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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 June 30, 2003
-------------
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 1-8974
Honeywell International Inc.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 22-2640650
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 Columbia Road
P.O. Box 4000
Morristown, New Jersey 07962-2497
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(973)455-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
NOT APPLICABLE
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Outstanding at
Class of Common Stock June 30, 2003
- -------------------- ------------------
$1 par value 860,054,513 shares
Honeywell International Inc.
Index
Page No.
--------
Part I. - Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheet - June 30, 2003 and December 31,
2002 3
Consolidated Statement of Operations - Three and Six Months
Ended June 30, 2003 and 2002 4
Consolidated Statement of Cash Flows - Six Months Ended
June 30, 2003 and 2002 5
Notes to Financial Statements 6
Report of Independent Auditors 20
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 32
Item 4. Controls and Procedures 32
Part II. - Other Information
Item 1. Legal Proceedings 32
Item 6. Exhibits and Reports on Form 8-K 38
Signatures 39
- ----------
This report contains certain statements that may be deemed "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934. All statements, other than statements of historical fact, that address
activities, events or developments that we or our management intends, expects,
projects, believes or anticipates will or may occur in the future are
forward-looking statements. Such statements are based upon certain assumptions
and assessments made by our management in light of their experience and their
perception of historical trends, current conditions, expected future
developments and other factors they believe to be appropriate. The
forward-looking statements included in this report are also subject to a number
of material risks and uncertainties, including but not limited to economic,
competitive, governmental and technological factors affecting our operations,
markets, products, services and prices. Such forward-looking statements are not
guarantees of future performance and actual results, developments and business
decisions may differ from those envisaged by such forward-looking statements.
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
Honeywell International Inc.
Consolidated Balance Sheet
(Unaudited)
June 30, December 31,
2003 2002
-------- ------------
(Dollars in millions)
ASSETS
Current assets:
Cash and cash equivalents $ 2,626 $ 2,021
Accounts, notes and other receivables 3,353 3,264
Inventories 3,055 2,953
Deferred income taxes 1,592 1,296
Other current assets 490 661
------- -------
Total current assets 11,116 10,195
Investments and long-term receivables 649 624
Property, plant and equipment - net 4,222 4,055
Goodwill 5,717 5,698
Other intangible assets - net 1,087 1,074
Insurance recoveries for asbestos
related liabilities 1,370 1,636
Deferred income taxes 303 533
Prepaid pension benefit cost 2,775 2,675
Other assets 1,294 1,069
------- -------
Total assets $28,533 $27,559
======= =======
LIABILITIES
Current liabilities:
Accounts payable $ 2,093 $ 1,912
Short-term borrowings 147 60
Commercial paper 188 201
Current maturities of long-term debt 53 109
Accrued liabilities 4,168 4,292
------- -------
Total current liabilities 6,649 6,574
Long-term debt 5,042 4,719
Deferred income taxes 512 419
Postretirement benefit obligations
other than pensions 1,685 1,684
Asbestos related liabilities 2,394 2,700
Other liabilities 2,512 2,538
SHAREOWNERS' EQUITY
Capital - common stock issued 958 958
- additional paid-in capital 3,443 3,409
Common stock held in treasury, at cost (3,674) (3,783)
Accumulated other nonowner changes (689) (1,109)
Retained earnings 9,701 9,450
------- -------
Total shareowners' equity 9,739 8,925
------- -------
Total liabilities and shareowners' equity $28,533 $27,559
======= =======
The Notes to Financial Statements are an integral part of this statement.
3
Honeywell International Inc.
Consolidated Statement of Operations
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2003 2002 2003 2002
------ ------ ------- -------
(Dollars in millions,
except per share amounts)
Net sales $5,749 $5,651 $11,148 $10,850
------ ------ ------- -------
Costs, expenses and other
Cost of goods sold 4,514 4,431 8,754 8,504
Selling, general and administrative
expenses 762 660 1,465 1,277
(Gain) loss on sale of non-strategic
businesses (31) 166 (31) 41
Business impairment charges -- -- -- 43
Equity in (income) loss of
affiliated companies (6) (3) (4) (10)
Other (income) expense (24) (6) (27) (22)
Interest and other financial charges 87 88 171 175
------ ------ ------- -------
5,302 5,336 10,328 10,008
------ ------ ------- -------
Income before taxes and cumulative
effect of accounting change 447 315 820 842
Tax expense (benefit) 128 (144) 227 7
------ ------ ------- -------
Income before cumulative effect of
accounting change 319 459 593 835
Cumulative effect of accounting change -- -- (20) --
------ ------ ------- -------
Net income $ 319 $ 459 $ 573 $ 835
====== ====== ======= =======
Earnings per share of common stock -
basic:
Income before cumulative effect of
accounting change $ 0.37 $ 0.56 $ 0.69 $ 1.02
Cumulative effect of accounting
change -- -- (0.02) --
------ ------ ------- -------
Net income $ 0.37 $ 0.56 $ 0.67 $ 1.02
====== ====== ======= =======
Earnings per share of common stock -
assuming dilution:
Income before cumulative effect of
accounting change $ 0.37 $ 0.56 $ 0.69 $ 1.02
Cumulative effect of accounting
change -- -- (0.02) --
------ ------ ------- -------
Net income $ 0.37 $ 0.56 $ 0.67 $ 1.02
====== ====== ======= =======
Cash dividends per share of common
stock $.1875 $.1875 $ .3750 $ .3750
====== ====== ======= =======
The Notes to Financial Statements are an integral part of this statement.
4
Honeywell International Inc.
Consolidated Statement of Cash Flows
(Unaudited)
Six Months Ended
June 30,
---------------------
2003 2002
------ ------
(Dollars in millions)
Cash flows from operating activities:
Net income $ 573 $ 835
Adjustments to reconcile net income to net cash provided
by operating activities:
Cumulative effect of accounting change 31 --
(Gain) loss on sale of non-strategic businesses (31) 41
Repositioning and other charges 34 190
Business impairment charges -- 43
Insurance receipts for asbestos related liabilities 477 55
Asbestos related liability payments (388) (50)
Depreciation 290 340
Undistributed earnings of equity affiliates (4) (23)
Deferred income taxes 134 35
Pension contributions - U.S. plans (170) --
Other 65 (251)
Changes in assets and liabilities, net of the effects
of acquisitions and divestitures:
Accounts, notes and other receivables (80) (77)
Inventories (95) 42
Other current assets 18 (26)
Accounts payable 175 (8)
Accrued liabilities (3) (19)
------ ------
Net cash provided by operating activities 1,026 1,127
------ ------
Cash flows from investing activities:
Expenditures for property, plant and equipment (276) (299)
Proceeds from disposals of property, plant and
equipment -- 21
Cash paid for acquisitions (122) (19)
Proceeds from sales of businesses 90 186
Decrease in short-term investments -- 7
------ ------
Net cash (used for) investing activities (308) (104)
------ ------
Cash flows from financing activities:
Net increase (decrease) in commercial paper (13) 237
Net increase (decrease) in short-term borrowings 78 (62)
Proceeds from issuance of common stock 31 34
Payments of long-term debt (70) (382)
Cash dividends on common stock (322) (306)
------ ------
Net cash (used for) financing activities (296) (479)
------ ------
Effect of foreign exchange rate changes on cash and cash
equivalents 183 39
------ ------
Net increase in cash and cash equivalents 605 583
Cash and cash equivalents at beginning of year 2,021 1,393
------ ------
Cash and cash equivalents at end of period $2,626 $1,976
====== ======
The Notes to Financial Statements are an integral part of this statement.
5
Honeywell International Inc.
Notes to Financial Statements
(Unaudited)
(Dollars in millions, except per share amounts)
NOTE 1. In the opinion of management, the accompanying unaudited consolidated
financial statements reflect all adjustments, consisting only of normal
adjustments, necessary to present fairly the financial position of Honeywell
International Inc. and its consolidated subsidiaries at June 30, 2003 and the
results of operations for the three and six months ended June 30, 2003 and 2002
and cash flows for the six months ended June 30, 2003 and 2002. The results of
operations for the three- and six-month periods ended June 30, 2003 should not
necessarily be taken as indicative of the results of operations that may be
expected for the entire year 2003. Certain prior year amounts have been
reclassified to conform with the current year presentation.
The financial information as of June 30, 2003 should be read in conjunction
with the financial statements contained in our Annual Report on Form 10-K for
2002.
NOTE 2. In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 143, "Accounting for Asset
Retirement Obligations" (SFAS No. 143). SFAS No. 143 requires recognition of the
fair value of obligations associated with the retirement of tangible long-lived
assets when there is a legal obligation to incur such costs. Upon initial
recognition of a liability the cost is capitalized as part of the related
long-lived asset and depreciated over the corresponding asset's useful life.
SFAS No. 143 primarily impacts our accounting for costs associated with the
future retirement of nuclear fuel conversion facilities in our Specialty
Materials reportable segment. Upon adoption on January 1, 2003, we recorded an
increase in property, plant and equipment, net of $16 million and recognized an
asset retirement obligation of $47 million. This resulted in the recognition of
a non-cash charge of $31 million ($20 million after-tax, or $0.02 per share)
that is reported as a cumulative effect of an accounting change. This accounting
change is not expected to have a material impact on future results of
operations. Pro forma effects for the three- and six-month periods ended June
30, 2002, assuming adoption of SFAS No. 143 as of January 1, 2002, were not
material to net income or per share amounts.
In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities" (FIN 46). FIN 46 provides guidance on
consolidation of variable interest entities and applies immediately to variable
interests created after January 31, 2003. FIN 46 will become applicable
effective July 1, 2003 for variable interest entities created before February 1,
2003. We do not expect that the adoption of FIN 46 will have a material effect
on our consolidated results of operations and financial position.
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus
on EITF Issue No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." EITF Issue No. 00-21 provides guidance on when and how to
separate elements of an arrangement that may involve the delivery or performance
of multiple products, services and rights to use assets into separate units of
accounting. The guidance in the consensus is effective for revenue arrangements
entered into in fiscal periods beginning after June 15, 2003. We will adopt EITF
Issue No. 00-21 prospectively in the quarter beginning July 1, 2003. We do not
expect that the adoption of EITF Issue No. 00-21 will have a material effect on
our consolidated results of operations and financial position.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" (FIN 45), which requires us to recognize a
6
liability for the fair value of an obligation assumed by issuing a guarantee.
FIN 45 became effective for guarantees issued or modified on or after January 1,
2003, and did not have a material effect on our consolidated financial position
as of June 30, 2003 or our consolidated results of operations for the three and
six months ended June 30, 2003. As disclosed in Note 21 to our consolidated
financial statements in our 2002 Annual Report on Form 10-K, we have issued or
are a party to certain direct and indirect guarantees. At June 30, 2003, except
for the fact that we no longer guarantee the debt of Bendix Commercial Vehicle
Systems of $172 million, there has been no material change to these guarantees.
The following table summarizes information concerning our recorded
obligations for product warranties and product performance guarantees:
Six Months Ended
June 30, 2003
----------------
Beginning of period $217
Accruals for warranties/guarantees issued during period 104
Adjustments of pre-existing warranties/guarantees 11
Settlement of warranty/guarantee claims (80)
----
End of period $252
====
NOTE 3. We account for our fixed stock option plans under Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB No. 25).
Under APB No. 25, there is generally no compensation cost recognized for our
fixed stock option plans, because the options granted under these plans have an
exercise price equal to the market value of the underlying stock at the grant
date. Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123) allows, but does not require, companies
to record compensation cost for fixed stock option plans using a fair value
based method. As permitted by SFAS No. 123, we elected to continue to account
for compensation cost for our fixed stock option plans using the intrinsic value
based method under APB No. 25. The following table sets forth pro forma
information as if compensation cost had been determined consistent with the
requirements of SFAS No. 123.
