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HONEYWELL INTERNATIONAL INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) (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, 2012. 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, 2012 marked another year of strong growth despite a challenging
political and macro-economic environment. The Company continued to manage
uncertainty associated with slower than expected economic growth in the United
States, recession in the European Union, political unrest in the Middle East,
and slowing growth in China and other emerging economies. Despite a modest 2.6
percent growth in World GDP and Industrial Production, Honeywell's 2012 revenues
were $37.7 billion representing a 3 percent improvement compared to 2011
revenues of $36.5 billion. Honeywell's 2012 revenue growth was achieved despite
significant foreign exchange weakness in the Euro and other non-U.S. dollar
currencies which had a negative 2 percent impact on our 2012 revenues. Our
segment profit improved by 10 percent, in excess of three times revenue growth,
evidencing the Company's continued focus on operational excellence. 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 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 2012, 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 70 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.
• Organizational Efficiency ("OEF"): OEF is, in its simplest form, the cost of labor.
Improvements in OEF represent the success of Honeywell's initiatives to increase labor cost
efficiency and employee productivity.
The Company continues to invest for future growth as measured by a number of
important metrics:
• R&D spending at 4.9 percent of revenues was targeted at such high growth areas as natural gas
processing, low global warming refrigerants and blowing agents, and wireless control devices and
technologies.
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--------------------------------------------------------------------------------• Capital expenditures grew 11 percent to $884 million including the construction or expansion
of technology centers in India and Saudi Arabia.
• The Company recognized approximately $119 million of restructuring actions to support
sustainable productivity in years to come.
• The Company completed $438 million (net of cash acquired) in acquisitions in 2012, including
acquisition of a 70 percent ownership interest in Thomas Russell L.L.C. ("Thomas Russell
Co."), a leader in technology and equipment for natural gas processing and treating,
primarily serving the US market.
• 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 24 percent in 2012 to $3,517 million. This operating
cash flow performance enabled us to invest $884 million in capital expenditures,
fund the acquisitions discussed above, make $1,039 million in pension
contributions, and provide an 11 percent increase in dividends paid (vs. 2011)
and repurchase 5 million shares of common stock.
CONSOLIDATED RESULTS OF OPERATIONS
Net Sales
2012 2011 2010
Net sales $ 37,665 $ 36,529 $ 32,350
% change compared with prior period 3% 13%
The change in net sales compared to the prior year period is attributable to the
following:
2012 2011
Versus Versus
2011 2010
Volume 2 % 6 %
Price 1 % 2 %
Acquisitions/Divestitures 2 % 3 %
Foreign Exchange (2 )% 2 %
3 % 13 %
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
2012 2011 2010
Cost of products and services sold $ 28,291 $ 28,556
$ 24,721
% change compared with prior period (1)% 16%
Gross Margin percentage 24.9 % 21.8 % 23.6 %
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
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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).
Cost of products and services sold increased by $3,835 million or 16 percent in
2011 compared with 2010, principally due to an estimated increase in direct
material costs, labor costs and indirect costs of approximately $2 billion, $520
million, and $280 million, respectively, driven substantially by a 13 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, an increase
in pension and other postretirement expense of approximately $880 million
(primarily driven by the increase in the pension mark-to-market adjustment
allocated to cost of products and services sold of $1.1 billion) and an increase
in repositioning and other charges of approximately $90 million.
Gross margin percentage decreased by 1.8 percentage points in 2011 compared with
2010, primarily due to higher pension and other postretirement expense
(approximate 2.8 percentage point impact primarily driven by an unfavorable 3.3
percentage point impact resulting from the increase in the pension
mark-to-market adjustment allocated to cost of products and services sold) and
repositioning and other charges (approximate 0.2 percentage point impact),
partially offset by higher sales volume driven by each of our business segments
(approximate 1.2 percentage point impact).
Selling, General and Administrative Expenses
2012 2011 2010
Selling, general and administrative expense $ 5,218 $ 5,399
$ 4,618
Percent of sales 13.9% 14.8% 14.3%
Selling, general and administrative expenses (SG&A) 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 an estimated
$140 million increase in costs resulting from acquisitions, investment for
growth and merit increases (net of other employee related costs).
