You will write a thorough analysis of Verizon Communications Inc. (VZ)'sannual report. The report should contain professional terminology as well as proper grammar and spelling. Please don't CUT and PASTE from web sites or annual reports.

Annual Report Project Outline I. Company Overview A. Business Segments B. Market Conditions C. Methods of Revenue Recognition II. Ratio Analysis A. Profitability B. Liquidity C. Stability D. Shareholder Value III.Summary 2 United Technologies is a global corporation comprised of five principle business segments, Otis, Carrier, Pratt & Whitney, Flight Systems (Hamilton Sundstrand and Sikorsky) and UTC Fuel Cells. Ranked in order of revenue generation, Carrier is the world's largest manufacturer of commercial and residential heating, ventilating and air conditioning systems and equipment (HVAC). Complementing this segment of the business Carrier is also a major manufacturer of commercial and transport refrigeration equipment. Pratt & Whitney represents the aerospace industry, manufacturing commercial and military aircraft engines and is also a leading supplier in the spare parts market. Otis is the world's largest elevator and escalator manufacturing, installation and service company. In order to sustain growth and meet future technological demands Otis has expanded into the market of automated people movers and developed the revolutionary new Gen2 elevator system. The Flight Systems business is comprised of two segments, Sikorsky and Hamilton Sundstrand. Sikorsky is one of the world's largest manufacturers of military and commercial helicopters and the primary supplier of transport helicopters to the U.S. Army and Navy. Hamilton Sundstrand provides aerospace and industrial products and aftermarket services and is the prime contractor for NASA's space suit/life support system and produces environmental control, life support, mechanical systems and thermal control systems for international space programs. And finally, UTC Fuel Cells builds fuel cell systems for commercial, transportation, residential, defense and space applications (including the U.S. space shuttle program). These five unique and complex businesses comprise the diverse portfolio of United Technologies. 3 As a global corporation UTC is impacted by political, economic, environmental and climatic conditions throughout the world. Doing business in over 200 countries, speaking 98 languages and funding in 163 currencies adds an additional layer of complexity to this organization. Since UTC has business operations throughout the world, changes in local government regulations and policies, including those related to investments, export policies and repatriation of earnings can have a huge impact on the financial health of the organization. Further constraints involving foreign customers in the Corporation's aerospace and defense businesses and environmental regulations by federal, state and local authorities in the United States and regulatory authorities with jurisdiction over its foreign operations bring their share of financial complications as well. Each segment of the business faces unique and challenging conditions, which, as we will see, place additional burdens on the financial position of this corporation. Changes in legislation or government policies also have an impact on the Corporation's worldwide operations. For example, governmental regulation of refrigerants is important to Carrier's businesses, while government safety regulations, restrictions on aircraft engine noise and emissions and government procurement practices can impact the Corporation's aerospace and defense businesses. Both Otis and Carrier serve customers in the commercial and residential sectors and are impacted by various economic factors, including fluctuations in commercial construction, labor costs, fuel costs, interest rate fluctuation and foreign currency and exchange rates. Pratt & Whitney and Flight Systems are tied directly to the health of the aviation and defense industries. Factors such as air traffic growth, fuel costs, air safety and consumer confidence have a direct and correlative impact on the bottomline. As a result of September 11, both Pratt & Whitney and Flight Systems have seen rapid a decline in both sales and profit margin. With the health of the airline industry in jeopardy, the long-term impact will be felt for years to come. As we begin to look into the financial health of UTC and discuss the factors impacting the financial ratios, you will gain a better appreciation for the importance of these market factors and their impacts on the major corporations in worldwide markets. 4 Earlier, we identified the business makeup of UTC, a diversified corporation comprised of 5 separate business segments. As such, each business segment has it's own method of recognizing revenues, and in several segments, there are multiple methods employed. Revenue Recognition Methods In millions of Dollars Revenues Operating Profits Operating Profit Margin 2001 2000 1999 2001 2000 1999 2001 2000 1999 Otis $6,338 $6,153 $5,654 $ 847 $ 798 $ 493 13.4% 13.0% 8.7% Carrier 8,895 8,340 7,353 590 795 459 6.6% 9.4% 6.2% Pratt & Whitney 7,679 7,366 7,647 1,308 1,200 634 17.0% 16.3% 8.3% Flight Systems 5,292 4,992 3,810 670 614 247 12.7% 12.3% 6.5% Let's begin our review with a look into Carrier since they contribute the largest portion of revenues. First, it is important to distinguish the makeup of Carrier's revenues. During 2001, 47% of Carrier's revenue was generated outside the United States and by U.S. exports. Carrier has three main methods of revenue recognition. Special orders or large commercial projects are accounted for under cost-reimbursement contracts and are recorded as work is performed and billed. Sales under installation and modernization contracts are accounted for under the percentage-of-completion method. And distribution sales (over the counter sales) are immediately