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
----- ----- ----- -----
Net income, as reported $ 319 $ 459 $ 573 $ 835
Deduct: Total stock-based employee
compensation cost determined under fair
value method for fixed stock option
plans, net of related tax effects (12) (16) (25) (32)
----- ----- ----- -----
Pro forma net income $ 307 $ 443 $ 548 $ 803
===== ===== ===== =====
Earnings per share of common stock:
Basic - as reported $0.37 $0.56 $0.67 $1.02
===== ===== ===== =====
Basic - pro forma $0.36 $0.54 $0.64 $0.98
===== ===== ===== =====
Earnings per share of common stock:
Assuming dilution - as reported $0.37 $0.56 $0.67 $1.02
===== ===== ===== =====
Assuming dilution - pro forma $0.36 $0.54 $0.64 $0.98
===== ===== ===== =====
7
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
----- ------ ----- ------
The following sets forth fair value per share information,
including related assumptions, used to determine compensation
cost consistent with the requirements of SFAS No. 123:
Weighted average fair value per share of
options granted during the period
(estimated on grant date using
Black-Scholes option-pricing model) $8.12 $14.24 $8.80 $12.79
Assumptions:
Historical dividend yield 2.2% 1.9% 2.0% 1.9%
Historical volatility 46.9% 43.9% 46.7% 43.7%
Risk-free rate of return 2.9% 4.4% 2.9% 4.2%
Expected life (years) 5.0 5.0 5.0 5.0
NOTE 4. Accounts, notes and other receivables consist of the following:
June 30, December 31,
2003 2002
-------- ------------
Trade $3,110 $3,064
Other 405 347
------ ------
3,515 3,411
Less - Allowance for doubtful
accounts (162) (147)
------ ------
$3,353 $3,264
====== ======
NOTE 5. Inventories consist of the following:
June 30, December 31,
2003 2002
-------- ------------
Raw materials $1,050 $ 936
Work in process 840 804
Finished products 1,301 1,361
------ ------
3,191 3,101
Less - Progress payments (16) (28)
Reduction to LIFO cost basis (120) (120)
------ ------
$3,055 $2,953
====== ======
8
NOTE 6. The change in the carrying amount of goodwill for the six months ended
June 30, 2003 by reportable segment is as follows:
Currency
Translation
Dec. 31, 2002 Acquisitions (Divestitures) Adjustment June 30, 2003
------------- ------------ -------------- ----------- -------------
Aerospace $1,644 $-- $ -- $ 7 $1,651
Automation and
Control Solutions 2,678 63 -- 11 2,752
Specialty Materials 849 5 (80) 12 786
Transportation Systems 527 -- -- 1 528
------ --- ---- --- ------
$5,698 $68 $(80) $31 $5,717
====== === ==== === ======
Intangible assets are comprised of:
June 30, 2003 December 31, 2002
---------------------------------- ----------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
-------- ------------ -------- -------- ------------ --------
Intangible assets with
determinable lives:
Investments in Aerospace
customer incentives $ 814 $(122) $ 692 $ 769 $(107) $ 662
Patents and trademarks 409 (289) 120 411 (286) 125
Other 417 (179) 238 433 (183) 250
------ ----- ------ ------ ----- ------
1,640 (590) 1,050 1,613 (576) 1,037
Trademark with indefinite
life 46 (9) 37 46 (9) 37
------ ----- ------ ------ ----- ------
$1,686 $(599) $1,087 $1,659 $(585) $1,074
====== ===== ====== ====== ===== ======
Amortization expense related to intangible assets was $31 and $29 million
for the six months ended June 30, 2003 and 2002, respectively. Amortization
expense related to intangible assets for 2003 to 2007 is expected to approximate
$60 million each year.
We completed our goodwill and intangible assets impairment testing for our
reporting units as of March 31, 2003 and determined that there was no impairment
as of that date.
NOTE 7. Total nonowner changes in shareowners' equity consist of the following:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ------
Net income $319 $459 $573 $ 835
Foreign exchange translation
adjustments 270 242 363 246
Change in fair value of effective
cash flow hedges 29 (23) 57 (19)
---- ---- ---- ------
$618 $678 $993 $1,062
==== ==== ==== ======
9
NOTE 8. Segment financial data follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2003 2002 2003 2002
------ ------ ------- -------
Net Sales
Aerospace $2,161 $2,204 $ 4,223 $ 4,293
Automation and Control Solutions 1,837 1,758 3,554 3,367
Specialty Materials 823 870 1,600 1,628
Transportation Systems 925 805 1,765 1,531
Corporate 3 14 6 31
------ ------ ------- -------
$5,749 $5,651 $11,148 $10,850
====== ====== ======= =======
Segment Profit
Aerospace $ 224 $ 364 $ 442 $ 671
Automation and Control Solutions 177 220 362 427
Specialty Materials 28 34 38 42
Transportation Systems 112 104 187 177
Corporate (34) (35) (66) (71)
------ ------ ------- -------
Total segment profit 507 687 963 1,246
------ ------ ------- -------
Gain (loss) on sale of non-strategic
businesses 31 (166) 31 (41)
Business impairment charges -- -- -- (43)
Equity in income of affiliated companies 6 3 4 10
Other income 24 6 27 22
Interest and other financial charges (87) (88) (171) (175)
Repositioning and other charges included
in cost of goods sold and selling,
general and administrative expenses (34) (127) (34) (177)
------ ------ ------- -------
Income before taxes and cumulative
effect of accounting change $ 447 $ 315 $ 820 $ 842
====== ====== ======= =======
10
NOTE 9. The details of the earnings per share calculations for the three- and
six-month periods ended June 30, 2003 and 2002 follow:
Three Months 2003 Six Months 2003
------------------------- -------------------------
Per Per
Average Share Average Share
Income Shares Amount Income Shares Amount
------ ------- ------ ------ ------- ------
Income Before Cumulative
Effect of Accounting Change
Earnings per share of common
stock - basic $319 859.9 $0.37 $593 858.4 $0.69
Dilutive securities issuable
in connection with stock
plans 1.0 0.8
---- ----- ----- ---- ----- -----
Earnings per share of common
stock - assuming dilution $319 860.9 $0.37 $593 859.2 $0.69
==== ===== ===== ==== ===== =====
Net Income
Earnings per share of common
stock - basic $319 859.9 $0.37 $573 858.4 $0.67
Dilutive securities issuable
in connection with stock
plans 1.0 0.8
---- ----- ----- ---- ----- -----
Earnings per share of common
stock - assuming dilution $319 860.9 $0.37 $573 859.2 $0.67
==== ===== ===== ==== ===== =====
Three Months 2002 Six Months 2002
------------------------- -------------------------
Per Per
Average Share Average Share
Income Shares Amount Income Shares Amount
------ ------- ------ ------ ------- ------
Net Income
Earnings per share of common
stock - basic $459 819.4 $0.56 $835 818.2 $1.02
Dilutive securities issuable
in connection with stock
plans 3.9 3.5
---- ----- ----- ---- ----- -----
Earnings per share of common
stock - assuming dilution $459 823.3 $0.56 $835 821.7 $1.02
==== ===== ===== ==== ===== =====
The diluted earnings per share calculation excludes the effect of stock
options when the options' exercise prices exceed the average market price of the
common shares during the period. For the three- and six-month periods ended June
30, 2003, the number of stock options not included in the computations were 43.7
and 44.3 million, respectively. For the three- and six-month periods ended June
30, 2002, the number of stock options not included in the computations were 22.4
and 24.7 million, respectively. These stock options were outstanding at the end
of each of the respective periods.
11
NOTE 10. A summary of repositioning, business impairment and other charges
follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Severance $ 22 $ 32 $ 22 $ 73
Asset impairments -- 57 -- 68
Exit costs 3 10 3 23
Reserve adjustments (23) (31) (23) (43)
---- ---- ---- ----
Total net repositioning charge 2 68 2 121
---- ---- ---- ----
Probable and resonably estimable
environmental liabilities 32 -- 32 --
Business impairment charges -- -- -- 43
Customer claims and settlements
of contract liabilities -- 29 -- 29
Write-offs of receivables,
inventories and other assets -- 40 -- 40
---- ---- ---- ----
Total net repositioning, business
impairment and other charges $ 34 $137 $ 34 $233
==== ==== ==== ====
The following table summarizes the pretax distribution of total net
repositioning, business impairment and other charges by income statement
classification:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Cost of goods sold $29 $127 $29 $173
Selling, general and administrative
expenses 5 -- 5 4
Business impairment charges -- -- -- 43
Equity in (income) loss of affiliated
companies -- 10 -- 13
--- ---- --- ----
$34 $137 $34 $233
=== ==== === ====
The following table summarizes the pretax impact of total net
repositioning, business impairment and other charges by reportable segment:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Aerospace $(2) $ 6 $(2) $ 6
Automation and Control Solutions (8) 22 (8) 61
Specialty Materials 7 107 7 132
Transportation Systems -- 2 -- 30
Corporate 37 -- 37 4
--- ---- --- ----
$34 $137 $34 $233
=== ==== === ====
In the second quarter of 2003, we recognized a charge of $25 million mainly
for severance costs related to workforce reductions of 448 manufacturing and
administrative positions principally in our Specialty Materials and Aerospace
reportable segments. Also, $23 million of previously established accruals,
mainly for severance, were returned to income in the second quarter of 2003, due
to fewer employee separations than originally anticipated associated with
certain 2002
12
repositioning actions, resulting in reduced severance liabilities in our
Automation and Control Solutions, Aerospace and Specialty Materials reportable
segments.
As disclosed in our 2002 Annual Report on Form 10-K, we recognized
repositioning charges totaling $453 million in 2002 ($99 and $164 million were
recognized in the three- and six-month periods ended June 30, 2002). The
components of the charges included severance costs of $270 million, asset
impairments of $121 million and other exit costs of $62 million. Severance costs
were related to announced workforce reductions of approximately 8,100
manufacturing and administrative positions across all of our reportable segments
and our UOP process technology joint venture, of which approximately 5,200
positions have been eliminated as of June 30, 2003. These actions are expected
to be substantially completed by December 31, 2003. Also, $76 million of
previously established severance accruals were returned to income in 2002, due
to fewer employee separations than originally anticipated and higher than
expected voluntary employee attrition resulting in reduced severance liabilities
in our Aerospace, Automation and Control Solutions and Specialty Materials
reportable segments.
The following table summarizes the status of our total repositioning costs:
Severance Asset Exit
Costs Impairments Costs Total
--------- ----------- ----- -----
Balance at December 31, 2002 $325 $-- $ 81 $406
2003 charges 22 -- 3 25
2003 usage (78) -- (15) (93)
Adjustments (20) -- (3) (23)
---- --- ---- ----
Balance at June 30, 2003 $249 $-- $ 66 $315
==== === ==== ====
In the second quarter of 2003, we recognized other charges of $32 million
for legacy environmental matters deemed probable and reasonably estimable in the
second quarter of 2003 including the matter entitled Interfaith Community
Organization, et al. v. Honeywell International Inc., et al. as discussed in
Note 12.
In the second quarter of 2002, we recognized other charges consisting of
customer claims and settlements of contract liabilities of $29 million and
write-offs of receivables, inventories and other assets of $40 million. Such
charges related mainly to our Advanced Circuits business which was sold in the
fourth quarter of 2002, bankruptcy of a customer in our Aerospace reportable
segment, and customer claims in our Industry Solutions business.
In the first quarter of 2002, we recognized an impairment charge of $27
million related to the write-down of property, plant and equipment of our
Friction Materials business, which is classified as assets held for disposal in
Other Current Assets (a plan of disposal of Friction Materials was adopted in
2001; in January 2003, we entered into a letter of intent to sell this business
to Federal-Mogul Corp. - See Note 12). In the first quarter of 2002, we also
recognized an asset impairment charge of $16 million related to the planned
shutdown of a chemical manufacturing facility in our Specialty Materials
reportable segment.
