FORM 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission file number 1-812

 

 

UNITED TECHNOLOGIES CORPORATION

 

 

 

DELAWARE   06-0570975

One Financial Plaza, Hartford, Connecticut 06103

(860) 728-7000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x.    No  ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x.    No  ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨.    No  x.

At September 30, 2012 there were 916,544,528 shares of Common Stock outstanding.

 

 

 


Table of Contents

UNITED TECHNOLOGIES CORPORATION

AND SUBSIDIARIES

CONTENTS OF QUARTERLY REPORT ON FORM 10-Q

Quarter Ended September 30, 2012

 

         Page  

PART I – FINANCIAL INFORMATION

     3   

Item 1. Financial Statements:

     3   
 

Condensed Consolidated Statement of Comprehensive Income for the quarters ended September  30, 2012 and 2011

     3   
 

Condensed Consolidated Statement of Comprehensive Income for the nine months ended September  30, 2012 and 2011

     4   
 

Condensed Consolidated Balance Sheet at September 30, 2012 and December 31, 2011

     5   
 

Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2012 and 2011

     6   
 

Notes to Condensed Consolidated Financial Statements

     7   
 

Report of Independent Registered Public Accounting Firm

     34   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     35   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     55   

Item 4. Controls and Procedures

     55   

PART II – OTHER INFORMATION

     56   

Item 1. Legal Proceedings

     56   

Item 1A. Risk Factors

     57   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     62   

Item 3. Defaults Upon Senior Securities

     63   

Item 4. Mine Safety Disclosures

     63   

Item 6. Exhibits

     64   

SIGNATURES

     65   

EXHIBIT INDEX

     66   

United Technologies Corporation and its subsidiaries’ names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or tradenames of United Technologies Corporation and its subsidiaries. Names, abbreviations of names, logos, and products and service designators of other companies are either the registered or unregistered trademarks or tradenames of their respective owners. As used herein, the terms “we,” “us,” “our” or “UTC,” unless the context otherwise requires, mean United Technologies Corporation and its subsidiaries.

 

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PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

UNITED TECHNOLOGIES CORPORATION

AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Unaudited)

 

     Quarter Ended September 30,  

(Dollars in millions, except per share amounts)

   2012     2011  

Net Sales:

    

Product sales

   $ 10,839     $ 9,992  

Service sales

     4,203       4,243  
  

 

 

   

 

 

 
     15,042       14,235  
  

 

 

   

 

 

 

Costs and Expenses:

    

Cost of products sold

     8,278       7,519  

Cost of services sold

     2,725       2,819  

Research and development

     590       465  

Selling, general and administrative

     1,619       1,512  
  

 

 

   

 

 

 
     13,212       12,315  
  

 

 

   

 

 

 

Other income, net

     211       231  
  

 

 

   

 

 

 

Operating profit

     2,041       2,151  

Interest expense, net

     216       139  
  

 

 

   

 

 

 

Income from continuing operations before income taxes

     1,825       2,012  

Income tax expense

     484       628  
  

 

 

   

 

 

 

Net income from continuing operations

     1,341       1,384  

Discontinued operations (Note 2):

    

Income from operations

     91       52  

Loss on disposal

     (26     —     

Income tax benefit (expense)

     105       (15
  

 

 

   

 

 

 

Net income on discontinued operations

     170       37  
  

 

 

   

 

 

 

Net income

     1,511       1,421  

Less: Noncontrolling interest in subsidiaries’ earnings

     96       97  
  

 

 

   

 

 

 

Net income attributable to common shareowners

   $ 1,415     $ 1,324  
  

 

 

   

 

 

 

Comprehensive income

   $ 2,546     $ 526  

Less: Comprehensive income attributable to noncontrolling interests

     119       72  
  

 

 

   

 

 

 

Comprehensive income attributable to common shareowners

   $ 2,427     $ 454  
  

 

 

   

 

 

 

Net income attributable to common shareowners:

    

Net income from continuing operations

   $ 1,247     $ 1,290  

Net income from discontinued operations

   $ 168     $ 34  

Earnings Per Share of Common Stock - Basic:

    

Net income from continuing operations

   $ 1.39     $ 1.45  

Net income attributable to common shareowners

   $ 1.58     $ 1.49  

Earnings Per Share of Common Stock - Diluted:

    

Net income from continuing operations

   $ 1.37     $ 1.43  

Net income attributable to common shareowners

   $ 1.56     $ 1.47  

See accompanying Notes to Condensed Consolidated Financial Statements

 

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UNITED TECHNOLOGIES CORPORATION

AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Unaudited)

 

     Nine Months Ended September 30,  

(Dollars in millions, except per share amounts)

   2012     2011  

Net Sales:

    

Product sales

   $ 28,843     $ 28,900  

Service sales

     12,422       12,477  
  

 

 

   

 

 

 
     41,265       41,377  
  

 

 

   

 

 

 

Costs and Expenses:

    

Cost of products sold

     21,724       21,650  

Cost of services sold

     8,143       8,308  

Research and development

     1,659       1,427  

Selling, general and administrative

     4,657       4,538  
  

 

 

   

 

 

 
     36,183       35,923  
  

 

 

   

 

 

 

Other income, net

     851       547  
  

 

 

   

 

 

 

Operating profit

     5,933       6,001  

Interest expense, net

     513       429  
  

 

 

   

 

 

 

Income from continuing operations before income taxes

     5,420       5,572  

Income tax expense

     1,257       1,731  
  

 

 

   

 

 

 

Net income from continuing operations

     4,163       3,841  

Discontinued operations (Note 2):

    

Income from operations

     118       201  

Loss on disposal

     (1,197     —     

Income tax benefit (expense)

     256       (90
  

 

 

   

 

 

 

Net (loss) income on discontinued operations

     (823     111  
  

 

 

   

 

 

 

Net income

     3,340       3,952  

Less: Noncontrolling interest in subsidiaries’ earnings

     267       298  
  

 

 

   

 

 

 

Net income attributable to common shareowners

   $ 3,073     $ 3,654  
  

 

 

   

 

 

 

Comprehensive income

   $ 4,171     $ 3,968  

Less: Comprehensive income attributable to noncontrolling interests

     271       311  
  

 

 

   

 

 

 

Comprehensive income attributable to common shareowners

   $ 3,900     $ 3,657  
  

 

 

   

 

 

 

Net income (loss) attributable to common shareowners:

    

Net income from continuing operations

   $ 3,902     $ 3,551  

Net (loss) income from discontinued operations

   $ (829   $ 103  

Earnings Per Share of Common Stock - Basic:

    

Net income from continuing operations

   $ 4.37     $ 3.97  

Net income attributable to common shareowners

   $ 3.44     $ 4.09  

Earnings Per Share of Common Stock - Diluted:

    

Net income from continuing operations

   $ 4.31     $ 3.91  

Net income attributable to common shareowners

   $ 3.39     $ 4.02  

See accompanying Notes to Condensed Consolidated Financial Statements

 

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UNITED TECHNOLOGIES CORPORATION

AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

 

(Dollars in millions)

   September 30,
2012
    December 31,
2011
 
Assets     

Cash and cash equivalents

   $ 6,242     $ 5,960  

Accounts receivable, net

     10,610       9,546  

Inventories and contracts in progress, net

     10,467       7,797  

Future income tax benefits, current

     1,474       1,662  

Assets of discontinued operations

     1,884       —     

Other assets, current

     1,008       793  
  

 

 

   

 

 

 

Total Current Assets

     31,685       25,758  
  

 

 

   

 

 

 

Customer financing assets

     1,185       1,035  

Future income tax benefits

     1,541       2,387  

Fixed assets

     17,861       15,980  

Less: Accumulated depreciation

     (9,622     (9,779
  

 

 

   

 

 

 

Fixed assets, net

     8,239       6,201  
  

 

 

   

 

 

 

Goodwill

     27,630       17,943  

Intangible assets, net

     15,146       3,918  

Other assets

     6,520       4,210  
  

 

 

   

 

 

 

Total Assets

   $ 91,946     $ 61,452  
  

 

 

   

 

 

 
Liabilities and Equity     

Short-term borrowings

   $ 5,224     $ 630  

Accounts payable

     6,156       5,570  

Accrued liabilities

     14,600       12,287  

Liabilities of discontinued operations

     405       —     

Long-term debt currently due

     67       129  
  

 

 

   

 

 

 

Total Current Liabilities

     26,452       18,616  
  

 

 

   

 

 

 

Long-term debt

     23,409       9,501  

Future pension and postretirement benefit obligations

     6,632       5,007  

Other long-term liabilities

     9,129       5,150  
  

 

 

   

 

 

 

Total Liabilities

     65,622       38,274  
  

 

 

   

 

 

 

Commitments and contingent liabilities (Note 13)

    

Redeemable noncontrolling interest

     233       358  

Shareowners’ Equity:

    

Common Stock

     13,799       13,445  

Treasury Stock

     (19,258     (19,410

Retained earnings

     35,219       33,487  

Unearned ESOP shares

     (142     (152

Accumulated other comprehensive loss

     (4,663     (5,490
  

 

 

   

 

 

 

Total Shareowners’ Equity

     24,955       21,880  

Noncontrolling interest

     1,136       940  
  

 

 

   

 

 

 

Total Equity

     26,091       22,820  
  

 

 

   

 

 

 

Total Liabilities and Equity

   $ 91,946     $ 61,452  
  

 

 

   

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements

 

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UNITED TECHNOLOGIES CORPORATION

AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

 

     Nine Months Ended
September 30,
 

(Dollars in millions)

   2012     2011  

Operating Activities of Continuing Operations:

    

Income from continuing operations

   $ 4,163     $ 3,841  

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

    

Depreciation and amortization

     1,047       962  

Deferred income tax provision

     29       337  

Stock compensation cost

     150       179  

Change in:

    

Accounts receivable

     406       (542

Inventories and contracts in progress

     (1,162     (880

Other current assets

     (101     (30

Accounts payable and accrued liabilities

     708       900  

Global pension contributions*

     (233     (246

Other operating activities, net

     (356     29  
  

 

 

   

 

 

 

Net cash flows provided by operating activities of continuing operations

     4,651       4,550  
  

 

 

   

 

 

 

Investing Activities of Continuing Operations:

    

Capital expenditures

     (748     (570

Investments in businesses

     (16,008     (229

Dispositions of businesses

     362       382  

Decrease in customer financing assets, net

     1       43  

Increase in restricted cash

     (16,133     —     

Decrease in restricted cash

     15,942       8  

Increase in collaboration intangible assets

     (1,394     —     

Other investing activities, net

     (17     78  
  

 

 

   

 

 

 

Net cash flows used in investing activities of continuing operations

     (17,995     (288
  

 

 

   

 

 

 

Financing Activities of Continuing Operations:

    

Issuance (repayment) of long-term debt, net

     10,798       (50

Increase in short-term borrowings, net

     4,509       1,130  

Common Stock issued under employee stock plans

     460       196  

Dividends paid on Common Stock

     (1,288     (1,192

Repurchase of Common Stock

     —          (2,175

Other financing activities, net

     (493     (299
  

 

 

   

 

 

 

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

     13,986       (2,390
  

 

 

   

 

 

 

Discontinued Operations:

    

Net cash provided by operating activities

     22       28  

Net cash used in investing activities

     (352     (10

Net cash used in financing activities

     —          (20
  

 

 

   

 

 

 

Net cash flows used in discontinued operations

     (330     (2
  

 

 

   

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

     25       13  
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     337       1,883  

Cash and cash equivalents, beginning of year

     5,960       4,083  
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

     6,297       5,966  

Less: Cash and cash equivalents of discontinued operations

     55       —     
  

 

 

   

 

 

 

Cash and cash equivalents of continuing operations, end of period

   $ 6,242     $ 5,966  
  

 

 

   

 

 

 

 

* Non-cash activities include contributions of UTC common stock of $450 million to domestic defined benefit pension plans in the third quarter of 2011.

See accompanying Notes to Condensed Consolidated Financial Statements

 

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UNITED TECHNOLOGIES CORPORATION

AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Condensed Consolidated Financial Statements at September 30, 2012 and for the quarters and nine months ended September 30, 2012 and 2011 are unaudited, but in the opinion of management include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the results for the interim periods. The results reported in these Condensed Consolidated Financial Statements should not necessarily be taken as indicative of results that may be expected for the entire year. The financial information included herein should be read in conjunction with the financial statements and notes in our Annual Report to Shareowners (2011 Annual Report) incorporated by reference to our Annual Report on Form 10-K for calendar year 2011 (2011 Form 10-K).

Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. On September 28, 2011, we announced a new organizational structure that allows us to better serve customers through greater integration across product lines. Effective January 1, 2012, we formed the UTC Climate, Controls & Security segment which combines the former Carrier and UTC Fire & Security segments. In 2012, the Company approved plans for the divestiture of a number of non-core businesses. The results of operations including the expected loss on disposition and the related cash flows which result from these non-core businesses have been reclassified to Discontinued Operations in our Condensed Consolidated Statement of Comprehensive Income and Condensed Consolidated Statement of Cash Flows for all periods presented. See Note 2 for further discussion.

Note 1: Acquisitions, Dispositions, Goodwill and Other Intangible Assets

Business Acquisitions and Dispositions. During the first nine months of 2012, our investment in business acquisitions was $18.6 billion (including debt assumed of $2.6 billion).

On July 26, 2012, we completed the acquisition of Goodrich Corporation (Goodrich), a global supplier of systems and services to the aerospace and defense industry with 2011 sales of $8.1 billion. Goodrich products include aircraft nacelles, interior, actuation, landing and electronic systems. Under the terms of the agreement, Goodrich shareholders received $127.50 in cash for each share of Goodrich common stock they owned on July 26, 2012. This equated to a total enterprise value of $18.3 billion, including $1.9 billion in net debt assumed. The acquired Goodrich businesses were combined with the legacy Hamilton Sundstrand businesses to form the new UTC Aerospace Systems segment. The acquisition of Goodrich and the formation of UTC Aerospace Systems provide increased scale, financial strength and complementary product offerings, allowing us to significantly strengthen our position in the aerospace and defense industry, create aftermarket efficiencies for our customers, accelerate our ability to drive innovation within the aerospace industry, and enhance our ability to support our customers with more integrated systems. This acquisition, coupled with our acquisition of an additional interest in IAE International Aero Engines AG (IAE) resulting in a controlling interest in IAE, as discussed below, further advances the Company’s strategy of focusing on our core businesses.