Selling, general and administrative expenses increased as a percentage of sales
by 0.5 percent in 2011 compared to 2010 driven by an estimated $430 million
increase in labor costs resulting from acquisitions, investment for growth, and
merit increases, an estimated increase of $240 million in pension and other
postretirement expense (driven primarily by the allocated portion of the pension
mark-to-market charge increase of approximately $270 million) and an estimated
increase of $60 million in repositioning actions, partially offset by the impact
of higher sales volume as a result of the factors discussed in the Review of
Business Segments section of this MD&A.
Other (Income) Expense
2012 2011 2010
Equity (income)/loss of affiliated companies $ (45 ) $ (51 ) $ (28 )
Gain on sale of non-strategic businesses and assets (5 ) (61 ) -
Interest income (58 ) (58 ) (39 )
Foreign exchange 36 50 12
Other, net 2 36 (42 )
$ (70 ) $ (84 ) $ (97 )
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".
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Other income decreased by $13 million in 2011 compared to 2010 due primarily to
a $29 million loss resulting from early redemption of debt in the first quarter
of 2011, included within "Other, net", and the absence of a $62 million pre-tax
gain related to the consolidation of a joint venture within our Performance
Materials and Technologies segment in the third quarter of 2010, included within
"Other, net", (see Note 4 of Notes to Financial Statements for further details),
partially offset by a $61 million increase in gain on sale of non-strategic
businesses and assets 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 and the reduction of approximately $12
million of acquisition related costs compared to 2010 included within "Other,
net".
Interest and Other Financial Charges
2012 2011 2010
Interest and other financial charges $ 351 $ 376 $ 386
% change compared with prior period (7)%
(3)%
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.
Interest and other financial charges decreased by 3% percent in 2011 compared
with 2010 primarily due to lower borrowing costs, partially offset by higher
debt balances.
Tax Expense
2012 2011 2010
Tax expense $ 944 $ 417 $ 765
Effective tax rate 24.4 % 18.3 % 28.1 %
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 earnings taxed at lower
foreign rates.
The effective tax rate decreased by 9.8 percentage points in 2011 compared with
2010 primarily due to a change in the mix of earnings between U.S. and foreign
sources related to higher U.S. pension expense (primarily driven by an
approximate 7.6 percentage point impact which resulted from the increase in
pension mark-to-market expense), an increased benefit from manufacturing
incentives, an increased benefit from the favorable settlement of tax audits and
an increased benefit from a lower foreign effective tax rate. The foreign
effective tax rate was 21.1 percent, a decrease of approximately 4.9 percentage
points which primarily consisted of (i) a 5.1 percent impact from decreased
valuation allowances on net operating losses primarily due to an increase in
German earnings available to be offset by net operating loss carry forwards,
(ii) a 2.4 percent impact from tax benefits related to foreign exchange and
investment losses, (iii) a 1.2 percent impact from an increased benefit in tax
credits and lower statutory tax rates, and (iv) a 4.1 percent impact related to
an increase in tax reserves. The effective tax rate was lower than the U.S.
statutory rate of 35 percent primarily due to earnings taxed at lower foreign
rates.
The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013.
Some of these provisions provide 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 will be
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recorded in the first quarter of 2013, however, the 2013 effective tax rate
could also change based upon the Company's operating results, mix of earnings
and the outcome of tax positions taken regarding previously filed tax returns
currently under audit by various Federal, State and foreign tax authorities,
several of which may be finalized in the foreseeable future. The Company
believes that it has adequate reserves for these matters. However, the ultimate
outcome of these matters may differ and could materially impact the results of
operations and operating cash flows in the period they are resolved.
Net Income Attributable to Honeywell
2012 2011 2010
Amounts attributable to Honeywell
Income from continuing operations $ 2,926 $ 1,858 $ 1,944
Income from discontinued operations - 209 78
Net income attributable to Honeywell $ 2,926 $ 2,067 $ 2,022
Earnings per share of common stock-assuming dilution
Income from continuing operations
$ 3.69 $ 2.35 $ 2.49
Income from discontinued operations - 0.26 0.10
Net income attributable to Honeywell $ 3.69 $ 2.61 $ 2.59
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.