NOTE 11. In May 2003, we completed the sale of Specialty Materials' Engineering
Plastics (Engineering Plastics) business to BASF in exchange for BASF's nylon
fiber business and $90 million in cash. This transaction is not expected to have
a material impact on Specialty Materials' sales or segment profit in 2003. The
sale of Engineering Plastics resulted in a pretax gain of $31 million, after-tax
$9 million, including the tax benefits associated with prior capital losses.
In June 2002, we sold Specialty Materials' Pharmaceutical Fine Chemicals
(PFC) and Automation and Control's Consumer Products (Consumer Products)
businesses for proceeds of approximately $105 million, mainly cash, resulting in
a pretax loss
13
of $166 million (after-tax gain of $98 million). The businesses sold had a
higher deductible tax basis than book basis which resulted in an after-tax gain.
In March 2002, we completed the disposition of our Bendix Commercial Vehicle
Systems (BCVS) business for approximately $350 million in cash and investment
securities resulting in a pretax gain of $125 million. In January 2002, we had
reached an agreement with Knorr-Bremse AG (Knorr) to transfer control of our
global interests in BCVS to Knorr.
NOTE 12. COMMITMENTS AND CONTINGENCIES
Shareowner Litigation - Honeywell and seven of its current and former
officers were named as defendants in several purported class action lawsuits
filed in the United States District Court for the District of New Jersey (the
Securities Law Complaints). The Securities Law Complaints principally allege
that the defendants violated federal securities laws by purportedly making false
and misleading statements and by failing to disclose material information
concerning Honeywell's financial performance, thereby allegedly causing the
value of Honeywell's stock to be artificially inflated. On January 15, 2002, the
District Court dismissed the consolidated complaint against four of Honeywell's
current and former officers. The Court has granted plaintiffs' motion for class
certification defining the purported class as all purchasers of Honeywell stock
between December 20, 1999 and June 19, 2000.
The parties participated in a two day settlement mediation in April 2003 in
an attempt to resolve the cases without resort to a trial. The mediation proved
unsuccessful in resolving the cases. Discovery in the cases, which had been
stayed pending completion of the mediation, has resumed.
We continue to believe that the allegations in the Securities Law
Complaints are without merit. Although it is not possible at this time to
predict the outcome of these cases, we expect to prevail. However, an adverse
outcome could be material to our consolidated financial position or results of
operations. As a result of the uncertainty regarding the outcome of this matter
no provision has been made in our financial statements with respect to this
contingent liability.
ERISA Class Action Lawsuit - In April 2003, Honeywell and several of its
current and former officers were named as defendants in a purported class action
lawsuit filed in the United States District Court for the District of New
Jersey. The complaint principally alleges that the defendants breached their
fiduciary duties to participants in the Honeywell Savings and Ownership Plan
(the "Savings Plan") by purportedly making false and misleading statements,
failing to disclose material information concerning Honeywell's financial
performance, and failing to diversify the Savings Plan's assets and monitor the
prudence of Honeywell stock as a Savings Plan investment. In July 2003, an
amended complaint making similar allegations and naming several current and
former officers and directors as defendants was filed in the same district. No
answers have been filed and discovery has not commenced. Although it is not
possible at this time to predict the outcome of this litigation, we believe that
the allegations in these complaints are without merit and we expect to prevail.
An adverse litigation outcome could, however, be material to our consolidated
financial position or results of operations. As a result of the uncertainty
regarding the outcome of this matter, no provision has been made in our
financial statements with respect to this contingent liability.
Environmental Matters - We are subject to various federal, state and local
government requirements relating to the protection of employee health and safety
and the environment. We believe that, as a general matter, our policies,
practices and procedures are properly designed to prevent unreasonable risk of
environmental damage and personal injury to our employees and employees of our
customers and that our handling, manufacture, use and disposal of hazardous or
toxic substances are in accord with environmental laws and regulations. However,
14
mainly because of past operations and operations of predecessor companies, we,
like other companies engaged in similar businesses, have incurred remedial
response and voluntary cleanup costs for site contamination and are a party to
lawsuits and claims associated with environmental matters, including past
production of products containing toxic substances. Additional lawsuits, claims
and costs involving environmental matters are likely to continue to arise in the
future.
With respect to environmental matters involving site contamination, we
continually conduct studies, individually at our owned sites, and jointly as a
member of industry groups at non-owned sites, to determine the feasibility of
various remedial techniques to address environmental matters. It is our policy
to record appropriate liabilities for environmental matters when environmental
assessments are made or remedial efforts or damage claim payments are probable
and the costs can be reasonably estimated. With respect to site contamination,
the timing of these accruals is generally no later than the completion of
feasibility studies. We expect to fund expenditures for these matters from
operating cash flow. The timing of cash expenditures depends on a number of
factors, including the timing of litigation and settlements of personal injury
and property damage claims, regulatory approval of cleanup projects, remedial
techniques to be utilized and agreements with other parties.
Although we do not currently possess sufficient information to reasonably
estimate the amounts of liabilities to be recorded upon future completion of
studies, litigation or settlements, and neither the timing nor the amount of the
ultimate costs associated with environmental matters can be determined, they
could be material to our consolidated results of operations. However,
considering our past experience and existing reserves, we do not expect that
these matters will have a material adverse effect on our consolidated financial
position.
In the matter entitled Interfaith Community Organization, et al. v.
Honeywell International Inc., et al., the United States District Court for the
District of New Jersey held in May 2003 that a predecessor Honeywell site
located in Jersey City, New Jersey constituted an imminent and substantial
endangerment and ordered Honeywell to conduct the excavation and transport for
offsite disposal of approximately one million tons of chromium residue present
at the site. Honeywell strongly disagrees with the court's determinations and
has appealed the court's decision. Honeywell is also seeking a stay of aspects
of the court's order. The site at issue is one of twenty-one sites located in
Jersey City, New Jersey which are the subject of an Administrative Consent Order
(ACO) entered into with the New Jersey Department of Environmental Protection
(NJDEP) in 1993. Under the ACO, Honeywell agreed to study and remediate these
sites in accordance with NJDEP's directions, provided that the total costs of
such studies and remediation does not exceed $60 million. Honeywell has
cooperated with the NJDEP under the ACO and believes that decisions regarding
site cleanups should be made by NJDEP under the ACO. We are confident that
proceeding under the ACO will ensure a safe remediation and allow the property
to be placed back into productive use much faster and at a cost significantly
less than the remedies required by the court's order. We have not developed a
remedial action plan for the excavation and offsite disposal directed under the
court's order and therefore are unable to estimate the cost of such actions. At
trial, plaintiff's expert testified that the excavation and offsite disposal
cost might be $400 million. However, there are significant variables in the
implementation of the court's order and depending on the method of
implementation chosen, the estimate could increase or decrease. Provisions have
been previously made in our financial statements as to remedial costs
consistent with the ACO and during the three months ended June 30, 2003 we
provided for additional costs which are likely to be incurred during the
pendency of our appeal, which provisions do not assume excavation and offsite
removal of chromium from the site. There are alternative outcomes and remedies
beyond the scope of the ACO that could result from the remanding, reversal or
replacement of the Court's decision and order. At this time, we can neither
identify a probable alternative outcome
15
nor reasonably estimate the cost of an alternative remedy. Although we expect
the court's decision and order to be remanded, reversed or replaced, should the
remedies prescribed in the court's decision and order ultimately be upheld, such
outcome could have a material adverse impact on our consolidated results of
operations or operating cash flows in the periods recognized or paid.
Asbestos Matters - Like many other industrial companies, Honeywell is a
defendant in personal injury actions related to asbestos. We did not mine or
produce asbestos, nor did we make or sell insulation products or other
construction materials that have been identified as the primary cause of
asbestos related disease in the vast majority of claimants. Rather, we made
several products that contained small amounts of asbestos.
Honeywell's Bendix Friction Materials business manufactured automotive
brake pads that included asbestos in an encapsulated form. There is a group of
potential claimants consisting largely of professional brake mechanics. From
1981 through June 30, 2003, we have resolved over 62,000 Bendix claims at an
average indemnity cost per claim of approximately two thousand six hundred
dollars. Through the second quarter of 2002, Honeywell had no out-of-pocket
costs for these cases since its insurance deductible was satisfied many years
ago. Beginning with claim payments made in the third quarter of 2002, Honeywell
began advancing indemnity and defense claim costs which amounted to
approximately $50 million in payments in the six months ended June 30, 2003. A
substantial portion of this amount is expected to be reimbursed by insurance.
There are currently approximately 69,000 claims pending.
On January 30, 2003, Honeywell and Federal-Mogul Corp. (Federal-Mogul)
entered into a letter of intent (LOI) pursuant to which Federal-Mogul would
acquire Honeywell's automotive Bendix Friction Materials (Bendix) business, with
the exception of certain U.S. based assets. In exchange, Honeywell would receive
a permanent channeling injunction shielding it from all current and future
personal injury asbestos liabilities related to Honeywell's Bendix business.
Federal-Mogul, its U.S. subsidiaries and certain of its United Kingdom
subsidiaries voluntarily filed for financial restructuring under Chapter 11 of
the U.S. Bankruptcy Code in October 2001. Federal-Mogul will seek to establish
one or more trusts under Section 524(g) of the U.S. Bankruptcy Code as part of
its reorganization plan, including a trust for the benefit of Bendix asbestos
claimants. The reorganization plan to be submitted to the Bankruptcy Court for
approval will contemplate that the U.S. Bankruptcy Court in Delaware would issue
an injunction in favor of Honeywell that would channel to the Bendix 524(g)
trust all present and future asbestos claims relating to Honeywell's Bendix
business. The 524(g) trust created for the benefit of the Bendix claimants would
receive the rights to proceeds from Honeywell's Bendix related insurance
policies and would make these proceeds available to the Bendix claimants.
Honeywell would have no obligation to contribute any additional amounts toward
the settlement or resolution of Bendix related asbestos claims.
In the fourth quarter of 2002, we recorded a charge of $167 million
consisting of a $131 million reserve for the sale of Bendix to Federal-Mogul,
our estimate of asbestos related liability net of insurance recoveries and costs
to complete the anticipated transaction with Federal-Mogul. Completion of the
transaction contemplated by the LOI is subject to the negotiation of definitive
agreements, the confirmation of Federal-Mogul's plan of reorganization by the
Bankruptcy Court, the issuance of a final, non-appealable 524(g) channeling
injunction permanently enjoining any Bendix related asbestos claims against
Honeywell, and the receipt of all required governmental approvals. We do not
believe that completion of such transaction would have a material adverse impact
on our consolidated results of operations or financial position.
16
There can be no assurance, however, that the transaction contemplated by
the LOI will be completed. Honeywell presently has approximately $1.9 billion
(excluding coverage previously available from Equitas; see discussion below) of
insurance coverage remaining with respect to Bendix related asbestos claims.
Although it is impossible to predict the outcome of pending or future claims,
in light of our potential exposure, our prior experience in resolving these
claims, and our insurance coverage, we do not believe that the Bendix related
asbestos claims will have a material adverse effect on our consolidated
financial position.
Another source of claims is refractory products (high temperature bricks
and cement) sold largely to the steel industry in the East and Midwest by North
American Refractories Company (NARCO), a business we owned from 1979 to 1986.
Less than 2 percent of NARCO's products contained asbestos.