To finance the cash consideration for the Goodrich acquisition and pay related fees, expenses and other amounts due and payable, we utilized the previously disclosed 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 under our April 24, 2012 term loan credit agreement in July 2012. For the remainder of the cash consideration, we utilized approximately $0.5 billion of cash and cash equivalents generated from operating activities.

Preliminary Allocation of Consideration Transferred to Net Assets Acquired:

The following amounts represent the preliminary determination of the fair value of identifiable assets acquired and liabilities assumed from our acquisition of Goodrich. The final determination of the fair value of certain assets and liabilities will be completed within the one year measurement period as required by the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 805, “Business Combinations.” The size and breadth of the Goodrich acquisition will necessitate the use of this measurement period to adequately analyze and assess a number of the factors used in establishing the asset and liability fair values as of the acquisition date including the significant contractual and operational factors underlying the customer relationship intangible asset; the final negotiated sales values for businesses that are required to be sold as part of the regulatory approval of the Goodrich acquisition; the assumptions underpinning certain reserves such as those for environmental obligations, and the related tax impacts of any changes made. Any potential adjustments made could be material in relation to the preliminary values presented below:

 

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(Dollars in millions)

      

Cash and cash equivalents

   $ 538  

Accounts receivable, net

     1,182  

Inventories and contracts in progress, net

     1,729  

Future income tax benefits, current

     280  

Other assets, current

     574  

Fixed assets

     2,342  

Intangible assets:

  

Customer relationships

     8,550  

Trademarks

     1,550  

Other assets

     1,831  

Short-term borrowings

     (83

Accounts payable

     (443

Accrued liabilities

     (2,242

Long-term debt

     (2,961

Future pension and postretirement benefit obligations

     (1,745

Other long-term liabilities:

  

Customer contractual obligations

     (2,050

Other long-term liabilities

     (3,758

Non-controlling interests

     (41
  

 

 

 

Total identifiable net assets

     5,253  

Goodwill

     11,167  
  

 

 

 

Total consideration transferred

   $ 16,420  
  

 

 

 

In order to allocate the consideration transferred for Goodrich, the fair values of all identifiable assets and liabilities needed to be established. For accounting and financial reporting purposes, fair value is defined under ASC Topic 820, “Fair Value Measurement and Disclosure” as the price that would be received upon sale of an asset or the amount paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are assumed to be buyers and sellers in the principal (most advantageous) market for the asset or liability. Additionally, fair value measurements for an asset assume the highest and best use of that asset by market participants. Use of different estimates and judgments could yield different results.

In determining the fair value of identifiable assets acquired and liabilities assumed, a review was conducted for any significant contingent assets or liabilities existing as of the acquisition date. The preliminary assessment did not note any significant legal or governmental action contingencies. Based upon UTC’s existing practices and phase II environmental assessments done on a number of Goodrich sites, UTC determined it assumed an obligation of $232 million related to environmental liabilities.

The fair values of the customer relationship intangible assets were determined by using an “income approach” which is the most common valuation approach utilized. Under this approach, the net earnings attributable to the asset or liability being measured are isolated using the discounted projected net cash flows. These projected cash flows are isolated from the projected cash flows of the combined asset group over the remaining economic life of the intangible asset or liability being measured. Both the amount and the duration of the cash flows are considered from a market participant perspective. The Company’s estimates of market participant net cash flows considered historical and projected pricing, remaining developmental effort, operational performance including company specific synergies, aftermarket retention, product life cycles, material and labor pricing, and other relevant customer, contractual and market factors. Where appropriate, the net cash flows are probability-adjusted to reflect the uncertainties associated with the underlying assumptions, as well as the risk profile of the net cash flows utilized in the valuation. The probability-adjusted future cash flows are then discounted to present value using an appropriate discount rate. The customer relationship intangible asset is being amortized on a straight-line basis (which approximates the economic pattern of benefits) over the estimated economic life of the underlying programs of 10 to 25 years.

We also identified customer contractual obligations on certain original equipment manufacturing (OEM) development programs where the expected costs exceed the expected revenue under contract. We measured these liabilities under the measurement provisions of ASC Topic 820, “Fair Value Measurement,” which is based on the price to transfer the obligation to a market participant at the measurement date, assuming that the liability will remain outstanding in the marketplace. Based on the estimated net cash outflows of the OEM developmental programs plus a reasonable contracting profit margin required to transfer the contracts to market participants, we recorded assumed liabilities of approximately $2.0 billion. 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.

 

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Goodrich had not recorded an income tax liability on the unremitted earnings of its non-U.S. subsidiaries, which was approximately $853 million as of December 31, 2011. In connection with the acquisition, the Company has made a determination to repatriate certain of these unremitted earnings, making such amounts subject to both U.S. and Non-U.S. income taxes. Accordingly, a deferred income tax liability of $218 million has been recorded in purchase accounting for the unremitted earnings no longer considered permanently reinvested.

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

Pre-Existing Relationships:

Our Pratt & Whitney division entered into a preferred supplier contract in 2010 with Goodrich for the development and subsequent production of nacelles for the PW1500G (Bombardier C Series) and PW1200G (Mitsubishi Regional Jet). That preferred supplier contract replaced previous contracts and preliminary Memorandum of Understandings entered into in 2006 and 2008. Under the 2010 agreement, Pratt & Whitney agreed to fund Goodrich’s non-recurring development effort and established a recurring price for the production nacelles. Prior to the date of UTC’s acquisition of Goodrich, Pratt & Whitney and Goodrich had asserted claims against each other in a contractual dispute and would have ultimately arbitrated the matter were it not for the acquisition. In accordance with ASC Topic 805, “Business Combinations,” pre-existing relationships must be effectively settled at acquisition as the relationships become intercompany relationships upon acquisition and are eliminated in the post-combination financial statements. Any resulting settlement gains or losses should be measured at fair value and recorded on the acquisition date. Accordingly, a $46 million gain was recorded in other income by Pratt & Whitney in the third quarter of 2012 based upon a third party determination of the probability-weighted outcome had the matter gone to arbitration.

Acquisition-Related Costs:

Acquisition-related costs are being expensed as incurred. For the nine months ended September 30, 2012, approximately $84 million of transaction costs (including integration costs) have been incurred in addition to approximately $29 million of restructuring costs, including exit costs in connection with the acquisition (see additional discussion in Note 8). In connection with the financing of the Goodrich acquisition, approximately $130 million in interest costs have been recorded through the nine months ended September 30, 2012.

Under Goodrich’s pre-existing management continuity arrangements (MCA), we assumed potential change-in-control obligations related to certain executives at Goodrich. We evaluated the change-in-control provisions governed by the MCA and for certain of the executives we determined that we had assumed liabilities of approximately $73 million as the benefit payments were effectively single trigger in substance. We measured the assumed liability based on fair value concepts of ASC Topic 820, “Fair Value Measurements,” using weighted average techniques of possible outcomes of the employees electing to receive such benefits. We expensed approximately $12 million for MCA arrangements where we amended the term of the MCA arrangement beyond the original expiration date for certain executives.

 

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Supplemental Pro-Forma Data:

Goodrich’s results of operations have been included in UTC’s financial statements for the period subsequent to the completion of the acquisition on July 26, 2012. Goodrich contributed sales of approximately $1.5 billion and operating profit of approximately $100 million for the period from the completion of the acquisition through September 30, 2012. The following unaudited supplemental pro-forma data presents consolidated information as if the acquisition had been completed on January 1, 2011. The pro-forma results were calculated by combining the results of UTC with the stand-alone results of Goodrich for the pre-acquisition periods, which were adjusted to account for certain costs which would have been incurred during this pre-acquisition period:

 

     Three Months Ended September 30,      Nine Months Ended September 30,  

(Dollars in millions, except per share amounts)

   2012      2011      2012      2011  

Net sales

   $ 15,512      $ 16,103      $ 45,730      $ 46,854  

Net income attributable to common shareowners from continuing operations

     1,266        1,403        4,096        3,483  

Basic earnings per share of common stock from continuing operations

     1.41        1.58        4.58        3.90  

Diluted earnings per share of common stock from continuing operations

     1.40        1.56        4.52        3.83  

The unaudited supplemental pro-forma data above includes the following significant adjustments made to account for certain costs which would have been incurred if the acquisition had been completed on January 1, 2011, as adjusted for the applicable tax impact. As our acquisition of Goodrich was completed on July 26, 2012, the pro-forma adjustments for the three and nine months ended September 30, 2012 in the table below only include the required adjustments through July 26, 2012:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Amortization of inventory fair value adjustment1

   $ —        $ —        $ —        $ 103  

Amortization of acquired Goodrich intangible assets, net2

     15       46       107       138  

Utilization of contractual customer obligation3

     (10     (46     (103     (154

UTC/Goodrich fees for advisory, legal, accounting services4

     —          —          —          196  

Interest expense incurred on acquisition financing, net5

     (3     44       63       133  

 

  1

Added the expense for inventory fair value adjustments which would have been amortized as the corresponding inventory would have been completely sold during the first two quarters of 2011.

  2 

Added the additional amortization of the acquired Goodrich intangible assets recognized at fair value in purchase accounting and eliminated the historical Goodrich intangible asset amortization expense.

  3

Added the additional utilization of the Goodrich contractual customer obligation recognized in purchase accounting.

  4 

Added the UTC/Goodrich fees that were incurred in connection with the acquisition of Goodrich during the first quarter of 2011.

  5 

Added the additional interest expense for the debt incurred to finance our acquisition of Goodrich and reduced interest expense for the debt fair value adjustment which would have been amortized.

The unaudited supplemental pro-forma financial information does not reflect the potential realization of cost savings relating to the integration of the two companies. Further, the pro-forma data should not be considered indicative of the results that would have occurred if the acquisition and related financing been consummated on January 1, 2011, nor are they indicative of future results.

Other Acquisition and Disposition Activity:

In 2012, the Company approved plans for the divestiture of a number of non-core businesses. Cash generated from these divestitures is intended to be used to repay debt incurred to finance the acquisition of Goodrich. See Note 2 for further discussion.

On July 23, 2012, we announced an agreement to sell Rocketdyne to GenCorp Inc. for $550 million. The transaction is expected to close in the first half of 2013. Proceeds from the sale are expected to be used to repay debt incurred to finance the acquisition of Goodrich. The sale is subject to customary closing conditions, including receipt of regulatory approvals.

On July 25, 2012, we announced an agreement to sell the legacy Hamilton Sundstrand Industrial businesses to BC Partners and The Carlyle Group for $3.46 billion. The sale is expected to close before the end of the year and the proceeds from the sale are expected to be used to repay a portion of the short-term debt incurred to finance the acquisition of Goodrich. The sale is subject to customary closing conditions, including regulatory approvals.

 

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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 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 an agreement to license its V2500 intellectual property to 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 conditional upon each hour flown by V2500-powered aircraft in service at the closing date of the purchase from Rolls-Royce during the fifteen year period following closing of the purchase. The collaboration interest and intellectual property licenses are reflected as intangible assets and will be amortized in relation to the economic benefits received over the remaining estimated 30 year life of the V2500 program. Rolls-Royce will continue to support the program as a strategic supplier for the V2500 engine and continue to manufacture parts and assemble engines. 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. As a result of these transactions, Pratt & Whitney holds a 61% net interest in the collaboration and a 49.5% ownership interest in IAE. Based on the criteria set forth in the Consolidation Topic of the FASB ASC, we have determined that IAE is a variable interest entity (VIE). IAE’s business purpose is to coordinate the design, development, manufacturing and product support of the V2500 program through involvement with the collaborators. IAE retains limited equity with the primary economics of the V2500 program passed to the participants in the separate collaboration arrangement. As such, UTC is determined to be the primary beneficiary of IAE as it absorbs the significant economics of IAE and has the power to direct the activities that are considered most significant to IAE. The consolidation of IAE resulted in a gain of $21 million recognized during the second quarter of 2012 on the re-measurement to fair value of our previously held equity interest on obtaining control of IAE. The carrying amounts and classification of assets and liabilities for IAE in our condensed consolidated balance sheet as of September 30, 2012 are as follows:

 

(Dollars in millions)

      

Current assets

   $ 1,521  

Noncurrent assets

     931  
  

 

 

 

Total assets

   $ 2,452  
  

 

 

 

Current liabilities

   $ 1,556  

Noncurrent liabilities

     1,013  
  

 

 

 

Total liabilities

   $ 2,569  
  

 

 

 

Goodwill. Changes in our goodwill balances for the first nine months of 2012 were as follows:

 

(Dollars in millions)

   Balance as of
January 1, 2012
     Goodwill resulting from
business combinations
     Foreign currency
translation and other
    Balance as of
September 30, 2012
 

Otis

   $ 1,516      $ 23      $ 9     $ 1,548  

UTC Climate, Controls & Security

     9,758        88        (25     9,821  

Pratt & Whitney

     1,223        272        (174     1,321  

UTC Aerospace Systems

     4,475        11,167        (1,053     14,589  

Sikorsky

     348        —           3       351  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Segments

     17,320        11,550        (1,240     27,630  

Eliminations and other

     623        —           (623     —     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 17,943      $ 11,550      $ (1,863   $ 27,630  
  

 

 

    

 

 

    

 

 

   

 

 

 

The $11.2 billion increase to UTC Aerospace Systems goodwill resulting from business combinations in the nine months ended September 30, 2012 pertains to the previously discussed acquisition of Goodrich. The goodwill results from the workforce acquired with the business as well as the significant synergies that are expected to be realized through the consolidation of manufacturing facilities and overhead functions. No amount of this goodwill is deductible for tax purposes. The goodwill acquired has been allocated to the two reporting units within the UTC Aerospace Systems segment.

