $   4,195  
Diluted earnings per share from continuing operations    $ 5.35      $ 5.33      $ 4.55  
                            

Foreign currency translation, including hedging at Pratt & Whitney Canada (P&WC) generated a net adverse impact of $0.17 per diluted share on our operational performance in 2012. 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. In 2011, foreign currency generated a net positive impact on our operational results of $0.11 per diluted share, while in 2010 foreign currency had a favorable impact of $0.12 per diluted share. For additional discussion of foreign currency exposure, see “Market Risk and Risk Management—Foreign Currency Exposures.”

Diluted earnings per share from continuing operations for 2012 include a net charge of $0.01 per share from net restructuring and non-recurring items. Besides the restructuring charges of $590 million, non-recurring items included approximately $218 million of favorable pre-tax interest and income tax adjustments related to the conclusion of the IRS examination of the 2006 – 2008 tax years, approximately $59 million of favorable pre-tax interest and income tax adjustments related to the resolution of disputes with the Appeals division of the IRS for the 2004 – 2005 tax years, approximately $157 million of net gains resulting from UTC Climate, Controls & Security’s ongoing portfolio transformation, and an approximately $34 million non-cash gain recognized on the re-measurement to fair value of our previously held shares of Goodrich stock resulting from our acquisition of the company.

Net Income Attributable to Common Shareowners from Discontinued Operations

 

(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)    2012      2011      2010  
Net income attributable to common shareowners from discontinued operations    $   283      $   148      $   178  
Diluted earnings per share from discontinued operations    $ 0.31      $ 0.16      $ 0.19  
                            

Diluted earnings per share from discontinued operations for 2012 includes $0.82 per share of goodwill and net asset impairment charges related to Rocketdyne, Clipper and UTC Power, and $1.01 per share gain on the disposition of the legacy Hamilton

Sundstrand Industrial businesses. A $0.16 per share benefit from the results of operations of discontinued entities was partially offset by the $0.07 per share Clipper warranty charge.

RESTRUCTURING COSTS

We recorded net pre-tax restructuring costs totaling $614 million in 2012 and $336 million in 2011 for new and ongoing restructuring actions. We recorded these charges in the segments as follows:

 

(DOLLARS IN MILLIONS)    2012      2011  
Otis    $   164      $   73  
UTC Climate, Controls & Security      143        126  
Pratt & Whitney      96        52  
UTC Aerospace Systems      115        11  
Sikorsky      53        53  
Eliminations and other      19         
Restructuring costs recorded within continuing operations      590        315  
Restructuring costs recorded within discontinued operations      24        21  
Total    $   614      $   336  
                   

Restructuring charges incurred in 2012 and 2011 were recorded as follows:

 

(DOLLARS IN MILLIONS)    2012      2011  
Cost of sales    $   340      $   164  
Selling, general and administrative      249        149  
Other income, net      1        2  
Restructuring costs recorded within continuing operations      590        315  
Restructuring costs recorded within discontinued operations      24        21  
Total    $ 614      $ 336  
                   

As described below, the 2012 charges relate primarily to actions initiated during 2012 and 2011, while the 2011 charges relate primarily to actions initiated during 2011 and 2010. The 2012 restructuring costs reflected in Eliminations and other largely reflect curtailment charges required under our domestic pension plans due to the headcount reductions associated with the various restructuring actions.

Restructuring actions are an essential component of our operating margin improvement efforts and relate to both existing operations and those recently acquired. We expect to incur additional restructuring costs in 2013 of approximately $300 million, including trailing costs related to prior actions, associated with our continuing cost reduction efforts and to the integration of acquisitions. The expected adverse impact on earnings in 2013 from anticipated additional restructuring costs is expected to be offset by the beneficial impact from non-recurring items. Although no specific plans for significant actions have been finalized at this time, we

 


 

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continue to closely monitor the economic environment and may undertake further restructuring actions to keep our cost structure aligned with the demands of the prevailing market conditions.

2012 Actions. During 2012, we initiated restructuring actions relating to ongoing cost reduction efforts, including workforce reductions and consolidation of manufacturing operations. We recorded net pre-tax restructuring charges totaling $576 million as follows:

 

(DOLLARS IN MILLIONS)    2012  
Otis    $   146  
UTC Climate, Controls & Security      123  
Pratt & Whitney      94  
UTC Aerospace Systems      121  
Sikorsky      47  
Eliminations and other      19  
Restructuring costs recorded within continuing operations      550  
Restructuring costs recorded within discontinued operations      26  
Total    $ 576  
          

The following table summarizes the charges associated with the 2012 restructuring actions:

 

(DOLLARS IN MILLIONS)    2012  
Cost of sales    $   313  
Selling, general and administrative      236  
Other income, net      1  
Restructuring costs recorded within continuing operations      550  
Restructuring costs recorded within discontinued operations      26  
Total    $ 576  
          

The following table summarizes the charges associated with the 2012 restructuring actions by cost type:

 

(DOLLARS IN MILLIONS)    2012  
Severance    $   426  
Asset write-downs      14  
Facility exit, lease termination and other costs      110  
Restructuring costs recorded within continuing operations      550  
Restructuring costs recorded within discontinued operations      26  
Total    $ 576  
          

We expect the actions initiated in 2012, once fully complete, to result in net workforce reductions of approximately 7,000 hourly and salaried employees, the exiting of approximately 2.6 million net square feet of facilities and the disposal of assets associated with the exited facilities. As of December 31, 2012, with respect to the actions initiated in 2012, we have completed net workforce reductions of approximately 4,000 employees, and 750,000 net square feet of facilities have been exited. We are targeting to complete in 2013 the majority of the remaining workforce and facility related cost reduction actions initiated in 2012.

Approximately 80% of the total pre-tax charge will require cash payments, which we have and expect to continue to fund with cash generated from operations. During 2012, we had cash outflows of approximately $199 million related to the 2012 actions. We expect to incur additional restructuring and other charges of $105 million to complete these actions. We expect recurring pre-tax savings to increase over the two-year period subsequent to initiating the actions to approximately $560 million annually, of which, approximately $125 million was realized in 2012.

2011 Actions. During 2012 and 2011, we recorded net pre-tax restructuring charges of $53 million and $286 million, respectively, for actions initiated in 2011. The 2011 actions relate to ongoing cost reduction efforts, including workforce reductions and the consolidation of field operations. We recorded net pre-tax restructuring charges in 2012 and 2011 as follows:

 

(DOLLARS IN MILLIONS)    2012      2011  
Otis    $   19      $ 76  
UTC Climate, Controls & Security      25        93  
Pratt & Whitney      3        37  
UTC Aerospace Systems              8  
Sikorsky      5        51  
Restructuring costs recorded within continuing operations      52        265  
Restructuring costs recorded within discontinued operations      1        21  
Total    $   53      $   286  
                   

The following table summarizes the charges associated with the 2011 restructuring actions:

 

(DOLLARS IN MILLIONS)   2012     2011  
Cost of sales   $   33     $   120  
Selling, general and administrative     19       142  
Other income, net            3  
Restructuring costs recorded within continuing operations     52       265  
Restructuring costs recorded within discontinued operations     1       21  
Total   $ 53     $ 286  
                 

The following table summarizes the 2012 and 2011 charges associated with the 2011 restructuring actions by cost type:

 

(DOLLARS IN MILLIONS)   2012     2011  
Severance   $   30     $   242  
Asset write-downs     1       4  
Facility exit, lease termination and other costs     21       19  
Restructuring costs recorded within continuing operations     52       265  
Restructuring costs recorded within discontinued operations     1       21  
Total   $ 53     $ 286  
                 

We expect the actions initiated in 2011, once fully completed, to result in net workforce reductions of approximately 4,900

 


 

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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 December 31, 2012, we have completed, with respect to the actions initiated in 2011, net workforce reductions of approximately 4,200 employees and exited 200,000 net square feet of facilities. We are targeting to complete in 2013 the majority of the remaining workforce and all facility related cost reduction actions initiated in 2011. Approximately 75% of the total pre-tax charge will require cash payments, which we have and

expect to continue to fund with cash generated from operations. During 2012, we had cash outflows of approximately $153 million related to the 2011 actions. We expect to incur additional restructuring charges of $29 million to complete these actions. We expect recurring pre-tax savings to increase over the two-year period subsequent to initiating the actions to approximately $280 million annually.

For additional discussion of restructuring, see Note 13 to the Consolidated Financial Statements.

 

 

SEGMENT REVIEW

 

     Net Sales     Operating Profits     Operating Profit Margin  
(DOLLARS IN MILLIONS)    2012     2011     2010     2012     2011     2010     2012      2011      2010  
Otis    $   12,056     $   12,437     $   11,579     $   2,512     $   2,815     $   2,575       20.8%         22.6%         22.2%   
UTC Climate, Controls & Security      17,090       18,864       17,876       2,425       2,212       1,776       14.2%         11.7%         9.9%   
Pratt & Whitney      13,964       12,711       12,150       1,589       1,867       1,885       11.4%         14.7%         15.5%   
UTC Aerospace Systems      8,334       4,760       4,399       944       759       654       11.3%         15.9%         14.9%   
Sikorsky      6,791       7,355       6,684       712       840       716       10.5%         11.4%         10.7%   
Total segment      58,235       56,127       52,688       8,182       8,493       7,606       14.0%         15.1%         14.4%   
Eliminations and other      (527     (373     (413     (72     (228     (331              
General corporate expenses                           (426     (419     (377                          
Consolidated    $ 57,708     $ 55,754     $ 52,275     $ 7,684     $ 7,846     $ 6,898       13.3%         14.1%         13.2%   
                                                                            

 

Commercial Businesses

The financial performance of our commercial businesses can be 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 and 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 for its residential business, weather conditions. Geographic and industry diversity across the commercial businesses help to balance the impact of such factors on our consolidated operating results, particularly in the face of uneven economic growth. While Otis faced challenging economic conditions in Europe and lower order rates in China during the first half of the year, improving market conditions

in China and North America resulted in higher order rates in the second half of the year. New equipment orders in China declined for the year (3%), but increased during the fourth quarter (19%) as compared with the fourth quarter of 2011. Organic sales for 2012 within each of our commercial businesses were consistent with prior year levels.

In 2012, 70% of total commercial business sales were generated outside the U.S., including U.S. export sales, as compared to 72% in 2011. The following table shows sales generated outside the U.S., including U.S. export sales, for each of the commercial business segments:

 

      2012      2011  
Otis      82%         83%   
UTC Climate, Controls & Security      62%         65%   
                   
 


 

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Otis is the world’s largest elevator and escalator manufacturing, installation and service company. Otis designs, manufactures, sells and installs a wide range of passenger and freight elevators for low-, medium- and high-speed applications, as well as a broad line of escalators and moving walkways. In addition to new equipment, Otis provides modernization products to upgrade elevators and

escalators as well as maintenance and repair services for both its products and those of other manufacturers. Otis serves customers in the commercial and residential property industries around the world. Otis sells directly to the end customer and through sales representatives and distributors.

 

 

                             Total Increase (Decrease) Year-Over-Year for:  
(DOLLARS IN MILLIONS)    2012      2011      2010      2012 Compared with 2011      2011 Compared with 2010  
Net Sales    $   12,056      $   12,437      $   11,579      $   (381     (3)%       $   858        7%   
Cost of Sales      8,008        8,090        7,540        (82     (1)%         550        7%   
     4,048        4,347        4,039                     
Operating Expenses and Other      1,536        1,532        1,464                     
Operating Profits    $ 2,512      $ 2,815      $ 2,575      $ (303     (11)%       $ 240        9%   
                                                               

 

    Factors Contributing to Total % Increase (Decrease) Year-Over-Year in:  
    2012     2011  
     Net Sales     Cost of Sales     Operating
Profits
    Net Sales     Cost of Sales     Operating
Profits
 
Organic / Operational     –             1%        (3)%        2%        2%        2%   
Foreign currency translation     (3)%        (3)%        (4)%        4%        4%        5%   
Acquisitions and divestitures, net     –             –             –             1%        1%        –       
Restructuring costs     –             1 %        (4)%        –            –            –       
Other     –             –             –             –            –            2%   
Total % change     (3)%        (1)%        (11)%        7%        7%        9%   
                                                 

 

2012 Compared with 2011

There was no organic sales growth in 2012 as higher service sales were offset by lower new equipment sales. Higher service sales in Asia and the Americas (2%) were offset by declines in Europe (1%). Lower new equipment volume (1%) primarily in China and Europe was partially offset by a slight increase in the Americas and Russia.