When we sold the NARCO business in 1986, we agreed to indemnify NARCO with
respect to personal injury claims for products that had been discontinued prior
to the sale (as defined in the sale agreement). NARCO retained all liability for
all other claims. NARCO had resolved approximately 176,000 claims through
January 4, 2002, the date NARCO filed for reorganization under Chapter 11 of the
U.S. Bankruptcy Code, at an average cost per claim of two thousand two hundred
dollars. Of those claims, 43 percent were dismissed on the ground that there was
insufficient evidence that NARCO was responsible for the claimant's asbestos
exposure. As of the date of NARCO's bankruptcy filing, there were approximately
116,000 remaining claims pending against NARCO, including approximately 7
percent in which Honeywell was also named as a defendant. Since 1983, Honeywell
and our insurers have contributed to the defense and settlement costs associated
with NARCO claims. We have approximately $1.5 billion (excluding coverage
previously available from Equitas; see discussion below) of insurance remaining
that can be specifically allocated to NARCO related liability.
As a result of the NARCO bankruptcy filing, all of the claims pending
against NARCO are automatically stayed pending the reorganization of NARCO. In
addition, because the claims pending against Honeywell necessarily will impact
the liabilities of NARCO, because the insurance policies held by Honeywell are
essential to a successful NARCO reorganization, and because Honeywell has
offered to commit the value of those policies to the reorganization, the
bankruptcy court has temporarily enjoined any claims against Honeywell, current
or future, related to NARCO. Although the stay has been extended sixteen times
since January 4, 2002, there is no assurance that such stay will remain in
effect. In connection with NARCO's bankruptcy filing, we paid NARCO's parent
company $40 million and agreed to provide NARCO with up to $20 million in
financing. We also agreed to pay $20 million to NARCO's parent company upon the
filing of a plan of reorganization for NARCO acceptable to Honeywell, and to pay
NARCO's parent company $40 million, and to forgive any outstanding NARCO
indebtedness, upon the confirmation and consummation of such a plan.
As a result of ongoing negotiations with counsel representing NARCO related
asbestos claimants regarding settlement of all pending and potential NARCO
related asbestos claims against Honeywell, we have reached definitive agreements
or agreements in principle with approximately 236,000 claimants, which
represents approximately 90 percent of the approximately 260,000 current
claimants who are now expected to file a claim as part of the NARCO
reorganization process. We are also in discussions with the NARCO Committee of
Asbestos Creditors on Trust Distribution Procedures for NARCO. We believe that,
as part of the NARCO plan of reorganization, a trust will be established
pursuant to these Trust Distribution Procedures for the benefit of all asbestos
claimants, current and future. If the trust is put in place and approved by the
court as fair and equitable, Honeywell as well as NARCO will be entitled to a
permanent channeling injunction barring all present and future individual
actions in state or federal courts and requiring all asbestos related claims
based on exposure to NARCO products to be made against the federally-supervised
trust. As part of its ongoing settlement
17
negotiations, Honeywell is seeking to cap its annual contributions to the
trust with respect to future claims at a level that would not have a material
impact on Honeywell's operating cash flows. Given the substantial progress of
negotiations between Honeywell and NARCO related asbestos claimants and
between Honeywell and the Committee of Asbestos Creditors during the fourth
quarter of 2002, Honeywell developed an estimated liability for settlement of
pending and future asbestos claims.
During the fourth quarter of 2002, Honeywell recorded a charge of $1.4
billion for NARCO related asbestos litigation charges, net of insurance
recoveries. This charge consists of the estimated liability to settle current
asbestos related claims, the estimated liability related to future asbestos
related claims through 2018 and obligations to NARCO's parent, net of insurance
recoveries of $1.8 billion.
The estimated liability for current claims is based on terms and
conditions, including evidentiary requirements, in definitive agreements or
agreements in principle with approximately 90 percent of current claimants. Once
finalized, settlement payments with respect to current claims are expected to be
made over approximately a four-year period.
The liability for future claims estimates the probable value of future
asbestos related bodily injury claims asserted against NARCO over a 15 year
period and obligations to NARCO's parent as discussed above. In light of the
uncertainties inherent in making long-term projections we do not believe that we
have a reasonable basis for estimating asbestos claims beyond 2018 under
Statement of Financial Accounting Standard No. 5 "Accounting for Contingencies."
Honeywell retained the expert services of Hamilton, Rabinovitz and Alschuler,
Inc. (HR&A) to project the probable number and value, including trust claim
handling costs, of asbestos related future liabilities. The methodology used to
estimate the liability for future claims has been commonly accepted by numerous
courts and is the same methodology that is utilized by an expert who is
routinely retained by the asbestos claimants committee in asbestos related
bankruptcies. The valuation methodology includes an analysis of the population
likely to have been exposed to asbestos containing products, epidemiological
studies to estimate the number of people likely to develop asbestos related
diseases, NARCO claims filing history and the pending inventory of NARCO
asbestos related claims.
Honeywell has substantial insurance that reimburses it for portions of the
costs incurred to settle NARCO related claims and court judgments as well as
defense costs. This coverage is provided by a large number of insurance policies
written by dozens of insurance companies in both the domestic insurance market
and the London excess market. At June 30, 2003, a significant portion of this
coverage is with London-based insurance companies under a coverage-in-place
agreement. See below for discussion of separate Equitas settlement.
Coverage-in-place agreements are settlement agreements between policyholders and
the insurers specifying the terms and conditions under which coverage will be
applied as claims are presented for payment. These agreements govern such things
as what events will be deemed to trigger coverage, how liability for a claim
will be allocated among insurers and what procedures the policyholder must
follow in order to obligate the insurer to pay claims. We conducted an analysis
to determine the amount of insurance that we estimate is probable that we will
recover in relation to payment of current and projected future claims. While the
substantial majority of our insurance carriers are solvent, some of our
individual carriers are insolvent, which has been considered in our analysis of
probable recoveries. Some of our insurance carriers have challenged our right to
enter into settlement agreements resolving all NARCO related asbestos claims
against Honeywell. However, we believe there is no factual or legal basis for
such challenges and we believe that it is probable that we will prevail in the
resolution of, or in any litigation that is brought regarding these disputes and
as of June 30, 2003, we have recognized approximately $550 million in probable
insurance recoveries from these carriers. We made judgments concerning insurance
18
coverage that we believe are reasonable and consistent with our historical
dealings with our insurers, our knowledge of any pertinent solvency issues
surrounding insurers and various judicial determinations relevant to our
insurance programs. Based on our analysis, we recorded insurance recoveries that
are deemed probable through 2018 of $1.8 billion. A portion of this insurance
has been received, primarily from Equitas, as discussed below.
During the six months ended June 30, 2003, we made asbestos related
payments of $388 million, including legal fees. During the six months ended June
30, 2003, we received $477 million in insurance reimbursements including $472
million in cash received from Equitas related to a comprehensive policy buy-back
settlement of all insurance claims by Honeywell against Equitas. The settlement
resolves all claims by Honeywell against Equitas arising from asbestos claims
related to NARCO and Bendix. The coverage amounts discussed above for NARCO and
Bendix do not include coverage previously available from Equitas.
Projecting future events is subject to many uncertainties that could cause
the NARCO related asbestos liabilities to be higher or lower than those
projected and recorded. There is no assurance that ongoing settlement
negotiations will be successfully completed, that a plan of reorganization will
be proposed or confirmed, that insurance recoveries will be timely or whether
there will be any NARCO related asbestos claims beyond 2018. Given the inherent
uncertainty in predicting future events, we plan to review our estimates
periodically, and update them based on our experience and other relevant
factors. Similarly we will reevaluate our projections concerning our probable
insurance recoveries in light of any changes to the projected liability or other
developments that may impact insurance recoveries.
NARCO and Bendix asbestos related balances are included in the
following balance sheet accounts:
June 30, December 31,
2003 2002
-------- ------------
Other current assets $ 170 $ 320
Insurance recoveries for asbestos related liabilities 1,370 1,636
------ ------
$1,540 $1,956
====== ======
Accrued liabilities $ 727 $ 741
Asbestos related liabilities 2,394 2,700
------ ------
$3,121 $3,441
====== ======
19
Report of Independent Auditors
To the Board of Directors and Shareowners
of Honeywell International Inc.
We have reviewed the accompanying consolidated balance sheet of Honeywell
International Inc. and its subsidiaries as of June 30, 2003, and the related
consolidated statement of operations for each of the three-month and six-month
periods ended June 30, 2003 and 2002 and the consolidated statement of cash
flows for the six-month periods ended June 30, 2003 and 2002. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. 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 generally
accepted auditing standards, 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 consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
We previously audited in accordance with auditing standards generally accepted
in the United States of America, the consolidated balance sheet as of December
31, 2002, and the related consolidated statements of operations, of shareowners'
equity, and of cash flows for the year then ended (not presented herein), and in
our report dated February 6, 2003, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying consolidated balance sheet information as of December 31, 2002,
is fairly stated in all material respects in relation to the consolidated
balance sheet from which it has been derived.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Florham Park, NJ
August 8, 2003
- -----------------------
The "Report of Independent Auditors" included above is not a "report" or
"part of a Registration Statement" prepared or certified by an independent
accountant within the meanings of Sections 7 and 11 of the Securities Act of
1933, and the accountants' Section 11 liability does not extend to such report.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
A. RESULTS OF OPERATIONS - SECOND QUARTER 2003 COMPARED WITH SECOND QUARTER 2002
Net sales in the second quarter of 2003 were $5,749 million, an increase of
$98 million, or 2 percent compared with the second quarter of 2002. The increase
in sales is attributable to the following:
Acquisitions 2%
Divestitures (2)
Price --
Volume (2)
Foreign exchange 4
--
2%
==
A discussion of net sales by reportable segment can be found in the Review
of Business Segments section below.
Cost of goods sold of $4,514 million in the second quarter of 2003
increased by $83 million, or 2 percent compared with the second quarter of 2002.
This increase resulted from a $181 million increase due primarily to the
unfavorable impact of foreign exchange, a decrease in sales of higher-margin
products and services, primarily in our Aerospace and Automation and Control
Solutions reportable segments, and higher pension, product development and other
expenses. This increase was partially offset by a decrease of $98 million in
repositioning and other charges.
Selling, general and administrative expenses of $762 million in the second
quarter of 2003 increased by $102 million, or 15 percent compared with the
second quarter of 2002 due mainly to higher pension and other employee benefit
costs and the unfavorable impact of foreign exchange.
Pension expense was $44 million in the second quarter of 2003 compared with
pension income of $39 million in the second quarter of 2002. The increase of $83
million in pension expense in the second quarter of 2003 compared with the
second quarter of 2002 was due principally to a reduction in 2003 in the assumed
rate of return on plan assets from 10 to 9 percent, a decrease in the
market-related value of our pension plan assets during the period 2000 to 2002
and the systematic recognition of higher net losses. These losses resulted
mainly from actual pension plan asset returns below the assumed rate of return
during the period 2000 to 2002.
Gain on sale of non-strategic businesses of $31 million in the second
quarter of 2003 represents the pretax gain on the disposition of Specialty
Materials' Engineering Plastics (Engineering Plastics) business. Loss on sale of
non-strategic businesses of $166 million in the second quarter of 2002
represented the pretax loss on the dispositions of Specialty Materials'
Pharmaceutical Fine Chemicals (PFC) and Automation and Control's Consumer
Products (Consumer Products) businesses.
Equity in (income) loss of affiliated companies was income of $6 million in
the second quarter of 2003 compared with income of $3 million in the second
quarter of 2002. The increase of $3 million in equity income in the second
quarter of 2003 compared with the second quarter of 2002 was due mainly to the
inclusion of a charge of $10 million in the prior year's quarter for severance
actions by our UOP process technology (UOP) joint venture partially offset by
income of $7 million resulting from exiting a joint venture in our Aerospace
reportable segment also in the prior year's quarter.
21
Other (income) expense, $24 million of income in the second quarter of
2003, compared with $6 million of income in the second quarter of 2002. The
increase of $18 million in other income in the second quarter of 2003 compared
with the second quarter of 2002 was due mainly to a gain of $20 million related
to the settlement of a patent infringement lawsuit.