The $272 million increase to Pratt & Whitney goodwill resulting from business combinations in the nine months ended September 30, 2012 pertains to tax-deductible goodwill resulting from its increased ownership interest and consolidation of IAE.

The approximately $1.9 billion decrease reflected under “Foreign currency translation and other” in the table above primarily reflects the decision to divest a number of non-core businesses and the resulting reclassification to Assets of discontinued operations. See Note 2 for further discussion. In addition, approximately $360 million of goodwill was transferred from UTC Aerospace Systems to Pratt & Whitney in connection with the transfer of the auxiliary power unit (APU) business from UTC Aerospace Systems to Pratt & Whitney. See Note 14 for further discussion of the transfer of the APU business.

 

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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 Subtopic 350-30, Intangibles—Goodwill and Other—General Intangibles Other than Goodwill. We completed our annual impairment testing in the third quarter of 2012 and determined that no significant adjustments to the carrying amount of goodwill or indefinite lived intangible assets were necessary based on the results of the impairment tests.

Intangible Assets. Identifiable intangible assets are comprised of the following:

 

     September 30, 2012     December 31, 2011  

(Dollars in millions)

   Gross Amount      Accumulated
Amortization
    Gross Amount      Accumulated
Amortization
 

Amortized:

          

Service portfolios

   $ 2,120      $ (1,165   $ 2,036      $ (1,060

Patents and trademarks

     398        (164     463        (183

IAE collaboration

     1,376        —          —           —     

Customer relationships and other

     11,836        (1,574     3,329        (1,429
  

 

 

    

 

 

   

 

 

    

 

 

 
     15,730        (2,903     5,828        (2,672
  

 

 

    

 

 

   

 

 

    

 

 

 

Unamortized:

          

Trademarks and other

     2,319          762     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 18,049      $ (2,903   $ 6,590      $ (2,672
  

 

 

    

 

 

   

 

 

    

 

 

 

The increase to amortized and unamortized intangible assets pertains to the previously discussed acquisition of Goodrich. Acquired intangible assets are recognized at fair value in purchase accounting and then amortized to cost of sales and selling general & administrative expenses over the applicable useful lives. The customer relationship intangible assets are being amortized on a straight line basis as it approximates the underlying economic pattern of benefit. Amortization of intangible assets for the quarter and nine months ended September 30, 2012 was $166 million and $360 million respectively, compared with $102 million and $304 million for the same periods of 2011.

The following is the expected amortization of intangible assets for the fourth quarter of 2012 through 2017 as of September 30, 2012:

 

(Dollars in millions)

   Fourth
quarter of
2012
     2013      2014      2015      2016      2017  

Amortization expense

   $ 178      $ 703      $ 678      $ 647      $ 628      $ 662  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Note 2: Discontinued Operations

In 2012, the Company approved plans for the divestiture of a number of non-core businesses. Cash generated from these divestitures is intended to be used to repay debt incurred to finance the acquisition of Goodrich. These divestitures are expected to generate approximately $3 billion in net cash, on an after-tax basis.

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 approved a plan for the divestiture of UTC Power. The operating results of Clipper and UTC Power had previously been reported within “Eliminations & other” in our segment disclosure. The results of operations, including the net losses realized or expected on disposition, and the related cash flows which result from these non-core businesses have been reclassified to Discontinued Operations in our Condensed Consolidated Statement of Comprehensive Income and Condensed Consolidated Statement of Cash Flows for all periods presented. The assets and liabilities of these non-core businesses have been reclassified to Assets of discontinued operations and Liabilities of discontinued operations in our Condensed Consolidated Balance Sheet as of September 30, 2012. Cash flows from the operation of these discontinued businesses will continue until their disposals, which are expected to occur before the end of the first half of 2013.

 

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As a result of the decision to dispose of these businesses, the Company has recorded pre-tax goodwill impairment charges of approximately $360 million and $590 million related to Rocketdyne and Clipper, respectively, in discontinued operations during the first quarter of 2012, and pre-tax net asset impairment charges of approximately $179 million related to UTC Power in discontinued operations during the second quarter of 2012. The goodwill impairment charges result from the decision to dispose of both Rocketdyne and Clipper within a relatively short period after acquiring the businesses. 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 results from adjusting the net assets of the business to the estimated fair value expected to be realized upon sale, less costs to sell the business, and further reflects the loss in value from the disposition of the business before the benefits of the technology investments were fully realized. The fair value of these businesses has been estimated using information available in the marketplace as we market these businesses for sale. There could be gains or additional losses recorded upon final disposition of these businesses based upon the values, terms and conditions that are ultimately negotiated.

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. These payments are largely reflected in Net cash flows used in investing activities within the discontinued operations section of the Condensed Consolidated Statement of Cash Flows. There was no significant additional loss on disposition beyond the impairment charge recorded in the first quarter of 2012. We have no continuing involvement with the Clipper business post disposition.

The following summarized financial information related to these non-core businesses has been segregated from continuing operations and will be reported as discontinued operations through the dates of disposition:

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Discontinued Operations:

        

Net sales

   $ 522     $ 570     $ 1,607     $ 1,847  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

   $ 91     $ 52     $ 118     $ 201  

Income tax expense

     (30     (15     (38     (90
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations, net of income taxes

     61       37       80       111  

Loss on disposal

     (26     —          (1,197     —     

Income tax benefit

     135       —          294       —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) on discontinued operations

   $ 170     $ 37     $ (823   $ 111  
  

 

 

   

 

 

   

 

 

   

 

 

 

The income tax benefit for the nine months ended September 30, 2012 includes approximately $113 million of net unfavorable income tax adjustments related to the recognition of a deferred tax liability on the existing difference between the accounting versus tax gain on the planned disposition of the legacy Hamilton Sundstrand Industrial businesses. During the first half of 2012, unfavorable income tax adjustments of approximately $240 million were recognized based on the anticipated structure of the sale. However, during the third quarter of 2012, as a result of the structure of the transaction, approximately $127 million of those adjustments were reversed and cannot be recorded until the sale is complete.

 

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The assets and liabilities of discontinued operations on the Condensed Consolidated Balance Sheet as of September 30, 2012 are as follows:

 

(Dollars in millions)

 
Assets   

Cash and cash equivalents

   $ 55  

Accounts receivable, net

     332  

Inventories and contracts in progress, net

     172  

Future income tax benefits, current

     7  

Other assets, current

     3  

Future income tax benefits

     2  

Fixed assets, net

     300  

Goodwill

     909  

Intangible assets, net

     60  

Other assets

     44  
  

 

 

 

Assets of discontinued operations

   $ 1,884  
  

 

 

 
Liabilities   

Short-term borrowings

   $ 1  

Accounts payable

     128  

Accrued liabilities

     229  

Future pension and postretirement benefit obligations

     1  

Other long-term liabilities

     46  
  

 

 

 

Liabilities of discontinued operations

   $ 405  
  

 

 

 

Note 3: Earnings Per Share

 

     Quarter Ended September 30,      Nine Months Ended September 30,  

(Dollars in millions, except per share amounts; shares in millions)

   2012      2011      2012     2011  

Net income from continuing operations

   $ 1,247      $ 1,290      $ 3,902     $ 3,551  

Net income (loss) from discontinued operations

     168        34        (829     103  
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income attributable to common shareowners

   $ 1,415      $ 1,324      $ 3,073     $ 3,654  
  

 

 

    

 

 

    

 

 

   

 

 

 

Basic weighted average number of shares outstanding

     896.3        888.8        893.6       893.7  

Stock awards

     10.9        13.1        11.7       15.4  
  

 

 

    

 

 

    

 

 

   

 

 

 

Diluted weighted average number of shares outstanding

     907.2        901.9        905.3       909.1  
  

 

 

    

 

 

    

 

 

   

 

 

 

Earnings (Loss) Per Share of Common Stock - Basic:

          

Net income from continuing operations

   $ 1.39      $ 1.45      $ 4.37     $ 3.97  

Net income (loss) from discontinued operations

     0.19        0.04        (0.93     0.12  

Net income attributable to common shareowners

     1.58        1.49        3.44       4.09  

Earnings (Loss) Per Share of Common Stock - Diluted:

          

Net income from continuing operations

   $ 1.37      $ 1.43      $ 4.31     $ 3.91  

Net income (loss) from discontinued operations

     0.19        0.04        (0.92     0.11  

Net income attributable to common shareowners

     1.56        1.47        3.39       4.02  

The computation of diluted earnings per share excludes the effect of the potential exercise of stock awards, including stock appreciation rights and stock options, when the average market price of the common stock is lower than the exercise price of the related stock awards during the period. These outstanding stock awards are not included in the computation of diluted earnings per share because the effect would be anti-dilutive. For the quarter and nine months ended September 30, 2012, the number of stock awards excluded from the computation was 6.1 million and 4.8 million, respectively. For the quarter ended September 30, 2011, there were 6.5 million anti-dilutive stock awards excluded from the computation. For the nine months ended September 30, 2011, there were no anti-dilutive stock awards excluded from the computation.

 

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Note 4: Inventories and Contracts in Progress

 

(Dollars in millions)

   September 30, 2012     December 31, 2011  

Raw materials

   $ 1,912     $ 1,321  

Work-in-process

     4,659       3,175  

Finished goods

     3,463       3,078  

Contracts in progress

     7,635       6,899  
  

 

 

   

 

 

 
     17,669       14,473  

Less:

    

Progress payments, secured by lien, on U.S. Government contracts

     (360     (422

Billings on contracts in progress

     (6,842     (6,254
  

 

 

   

 

 

 
   $ 10,467     $ 7,797  
  

 

 

   

 

 

 

As of September 30, 2012 and December 31, 2011, inventory includes capitalized contract development costs of $813 million and $776 million, respectively, related to certain aerospace programs. These capitalized costs are liquidated as production units are delivered to the customer. The capitalized contract development costs within inventory principally relate to costs capitalized on Sikorsky’s CH-148 contract with the Canadian government. The CH-148 is a derivative of the H-92, a military variant of the S-92.

Note 5: Borrowings and Lines of Credit

 

(Dollars in millions)

   September 30, 2012      December 31, 2011  

Commercial paper

   $ 2,994      $ 455  

Term loan credit borrowings

     2,000        —     

Other borrowings

     230        175  
  

 

 

    

 

 

 

Total short-term borrowings

   $ 5,224      $ 630  
  

 

 

    

 

 

 

On April 24, 2012, we entered into a term loan credit agreement with various financial institutions that provides for a $2 billion unsecured term loan facility. On July 26, 2012 we borrowed the full $2 billion available under this facility to partially finance the cash consideration of the Goodrich acquisition and pay related fees, expenses and other amounts due and payable by UTC as a result of the acquisition. The outstanding balance under this term loan credit agreement matures on December 31, 2012.

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 2013, and $0.5 billion aggregate principal amount of three-month LIBOR plus 0.500% floating rate notes due 2015. We utilized the net proceeds of these notes of approximately $9.6 billion to partially finance the cash consideration of the acquisition of Goodrich and pay related fees, expenses and other amounts due and payable by UTC as a result of the acquisition. The three-month LIBOR rate as of September 30, 2012 was approximately 0.4%.

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. We used the net proceeds of the Equity Units to partially finance the cash consideration of the Goodrich acquisition and pay related fees, expenses and other amounts due and payable by UTC as a result of the acquisition.

The net proceeds from the sale of the Equity Units were allocated between the purchase contracts and the notes in our financial statements based on the underlying fair value of each instrument at the time of issuance taking into consideration the contract adjustment payments. The fair value of the purchase contracts is expected to approximate the present value of the contract adjustment payments and was recorded as a reduction to Common Stock, with an offsetting credit to liabilities. This liability will be accreted over three years through interest charges to the income statement based on a constant rate calculation. The purchase contracts are reflected in our diluted earnings per share calculations using the treasury stock method.

 

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To finance the remainder of the cash consideration of the Goodrich acquisition and pay related fees, expenses and other amounts due and payable, we utilized $3.2 billion from the issuance of commercial paper during July 2012 and utilized approximately $0.5 billion of cash and cash equivalents generated from operating activities. In addition, as a result of the acquisition of Goodrich, we assumed $3.0 billion of debt, including an adjustment of $600 million to increase the value of long-term debt assumed to its fair market value. Details of the debt assumed are included in the long-term debt table below.

On July 26, 2012, upon completing the Goodrich acquisition, we terminated the bridge credit agreement, initially entered into as of November 8, 2011, with various financial institutions that had provided for a $15 billion unsecured bridge loan facility which was available to partially fund the cash consideration of the acquisition of Goodrich and pay related fees, expenses and other amounts due and payable by UTC as a result of the acquisition.

See Note 1 for further details regarding the completion of our acquisition of Goodrich, as discussed above.

At September 30, 2012, we had revolving credit agreements with various banks permitting aggregate borrowings of up to $4 billion pursuant to a $2 billion revolving credit agreement and a $2 billion multicurrency revolving credit agreement, both of which expire in November 2016. As of September 30, 2012, there were no borrowings under either of these revolving credit agreements. The undrawn portions of these revolving credit agreements are also available to serve as backup facilities for the issuance of commercial paper. As of September 30, 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.