Earnings per share of common stock-assuming dilution increased by $0.02 per
share in 2011 compared with 2010 primarily due to an increase in segment profit
in each of our business segments, lower tax expense, the gain on disposal of
discontinued operations, and lower other postretirement expense, partially
offset by higher pension expense (primarily due to an increase in the pension
mark-to-market adjustment) and higher repositioning and other charges.
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 2013 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, 2012. 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 on 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;
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--------------------------------------------------------------------------------• 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 2013
The 2013 areas of focus will be supported by the enablers including the
Honeywell Operating System, our Velocity Product Development process, and
Functional Transformation/ Organizational Efficiency. 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, restructuring, 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.
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Review of Business Segments
2012 2011 2010
Net Sales
Aerospace
Product $ 6,999 $ 6,494 $ 5,868
Service 5,041 4,981 4,815
Total 12,040 11,475 10,683
Automation and Control Solutions
Product 13,610 13,328 11,733
Service 2,270 2,207 2,016
Total 15,880 15,535 13,749
Performance Materials and Technologies
Product 5,642 5,064 4,449
Service 542 595 277
Total 6,184 5,659 4,726
Transportation Systems
Product 3,561 3,859 3,192
Service - - -
Total 3,561 3,859 3,192
Corporate
Product - - -
Service - 1 -
Total - 1 -
$ 37,665 $ 36,529 $ 32,350
Segment Profit
Aerospace $ 2,279 $ 2,023 $ 1,835
Automation and Control Solutions 2,232 2,083 1,770
Performance Materials and Technologies 1,154 1,042 749
Transportation Systems 432 485 353
Corporate (218 ) (276 ) (222 )
$ 5,879 $ 5,357 $ 4,485
A reconciliation of segment profit to consolidated income from continuing
operations before taxes are as follows:
Years Ended December 31,
2012 2011 2010
Segment Profit $ 5,879 $ 5,357 $ 4,485
Other income/ (expense)(1) 25 33 69
Interest and other financial charges (351 ) (376 ) (386 )
Stock compensation expense(2) (170 ) (168 ) (163 )
Pension ongoing expense(2) (36 ) (105 ) (185 )
Pension mark-to-market expense(2) (957 ) (1,802 ) (471 )
Other postretirement income/(expense)(2) (72 ) 86 (29 )
Repositioning and other charges(2) (443 ) (743 ) (598 )
Income from continuing operations before taxes $ 3,875 $
2,282 $ 2,722
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(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.
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% Change
2012 2011
Versus Versus
2012 2011 2010 2011 2010
Aerospace Sales
Commercial:
Original Equipment
Air transport and regional $ 1,601 $ 1,439 $ 1,362 11 % 6 %
Business and general aviation 967 723 513 34 % 41 %
Aftermarket
Air transport and regional 2,947 2,828 2,437 4 % 16 %
Business and general aviation 1,417 1,207 976 17 % 24 %
Defense and Space 5,108 5,278 5,395 (3 )% (2 )%
Total Aerospace Sales 12,040 11,475 10,683
Automation and Control Solutions
Sales
Energy Safety & Security 8,123 7,977 6,789 2 % 17 %
Process Solutions 3,093 3,010 2,678 3 % 12 %
Building Solutions & Distribution 4,664 4,548 4,282 3 % 6 %
Total Automation and Control
Solutions Sales 15,880 15,535 13,749
Performance Materials and
Technologies Sales
UOP 2,253 1,931 1,556 17 % 24 %
Advanced Materials 3,931 3,728 3,170 5 % 18 %
Total Performance Materials and
Technologies Sales 6,184 5,659 4,726
Transportation Systems Sales
Turbo Technologies 3,561 3,859 3,192 (8 )% 21 %
Total Transportation Systems Sales 3,561 3,859 3,192
Corporate - 1 -
Net Sales $ 37,665 36,529 32,350
Aerospace
Overview
Aerospace is a leading global supplier of aircraft engines, avionics, and
related products and services for aircraft manufacturers, airlines, aircraft
operators, military services, and defense and space contractors. Our Aerospace
products and services include auxiliary power units, propulsion engines,
environmental control systems, electric power systems, engine controls, flight
safety, communications, navigation, radar and surveillance systems, aircraft
lighting, management and technical services, logistics services, advanced
systems and instruments, aircraft wheels and brakes and repair and overhaul
services. Aerospace sells its products to original equipment (OE) manufacturers
in the air transport, regional, business and general aviation aircraft segments,
and provides spare parts and repair and maintenance services for the aftermarket
(principally to aircraft operators). The United States Government is a major
customer for our defense and space products.