The operational profit decline for the year (3%) is due to lower new equipment contribution driven by lower volume and pricing pressures (4%), lower service contribution (1%) resulting from continued pricing pressure primarily in Europe, and the impact of higher commodity costs (1%). Partially offsetting these factors were benefits derived from ongoing cost reduction initiatives (3%).

2011 Compared with 2010

The organic sales increase (2%) in the year was due to higher new equipment sales volume in China, Russia and Brazil (combined 3%), partially offset by declines in North America (1%). Increased contractual maintenance and repair volume across all regions was offset by a decline in modernization volume in Europe. New equipment orders improved 15% versus the prior year, led by strong order growth in China. Selling prices remained under pressure.

The operational profit improvement (2%) in the period was due to higher new equipment volume, increases in contractual maintenance and repair services, and the benefits of ongoing cost reduction initiatives, partially offset by lower pricing, the impact of

higher commodity costs, and lower modernization volume in Europe.

UTC Climate, Controls & Security As described above, on September 28, 2011, we announced a new organizational structure that allows us to better serve customers through greater integration across product lines. As part of this new structure, effective January 1, 2012, we formed the UTC Climate, Controls & Security segment, which is composed of the former Carrier and UTC Fire & Security segments. UTC Climate, Controls & Security is the leading provider of HVAC and refrigeration solutions, including controls for residential, commercial, industrial and transportation applications. These products and services are sold under the Carrier name and other brand names to building contractors and owners, homeowners, transportation companies, retail stores and food service companies. UTC Climate, Controls & Security is also a global provider of security and fire safety products and services. UTC Climate, Controls & Security provides electronic security products such as intruder alarms, access control systems and video surveillance systems and designs and manufactures a wide range of fire safety products including specialty hazard detection and fixed suppression products, portable fire extinguishers, fire detection and life safety systems, and other firefighting equipment. Services provided to the electronic security and fire safety industries include systems integration, video surveillance, installation, maintenance, and inspection. In certain markets, UTC Climate, Controls & Security

 


 

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also provides monitoring, response and security personnel services, including cash-in-transit security, to complement its electronic security and fire safety businesses. Through its venture with Watsco, Inc., UTC Climate, Controls & Security distributes Carrier, Bryant, Payne and Totaline residential and light commercial HVAC products in the U.S. and selected territories in the Caribbean and Latin America. UTC Climate, Controls & Security sells directly to end customers and through manufacturers’ representatives, distributors, wholesalers, dealers and retail outlets. Certain of UTC Climate, Controls & Security’s HVAC businesses are seasonal and can be impacted by weather. UTC Climate, Controls & Security customarily offers its customers incentives to purchase products to ensure an adequate supply of its products in the distribution chan-

nels. 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. UTC Climate, Controls & Security products and services are used by governments, financial institutions, architects, building owners and developers, security and fire consultants, homeowners and other end-users requiring a high level of security and fire protection for their businesses and residences. UTC Climate, Controls & Security provides its security and fire safety products and services under Chubb, Kidde and other brand names and sells directly to customers as well as through manufacturer representatives, distributors, dealers and U.S. retail distribution.

 

 

                             Total Increase (Decrease) Year-Over-Year for:  
(DOLLARS IN MILLIONS)    2012      2011      2010      2012 Compared with 2011      2011 Compared with 2010  
Net Sales    $   17,090      $   18,864      $   17,876      $   (1,774     (9)%       $   988        6%   
Cost of Sales      12,316        13,848        13,158        (1,532     (11)%         690        5%   
     4,774        5,016        4,718                     
Operating Expenses and Other      2,349        2,804        2,942                     
Operating Profits    $ 2,425      $ 2,212      $ 1,776      $ 213       10 %       $ 436        25%   
                                                               

 

    Factors Contributing to Total % Increase (Decrease) Year-Over-Year in:  
    2012     2011  
     Net Sales     Cost of Sales     Operating
Profits
    Net Sales     Cost of Sales     Operating
Profits
 
Organic / Operational     –             –             10 %        7 %        8 %        13 %   
Foreign currency translation     (2)%        (3)%        (2)%        3 %        3 %        3 %   
Acquisitions and divestitures, net     (7)%        (8)%        –             (4)%        (5)%        (2)%   
Restructuring costs     –             –             (1)%        –             –             2 %   
Other     –             –             3 %        –             (1)%        9 %   
Total % change     (9)%        (11)%        10 %        6 %        5 %        25 %   
                                                 

 

2012 Compared with 2011

There was no organic sales growth during 2012 as lower volumes in the transport refrigeration business (1%) were offset by growth in the Americas (1%) attributable to the residential and commercial HVAC businesses. The decrease in “Acquisitions and divestitures, net” (7%) reflects the year-over-year impact of divestitures completed in the preceding twelve months associated with UTC Climate, Controls & Security’s ongoing portfolio transformation.

The 10% operational profit increase was driven largely by the benefits of net cost productivity and restructuring actions (combined 3%) including savings from the consolidation of legacy Carrier and UTC Fire & Security, favorable commodity costs (2%), and higher equity income from joint venture partners (2%). Also, operational profit included the benefit of a special cash dividend (1%) received from an interest in a distribution partner. The 3% increase in “Other” primarily reflects an approximately $46 million net year-over-year gain from UTC Climate, Controls & Security’s ongoing portfolio transformation and the absence of a $66 million

other-than-temporary impairment charge recorded on an Asian equity investment in the prior year. This was partially offset by the absence of an approximately $25 million favorable litigation resolution and gain on the disposition of the U.K. Security business, both recorded in 2011. The year-over-year net portfolio transformation gain primarily includes approximately $120 million from the sale of a controlling interest in a Canadian distribution business, including a $24 million pension settlement charge, combined with an approximately $215 million net gain from the sale of a controlling interest in a manufacturing and distribution joint venture in Asia. These gains were partially offset by a $32 million loss on the disposition of the U.S. Fire & Security branch operations, $142 million of impairment charges recorded in 2012 related to ongoing business dispositions, and the absence of an approximately $80 million prior year gain resulting primarily from the contribution of legacy Carrier’s HVAC operations in Brazil, Argentina and Chile into a new venture controlled by Midea Group of China.

 


 

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2011 Compared with 2010

Organic sales growth was 7%, with the recovery in the transport refrigeration market partially offset by declines in the U.K. and U.S. service businesses. The 4% decrease in “Acquisitions and divestitures, net” primarily reflects the net impact from acquisitions and the business transformation actions completed in the preceding twelve months as part of UTC Climate, Controls & Security’s ongoing portfolio transformation initiative.

The operational profit improvement of 13% was driven by strong conversion on organic sales growth (7%), particularly in the higher margin transport refrigeration business, lower bad debt expense, and earnings improvement in a joint venture in Japan (2%). This was partially offset by lower margins and unfavorable sales mix primarily within the fire protection products business in the U.K. and higher net commodity costs (6%). The 9% increase in “Other” primarily reflects the year-over-year impact of net gains associated with UTC Climate, Control & Security’s ongoing portfolio transformation. This includes an approximately $80 million gain recorded in 2011 as a result of the contribution of legacy Carrier’s HVAC operations in Brazil, Argentina, and Chile into a new venture controlled by Midea Group of China. Also included in “Other” is the favorable resolution of litigation and gains on the dispositions of U.K. security businesses and the absence of an asset impairment charge in 2010 of approximately $58 million, all of which was partially offset by a $66 million other-than-temporary impairment charge recorded on an equity investment in Asia in 2011.

Aerospace Businesses

The financial performance of Pratt & Whitney, UTC Aerospace Systems and Sikorsky is directly tied to the economic conditions of the commercial aerospace and defense aerospace industries. In particular, Pratt & Whitney experiences intense competition for new commercial airframe/engine combinations. Engine suppliers may offer substantial discounts and other financial incentives, performance and operating cost guarantees, participation in financing arrangements and maintenance agreements. At times, the aerospace businesses also enter into development programs and firm fixed-price development contracts, which may require the company to bear cost overruns related to unforeseen technical and design challenges that arise during the development stage of the program. Customer selections of engines and components can also have a significant impact on later sales of parts and service. Predicted traffic levels, load factors, worldwide airline profits, general economic activity and global defense spending have been reliable indicators for new aircraft and aftermarket orders within the aerospace industry. Spare part sales and aftermarket service trends are affected by many factors, including usage, technological improvements, pricing, regulatory changes and the retirement of older aircraft. Performance in the general aviation sector is closely tied to the overall health of the economy and is positively correlated to corporate profits.

Our long-term aerospace contracts are subject to strict safety and performance regulations which can affect our ability to estimate costs precisely. Contract cost estimation for the development of complex projects, in particular, requires management to make significant judgments and assumptions regarding the complexity of the work to be performed, availability of materials, the performance by subcontractors, the timing of funding from customers and the length of time to complete the contract. As a result, we review and update our cost estimates on significant contracts on a quarterly basis, and no less frequently than annually for all others, or when circumstances change and warrant a modification to a previous estimate. Changes in estimates relate to the current period impact of revisions to total estimated contract sales and costs at completion. We record changes in contract estimates using the cumulative catch-up method in accordance with the Revenue Recognition Topic of the FASB Accounting Standards Codification (“ASC”). The net decrease in operating profits as a result of significant changes in aerospace contract estimates was $19 million in 2012, including the revision in estimate on the Sikorsky CH-148 contract discussed further below. The adverse impact of this contract adjustment was partially offset by several positive contract adjustments recorded throughout the year largely at the Pratt & Whitney segment. The impact of these adjustments was not considered significant to either the sales or operating profits of the segment in the quarter in which they were recorded other than the impact of a contract termination which was disclosed in the Pratt & Whitney segment results in the first quarter of 2012.

The commercial airline industry remained strong throughout 2012. Airline traffic growth rates, as measured by revenue passenger miles (RPMs), stabilized during 2012 and 2011 after rebounding in 2010. RPMs grew 5.5% in 2012, as compared with 2011, and we expect RPMs will continue to grow between 4% and 6% in 2013. We made significant investment in engineering and development in 2012 and expect continued investment in 2013, primarily at Pratt & Whitney as we continue to develop five separate geared turbofan platforms to meet demand for new engines which are fuel efficient and have reduced noise levels and exhaust emissions. Although airlines have generally returned to profitability, high fuel prices continue to challenge the airlines to consider the need for more fuel efficient aircraft.

Deficit reduction measures considered by the U.S. Government are expected to pressure the U.S. Department of Defense budget in the coming years, resulting in a decline in U.S. Department of Defense spending. Total sales to the U.S. Government of $10.1 billion in 2012, $9.1 billion in 2011, and $9.1 billion in 2010 were 18%, 16% and 17% of total UTC sales in 2012, 2011 and 2010, respectively. The defense portion of our aerospace business is affected by changes in market demand and the global political environment. Our participation in long-term production and development programs for the U.S. Government has contributed positively to our results in 2012 and is expected to continue to benefit results in 2013.

 


 

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Sikorsky continued to benefit from military spending, with approximately 86% of Sikorsky’s 2012 helicopter deliveries based on military platforms. In July 2012, the U.S. Government and Sikorsky signed a five-year multiservice contract for approximately 650 H-60 helicopters. Actual production quantities will be determined year-by-year over the life of the program based on funding allocations set by Congressional and Pentagon acquisition priorities. Commercial helicopter aftermarket sales volumes were consistent with the prior year on strong demand for the S-92 helicopter which was offset by lower volumes of the S-76 helicopter as Sikorsky transitions to the new S-76D helicopter.

As previously reported, Sikorsky is developing the CH-148 derivative of the H-92 helicopter (the “Cyclone”), a military variant of the S-92 helicopter, for the Canadian Government. The Cyclone is being developed under a fixed-price contract that provides for the development and production of 28 helicopters (the “Acquisition Contract”), and a related In Service Support contract (the “ISS Contract”) through March 2028 (collectively, the “Arrangements”). The current contract values of the Arrangements are estimated to be $4.3 billion. Revenues are subject to changes in underlying variables such as the timing of deliveries, future flight hours and fluctuations in foreign currency exchange rates.

