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HON > SEC Filings for HON > Form 10-K on 14-Feb-2014All Recent SEC Filings

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Form 10-K for HONEYWELL INTERNATIONAL INC


14-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

(Dollars in millions, except per share amounts)

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help the reader understand the results of operations and financial condition of Honeywell International Inc. and its consolidated subsidiaries ("Honeywell" or the "Company") for the three years ended December 31, 2013. All references to Notes related to Notes to the Financial Statements in "Item 8-Financial Statements and Supplementary Data".

The Consumer Products Group (CPG) automotive aftermarket business had historically been part of the Transportation Systems reportable segment. In accordance with generally accepted accounting principles, CPG results are excluded from continuing operations and are presented as discontinued operations in all periods presented. See Note 2 Acquisitions and Divestitures for further details.

EXECUTIVE SUMMARY

For Honeywell, 2013 marked another year of growth and enhanced profitability. Despite a modest 2.5 percent growth in World GDP and Industrial Production, Honeywell's 2013 revenues were $39.1 billion representing a 4 percent improvement compared to 2012 revenues of $37.7 billion. Our segment profit improved by 8 percent, roughly two times revenue growth, evidencing the Company's continued focus on operational excellence. We achieved strong segment profit expansion while reinvesting in our businesses through seed planting and continued focus on proactive repositioning. See Review of Business Segments section of this MD&A for a reconciliation of segment profit to consolidated income from continuing operations before taxes.

The Company's operational excellence and ability to expand profit faster than sales growth is due in part to a consistent, methodical application of several key internal business processes which drive improvements in organizational efficiency and service quality, bringing world-class products and services to markets faster and more cost effectively for our customers. Honeywell refers to these processes as the Honeywell Enablers. In 2013, Honeywell continued to strengthen and expand the use of the Honeywell Enablers:

The Honeywell Operating System ("HOS"): HOS drives sustainable improvements in our manufacturing operations to generate exceptional performance in safety, quality, delivery, cost, and inventory management. Approximately 75 percent of our manufacturing cost base has achieved HOS certification.

Velocity Product Development ("VPD"): VPD is a process which brings together all of the functions necessary to successfully launch new products-R&D, manufacturing, marketing and sales-to increase the probability that in commercializing new technologies Honeywell delivers the right products at the right price.

Functional Transformation ("FT"): Functional Transformation is HOS for our administrative functions-Finance, Legal, HR, IT and Purchasing-standardizing the way we work, which improves service quality and reduces costs.

The Company continues to invest for future growth as measured by a number of important metrics:

R&D spending at 4.6 percent of revenues was targeted at such high growth areas as natural gas processing, low global warming refrigerants and blowing agents, and voice control and wireless control devices and technologies.

Capital expenditures grew 7 percent to $947 million principally related to the construction and expansion of Performance Materials and Technologies manufacturing facilities, as well as upgrades to our Aerospace facilities.

The Company recognized approximately $231 million of charges relating to restructuring actions to support sustainable productivity in years to come.


The Company completed $1,133 million (net of cash acquired) in acquisitions in 2013, including the acquisition of Intermec, Inc. ("Intermec"), a leading provider of mobile computing, radio frequency identification solutions (RFID) and bar code, label and receipt printers for use in warehousing, supply chain, field service and manufacturing environments and RAE Systems, Inc. (RAE), a global manufacturer of fixed and portable gas and radiation detection systems, and software.

The Company continued to monitor its portfolio of businesses and to divest those that do not fit within our long-term strategic plan. In January 2014, the Company entered into a definitive agreement to sell its Friction Materials business for approximately $155 million.

Expansion of Honeywell's presence and sales in high growth regions and countries such as China, India, Eastern Europe, the Middle-East, and Latin America. Sales to customers outside the United States now account for approximately 55 percent of total revenues.

Operating cash flow grew by 23 percent in 2013 to $4,335 million. This operating cash flow performance enabled us to invest $947 million in capital expenditures, partially fund the acquisitions discussed above, make $156 million in non-U.S. pension contributions, provide a 10 percent increase in the Company's cash dividend rate (vs. 2012) and repurchase 13.5 million shares of common stock.

CONSOLIDATED RESULTS OF OPERATIONS

Net Sales


                                           2013              2012              2011
Net sales                               $   39,055        $   37,665        $   36,529
% change compared with prior period         4%                3%

The change in net sales compared to the prior year period is attributable to the following:

                                2013           2012
                               Versus         Versus
                                2012           2011
Volume                             1 %           2 %
Price                              1 %           1 %
Acquisitions/Divestitures          2 %           2 %
Foreign Exchange                   -            (2 )%

                                   4 %           3 %

A discussion of net sales by segment can be found in the Review of Business Segments section of this MD&A.