Interest and other financial charges of $87 million in the second quarter
of 2003 was basically flat compared with the second quarter of 2002.
Tax expense was $128 million in the second quarter of 2003 resulting in an
effective tax rate of 28.6 percent which was lower than the statutory tax rate
of 35 percent principally due to tax benefits on export sales, favorable tax
audit settlements and foreign tax planning strategies. Tax (benefit) was ($144)
million in the second quarter of 2002 resulting from the impact of repositioning
and other charges and the loss on the dispositions of our PFC and Consumer
Products businesses. The businesses sold had a higher deductible tax basis than
book basis which resulted in a tax benefit.
Net income was $319 million, or $0.37 per share, in the second quarter of
2003 compared with net income of $459 million, or $0.56 per share, in the second
quarter of 2002. The decrease of $0.19 per share in the second quarter of 2003
compared with the second quarter of 2002 was primarily due to higher pension
expense, including the impact of dilution from the prior year contribution of
Honeywell common stock to our U.S. pension plans, lower sales of higher margin
products and services, principally in our Aerospace and Automation and Control
Solutions reportable segments and higher product development and other expenses.
22
Review of Business Segments
Three Months Ended
June 30,
------------------
2003 2002
------ ------
Net Sales
Aerospace $2,161 $2,204
Automation and Control Solutions 1,837 1,758
Specialty Materials 823 870
Transportation Systems 925 805
Corporate 3 14
------ ------
$5,749 $5,651
====== ======
Segment Profit
Aerospace $ 224 $ 364
Automation and Control Solutions 177 220
Specialty Materials 28 34
Transportation Systems 112 104
Corporate (34) (35)
------ ------
Total segment profit 507 687
------ ------
Gain (loss) on sale of non-strategic businesses 31 (166)
Equity in income of affiliated companies 6 3
Other income 24 6
Interest and other financial charges (87) (88)
Repositioning and other charges included in cost of goods
sold and selling, general and administrative expenses (34) (127)
------ ------
Income before taxes and cumulative effect
of accounting change $ 447 $ 315
====== ======
Aerospace sales of $2,161 million in the second quarter of 2003 decreased
by $43 million, or 2 percent compared with the second quarter of 2002 due to
continued weakness in sales to our commercial original equipment (OE) and
aftermarket customers. Sales to our air transport OE customers decreased by 18
percent reflecting scheduled production declines by our OE customers (primarily
Boeing and Airbus) due to reduced aircraft orders by commercial airlines. The
airline industry continues to be negatively impacted by general weakness in the
economy and the financial difficulties being encountered by certain major
carriers. Sales to our business and general aviation OE customers also decreased
by 18 percent reflecting a decline in projected deliveries of business jet
airplanes due to weakness in fractional demand and corporate profitability.
Sales to our commercial air transport aftermarket customers were lower by 5
percent as a decline in sales of commercial spare parts of 16 percent due to
lower discretionary spending by the airlines was partially offset by higher
sales of repair and overhaul services of 7 percent. Sales to our regional
transport aftermarket customers declined by 15 percent due to weak market
conditions. The decrease in Aerospace sales in the second quarter of 2003
compared with the second quarter of 2002 was partially offset by an increase in
sales to our defense and space customers, with aftermarket sales up by 11
percent and OE sales higher by 5 percent, resulting principally from increased
military activity and growth in precision guidance and spare parts. Sales to our
business and general aviation aftermarket customers improved by 7 percent
largely due to strong repair and overhaul activity and higher sales of spare
parts.
Aerospace segment profit of $224 million in the second quarter of 2003
decreased by $140 million, or 38 percent compared with the second quarter of
2002 due mainly to lower sales of commercial original equipment and
higher-margin
23
commercial aftermarket spare parts as well as higher pension, research,
development and engineering and other expenses.
Automation and Control Solutions sales of $1,837 million in the second
quarter of 2003 increased by $79 million, or 4 percent compared with the second
quarter of 2002 due to the favorable effects of foreign exchange of 6 percent
and acquisitions, net of the prior year disposition of our Consumer Products
business, of 3 percent, partially offset by the impact of lower prices of 1
percent and lower volumes of 4 percent. Sales increased by 8 percent for our
Automation and Control Products business as the effects of acquisitions, mainly
Invensys Sensor Systems, foreign exchange and strong sales of fire solutions
products more than offset the impact of the prior year disposition of our
Consumer Products business and general weakness in the economy. Sales for our
Service business increased by 1 percent as the favorable impact from foreign
exchange was partially offset by lower volumes due to continued softness in
capital spending as well as commercial and residential construction. Sales for
our Industry Solutions business were flat.
Automation and Control Solutions segment profit of $177 million in the
second quarter of 2003 decreased by $43 million, or 20 percent compared with the
second quarter of 2002 due mainly to higher pension expense, the decline in
higher-margin energy-retrofit and discretionary spot sales in our Service
business, and increased research and development and other expenses, mainly in
our Automation and Control Products and Service businesses, respectively.
Specialty Materials sales of $823 million in the second quarter of 2003
decreased by $47 million, or 5 percent compared with the second quarter of 2002
due largely to the impact from the prior year divestitures of our Advanced
Circuits and PFC businesses. The favorable impact of foreign exchange of 3
percent was offset by lower volumes mainly in our Nylon Systems, Performance
Products and Fluorines businesses.
Specialty Materials segment profit of $28 million in the second quarter of
2003 decreased by $6 million, or 18 percent compared with the second quarter of
2002. This decrease mainly resulted from higher raw material costs (principally
natural gas) and higher pension expense, partially offset by the impact of the
prior year write-down of property, plant and equipment in several businesses,
divestitures of non-strategic businesses and the benefits of cost actions.
Transportation Systems sales of $925 million in the second quarter of 2003
increased by $120 million, or 15 percent compared with the second quarter of
2002 due mainly to the favorable impact of foreign exchange of 11 percent and
volume growth at our Garrett Engine Boosting Systems business. Sales at our
Garrett Engine Boosting Systems business increased by 31 percent due to volume
growth of 16 percent as worldwide demand for our turbochargers continued to be
strong, and the favorable impact of foreign exchange of 15 percent.
Transportation Systems segment profit of $112 million in the second quarter
of 2003 increased by $8 million, or 8 percent compared with the second quarter
of 2002 due mainly to the effect of higher sales in our Garrett Engine Boosting
Systems business partially offset by higher pension, new product development and
introduction, facility relocations and other expenses.
24
B. RESULTS OF OPERATIONS - SIX MONTHS 2003 COMPARED WITH SIX MONTHS 2002
Net sales in the first six months of 2003 were $11,148 million, an increase
of $298 million, or 3 percent compared with the first six months of 2002. The
increase in sales is attributable to the following:
Acquisitions 2%
Divestitures (2)
Price --
Volume (1)
Foreign exchange 4
--
3%
==
A discussion of net sales by reportable segment can be found in the Review
of Business Segments section below.
Cost of goods sold of $8,754 million in the first six months of 2003
increased by $250 million, or 3 percent compared with the first six months of
2002. This increase resulted from a $394 million increase due primarily to the
unfavorable impact of foreign exchange, a decrease in sales of higher-margin
products and services, primarily in our Aerospace and Automation and Control
Solutions reportable segments, and higher pension, product development and other
expenses. This increase was partially offset by a decrease of $144 million in
repositioning and other charges.
Selling, general and administrative expenses of $1,465 million in the first
six months of 2003 increased by $188 million, or 15 percent compared with the
first six months of 2002 due mainly to higher pension and other employee benefit
costs and the unfavorable impact of foreign exchange.
Pension expense was $88 million in the first six months of 2003 compared
with pension income of $78 million in the first six months of 2002. The increase
of $166 million in pension expense in the first six months of 2003 compared with
the first six months of 2002 was due principally to a reduction in 2003 in the
assumed rate of return on plan assets from 10 to 9 percent, a decrease in the
market-related value of our pension plan assets during the period 2000 to 2002
and the systematic recognition of higher net losses. These losses resulted
mainly from actual pension plan asset returns below the assumed rate of return
during the period 2000 to 2002.
Gain on sale of non-strategic businesses of $31 million in the first six
months of 2003 represents the pretax gain on the disposition of our Engineering
Plastics business. Loss on sale of non-strategic businesses of net $41 million
in the first six months of 2002 represented the pretax loss on the dispositions
of our PFC and Consumer Products businesses of $166 million partially offset by
the pretax gain on the disposition of our Bendix Commercial Vehicle Systems
(BCVS) business of $125 million.
Business impairment charges of $43 million in the first six months of 2002
related to the write-down of property, plant and equipment in our Friction
Materials business and the planned shutdown of a manufacturing facility in our
Specialty Materials reportable segment. See the repositioning, business
impairment and other charges section of this MD&A for further details.
Equity in (income) loss of affiliated companies was income of $4 million in
the first six months of 2003 compared with income of $10 million in the first
six months of 2002. The decrease of $6 million in equity income in the first six
months of 2003 compared with the first six months of 2002 was due mainly to the
inclusion of a charge of $13 million in the prior year's first six months for
25
severance actions by our UOP joint venture partially offset by income of $15
million resulting from exiting joint ventures in our Aerospace and
Transportation Systems reportable segments also in the prior year's first
six months.
Other (income) expense, $27 million of income in the first six months of
2003, compared with $22 million of income in the first six months of 2002. The
increase of $5 million in other income in the first six months of 2003 compared
with the first six months of 2002 was due mainly to a gain of $20 million
related to the settlement of a patent infringement lawsuit partially offset by a
decrease in benefits from foreign exchange hedging resulting from the weakness
in the U.S. dollar.
Interest and other financial charges of $171 million in the first six
months of 2003 decreased by $4 million, or 2 percent compared with the first six
months of 2002 due mainly to lower interest rates in the current period.
Tax expense was $227 million in the first six months of 2003 resulting in
an effective tax rate of 27.7 percent which was lower than the statutory tax
rate of 35 percent principally due to tax benefits on export sales, favorable
tax audit settlements and foreign tax planning strategies. Tax expense was $7
million in the first six months of 2002 resulting in an effective tax rate of
0.8 percent. This includes the tax benefit of 25.7 percentage points related to
repositioning, business impairment and other charges, the gain on the sale of
our BCVS business, and the loss on the dispositions of our PFC and Consumer
Products businesseses. The PFC and Consumer Products businesses had a higher
deductible tax basis than book basis basis which resulted in a tax benefit.
Net income was $573 million, or $0.67 per share, in the first six months of
2003 compared with net income of $835 million, or $1.02 per share, in the first
six months of 2002. The decrease of $0.35 per share in the first six months of
2003 compared with the first six months of 2002 was primarily due to higher
pension expense, including the impact of dilution from the prior year
contribution of Honeywell common stock to our U.S. pension plans, lower sales
of higher margin products and services, principally in our Aerospace and
Automation and Control Solutions reportable segments, higher product
development and other expenses and the cumulative effect of a change in
accounting related to our adoption of SFAS No. 143 on January 1, 2003.