As previously disclosed, in June 2010 Sikorsky and the Canadian Government signed contract amendments that revised the delivery schedule and contract specifications, while also establishing requirements that enabled initial operational test and evaluation activities for the first six interim aircraft. The amendments also included modifications to the liquidated damages schedule, readjustment of payment schedules, resolution of open disputes and other program related enhancements.

In accordance with our revenue recognition policy, losses, if any, on long-term contracts are provided for when anticipated. Loss provisions on original equipment contracts are recognized to the extent that estimated inventoriable manufacturing, engineering, product warranty and product performance guarantee costs, as appropriate, exceed the projected revenue from the products contemplated under the contractual arrangement. In 2011, Sikorsky completed a significant contractual milestone for work on four interim configuration helicopters and recognized the revenues and related costs. Although the Arrangements were expected to be profitable on a combined basis in 2011, $56 million of losses were recorded upon completing the milestones for the four aircraft as the actual costs exceeded revenues. These interim configuration aircraft will require further software and hardware upgrades before full mission capability can be achieved.

Delivery of the final configuration aircraft, which was scheduled to begin in 2012, did not occur due to a number of disputes between the Canadian Government and Sikorsky that arose during the course of 2012 related to contractual requirements and contract performance. These included issues related to excusable delays, development, production, logistical support and delays in

the delivery of final configuration aircraft. The parties have been unable to resolve these disputes and are engaged in the dispute resolution process.

As a result of these matters, Sikorsky recorded a loss provision of $157 million during the fourth quarter of 2012 as the estimated profits on the ISS Contract no longer exceeded the estimated remaining losses on the Acquisition Contract. The profit erosion was driven by an increase in total expected costs to be incurred primarily as a result of the delays in delivering the final configuration aircraft, and a reduction of expected flight hour revenues on the ISS Contract. Since the Acquisition Contract’s costs exceed its revenues on a stand-alone basis, we expect to record a $14 million loss upon the contractual delivery of each aircraft in the future.

Sikorsky is prepared to deliver additional aircraft in a configuration that would allow for the commencement of certain contractually required activities such as pilot training, customer testing, and limited mission capability. These aircraft would require the incorporation of additional hardware and software upgrades before full mission capability can be achieved and final configuration aircraft subsequently delivered. Sikorsky continues discussions with the Canadian Government in an effort to resolve the open disputes including the establishment of a potential arrangement that allows for the delivery of interim configuration aircraft. However, if these efforts are unsuccessful and the Canadian Government requires the delivery of only final configuration aircraft under current contractual requirements, no deliveries are expected to occur until 2015 at the earliest.

While Sikorsky is committed to the program, the current disputes and unresolved contract status, coupled with the remaining development issues and long-term nature of this program, provide substantial uncertainty and risk in regards to the future profitability of the overall program. While the loss provisions recorded to date reflect management’s best estimate of the projected costs to complete the development and manufacture of the final configuration aircraft, there is still significant effort required to complete the development of the mission system capability as well as complete the manufacturing, testing and retrofit activities. Future variability in internal cost targets related to the aircraft may be caused by increases in holding costs, retrofit estimates, subcontractor performance and changes in liquidated damages. With respect to the multi-year ISS Contract, the future profitability is dependent upon a number of factors including aircraft flight hours, deployed aircraft availability, aircraft performance, availability of trained pilots and government budgetary pressures. The inability to achieve a satisfactory contractual solution, further unplanned delays, additional developmental cost growth or variations in any of the estimates used in the existing contract analysis could lead to further loss provisions on the Arrangements. Additional losses could have a material adverse impact on the consolidated results of operations in the period in which the loss may be recognized.

 


 

  14    

 

Effective July 1, 2012, the auxiliary power unit business (APU) of the UTC Aerospace Systems business segment was transferred to the Pratt & Whitney business segment. The APU business designs and manufactures a variety of products for commercial and military aircraft. Annual sales for the APU business are approximately $600 million. The reclassification has been made prospectively; prior year results have not been restated for the transfer of the business.

Pratt & Whitney is among the world’s leading suppliers of aircraft engines for the commercial, military, business jet and general aviation markets. Pratt & Whitney Commercial Engines provides maintenance, repair and overhaul services, including the sale of spare parts, as well as fleet management services for large commercial engines. Pratt & Whitney produces families of engines for wide- and narrow-body and large regional aircraft in the commercial market and for fighter and transport aircraft in the military market. P&WC is a world leader in the production of engines powering business, regional, light jet, utility and military airplanes and helicopters and provides related maintenance, repair and overhaul services, including the sale of spare parts, as well as fleet management services. Pratt & Whitney’s products are sold principally to aircraft manufacturers, airlines and other aircraft operators, aircraft leasing companies, space launch vehicle providers and the U.S. and foreign governments. Pratt & Whitney’s products and services must adhere to strict regulatory and market-driven safety and performance standards. The frequently changing nature of these standards, along with the long duration of aircraft engine development, production and support programs, creates uncertainty regarding engine program profitability. The vast majority of sales are made directly to the end customer and, to a limited extent, through independent distributors and foreign sales representatives.

Pratt & Whitney is currently developing technology, including the PurePower PW1000G Geared TurboFan engine, intended to enable it to power both currently-proposed and future aircraft. The PurePower PW1000G engine targets a significant reduction in fuel burn and noise levels with lower environmental emissions and operating costs than current production engines. In December 2010, Airbus announced that it will offer a version of the PurePower PW1000G engine as a new engine option to power its A320neo family of aircraft scheduled to enter into service in 2015. In November 2012, Pratt & Whitney commenced testing on this new engine, the PW1100G-JM, being developed as part of a collabo-

ration with MTU and JAEC. Additionally, PurePower PW1000G engine models have been selected by Bombardier to power the new CSeries passenger aircraft, by Mitsubishi Aircraft Corporation to power the new Mitsubishi Regional Jet, and by Irkut Corporation of Russia to power the proposed new Irkut MC-21 passenger aircraft. These aircraft are scheduled to enter into service in 2013, 2015 and 2017, respectively. Further, on January 8, 2013, Embraer announced the selection of the PurePower engine to exclusively power the next generation of Embraer’s E-Jet family of aircraft scheduled to enter service in 2018. The success of these aircraft and the PurePower PW1000G family of engines is dependent upon many factors including technological challenges, aircraft demand, and regulatory approval. Based on these factors, as well as the level of success of aircraft program launches by aircraft manufacturers and other conditions, additional investment in the PurePower program may be required. P&WC has developed or is developing the PW210 engine family for helicopters manufactured by Sikorsky, AgustaWestland and The Eurocopter Group and is developing the PurePower PW800 engine for the new generation of long-range and heavy business jets. Pratt & Whitney continues to enhance its programs through performance improvement measures and product base expansion.

In view of the risks and costs associated with developing new engines, Pratt & Whitney has entered into collaboration arrangements in which sales, costs and risks are shared. At December 31, 2012, the interests of third party participants in Pratt & Whitney-directed commercial jet engine programs ranged from 14 percent to 48 percent. In addition, Pratt & Whitney has interests in other engine programs, including a 50 percent ownership interest in the Engine Alliance (EA), a joint venture with GE Aviation, which markets and manufactures the GP7000 engine for the Airbus A380 aircraft. Pratt & Whitney has entered into risk and revenue sharing arrangements with third parties for 40 percent of the products and services that Pratt & Whitney is responsible for providing to the EA. Pratt & Whitney accounts for its interests in the EA joint venture under the equity method of accounting. Pratt & Whitney continues to pursue additional collaborators.

On June 29, 2012, Pratt & Whitney, Rolls-Royce, MTU and JAEC, participants in the IAE collaboration, completed a restructuring of their interests in IAE. Pratt & Whitney now has a 61% net interest in the collaboration and a 49.5% ownership interest in IAE. See the Business Overview section of Management’s Discussion and Analysis for further information on the IAE transaction.

 

 

                             Total Increase (Decrease) Year-Over-Year for:  
(DOLLARS IN MILLIONS)    2012      2011      2010      2012 Compared with 2011      2011 Compared with 2010  
Net Sales    $   13,964      $   12,711      $   12,150      $   1,253        10 %       $   561        5 %   
Cost of Sales      10,600        9,282        9,011        1,318        14 %         271        3 %   
     3,364        3,429        3,139                      
Operating Expenses and Other      1,775        1,562        1,254                      
Operating Profits    $ 1,589      $ 1,867      $ 1,885      $ (278)         (15)%       $ (18)         (1)%   
                                                                


 

    15  

 

     Factors Contributing to Total % Increase (Decrease) Year-Over-Year in:  
     2012      2011  
      Net Sales     Cost of Sales      Operating
Profits
     Net Sales     Cost of Sales      Operating
Profits
 
Organic* / Operational*      2 %        5 %         (16)%         6 %        3%         (3)%   
Foreign currency (including P&WC net hedging)*      (1)%        –            (3)%         (1)%        –             (2)%   
Acquisitions and divestitures, net      9 %        9 %         6 %         –            –             –        
Restructuring costs      –            –            (2)%         –            –             2 %   
Other      –            –            –             –            –             2 %   
Total % change      10 %        14 %         (15)%         5 %        3%         (1)%   
                                                     

 

* As discussed further in the “Business Overview” and “Results of Operations” sections, for Pratt & Whitney only, the transactional impact of foreign exchange hedging at P&WC has been netted against the translational foreign exchange impact for presentation purposes in the above table. For all other segments, these foreign exchange transactional impacts are included within the organic sales/operational operating profit caption in their respective tables. Due to its significance to Pratt & Whitney’s overall operating results, we believe it is useful to segregate the foreign exchange transactional impact in order to clearly identify the underlying financial performance.

 

2012 Compared with 2011

Organic sales growth (2%) was driven by higher military engine deliveries and aftermarket sales (5%), higher P&WC engine and spares volume (1%), and higher industrial volume at Pratt & Whitney Power Systems (1%), offset by a decrease in commercial aftermarket (6%). Sales increased (9%) as a result of the consolidation of IAE and the transfer of the APU business to Pratt & Whitney from UTC Aerospace Systems.

The operational profit decrease (16%) was primarily driven by lower profit on commercial aftermarket (17%), higher research and development (8%), partially offset by favorable P&WC engine volume and delivery mix (3%), higher military engine and spares volume (3%) and an increase in contract settlements and close outs (3%). Operating profit increased due to net acquisitions (6%) primarily as a result of the consolidation of IAE.

2011 Compared with 2010

Organic sales growth (6%) was driven by growth in the large commercial engine business (5%), higher spares volume across the business (combined 2%), and higher industrial volume at Pratt & Whitney Power Systems (1%). These increases were partially offset by lower military engine sales.

The operational profit decline (3%) primarily reflects higher year-over-year research and development costs (14%), unfavorable commercial engine business mix and fewer military engine business deliveries (combined 7%), partially offset by higher commercial spares and aftermarket volume (14%). Additionally, gains recorded on contract settlements and contract close-outs were offset, in

part, by losses incurred as a result of increased airline industry exposures during the year (combined 4%). The 2% contributed by “Other” primarily reflects the gain on a sale of an equity investment.

UTC Aerospace Systems—On July 26, 2012, UTC acquired Goodrich, pursuant to a merger agreement dated September 21, 2011. As a result of the acquisition, Goodrich became a wholly-owned subsidiary of UTC. The acquired Goodrich business and the former Hamilton Sundstrand segment have been combined to form the new UTC Aerospace Systems segment. UTC Aerospace Systems is among the world’s leading suppliers of technologically advanced aerospace products and aftermarket services for diversified industries worldwide. UTC Aerospace Systems’ aerospace products include electric power generation, management and distribution systems, flight control systems, engine control systems, intelligence, surveillance and reconnaissance systems, engine components, environmental control systems, fire protection and detection systems, propeller systems, aircraft nacelles, and interior, actuation, landing and electronic systems. UTC Aerospace Systems products serve commercial, military, regional, business and general aviation, as well as military ground vehicle, space and undersea applications. Aftermarket services include spare parts, overhaul and repair, engineering and technical support and fleet maintenance programs. UTC Aerospace Systems sells aerospace products to airframe manufacturers, the U.S. and foreign governments, aircraft operators, maintenance, repair and overhaul providers, and independent distributors.