Cost of Products and Services Sold


                                            2013               2012               2011
Cost of products and services sold      $   28,364         $   28,291         $   28,556
% change compared with prior period          -                 (1)%
Gross Margin percentage                       27.4 %             24.9 %             21.8 %

Cost of products and services sold increased by $73 million in 2013 compared with 2012 principally due to an estimated increase in direct material costs of approximately $585 million and indirect material costs of approximately $115 million (driven by higher sales volume and acquisitions) and increased repositioning and other charges of approximately $140 million partially offset by a decrease in pension expense of approximately $760 million, primarily driven by the $650 million decrease in the pension mark-to-market adjustment allocated to cost of products and services sold (approximately $30 million in 2013 versus approximately $680 million in 2012).

Gross margin percentage increased by 2.5 percentage points in 2013 compared with 2012 principally due to lower pension expense (approximately 2.0 percentage point impact primarily driven by the decrease in the pension mark-to-market adjustment allocated to cost of products and services


sold), higher segment gross margin in all of our business segments (approximately 0.5 percentage point impact collectively) and lower other postretirement expense (0.1 percentage point impact) partially offset by higher repositioning and other charges (approximately 0.4 percentage point impact)

Cost of products and services sold decreased by $265 million or 1 percent in 2012 compared with 2011, principally due to a decrease in pension expense of approximately $800 million (primarily driven by the decrease in the pension mark-to-market adjustment allocated to cost of products and services sold of $780 million) and a decrease in repositioning and other charges of approximately $220 million, partially offset by an estimated increase in direct material costs of approximately $620 million driven substantially by a 3 percent increase in sales as a result of the factors (excluding price) shown above and discussed in the Review of Business Segments section of this MD&A and an increase in other postretirement expense of approximately $135 million due to the absence of 2011 curtailment gains.

Gross margin percentage increased by 3.1 percentage points in 2012 compared with 2011 principally due to lower pension expense (approximately 2.2 percentage point impact primarily driven by the decrease in the pension mark-to-market adjustment allocated to cost of products and services sold), lower repositioning actions (approximately 0.6 percentage point impact) and higher segment gross margin in our Aerospace, Automation and Control Solutions and Performance Materials and Technologies segments (approximately 0.4 percentage point impact collectively), partially offset by higher other postretirement expense (approximately 0.4 percentage point impact).

Selling, General and Administrative Expenses


                                                   2013             2012             2011
Selling, general and administrative expense     $   5,190        $   5,218        $   5,399
Percent of sales                                  13.3%            13.9%            14.8%

Selling, general and administrative expenses (SG&A) decreased as a percentage of sales by 0.6 percent in 2013 compared to 2012 primarily driven by (i) higher sales as a result of the factors discussed in the Review of Business Segments section of this MD&A, (ii) an estimated $270 million decrease in pension expense primarily driven by an approximately $250 million decrease in the pension mark-to-market charge allocated to SG&A (approximately $20 million in 2013 versus approximately $270 million in 2012) partially offset by an estimated $215 million increase in labor costs (primarily acquisitions, merit increases and investment for growth) and an $80 million increase in repositioning charges.

Selling, general and administrative expenses decreased as a percentage of sales by 0.9 percent in 2012 compared to 2011 driven by the impact of higher sales as a result of the factors discussed in the Review of Business Segments section of this MD&A, an estimated $110 million decrease in pension expense (driven by the decrease in the portion of the pension mark-to-market charge allocated to SG&A), $90 million decrease due to foreign exchange and $80 million decrease in repositioning actions, partially offset by the impact of an estimated $140 million increase in costs resulting from acquisitions, investment for growth and merit increases (net of other employee related costs).

Other (Income) Expense


                                                            2013            2012            2011
Equity (income) loss of affiliated companies             $    (36 )       $   (45 )       $   (51 )
Gain on sale of available for sale investments               (195 )             -               -
Loss (gain) on sale of non-strategic businesses and
assets                                                         20              (5 )           (61 )
Interest income                                               (69 )           (58 )           (58 )
Foreign exchange                                               34              36              50
Other, net                                                      8               2              36

                                                         $   (238 )       $   (70 )       $   (84 )

Other income increased by $168 million in 2013 compared to 2012 primarily due to $195 million of realized gain related to the sale of marketable equity securities. These securities (B/E Aerospace common stock), designated as available for sale, were obtained in conjunction with the sale of the


Consumables Solutions business in July 2008. This gain was partially offset by an increase in loss on sale of non-strategic businesses and assets of $25 million, primarily due to a pre-tax loss of approximately $28 million related to the pending divestiture of the Friction Materials business within our Transportation Systems segment. See Note 2, Acquisitions and Divestitures for further details.