recognized at the point of sale. Losses, if any, are provided for when anticipated according to GAAP requirements. Carrier also generates revenues via Intercompany and intracompany sales. All intracompany sales are eliminated during month end consolidations and revenues for Intercompany sales are recognized at the point of invoicing. Pratt & Whitney generates 14% of their revenue from sales to the U.S. Government. Sales under government and commercial fixed-price contracts and government fixedprice-incentive contracts are recorded at the time deliveries are made or, in some cases, on a percentage-of-completion basis. Sales under cost-reimbursement contracts are recorded as work is performed and billed. Sales of commercial aircraft engines 5 sometimes require participation by the Corporation in aircraft financing arrangements; when appropriate, such sales are accounted for as operating leases. Otis generated 76% of its revenues outside the United States. The majority of Otis' business is from the sales and installation of elevators and escalators and unit modernization contracts. These contracts are accounted for under the percentage-ofcompletion method and revenue can be spread over several quarters. Anticipated losses are accrued for when anticipated. Losses arise from excess inventory manufacturing and product and warranty guarantee costs over the net revenue from the contract specifics. Revenue for service sales which includes aftermarket repair and maintenance are recognized over the contractual period or as services are performed on non-contract basis. Flight Systems follows the same methods of revenue recognition as Pratt & Whitney. Sales under government and commercial fixed-price contracts and government fixedprice-incentive contracts are recorded at the time deliveries are made or, in some cases, on a percentage-of-completion basis. Sales under cost-reimbursement contracts are recorded as work is performed and billed. Sales of commercial aircraft engines sometimes require participation by the Corporation in aircraft financing arrangements; when appropriate, such sales are accounted for as operating leases. Revenue recognition for UTC is a complicated business. With diversity in product, customer type and duration of delivery, multiple methods are required and are occurring simultaneously. What, if any, is the impact of these various methods on the profitability, efficiency and leverage ratios of the corporation? Before we take a look into the financial ratios' of UTC we need to point out how certain events in 2001 have had an impact on corporate revenues. On an annual basis specific events trigger changes in the financial position of a company. Systematic risk is part of the cost of doing business. Some corporations are impacted more than others. UTC is largely impacted by several factors. First, a large portion of the business portfolio is located outside of the United States. Second, a large number of 6 sales are generated outside of the United States. Both of these circumstances are impacted by foreign currency translations and the uncertainty associated with changes in the value of foreign currency. As the dollar strengthens there is corresponding devaluation in foreign currency. For UTC this devaluation was in two primary currencies, European, i.e. Euro dollars and Asian currency. Another significant factor impacting the financial results of UTC was acquisitions and divestitures. During 2000 and 2001 Carrier enhanced their portfolio by acquiring five major businesses; Electrolux Europe, Specialty Equipment, World Dryer, International Comfort Products and 15 independent distributors merged into Carrier Distribution Company. These acquisitions resulted in an increase to revenue of 17.5%. Offsetting this increase however was a decrease in operating profits due to restructuring costs of over 300 million. And finally, and sadly, September 11 happened. While the impact of September 11 will surely be felt for years to come, an immediate impact hit Pratt & Whitney and Flight Systems. The core of both businesses is in the manufacture and sale of aerospace products. With the loss of customer confidence in airline security and resulting decline in air travel sales plummeted and anticipated future contracts were cancelled. A large portion of the portfolio consisted of the sale of spare parts within the airline industry. With major airlines decreasing flight operations and grounding unused planes, sales in this market became dry. Alternatively Sikorsky saw a small increase in the sale of the Blackhawk helicopters to the government to assist in the war on terrorism. However, this increase was not enough to offset the losses sustained by the other businesses. Now we are ready to begin our discussion on financial ratios and understand the financial health of UTC. Since we have already determined how the various companies recognize revenue, let's focus on the ratios. Some accounts believe that ratio analysis should begin with ROE using the DuPont framework. This analysis provides an in depth view of the company's strengths and weaknesses and highlights areas of concern. But before we look at profitability, let's quickly review the liquidity ratios. 