 

 

                          Total Increase (Decrease) Year-Over-Year for:  
(DOLLARS IN MILLIONS)    2012      2011      2010      2012 Compared with 2011      2011 Compared with 2010  
Net Sales    $   8,334      $   4,760      $   4,399      $   3,574        75%       $   361        8%   
Cost of Sales      6,090        3,403        3,112        2,687        79%         291        9%   
     2,244        1,357        1,287                      
Operating Expenses and Other      1,300        598        633                      
Operating Profits    $ 944      $ 759      $ 654      $ 185        24%       $ 105        16%   
                                                                


 

  16    

 

     Factors Contributing to Total % Increase (Decrease) Year-Over-Year in:  
     2012      2011  
      Net Sales     Cost of Sales      Operating
Profits
     Net Sales      Cost of Sales      Operating
Profits
 
Organic / Operational      7 %        6 %         6 %         8 %         10 %         8 %   
Foreign currency translation      (1)%        (1)%         (1)%         1 %         1 %         2 %   
Acquisitions and divestitures, net      69 %        73 %         33 %         (1)%         (1)%         (1)%   
Restructuring costs      –            1 %         (14)%         –              –             2 %   
Other      –            –              –               –             (1)%         5 %   
Total % change      75 %        79 %         24 %         8 %         9 %         16 %   
                                                      

 

2012 Compared with 2011

The organic sales growth (7%) reflects higher commercial aerospace OEM (4%), military aerospace OEM (2%), and aftermarket (1%) volume.

The organic increase in operational profit (6%) primarily reflects the benefit of profit contribution on higher sales (11%) and lower warranty costs (5%) partially offset by higher engineering and development (4%) and pension costs (6%). “Acquisitions and divestitures, net” is principally a result of the acquisition of Goodrich.

2011 Compared with 2010

The organic sales growth (8%), primarily reflects higher aftermarket (6%) and OEM (2%) volumes. The organic cost of sales growth (10%) exceeded the organic sales growth due largely to an adverse mix within aerospace OEM and higher warranty costs.

The increase in operational profit (8%) reflects an increase in aftermarket volume, partially offset by adverse mix within OEM, including a reduction in military ground vehicle volumes and an increase in volume of lower margin commercial programs (8%). Also, operational profit growth reflects the benefit of lower research and development costs (5%), offset by higher warranty costs (6%). The increase contributed by “Other” primarily reflects the absence of approximately $28 million of asset impairment charges recorded in the second quarter of 2010. These charges related primarily to the disposition of an aerospace business as part of UTC Aerospace System’s efforts to implement low cost sourcing initiatives.

Sikorsky is one of the world’s largest helicopter companies. Sikorsky manufactures military and commercial helicopters and also provides aftermarket helicopter and aircraft parts and services.

Current major production programs at Sikorsky include the UH-60M Black Hawk medium-transport helicopters and HH-60M Medevac helicopters for the U.S. and foreign governments, the S-70 Black Hawk for foreign governments, the MH-60S and MH-60R helicopters for the U.S. Navy, the International Naval Hawk for multiple naval missions, and the S-76 and S-92 helicopters for commercial operations. The UH-60M helicopter is the latest and most modern in a series of Black Hawk variants that Sikorsky has been delivering to the U.S. Army since 1978. In July 2012, the U.S. Government and Sikorsky signed a five-year multi-service contract for approximately 650 H-60 helicopters. Actual production quantities will be determined year-by-year over the life of the program based on funding allocations set by Congress and the U.S. Department of Defense acquisition priorities, as well as the level of Foreign Military Sales. Sikorsky is also developing the CH-53K next generation heavy lift helicopter for the U.S. Marine Corps and the CH-148 derivative of the H-92 helicopter, a military variant of the S-92 helicopter, for the Canadian Government. See the Aerospace Business section of Management’s Discussion and Analysis, above, for further discussion of Sikorsky’s contract with the Canadian Government.

Sikorsky’s aftermarket business includes spare parts sales, mission equipment, overhaul and repair services, maintenance contracts and logistics support programs for helicopters and other aircraft. Sales are principally made to the U.S. and foreign governments, and commercial helicopter operators. Sikorsky is increasingly engaging in logistics support programs and partnering with its government and commercial customers to manage and provide logistics, maintenance and repair services.

 

 

                          Total Increase (Decrease) Year-Over-Year for:  
(DOLLARS IN MILLIONS)    2012      2011      2010      2012 Compared with 2011      2011 Compared with 2010  
Net Sales    $   6,791      $   7,355      $   6,684      $ (564)         (8)%       $   671        10%   
Cost of Sales      5,643        6,120        5,539        (477)         (8)%         581        10%   
     1,148        1,235        1,145                      
Operating Expenses and Other      436        395        429                      
Operating Profits    $ 712      $ 840      $ 716      $   (128)         (15)%       $ 124        17%   
                                                                


 

    17  

 

     Factors Contributing to Total % Increase (Decrease) Year-Over-Year in:  
     2012      2011  
      Net Sales     Cost of Sales      Operating
Profits
     Net Sales      Cost of Sales      Operating
Profits
 
Organic / Operational      (8)%        (8)%         (7)%         10%         10%         12 %   
Restructuring costs      –            –             –             –             –             (5)%   
Other      –            –             (8)%         –             –             10 %   
Total % change      (8)%        (8)%         (15)%         10%         10%         17 %   
                                                      

 

2012 Compared with 2011

The organic sales decrease (8%) reflects reduced aircraft deliveries and completions from foreign military operations (6%) across various programs including four fewer CH-148 aircraft for the Canadian Government, reduced U.S. Government sales (2%) and lower volume from customer funded development programs (2%). These decreases were partially offset by increased commercial aircraft volume (2%) due primarily to increased S-92 sales, which were partially offset by lower S-76 sales as Sikorsky transitions to the new S-76D model.

The operational profit decrease (7%) is a result of lower sales to the U.S. Government (12%), higher engineering and development costs (1%) and lower profits from foreign military operations (8%) due in large part to the previously noted $157 million loss provision for the CH-148 contract with the Canadian Government, partially offset by favorable aircraft mix within the foreign military operations business. These decreases were partially offset by an increase in commercial profits (10%) due primarily to strong S-92 volume and profitability, and increased aftermarket support (5%) due primarily to increased U.S. Government spares sales, favorable contract performance and savings from restructuring initiatives. The 8% decrease in “Other” primarily reflects the absence of a gain recognized on the contribution of a business to a venture in the United Arab Emirates in 2011.

2011 Compared with 2010

The increase in organic sales (10%) was primarily attributable to higher military aircraft sales including higher international development aircraft sales and favorable military aircraft configuration mix (8% combined), which more than offset a decrease from commercial operations (2%) due to fewer aircraft deliveries. Net sales from aftermarket support increased (4%) primarily driven by higher spares volume.

The operational profit improvement (12%) was primarily attributable to an increase in aftermarket support (10%) driven by higher spares volume. Operating profits in the military business increased as higher aircraft deliveries and favorable aircraft configuration mix more than offset the adverse impact of losses associated with higher than expected development costs on international military development aircraft sales (2% combined). The remainder of the operational profit increase was primarily driven by lower manufacturing costs, higher volume on customer funded development and lower research and development costs, which

more than offset the impact of fewer aircraft deliveries from commercial operations. The 10% increase contributed by “Other” reflects the gain recognized on contribution of a business to a venture in the United Arab Emirates.

Eliminations and other

Eliminations and other reflects the elimination of sales, other income and operating profit transacted between segments, as well as the operating results of certain smaller businesses. We have previously reported the results of UTC Power and Clipper within eliminations and other but have reclassified the results of these businesses to discontinued operations for all periods presented. The change in sales in 2012, as compared with 2011, reflects an increase in the amount of inter-segment sales eliminations due to our acquisition of Goodrich. The change in the operating profit elimination in 2012, as compared with 2011, primarily reflects the benefit of lower insurance and legal costs and gains on corporate-held investments.

LIQUIDITY AND FINANCIAL CONDITION

 

(DOLLARS IN MILLIONS)   2012      2011  
Cash and cash equivalents   $ 4,819      $ 5,960  
Total debt       23,221          10,260  
Net debt (total debt less cash and cash equivalents)     18,402        4,300  
Total equity     27,069        22,820  
Total capitalization (total debt plus total equity)     50,290        33,080  
Net capitalization (total debt plus total equity less cash and cash equivalents)     45,471        27,120  
Total debt to total capitalization     46%         31%   
Net debt to net capitalization     40%         16%   
                  

We assess our liquidity in terms of our ability to generate cash to fund our operating, investing and financing activities. Our principal source of liquidity is operating cash flows from continuing operations, which, after netting out capital expenditures, we target to equal or exceed net income attributable to common shareowners from continuing operations. In addition to operating cash flows, other significant factors that affect our overall management of liquidity include: capital expenditures, customer financing requirements, investments in businesses, dividends, common stock repurchases, pension funding, access to the commercial paper markets,

 


 

  18    

 

adequacy of available bank lines of credit, and the ability to attract long-term capital at satisfactory terms.

Improvement in the global economy remains uneven. While there continues to be a level of fiscal uncertainty in Europe and the U.S., we have seen signs of stabilization in Europe, gradual recovery in the U.S., and continued but modest strength in emerging markets. In light of these circumstances, we continue to assess our current business and closely monitor the impact on our customers and suppliers, and have determined that overall there has not been a significant impact on our financial position, results of operations or liquidity during 2012.

Our domestic pension funds, excluding the acquired Goodrich domestic pension funds, experienced a positive return on assets of approximately 14% and 7% during 2012 and 2011, respectively. Approximately 89% of these domestic pension plans are invested in readily-liquid investments, including equity, fixed income, asset-backed receivables and structured products. The balance of these domestic pension plans (11%) is invested in less-liquid but market-valued investments, including real estate and private equity. Across our global pension plans, the continued recognition of prior pension losses and the impact of a lower discount rate, partially offset by additional funding and the positive returns experienced during 2012, are expected to result in increased pension expense in 2013 of approximately $250 million as compared to 2012. As part of the Goodrich acquisition, we assumed approximately $5.2 billion of pension projected benefit obligation and $3.8 billion of plan assets.

As discussed further below, despite our increased debt levels incurred to finance the Goodrich acquisition, our strong debt ratings and financial position have historically enabled us to issue long-term debt at favorable market rates, including our issuance of $9.8 billion of long-term debt in June 2012. Our ability to obtain debt financing at comparable risk-based interest rates is partly a function of our existing debt-to-total-capitalization level as well as our current credit standing.

The purchase price of Goodrich of $127.50 per share in cash equated to a total enterprise value of $18.3 billion, including $1.9 billion in net debt assumed. To finance the cash consideration for the Goodrich acquisition and pay related fees, expenses and other amounts due and payable as a result of the acquisition, we utilized the net proceeds of approximately $9.6 billion from the $9.8 billion of long-term notes issued on June 1, 2012, the net proceeds of approximately $1.1 billion from the equity units issued on June 18, 2012, $3.2 billion from the issuance of commercial paper during July 2012 and $2.0 billion of proceeds borrowed on July 26, 2012 pursuant to our April 24, 2012 term loan credit agreement, all of which are discussed below. The $2.0 billion borrowed pursuant to our April 24, 2012 term loan credit agreement was prepaid in November and December 2012. For the remainder of the cash consideration, we utilized approximately $0.5 billion of cash and cash equivalents generated from operating activities.

On December 6, 2012, we announced that we had commenced cash tender offers for six series of outstanding notes originally issued by Goodrich and assumed by us through the acquisition. These offers expired on January 7, 2013. Holders validly tendering their notes by December 19, 2012 received consideration determined by reference to a fixed spread over the yield to maturity (or in the case of one series, yield to call) of the applicable U.S. Treasury security with the same maturity, plus an early tender payment of $30 per $1,000 principal amount of notes accepted for purchase. Holders validly tendering their notes after December 19, 2012 but prior to January 8, 2013 received consideration determined by reference to a fixed spread over the yield to maturity (or in the case of one series, yield to call) of the applicable U.S. Treasury security with the same maturity. Approximately $637 million in aggregate principal amount of the outstanding Goodrich notes were tendered under these offers, with $635 million in aggregate principal amount being eligible for the early tender premium. Total payments under these tender offers were approximately $790 million including principal, premium and interest.