Long-term debt consisted of the following:

 

(Dollars in millions)

   September 30, 2012     December 31, 2011  

LIBOR plus 0.270% floating rate notes due 2013

   $ 1,000     $ —     

LIBOR plus 0.500% floating rate notes due 2015

     500       —     

1.200% notes due 2015*

     1,000       —     

4.875% notes due 2015*

     1,200       1,200  

6.290% notes due 2016***

     291       —     

5.375% notes due 2017*

     1,000       1,000  

1.800% notes due 2017*

     1,500       —     

6.800% notes due 2018***

     130       —     

6.125% notes due 2019***

     300       —     

6.125% notes due 2019*

     1,250       1,250  

8.875% notes due 2019

     272       272  

4.500% notes due 2020*

     1,250       1,250  

4.875% notes due 2020***

     300       —     

3.600% notes due 2021***

     600       —     

8.750% notes due 2021

     250       250  

3.100% notes due 2022*

     2,300       —     

1.550% junior subordinated notes due 2022**

     1,100       —     

7.100% notes due 2027***

     150       —     

6.700% notes due 2028

     400       400  

7.500% notes due 2029*

     550       550  

5.400% notes due 2035*

     600       600  

6.050% notes due 2036*

     600       600  

6.800% notes due 2036***

     255       —     

7.000% notes due 2038***

     200       —     

6.125% notes due 2038*

     1,000       1,000  

5.700% notes due 2040*

     1,000       1,000  

4.500% notes due 2042*

     3,500       —     

Project financing obligations

     93       127  

Other (including capitalized leases, discounts, and fair market value adjustment)***

     885       131  
  

 

 

   

 

 

 

Total long-term debt

     23,476       9,630  

Less current portion

     (67     (129
  

 

 

   

 

 

 

Long-term debt, net of current portion

   $ 23,409     $ 9,501  
  

 

 

   

 

 

 

 

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  * We may redeem some or all of these series of notes at any time at a redemption price in U.S. dollars equal to the greater of 100% of the principal amount outstanding of the applicable series of notes to be redeemed, or the sum of the present values of the remaining scheduled payments of principal and interest on the applicable series of notes to be redeemed. The discounts applied on such redemptions are based on a semiannual calculation at an adjusted treasury rate plus 10-50 basis points, depending on the particular series. The redemption price will also include interest accrued to the date of redemption on the principal balance of the notes being redeemed.
  ** The junior subordinated notes are redeemable at our option, in whole or in part, on a date not earlier than August 1, 2017. The redemption price will be the principal amount, plus accrued and unpaid interest, if any, up to but excluding the redemption date. We may extend or eliminate the optional redemption date as part of a remarketing of the junior subordinated notes which could occur between April 29, 2015 and July 15, 2015 or between July 23, 2015 and July 29, 2015.
  *** Notes were assumed as a part of our acquisition of Goodrich on July 26, 2012. Within “Other (including capitalized leases, discounts, and fair market value adjustments),” approximately $702 million was assumed/established as part of the acquisition.

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

Note 6: Income Taxes

We conduct business globally and, as a result, UTC or one or more of our subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as Australia, Belgium, Canada, China, France, Germany, Hong Kong, Italy, Japan, South Korea, Singapore, Spain, the United Kingdom and the United States. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years before 1998.

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. Where applicable, associated interest has also been recognized; interest accrued in relation to unrecognized tax benefits is recorded in interest expense. Penalties, if incurred, would be recognized as a component of income tax expense.

It is reasonably possible that over the next twelve months the amount of unrecognized tax benefits may change within a range of a net increase of $25 million to a net decrease of $110 million as a result of additional worldwide uncertain tax positions, the revaluation of current uncertain tax positions arising from developments in examinations, in appeals or in the courts, or the closure of tax statutes. A portion of this net reduction may impact the Company’s 2012 or 2013 income tax expense. Not included in the range is €198 million (approximately $257 million) of tax benefits that we have claimed related to a 1998 German reorganization. A portion of these tax benefits was denied by the German Tax Office on July 5, 2012, as a result of the audit of tax years 1999 to 2000. On August 3, 2012, the Company filed suit in the German Tax Court and expects to litigate this case. In 2008 the German Federal Tax Court denied benefits to another taxpayer in a case involving a German tax law relevant to our reorganization. The determination of the German Federal Tax Court on this other matter was appealed to the European Court of Justice (ECJ) to determine if the underlying German tax law is violative of European Union (EU) principles. On September 17, 2009 the ECJ issued an opinion in this case that is generally favorable to the other taxpayer and referred the case back to the German Federal Tax Court for further consideration of certain related issues. In May 2010, the German Federal Tax Court released its decision, in which it resolved certain tax issues that may be relevant to our audit and remanded the case to a lower court for further development. After consideration of the ECJ decision and the latest German Federal Tax Court decision, we continue to believe that it is more likely than not that the relevant German tax law is violative of EU principles and we have not accrued tax expense for this matter. As we continue to monitor developments related to this matter, it may become necessary for us to accrue tax expense and related interest.

During the quarter, UTC concluded proceedings with the Appeals Division of the Internal Revenue Service (IRS Appeals) for tax years 2004 and 2005, achieving resolution on all disputed issues for those years, resulting in a reduction in tax expense of approximately $34 million and a reduction to interest reserves of $25 million. Tax years 2006 through 2008 are currently before IRS Appeals for resolution discussions regarding certain proposed adjustments with which UTC does not agree and are expected to continue through 2013. Tax years 2009 and 2010 are currently under review by the Examination Division of the IRS (IRS Examination), which is expected to continue into 2014.

 

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Goodrich pre-acquisition tax years are also the subject of certain IRS audit, appeals and litigation activity. Goodrich tax years 2000 and 2001 are currently the subject of litigation involving the proper timing of certain deductions, which is expected to continue into 2013. Goodrich tax years 2005 and 2006 are the subject of litigation with respect to a separate issue involving the proper timing of deductions, which is expected to continue into 2013. Goodrich tax years 2007 and 2008 are currently before IRS Appeals for resolution discussions regarding certain disputed proposed adjustments. We expect the discussions before the IRS Appeals to be concluded within the next twelve months. Goodrich tax years 2009 and 2010 are currently under review by IRS Examination, which is expected to continue into 2013.

Note 7: Employee Benefit Plans

Pension and Postretirement Plans. We sponsor both funded and unfunded domestic and foreign defined pension and other postretirement benefit plans, and defined contribution plans. As part of our acquisition of Goodrich on July 26, 2012, we assumed approximately $1.5 billion of pension and post retirement benefit plan obligations. Contributions to our plans were as follows:

 

     Quarter Ended September 30,      Nine Months Ended September 30,  

(Dollars in millions)

   2012      2011      2012      2011  

Defined Benefit Plans

   $ 209      $ 627      $ 233      $ 697  
  

 

 

    

 

 

    

 

 

    

 

 

 

Defined Contribution Plans

   $ 65      $ 52      $ 183      $ 165  
  

 

 

    

 

 

    

 

 

    

 

 

 

In the first nine months of 2012, we made contributions of $201 million to our domestic defined benefit pension plans, all of which was contributed in the third quarter of 2012. In the first nine months of 2011, we made contributions of $606 million to our domestic defined benefit pension plans, all of which was contributed in the third quarter of 2011. Included in the total domestic contributions was a $450 million contribution of UTC common stock.

The following tables illustrate the components of net periodic benefit cost for our defined pension and other postretirement benefit plans:

 

     Pension Benefits
Quarter Ended
September 30,
    Other Postretirement  Benefits
Quarter Ended
September 30,
 

(Dollars in millions)

   2012     2011     2012     2011  

Service cost

   $ 131     $ 111     $ 1     $ 1  

Interest cost

     344       325       10       9  

Expected return on plan assets

     (503     (458     —          —     

Amortization

     (7     (2     (2     —     

Recognized actuarial net loss (gain)

     180       116       (1     (2

Net settlement and curtailment loss

     15       —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net periodic benefit cost

   $ 160     $ 92     $ 8     $ 8  
  

 

 

   

 

 

   

 

 

   

 

 

 
     Pension Benefits
Nine Months Ended
September 30,
    Other Postretirement  Benefits
Nine Months Ended
September 30,
 

(Dollars in millions)

   2012     2011     2012     2011  

Service cost

   $ 361     $ 333     $ 3     $ 3  

Interest cost

     970       975       26       29  

Expected return on plan assets

     (1,415     (1,372     —          —     

Amortization

     (13     (8     (2     (2

Recognized actuarial net loss (gain)

     541       347       (5     (6

Net settlement and curtailment loss

     50       13       —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net periodic benefit cost

   $ 494     $ 288     $ 22     $ 24  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net settlements and curtailment losses for pension benefits includes curtailment losses of approximately $24 million related to, and recorded in, discontinued operations for the nine months ended September 30, 2012. There were no curtailment losses related to discontinued operations for the quarter ended September 30, 2012.

 

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Note 8: Restructuring Costs

During the first nine months of 2012, we recorded net pre-tax restructuring costs totaling $360 million for new and ongoing restructuring actions as follows:

 

(Dollars in millions)

      

Otis

   $ 105  

UTC Climate, Controls & Security

     98  

Pratt & Whitney

     57  

UTC Aerospace Systems

     40  

Sikorsky

     18  

Eliminations and other

     14  
  

 

 

 

Restructuring costs recorded within continuing operations

     332  

Restructuring costs recorded within discontinued operations

     28  
  

 

 

 

Total

   $ 360  
  

 

 

 

The net costs included $191 million recorded in cost of sales, $141 million in selling, general and administrative expenses, and $28 million in discontinued operations. As described below, these costs primarily relate to actions initiated during 2012 and 2011.

2012 Actions. During the first nine months of 2012, we initiated restructuring actions relating to ongoing cost reduction efforts, including workforce reductions and the consolidation of field operations. We recorded net pre-tax restructuring costs totaling $310 million, including $166 million in cost of sales, $117 million in selling, general and administrative expenses and $27 million in discontinued operations. Additionally, due to the Goodrich acquisition, we assumed restructuring accruals totaling $19 million.

We expect the actions initiated in the first nine months of 2012 to result in net workforce reductions of approximately 5,000 hourly and salaried employees, the exiting of approximately 2.2 million net square feet of facilities and the disposal of assets associated with exited facilities. As of September 30, 2012, we have completed net workforce reductions of approximately 2,000 employees and exited approximately 100,000 net square feet. We are targeting the majority of the remaining workforce and all facility related cost reduction actions for completion during 2012 and 2013. No specific plans for significant other actions have been finalized at this time.

The following table summarizes the accrual balances and utilization by cost type for the 2012 restructuring actions:

 

(Dollars in millions)

   Severance     Asset
Write-Downs
    Facility Exit, Lease
Termination and
Other Costs
    Total  

Restructuring accruals at June 30, 2012

   $ 93     $ —        $ 10     $ 103  

Restructuring accruals assumed from Goodrich

     19       —          —          19  

Net pre-tax restructuring costs

     109       1       13       123  

Utilization and foreign exchange

     (58     (1     (7     (66
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 163     $ —        $ 16     $ 179  
  

 

 

   

 

 

   

 

 

   

 

 

 

The following table summarizes expected, incurred and remaining costs for the 2012 restructuring actions by type:

 

(Dollars in millions)

   Severance     Asset
Write-Downs
    Facility Exit, Lease
Termination and
Other Costs
    Total  

Expected costs

   $ 321     $ 14     $ 150     $ 485  

Costs incurred - quarter ended March 31, 2012

     (96     (12     (8     (116

Costs incurred - quarter ended June 30, 2012

     (59     (1     (11     (71

Costs incurred - quarter ended September 30, 2012

     (109     (1     (13     (123
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 57     $ —        $ 118     $ 175  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table summarizes expected, incurred and remaining costs for the 2012 restructuring actions by segment:

 

(Dollars in millions)

  Expected
Costs
    Costs Incurred
Quarter Ended
March 31, 2012
    Costs Incurred
Quarter Ended
June 30, 2012
    Costs Incurred
Quarter Ended
September 30, 2012
    Remaining
Costs at
September 30, 2012
 

Otis

  $ 113     $ (23   $ (31   $ (38   $ 21  

UTC Climate, Controls & Security

    122       (25     (24     (24     49  

Pratt & Whitney

    74       (34     (16     (2     22  

UTC Aerospace Systems

    84       (1     (2     (38     43  

Sikorsky

    51       —          —          (11     40  

Eliminations and other

    14       (6     2       (10     —     

Discontinued operations

    27       (27     —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 485     $ (116   $ (71   $ (123   $ 175  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

2011 Actions. During the first nine months of 2012, we recorded net pre-tax restructuring costs totaling $49 million for restructuring actions initiated in 2011, including $25 million in cost of sales, $23 million in selling, general and administrative expenses and $1 million in discontinued operations. The 2011 actions relate to ongoing cost reduction efforts, including workforce reductions and the consolidation of field operations.

As of September 30, 2012, we have completed net workforce reductions of approximately 4,000 employees of an expected 5,000 employees, and have exited approximately 100,000 net square feet of facilities of an expected 2 million net square feet. We are targeting the majority of the remaining workforce and facility related cost reduction actions for completion during 2012 and 2013.

The following table summarizes the accrual balances and utilization by cost type for the 2011 restructuring actions:

 

(Dollars in millions)

   Severance     Asset
Write-Downs
     Facility Exit, Lease
Termination and
Other Costs
    Total  

Restructuring accruals at June 30, 2012

   $ 70     $ —         $ 12     $ 82  

Net pre-tax restructuring costs

     4       —           4       8  

Utilization and foreign exchange

     (19     —           (8     (27
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at September 30, 2012

   $ 55     $ —         $ 8     $ 63  
  

 

 

   

 

 

    

 

 

   

 

 

 

The following table summarizes expected, incurred and remaining costs for the 2011 restructuring actions by type:

 

(Dollars in millions)

   Severance     Asset
Write-Downs
    Facility Exit, Lease
Termination and
Other Costs
    Total  

Expected costs

   $ 304     $ 4     $ 68     $ 376  

Costs incurred through December 31, 2011

     (259     (4     (23     (286

Costs incurred - quarter ended March 31, 2012

     (10     —          (10     (20

Costs incurred - quarter ended June 30, 2012

     (18     —          (3     (21

Costs incurred - quarter ended September 30, 2012

     (4     —          (4     (8
  

 

 

   

 

 

   

 

 

   

 

 

 

Remaining costs at September 30, 2012

   $ 13     $ —        $ 28     $ 41  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table summarizes expected, incurred and remaining costs for the 2011 restructuring actions by segment:

 

(Dollars in millions)

  Expected
Costs
    Costs Incurred
through
December 31, 2011
    Costs Incurred
Quarter Ended
March 31, 2012
    Costs Incurred
Quarter Ended
June 30, 2012
    Costs Incurred
Quarter Ended
September 30, 2012
    Remaining
Costs at
September 30, 2012
 

Otis

  $ 101     $ (76   $ (6   $ (4   $ (4   $ 11  

UTC Climate, Controls & Security

    121       (93     (9     (13     (2     4  

Pratt & Whitney

    47       (37     (2     (1     (1     6  

UTC Aerospace Systems

    8       (8     —          —          —          —     

Sikorsky

    75       (51     (3     (2     (1     18  

Discontinued operations

    24       (21     —          (1     —          2  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 376     $ (286   $ (20   $ (21   $ (8   $ 41  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

2010 Actions. As of September 30, 2012, we have approximately $34 million of accrual balances remaining related to 2010 actions.

