United Technologies 2012 Annual Report Download - page 39

Management’s Discussion and Analysis 2012 ANNUAL REPORT 37
2011 Compared with 2010
Organic sales growth was 7%, with the recovery in the transport
refrigeration market partially offset by declines in the U.K. and U.S.
service businesses. The 4% decrease in “Acquisitions and divest-
itures, net” primarily reflects the net impact from acquisitions and
the business transformation actions completed in the preceding
twelve months as part of UTC Climate, Controls & Security’s
ongoing portfolio transformation initiative.
The operational profit improvement of 13% was driven by
strong conversion on organic sales growth (7%), particularly in the
higher margin transport refrigeration business, lower bad debt
expense, and earnings improvement in a joint venture in Japan
(2%). This was partially offset by lower margins and unfavorable
sales mix primarily within the fire protection products business in
the U.K. and higher net commodity costs (6%). The 9% increase in
“Other” primarily reflects the year-over-year impact of net gains
associated with UTC Climate, Control & Security’s ongoing portfolio
transformation. This includes an approximately $80 million gain
recorded in 2011 as a result of the contribution of legacy Carrier’s
HVAC operations in Brazil, Argentina, and Chile into a new venture
controlled by Midea Group of China. Also included in “Other” is the
favorable resolution of litigation and gains on the dispositions of
U.K. security businesses and the absence of an asset impairment
charge in 2010 of approximately $58 million, all of which was parti-
ally offset by a $66 million other-than-temporary impairment charge
recorded on an equity investment in Asia in 2011.
Aerospace Businesses
The financial performance of Pratt & Whitney, UTC Aerospace
Systems and Sikorsky is directly tied to the economic conditions of
the commercial aerospace and defense aerospace industries. In
particular, Pratt & Whitney experiences intense competition for new
commercial airframe/engine combinations. Engine suppliers may
offer substantial discounts and other financial incentives, perform-
ance and operating cost guarantees, participation in financing
arrangements and maintenance agreements. At times, the aero-
space businesses also enter into development programs and firm
fixed-price development contracts, which may require the company
to bear cost overruns related to unforeseen technical and design
challenges that arise during the development stage of the program.
Customer selections of engines and components can also have a
significant impact on later sales of parts and service. Predicted traf-
fic levels, load factors, worldwide airline profits, general economic
activity and global defense spending have been reliable indicators
for new aircraft and aftermarket orders within the aerospace
industry. Spare part sales and aftermarket service trends are
affected by many factors, including usage, technological improve-
ments, pricing, regulatory changes and the retirement of older air-
craft. Performance in the general aviation sector is closely tied to
the overall health of the economy and is positively correlated to
corporate profits.
Our long-term aerospace contracts are subject to strict
safety and performance regulations which can affect our ability to
estimate costs precisely. Contract cost estimation for the develop-
ment of complex projects, in particular, requires management to
make significant judgments and assumptions regarding the com-
plexity of the work to be performed, availability of materials, the
performance by subcontractors, the timing of funding from
customers and the length of time to complete the contract. As a
result, we review and update our cost estimates on significant con-
tracts on a quarterly basis, and no less frequently than annually for
all others, or when circumstances change and warrant a mod-
ification to a previous estimate. Changes in estimates relate to the
current period impact of revisions to total estimated contract sales
and costs at completion. We record changes in contract estimates
using the cumulative catch-up method in accordance with the
Revenue Recognition Topic of the FASB Accounting Standards
Codification (“ASC”). The net decrease in operating profits as a
result of significant changes in aerospace contract estimates was
$19 million in 2012, including the revision in estimate on the Sikor-
sky CH-148 contract discussed further below. The adverse impact
of this contract adjustment was partially offset by several positive
contract adjustments recorded throughout the year largely at the
Pratt & Whitney segment. The impact of these adjustments was not
considered significant to either the sales or operating profits of the
segment in the quarter in which they were recorded other than the
impact of a contract termination which was disclosed in the Pratt &
Whitney segment results in the first quarter of 2012.
The commercial airline industry remained strong throughout
2012. Airline traffic growth rates, as measured by revenue pas-
senger miles (RPMs), stabilized during 2012 and 2011 after
rebounding in 2010. RPMs grew 5.5% in 2012, as compared with
2011, and we expect RPMs will continue to grow between 4% and
6% in 2013. We made significant investment in engineering and
development in 2012 and expect continued investment in 2013,
primarily at Pratt & Whitney as we continue to develop five separate
geared turbofan platforms to meet demand for new engines which
are fuel efficient and have reduced noise levels and exhaust emis-
sions. Although airlines have generally returned to profitability, high
fuel prices continue to challenge the airlines to consider the need
for more fuel efficient aircraft.
Deficit reduction measures considered by the U.S. Govern-
ment are expected to pressure the U.S. Department of Defense
budget in the coming years, resulting in a decline in U.S. Depart-
ment of Defense spending. Total sales to the U.S. Government of
$10.1 billion in 2012, $9.1 billion in 2011, and $9.1 billion in 2010
were 18%, 16% and 17% of total UTC sales in 2012, 2011 and
2010, respectively. The defense portion of our aerospace business
is affected by changes in market demand and the global political
environment. Our participation in long-term production and
development programs for the U.S. Government has contributed
positively to our results in 2012 and is expected to continue to
benefit results in 2013.