In 2012, we approved plans for the divestiture of a number of non-core businesses. On December 13, 2012, we completed the sale of the legacy Hamilton Sundstrand Industrial businesses to a private limited liability company formed by affiliates of BC Partners and affiliates of The Carlyle Group for $3.4 billion. The tax expense associated with this transaction was approximately $1.2 billion. A significant portion of the tax will be included in our net tax payments for 2013. On July 23, 2012, we announced an agreement to sell our Rocketdyne unit to GenCorp Inc. for $550 million. On December 12, 2012, we announced an agreement to sell our Pratt & Whitney Power Systems unit to Mitsubishi Heavy Industries. Both transactions are expected to close in the first half of 2013. On December 22, 2012 we announced an agreement to sell our UTC Power unit to ClearEdge Power with an expected closing in the first quarter of 2013. Cash generated from these divestitures is intended to be used to repay debt incurred to finance the Goodrich acquisition.

To manage the cash flow and liquidity impacts of these actions, we suspended share repurchases in 2012 and the fourth quarter of 2011, and will significantly reduce repurchases from historical levels for 2013 and 2014. In addition, we will reduce our budgeted acquisition spending for the next few years, which for 2013 we expect to approximate $1 billion; however, actual acquisition spending may vary depending on the timing, availability and appropriate value of acquisition opportunities.

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

 


 

    19  

 

2013, and $0.5 billion aggregate principal amount of three-month LIBOR plus 0.500% floating rate notes due 2015. The three-month LIBOR rate as of December 31, 2012 was approximately 0.3%.

On June 18, 2012, we issued 22,000,000 equity units and received approximately $1.1 billion in net proceeds. 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 are 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.

At December 31, 2012, we had revolving credit agreements with various banks permitting aggregate borrowings of up to $4.0 billion pursuant to a $2.0 billion revolving credit agreement and a $2.0 billion multicurrency revolving credit agreement, both of which expire in November 2016. As of December 31, 2012 and 2011, 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 December 31, 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.

We continue to have access to the commercial paper markets and our existing credit facilities, and expect to continue to generate strong operating cash flows. While the impact of market volatility cannot be predicted, we believe we have sufficient operating flexibility, cash reserves and funding sources to maintain adequate amounts of liquidity and to meet our future operating cash needs.

Given our extensive international operations, most of our cash is denominated in foreign currencies. We manage our worldwide cash requirements by reviewing available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. The repatriation of cash balances from certain of our subsidiaries could have adverse tax consequences or be subject to capital controls; however, those balances are generally available without legal restrictions to fund ordinary business operations. As discussed in Note 11, with few exceptions, U.S. income taxes have not been provided on undistributed earnings of international subsidiaries. Our intention is to reinvest these earnings permanently or to repatriate the earnings only when it is tax effective to do so.

On occasion, we are required to maintain cash deposits with certain banks with respect to contractual obligations related to acquisitions or divestitures or other legal obligations. As of

December 31, 2012 and 2011, the amount of such restricted cash was approximately $35 million and $37 million, respectively, and is included in current assets.

We believe our future operating cash flows will be sufficient to meet our future operating cash needs. Further, our ability to obtain debt or equity financing, as well as the availability under committed credit lines, provides additional potential sources of liquidity should they be required or appropriate.

Cash Flow—Operating Activities of Continuing Operations

 

(DOLLARS IN MILLIONS)    2012      2011  
Net cash flows provided by operating activities of continuing operations    $   6,605      $   6,460  
                   

The increase in net cash flows provided by operating activities of continuing operations in 2012 as compared with 2011 was driven primarily by lower working capital cash requirements, and a decrease in global pension contributions of $121 million. Included in income from continuing operations in 2012 were approximately $157 million of net non-cash gains from the portfolio transformation activities at UTC Climate, Controls & Security, an approximately $218 million non-cash tax and interest benefit from the conclusion of the examination by the Internal Revenue Service (IRS) of our 2006 – 2008 tax years and an approximately $59 million non-cash tax and interest benefit from the resolution of disputes with the Appeals Division of the IRS for our 2004 – 2005 tax years. In 2012, the net decrease in working capital provided positive cash flow of $103 million, including a $157 million loss provision recorded on the CH-148 contract at Sikorsky, compared to a cash outflow of $291 million in 2011. This increase of $394 million was primarily driven by a decrease in accounts receivable due to strong collections, partially offset by an increase in inventories largely associated with anticipated volume changes at Sikorsky and Pratt & Whitney.

The funded status of our defined benefit pension plans is dependent upon many factors, including returns on invested assets and the level of market interest rates. We can contribute cash or UTC shares to our plans at our discretion, subject to applicable regulations. Total cash contributions to our global defined benefit pension plans were $430 million and $551 million during 2012 and 2011, respectively. During 2011, we also contributed $450 million in UTC common stock to our defined benefit pension plans. As of December 31, 2012, the total investment by the global defined benefit pension plans in our securities was approximately 3% of total plan assets. We expect to make contributions of approximately $200 million to our foreign defined benefit pension plans in 2013. Although our domestic defined benefit pension plans are approximately 84% funded on a projected benefit obligation basis, and we are not required to make additional contributions through the end of 2013, we may elect to make discretionary contributions in 2013. Contributions to our global defined benefit pension plans in 2013 are expected to meet or exceed the current funding requirements.

 


 

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Cash Flow—Investing Activities of Continuing Operations

 

(DOLLARS IN MILLIONS)    2012     2011  
Net cash flows used in investing activities of continuing operations    $   (18,795   $   (672
                  

The increase in cash used in investing activities of continuing operations was primarily a result of the Goodrich acquisition, which required cash payments, net of cash acquired, of $15.8 billion, as well as payments made to Rolls-Royce, net of cash acquired, to acquire their ownership and collaboration interests in IAE and license its V2500 intellectual property to Pratt & Whitney of approximately $1.7 billion in total, reflected in acquisitions of businesses and as an increase in collaboration intangible assets. Partially offsetting these increases, concurrent with the closing of the purchase of Rolls-Royce’s interests in IAE, 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. Investments in businesses during 2012 also included a number of additional small acquisitions in our commercial and aerospace businesses. We expect total cash investments for acquisitions in 2013 to be approximately $1 billion; however, actual acquisition spending may vary depending upon the timing, availability and appropriate value of acquisition opportunities. Capital expenditures increased $460 million primarily at Pratt & Whitney and Otis, reflecting expenditures related to investments in new programs and low-cost manufacturing facilities, as well as at UTC Aerospace Systems due to spending at legacy Goodrich businesses subsequent to acquisition.

Customer financing activities were a net use of cash of $25 million in 2012, compared to a net source of cash of $50 million in 2011. While we expect that 2013 customer financing activity will be a net use of funds, actual funding is subject to usage under existing customer financing commitments during the year. We may also arrange for third-party investors to assume a portion of our commitments. At December 31, 2012, we had commercial aerospace financing and other contractual commitments of approximately $10.9 billion, which includes approximately $5.8 billion of IAE commitments, related to commercial aircraft and certain contractual rights to provide product on new aircraft platforms, of which as much as $1.1 billion may be required to be disbursed during 2013. As discussed in Note 17, we have entered into certain collaboration arrangements, which may include participation by our collaborators in these commitments. At December 31, 2012, our collaborators’ share of these commitments was approximately $2.0 billion, which includes approximately $1.1 billion of IAE commitments, of which as much as $252 million may be required to be disbursed during 2013. Refer to Note 5 to the Consolidated Financial Statements for additional discussion of our commercial aerospace industry assets and commitments.

Cash Flow—Financing Activities of Continuing Operations

 

(DOLLARS IN MILLIONS)    2012      2011  
Net cash flows provided by (used in) financing activities of continuing operations    $   8,021      $   (3,983
                   

The timing and levels of certain cash flow activities, such as acquisitions and repurchases of our stock, have resulted in the issuance of both long-term and short-term debt. In June 2012, we issued $9.8 billion of long-term debt and $1.1 billion of equity units, and in July 2012, we borrowed $2.0 billion from our term loan credit agreement and issued $3.2 billion of commercial paper primarily to partially finance the Goodrich acquisition and pay related fees, expenses and other amounts due and payable by UTC as a result of the acquisition. Commercial paper borrowings and revolving credit facilities provide short-term liquidity to supplement operating cash flows and are used for general corporate purposes, including the funding of potential acquisitions and repurchases of our stock. We had $320 million and $455 million of commercial paper outstanding at December 31, 2012 and 2011, respectively. In December 2011, we redeemed the entire $500 million outstanding principal amount of our 6.100% notes that would otherwise have been due May 15, 2012.

In connection with the Goodrich acquisition, we suspended share repurchases for 2012 and the fourth quarter of 2011, and will significantly reduce repurchases from historical levels for 2013 and 2014. At December 31, 2012, management had authority to repurchase approximately 7 million shares under the previously announced share repurchase program. When we repurchase shares, our share repurchases vary depending upon various factors including the level of other investing activities. Financing cash outflows for 2011 included the repurchase of 26.9 million shares of our common stock for approximately $2.2 billion under the previously announced share repurchase program.

In 2012, we paid aggregate dividends on common stock of approximately $1.8 billion, consisting of $0.48 per share in the first quarter of 2012 totaling $412 million, $0.48 per share in the second quarter of 2012 totaling $413 million, $0.535 per share in the third quarter of 2012 totaling $463 million, and $0.535 per share in the fourth quarter of 2012 totaling $464 million. During 2011, an aggregate $1.6 billion of cash dividends were paid to common stock shareowners.

We have an existing universal shelf registration statement filed with the SEC for an indeterminate amount of debt and equity securities for future issuance, subject to our internal limitations on the amount of securities to be issued under this shelf registration statement.

Cash Flow—Discontinued Operations

 

(DOLLARS IN MILLIONS)    2012      2011  
Net cash flows provided by discontinued operations    $   3,015      $   73  
                   
 


 

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Cash flows provided by discontinued operations primarily relate to the completed divestitures of two businesses. As discussed above, on December 13, 2012 we completed the sale of the legacy Hamilton Sundstrand Industrial businesses for $3.4 billion. The tax expense associated with this transaction was approximately $1.2 billion. A significant portion of the tax will be included in our net tax payments for 2013. Also, on August 7, 2012, we completed the disposition of Clipper to a private equity acquirer. The disposition resulted in payments totaling approximately $367 million, which included capitalization of the business prior to sale, transaction fees, and funding of operations as the acquirer took control of a business with significant net liabilities.

CRITICAL ACCOUNTING ESTIMATES

Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Consolidated Financial Statements describes the significant accounting policies used in preparation of the Consolidated Financial Statements. Management believes 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. The most significant areas involving management judgments and estimates are described below. Actual results in these areas could differ from management’s estimates.

Long-Term Contract Accounting. We utilize percentage-of-completion accounting on certain of our long-term contracts. The percentage-of-completion method requires estimates of future revenues and costs over the full term of product and/or service delivery. We also utilize the completed-contract method of accounting on certain lesser value commercial contracts. Under the completed-contract method, sales and cost of sales are recognized when a contract is completed.

Losses, if any, on long-term contracts are provided for when anticipated. We recognize loss provisions on original equipment contracts to the extent that estimated inventoriable manufacturing, engineering, product warranty and product performance guarantee costs, as appropriate, exceed the projected revenue from the products contemplated under the contractual arrangement. For new commitments, we generally record loss provisions at the earlier of contract announcement or contract signing except for certain requirements contracts under which losses are recorded based upon receipt of the purchase order. For existing commitments, anticipated losses on contracts are recognized in the period in which losses become evident. Products contemplated under the contractual arrangement include products purchased under the contract and, in the large commercial engine and wheels and brakes businesses, future highly probable sales of replacement parts required by regulation that are expected to be purchased

subsequently for incorporation into the original equipment. Revenue projections used in determining contract loss provisions are based upon estimates of the quantity, pricing and timing of future product deliveries. We generally recognize losses on shipment to the extent that inventoriable manufacturing costs, estimated warranty costs and product performance guarantee costs, as appropriate, exceed revenue realized. We measure the extent of progress toward completion on our long-term commercial aerospace equipment and helicopter contracts using units-of-delivery. In addition, we use the cost-to-cost method for elevator and escalator sales, installation and modernization contracts in the commercial businesses. For long-term aftermarket contracts, we recognize revenue over the contract period in proportion to the costs expected to be incurred in performing services under the contract. Contract accounting also requires estimates of future costs over the performance period of the contract as well as an estimate of award fees and other sources of revenue.