Note 9: Financial Instruments

We enter into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments under the Derivatives and Hedging Topic of the FASB ASC and those utilized as economic hedges. We operate internationally and, in the normal course of business, are exposed to fluctuations in interest rates, foreign exchange rates and commodity prices. These fluctuations can increase the costs of financing, investing and operating the business. We have used derivative instruments, including swaps, forward contracts and options to manage certain foreign currency, interest rate and commodity price exposures.

By their nature, all financial instruments involve market and credit risks. We enter into derivative and other financial instruments with major investment grade financial institutions and have policies to monitor the credit risk of those counterparties. We limit counterparty exposure and concentration of risk by diversifying counterparties. While there can be no assurance, we do not anticipate any material non-performance by any of these counterparties.

Foreign Currency Forward Contracts. We manage our foreign currency transaction risks to acceptable limits through the use of derivatives that hedge forecasted cash flows associated with foreign currency transaction exposures, which are accounted for as cash flow hedges, as we deem appropriate. To the extent these derivatives are effective in offsetting the variability of the hedged cash flows, and otherwise meet the hedge accounting criteria of the Derivatives and Hedging Topic of the FASB ASC, the changes in the derivatives’ fair values are not included in current earnings but are included in “Accumulated other comprehensive loss.” These changes in fair value will subsequently be reclassified into earnings as a component of product sales or expenses, as applicable, when the forecasted transaction occurs. To the extent that a previously designated hedging transaction is no longer an effective hedge, any ineffectiveness measured in the hedging relationship is recorded currently in earnings in the period in which it occurs.

To the extent the hedge accounting criteria are not met, the foreign currency forward contracts are utilized as economic hedges and changes in the fair value of these contracts are recorded currently in earnings in the period in which they occur. These include hedges that are used to reduce exchange rate risks arising from the change in fair value of certain foreign currency denominated assets and liabilities (e.g. payables, receivables) and other economic hedges where the hedge accounting criteria were not met.

The four quarter rolling average of the notional amount of foreign exchange contracts hedging foreign currency transactions was $11.3 billion and $10.4 billion at September 30, 2012 and December 31, 2011, respectively.

 

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The following table summarizes the fair value of derivative instruments as of September 30, 2012 and December 31, 2011 which consist solely of foreign exchange contracts:

 

     September 30, 2012      December 31, 2011  

(Dollars in millions)

   Derivatives
designated
as hedging
instruments
     Derivatives not
designated as
hedging
instruments
     Derivatives
designated
as hedging
instruments
     Derivatives not
designated as
hedging
instruments
 

Balance Sheet Asset Locations:

           

Other assets, current

   $ 36      $ 40      $ 69      $ 40  

Other assets

     44        3        3        2  
  

 

 

    

 

 

    

 

 

    

 

 

 
     80        43        72        42  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Asset Derivative Contracts

      $ 123         $ 114  
     

 

 

       

 

 

 

Balance Sheet Liability Locations:

           

Accrued liabilities

   $ 9      $ 29      $ 81      $ 40  

Other long-term liabilities

     —           3        43        1  
  

 

 

    

 

 

    

 

 

    

 

 

 
     9        32        124        41  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Liability Derivative Contracts

      $ 41         $ 165  
     

 

 

       

 

 

 

The impact from foreign exchange derivative instruments that qualified as cash flow hedges was as follows:

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012      2011     2012      2011  

Gain (loss) recorded in Accumulated other comprehensive loss

   $ 146      $ (125   $ 83      $ (25
  

 

 

    

 

 

   

 

 

    

 

 

 

Gain reclassified from Accumulated other comprehensive loss into Product sales (effective portion)

   $ 7      $ 17     $ 26      $ 93  
  

 

 

    

 

 

   

 

 

    

 

 

 

Assuming current market conditions continue, a $33 million pre-tax loss is expected to be reclassified from Accumulated other comprehensive loss into Product sales to reflect the fixed prices obtained from foreign exchange hedging within the next 12 months. At September 30, 2012, all derivative contracts accounted for as cash flow hedges will mature by December 2015.

The effect on the Condensed Consolidated Statement of Comprehensive Income from foreign exchange contracts not designated as hedging instruments was as follows:

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Loss recognized in Other income, net

   $ (19   $ (51   $ (21   $ (23
  

 

 

   

 

 

   

 

 

   

 

 

 

Fair Value Disclosure. As of January 1, 2012, we adopted the provisions of the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU clarifies many of the existing concepts for measuring fair value and does not result in a change in our application of the Fair Value Measurements and Disclosures Topic of the FASB ASC. The guidance includes enhanced disclosure requirements about recurring Level 3 fair value measurements for each class of assets and liabilities measured at fair value in the balance sheet, which has no impact on our financial statements or disclosures as there are presently no Level 3 fair value measurements in our Condensed Consolidated Balance Sheet. This ASU also requires additional disclosures for items that are not measured at fair value in the balance sheet but for which the fair value is required to be disclosed.

 

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Valuation Hierarchy. The following table provides the valuation hierarchy classification of assets and liabilities that are carried at fair value and measured on a recurring and nonrecurring basis in our Condensed Consolidated Balance Sheet as of September 30, 2012 and December 31, 2011:

 

(Dollars in millions)

   Total Carrying
Value at

September 30, 2012
    Quoted price in
active markets
(Level 1)
     Significant other
observable inputs

(Level 2)
    Unobservable
inputs

(Level 3)
 

Recurring fair value measurements:

         

Available-for-sale securities

   $ 778     $ 778      $ —        $ —     

Derivative assets

     123       —           123       —     

Derivative liabilities

     (41     —           (41     —     

Nonrecurring fair value measurements:

         

Equity method investments

     440       —           440       —     

Business dispositions

     97       —           97       —     

During 2012, we recorded net gains on nonrecurring fair value measurements of approximately $220 million within Other income, net from UTC Climate, Controls & Security’s ongoing portfolio transformation efforts including the integration of the legacy UTC Fire & Security businesses with the legacy Carrier businesses. These net gains include approximately $357 million from the sales of controlling interests in manufacturing and distribution joint ventures in Asia and Canada, of which approximately $272 million was non-cash. These gains were partially offset by $103 million of other-than-temporary impairment charges related to business dispositions and a $32 million loss on the disposition of the U.S. UTC Fire & Security branch operations. In addition, we recorded a $34 million gain on the fair market measurement of the Company’s previously held interest in Goodrich.

 

(Dollars in millions)

   Total Carrying
Value at
December 31, 2011
    Quoted price in
active markets

(Level 1)
     Significant other
observable inputs

(Level 2)
    Unobservable
inputs

(Level 3)
 

Recurring fair value measurements:

         

Available-for-sale securities

   $ 926     $ 926      $ —        $ —     

Derivative assets

     114       —           114       —     

Derivative liabilities

     (165     —           (165     —     

Nonrecurring fair value measurements:

         

Equity method investment

     13       13        —          —     

During 2011, we recorded a non-cash other-than-temporary impairment charge of $66 million within Other income, net on an equity investment. The impairment charge recorded on our investment was determined by comparing the carrying value of our investment to the closing market value of the shares on the date the investment was deemed to be impaired.

Valuation Techniques. Our available-for-sale securities include equity investments that are traded in active markets, either domestically or internationally. They are measured at fair value using closing stock prices from active markets and are classified within Level 1 of the valuation hierarchy. Our derivative assets and liabilities are managed on the basis of net exposure to market and credit risks of each of the counterparties. The fair value for these derivative assets and liabilities is measured at the price that would be received on a net asset position for a particular risk or to transfer a net liability position for a particular risk in an orderly transaction between market participants at the measurement date. Our derivative assets and liabilities include foreign exchange contracts and commodity derivatives that are measured at fair value using internal models based on observable market inputs such as forward rates, interest rates, our own credit risk and our counterparties’ credit risks. Based on these inputs, the derivative assets and liabilities are classified within Level 2 of the valuation hierarchy. Based on our continued ability to trade securities and enter into forward contracts, we consider the markets for our fair value instruments to be active. As of September 30, 2012, there were no significant transfers in and out of Level 1 and Level 2.

As of September 30, 2012, there has not been any significant impact to the fair value of our derivative liabilities due to our own credit risk. Similarly, there has not been any significant adverse impact to our derivative assets based on our evaluation of our counterparties’ credit risks.

 

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Table of Contents

The following table provides carrying amounts and fair values of financial instruments that are not carried at fair value in our Condensed Consolidated Balance Sheet at September 30, 2012 and December 31, 2011:

 

     September 30, 2012     December 31, 2011  

(Dollars in millions)

   Carrying
Amount
    Fair
Value
    Carrying
Amount
    Fair
Value
 

Long-term receivables

   $ 517     $ 478     $ 283     $ 276  

Customer financing notes receivable

     350       328       309       297  

Short-term borrowings

     (5,224     (5,224     (630     (630

Long-term debt (excluding capitalized leases)

     (23,421     (26,784     (9,575     (11,639

The following table provides the valuation hierarchy classification of assets and liabilities that are not carried at fair value in our Condensed Consolidated Balance Sheet as of September 30, 2012:

 

(Dollars in millions)

  Total Fair
Value at
September 30, 2012
    Quoted price in
active markets

(Level 1)
    Significant other
observable inputs

(Level 2)
    Unobservable
inputs

(Level 3)
 

Recurring fair value measurements:

       

Long-term receivables

  $ 478     $ —        $ 478     $ —     

Customer financing notes receivable

    328       —          328       —     

Short-term borrowings

    (5,224     —          (4,996     (228

Long-term debt (excluding capitalized leases)

    (26,784     —          (26,583     (201

Valuation Techniques. Our long-term receivables and customer financing notes receivables include our commercial and aerospace long-term trade, government and other receivables, leases, and notes receivable. Our long-term receivables and customer financing notes receivables are measured at fair value using an income approach based on the present value of the contractual, promised or most likely cash flows discounted at observed or estimated market rate for comparable assets or liabilities that are traded in the market. Based on these inputs, long-term receivables and customer financing notes receivables are classified within Level 2 of the valuation hierarchy. Our short-term borrowings include commercial paper and other international credit facility agreements. Our long-term debt includes domestic and international notes. Commercial paper and domestic long-term notes are measured at fair values based on comparable transactions and current market interest rates quoted in active markets for similar assets, and are classified within Level 2 of the valuation hierarchy. Foreign short-term borrowings and foreign long-term notes are measured at fair value based on comparable transactions and rates calculated from the respective countries’ yield curves. Based on these inputs, foreign borrowings and foreign long-term notes are classified within Level 3 of the valuation hierarchy. The fair values of Accounts receivable and Accounts payable approximate the carrying amounts due to the short-term maturities of these instruments.

We had commercial aerospace financing and other contractual commitments totaling approximately $2.8 billion at September 30, 2012, which now include approximately $538 million of IAE commitments, related to commercial aircraft and certain contractual rights to provide product on new aircraft platforms. We had commercial aerospace financing and other contractual commitments of approximately $2.3 billion at December 31, 2011. Risks associated with changes in interest rates on these commitments are mitigated by the fact that interest rates are variable during the commitment term, and are set at the date of funding based on current market conditions, the fair value of the underlying collateral and the credit worthiness of the customers. As a result, the fair value of these financings is expected to equal the amounts funded. The fair value of the commitment itself is not readily determinable and is not considered significant.

Note 10: Credit Quality of Long-Term Receivables

A long-term or financing receivable represents a contractual right to receive money on demand or on fixed and determinable dates, including trade receivable balances with maturity dates greater than one year. Our long-term and financing receivables primarily represent balances related to the aerospace businesses such as long-term trade accounts receivable, leases, and notes receivable. We also have other long-term receivables in our commercial businesses; however, both the individual and aggregate amounts are not significant.

 

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Long-term trade accounts receivable represent amounts arising from the sale of goods and services with a contractual maturity date of greater than one year and are recognized as “Other assets” in our Condensed Consolidated Balance Sheet. Notes and leases receivable represent notes and lease receivables other than receivables related to operating leases, and are recognized as “Customer financing assets” in our Condensed Consolidated Balance Sheet. The following table summarizes the balance by class of aerospace long-term receivables as of September 30, 2012 and December 31, 2011:

 

(Dollars in millions)

   September 30,
2012
     December 31,
2011
 

Long-term trade accounts receivable

   $ 483      $ 204  

Notes and leases receivable

     553        365  
  

 

 

    

 

 

 

Total long-term receivables

   $ 1,036      $ 569  
  

 

 

    

 

 

 

The increases reflected above as of September 30, 2012, as compared to December 31, 2011, primarily reflect the impacts of our acquisition of Goodrich and our consolidation of IAE. See Note 1 for further discussion related to acquisitions.

Economic conditions and air travel influence the operating environment for most airlines, and the financial performance of our aerospace businesses is directly tied to the economic conditions of the commercial aerospace and defense industries. Additionally, the value of the collateral is also closely tied to commercial airline performance and may be subject to exposure of reduced valuation as a result of market declines. We determine a receivable is impaired when, based on current information and events, it is probable that we will be unable to collect amounts due according to the contractual terms of the receivable agreement. Factors considered in assessing collectability and risk include, but are not limited to, examination of credit quality indicators and other evaluation measures, underlying value of any collateral or security interests, significant past due balances, historical losses, and existing economic conditions.

