United Technologies 2012 Annual Report Download - page 40

38 UNITED TECHNOLOGIES CORPORATION
Sikorsky continued to benefit from military spending, with
approximately 86% of Sikorsky’s 2012 helicopter deliveries based
on military platforms. In July 2012, the U.S. Government and Sikor-
sky signed a five-year multiservice contract for approximately 650
H-60 helicopters. Actual production quantities will be determined
year-by-year over the life of the program based on funding alloca-
tions set by Congressional and Pentagon acquisition priorities.
Commercial helicopter aftermarket sales volumes were consistent
with the prior year on strong demand for the S-92 helicopter which
was offset by lower volumes of the S-76 helicopter as Sikorsky
transitions to the new S-76D helicopter.
As previously reported, Sikorsky is developing the CH-148
derivative of the H-92 helicopter (the “Cyclone”), a military variant of
the S-92 helicopter, for the Canadian Government. The Cyclone is
being developed under a fixed-price contract that provides for the
development and production of 28 helicopters (the “Acquisition
Contract”), and a related In Service Support contract (the “ISS
Contract”) through March 2028 (collectively, the “Arrangements”).
The current contract values of the Arrangements are estimated to
be $4.3 billion. Revenues are subject to changes in underlying
variables such as the timing of deliveries, future flight hours and
fluctuations in foreign currency exchange rates.
As previously disclosed, in June 2010 Sikorsky and the
Canadian Government signed contract amendments that revised
the delivery schedule and contract specifications, while also estab-
lishing requirements that enabled initial operational test and evalua-
tion activities for the first six interim aircraft. The amendments also
included modifications to the liquidated damages schedule,
readjustment of payment schedules, resolution of open disputes
and other program related enhancements.
In accordance with our revenue recognition policy, losses,
if any, on long-term contracts are provided for when anticipated.
Loss provisions on original equipment contracts are recognized to
the extent that estimated inventoriable manufacturing, engineering,
product warranty and product performance guarantee costs, as
appropriate, exceed the projected revenue from the products con-
templated under the contractual arrangement. In 2011, Sikorsky
completed a significant contractual milestone for work on four
interim configuration helicopters and recognized the revenues and
related costs. Although the Arrangements were expected to be
profitable on a combined basis in 2011, $56 million of losses were
recorded upon completing the milestones for the four aircraft as the
actual costs exceeded revenues. These interim configuration air-
craft will require further software and hardware upgrades before full
mission capability can be achieved.
Delivery of the final configuration aircraft, which was sched-
uled to begin in 2012, did not occur due to a number of disputes
between the Canadian Government and Sikorsky that arose during
the course of 2012 related to contractual requirements and con-
tract performance. These included issues related to excusable
delays, development, production, logistical support and delays in
the delivery of final configuration aircraft. The parties have been
unable to resolve these disputes and are engaged in the dispute
resolution process.
As a result of these matters, Sikorsky recorded a loss provi-
sion of $157 million during the fourth quarter of 2012 as the esti-
mated profits on the ISS Contract no longer exceeded the
estimated remaining losses on the Acquisition Contract. The profit
erosion was driven by an increase in total expected costs to be
incurred primarily as a result of the delays in delivering the final con-
figuration aircraft, and a reduction of expected flight hour revenues
on the ISS Contract. Since the Acquisition Contract’s costs exceed
its revenues on a stand-alone basis, we expect to record a $14 mil-
lion loss upon the contractual delivery of each aircraft in the future.
Sikorsky is prepared to deliver additional aircraft in a config-
uration that would allow for the commencement of certain con-
tractually required activities such as pilot training, customer testing,
and limited mission capability. These aircraft would require the
incorporation of additional hardware and software upgrades before
full mission capability can be achieved and final configuration air-
craft subsequently delivered. Sikorsky continues discussions with
the Canadian Government in an effort to resolve the open disputes
including the establishment of a potential arrangement that allows
for the delivery of interim configuration aircraft. However, if these
efforts are unsuccessful and the Canadian Government requires the
delivery of only final configuration aircraft under current contractual
requirements, no deliveries are expected to occur until 2015 at the
earliest.
While Sikorsky is committed to the program, the current
disputes and unresolved contract status, coupled with the remain-
ing development issues and long-term nature of this program, pro-
vide substantial uncertainty and risk in regards to the future
profitability of the overall program. While the loss provisions
recorded to date reflect management’s best estimate of the pro-
jected costs to complete the development and manufacture of the
final configuration aircraft, there is still significant effort required to
complete the development of the mission system capability as well
as complete the manufacturing, testing and retrofit activities. Future
variability in internal cost targets related to the aircraft may be
caused by increases in holding costs, retrofit estimates, subcon-
tractor performance and changes in liquidated damages. With
respect to the multi-year ISS Contract, the future profitability is
dependent upon a number of factors including aircraft flight hours,
deployed aircraft availability, aircraft performance, availability of
trained pilots and government budgetary pressures. The inability to
achieve a satisfactory contractual solution, further unplanned
delays, additional developmental cost growth or variations in any of
the estimates used in the existing contract analysis could lead to
further loss provisions on the Arrangements. Additional losses could
have a material adverse impact on the consolidated results of oper-
ations in the period in which the loss may be recognized.