26
Review of Business Segments
Six Months Ended
June 30,
-----------------
2003 2002
------- -------
Net Sales
Aerospace $ 4,223 $ 4,293
Automation and Control Solutions 3,554 3,367
Specialty Materials 1,600 1,628
Transportation Systems 1,765 1,531
Corporate 6 31
------- -------
$11,148 $10,850
======= =======
Segment Profit
Aerospace $ 442 $ 671
Automation and Control Solutions 362 427
Specialty Materials 38 42
Transportation Systems 187 177
Corporate (66) (71)
------- -------
Total segment profit 963 1,246
------- -------
Gain (loss) on sale of non-strategic businesses 31 (41)
Business impairment charges -- (43)
Equity in income of affiliated companies 4 10
Other income 27 22
Interest and other financial charges (171) (175)
Repositioning and other charges included in cost of goods
sold and selling, general and administrative expenses (34) (177)
------- -------
Income before taxes and cumulative effect
of accounting change $ 820 $ 842
======= =======
Aerospace sales of $4,223 million in the first six months of 2003 decreased
by $70 million, or 2 percent compared with the first six months of 2002 due to
continued weakness in sales to our commercial original equipment (OE) and
aftermarket customers. Sales to our air transport OE customers declined by 22
percent reflecting dramatically lower projected deliveries by our OE customers
(primarily Boeing and Airbus) due to reduced aircraft orders by commercial
airlines. The airline industry continues to be negatively impacted by general
weakness in the economy and the financial difficulties being encountered by
certain major carriers. Sales to our business and general aviation OE customers
decreased by 25 percent reflecting a decline in projected deliveries of business
jet airplanes due to weakness in fractional demand and corporate profitability.
Sales to our commercial air transport and regional aftermarket customers were
lower by 1 and 12 percent, respectively, mainly due to weakness in sales of
spare parts. The decrease in Aerospace sales in the first six months of 2003
compared with the first six months of 2002 was partially offset by an increase
in sales to our defense and space customers, with aftermarket sales up by 14
percent and OE sales higher by 6 percent, resulting principally from increased
military activity and growth in precision guidance and spare parts. Sales to our
business and general aviation aftermarket customers were higher by 8 percent
largely due to increases in repair and overhaul activity. We currently expect
full year 2003 sales to our air transport and business and general aviation OE
customers to decline by 15 and 21 percent, respectively, compared with the prior
year due to reduced aircraft orders. We currently expect that sales to our
commercial aftermarket customers will be down by 3 percent for the full year
2003 compared with the prior year due mainly to the financial difficulties being
experienced by the airlines and reduced flying hours.
27
Aerospace segment profit of $442 million in the first six months of 2003
decreased by $229 million, or 34 percent compared with the first six months of
2002 due mainly to lower sales of commercial original equipment and
higher-margin commercial aftermarket spare parts as well as higher pension,
research, development and engineering and other expenses.
Automation and Control Solutions sales of $3,554 million in the first six
months of 2003 increased by $187 million, or 6 percent compared with the first
six months of 2002 due to the favorable effects of foreign exchange of 6 percent
and acquisitions, net of the prior year disposition of our Consumer Products
business, of 3 percent, partially offset by the impact of lower prices of 1
percent and lower volumes of 2 percent. Sales increased by 8 percent for our
Automation and Control Products business as the effects of foreign exchange and
prior year acquisitions, mainly Invensys Sensor Systems, more than offset the
impact of the prior year disposition of our Consumer Products business and lower
volumes. Sales for our Industry Solutions business increased by 6 percent due to
the favorable impact of foreign exchange. Sales for our Service business
increased by 1 percent as the favorable impact from foreign exchange was largely
offset by a decline in volumes due to softness in capital spending as well as
commercial and residential construction.
Automation and Control Solutions segment profit of $362 million in the
first six months of 2003 decreased by $65 million, or 15 percent compared with
the first six months of 2002 due mainly to higher pension expense, the decline
in higher-margin energy-retrofit and discretionary spot sales in our Service
business, and increased research and development and other expenses, mainly in
our Automation and Control Products and Service businesses, respectively.
Specialty Materials sales of $1,600 million in the first six months of 2003
decreased by $28 million, or 2 percent compared with the first six months of
2002 due to the impact of the prior year divestitures of our Advanced Circuits
and PFC businesses of 7 percent and lower prices of 1 percent partially offset
by the favorable impact of foreign exchange of 4 percent and higher volumes of 2
percent.
Specialty Materials segment profit of $38 million in the first six months
of 2003 decreased by $4 million, or 10 percent compared with the first six
months of 2002. This decrease mainly resulted from higher raw material costs
(principally natural gas) and higher pension expense, partially offset by the
impact of the prior year write-down of property, plant and equipment in several
businesses, divestitures of non-strategic businesses and the benefits of cost
actions.
Transportation Systems sales of $1,765 million in the first six months of
2003 increased by $234 million, or 15 percent compared with the first six months
of 2002 due mainly to the favorable impact of foreign exchange of 10 percent and
volume growth. This increase resulted mainly from a 30 percent increase in sales
for our Garrett Engine Boosting Systems business due to volume growth of 17
percent as worldwide demand for our turbochargers continued to be strong, and
the favorable impact of foreign exchange of 13 percent.
Transportation Systems segment profit of $187 million in the first six
months of 2003 increased by $10 million, or 6 percent compared with the first
six months of 2002 as the effect of higher sales in our Garrett Engine Boosting
Systems business was partially offset by higher pension, new product development
and introduction, facility relocations and other expenses.
28
C. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Total assets at June 30, 2003 were $28,533 million, an increase of $974
million, or 4 percent from December 31, 2002 mainly due to an increase in cash
of $605 million. See details in Consolidated Statement of Cash Flows. The
increase in total assets also resulted from foreign currency translation due
primarily to the strengthing of the Euro in relation to the U.S. dollar.
Cash provided by operating activities of $1,026 million during the first
six months of 2003 decreased by $101 million compared with the first six months
of 2002 mainly due to lower earnings and a voluntary contibution to our U.S.
defined benefit pension plans partially offset by lower spending for severance
and an increase in net insurance receipts for asbestos related liabilities.
We made asbestos related payments of $388 million, including legal fees, in
the first six months of 2003 and expect to make additional asbestos related
payments of approximately $215 million during the remainder of 2003. This
estimate is based on our experience in the first six months of 2003 regarding
the timing of submissions of required evidential data by plantiffs firms. We had
$477 million of asbestos related insurance recoveries during the first six
months of 2003, including the buyout of the NARCO and Bendix Equitas insurance
policies in April 2003. We previously anticipated receiving the Equitas payments
primarily during the period 2003 through 2007. We expect to receive
approximately $90 million in asbestos related insurance recoveries during the
remainder of 2003. These cash flow projections are consistent with our existing
asbestos reserves. See Note 12 of Notes to Financial Statements for further
details.
Cash used for investing activities of $308 million during the first six
months of 2003 increased by $204 million compared with the first six months of
2002 due mainly to an increase in spending for acquisitions of $103 million and
lower proceeds from sales of businesses of $96 million. The increase in spending
for acquisitions in the current period mainly relates to the acquisitions of a
fire controls and detection technology business and a sensor business by our
Automation and Control Solutions reportable segment and a nylon films business
by our Specialty Materials reportable segment. The first six months of 2003
included the proceeds from our disposition of our Engineering Plastics business
of $90 million, whereas the first six months of 2002 included the proceeds from
the dispositions of our BCVS, PFC and Consumer Products businesses of $186
million. This increase in cash used for investing activities was partially
offset by lower capital spending of $23 million mainly reflecting the completion
in 2002 of a major plant in our Fluorines business. Our total capital spending
for the full year 2003 is projected to be approximately $650 million.
We continuously assess the relative strength of each business in our
portfolio as to strategic fit, market position, profit and cash flow
contribution in order to upgrade our combined portfolio and identify business
units that will most benefit from increased investment. We identify acquisition
candidates that will further our strategic plan and strengthen our existing core
businesses. We also identify business units that do not fit into our long-term
strategic plan based on their market position, relative profitability or growth
potential. These business units are considered for potential divestiture,
restructuring or other repositioning actions subject to regulatory constraints.
Cash used for financing activities of $296 million during the first six
months of 2003 decreased by $183 million compared with the first six months of
2002 due mainly to a decrease in scheduled repayments of long-term debt in the
current period partially offset by lower net borrowings of short-term debt.
Total debt of $5,430 million at June 30, 2003 was $341 million, or 7 percent
higher than at December 31, 2002 principally reflecting the assumption of $268
29
million of debt associated with the purchase of assets under leases qualifying
as variable interest entities and higher short-term borrowings.
Repositioning, Business Impairment and Other Charges
A summary of repositioning, business impairment and other charges follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Severance $ 22 $ 32 $ 22 $ 73
Asset impairments -- 57 -- 68
Exit costs 3 10 3 23
Reserve adjustments (23) (31) (23) (43)
---- ---- ---- ----
Total net repositioning charge 2 68 2 121
---- ---- ---- ----
Probable and reasonably estimable
environmental liabilities 32 -- 32 --
Business impairment charges -- -- -- 43
Customer claims and settlements
of contract liabilities -- 29 -- 29
Write-offs of receivables,
inventories and other assets -- 40 -- 40
---- ---- ---- ----
Total net repositioning, business
impairment and other charges $ 34 $137 $ 34 $233
==== ==== ==== ====
The following table summarizes the pretax distribution of total net
repositioning, business impairment and other charges by income statement
classification:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Cost of goods sold $29 $127 $29 $173
Selling, general and administrative
expenses 5 -- 5 4
Business impairment charges -- -- -- 43
Equity in (income) loss of
affiliated companies -- 10 -- 13
--- ---- --- ----
$34 $137 $34 $233
=== ==== === ====
In the second quarter of 2003, we recognized a charge of $25 million mainly
for severance costs related to workforce reductions of 448 manufacturing and
administrative positions mainly in our Specialty Materials and Aerospace
reportable segments. Also, $23 million of previously established accruals,
mainly for severance, were returned to income in the second quarter of 2003, due
to fewer employee separations than originally anticipated associated with
certain 2002 repositioning actions, resulting in reduced severance liabilities
in our Automation and Control Solutions, Aerospace and Specialty Materials
reportable segments.
As disclosed in our 2002 Annual Report on Form 10-K, we recognized
repositioning charges totaling $453 million in 2002 ($99 and $164 million were
recognized in the three- and six-month periods ended June 30, 2002). The
components of the charges included severance costs of $270 million, asset
impairments of $121 million and other exit costs of $62 million. Severance costs
were related to announced workforce reductions of approximately 8,100
manufacturing and administrative positions across all of our reportable segments
and our UOP process technology joint venture, of which approximately 5,200
positions have been eliminated as of June 30, 2003. These actions are expected
to be substantially
30
completed by December 31, 2003. Also, $76 million of previously established
severance accruals were returned to income in 2002, due to fewer employee
separations than originally anticipated and higher than expected voluntary
employee attrition resulting in reduced severance liabilities in our Aerospace,
Automation and Control Solutions and Specialty Materials reportable segments.
These repositioning actions are expected to generate incremental pretax
savings of approximately $400 million in 2003 compared with 2002 principally
from planned workforce reductions and facility consolidations. Cash expenditures
for severance and other exit costs necessary to execute these actions were $93
million in the six months ended June 30, 2003 and were funded through operating
cash flows. Cash spending for severance and other exit costs necessary to
execute the 2003 and remaining 2002 repositioning actions will approximate $300
million in 2003 and will be funded mainly though operating cash flows.
In the second quarter of 2003, we recognized other charges of $32 million
for legacy environmental matters deemed probable and reasonably estimable in the
second quarter of 2003 including the matter entitled Interfaith Community
Organization, et al. v. Honeywell International Inc., et al. as discussed in
Note 12 of Notes to Financial Statements.
In the second quarter of 2002, we recognized other charges consisting of
customer claims and settlements of contract liabilities of $29 million and
write-offs of receivables, inventories and other assets of $40 million. Such
charges related mainly to our Advanced Circuits business which was sold in the
fourth quarter of 2002, bankruptcy of a customer in our Aerospace reportable
segment, and customer claims in our Industry Solutions business.