Long-term receivables can be considered delinquent if payment has not been received in accordance with the underlying agreement. If determined delinquent, long-term trade accounts receivable and notes and leases receivable balances accruing interest may be placed on nonaccrual status. We record potential losses related to long-term receivables when identified. The reserve for credit losses on these receivables relates to specifically identified receivables that are evaluated individually for impairment. For notes and leases receivable, we determine a specific reserve for exposure based on the difference between the carrying value of the receivable and the estimated fair value of the related collateral in connection with the evaluation of credit risk and collectability. For long-term trade accounts receivable, we evaluate credit risk and collectability individually to determine if an allowance is necessary. Uncollectible long-term receivables are written-off when collection of the indebtedness has been pursued for a reasonable period of time without collection; the customer is no longer in operation; or judgment has been levied, but the underlying assets are not adequate to satisfy the indebtedness. At both September 30, 2012 and December 31, 2011, we do not have any significant balances that are considered to be delinquent, on non-accrual status, past due 90 days or more, or considered to be impaired.

The following table provides the balance of aerospace long-term receivables and summarizes the associated changes in the reserve for estimated credit losses and exposure for the nine months ended September 30, 2012 and 2011, respectively:

 

(Dollars in millions)

  2012     2011  

Beginning balance of the reserve for credit losses and exposure as of January 1

  $ 70     $ 42  

Provision

    1       1  

Charge-offs

    —          —     

Recoveries

    (5     (9

Other

    (5     (2
 

 

 

   

 

 

 

Ending balance of the reserve for credit losses and exposure: individually evaluated for impairment as of September 30

  $ 61     $ 32  
 

 

 

   

 

 

 

Ending balance of long-term receivables: individually evaluated for impairment as of September 30

  $ 1,036     $ 598  
 

 

 

   

 

 

 

We determine credit ratings for each customer in the portfolio based upon public information and information obtained directly from our customers. We conduct a review of customer credit ratings, published historical credit default rates for different rating categories, and multiple third party aircraft value publications as a basis to validate the reasonableness of the allowance for losses on these balances quarterly or when events and circumstances warrant. The credit ratings listed below range from “A” which indicates an extremely strong capacity to meet financial obligations and the receivable is either collateralized or uncollateralized, to “D” which

 

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indicates that payment is in default and the receivable is uncollateralized. There can be no assurance that actual results will not differ from estimates or that consideration of these factors in the future will not result in an increase or decrease to the allowance for credit losses on long-term receivables.

The following table summarizes the credit risk profile by creditworthiness category for aerospace long-term receivable balances at September 30, 2012 and December 31, 2011:

 

     September 30, 2012      December 31, 2011  

(Dollars in millions)

   Long-term
trade accounts
receivable
     Notes and
leases
receivable
     Long-term
trade accounts
receivable
     Notes and
leases
receivable
 

A - (low risk, collateralized/uncollateralized)

   $ 459      $ 26      $ 201      $ —     

B - (moderate risk, collateralized/uncollateralized)

     22        463        3        295  

C - (high risk, collateralized/uncollateralized)

     2        64        —           70  

D - (in default, uncollateralized)

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 483      $ 553      $ 204      $ 365  
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 11: Shareowners’ Equity and Noncontrolling Interest

As of January 1, 2012, we adopted the provisions of the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” As a result of this adoption, we have presented total comprehensive income for each of the periods presented within a single continuous Condensed Consolidated Statement of Comprehensive Income.

 

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A summary of the changes in shareowners’ equity and noncontrolling interest comprising total equity for the quarters and nine months ended September 30, 2012 and 2011 is provided below:

 

     Quarter Ended September 30,  
     2012     2011  

(Dollars in millions)

   Shareowners’
Equity
    Noncontrolling
Interest
    Total
Equity
    Shareowners’
Equity
    Noncontrolling
Interest
    Total
Equity
 

Equity, beginning of period

   $ 22,604     $ 1,121     $ 23,725     $ 22,723     $ 1,016     $ 23,739  

Comprehensive income (loss) for the period:

            

Net income

     1,415       96       1,511       1,324       97       1,421  

Total other comprehensive income (loss)

     1,012       23       1,035       (870     (25     (895
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income for the period

     2,427       119       2,546       454       72       526  

Common Stock issued under employee plans

     275         275       119         119  

Treasury Stock reissued under employee plans

     141         141       —            —     

Common Stock repurchased

     —            —          (675       (675

Common Stock contributed to pension plans

     —            —          450         450  

Equity Units issuance

     —            —          —            —     

Dividends on Common Stock

     (463       (463     (411       (411

Dividends on ESOP Common Stock

     (18       (18     (16       (16

Dividends attributable to noncontrolling interest

       (162     (162       (82     (82

Purchase of subsidiary shares from noncontrolling interest

     (11     (1     (12     (51     (17     (68

Sale of subsidiary shares in noncontrolling interest

     —          17       17       —          2       2  

Acquisition of noncontrolling interest

       39       39         8       8  

Disposition of noncontrolling interest

       —          —            (1     (1

Redeemable noncontrolling interest in subsidiaries’ earnings

       (11     (11       (4     (4

Redeemable noncontrolling interest in total other comprehensive income (loss)

       (7     (7       4       4  

Change in redemption value of put options

     —            —          (3       (3

Redeemable noncontrolling interest reclassification to noncontrolling interest

       21       21         —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity, end of period

   $ 24,955     $ 1,136     $ 26,091     $ 22,590     $ 998     $ 23,588  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Nine Months Ended September 30,  
     2012     2011  

(Dollars in millions)

   Shareowners’
Equity
    Noncontrolling
Interest
    Total
Equity
    Shareowners’
Equity
    Noncontrolling
Interest
    Total
Equity
 

Equity, beginning of period

   $ 21,880     $ 940     $ 22,820     $ 21,385     $ 947     $ 22,332  

Comprehensive income for the period:

            

Net income

     3,073       267       3,340       3,654       298       3,952  

Total other comprehensive income

     827       4       831       3       13       16  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income for the period

     3,900       271       4,171       3,657       311       3,968  

Common Stock issued under employee plans

     608         608       566         566  

Treasury Stock reissued under employee plans

     141         141       —            —     

Common Stock repurchased

     —            —          (2,175       (2,175

Common Stock contributed to pension plans

     —            —          450         450  

Equity Units issuance

     (216       (216     —            —     

Dividends on Common Stock

     (1,288       (1,288     (1,192       (1,192

Dividends on ESOP Common Stock

     (50       (50     (47       (47

Dividends attributable to noncontrolling interest

       (292     (292       (248     (248

Purchase of subsidiary shares from noncontrolling interest

     (19     (4     (23     (51     (17     (68

Sale of subsidiary shares in noncontrolling interest

     —          52       52       3       10       13  

Acquisition of noncontrolling interest

       94       94         13       13  

Disposition of noncontrolling interest

       (4     (4       (1     (1

Redeemable noncontrolling interest in subsidiaries’ earnings

       (22     (22       (15     (15

Redeemable noncontrolling interest in total other comprehensive income

       1       1         (2     (2

Change in redemption value of put options

     (1       (1     (6       (6

Redeemable noncontrolling interest reclassification to noncontrolling interest

       100       100         —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity, end of period

   $ 24,955     $ 1,136     $ 26,091     $ 22,590     $ 998     $ 23,588  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

A summary of the changes in each component of accumulated other comprehensive (loss) income for the quarter and nine months ended September 30, 2012 is provided below:

 

(Dollars in millions)

   Foreign
Currency
Translation
    Defined
Benefit
Pension and
Post-
retirement
Plans
    Unrealized Gains
(Losses) on
Available-for-Sale
Securities
    Unrealized
Hedging
(Losses)
Gains
    Accumulated
Other
Comprehensive
(Loss) Income
 

Balance at December 31, 2011

   $ 206     $ (5,810   $ 164     $ (50   $ (5,490

Other comprehensive income - quarter ended March 31, 2012

     318       99       11       61       489  

Other comprehensive (loss) income - quarter ended June 30, 2012

     (628     136       (42     (140     (674

Other comprehensive income - quarter ended September 30, 2012

     690       187       2       133       1,012  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 586     $ (5,388   $ 135     $ 4     $ (4,663
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

All noncontrolling interests with redemption features, such as put options, that are not solely within our control (redeemable noncontrolling interests) are reported in the mezzanine section of the Condensed Consolidated Balance Sheet, between liabilities and equity, at the greater of redemption value or initial carrying value.

 

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A summary of the changes in redeemable noncontrolling interest recorded in the mezzanine section of the Condensed Consolidated Balance Sheet for the quarters and nine months ended September 30, 2012 and 2011 is provided below:

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Redeemable noncontrolling interest, beginning of period

   $ 238     $ 348     $ 358     $ 317  

Net income

     11       4       22       15  

Foreign currency translation, net

     7       (4     (1     2  

Dividends attributable to noncontrolling interest

     (2     —          (13     (11

Purchase of subsidiary shares from noncontrolling interest

     —          (2     (34     (2

Change in redemption value of put options

     —          3       1       6  

Redeemable noncontrolling interest reclassification to noncontrolling interest

     (21     —          (100     —     

Other changes in redeemable noncontrolling interest

     —          (22     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Redeemable noncontrolling interest, end of period

   $ 233     $ 327     $ 233     $ 327  
  

 

 

   

 

 

   

 

 

   

 

 

 

Changes in noncontrolling interests that do not result in a change of control and where there is a difference between fair value and carrying value are accounted for as equity transactions. A summary of these changes in ownership interests in subsidiaries and the effect on shareowners’ equity for the quarters and nine months ended September 30, 2012 and 2011 is provided below:

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Net income attributable to common shareowners

   $ 1,415     $ 1,324     $ 3,073     $ 3,654  
  

 

 

   

 

 

   

 

 

   

 

 

 

Transfers to noncontrolling interests:

        

Increase in common stock for sale of subsidiary shares

     —          —          —          3  

Decrease in common stock for purchase of subsidiary shares

     (11     (51     (19     (51
  

 

 

   

 

 

   

 

 

   

 

 

 

Change from net income attributable to common shareowners and transfers to noncontrolling interests

   $ 1,404     $ 1,273     $ 3,054     $ 3,606  
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 12: Guarantees

We extend a variety of financial, market value and product performance guarantees to third parties. As disclosed in Note 1, on June 29, 2012 Pratt & Whitney, Rolls-Royce, MTU and JAEC, completed a restructuring of their interests in IAE. This transaction has resulted in an increase in our net proportionate share of IAE’s obligations from 33% to 61%. There were no material changes to IAE’s financing arrangements, which, as previously disclosed, were $989 million as of December 31, 2011.

As disclosed in Note 1, on July 26, 2012 we completed the acquisition of Goodrich. The acquisition of Goodrich resulted in an increase in credit facilities and debt obligations of unconsolidated subsidiaries of approximately $156 million related to the maximum potential payout under those facilities and obligations, with no associated carrying amount of a liability as of September 30, 2012.

There have been no other material changes to guarantees outstanding since December 31, 2011.

The changes in the carrying amount of service and product warranties and product performance guarantees for the nine months ended September 30, 2012 and 2011 are as follows:

 

(Dollars in millions)

   2012     2011  

Balance as of January 1

   $ 1,468     $ 1,136  

Warranties and performance guarantees issued

     235       370  

Settlements made

     (217     (333

Other

     (165     315  
  

 

 

   

 

 

 

Balance as of September 30

   $ 1,321     $ 1,488  
  

 

 

   

 

 

 

 

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The decrease in the above table in “Other” during the nine months ended September 30, 2012 primarily reflects a decrease for Clipper warranty reserves reclassified to Liabilities of Discontinued Operations during the quarter ended March 31, 2012, partially offset by an increase from our acquisition of Goodrich. See Note 2 and Note 1, respectively, for further discussion. The increase reflected in “Other” during the nine months ended September 30, 2011 primarily reflected the impact of finalizing purchase accounting on the acquisition of Clipper.

Note 13: Contingent Liabilities

Summarized below are the matters previously described in Note 17 of the Notes to the Consolidated Financial Statements in our 2011 Annual Report, incorporated by reference in our 2011 Form 10-K, updated as applicable.

Environmental. 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. We accrue for the costs of environmental investigatory, remediation, operating and maintenance costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. The most likely cost to be incurred is accrued based on an evaluation of currently available facts with respect to each individual site, including existing technology, current laws and regulations and prior remediation experience. Where no amount within a range of estimates is more likely, we accrue the minimum. For sites with multiple responsible parties, we consider our likely proportionate share of the anticipated remediation costs and the ability of the other parties to fulfill their obligations in establishing a provision for those costs. We discount liabilities with fixed or reliably determinable future cash payments. We do not reduce accrued environmental liabilities by potential insurance reimbursements. We periodically reassess these accrued amounts. We believe that the likelihood of incurring losses materially in excess of amounts accrued is remote.

In conjunction with the completion of our acquisition of Goodrich on July 26, 2012, we recorded additional environmental reserves of $232 million. See Note 1 for further discussion.

Government. We are now, and believe that in light of the current U.S. government contracting environment we will continue to be, the subject of one or more U.S. government investigations. If we or one of our business units were charged with wrongdoing as a result of any of these investigations or other government investigations (including violations of certain environmental or export laws) the U.S. government could suspend us from bidding on or receiving awards of new U.S. government contracts pending the completion of legal proceedings. If convicted or found liable, the U.S. government could fine and debar us from new U.S. government contracting for a period generally not to exceed three years. The U.S. government could void any contracts found to be tainted by fraud.

Our contracts with the U.S. government are also subject to audits. 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 involve substantial amounts. We have made voluntary refunds in those cases we believe appropriate, have settled some allegations and continue to litigate certain other cases. In addition, we accrue for liabilities associated with those matters that are probable and can be reasonably estimated. The most likely settlement amount to be incurred is accrued based upon a range of estimates. Where no amount within a range of estimates is more likely, then we accrue the minimum amount.