Contract costs are incurred over a period of time, which can be several years, and the estimation of these costs requires management’s judgment. The long-term nature of these contracts, the complexity of the products, and the strict safety and performance standards under which they are regulated can affect our ability to estimate costs precisely. As a result, we review and update our cost estimates on significant contracts on a quarterly basis, and no less frequently than annually for all others, or when circumstances change and warrant a modification to a previous estimate. We record changes in contract estimates using the cumulative catch-up method in accordance with the Revenue Recognition Topic of the FASB ASC.

Income Taxes. The future tax benefit arising from net deductible temporary differences and tax carryforwards was $3.2 billion at December 31, 2012 and $4.0 billion at December 31, 2011. Management believes that our earnings during the periods when the temporary differences become deductible will be sufficient to realize the related future income tax benefits. For those jurisdictions where the expiration date of tax carryforwards or the projected operating results indicate that realization is not likely, a valuation allowance is provided.

In assessing the need for a valuation allowance, we estimate future taxable income, considering the feasibility of ongoing tax planning strategies and the realizability of tax loss carryforwards. Valuation allowances related to deferred tax assets can be affected by changes to tax laws, changes to statutory tax rates and future taxable income levels. In the event we were to determine that we would not be able to realize all or a portion of our deferred tax assets in the future, we would reduce such amounts through an increase to tax expense in the period in which that determination is made or when tax law changes are enacted. Conversely, if we were to determine that we would be able to realize our deferred tax assets in the future in excess of the net carrying amounts, we would decrease the recorded valuation allowance through a decrease to tax expense in the period in which that determination is made.

 


 

  22    

 

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. See Notes 1 and 11 to the Consolidated Financial Statements for further discussion.

Goodwill and Intangible Assets. Our investments in businesses in 2012 totaled $18.6 billion, including approximately $2.6 billion of debt assumed. The assets and liabilities of acquired businesses are recorded under the acquisition method of accounting at their estimated fair values at the dates of acquisition. Goodwill represents costs in excess of fair values assigned to the underlying identifiable net assets of acquired businesses. Intangible assets consist of service portfolios, patents, trademarks/tradenames, customer relationships and other intangible assets including a collaboration asset established in connection with the restructuring of IAE as discussed above and in Note 2 to the Consolidated Financial Statements. Also included within other intangible assets are commercial aerospace payments made to secure certain contractual rights to provide product on new aircraft platforms. Payments made on these contractual commitments are to be amortized as the related OEM and aftermarket units are delivered. The gross value of these contractual commitments at December 31, 2012 was approximately $2.6 billion, of which approximately $700 million has been paid to date. We record these payments as intangible assets when such payments are no longer conditional. The recoverability of these intangibles is dependent upon the future success and profitability of the underlying aircraft platforms including the associated aftermarket revenue streams.

Goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment testing using the guidance and criteria described in the “Intangibles—Goodwill and Other” Topic of the FASB ASC. This testing compares carrying values to fair values and, when appropriate, the carrying values of these assets is reduced to fair value. During 2012 we early adopted the FASB Accounting Standards Update (ASU) No. 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment” in connection with the performance of our annual goodwill and indefinite lived intangible assets impairment test. This ASU intends to align impairment testing guidance among long-lived asset categories. This ASU allows the assessment based on qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired prior to determining whether it is

necessary to perform the quantitative impairment test in accordance with ASC Subtopic 350-30, “Intangibles—Goodwill and Other—General Intangibles Other than Goodwill.” We completed our annual impairment testing as of July 1, 2012 and determined that no significant adjustments to the carrying value of goodwill or indefinite lived intangible assets were necessary based on the results of the impairment tests, other than those impairment charges associated with certain businesses reclassified to discontinued operations. During 2012, we recorded goodwill impairment charges of $980 million in discontinued operations in connection with the disposition of Rocketdyne, Clipper and UTC Power. The goodwill impairment charges on both Rocketdyne and Clipper result from the decision to dispose of the businesses within a relatively short period after they were acquired. 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 resulted from the disposition of the business before the benefits of the technology investments were fully realized. Although the remaining goodwill is not currently impaired, there can be no assurances that future goodwill impairments will not occur. See Note 2 to the Consolidated Financial Statements for further discussion.

Product Performance. We extend performance and operating cost guarantees beyond our normal service and warranty policies for extended periods on some of our products, particularly commercial aircraft engines. Liability under such guarantees is based upon future product performance and durability. In addition, we incur discretionary costs to service our products in connection with product performance issues. We accrue for such costs that are probable and can be reasonably estimated. The costs associated with these product performance and operating cost guarantees require estimates over the full terms of the agreements, and require management to consider factors such as the extent of future maintenance requirements and the future cost of material and labor to perform the services. These cost estimates are largely based upon historical experience. See Note 16 to the Consolidated Financial Statements for further discussion.

Contracting with the U.S. Government. Our contracts with the U.S. Government are subject to government oversight and audit. 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 have involved substantial amounts. We have made voluntary refunds in those cases we believe appropriate, have settled some allegations and continue to litigate certain cases. In addition, we accrue for liabilities associated with those government contracting matters that are probable and can be reasonably estimated. The inherent uncertainty related to the outcome of these matters can result in amounts materially different from any provisions made with respect to their resolution. See Note 18 to the Consolidated Financial Statements for further discussion. We

 


 

    23  

 

recorded sales to the U.S. Government of $10.1 billion in 2012, $9.1 billion in 2011, and $9.1 billion in 2010.

Employee Benefit Plans. We sponsor domestic and foreign defined benefit pension and other postretirement plans. Major assumptions used in the accounting for these employee benefit plans include the discount rate, expected return on plan assets, rate of increase in employee compensation levels, and health care cost increase projections. Assumptions are determined based on company data and appropriate market indicators, and are evaluated each year at December 31. A change in any of these assumptions would have an effect on net periodic pension and postretirement benefit costs reported in the Consolidated Financial Statements.

In the following table, we show the sensitivity of our pension and other postretirement benefit plan liabilities and net annual periodic cost to a 25 basis point change in the discount rate as of December 31, 2012:

 

(DOLLARS IN MILLIONS)   Increase in
Discount Rate
of 25 bps
    Decrease in
Discount Rate
of 25 bps
 
Pension plans        

Projected benefit obligation

  $   (1,073   $   1,111  

Net periodic pension cost

    (85     88  
   
Other postretirement benefit plans        

Accumulated postretirement benefit obligation

    (20     21  

Net periodic postretirement benefit cost

    1       (1
                 

Pension expense is also sensitive to changes in the expected long-term rate of asset return. An increase or decrease of 25 basis points in the expected long-term rate of asset return would have decreased or increased 2012 pension expense by approximately $67 million.

The weighted-average discount rate used to measure pension liabilities and costs is set by reference to UTC specific analysis using each plan’s specific cash flows and is then compared to high-quality bond indices for reasonableness. Global market interest rates have decreased in 2012 as compared with 2011 and, as a result, the weighted-average discount rate used to measure pension liabilities decreased from 4.7% in 2011 to 4.0% in 2012. In December 2009, we amended the salaried retirement plans (qualified and non-qualified) to change the retirement formula effective January 1, 2015. At that time, final average earnings (FAE) and credited service will stop under the formula applicable for hires before July 1, 2002. Employees hired after 2009 are not eligible for any defined benefit pension plan and will instead receive an enhanced benefit under the UTC Savings Plan. As of July 26, 2012 the same amendment was applied to legacy Goodrich salaried employees. The continued recognition of prior pension losses and the impact of a lower discount rate, partially offset by additional funding and the positive returns experienced during 2012, are

expected to increase pension expense in 2013 by approximately $250 million as compared to 2012. See Note 12 to the Consolidated Financial Statements for further discussion.

Inventory Valuation Reserves. Inventory valuation reserves are established in order to report inventories at the lower of cost or market value on our Consolidated Balance Sheet. The determination of inventory valuation reserves requires management to make estimates and judgments on the future salability of inventories. Valuation reserves for excess, obsolete, and slow-moving inventory are estimated by comparing the inventory levels of individual parts to both future sales forecasts or production requirements and historical usage rates in order to identify inventory where the resale value or replacement value is less than inventoriable cost. Other factors that management considers in determining the adequacy of these reserves include whether individual inventory parts meet current specifications and cannot be substituted for a part currently being sold or used as a service part, overall market conditions, and other inventory management initiatives.

As of December 31, 2012 and 2011, we had $866 million and $884 million, respectively, of inventory valuation reserves recorded. Although management believes these reserves are adequate, any abrupt changes in market conditions may require us to record additional inventory valuation reserves.

OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS

We extend a variety of financial guarantees to third parties in support of unconsolidated affiliates and for potential financing requirements of commercial aerospace customers. We also have obligations arising from sales of certain businesses and assets, including indemnities for representations and warranties and environmental, health and safety, tax and employment matters. Circumstances that could cause the contingent obligations and liabilities arising from these arrangements to come to fruition include changes in an underlying transaction (e.g., hazardous waste discoveries, etc.), nonperformance under a contract, customer requests for financing, or deterioration in the financial condition of the guaranteed party.

A summary of our consolidated contractual obligations and commitments as of December 31, 2012 is as follows:

 

           Payments Due by Period  
(DOLLARS IN MILLIONS)   Total     2013     2014 – 2015     2016 – 2017     Thereafter  
Long-term debt—principal   $   22,365     $ 1,121     $ 2,773     $ 2,841     $ 15,630  
Long-term debt—future interest     14,628       1,023       1,982       1,708       9,915  
Operating leases     2,486       646       888       413       539  
Purchase obligations     16,076       8,389       5,376       982       1,329  
Other long-term liabilities     4,586       862       1,369       1,272       1,083  
Total contractual obligations  

$

60,141

 

 

$

  12,041

 

 

$

  12,388

 

 

$

  7,216

 

 

$

  28,496

 

                                         
 


 

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Purchase obligations include amounts committed under legally enforceable contracts or purchase orders for goods and services with defined terms as to price, quantity, delivery and termination liability. Approximately 21% of the purchase obligations disclosed above represent purchase orders for products to be delivered under firm contracts with the U.S. Government for which we have full recourse under customary contract termination clauses.

Other long-term liabilities primarily include those amounts on our December 31, 2012 balance sheet representing obligations under product service and warranty policies, performance and operating cost guarantees, estimated environmental remediation costs and expected contributions under employee benefit programs. The timing of expected cash flows associated with these obligations is based upon management’s estimates over the terms of these agreements and is largely based upon historical experience.

In connection with the acquisition of Goodrich, we recorded customer contractual obligations of approximately $2.0 billion relating to certain Goodrich OEM development programs where the expected costs exceed the expected revenues under contract. These liabilities will be liquidated in accordance with the underlying economic pattern of obligations, as reflected by the net cash outflows incurred on the OEM contracts. We expect these customer contractual obligations will be liquidated as follows: $283 million in 2013, $513 million in 2014 through 2015, $456 million in 2016 through 2017, and $634 million thereafter. These amounts are not included in the table above.

The above table also does not reflect unrecognized tax benefits of $1,073 million, the timing of which is uncertain, except for approximately $129 million that may become payable during 2013. Refer to Note 11 to the Consolidated Financial Statements for additional discussion on unrecognized tax benefits.