In the first quarter of 2002, we recognized an impairment charge of $27
million related to the write-down of property, plant and equipment of our
Friction Materials business, which is classified as assets held for disposal in
Other Current Assets (a plan of disposal of Friction Materials was adopted in
2001; in January 2003, we entered into a letter of intent to sell this business
to Federal-Mogul Corp. - See Note 12 of Notes to Financial Statements). In the
first quarter of 2002, we also recognized an asset impairment charge of $16
million related to the planned shutdown of a chemical manufacturing facility
in our Specialty Materials reportable segment.
The following table summarizes the pretax impact of total net
repositioning, business impairment and other charges by reportable segment:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Aerospace $(2) $ 6 $(2) $ 6
Automation and Control Solutions (8) 22 (8) 61
Specialty Materials 7 107 7 132
Transportation Systems -- 2 -- 30
Corporate 37 -- 37 4
--- ---- --- ----
$34 $137 $34 $233
=== ==== === ====
31
D. OTHER MATTERS
Critical Accounting Policies
As disclosed in the Defined Benefit Pension Plans section of our Critical
Accounting Policies in Management's Discussion and Analysis of Financial
Condition and Results of Operations of our 2002 Annual Report on Form 10-K, the
key assumptions in determining pension expense are our expected return on plan
assets and the discount rate. Assuming our pension fund assets earn a 9 percent
rate of return in the year ending December 31, 2003, the discount rate decreases
to 6.25 percent at December 31, 2003 (assumed rate based on current market
conditions), and there are no additional plan contributions beyond the $170
million contributed in April 2003, pension expense would increase by
approximately $0.30 per share for the year ending December 31, 2004. Such
increase in pension expense in 2004 compared with 2003 would be principally due
to a decrease in the market-related value of pension plan assets and the
systematic recognition of unrecognized net losses mainly resulting from actual
pension plan asset retuns below the asssumed rate of return during the period
2000 to 2002, as well as lower interest rates.
Future pension plan contributions are dependent upon actual plan asset
returns and interest rates. Assuming that actual plan returns are consistent
with our assumed plan return rate of 9 percent in 2003 and beyond, and the
discount rate is 6.25 percent, we would not be required to make any
contributions in 2003 or 2004.
Recent Accounting Pronouncements
See Note 2 of Notes to Financial Statements for a discussion of recent
accounting pronouncements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See our 2002 Annual Report on Form 10-K (Item 7A). At June 30, 2003, there
has been no material change in this information.
ITEM 4. CONTROLS AND PROCEDURES
Honeywell management, including the Chief Executive Officer and Chief
Financial Officer, conducted an evaluation of the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
Quarterly Report on Form 10-Q. Based upon that evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that such disclosure controls
and procedures were effective as of the end of the period covered by this
Quarterly Report on Form 10-Q in alerting them on a timely basis to material
information relating to Honeywell required to be included in Honeywell's
periodic filings under the Exchange Act. There have been no changes that have
materially affected, or are reasonably likely to materially affect, Honeywell's
internal control over financial reporting that have occurred during the period
covered by this Quarterly Report on Form 10-Q.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Shareowner Litigation - Honeywell and seven of its current and former
officers were named as defendants in several purported class action lawsuits
filed in the United States District Court for the District of New Jersey (the
32
Securities Law Complaints). The Securities Law Complaints principally allege
that the defendants violated federal securities laws by purportedly making false
and misleading statements and by failing to disclose material information
concerning Honeywell's financial performance, thereby allegedly causing the
value of Honeywell's stock to be artificially inflated. On January 15, 2002,
the District Court dismissed the consolidated complaint against four of
Honeywell's current and former officers. The Court has granted plaintiffs'
motion for class certification defining the purported class as all purchasers
of Honeywell stock between December 20, 1999 and June 19, 2000.
The parties participated in a two day settlement mediation in April 2003 in
an attempt to resolve the cases without resort to a trial. The mediation proved
unsuccessful in resolving the cases. Discovery in the cases, which had been
stayed pending completion of the mediation, has resumed.
We continue to believe that the allegations in the Securities Law
Complaints are without merit. Although it is not possible at this time to
predict the outcome of these cases, we expect to prevail. However, an adverse
outcome could be material to our consolidated financial position or results of
operations. As a result of the uncertainty regarding the outcome of this matter
no provision has been made in our financial statements with respect to this
contingent liability.
ERISA Class Action Lawsuit - In April 2003, Honeywell and several of its
current and former officers were named as defendants in a purported class action
lawsuit filed in the United States District Court for the District of New
Jersey. The complaint principally alleges that the defendants breached their
fiduciary duties to participants in the Honeywell Savings and Ownership Plan
(the "Savings Plan") by purportedly making false and misleading statements,
failing to disclose material information concerning Honeywell's financial
performance, and failing to diversify the Savings Plan's assets and monitor the
prudence of Honeywell stock as a Savings Plan investment. In July 2003, an
amended complaint making similar allegations and naming several current and
former officers and directors as defendants was filed in the same district. No
answers have been filed and discovery has not commenced. Although it is not
possible at this time to predict the outcome of this litigation, we believe that
the allegations in these complaints are without merit and we expect to prevail.
An adverse litigation outcome could, however, be material to our consolidated
financial position or results of operations. As a result of the uncertainty
regarding the outcome of this matter, no provision has been made in our
financial statements with respect to this contingent liability.
Environmental Matters - We are subject to various federal, state and local
government requirements relating to the protection of employee health and safety
and the environment. We believe that, as a general matter, our policies,
practices and procedures are properly designed to prevent unreasonable risk of
environmental damage and personal injury to our employees and employees of our
customers and that our handling, manufacture, use and disposal of hazardous or
toxic substances are in accord with environmental laws and regulations. However,
mainly because of past operations and operations of predecessor companies, we,
like other companies engaged in similar businesses, have incurred remedial
response and voluntary cleanup costs for site contamination and are a party to
lawsuits and claims associated with environmental matters, including past
production of products containing toxic substances. Additional lawsuits, claims
and costs involving environmental matters are likely to continue to arise in the
future.
With respect to environmental matters involving site contamination, we
continually conduct studies, individually at our owned sites, and jointly as a
member of industry groups at non-owned sites, to determine the feasibility of
various remedial techniques to address environmental matters. It is our policy
to record appropriate liabilities for environmental matters when environmental
33
assessments are made or remedial efforts or damage claim payments are probable
and the costs can be reasonably estimated. With respect to site contamination,
the timing of these accruals is generally no later than the completion of
feasibility studies. We expect to fund expenditures for these matters from
operating cash flow. The timing of cash expenditures depends on a number of
factors, including the timing of litigation and settlements of personal injury
and property damage claims, regulatory approval of cleanup projects, remedial
techniques to be utilized and agreements with other parties.
Although we do not currently possess sufficient information to reasonably
estimate the amounts of liabilities to be recorded upon future completion of
studies, litigation or settlements, and neither the timing nor the amount of the
ultimate costs associated with environmental matters can be determined, they
could be material to our consolidated results of operations. However,
considering our past experience and existing reserves, we do not expect that
these matters will have a material adverse effect on our consolidated financial
position.
In the matter entitled Interfaith Community Organization, et al. v.
Honeywell International Inc., et al., the United States District Court for the
District of New Jersey held in May 2003 that a predecessor Honeywell site
located in Jersey City, New Jersey constituted an imminent and substantial
endangerment and ordered Honeywell to conduct the excavation and transport for
offsite disposal of approximately one million tons of chromium residue present
at the site. Honeywell strongly disagrees with the court's determinations and
has appealed the court's decision. Honeywell is also seeking a stay of aspects
of the court's order. The site at issue is one of twenty-one sites located in
Jersey City, New Jersey which are the subject of an Administrative Consent Order
(ACO) entered into with the New Jersey Department of Environmental Protection
(NJDEP) in 1993. Uner the ACO, Honeywell agreed to study and remediate these
sites in accordance with NJDEP's directions, provided that the total cost of
such studies and remediation does not exceed $60 million. Honeywell has
cooperated with the NJDEP under the ACO and believes that decisions regarding
site cleanups should be made by NJDEP under the ACO. We are confident that
proceeding under the ACO will ensure a safe remediation and allow the property
to be placed back into productive use much faster and at a cost significantly
less than the remedies required by the court's order. We have not developed a
remedial action plan for the excavation and offsite disposal directed under the
court's order and therefore are unable to estimate the cost of such actions. At
trial, plaintiff's expert testified that the excavation and offsite disposal
cost might be $400 million. However, there are significant variables in the
implementation of the court's order and depending on the method of
implementation chosen, the estimate could increase or decrease. Provisions have
been previously made in our financial statements as to remedial costs
consistent with the ACO and during the three months ended June 30, 2003 we
provided for additional costs which are likely to be incurred during the
pendency of our appeal, which provisions do not assume excavation and offsite
removal of chromium from the site. There are alternative outcomes and remedies
beyond the scope of the ACO that could result from the remanding, reversal or
replacement of the Court's decision and order. At this time, we can neither
identify a probable alternative outcome nor reasonably estimate the cost of an
alternative remedy. Although we expect the court's decision and order to be
remanded, reversed or replaced, should the remedies prescribed in the court's
decision and order ultimately be upheld, such outcome could have a material
adverse impact on our consolidated results of operations or operating cash
flows in the periods recognized or paid.
Asbestos Matters - Like many other industrial companies, Honeywell is a
defendant in personal injury actions related to asbestos. We did not mine or
produce asbestos, nor did we make or sell insulation products or other
construction materials that have been identified as the primary cause of
asbestos related disease in the vast majority of claimants. Rather, we made
several products that contained small amounts of asbestos.
34
Honeywell's Bendix Friction Materials business manufactured automotive
brake pads that included asbestos in an encapsulated form. There is a group of
potential claimants consisting largely of professional brake mechanics. From
1981 through June 30, 2003, we have resolved over 62,000 Bendix claims at an
average indemnity cost per claim of approximately two thousand six hundred
dollars. Through the second quarter of 2002, Honeywell had no out-of-pocket
costs for these cases since its insurance deductible was satisfied many years
ago. Beginning with claim payments made in the third quarter of 2002, Honeywell
began advancing indemnity and defense claim costs which amounted to
approximately $50 million in payments in the six months ended June 30, 2003. A
substantial portion of this amount is expected to be reimbursed by insurance.
There are currently approximately 69,000 claims pending.
On January 30, 2003, Honeywell and Federal-Mogul Corp. (Federal-Mogul)
entered into a letter of intent (LOI) pursuant to which Federal-Mogul would
acquire Honeywell's automotive Bendix Friction Materials (Bendix) business, with
the exception of certain U.S. based assets. In exchange, Honeywell would receive
a permanent channeling injunction shielding it from all current and future
personal injury asbestos liabilities related to Honeywell's Bendix business.
Federal-Mogul, its U.S. subsidiaries and certain of its United Kingdom
subsidiaries voluntarily filed for financial restructuring under Chapter 11 of
the U.S. Bankruptcy Code in October 2001. Federal-Mogul will seek to establish
one or more trusts under Section 524(g) of the U.S. Bankruptcy Code as part of
its reorganization plan, including a trust for the benefit of Bendix asbestos
claimants. The reorganization plan to be submitted to the Bankruptcy Court for
approval will contemplate that the U.S. Bankruptcy Court in Delaware would issue
an injunction in favor of Honeywell that would channel to the Bendix 524(g)
trust all present and future asbestos claims relating to Honeywell's Bendix
business. The 524(g) trust created for the benefit of the Bendix claimants would
receive the rights to proceeds from Honeywell's Bendix related insurance
policies and would make these proceeds available to the Bendix claimants.
Honeywell would have no obligation to contribute any additional amounts toward
the settlement or resolution of Bendix related asbestos claims.