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 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 now seeks a total award in this case of $661 million, including interest and penalties. Pratt & Whitney continues to contend that the government suffered no actual damages. 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.

 

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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 $93 million (including interest through September 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 started on October 22, 2012, and the court is expected to issue its decision in 2013. 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 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 ITAR. DTCC administers the State Department’s authority under the 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 ITAR; (3) continue and undertake additional remedial actions to strengthen 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 legacy Hamilton Sundstrand to Pratt & Whitney Canada (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 legacy 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, legacy Hamilton Sundstrand and UTC made false statements in disclosures to DTCC regarding these ITAR violations; and (3) that P&WC and legacy Hamilton Sundstrand violated a separate provision of the ITAR by failing timely to notify DTCC of the unlicensed software shipments to China, an embargoed country. P&WC pleaded guilty to violating 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, legacy 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 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 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.

By reason of P&WC’s guilty plea to a criminal violation of 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. Various military department and defense agency officials are also reviewing 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. We do not believe the ultimate resolution of these matters, individually or collectively, will have a material adverse effect on our competitive position, results of operations, cash flows or financial condition.

 

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As previously disclosed in footnotes regarding Income Taxes that accompany the financial statements included in UTC’s Reports on Form 10-Q and 10-K, UTC has been involved in administrative review proceedings with the German Tax Office concerning €198 million (approximately $257 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 was denied 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 vigorously to litigate 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. We extend performance and operating cost guarantees beyond our normal warranty and service policies for extended periods on some of our products. We have accrued our estimate of the liability that may result under these guarantees and for service costs that are probable and can be reasonably estimated.

Like many other industrial companies in recent years, we or our subsidiaries are named as a defendant in lawsuits alleging personal injury as a result of exposure to asbestos integrated into certain of our products or premises. While we have never manufactured asbestos and no longer incorporate it in any currently-manufactured products, certain of our historical products, like those of many other manufacturers, have contained components incorporating asbestos. A substantial majority of these asbestos-related claims have been covered by insurance or other forms of indemnity or have been dismissed without payment. The remainder of the closed cases have been resolved for amounts that are not material individually or in the aggregate. While insurance coverage litigation is pending against a number of Goodrich insurers, based on information currently available we do not believe that resolution of asbestos-related matters will have a material adverse effect upon our competitive position, results of operations, cash flows or financial condition.

We are involved in a number of other legal proceedings, investigations and other contingency matters, including government audit matters, environmental investigatory, remediation, operating and maintenance costs, performance guarantees, self-insurance programs and matters arising out of the normal course of business. We are also subject to a number of routine lawsuits, investigations and claims (some of which involve substantial amounts) arising out of the ordinary course of our business. Many of these proceedings are at preliminary stages, and many of these cases seek an indeterminate amount of damages. We regularly evaluate the status of legal proceedings in which we are involved, to assess whether a loss is probable or there is a reasonable possibility that a loss or additional loss may have been incurred and determine if accruals and related disclosures are appropriate. The Company has established reserves for several hundred of its legal proceedings and other matters. We accrue contingencies based upon a range of possible outcomes. If no amount within this range is a better estimate than any other, then we accrue the minimum amount. With respect to any additional losses that may be incurred in excess of those accrued, either they are considered not material or we do not believe that a range of reasonably possible losses (defined by the relevant accounting literature to include all potential losses other than those deemed “remote”) can be determined. We do not believe that these matters will have a material adverse effect upon our competitive position, results of operations, cash flows or financial condition.

All forward-looking statements concerning the possible or anticipated outcome of environmental, investigatory, litigation proceedings and other contingency matters involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. For further information as to these risks and uncertainties, see “Cautionary Note Concerning Factors That May Affect Future Results” and Part II, Item 1A, “Risk Factors” in this Form 10-Q.

Note 14: Segment Financial Data

Our operations are classified into five principal segments: Otis, UTC Climate, Controls & Security, Pratt & Whitney, UTC Aerospace Systems and Sikorsky. The segments are generally based on the management structure of the businesses and the grouping of similar operating companies, where each management organization has general operating autonomy over diversified products and services. On September 28, 2011, we announced a new organizational structure that allows us to better serve customers through greater integration across product lines. Effective January 1, 2012, we formed the UTC Climate, Controls & Security segment which combines the former Carrier and UTC Fire & Security segments. Subsequent to the completion of our acquisition of Goodrich on July 26, 2012, the Goodrich businesses were combined with the legacy Hamilton Sundstrand businesses to form the new UTC Aerospace Systems segment. Effective July 1, 2012, the APU business of UTC Aerospace Systems 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 segment results have not been restated for the transfer of the business. See Note 1 for further information on our acquisition of Goodrich.

 

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Results for the quarters and nine months ended September 30, 2012 and 2011 are as follows:

 

Quarter Ended September 30,    Net Sales     Operating Profits     Operating Profit Margins  

(Dollars in millions)

   2012     2011     2012     2011     2012     2011  

Otis

   $ 3,054     $ 3,262     $ 651     $ 731       21.3     22.4

UTC Climate, Controls & Security

     4,259       4,921       632       615       14.8     12.5

Pratt & Whitney

     3,574       3,081       409       496       11.4     16.1

UTC Aerospace Systems

     2,670       1,187       271       204       10.1     17.2

Sikorsky

     1,649       1,877       203       215       12.3     11.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segments

     15,206       14,328       2,166       2,261       14.2     15.8

Eliminations and other

     (164     (93     (22     (8    

General corporate expenses

     —          —          (103     (102    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 15,042     $ 14,235     $ 2,041     $ 2,151       13.6     15.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
Nine Months Ended September 30,    Net Sales     Operating Profits     Operating Profit Margins  

(Dollars in millions)

   2012     2011     2012     2011     2012     2011  

Otis

   $ 8,851     $ 9,226     $ 1,868     $ 2,104       21.1     22.8

UTC Climate, Controls & Security

     12,943       14,454       1,965       1,751       15.2     12.1

Pratt & Whitney

     10,073       9,230       1,225       1,348       12.2     14.6

UTC Aerospace Systems

     5,160       3,496       680       561       13.2     16.0

Sikorsky

     4,615       5,245       552       633       12.0     12.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segments

     41,642       41,651       6,290       6,397       15.1     15.4

Eliminations and other

     (377     (274     (54     (101    

General corporate expenses

     —          —          (303     (295    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

   $ 41,265     $ 41,377     $ 5,933     $ 6,001       14.4     14.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Note 8 to the Condensed Consolidated Financial Statements for a discussion of restructuring costs included in segment operating results.

Note 15: Accounting Pronouncements

In December 2011, the FASB issued ASU No. 2011-11, “Disclosures about Offsetting Assets and Liabilities.” This ASU is intended to enhance a financial statement user’s ability to understand the effects of netting arrangements on an entity’s financial statements, including financial instruments and derivative instruments that are either offset or subject to an enforceable master netting or similar arrangement. The scope of this ASU includes derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. This ASU includes enhanced disclosure requirements, including both gross and net information about instruments and transactions eligible for offset or subject to an agreement similar to a master netting arrangement. The provisions of this ASU will be applied retrospectively for interim and annual periods beginning on or after January 1, 2013. We will adopt the disclosure requirements of this ASU beginning in the first quarter of 2013.

 

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With respect to the unaudited condensed consolidated financial information of UTC for the quarters and nine months ended September 30, 2012 and 2011, PricewaterhouseCoopers LLP (PricewaterhouseCoopers) reported that it has applied limited procedures in accordance with professional standards for a review of such information. However, its report dated October 26, 2012, appearing below, states that the firm did not audit and does not express an opinion on that unaudited condensed consolidated financial information. PricewaterhouseCoopers has not carried out any significant or additional audit tests beyond those that would have been necessary if their report had not been included. Accordingly, the degree of reliance on its report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers is not subject to the liability provisions of Section 11 of the Securities Act of 1933 (the Act) for its report on the unaudited condensed consolidated financial information because that report is not a “report” or a “part” of a registration statement prepared or certified by PricewaterhouseCoopers within the meaning of Sections 7 and 11 of the Act.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareowners of United Technologies Corporation:

We have reviewed the accompanying condensed consolidated balance sheet of United Technologies Corporation and its subsidiaries as of September 30, 2012 and the related condensed consolidated statement of comprehensive income for the three-month and nine-month periods ended September 30, 2012 and 2011 and the condensed consolidated statement of cash flows for the nine-month periods ended September 30, 2012 and 2011. This interim financial information is the responsibility of the Corporation’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying condensed consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2011, and the related consolidated statements of operations, of cash flows and of changes in equity for the year then ended (not presented herein), and in our report dated February 9, 2012, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2011, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP

Hartford, Connecticut

October 26, 2012

 

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Item 2. 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 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.”

On September 28, 2011, we announced a new organizational structure that allows us to better serve customers through greater integration across product lines. 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, UTC acquired Goodrich Corporation (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 legacy Hamilton Sundstrand business have been combined to form a new segment named UTC Aerospace 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 nine months ended September 30, 2012 do not reflect a full nine months 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 acquisition materially affected UTC’s results of operations and financial position.

Certain reclassifications have been made to the prior year amounts to conform to the current year presentation. The current status of significant factors impacting our business environment in 2012 is discussed below. For additional discussion, refer to the “Business Overview” section in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2011 Annual Report, which is incorporated by reference in our 2011 Form 10-K.

General

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 businesses include both commercial and aerospace operations, original equipment manufacturing (OEM) and extensive related aftermarket parts and services businesses, as well as the combination of shorter cycles at UTC Climate, Controls & Security and at our commercial aerospace aftermarket businesses, and longer cycles at Otis and at 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.

Economic projections indicate minimal growth through 2013 within Europe as it struggles to find a permanent solution to its debt crisis. This uncertainty has adversely affected UTC sales and profit growth due to an unfavorable Euro foreign exchange rate and lower sales volumes in the region. Improvements in economic growth rates in the United States are threatened by the potential for sequestration in early 2013. Unfortunately, it remains difficult to estimate the probability of policy action in the United States, and this uncertainty contributes to lower growth rates in the United States. U.S. Government defense spending, together with the European market, represents over 40% of UTC sales. China’s reported third quarter GDP growth rate was 7.4%, which while still strong was its lowest growth rate since 2009 on tightening credit conditions and decreased public investment. Despite the recent lower growth rates, China is projected to generate over one-quarter of world GDP growth in 2013. With an uneven growth outlook, we continue to take preemptive steps to position our business for future earnings growth by further reducing operating costs even as we continue to invest in new product launches and growth markets. As a result, we are increasing our 2012 full year estimate of restructuring costs in continuing operations from $500 million to $600 million.

Discontinued Operations

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 is intended to be used to repay debt incurred to finance the acquisition of Goodrich. These divestitures are expected to generate approximately $3 billion in net cash, on an after-tax basis. 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 losses expected on disposition, and the related cash flows which result from these non-core businesses have been reclassified to Discontinued Operations in our Condensed Consolidated Statements of Comprehensive Income and Cash Flows for all periods presented. Cash flows from the operation of these discontinued businesses are expected to continue until their disposals, most of which are expected to occur in the second half of 2012. As a result of the decision to dispose of these businesses, the Company recorded pre-tax goodwill impairment charges of approximately $360 million and $590 million related to Rocketdyne and Clipper, respectively, in discontinued operations during the first quarter of 2012, and pre-tax net

 

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asset impairment charges of approximately $179 million related to UTC Power in discontinued operations during the second quarter of 2012. The goodwill impairment charges result from the decision to dispose of both Rocketdyne and Clipper within a relatively short period after acquiring the businesses. 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 results from adjusting the net assets of the business to the estimated fair value less costs to sell the business expected to be realized upon sale, and further reflects the loss in value from the disposition of the business before the benefits of the technology investments could be fully realized. There could be additional gains or losses recorded upon final disposition of the businesses based upon the values, terms and conditions that are ultimately negotiated.

Acquisition and Disposition Activity

As discussed below in “Results of Operations,” our results include 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, including those related to the ongoing portfolio transformation at UTC Climate, Controls & Security. Our growth strategy contemplates acquisitions. Our operations and results can be affected by the rate and extent to which appropriate acquisition opportunities are available, acquired businesses are effectively integrated, and anticipated synergies or cost savings are achieved.

During the first nine months of 2012, our investment in business acquisitions was approximately $18.6 billion (including net debt assumed of approximately $2.6 billion), and consisted primarily of our acquisition of Goodrich, an increase of our interest in IAE International Aero Engines AG (IAE) and a number of additional small acquisitions in our commercial and aerospace businesses. We recorded the excess of the purchase price over the estimated fair value of the assets acquired as an increase in goodwill. As a result of acquisition activity in the first nine months of 2012, goodwill increased $11.6 billion, of which $11.2 billion was a result of the Goodrich acquisition.

On July 26, 2012, we completed the acquisition of Goodrich, a global supplier of systems and services to the aerospace and defense industry with 2011 sales of $8.1 billion. Goodrich products include aircraft nacelles, interior, actuation, landing and electronic systems. Under the terms of the agreement, Goodrich shareholders received $127.50 in cash for each share of Goodrich common stock they owned on July 26, 2012. This equated to a total enterprise value of $18.3 billion, including $1.9 billion in net debt assumed. The acquisition of Goodrich and the formation of UTC Aerospace Systems provides increased scale, financial strength and complementary product offerings, allowing us to significantly strengthen our position in the aerospace and defense industry, create aftermarket efficiencies for our customers, accelerate our ability to drive innovation within the aerospace industry, and enhance our ability to support our customers with more integrated systems. This acquisition, coupled with our acquisition of an additional interest in IAE resulting in a controlling interest in IAE, as discussed below, further advances the Company’s strategy of focusing on our core businesses.