7 Liquidity Current Ratio Quick Ratio Cash flow from Operations 1.34 0.67 1.84 1.14 0.56 1.42 1.15 0.57 1.38 Current ratio shows the company's ability to meet current obligations in the short term. Short term is defined as obligations due within 1 year and utilizes only current assets and liabilities. Historically, a ratio was 2 was considered risky, however the rule of thumb has changed to indicate any ratio over 1 provides adequate liquidity. In the case of UTC for each dollar in liability, UTC has 1.34 available to cover existing liabilities. Research shows the industry average is 1.28, so UTC is performing slightly better than industry. A variable to current ratio is the quick ratio which removes inventory from the calculation. As we will see a bit later on, UTC carries a high inventory value on their books, so the quick ratio should show a large drop. As you can see, the quick ratio is under 1.0, which indicates some concern in meeting current obligations. The third ratio which identifies a company's ability to meet obligations is the cash flow adequacy ratio. A sample of Fortune 500 companies shows the average adequacy ratio is .88; UTC is well above the average at 1.84. The importance in each of these trends is that they are strengthening each year, indicating management is making the changes necessary in their business conditions to meet the demands of the future. The next area we will review surrounds the profitability of UTC. Again there are several ratios' that are helpful to understand the areas of concern and ongoing trends. 2001 2000 1999 6.95 27.38 7.41 7.05 24.18 6.80 28.64 7.27 6.90 24.47 6.35 24.63 7.27 6.35 26.64 Profitability Return on Sales Gross Profit Margin Return on Total Assets Profit Margin Return on Shareholders Equity 8 Despite the difficulties outlined earlier, UTC continues to shown strength over the past three years. IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS Sales Gross margin Income from continuing operations Net income First $6,597 1,785 440 440 2001 Quarters Second Third $7,260 2,076 588 588 Fourth $6,734 1,811 565 565 $6,895 1,727 345 345 First 2000 Quarters Second Third $6,307 1,679 377 377 $6,871 1,884 509 509 $6,339 1,814 496 496 Profitability over the past 3 years is relatively stable, with the return on sales and return on assets showing continued strengthening each year. Within the various segments, all demonstrated growth in their revenue base by 16%. This growth also translated into improved operating profits for all segments except Carrier. Otis, Pratt and Flight Systems increased operating profits by 24% while Carrier's operating profits decreased by 26% due to restructuring charges of over $2 Million. Growth could have been stronger however; cost of goods sold as a percentage of sales grew from 72% to 73.8%, sales & general administrative expenses also increased by 5%. It is also important to note that while sales have increased year over year, 8% of the sales in 2001 came from newly acquired operations. In the event these acquisitions were not made, the original core businesses would have shown a decrease in sales. Again, as mentioned earlier this is due to several factors; an overall decrease in airline travel resulting in lower engine sales and aftermarket spare parts resulting from September, 11, the overall recession which caused a decrease in the construction industry trickling down into reduced sales and modernization contracts for both Otis and Carrier, and a reduction in sales in the commercial refrigeration business stemming from higher fuel prices and reduced trucking traffic within the interstate systems of the United States. Now that we understand the factors that drive company profitability, let's turn our attention to efficiency ratios. Efficiency Ratios Fixed Asset Turnover Accounts Receivable Turnover Inventory Turnover DSO Return on Assets 1.05 6.44 5.20 56.69 7.41 1.05 5.97 5.23 71.80 7.27 9 1.98 6.22 5.43 66.10 7.27 Fourth $6,689 1,859 426 426 Let's begin our review of efficiency ratios with a discussion on the fixed assets for the corporation. As a major manufacturing company, UTC has significant investments in property, plant and equipment in facilities throughout the world. As of December 31, 2001, the Corporation reported operating 37 plants in the U.S. which had 29.2 million square feet, of which 3.5 million square feet were leased; 97 plants outside the U.S. which had 20.0 million square feet, of which 2.3 million square feet were leased; 37 warehouses in the U.S. which had 10.6 million square feet, of which 6.9 million square feet were leased; and 18 warehouses outside the U.S. which had 5.9 million square feet, of which 3.7 million square feet were leased. Fixed assets are stated on the balance sheet at cost. Depreciation is computed over the assets' useful lives generally using the straight-line method, except for aerospace assets acquired prior to January 1, 1999, which are depreciated using accelerated methods. The change to straight-line depreciation for aerospace assets did not have a material impact on the Corporation's financial position. IN MILLIONS OF DOLLARS Estimated Useful Lives Perpetual 20-40 years 3-12 years - Land Buildings and improvements Machinery, tools and equipment Other, including under construction Accumulated depreciation 2001 2000 188 3,373 6,524 320 10,405 (5,856) $ 4,549 $ 193 3,403 6,292 467 10,355 (5,868) $ 4,487 $ With regards to fixed assets, for each dollar invested in fixed assets, only 1.05 of sales in generated. If you recall earlier discussions, Carrier began acquiring large distributorships and several smaller companies in 2000 and 2001. This is clearly indicated in the drop in the asset turnover between 1999 and 2001. In order to increase the asset turnover ratio UTC needs to become more efficient in the size and usage of assets. Recent news articles have indicated a move in this direction. Carrier, a division of UTC, has announced the closing and consolidation of 3 major North American plants and an undisclosed number of consolidations in Europe and Asia. In order to successfully reduce the number of physical assets housing inventories and providing manufacturing services, Carrier has identified the need to redefine their sourcing and distribution polices to meet the needs of 10 their customers while reducing overall costs associated with property, plant and equipment. The next efficiency ratio we will discuss is Accounts Receivable turnover ratio. Turnover bears a close relationship to the volume of credit sales generated by a company. The higher the turnover times, the more rapidly the average collection period. As you can