Other income decreased by $14 million in 2012 compared to 2011 due primarily to a $50 million pre-tax gain related to the divestiture of the automotive on-board sensors products business within our Automation and Control Solutions segment in the first quarter of 2011, partially offset by a loss of $29 million resulting from early redemption of debt in 2011 included within "Other, net" and the reduction of approximately $6 million of acquisition related costs compared to 2011 included within "Other, net".

Interest and Other Financial Charges


                                           2013           2012           2011
Interest and other financial charges     $   327        $   351        $   376
% change compared with prior period        (7)%           (7)%

Interest and other financial charges decreased by 7 percent in 2013 compared with 2012 primarily due to lower borrowing costs, partially offset by higher average debt balances.

Interest and other financial charges decreased by 7 percent in 2012 compared with 2011 primarily due to lower borrowing costs, partially offset by higher average debt balances.

Tax Expense


                          2013              2012             2011
Tax expense            $   1,450         $    944         $    417
Effective tax rate          26.8 %           24.4 %           18.3 %

The effective tax rate increased by 2.4 percentage points in 2013 compared with 2012. The year over year increase in the effective tax rate was primarily attributable to lower mark-to-market pension expense in the U.S. Other factors causing an increase in the effective tax rate include higher tax expense related to an increase in tax reserves and higher state tax expense. These increases in the effective tax rate were partially offset by tax benefits from retroactive law changes in the U.S. The Company's foreign effective tax rate for 2013 was 19.0 percent, an increase of approximately 2.0 percentage points compared to 2012. The year over year increase in the foreign effective tax rate was primarily attributable to higher expense related to retroactive tax law changes in Germany and additional reserves in various jurisdictions, coupled with higher earnings in higher tax rate jurisdictions. The effective tax rate was lower than the U.S. statutory rate of 35 percent primarily due to overall foreign earnings taxed at lower rates.

The effective tax rate increased by 6.1 percentage points in 2012 compared with 2011 primarily due to a change in the mix of earnings taxed at higher rates (primarily driven by an approximate 6.1 percentage point impact from the decrease in pension mark-to-market expense), a decreased benefit from valuation allowances, a decreased benefit from the settlement of tax audits and the absence of the U.S. R&D tax credit, partially offset by a decreased expense related to tax reserves. The foreign effective tax rate was 17.0 percent, a decrease of approximately 4.1 percentage points which primarily consisted of a 10.0 percent impact related to a decrease in tax reserves, partially offset by a 5.2 percent impact from increased valuation allowances on net operating losses primarily due to a decrease in Luxembourg and France earnings available to be offset by net operating loss carry forwards and a 1.4 percent impact from tax expense related to foreign exchange. The effective tax rate was lower than the U.S. statutory rate of 35 percent primarily due to overall foreign earnings taxed at lower rates.

The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013. Some of these provisions provided retroactive changes to the 2012 tax year which were not taken into account in determining the Company's effective tax rate for 2012. The impact of these retroactive changes was approximately $76 million of lower tax expense and was recorded in the first quarter of 2013.


Net Income Attributable to Honeywell


                                                            2013             2012             2011
Amounts attributable to Honeywell
Income from continuing operations                        $   3,924        $   2,926        $   1,858
Income from discontinued operations                              -                -              209

Net income attributable to Honeywell                     $   3,924        $   2,926        $   2,067

Earnings per share of common stock-assuming dilution
Income from continuing operations                        $    4.92        $    3.69        $    2.35
Income from discontinued operations                              -                -             0.26

Net income attributable to Honeywell                     $    4.92        $    3.69        $    2.61

Earnings per share of common stock-assuming dilution increased by $1.23 per share in 2013 compared with 2012 primarily due to lower pension expense (mainly due to a decrease in the pension mark-to-market adjustment), increased segment profit in each of our business segments and higher other income as discussed above, partially offset by increased tax expense and higher repositioning and other charges.

Earnings per share of common stock-assuming dilution increased by $1.08 per share in 2012 compared with 2011 primarily due to lower pension expense (mainly due to a decrease in the pension mark-to-market adjustment), increased segment profit in our Aerospace, Automation and Control Solutions and Performance Materials and Technologies segments, lower repositioning and other charges, partially offset by increased tax expense, decreased income from discontinued operations and higher other postretirement expense.

For further discussion of segment results, see "Review of Business Segments."

BUSINESS OVERVIEW

This Business Overview provides a summary of Honeywell and its four reportable operating segments (Aerospace, Automation and Control Solutions, Performance Materials and Technologies and Transportation Systems), including their respective areas of focus for 2014 and the relevant economic and other factors impacting their results, and a discussion of each segment's results for the three years ended December 31, 2013. Each of these segments is comprised of various product and service classes that serve multiple end markets. See Note 24 Segment Financial Data of Notes to the Financial Statements for further information on our reportable segments and our definition of segment profit.