Economic and Other Factors
Aerospace operating results are principally impacted by:
• New aircraft production rates and delivery schedules set by commercial air transport, regional
jet, business and general aviation OE manufacturers, as well as airline profitability, platform
mix and retirement of aircraft from service;
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--------------------------------------------------------------------------------• Global demand for commercial air travel as reflected in global flying hours and utilization rates
for corporate and general aviation aircraft, as well as the demand for spare parts and maintenance
and repair services for aircraft currently in use;
• Level and mix of U.S. and foreign government appropriations for defense and space programs and
military activity;
• Changes in customer platform development schedules, requirements and demands for new technologies;
and
• Availability and price variability of raw materials such as nickel, titanium and other metals.
Aerospace
2012 2011 Change 2010 Change
Net sales $ 12,040 $ 11,475 5 % $ 10,683 7 %
Cost of products and services sold 8,989 8,665 8,099
Selling, general and administrative expenses 619 591 553
Other 153 196 196
Segment profit $ 2,279 $ 2,023 13 % $ 1,835 10 %
2012 vs. 2011 2011 vs. 2010
Segment SegmentFactors Contributing to Year-Over-Year Change Sales Profit
Sales Profit
Organic growth/ Operational segment profit 3 % 8 % 7 % 9 %
Acquisitions and divestitures, net 1 % 1 % - -
Other 1 % 4 % - 1 %
Total % Change 5 % 13 % 7 % 10 %
Aerospace sales by major customer end-markets were as follows:
% of Aerospace % Increase (Decrease)
Sales in Sales
2012 2011
Versus Versus
Customer End-Markets 2012 2011 2010 2011 2010
Commercial original equipment
Air transport and regional 13 % 13 % 13 % 11 % 6 %
Business and general aviation 8 % 6 % 5 % 34 % 41 %
Commercial original equipment 21 % 19 % 18 % 19 % 15 %
Commercial aftermarket
Air transport and regional 25 % 25 % 23 % 4 % 16 %
Business and general aviation 12 % 11 % 9 % 17 % 24 %
Commercial aftermarket 37 % 36 % 32 % 8 % 18 %
Defense and Space 42 % 45 % 50 % (3 )% (2 )%
Total 100 % 100 % 100 % 5 % 7 %
2012 compared with 2011
Aerospace sales increased by 5 percent in 2012 compared with 2011 primarily due
to an increase in organic growth of 3 percent primarily due to increased
commercial sales volume, a 1 percent increase from acquisitions, net of
divestitures, and a 1 percent increase in revenue related to an $88 million
reduction in payments to business and general aviation OE manufacturers to
partially offset their pre-production costs associated with new aircraft
platforms (OEM payments).
Details regarding the changes in sales by customer end-markets are as follows:
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Commercial original equipment (OE) sales increased by 19 percent (12 percent
organic) in 2012 compared to 2011.
• Air transport and regional OE sales increased by 11 percent (11 percent organic) in 2012
primarily driven by higher sales to our OE customers, consistent with higher production rates,
and a favorable platform mix.
• Business and general aviation OE sales increased by 34 percent (15 percent organic) in 2012
driven by strong demand in the business jet end-market, favorable platform mix, growth from
acquisitions and the favorable 12 percent impact of the OEM payments discussed above.
Commercial aftermarket sales increased by 8 percent in 2012 compared to 2011.