see Accounts receivable turns only 6.4 times annually creating an average of 56 days for customers to pay their bills. While there has been significant improvement from 2000 and 1999, cash flow is certainly impacted by the collection period. Factors impacting the high collection period, industry average is 48 days. If you recall earlier discussions of revenue recognition you will recall that much of the billing was incremental based on the percentage of completion. With many long-term contracts in progress, billings will continue for many months, quarters and possibly years. The presentation of accounts receivable on the balance sheet makes it difficult to gauge the portion of outstanding long-term receivables versus current as the long-term receivables as lumped into other assets. Current receivables are in excess of 4 billion with 452 million reserved for doubtful accounts. Current and long-term accounts receivable include retainage and unbilled costs of approximately $153 million and $169 million at December 31, 2001 and 2000, respectively. Retainage represents amounts that, pursuant to the contract, are not due until project completion and acceptance by the customer. Unbilled costs represent revenues that are not currently billable to the customer under the terms of the contract. These items are expected to be collected in the normal course of business. The next ratio we will discuss relates to the inventory carried on the balance sheet. An efficient use of inventory will show inventory levels closely resembling monthly sales and is computed for a manufacturing corporation as cost of good sold over average inventory rather than using sales. UTC also values inventories and contracts in progress at the lower of cost or estimated realizable value and is primarily based on first-in, firstout (FIFO) or average cost methods. Costs accumulated against specific contracts or orders are stated at actual cost and materials in excess of requirements for contracts are 11 reserved and will be written-off as appropriate. Manufacturing costs are allocated to current production and firm contracts. General and administrative expenses are charged to expense as incurred. IN MILLIONS OF DOLLARS 2000 2001 Inventories consist of the following: Raw material Work-in-process Finished goods Contracts in progress $ Less: Progress payments, secured by lien, on U.S. Government contracts Billings on contracts in progress 728 1,208 2,176 2,106 6,218 $ 738 1,179 2,099 1,849 5,865 (146) (137) (2,099) $ 3,973 (1,972) $ 3,756 LIFO, inventory values would have been higher by $103 million and $106 million at December 31, 2001 and 2000. As discussed earlier, contracts in progress relate to elevator/escalator contracts and air handler and rooftop chiller installations and include costs of manufactured components, accumulated installation costs and estimated earnings on incomplete contracts. These sales contracts are typically long-term contracts to be performed over periods exceeding twelve months. Approximately 58% and 54% of total inventories and contracts in progress have been acquired or manufactured under such long-term contracts at December 31, 2001 and 2000, a portion of which is not scheduled for delivery under long-term contracts within the next twelve months. Due to these factors inventory typically turns 5.20 times annually with an average of 69 days sales in inventory. This ratio is trending upward and inventory efficiency is slowly eroding each year, from 66 days in 1999 to the current level of 69 days. These inventory levels are also indicative of the large investment in property, plant & equipment. With the number of manufacturing and distribution centers managed by UTC, the high level of inventory should be no surprise. Again, warehouse/plant consolidation efforts and better logistics would certainly help to improve the high carrying cost of inventory. 12 Overall return on assets for UTC is impacted by factors other than accounts receivable and inventory. Other assets play a significant role in the asset valuation at UTC. 2001 In Millions of Dollars Except Per Share Data (Shares in Thousands) 2000 1999 Assets Cash and cash equivalents Accounts Receivable (net for allowance of doubtful accts) Inventories and contracts in progress Future income tax benefits Other current assets Total Current Assets Customer financing assets Future income tax benefits Fixed assets Goodwill (net of accumulated amortization) Other assets Total Assets $ $ 1,558 $ 4093 3973 1378 261 11,263 665 1205 4549 6802 2485 26,969 $ 748 $ 4445 3756 1439 274 10,662 550 1065 4487 6771 1829 25,364 $ I will defer my discussion of future tax benefits until the section on the income tax structure of UTC. I will however discuss the impact of goodwill on the balance sheet. Goodwill is an intangible asset; it represents such items that identify the company such as company name, logo, reputation, credit rating, location, history of products and service. These factors allow a business to prosper above competitors. From a balance sheet perspective goodwill is booked upon the acquisition of a business. It does not represent the value associated with the UTC name but the value of the companies acquired. From a calculation perspective it represents the acquisition costs of the purchased company over the fair market values of physical assets. Goodwill is amortized using the straightline method of amortization over periods ranging from 10 to 40 years. In July 1, 2001, UTC adopted FASB 141&142, which impacted how goodwill would be amortized. Goodwill represents 25% of UTC's current assets and has decreased over the past 2 years. Research and development costs also represent the intangible assets owned by the corporation. UTC classifies R &D as costs not specifically covered by contracts and those related to the Corporation-sponsored share of research and development activity in 13 957 4337 3504 1563 266 10,627 553 873 4460 