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

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 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 an agreement to license its V2500 intellectual property to 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 conditional upon each hour flown by V2500-powered aircraft in service at the closing date of the purchase from Rolls-Royce during the fifteen year period following closing of the purchase. The collaboration interest and intellectual property licenses are reflected as intangible assets and will be amortized in relation to the economic benefits received over the remaining estimated 30 year life of the V2500 program. Rolls-Royce will continue to support the program as a strategic supplier for the V2500 engine and continue to manufacture parts and assemble engines. 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. As a result of these transactions, Pratt & Whitney holds a 61% net interest in the collaboration and a 49.5% ownership interest in IAE. Based on the criteria set forth in the Consolidation Topic of the FASB Accounting Standards Codification (ASC), we have determined that IAE is a variable interest entity (VIE). IAE’s business purpose is to coordinate the design, development, manufacturing and product support of, the V2500 program through involvement with the collaborators. IAE retains limited equity with the primary economics of the V2500 program passed to the participants in the separate collaboration arrangement. As such, UTC is determined to be the primary beneficiary of IAE as it absorbs the significant economics of IAE and has the power to direct the activities that are considered most significant to IAE. The consolidation of IAE resulted in a gain of $21 million recognized during the second quarter of 2012 on the re-measurement to fair value of our previously held equity interest on obtaining control of IAE.

 

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We now expect to invest approximately $300 million in acquisitions in 2012, excluding spending for the acquisition of Goodrich and Rolls-Royce’s interests in IAE. However, actual acquisition spending may vary depending upon the timing, availability and appropriate value of acquisition opportunities.

Other

Government legislation, policies and regulations can have a negative impact on our worldwide operations. Government regulation of refrigerants and energy efficiency standards, elevator safety codes and fire protection regulations are important to our commercial businesses. Government and market-driven safety and performance regulations, restrictions on aircraft engine noise and emissions, and government procurement practices can impact our aerospace and defense businesses.

Commercial airline financial distress and consolidation, global economic conditions, changes in raw material and commodity prices, interest rates, foreign currency exchange rates, energy costs, and the impact from natural disasters and weather conditions create uncertainties that could impact our earnings outlook for the remainder of 2012. See Part II, Item 1A, “Risk Factors” in this Form 10-Q for further discussion.

CRITICAL ACCOUNTING ESTIMATES

Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses. We believe 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. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 1 to the Consolidated Financial Statements in our 2011 Annual Report, incorporated by reference in our 2011 Form 10-K, describe the significant accounting estimates and policies used in preparation of the Consolidated Financial Statements. Actual results in these areas could differ from management’s estimates. There have been no significant changes in our critical accounting estimates during the first nine months of 2012. During the third quarter of 2012, we have conformed Goodrich’s accounting policies to UTC’s accounting policies.

RESULTS OF OPERATIONS

Net Sales

 

     Quarter Ended September 30,      Nine Months Ended September 30,  

(Dollars in millions)

   2012      2011      2012      2011  

Net Sales

   $ 15,042      $ 14,235      $ 41,265      $ 41,377  

The 6% increase in net sales for the third quarter of 2012 primarily reflects the impact of net acquisitions (11%), the adverse impact of foreign currency translation (3%) and organic sales decline (2%). The sales increase from acquisitions was primarily a result of Goodrich and IAE sales, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. During the third quarter of 2012, UTC Aerospace Systems experienced organic sales growth (6%) driven by higher aerospace OEM sales. This was more than offset by a contraction in Sikorsky organic sales (12%), driven by reduced aircraft deliveries from foreign military operations (12%). Sikorsky’s organic sales decline in the third quarter of 2012 follows organic growth of 21% in the third quarter of 2011. Our remaining business segments, Otis (1%), UTC Climate, Controls & Security (2%) and Pratt & Whitney (1%) each experienced organic sales declines in the third quarter.

Sales in the first nine months of 2012 are consistent with sales levels in the prior year with the impact of net acquisitions (2%) offset by the adverse impact of foreign currency translation (2%). During the first nine months of 2012, two of the five business segments experienced organic sales growth: UTC Aerospace Systems (8%) and Pratt & Whitney (3%). The organic growth at UTC Aerospace Systems is driven by higher aerospace OEM (6%) and aerospace aftermarket (1%) volumes. Pratt & Whitney’s organic growth is primarily a result of higher military engine and aftermarket sales (6%), partially offset by declines in Commercial spares sales (3%). Sikorsky organic sales contracted 12%, in the first nine months of 2012, following 13% organic growth in the first nine months of 2011, driven by reduced aircraft deliveries from foreign military operations (10%) in 2012.

 

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Cost of Products and Services Sold

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Cost of products sold

   $ 8,278     $ 7,519     $ 21,724     $ 21,650  

Percentage of product sales

     76.4     75.3     75.3     74.9

Cost of services sold

   $ 2,725     $ 2,819     $ 8,143     $ 8,308  

Percentage of service sales

     64.8     66.4     65.6     66.6

Total cost of products and services sold

   $ 11,003     $ 10,338     $ 29,867     $ 29,958  

The factors contributing to the total percentage change year-over-year for the quarter and nine months ended September 30, 2012 in total cost of products and services sold are as follows:

 

     Quarter Ended
September 30, 2012
    Nine Months Ended
September 30, 2012
 

Organic volume

     (2 )%      —     

Foreign currency translation

     (3 )%      (2 )% 

Acquisitions and divestitures, net

     11     

Other

     —          —     
  

 

 

   

 

 

 

Total % Change

         —     
  

 

 

   

 

 

 

The organic decrease in total cost of products and services sold (2%) in the third quarter of 2012 corresponded to the organic sales decline (2%) noted above. The increase in “Acquisitions and divestitures, net” (11%) is largely attributable to the acquisitions of Goodrich and IAE, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. The year-over-year increase in cost of products sold, as a percentage of product sales, reflects the higher proportion of commercial aerospace OEM sales as a result of lower commercial aerospace spares sales volume during the third quarter of 2012, partially offset by adverse impact of Goodrich and IAE.

Cost of sales in the first nine months of 2012 are consistent with levels in the prior year with the impact of net acquisitions (2%) offset by the favorable impact of foreign currency translation (2%). The 2% increase in “Acquisitions and divestitures, net” is attributable the acquisitions of Goodrich and IAE, partially offset by the ongoing portfolio transformation initiatives at UTC Climate, Controls & Security. The year-over-year decrease in cost of services sold, as a percentage of service sales, reflects favorable aftermarket service performance within the aerospace businesses.

Gross Margin

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Gross margin

   $ 4,039     $ 3,897     $ 11,398     $ 11,419  

Percentage of net sales

     26.9     27.4     27.6     27.6

The 50 basis point decline in gross margin as a percentage of sales for the third quarter of 2012 is due to the adverse impact of the acquisitions of Goodrich and IAE (70 basis points) as well as higher restructuring expense recorded in the third quarter relative to the same period of the prior year (20 basis points), partially offset by the disposition of lower margin businesses in connection with the UTC Climate, Controls & Security portfolio transformation (40 basis points).

Gross margin as a percentage of sales for the first nine months of 2012 is consistent with the prior year. The benefit from the disposition of lower margin businesses in connection with the UTC Climate, Controls & Security portfolio transformation (40 basis points) was offset by the adverse impact of the acquisitions of Goodrich and IAE (20 basis points) and higher restructuring expense in 2012 (20 basis points).

 

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Research and Development

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Company-funded

   $ 590     $ 465     $ 1,659     $ 1,427  

Percentage of net sales

     3.9     3.3     4.0     3.4

Customer-funded

   $ 508     $ 397     $ 1,146     $ 1,066  

Percentage of net sales

     3.4     2.8     2.8     2.6

Research and development spending is subject to the variable nature of program development schedules and, therefore, year-over-year fluctuations in spending levels are expected. The majority of the company-funded spending is incurred by the aerospace businesses. The year-over-year increase in company-funded research and development (27%) in the third quarter of 2012 primarily reflects an increase at UTC Aerospace Systems as a result of incremental research and development spending related to the Goodrich businesses (23%). Company-funded research and development spending also increased at Pratt & Whitney (6%) to further advance development primarily on military and commercial platforms.

The increase in company-funded research and development expenses for the first nine months of 2012 (16%) primarily reflects an increase at UTC Aerospace Systems (8%) as a result of spending by the Goodrich businesses and at Pratt & Whitney (7%) to further advance development of multiple geared turbo fan platforms and military engines. The remaining increase in company-funded research and development expenses is primarily in support of military programs at Sikorsky (1%). We continue to expect company-funded research and development for the full year 2012, excluding spending related to the former Goodrich businesses, to increase about $150 million, as compared with 2011, in support of multiple next generation aerospace platforms.

Selling, General and Administrative

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Selling, general and administrative expenses

   $ 1,619     $ 1,512     $ 4,657     $ 4,538  

Percentage of net sales

     10.8     10.6     11.3     11.0

Selling, general and administrative expenses increased 7% in the third quarter of 2012 due primarily to additional expenses related to the former Goodrich and IAE businesses (9%), higher pension and other employee related expenses (2%) and higher restructuring costs (1%), partially offset by the impact of favorable foreign exchange translation (4%).

Selling, general and administrative expenses increased 3% in the first nine months of 2012, due primarily to additional expenses related to acquisitions, net of divestitures completed over the preceding twelve months (3%), higher restructuring costs (2%), and higher pension and other employee related expenses (1%), all of which were partially offset by the impact of favorable foreign exchange translation (3%). The 30 basis point year-over-year increase as a percent of sales also reflects these higher acquisition related and restructuring costs.

Other Income, Net

 

     Quarter Ended September 30,      Nine Months Ended September 30,  

(Dollars in millions)

   2012      2011      2012      2011  

Other income, net

   $ 211      $ 231      $ 851      $ 547  
  

 

 

    

 

 

    

 

 

    

 

 

 

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 decrease in other income, net in the third quarter of 2012, is largely due to the absence of a $41 million gain recognized at Pratt & Whitney from the sale of an investment, and the absence of a $28 million gain resulting from dispositions associated with UTC Climate, Controls & Security’s ongoing portfolio transformation, both of which were recorded in the third quarter of 2011. Gains recognized within other income, net in the third quarter of 2012 include $34 million on the fair value re-measurement of the Company’s previously held shares of Goodrich and a $46 million gain as a result of the effective settlement of a pre-existing claim in connection with the acquisition of Goodrich. The remaining change in other income, net is attributable primarily to other normal recurring operational activity as disclosed above.

 

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The year-over-year increase in other income, net in the first nine months of 2012, largely reflects an approximately $215 million net gain from the sale of a controlling interest in a manufacturing and distribution joint venture in Asia and an approximately $142 million net gain from the sale of a controlling interest in a Canadian distribution business, partially offset by $103 million of impairment charges related to planned business dispositions and a $32 million loss on the disposition of the U.S. UTC Fire & Security branch operations, all of which are related to the ongoing UTC Climate, Controls & Security portfolio transformation. Gains recognized within other income, net in the first nine months of 2012 include $34 million on the fair value re-measurement of the Company’s previously held shares of Goodrich and a $46 million gain as a result of the effective settlement of a pre-existing claim in connection with the acquisition of Goodrich. The remaining change in other income, net is attributable primarily to net gains recognized on miscellaneous asset sales and normal recurring operational activity as disclosed above.

Interest Expense, Net

 

     Quarter Ended September 30,     Nine Months Ended September 30,  

(Dollars in millions)

   2012     2011     2012     2011  

Interest expense

   $ 260     $ 166     $ 614     $ 496  

Interest income

     (44     (27     (101     (67
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense, net

   $ 216     $ 139     $ 513     $ 429  
  

 

 

   

 

 

   

 

 

   

 

 

 

Average interest expense rate

     3.5     5.4     4.4     5.5
  

 

 

   

 

 

   

 

 

   

 

 

 

The increase in interest expense in the third quarter and for the first nine months of 2012 is a result of higher average debt balances associated with the financing of our acquisition of Goodrich. The increase in interest income in the third quarter of 2012, as compared with the same period of 2011, reflects approximately $25 million of favorable pre-tax interest adjustments related to the resolution of disputes with the Appeals Division of the IRS for the Company’s 2004 – 2005 tax years. The increase in interest income in the first nine months of 2012, as compared with the same period of 2011, also includes approximately $15 million of favorable pre-tax interest adjustments related to the conclusion of the IRS’s examination of our 2006 – 2008 tax years.

Income Taxes

 

     Quarter Ended September 30,     Nine Months Ended September 30,  
     2012     2011     2012     2011  

Effective tax rate

     26.6     31.2     23.2     31.1
  

 

 

   

 

 

   

 

 

   

 

 

 

The decrease in the effective tax rate for the quarter ended September 30, 2012, as compared to the same period of 2011, primarily reflects a reduction in tax expense of $34 million relating to the favorable resolution of disputed tax matters with the Appeals Division of the IRS for the tax years 2004 and 2005. The decrease is also the result of a reduction to the forecasted annual effective tax rate primarily due to changes in the jurisdictional mix of income and the deductibility of transaction-related expenses.

In addition to the items noted above, the decrease in the effective tax rate for the first nine months ended September 30, 2012, as compared to the same period of 2011, primarily reflects the favorable non-cash income tax impact of $203 million in the first quarter of 2012 related to the conclusion of the IRS’s examination of our 2006 through 2008 tax years. The decrease is also the result of the income tax impact of $168 million in the second quarter of 2012 related to the release of valuation allowances resulting from internal legal entity reorganizations.

We estimate our full year annual effective income tax rate in 2012 to be approximately 29%, absent non-recurring adjustments.

 

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Net Income Attributable to Common Shareowners from Continuing Operations

 

     Quarter Ended September 30,      Nine Months Ended September 30,  

(Dollars in millions, except per share amounts)

   2012      2011      2012      2011  

Net income attributable to common shareowners from continuing operations

   $ 1,247      $ 1,290      $ 3,902      $ 3,551  

Diluted earnings per share from continuing operations

   $ 1.37      $ 1.43      $ 4.31      $ 3.91  

Diluted earnings per share from continuing operations for the third quarter of 2012 includes a net $0.09 per share benefit from non-recurring items, offset by $0.09 per share of restructuring charges. The results for the third quarter of 2011 included $0.06 per sha