COMMERCIAL COMMITMENTS

 

    Amount of Commitment Expiration per Period  
(DOLLARS IN MILLIONS)   Committed     2013     2014 – 2015     2016 – 2017     Thereafter  
Commercial aerospace financing commitments   $ 3,237     $ 339     $ 1,150     $ 798     $ 950  
Other commercial aerospace commitments     7,628       736       1,196       1,314       4,382  
Commercial aerospace financing arrangements     346       42       118       14       172  
Unconsolidated subsidiary debt guarantees     240       108       35              97  
Performance guarantees     33       33                       
Total commercial commitments   $   11,484     $   1,258     $   2,499     $   2,126     $   5,601  
                                         

The table above includes IAE’s gross obligation at December 31, 2012; our proportionate share of IAE’s obligations was 61%. Refer to the Segment Review for additional discussion of our agreement with Rolls-Royce to restructure the IAE interests. Other commercial aerospace commitments include amounts related to our agreement with Embraer, which we announced on January 8, 2013, to power the next generation Embraer E-Jet family.

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 contingent upon each hour flown by the V2500-powered aircraft in service as of June 29, 2012 during the fifteen year period following closing of the purchase. These payments will be capitalized as a collaboration intangible asset and amortized in relation to the economic benefits received over the projected remaining 30 year life of the V2500 program. The flight hour payments are included in other commercial aerospace commitments in the table above. As previously reported, Pratt & Whitney entered into a collaboration arrangement with MTU with respect to a portion of the collaboration interest in IAE acquired from Rolls-Royce for consideration of approximately $233 million with additional payments due to Pratt & Whitney in the future.

Refer to Notes 5, 16, and 18 to the Consolidated Financial Statements for additional discussion on contractual and commercial commitments.

MARKET RISK AND RISK MANAGEMENT

We are exposed to fluctuations in foreign currency exchange rates, interest rates and commodity prices. To manage certain of those exposures, we use derivative instruments, including swaps, forward contracts and options. Derivative instruments utilized by us in our hedging activities are viewed as risk management tools, involve little complexity and are not used for trading or speculative purposes. We diversify the counterparties used and monitor the concentration of risk to limit our counterparty exposure.

We have evaluated our exposure to changes in foreign currency exchange rates, interest rates and commodity prices in our market risk sensitive instruments, which are primarily cash, debt and derivative instruments, using a value at risk analysis. Based on a 95% confidence level and a one-day holding period, at December 31, 2012, the potential loss in fair value on our market risk sensitive instruments was not material in relation to our financial position, results of operations or cash flows. Our calculated value at risk exposure represents an estimate of reasonably possible net losses based on volatilities and correlations and is not necessarily indicative of actual results. Refer to Notes 1, 9 and 14 to the Consolidated Financial Statements for additional discussion of foreign currency exchange, interest rates and financial instruments.

Foreign Currency Exposures. We have a large volume of foreign currency exposures that result from our international sales, purchases, investments, borrowings and other international transactions. International segment sales, including U.S. export sales, averaged approximately $34 billion over the last three years. We actively manage foreign currency exposures that are associated with committed foreign currency purchases and sales and other assets and liabilities created in the normal course of business at the operating unit level. More than insignificant exposures that cannot be naturally offset within an operating unit are hedged with foreign

 


 

    25  

 

currency derivatives. We also have a significant amount of foreign currency net asset exposures. Currently, we do not hold any derivative contracts that hedge our foreign currency net asset exposures but may consider such strategies in the future.

Within aerospace, our sales are typically denominated in U.S. Dollars under accepted industry convention. However, for our non-U.S. based entities, such as P&WC, a substantial portion of their costs are incurred in local currencies. Consequently, there is a foreign currency exchange impact and risk to operational results as U.S. Dollars must be converted to local currencies such as the Canadian Dollar in order to meet local currency cost obligations. In order to minimize the exposure that exists from changes in the exchange rate of the U.S. Dollar against these other currencies, we hedge a certain portion of sales to secure the rates at which U.S. Dollars will be converted. The majority of this hedging activity occurs at P&WC. At P&WC, firm and forecasted sales for both engines and spare parts are hedged at varying amounts up to 24 months on the U.S. Dollar sales exposure as represented by the excess of U.S. Dollar sales over U.S. Dollar denominated purchases. Hedging gains and losses resulting from movements in foreign currency exchange rates are partially offset by the foreign currency translation impacts that are generated on the translation of local currency operating results into U.S. Dollars for reporting purposes. While the objective of the hedging program is to minimize the foreign currency exchange impact on operating results, there are typically variances between the hedging gains or losses and the translational impact due to the length of hedging contracts, changes in the sales profile, volatility in the exchange rates and other such operational considerations.

Interest Rate Exposures. Our long-term debt portfolio consists mostly of fixed-rate instruments. From time to time, we may hedge to floating rates using interest rate swaps. The hedges are designated as fair value hedges and the gains and losses on the swaps are reported in interest expense, reflecting that portion of interest expense at a variable rate. We issue commercial paper, which exposes us to changes in interest rates. Currently, we do not hold any derivative contracts that hedge our interest exposures, but may consider such strategies in the future.

Commodity Price Exposures. We are exposed to volatility in the prices of raw materials used in some of our products and from time to time we may use forward contracts in limited circumstances to manage some of those exposures. In the future, if hedges are used, gains and losses may affect earnings. There were no significant outstanding commodity hedges as of December 31, 2012.

ENVIRONMENTAL MATTERS

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. As a result, we have established, and continually update, policies relating to

environmental standards of performance for our operations worldwide. We believe that expenditures necessary to comply with the present regulations governing environmental protection will not have a material effect upon our competitive position, results of operations, cash flows or financial condition.

We have identified 708 locations, mostly in the United States, at which we may have some liability for remediating contamination. We have resolved our liability at 261 of these locations. We do not believe that any individual location’s exposure will have a material effect on our results of operations. Sites in the investigation, remediation or operation and maintenance stage represent approximately 94% of our accrued environmental remediation reserve.

We have been identified as a potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act (CERCLA or Superfund) at 125 sites. The number of Superfund sites, in and of itself, does not represent a relevant measure of liability because the nature and extent of environmental concerns vary from site to site and our share of responsibility varies from sole responsibility to very little responsibility. In estimating our liability for remediation, we consider our likely proportionate share of the anticipated remediation expense and the ability of other potentially responsible parties to fulfill their obligations.

At December 31, 2012 and 2011, we had $847 million and $617 million reserved for environmental remediation, respectively. Cash outflows for environmental remediation were $35 million in 2012, $54 million in 2011 and $44 million in 2010. We estimate that ongoing environmental remediation expenditures in each of the next two years will not exceed approximately $70 million. The above described increase in reserves for environmental remediation as of December 31, 2012 compared to December 31, 2011 and the increase in estimated environmental expenditures in each of the next two years are primarily attributable to the Goodrich acquisition.

GOVERNMENT MATTERS

As described in “Critical Accounting Estimates—Contracting with the U.S. Government,” our contracts with the U.S. Government are subject to audits. Such audits may recommend that certain contract prices should be reduced to comply with various government regulations. We are also the subject of one or more investigations and legal proceedings initiated by the U.S. Government with respect to government contract matters.

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

 


 

  26    

 

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.

On 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 continues to seek damages of $624 million, plus interest. Pratt & Whitney continues to contend that the government suffered no actual damages. The parties have submitted briefs and await a decision from the trial court. 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 $94 million (including interest through December 31, 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 concluded in January 2013 and we await a decision from the court. 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 (AECA) 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 AECA and ITAR. DTCC administers the State Department’s authority under the AECA and 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 AECA and ITAR; (3) continue and undertake additional remedial actions to strengthen AECA and 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 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 AECA and ITAR violations; and (3) that P&WC and Hamilton Sundstrand violated a separate provision of the AECA and ITAR by failing timely to notify DTCC of the unlicensed software shipments to China. P&WC pleaded guilty to violating the AECA and 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

 


 

    27  

 

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 AECA and 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.

On June 28, 2012, by reason of P&WC’s guilty plea to a criminal violation of the AECA and 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. On December 20, 2012, UTC entered into an administrative agreement with the Department of the Army Suspension and Debarment Official, where Army officials determined that the UTC Entities are presently responsible and that further action is not necessary to protect the U.S. Government’s interests pursuant

to the Federal Acquisition Regulation and the National Defense Appropriations Act. The agreement with the Department of the Army Suspension and Debarment Official completes the Department of Defense review of 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.

As previously disclosed, UTC has been involved in administrative review proceedings with the German Tax Office, which concerns 203 million (approximately $270 million) of tax benefits that we have claimed related to a 1998 reorganization of the corporate structure of Otis operations in Germany. A portion of these tax benefits were disallowed by the local German Tax Office on July 5, 2012, as a result of the audit of tax years 1999 to 2000. The legal and factual issues relating to the denial of the tax benefits center on the interpretation and application of a German tax law. On August 3, 2012, the Company filed suit in the local German tax court and intends to litigate vigorously the matter to conclusion. We do not believe the resolution of this matter will have a material adverse effect on our results of operations, cash flows or financial condition.

OTHER MATTERS

Additional discussion of our environmental, U.S. Government contract matters, product performance and other contingent liabilities is included in “Critical Accounting Estimates” and Notes 1, 16 and 18 to the Consolidated Financial Statements. For additional discussion of our legal proceedings, see Item 3, “Legal Proceedings,” in our Annual Report on Form 10-K for 2012 (2012 Form 10-K).

 


 

  28    

 

Cautionary Note Concerning Factors That May Affect Future Results

 

This 2012 Annual Report to Shareowners (2012 Annual Report) contains statements which, to the extent they are not statements of historical or present fact, constitute “forward-looking statements” under the securities laws. From time to time, oral or written forward-looking statements may also be included in other materials released to the public. These forward-looking statements are intended to provide management’s current expectations or plans for our future operating and financial performance, based on assumptions currently believed to be valid. Forward-looking statements can be identified by the use of words such as “believe,” “expect,” “expectations,” “plans,” “strategy,” “prospects,” “estimate,” “project,” “target,” “anticipate,” “will,” “should,” “see,” “guidance,” “confident” and other words of similar meaning in connection with a discussion of future operating or financial performance. Forward-looking statements may include, among other things, statements relating to future sales, earnings, cash flow, results of operations, uses of cash and other measures of financial performance. All forward-looking statements involve risks, uncertainties and other factors that may cause actual results to differ materially from those expressed or implied in the forward-looking statements. For those statements we claim the protection of the safe harbor for forward-looking statements contained in the U.S. Private Securities Litigation Reform Act of 1995. Such risks, uncertainties and other factors include, without limitation:

 

    the effect of economic conditions in the markets in which we operate in the U.S. and globally and any changes therein, including financial market conditions, fluctuations in commodity prices, interest rates and foreign currency exchange rates, levels of end market demand in construction and in both the commercial and defense segments of the aerospace industry, levels of air travel, financial difficulties (including bankruptcy) of commercial airlines, the impact of weather conditions and natural disasters and the financial condition of our customers and suppliers;

 

    our ability to integrate the acquired Goodrich operations and to realize synergies and opportunities for growth and innovation;

 

    our ability to realize the intended benefits of recently announced organizational changes;

 

    future levels of indebtedness and capital spending and research and development spending;

 

    future availability of credit and factors that may affect such availability, including credit market conditions and our capital structure;

 

    delays and disruption in delivery of materials and services from suppliers;

 

    new business opportunities;
    cost reduction efforts and restructuring costs and savings and other consequences thereof;

 

    the scope, nature or impact of other acquisition and divestiture activity, including integration of acquired businesses into our existing businesses;

 

    the development, production, delivery, support, performance and anticipated benefits of advanced technologies and new products and services;

 

    the anticipated benefits of diversification and balance of operations across product lines, regions and industries;

 

    the impact of the negotiation of collective bargaining agreements and labor disputes;

 

    the outcome of legal proceedings and other contingencies;

 

    future repurchases of our common stock;

 

    pension plan assumptions and future contributions; and

 

    the effect of changes in tax, environmental and other laws and regulations or political conditions in the United States and other countries in which we operate.