• Air transport and regional aftermarket sales increased by 4 percent for 2012 primarily due to
increased sales of spare parts and higher maintenance activity driven by an approximate 2 percent
increase in global flying hours in 2012, increased sales of avionics upgrades, and changes in
customer buying patterns relating to maintenance activity in the first half of 2012.
• Business and general aviation aftermarket sales increased by 17 percent in 2012 primarily due to
increased sales of spare parts and revenue associated with maintenance service agreements and a
higher penetration in retrofit, modifications, and upgrades.
Defense and space sales decreased by 3 percent (negative 4 percent organic) in
2012 primarily due to anticipated program ramp downs, partially offset by higher
international aftermarket sales and growth from acquisitions, net of
divestitures.
Aerospace segment profit increased by 13 percent in 2012 compared with 2011
primarily due to an increase in operational segment profit of 8 percent, a 4
percent favorable impact from lower OEM payments, discussed above, and a 1
percent increase from acquisitions, net of divestitures. The increase in
operational segment profit is due to the favorable impact from higher price and
productivity, net of inflation, and commercial demand partially offset by
increased research, development and engineering investments. Cost of products
and services sold totaled $9.0 billion in 2012, an increase of approximately
$324 million from 2011 which is primarily a result of the factors discussed
above (excluding price).
2011 compared with 2010
Aerospace sales increased by 7 percent in 2011 compared with 2010 primarily due
to an increase in organic growth of 7 percent primarily due to increased
commercial sales volume.
Details regarding the increase in sales by customer end-markets are as follows:
Commercial OE sales increased by 15 percent (11 percent organic) in 2011
compared with 2010.
• Air transport and regional OE sales increased by 6 percent in 2011 primarily driven by higher
sales to our OE customers, consistent with higher production rates, platform mix and a higher
win rate on selectables (components selected by purchasers of new aircraft).
• Business and general aviation OE sales increased by 41 percent (24 percent organic) in 2011 due
to a rebound from near trough levels in 2010 and strong demand in the business jet end market,
favorable platform mix, growth from acquisitions and lower OEM Payments during 2011.
Commercial aftermarket sales increased by 18 percent in 2011 compared to 2010.
• Air transport and regional aftermarket sales increased by 16 percent in 2011 primarily due to
(i) increased maintenance activity and spare parts sales driven by an approximately 6 percent
increase in global flying hours, (ii) increased sales of avionics upgrades, and (iii) changes in
customer buying patterns relating to spare parts and maintenance activity.
• Business and general aviation aftermarket sales increased by 24 percent in 2011 primarily due to
increased sales of spare parts and revenue associated with maintenance service agreements.
Defense and space sales decreased by 2 percent (negative 3 percent organic) in
2011 primarily due to anticipated program ramp downs, partially offset by higher
domestic and international
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aftermarket sales, increased unmanned aerial vehicle (UAV) shipments and the EMS
acquisition (refer to Note 2).
Aerospace segment profit increased by 10 percent in 2011 compared to 2010
primarily due to an increase in operational segment profit of 9 percent and an
increase of 1 percent due to lower OEM Payments made during 2011. The increase
in operational segment profit is comprised of the positive impact from higher
commercial aftermarket demand, price and productivity, net of inflation,
partially offset by research, development and engineering investments. Cost of
products and services sold totaled $8.7 billion in 2011, an increase of
approximately $566 million from 2010 which is primarily a result of the factors
discussed above (excluding price).
2013 Areas of Focus
Aerospace's primary areas of focus for 2013 include:
• Global pursuit of new commercial, defense and space programs;
• Driving customer satisfaction through operational excellence (product quality, cycle time
reduction, and supplier management);
• Aligning research and development and customer support costs with customer requirements and
demand for new platforms;
• Expanding sales and operations in international locations;
• Focusing on cost structure initiatives to maintain profitability in face of economic
uncertainty and potential defense and space budget reductions and program specific
appropriations;
• Continuing to design equipment that enhances the safety, performance and durability of
aerospace and defense equipment, while reducing weight and operating costs; and
• Continued deployment and optimization of our common enterprise resource planning (ERP)
system.