5641 2212 24,366 connection with cost-sharing arrangements are charged to expense as incurred. Over the past two years Research & Development costs have declined from 1,320 to 1,254 (million). Reductions in R&D are a result of the corporations downsizing and focus on cost reduction over the past year. UTC has invested and owns 33% interest in International Aero Engines; an international consortium organized to support and develops the V2500 commercial aircraft engine project. As party to this development opportunity UTC shares in the financing commitments of IAE. To meet this commitment UTC has invested 291 million into the IAE business and receives costs and revenues equal to the 33% investment. Beyond this ownership interest there are no corporate assets pledged to IAE. The next area of review surrounds the liabilities of the corporation. Stability Ratio Debt to Equity Debt Ratio Times Interest Earned Book Value 2.23 0.69 7.82 18.29 2.31 0.7 11.61 17.63 2.43 0.71 32.76 17.11 With the exception of long term debt, total liabilities have decreased over the past 3 years. The decrease in Payables, accrued liabilities and short term debt are responsible for the decrease in the debt to equity ratio. Long term debt however, is a concern since this is predictive of a firms liabilities and their ability to service the debt. This debt is also apparent in the times interest earned ratios. As you can see in the calculations the interest requirements coverage has decreased significantly over the past 3 years. IN MILLIONS OF DOLLARS Weighted Average Interest Rate Notes and other debt denominated in: U.S. dollars Foreign currency Capital lease obligations ESOP debt 6.8% 10.7% 8.2% 7.7% Less: Long-term debt currently due 14 Maturity 2001 2000 2002-2029 2002-2018 2002-2015 2002-2009 $3,890 199 16 266 4,371 134 $4,237 $3,195 212 64 301 3,772 296 $3,476 Over the past two years UTC issued a total of $14 million in additional notes. The interest rate on the 2001 notes is 5.694% and the 2000 notes carry an interest rate of 7.125%. Proceeds from the debt issuances were used for general corporate purposes, including repayment of commercial paper, financing a portion of the acquisition of Specialty Equipment Companies and other acquisitions and repurchasing the Corporation's Common Stock. This debt is to be retired over the next five years under a repayment scheduled. The general concern voiced by several analysts over the past year is the rate of increased debt over generated sales and the ability to repay the debt without degradation to Earnings Per Share. We will have to watch over the next few years to see if market analysts concern was justified. Because of the nature of the business, UTC like many other major corporations provides for contingency of future events. There are four areas for which contingencies have been established, leases, environmental issues, U.S. government contracts and warranty contingencies. UT C leases office space and purchases equipment under lease arrangements. At the end of 2001 UTC accounted for rental commitments of $661 million, the majority under longterm noncancelable operating leases. In addition rent expense was $204 million in 2001, $194 million in 2000 and $194 million in 1999. In addition UTC has receivables and other financing assets with commercial aerospace industry customers totaling $1,438 million and $1,614 million at December 31, 2001 and 2000. These assets are related to commercial aerospace industry customers holding products under lease. Financing commitments, in the form of secured debt, guarantees or lease financing, are provided to commercial aerospace customers as well.. The Corporation also may also lease aircraft and subsequently sublease the aircraft to customers under long-term noncancelable operating leases. Lastly, the Corporation has residual value and other guarantees related to various commercial aircraft engine customer financing arrangements. The estimated fair market values of the guaranteed assets equal or exceed the value of the related 15 guarantees, net of existing reserves. As mentioned in the opening pages UTC operations are subject to environmental regulation by federal, state and local authorities in the United States and regulatory authorities with jurisdiction over its foreign operations. In order to meet potential obligations UTC accrues for the estimated costs of environmental remediation activities and periodically reassesses these amounts. In order to cover these obligations UTC has insurance in force with a number of insurance companies and continues to pursue litigation seeking indemnity and defense in relation to environmental liabilities. In January 2002, UTC settled the last of these lawsuits for payments totaling approximately $100 million. Accrued environmental liabilities are not reduced by potential insurance reimbursements. Because of the volume of business conducted with the U.S. Government, there are specific contracting requirements that must be adhered to. Compliance to FAR and DFAS requirements are continually monitored and regular audits are conducted. In order to safeguard the corporation in the event of a loss, accruals have been established to cover any potential action and charge backs by the government. And finally, UTC extends performance and operating cost guarantees beyond its normal warranty and service policies for extended periods on some of its products, particularly commercial aircraft engines. Liability under such guarantees is contingent upon future product performance and durability. In addition, the Corporation incurs discretionary costs to service its products in connection with product performance issues. The Corporation has accrued its estimated liability that may result under these guarantees and for service costs which are probable and can be reasonably estimated. Income tax has a large impact on any corporation, and UTC is no exceptions. And like any