In addition, our Annual Report on Form 10-K for 2012 includes important information as to risks, uncertainties and other factors that may cause actual results to differ materially from those expressed or implied in the forward-looking statements. See the “Notes to Consolidated Financial Statements” under the heading “Contingent Liabilities,” the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the headings “Business Overview,” “Critical Accounting Estimates,” “Results of Operations,” and “Liquidity and Financial Condition,” and the section titled “Risk Factors.” Our Annual Report on Form 10-K for 2012 also includes important information as to these factors in the “Business” section under the headings “General,” “Description of Business by Segment” and “Other Matters Relating to Our Business as a Whole,” and in the “Legal Proceedings” section. Additional important information as to these factors is included in this 2012 Annual Report in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the headings “Environmental Matters” and “Restructuring Costs.” The forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law. Additional information as to factors that may cause actual results to differ materially from those expressed or implied in the forward-looking statements are disclosed from time to time in our other filings with the SEC.

 


 

    29  

 

Management’s Report on Internal Control

over Financial Reporting

 

 

The management of UTC is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management has assessed the effectiveness of UTC’s internal control over financial reporting as of December 31, 2012. In making its assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in its Internal Control—Integrated Framework, released in 1992. Management concluded that based on its assessment, UTC’s internal control over financial reporting was effective as of December 31, 2012. The effectiveness of UTC’s internal control over financial reporting, as of December 31, 2012, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.

 

/s/ Louis R. Chênevert

Louis R. Chênevert

Chairman & Chief Executive Officer

 

/s/ Gregory J. Hayes

Gregory J. Hayes

Senior Vice President and Chief Financial Officer

 

/s/ Peter F. Longo

Peter F. Longo

Vice President, Controller

 


 

  30    

 

Report of Independent Registered Public Accounting Firm

 

TO THE BOARD OF DIRECTORS AND SHAREOWNERS OF UNITED TECHNOLOGIES CORPORATION:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of comprehensive income, of cash flows and of changes in equity present fairly, in all material respects, the financial position of United Technologies Corporation and its subsidiaries at December 31, 2012 and December 31, 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Corporation’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Corporation’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting,

assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A corporation’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the corporation are being made only in accordance with authorizations of management and directors of the corporation; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PricewaterhouseCoopers LLP

Hartford, Connecticut

February 7, 2013

 


 

    31  

 

Consolidated Statement of Operations

 

(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS; SHARES IN MILLIONS)    2012      2011      2010  
     
Net Sales:               

Product sales

   $   40,729      $   38,882      $   36,615  

Service sales

     16,979        16,872        15,660  
       57,708        55,754        52,275  
Costs and Expenses:               

Cost of products sold

     31,094        29,252        27,513  

Cost of services sold

     11,059        11,117        10,441  

Research and development

     2,371        1,951        1,656  

Selling, general and administrative

     6,452        6,161        5,798  
       50,976        48,481        45,408  

Other income, net

     952        573        31  
Operating profit      7,684        7,846        6,898  

Interest expense, net

     773        496        650  
Income from continuing operations before income taxes      6,911        7,350        6,248  

Income tax expense

     1,711        2,134        1,725  
Net income from continuing operations      5,200        5,216        4,523  
Discontinued operations (Note 3):               

Income from operations

     171        255        290  

Gain on disposal

     861                  

Income tax expense

     (742      (97      (102

Net income from discontinued operations

     290        158        188  
Net income      5,490        5,374        4,711  

Less: Non-controlling interest in subsidiaries’ earnings

     360        395        338  
Net income attributable to common shareowners    $ 5,130      $ 4,979      $ 4,373  
                            
     
Net income attributable to common shareowners:               

Net income from continuing operations

   $ 4,847      $ 4,831      $ 4,195  

Net income from discontinued operations

   $ 283      $ 148      $ 178  
     
Earnings Per Share of Common Stock—Basic:               

Net income from continuing operations

   $ 5.41      $ 5.41      $ 4.62  

Net income attributable to common shareowners

   $ 5.73      $ 5.58      $ 4.82  
     
Earnings Per Share of Common Stock—Diluted:               

Net income from continuing operations

   $ 5.35      $ 5.33      $ 4.55  

Net income attributable to common shareowners

   $ 5.66      $ 5.49      $ 4.74  
     
Dividends Per Share of Common Stock    $ 2.030      $ 1.865      $ 1.700  
     
Weighted average number of shares outstanding:               

Basic shares

     895.2        892.3        907.9  

Diluted shares

     906.6        906.8        922.7  
                            

See accompanying Notes to Consolidated Financial Statements


 

  32    

 

Consolidated Statement of Comprehensive Income

 

(DOLLARS IN MILLIONS)    2012     2011     2010  
     
Net income    $    5,490     $    5,374     $    4,711  
Other comprehensive income (loss), net of tax (expense) benefit:             

Foreign currency translation adjustments

            

Foreign currency translation adjustments arising during period

     556       (278     (39

Less: reclassification adjustments for (gain) loss on sale of an investment in a foreign entity recognized in net income

     (100     115       21  
       456       (163     (18

Change in pension and post-retirement benefit plans

            

Net actuarial loss arising during period

     (1,542     (2,692     (701

Prior service credit (cost) arising during period

     211       (21     (121

Other

     (3     (9     (3

Less: amortization of actuarial loss, prior service cost and transition obligation

     689       441       265  
     (645     (2,281     (560

Tax benefit

     205       796       224  
       (440     (1,485     (336

Unrealized (loss) gain on available-for-sale securities

            

Unrealized holding gain arising during period

     91       78       149  

Less: reclassification adjustments for (gain) loss included in net income

     (123     (27     8  
     (32     51       157  

Tax benefit (expense)

     13       (21     (61
       (19     30       96  

Change in unrealized cash flow hedging

            

Unrealized cash flow hedging gain (loss) arising during period

     88       (46     72  

Less: gain reclassified into Product sales

     (31     (96     (119
     57       (142     (47

Tax (expense) benefit

     (4     36       18  
       53       (106     (29
Other comprehensive income (loss), net of tax (expense) benefit      50       (1,724     (287
Comprehensive income      5,540       3,650       4,424  

Less: comprehensive income attributable to noncontrolling interest

     (368     (392     (333
Comprehensive income attributable to common shareowners    $ 5,172     $ 3,258     $ 4,091  
                          

See accompanying Notes to Consolidated Financial Statements


 

    33  

 

Consolidated Balance Sheet

 

(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS; SHARES IN THOUSANDS)    2012      2011  
   
Assets          
Cash and cash equivalents    $ 4,819      $ 5,960  
Accounts receivable (net of allowance for doubtful accounts of $443 and $394)      11,099        9,546  
Inventories and contracts in progress, net      9,537        7,797  
Future income tax benefits, current      1,611        1,662  
Assets held for sale      1,071          
Other assets, current      1,473        793  

Total Current Assets

     29,610        25,758  
Customer financing assets      1,150        1,035  
Future income tax benefits      1,599        2,387  
Fixed assets, net      8,518        6,201  
Goodwill      27,801        17,943  
Intangible assets, net      15,189        3,918  
Other assets      5,542        4,210  

Total Assets

   $ 89,409      $ 61,452  
                   
   
Liabilities and Equity          
Short-term borrowings    $ 503      $ 630  
Accounts payable      6,431        5,570  
Accrued liabilities      15,310        12,287  
Liabilities held for sale      421          
Long-term debt currently due      1,121        129  

Total Current Liabilities

     23,786        18,616  
Long-term debt      21,597        9,501  
Future pension and postretirement benefit obligations      7,520        5,007  
Other long-term liabilities      9,199        5,150  

Total Liabilities

     62,102        38,274  
Commitments and contingent liabilities (Notes 5 and 18)          
Redeemable non-controlling interest      238        358  
Shareowners’ Equity:          

Capital Stock:

         

Preferred Stock, $1 par value; 250,000 shares authorized; None issued or outstanding

               

Common Stock, $1 par value; 4,000,000 shares authorized; 1,407,780 and 1,400,212 shares issued

     13,976        13,445  

Treasury Stock—488,931 and 492,990 common shares at average cost

       (19,251        (19,410

Retained earnings

     36,776        33,487  

Unearned ESOP shares

     (139      (152

Total Accumulated other comprehensive loss

     (5,448      (5,490

Total Shareowners’ Equity

     25,914        21,880  
Non-controlling interest      1,155        940  

Total Equity

     27,069        22,820  

Total Liabilities and Equity

   $ 89,409      $ 61,452  
                   

See accompanying Notes to Consolidated Financial Statements


 

  34    

 

Consolidated Statement of Cash Flows

 

(DOLLARS IN MILLIONS)    2012      2011      2010  
Operating Activities of Continuing Operations:               

Net income attributable to common shareowners

   $    5,130      $    4,979      $    4,373  

Non-controlling interest in subsidiaries’ earnings

     360        395        338  

Net income

     5,490        5,374        4,711  

Less: Net income from discontinued operations

     290        158        188  

Income from continuing operations

     5,200        5,216        4,523  

Adjustments to reconcile income from continuing operations to net cash flows provided by operating activities of continuing operations:

              

Depreciation and amortization

     1,524        1,263        1,300  

Deferred income tax provision

     120        334        425  

Stock compensation cost

     210        221        148  

Change in:

              

Accounts receivable

     (165      (697      (313

Inventories and contracts in progress

     (539      (330      (259

Other current assets

     (4      (24      (20

Accounts payable and accrued liabilities

     811        760        1,168  

Global pension contributions

     (430      (551      (1,299

Other operating activities, net

     (122      268        47  

Net cash flows provided by operating activities of continuing operations

     6,605        6,460        5,720  
Investing Activities of Continuing Operations:               

Capital expenditures

     (1,389      (929      (838

Increase in customer financing assets

     (100      (42      (219

Decrease in customer financing assets

     75        92        162  

Investments in businesses

     (16,026      (357      (2,742

Dispositions of businesses

     425        494        205  

Increase in collaboration intangible assets

     (1,543              

Other investing activities, net

     (237      70        282  

Net cash flows used in investing activities of continuing operations

     (18,795      (672      (3,150
Financing Activities of Continuing Operations:               

Issuance of long-term debt

     10,899        59        2,362  

Repayment of long-term debt

     (842      (616      (1,751

(Decrease) increase in short-term borrowings, net

     (214      562        (141

Common Stock issued under employee stock plans

     522        226        386  

Dividends paid on Common Stock

     (1,752      (1,602      (1,482

Repurchase of Common Stock

            (2,175      (2,200

Other financing activities, net

     (592      (437      (314

Net cash flows provided by (used in) financing activities of continuing operations

     8,021        (3,983      (3,140
Discontinued Operations:               

Net cash provided by operating activities

     41        130        186  

Net cash provided by (used in) investing activities

     2,974        (35      (37

Net cash used in financing activities

            (22      (13

Net cash flows provided by discontinued operations

     3,015        73        136  
Effect of foreign exchange rate changes on cash and cash equivalents      30        (1      68  

Net (decrease) increase in cash and cash equivalents

     (1,124      1,877        (366
Cash and cash equivalents, beginning of year      5,960        4,083        4,449  
Cash and cash equivalents, end of year      4,836        5,960        4,083  

Less: Cash and cash equivalents of businesses held for sale

     17                
Cash and cash equivalents of continuing operations, end of year    $ 4,819      $ 5,960      $ 4,083  
                            
Supplemental Disclosure of Cash Flow Information:               

Interest paid, net of amounts capitalized

   $ 725      $ 642      $ 753  

Income taxes paid, net of refunds

   $ 1,772      $ 1,432      $ 1,222  
Non-cash investing and financing activities include:               

Contributions of UTC Common Stock to domestic defined benefit pension plans

   $      $ 450      $ 250  
                            

See accompanying Notes to Consolidated Financial Statements


 

    35  

 

Consolidated Statement of Changes In Equity

 

         
(DOLLARS IN MILLIONS)   

 

Common Stock

 
Balance at December 31, 2009    $    11,746  
          
Comprehensive income (loss):     

Net income

    

Redeemable non-controlling interest in subsidiaries’ earnings

    

Other comprehensive income (loss), net of tax

    
Common Stock issued under employee plans (11.8 million shares), net of tax benefit of $94      746  
Common Stock contributed to defined benefit pension plans (3.8 million shares)      117  
Common Stock repurchased (31.0 million shares)     
Dividends on Common Stock     
Dividends on ESOP Common Stock     
Dividends attributable to non-controlling interest     
Redeemable non-controlling interest accretion     
Purchase of subsidiary shares from non-controlling interest      (12