Economic and Other Factors

In addition to the factors listed below with respect to each of our operating segments, our consolidated operating results are principally impacted by:

Change in global economic growth rates and industry conditions and demand in our key end markets;

Overall sales mix, in particular the mix of Aerospace original equipment and aftermarket sales and the mix of Automation and Control Solutions (ACS) products, distribution and services sales;

The extent to which cost savings from productivity actions are able to offset or exceed the impact of material and non-material inflation;

The impact of the pension discount rate and asset returns on pension expense, including mark-to-market adjustments, and funding requirements; and

The impact of fluctuations in foreign currency exchange rates (in particular the Euro), relative to the U.S. dollar.


Areas of Focus for 2014

The 2014 areas of focus are supported by the enablers including the Honeywell Operating System, our Velocity Product Development process, and Functional Transformation. These areas of focus are generally applicable to each of our operating segments and include:

Driving profitable growth through R&D, technological excellence and optimized manufacturing capability to deliver innovative products that customers value;

Expanding margins by maintaining and improving the Company's cost structure through manufacturing and administrative process improvements, repositioning, and other actions, which will drive productivity and enhance the flexibility of the business as it works to proactively respond to changes in end market demand;

Proactively managing raw material costs through formula and long-term supply agreements and hedging activities, where feasible and prudent;

Driving strong cash flow conversion through effective working capital management which will enable the Company to undertake strategic actions to benefit the business including capital expenditures, strategic acquisitions, and returning cash to shareholders;

Increasing our sales penetration and expanding our localized footprint in high growth regions, including China, India, Eastern Europe, the Middle East and Latin America;

Aligning and prioritizing investments for long-term growth, while considering short-term demand volatility;

Monitoring both suppliers and customers for signs of liquidity constraints, limiting exposure to any resulting inability to meet delivery commitments or pay amounts due, and identifying alternate sources of supply as necessary; and

Controlling Corporate and other non-operating costs, including costs incurred for asbestos and environmental matters, pension and other post-retirement expenses and tax expense.


Review of Business Segments


                                               2013               2012               2011
Net Sales
Aerospace
Product                                    $    7,043         $    6,999         $    6,494
Service                                         4,937              5,041              4,981

Total                                          11,980             12,040             11,475
Automation and Control Solutions
Product                                        14,193             13,610             13,328
Service                                         2,363              2,270              2,207

Total                                          16,556             15,880             15,535
Performance Materials and Technologies
Product                                         6,223              5,642              5,064
Service                                           541                542                595

Total                                           6,764              6,184              5,659
Transportation Systems
Product                                         3,755              3,561              3,859
Service                                             -                  -                  -

Total                                           3,755              3,561              3,859
Corporate
Product                                             -                  -                  -
Service                                             -                  -                  1

Total                                               -                  -                  1

                                           $   39,055         $   37,665         $   36,529

Segment Profit
Aerospace                                  $    2,372         $    2,279         $    2,023
Automation and Control Solutions                2,437              2,232              2,083
Performance Materials and Technologies          1,271              1,154              1,042
Transportation Systems                            498                432                485
Corporate                                        (227 )             (218 )             (276 )

                                           $    6,351         $    5,879         $    5,357

A reconciliation of segment profit to consolidated income from continuing operations before taxes is as follows:

                                                                   Years Ended December 31,
                                                          2013              2012               2011
Segment Profit                                         $   6,351         $   5,879         $    5,357
Other income (expense)(1)                                    202                25                 33
Interest and other financial charges                        (327 )            (351 )             (376 )
Stock compensation expense(2)                               (170 )            (170 )             (168 )
Pension ongoing income (expense)(2)                           90               (36 )             (105 )
Pension mark-to-market expense(2)                            (51 )            (957 )           (1,802 )
Other postretirement income (expense)(2)                     (20 )             (72 )               86
Repositioning and other charges(2)                          (663 )            (443 )             (743 )

Income from continuing operations before taxes         $   5,412         $   3,875         $    2,282


(1) Equity income (loss) of affiliated companies is included in Segment Profit.

(2) Amounts included in cost of products and services sold and selling, general and administrative expenses.


                                                                                                        % Change
                                                                                                  2013            2012
                                                                                                 Versus          Versus
                                           2013               2012               2011             2012            2011
Aerospace Sales
Commercial:
Original Equipment
Air transport and regional             $    1,716         $    1,601         $    1,439              7 %            11 %
Business and general aviation                 935                967                723             (3 )%           34 %
Aftermarket
Air transport and regional                  2,960              2,947              2,828              -               4 %
Business and general aviation               1,499              1,417              1,207              6 %            17 %
Defense and Space                           4,870              5,108              5,278             (5 )%           (3 )%

Total Aerospace Sales                      11,980             12,040             11,475
Automation and Control Solutions
. . .
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