Automation and Control Solutions (ACS)
Overview
ACS provides innovative products and solutions that make homes, buildings,
industrial sites and infrastructure more efficient, safe and comfortable. Our
ACS products and services include controls and displays for heating, cooling,
indoor air quality, ventilation, humidification, combustion, lighting and home
automation; advanced software applications for home/building control and
optimization; sensors, switches, control systems and instruments for measuring
pressure, air flow, temperature and electrical current; security, fire and gas
detection; personal protection equipment; access control; video surveillance;
remote patient monitoring systems; products for automatic identification and
data collection; installation, maintenance and upgrades of systems that keep
buildings safe, comfortable and productive; and automation and control solutions
for industrial plants, including field instruments and advanced software and
automation systems that integrate, control and monitor complex processes in many
types of industrial settings as well as equipment that controls, measures and
analyzes natural gas production and transportation.
Economic and Other Factors
ACS's operating results are principally impacted by:
• Economic conditions and growth rates in developed (North America, Europe and Australia)
and high growth regions;
• Industrial production and global commercial construction (including retrofits and
upgrades);
• Demand for residential security, environmental control retrofits and upgrades and energy
efficient products and solutions;
• Government and public sector spending;
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--------------------------------------------------------------------------------• The strength of global capital and operating spending on process (including petrochemical and
refining) and building automation;
• Inventory levels in distribution channels; and
• Changes to energy, fire, security, health care, safety and environmental concerns and
regulations.
Automation and Control Solutions
2012 2011 Change 2010 Change
Net sales $ 15,880 $ 15,535 2 % $ 13,749 13 %
Cost of products and services
sold 10,691 10,448 9,312
Selling, general and
administrative expenses 2,790 2,819 2,480
Other 167 185 187
Segment profit $ 2,232 $ 2,083 7 % $ 1,770 18 %
2012 vs. 2011 2011 vs. 2010
Segment SegmentFactors Contributing to Year-Over-Year Change Sales Profit
Sales Profit
Organic growth/ Operational segment profit 3 % 8 % 5 % 9 %
Foreign exchange (2 )% (2 )% 2 % 3 %
Acquisitions and divestitures, net 1 % 1 % 6 % 6 %
Total % Change 2 % 7 % 13 % 18 %
2012 compared with 2011
Automation and Control Solutions ("ACS") sales increased by 2 percent in 2012
compared with 2011, primarily due to a 3 percent increase in organic revenue
driven by increased sales volume and 1 percent growth from acquisitions, net of
divestitures, partially offset by the unfavorable impact of foreign exchange.
• Sales in our Energy, Safety & Security businesses increased by 2 percent (1 percent organic) in
2012 principally due to (i) the positive impact of acquisitions (most significantly EMS
Technologies, Inc. and King's Safetywear Limited), net of divestitures, (ii) higher sales volumes
due to contract wins and new product introductions in the scanning and mobility business,
(iii) higher sales volumes due to improved U.S. residential market conditions and new product
introductions in the security business, partially offset by (i) the unfavorable impact of foreign
exchange, (ii) lower sales volume in Europe and (iii) decreases in sales volumes of our personal
protective equipment and sensing and control products primarily the result of softness in
industrial end markets.
• Sales in our Process Solutions business increased 3 percent (6 percent organic) in 2012
principally due to increased conversion to sales from backlog, partially offset by the
unfavorable impact of foreign exchange. Project orders decreased in the second half of 2012
compared to the corresponding period in 2011 primarily driven by extension of project timing by
customers and higher than typical project orders in the fourth quarter of 2011, which we expect
will lead to more moderate growth rates in 2013.
• Sales in our Building Solutions & Distribution businesses increased by 3 percent (4 percent
organic) in 2012 principally due to growth in our Building Solutions business reflecting
conversion to sales from backlog and increased sales volume in our Americas Distribution business
due to improved U.S. residential market conditions, partially offset by the unfavorable impact of
foreign exchange and softness in the energy retrofit business. Project orders decreased in the
fourth quarter of 2012 principally due to extension of project timing by customers and softness
in the energy retrofit business.