In the fourth quarter of 2002, we recorded a charge of $167 million
consisting of a $131 million reserve for the sale of Bendix to Federal-Mogul,
our estimate of asbestos related liability net of insurance recoveries and costs
to complete the anticipated transaction with Federal-Mogul. Completion of the
transaction contemplated by the LOI is subject to the negotiation of definitive
agreements, the confirmation of Federal-Mogul's plan of reorganization by the
Bankruptcy Court, the issuance of a final, non-appealable 524(g) channeling
injunction permanently enjoining any Bendix related asbestos claims against
Honeywell, and the receipt of all required governmental approvals. We do not
believe that completion of such transaction would have a material adverse impact
on our consolidated results of operations or financial position.
There can be no assurance, however, that the transaction contemplated by
the LOI will be completed. Honeywell presently has approximately $1.9 billion
(excluding coverage previously available from Equitas; see discussion below)
of insurance coverage remaining with respect to Bendix related asbestos claims.
Although it is impossible to predict the outcome of pending or future claims,
in light of our potential exposure, our prior experience in resolving these
claims, and our insurance coverage, we do not believe that the Bendix related
asbestos claims will have a material adverse effect on our consolidated
financial position.
Another source of claims is refractory products (high temperature bricks
and cement) sold largely to the steel industry in the East and Midwest by North
American Refractories Company (NARCO), a business we owned from 1979 to 1986.
Less than 2 percent of NARCO's products contained asbestos.
35
When we sold the NARCO business in 1986, we agreed to indemnify NARCO with
respect to personal injury claims for products that had been discontinued prior
to the sale (as defined in the sale agreement). NARCO retained all liability for
all other claims. NARCO had resolved approximately 176,000 claims through
January 4, 2002, the date NARCO filed for reorganization under Chapter 11 of the
U.S. Bankruptcy Code, at an average cost per claim of two thousand two hundred
dollars. Of those claims, 43 percent were dismissed on the ground that there was
insufficient evidence that NARCO was responsible for the claimant's asbestos
exposure. As of the date of NARCO's bankruptcy filing, there were approximately
116,000 remaining claims pending against NARCO, including approximately 7
percent in which Honeywell was also named as a defendant. Since 1983, Honeywell
and our insurers have contributed to the defense and settlement costs associated
with NARCO claims. We have approximately $1.5 billion (excluding coverage
previously available from Equitas; see discussion below) of insurance remaining
that can be specifically allocated to NARCO related liability.
As a result of the NARCO bankruptcy filing, all of the claims pending
against NARCO are automatically stayed pending the reorganization of NARCO. In
addition, because the claims pending against Honeywell necessarily will impact
the liabilities of NARCO, because the insurance policies held by Honeywell are
essential to a successful NARCO reorganization, and because Honeywell has
offered to commit the value of those policies to the reorganization, the
bankruptcy court has temporarily enjoined any claims against Honeywell, current
or future, related to NARCO. Although the stay has been extended sixteen times
since January 4, 2002, there is no assurance that such stay will remain in
effect. In connection with NARCO's bankruptcy filing, we paid NARCO's parent
company $40 million and agreed to provide NARCO with up to $20 million in
financing. We also agreed to pay $20 million to NARCO's parent company upon the
filing of a plan of reorganization for NARCO acceptable to Honeywell, and to pay
NARCO's parent company $40 million, and to forgive any outstanding NARCO
indebtedness, upon the confirmation and consummation of such a plan.
As a result of ongoing negotiations with counsel representing NARCO related
asbestos claimants regarding settlement of all pending and potential NARCO
related asbestos claims against Honeywell, we have reached definitive agreements
or agreements in principle with approximately 236,000 claimants, which
represents approximately 90 percent of the approximately 260,000 current
claimants who are now expected to file a claim as part of the NARCO
reorganization process. We are also in discussions with the NARCO Committee of
Asbestos Creditors on Trust Distribution Procedures for NARCO. We believe that,
as part of the NARCO plan of reorganization, a trust will be established
pursuant to these Trust Distribution Procedures for the benefit of all asbestos
claimants, current and future. If the trust is put in place and approved by the
court as fair and equitable, Honeywell as well as NARCO will be entitled to a
permanent channeling injunction barring all present and future individual
actions in state or federal courts and requiring all asbestos related claims
based on exposure to NARCO products to be made against the federally-supervised
trust. As part of its ongoing settlement negotiations, Honeywell is seeking to
cap its annual contributions to the trust with respect to future claims at a
level that would not have a material impact on Honeywell's operating cash flows.
Given the substantial progress of negotiations between Honeywell and NARCO
related asbestos claimants and between Honeywell and the Committee of Asbestos
Creditors during the fourth quarter of 2002, Honeywell developed an estimated
liability for settlement of pending and future asbestos claims.
During the fourth quarter of 2002, Honeywell recorded a charge of $1.4
billion for NARCO related asbestos litigation charges, net of insurance
recoveries. This charge consists of the estimated liability to settle current
asbestos related claims, the estimated liability related to future asbestos
related claims through 2018 and obligations to NARCO's parent, net of insurance
recoveries of $1.8 billion.
36
The estimated liability for current claims is based on terms and
conditions, including evidentiary requirements, in definitive agreements or
agreements in principle with approximately 90 percent of current claimants. Once
finalized, settlement payments with respect to current claims are expected to be
made over approximately a four-year period.
The liability for future claims estimates the probable value of future
asbestos related bodily injury claims asserted against NARCO over a 15 year
period and obligations to NARCO's parent as discussed above. In light of the
uncertainties inherent in making long-term projections we do not believe that we
have a reasonable basis for estimating asbestos claims beyond 2018 under
Statement of Financial Accounting Standard No. 5 "Accounting for Contingencies."
Honeywell retained the expert services of Hamilton, Rabinovitz and Alschuler,
Inc. (HR&A) to project the probable number and value, including trust claim
handling costs, of asbestos related future liabilities. The methodology used to
estimate the liability for future claims has been commonly accepted by numerous
courts and is the same methodology that is utilized by an expert who is
routinely retained by the asbestos claimants committee in asbestos related
bankruptcies. The valuation methodology includes an analysis of the population
likely to have been exposed to asbestos containing products, epidemiological
studies to estimate the number of people likely to develop asbestos related
diseases, NARCO claims filing history and the pending inventory of NARCO
asbestos related claims.
Honeywell has substantial insurance that reimburses it for portions of the
costs incurred to settle NARCO related claims and court judgments as well as
defense costs. This coverage is provided by a large number of insurance policies
written by dozens of insurance companies in both the domestic insurance market
and the London excess market. At June 30, 2003, a significant portion of this
coverage is with London-based insurance companies under a coverage-in-place
agreement. See below for discussion of separate Equitas settlement.
Coverage-in-place agreements are settlement agreements between policyholders and
the insurers specifying the terms and conditions under which coverage will be
applied as claims are presented for payment. These agreements govern such things
as what events will be deemed to trigger coverage, how liability for a claim
will be allocated among insurers and what procedures the policyholder must
follow in order to obligate the insurer to pay claims. We conducted an analysis
to determine the amount of insurance that we estimate is probable that we will
recover in relation to payment of current and projected future claims. While the
substantial majority of our insurance carriers are solvent, some of our
individual carriers are insolvent, which has been considered in our analysis of
probable recoveries. Some of our insurance carriers have challenged our right to
enter into settlement agreements resolving all NARCO related asbestos claims
against Honeywell. However, we believe there is no factual or legal basis for
such challenges and we believe that it is probable that we will prevail in the
resolution of, or in any litigation that is brought regarding these disputes and
as of June 30, 2003, we have recognized approximately $550 million in probable
insurance recoveries from these carriers. We made judgments concerning insurance
coverage that we believe are reasonable and consistent with our historical
dealings with our insurers, our knowledge of any pertinent solvency issues
surrounding insurers and various judicial determinations relevant to our
insurance programs. Based on our analysis, we recorded insurance recoveries that
are deemed probable through 2018 of $1.8 billion. A portion of this insurance
has been received, primarily from Equitas, as discussed below.
During the six months ended June 30, 2003, we made asbestos related
payments of $388 million, including legal fees. During the six months ended June
30, 2003, we received $477 million in insurance reimbursements including $472
million in cash received from Equitas related to a comprehensive policy buy-back
settlement of all insurance claims by Honeywell against Equitas. The settlement
resolves all claims by Honeywell against Equitas arising from asbestos claims
related to NARCO and
37
Bendix. The coverage amounts discussed above for NARCO and Bendix do not
include coverage previously available from Equitas.
Projecting future events is subject to many uncertainties that could cause
the NARCO related asbestos liabilities to be higher or lower than those
projected and recorded. There is no assurance that ongoing settlement
negotiations will be successfully completed, that a plan of reorganization will
be proposed or confirmed, that insurance recoveries will be timely or whether
there will be any NARCO related asbestos claims beyond 2018. Given the inherent
uncertainty in predicting future events, we plan to review our estimates
periodically, and update them based on our experience and other relevant
factors. Similarly we will reevaluate our projections concerning our probable
insurance recoveries in light of any changes to the projected liability or other
developments that may impact insurance recoveries.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. See the Exhibit Index on page 40 of this Quarterly Report on
Form 10-Q.
(b) Reports on Form 8-K. The following reports on Form 8-K were filed
during the three months ended June 30, 2003.
1. On April 17, 2003, a report was filed which furnished, under Item
12, a press release reporting our earnings for the first quarter
of 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
Honeywell International Inc.
Date: August 8, 2003 By: /s/ John J. Tus
-------------------------------
John J. Tus
Vice President and Controller
(on behalf of the Registrant
and as the Registrant's
Principal Accounting Officer)
39
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
2 Omitted (Inapplicable)
3 Omitted (Inapplicable)
4 Omitted (Inapplicable)
10.2* Deferred Compensation Plan for Non-Employee Directors of
Honeywell International Inc., as amended and restated (filed
herewith)
10.3* Stock Plan for Non-Employee Directors of AlliedSignal Inc.,
as amended (incorporated by reference to Exhibit C to
Honeywell's Proxy Statement, dated March 10, 1994, filed
pursuant to Rule 14a-6 of the Securities and Exchange Act of
1934) and Supplement I dated as of March 1, 1999, Supplement
II dated as of February 28, 2002, and Supplement III dated as
of May 30, 2003 (filed herewith)
10.6* Supplemental Non-Qualified Savings Plan for Highly
Compensated Employees of Honeywell International Inc. and
its Subsidiaries, as amended and restated (filed herewith)
10.8* Salary and Incentive Award Deferral Plan for Selected
Employees of Honeywell International Inc. and its
Affiliates, as amended and restated (filed herewith)
10.25* 2003 Stock Incentive Plan of Honeywell International Inc.
and its Affiliates (incorporated by reference to Exhibit A
to Honeywell's Proxy Statement dated March 17, 2003, filed
pursuant to Rule 14a-6 of the Securities and Exchange Act of
1934)
10.26* Letter between David J. Anderson and Honeywell International
Inc. dated June 12, 2003 (filed herewith)
11 Computation of Per Share Earnings**
12 Computation of Ratio of Earnings to Fixed Charges (filed
herewith)
15 Independent Auditors' Acknowledgment Letter as to the
incorporation of their report relating to unaudited interim
financial statements (filed herewith)
18 Omitted (Inapplicable)
19 Omitted (Inapplicable)
22 Omitted (Inapplicable)
40
EXHIBIT INDEX (continued)
Exhibit Number Description
- -------------- -----------
23 Omitted (Inapplicable)
24 Omitted (Inapplicable)
31.1 Certification of Principal Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
31.2 Certification of Principal Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith)
32.1 Certification of Principal Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (filed herewith)
32.2 Certification of Principal Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (filed herewith)
99 Omitted (Inapplicable)
- ----------
* The Exhibits identified above with an asterisk (*) are management contracts
or compensatory plans or arrangements.
** Data required by Statement of Financial Accounting Standards No. 128,
"Earnings per Share", is provided in Note 9 to the condensed consolidated
financial statements in this report.
41