other corporation, methods of revenue recognition, expense accruals and changes in tax laws provide both a positive and negative impact on the tax situation of a company. As reported on the Balance sheet UTC has outstanding tax benefits to apply against future income taxes in the amount of $1,205. This benefit is a result of transactions 16 which are reported in different accounting periods for tax and financial reporting purposes. These temporary differences are defined below: IN MILLIONS OF DOLLARS Future income tax benefits: Insurance and employee benefits Other asset basis differences Other liability basis differences Tax loss carryforwards Tax credit carryforwards Valuation allowance $ $ Future income taxes payable: Fixed assets Other items, net $ $ 2001 2000 840 $ 300 1,219 176 228 (180) 2,583 $ 685 313 1,332 165 217 (208) 2,504 64 $ 130 194 $ 67 81 148 As a result of these benefits and future income taxes payable the effective tax rate for UTC has decreased between 2000 and 2001. The decrease is attributable to favorable settlement of prior year tax audits. Without this settlement, the 2001 effective tax rate was 30.0%. If you remember our earlier discussion about interest expense, UTC does receive an income tax benefit from these high payments. Income tax is calculated on income remaining after payment of Interest expense. I would not suggest however, that carrying high interest payment costs is a solution to reducing annual income taxes. 2001 2000 1999 35.0% 35.0% 35.0% (6.2) (6.0) (7.5) Statutory U.S. federal income tax rate Varying tax rates of consolidated subsidiaries (including Foreign Sales Corporation) Goodwill Enacted tax law changes Tax audit settlement Other Effective income tax rate 1.7 2.5 1.8 1.9 (0.3) (3.1) (0.6) (1.7) (3.8) 26.9% 30.9% 25.9% The effective tax rate for 2000 increased significantly over 1999 due to two particular items, a revaluation of taxes due to the enactment of Connecticut tax law changes and benefits received for prior periods from an industry related court decision. A large expense for many major corporations is for pension and postretirement plans. UTC provides both domestic and foreign defined benefit pension and retirement plans. 17 One major benefit of employment with a large corporation is the ability to earn a pension and participate in employee savings plans. UTC provides tremendous opportunity here. One major benefit offered by UTC is in relation to the educational benefits provide to its' employees. UTC President George David has one aspiration, To have the best educated workforce in the world. To achieve this goal, UTC provides 100% upfront payment for degree seeking students. Each student is allowed upto 5 hours of paid time off to attend school and upon graduation receives stock awards valued up to $10,000. Beside educational benefits, an employee savings plan is offered in the form of a 401K plan. Employee contributions are matched by UTC at 6% of the employee's annual salary. Pension Benefits IN MILLIONS OF DOLLARS Change in Benefit Obligation: Beginning balance Service cost Interest cost Actuarial (gain) loss Total benefits paid Net settlement and curtailment loss (gain) Acquisitions Other Ending balance Change in Plan Assets: Beginning balance Actual return on plan assets Employer contributions Benefits paid from plan assets Acquisitions Other Ending balance Funded status Unrecognized net actuarial loss (gain) Unrecognized prior service cost Unrecognized net liability at transition Net amount recognized Amounts Recognized in the Consolidated Balance Sheet Consist of: Prepaid benefit cost Accrued benefit liability 2000 2001 $ $ $ $ $ 12,232 250 869 (239) (796) 13 3 22 12,354 13,119 (2,338) 51 (755) 1 (53) 10,025 (2,329) 2,173 287 $ $ $ $ $ 11,830 238 839 133 (830) (6) 84 (56) 12,232 12,196 1,669 47 (798) 52 (47) 13,119 887 (1,035) 284 Other Postretirement Benefits 2001 $ $ $ $ $ 6 7 1,175 15 85 (152) (106) 8 15 1,040 76 (7) 1 (11) 3 62 (978) (138) (105) $ $ $ $ $ 2000 1,118 13 82 8 (100) 39 15 1,175 78 4 1 (11) 4 76 (1,099) (9) (111) 18 $ 138 $ 142 $ (1,203) $ (1,219) $ 492 (1,534) $ 482 (449) $ (1,203) $ (1,219) 18 Intangible asset Accumulated other non-shareowners' changes in equity Net amount recognized $ 138 $ 142 $ (1,203) The last set of ratios we will review and interpret related to Shareholders value. 2001 2000 1999 4.06 3.83 15.92 1.39 2001 3.78 3.55 20.80 1.05 2000 3.22 3.01 37.36 1.17 1999 Shareholders Profitability EPS - Basic EPS - Diluted Price Earnings Ratio Dividend Yield Wall Street analysts pay particular attention to reported earnings per share vs. projected earnings per share. Any deviation will result in an offsetting revaluation of the corporate position on Wall Street. UTC pays particular attention to the projections provided Wall Street and has continued to undertake dramatic cost reductions to meet these projections. One such cost reduction method employed in late 2001 was a mandatory salaried employee furlough equaling one weeks pay. With 152,000 employees on payroll and 50% of these being salaried, projected savings exceeded $10Million for 2001. In addition a hiring freeze was implemented for all of 2002 and raises were frozen. UTC is hoping these stringent methods will result in higher profitability and increased earnings per share for 2002. Early estimates given to Wall Street indicated levels exceeding 4.50 per share. In addition UTC recently affirmed their commitment to dividend return and paid .98 per share. By reviewing the existing trends, it is obvious that these cost cutting measures are needed. Over the past 3 years the PE ratio has declined over 50% while earnings per share have increased. One important note which has been mentioned several times already is the impact of September 11. Prior to September 11, UTX was trading at over 76$ per share. Immediately after September 11, stock dropped to under $40.00 per share. This decrease was felt by UTC's competitors