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ACS segment profit increased by 7 percent in 2012 compared with 2011 due to a 8
percent increase in operational segment profit and a 1 percent increase from
acquisitions, net of divestitures partially offset by a 2 percent unfavorable
impact of foreign exchange. The increase in operational segment profit is
primarily the result of the positive impact from price and productivity, net of
inflation. Cost of products and services sold totaled $10.7 billion in 2012, an
increase of $243 million which is primarily due to higher sales, inflation and
acquisitions, net of divestitures partially offset by the favorable impact of
foreign exchange and productivity.
2011 compared with 2010
ACS sales increased by 13 percent in 2011 compared with 2010, primarily due to a
6 percent growth from acquisitions, net of divestitures, 5 percent increase in
organic revenue driven by increased sales volume and higher prices and 2 percent
favorable impact of foreign exchange through the first nine months partially
offset by the negative impact of foreign exchange in the fourth quarter.
• Sales in our Energy, Safety & Security businesses increased by 17 percent (6 percent organically)
in 2011 principally due to (i) the positive impact of acquisitions (most significantly Sperian and
EMS), net of divestitures (ii) higher sales volume due to general industrial recovery and new
product introductions and (iii) the favorable impact of foreign exchange.
• Sales in our Process Solutions increased 12 percent (6 percent organically) in 2011 principally
due to (i) increased volume reflecting conversion to sales from backlog (ii) the favorable impact
of foreign exchange and (iii) the impact of acquisitions. Orders increased in 2011 compared to
2010 primarily driven by continued favorable macro trends in oil and gas infrastructure projects,
growth in emerging regions and the positive impact of foreign exchange.
• Sales in our Building Solutions & Distribution increased by 6 percent (4 percent organically) in
2011 driven principally due to (i) volume growth in our Building Solutions business reflecting
conversion to sales from order backlog and increased sales volume in our Distribution business
(ii) the favorable impact of foreign exchange and (iii) the impact of acquisitions, net of
divestitures.
ACS segment profit increased by 18 percent in 2011 compared with 2010 due to a 9
percent increase in operational segment profit, 6 percent increase from
acquisitions, net of divestitures and 3 percent positive impact of foreign
exchange. The increase in operational segment profit is comprised of an
approximate 5 percent positive impact from price and productivity, net of
inflation and investment for growth and a 4 percent positive impact from higher
sales volumes. Cost of products and services sold totaled $10.4 billion in 2011,
an increase of approximately $1.1 billion which is primarily due to
acquisitions, net of divestitures, higher sales volume, foreign exchange and
inflation partially offset by positive impact from productivity.
2013 Areas of Focus
ACS's primary areas of focus for 2013 include:
• Extending technology leadership through continued investment in new product development and
introductions which deliver energy efficiency, lowest total installed cost and integrated
solutions;
• Defending and extending our installed base through customer productivity and globalization;
• Sustaining strong brand recognition through our brand and channel management;
• Continuing to identify, execute and integrate acquisitions in or adjacent to the markets which
we serve;
• Continuing to establish and grow presence and capability in high growth regions;
• Continued deployment and optimization of our common ERP system; and
• Continued proactive cost actions and successful execution of repositioning actions.
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Performance Materials and Technologies (PMT)
Overview
Performance Materials and Technologies develops and manufactures high-purity,
high-quality and high-performance chemicals and materials for applications in
the refining, petrochemical, automotive, healthcare, agricultural, packaging,
refrigeration, appliance, housing, semiconductor, wax and adhesives segments.
Performance Materials and Technologies also provides process technology,
products, including catalysts and adsorbents, and services for the petroleum
refining, gas processing, petrochemical, renewable energy and other industries.
Performance Materials and Technologies' product portfolio includes
fluorocarbons, hydrofluoroolefins, caprolactam, resins, ammonium sulfate for
fertilizer, phenol, specialty films, waxes, additives, advanced fibers,
customized research chemicals and intermediates, electronic materials and
chemicals, catalysts, and adsorbents.