in the aerospace industry also and is directly attributable to market conditions, not unique events within UTC itself. The value of UTC stock has appreciated since September, 11. While not yet back to it's 19 37 72 286 894 $ (1,219) level of trading before this horrible event, market confidence has returned and both trading volume and price per share are on the rise. IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS 2001 Quarters Second Third First Sales Gross margin Income from continuing operations Net income Earnings per share of Common Stock: Basic: Continuing operations Net earnings Diluted: Continuing operations Net earnings Fourth 2000 Quarters Second Third First $6,597 1,785 440 440 $7,260 2,076 588 588 $6,734 1,811 565 565 $6,895 1,727 345 345 $6,307 1,679 377 377 $6,871 1,884 509 509 $6,339 1,814 496 496 $6,689 1,859 426 426 $ $ .92 .92 $ 1.23 $ 1.23 $ 1.19 $ 1.19 $ $ .72 .72 $ $ .78 .78 $ 1.07 $ 1.07 $ 1.04 $ 1.04 $ $ .89 .89 $ $ .86 .86 $ 1.16 $ 1.16 $ 1.12 $ 1.12 $ $ .69 .69 $ $ .74 .74 $ 1.00 $ 1.00 $ $ $ $ .84 .84 Comparative Stock Data Common Stock First quarter Second quarter Third quarter Fourth quarter Fourth High 82.08 87.21 76.56 65.56 2001 Low 67.00 70.83 41.64 47.25 Dividend $.225 $.225 $.225 $.225 High 65.25 66.19 71.50 79.75 2000 Low 48.06 54.50 56.69 63.50 Dividend $ .20 $ .20 $ .20 $.225 As we have seen UTC is a very complex and diverse corporation impacted by the systematic risk of doing business. From my readings it appears that many of the difficulties experienced by UTC can be associated with one business unit, Carrier. While the entire industry suffers from lack of consumer confidence and the recession, it appears that Carrier also suffers from poor leadership and the ability to successful integrate newly acquired business into the corporate fold. Shortly after the events of September 11, and as a result of waning shareholder confidence, Carrier President Jon Ayers was replaced with Geraud Darneu. Major cost cutting efforts were put in place including corporate restructuring activites and plant consolidation and closure. The market has responded postitively to these changes and first quarter results were above forecast. Hopefully these changes will last and the remaining business will resume former levels of growth and profitability. 20 .98 .98 BIBLIOGRAPHY (including web references) 21 FIVE-YEAR SUMMARY IN MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS For the year Revenues Research and development Income from continuing operations Net income Earnings per share: Basic: Continuing operations Net earnings Diluted: Continuing operations Net earnings Cash dividends per common share Average number of shares of Common Stock outstanding: Basic Diluted Return on average common shareowners' equity, after tax Operating cash flows Acquisitions, including debt assumed Share repurchase At year end Working capital, continuing operations Total assets Long-term debt, including current portion Total debt Debt to total capitalization ESOP Preferred Stock, net Shareowners' equity Number of employees - continuing operations $ $ 22 2001 2000 1999 1998 1997 27,897 $ 1,254 1,938 1,938 26,583 $ 1,302 1,808 1,808 24,127 $ 1,292 841 1,531 22,809 $ 1,168 1,157 1,255 4.06 4.06 3.78 3.78 1.74 3.22 2.47 2.68 1.98 2.22 3.83 3.83 .90 3.55 3.55 .825 1.65 3.01 .76 2.33 2.53 .695 1.89 2.10 .62 470.2 505.4 23.6% 2,885 525 599 470.1 508.0 24.4% 2,503 1,340 800 465.6 506.7 24.6% 2,310 6,268 822 455.5 494.8 28.6% 2,314 1,237 650 468.9 507.1 24.5% 1,903 605 849 21,288 1,069 962 1,072 1,318 $ 1,412 $ 1,359 $ 1,712 2,892 $ 25,364 24,366 17,768 15,697 26,969 3,772 3,419 1,669 1,389 4,371 4,811 4,321 2,173 1,567 4,959 39% 38% 33% 28% 37% 432 449 456 450 429 7,662 7,117 4,378 4,073 8,369 153,800 148,300 134,400 130,400 152,000 Consolidated Balance Sheet In Millions of Dollars Except Per Share Data (Shares in Thousands) 2001 2000 1999 Assets Cash and cash equivalents Accounts Receivable (net for allowance of doubtful accts) Inventories and contracts in progress Future income tax benefits Other current assets Total Current Assets Customer financing assets Future income tax benefits Fixed assets Goodwill (net of accumulated amortization) Other assets Total Assets $1,558 4093 3973 1378 261 11,263 665 1205 4549 6802 2485 $26,969 $748 4445 3756 1439 274 10,662 550 1065 4487 6771 1829 $25,364 $957 4337 3504 1563 266 10,627 553 873 4460 5641 2212 $24,366 Short-term borrowing Accounts Payable Accrued Liabilities Long-term debt currently due Total Current Liabilities Long-term debt $588 2,156 5,493 134 8,371 4,237 $1,039 2,261 5,748 296 9,344 3,476 $902 1,957 6,023 333 9,215 3,086 Future pension and post retirement benefit obligations Future income tax payables Other long-term liabilities Commitments and contingent liabilities Minority interests in subsidiary companies 2,703 1,636 2,310 2,317 1,601 126 2,245 550 497 527 743 $(314.00) 429 767 $(335.00) 432 808 $(359.00) 449 - - - 5,090 4,665 4,227 (4,404) (3,955) (3,182) 9,149 7,743 6,463 (889) (563) (14) (1,466) 8,369 $26,969 (747) (44) (791) 7,662 $25,364 (563) (41) 213 (391) 7,117 $24,366 Liabilities and Shareholder's Equity Series A ESOP Convertible Preferred Stock, $ 1 par value Authorized-20,000 shares Outstanding-11,307 and 11,642 shares ESOP deferred compensation Shareholders' Equity: Capital Stock: Preferred Stock, $1 par value; Authorized-250,000 shares - none issued or outstanding Common Stock, $1 par value; Authorized-2,000,000 shares 603,076 and 597,213 and 588,737 TreasuryStock - 130,917 and 126,907 and 114,191 common shares at cost Retained Earnings Accumulated other non-shareholder changes in equity: Foreign currency translation Minimum pension liability Other Total Shareowner' Equity Total Liabilities and Shareowners' Equity 23 24 Annual Report Guidelines To begin assessing the quality of financial statements, think specifically about: 1. The types of underlying transactions and events that effect the company, 2. How well the financial accounting model (i.e. generally accepted accounting principals \"GAAP\") reflects those transactions and events 3. The aggressiveness or conservatism or management's account choices, 4. How well the annual report helps you assess the company's risks, financial position, earnings, etc. Listed below are common questions to address in your project. Financial Ratios Calculate each of the basic following financial statement ratios for each of the last two years. Is there a trend? If there are other ratios that you believe apply to your company, include those ratios also. Please be sure to provide the details of your computations. ! Stockholder Profitability ! Earning per share (EPS) ! Price/earnings ratio (P/E) ! Profitability ! Gross profit margin ! Return on total assets ! Profit Margin ! Return on stockholders' equity (ROE) ! Liquidity ! Current ratio ! Quick or acid test ratio ! Cash flow from operations to sales ! Stability ! Debt ratio ! Times interest earned ! Book value per common share Unusual events Describe all significant unusual or nonrecurring items during any of the fiscal years. How significant was the impact on the earnings? Did these items have a significant effect on the profitability ratios? Are these items likely to occur again in the future? Why or why not? Transaction and Recognition Methods Describe the company's revenue transaction and recognition methods. Are the timing or cash receipts from customers different than the timing of revenue recognition? Are there any uncertainties about the collectibles of customer receivables? What is the likelihood of significant product returns by customers? Trends in bad debt allowances? Business risks associated with estimates? Concentrations of revenues to one business or industry? Footnote disclosures that are of concern? Inventory Describe inventory and related costs. What types of inventory are included in the balance sheet? Working in process, finished inventory? Identify inventory valuation methods and are they reasonable for this type of business? Effect on balance sheet if inventory method changed or if business showed down. Property Describe the major types of property, plant and equipment (PP&E). What depreciation methods are used and are they current (life of the asset?). Are these assets undervalued or overvalued on the balance sheet? The nature of the company's assets. Effects on the balance sheet if these assets were carried by a different deprecation method. Do you agree with management's deprecation method? Should it be changed? Can it be changed? Business risk's associated with the company's assets. Should there be a more aggressive or less aggressive write down of impaired assets? Intangibles What are the major types of intangibles? Are all of them on the balance sheet? What does research and development, advertising or other types of intangibles look like? Collateral Are any of the company's assets pledged as collateral? If they are, please explain, if they are not, why not? If they are is the company in compliance with its covenants? Contingencies What are the company's contingencies and commitments? Any off balance sheet leases? How does the company accrue for its liabilities? Any significant litigation? What is your opinion of management? Use of estimates in contingent liabilities? What would be the impact if the company were unsuccessful in defending claims against it? Warranty Liabilities Are product warranty liabilities are overstated or understated? Does the company have product warranties? Does it have insurance against a claim? Warranty Costs? And are they accounted for? Pension plans Describe the types of pension plans and other post-employment plans. Are the plans over-funded or under-funded? Any liabilities from the pension fund not stated? Or potential asset's in pension fund? Taxes What is the company's effective tax rate? Major sources of deferred income assets or liabilities? Some analysts believe deferred taxes should be omitted from the company's balance sheet. What impact would this have on your company? Assets and Liabilities What are the company's current assets and current liabilities? Have you done a ratio analysis and if so what is your opinion of management's use of its current assets and liabilities? Cash Flow What are the company's major sources and uses of cash? What are the company's operating cash flows? Balance Sheet Analysis What does the balance sheet tell you? Is the company managing its assets and liabilities? What would you do differently? Even if this is a large or publicly traded company, management may not be running it correctly. Market Value/Book Value Compare the market value of the stock with its book value. What does this comparison suggest about the accounting valuation of the assets and liabilities? Income Statement Analysis Do the reported revenues and expenses appear to fairly represent the results of the revenue producing activities and are the costs associated with those activities? Why or why not? Be sure to consider your earlier evaluation of management accounting practices. Your written report should demonstrate that you have a complete understanding of the issues you discuss. It is essential that your report be thorough. Read, review and analyze your company and determine what needs and should be reviewed. Ask brokerage firms for their analyst's reports and check the Internet for any analyst of your company. Explain whether it is reasonable for an item to apply to your company. If an item does not apply to your company, you should state so explicitly. Make sure your notes on the financial statements provide adequate and understandable information about the accounting policies, assumptions, risks and transactions. Finally, your report should contain professional terminology as well as proper grammar and spelling. Please don't CUT and PASTE from web sites or annual reports