Economic and Other Factors
Performance Materials and Technologies operating results are principally
impacted by:
• Level and timing of capital spending and capacity and utilization rates in refining
and petrochemical end markets;
• Pricing volatility and industry supply conditions for raw materials such as cumene,
fluorspar, perchloroethylene, R240, natural gas, sulfur and ethylene;
• Impact of environmental and energy efficiency regulations;
• Global supply conditions and demand for non-ozone depleting, low global warming
refrigerants and blowing agents;
• Global supply conditions and demand for caprolactam, nylon resin and ammonium
sulfate;
• Condition of the U.S. residential housing and non-residential industries and
automotive demand;
• Extent of change in order rates from global semiconductor customers; and
• Demand for new products including renewable energy and biofuels, low global warming
products for insulation and refrigeration, additives, and enhanced nylon resin.
Performance Materials and Technologies
2012 2011 Change 2010 Change
Net sales $ 6,184 $ 5,659 9 % $ 4,726 20 %
Cost of products and services sold 4,543 4,151 3,554
Selling, general and administrative
expenses 439 420 345
Other 48 46 78
Segment profit $ 1,154 $ 1,042 11 % $ 749 39 %
2012 vs. 2011 2011 vs. 2010
Segment SegmentFactors Contributing to Year-Over-Year Change Sales Profit
Sales Profit
Organic growth/ Operational segment profit 4 % 9 % 16 % 38 %
Foreign exchange (1 )% (1 )% 1 % 1 %
Acquisitions and divestitures, net 6 % 3 % 3 % -
Total % Change 9 % 11 % 20 % 39 %
2012 compared with 2011
PMT sales increased by 9 percent in 2012 compared with 2011 due to a 6 percent
growth from acquisitions and 4 percent increase in organic growth, partially
offset by 1 percent unfavorable impact of foreign exchange.
38
--------------------------------------------------------------------------------• UOP sales increased by 17 percent (12 percent organic) in 2012 compared to 2011 primarily driven
by (i) increased equipment and licensing revenues and higher volume of petrochemical and refining
catalysts in the first nine months, reflecting continued strength in the refining and
petrochemical industries, and (ii) the favorable impact from acquisitions, partially offset by
lower service revenue related to scheduled project completions.
• Advanced Materials sales increased by 5 percent (flat organic) in 2012 compared to 2011 primarily
driven by an increase in Resins and Chemicals sales, primarily due to the phenol plant
acquisition; offset by lower sales in Fluorine Products primarily due to unfavorable pricing
reflecting more challenging global end market conditions and the unfavorable impact of foreign
exchange. We expect challenging global end market conditions to continue in the first quarter of
2013.
PMT segment profit increased by 11 percent in 2012 compared with 2011 due to a 9
percent increase in operational segment profit (net of a 10 percent decrease in
the fourth quarter due to the factors described below) and a 3 percent increase
from acquisitions partially offset by an unfavorable impact of 1 percent in
foreign exchange. The increase in operational segment profit is primarily due to
higher licensing, catalyst and equipment revenues in UOP and productivity (net
of continued investment in growth initiatives) partially offset by unfavorable
pricing in Fluorine Products and Resins and Chemicals reflecting more
challenging global end market conditions. Cost of products and services sold
totaled $4.5 billion in 2012, an increase of $392 million which is primarily due
to acquisitions, higher volume and continued investment in growth initiatives
partially offset by productivity and the favorable impact of foreign exchange.
In July 2012, the Company announced that it is evaluating a series of upgrades
to its Metropolis Works nuclear conversion facility, a Fluorine Products
facility, following a U.S. Nuclear Regulatory Commission (NRC) inspection that
focused on preparedness for extreme natural disasters such as strong earthquakes
and tornados. The NRC inspection was part of a comprehensive assessment of all
U.S. nuclear-related facilities following the Fukushima, Japan earthquake in
2011. Production at the Metropolis facility was suspended following the NRC
inspection and will not resume until certain seismic-related upgrades have been
implemented by the Company and reviewed by the NRC. The scope of these upgrades
has been defined in a Confirmatory Order issued by the NRC to Honeywell on
October 16, 2012. The Company believes that completion of the upgrades to the
facility could be completed by the third quarter of 2013. The continued
suspension of operations and the cost of the plant upgrades are not expected to
have a material negative impact on Performance Materials and Technologies' 2013
results of operations.
2011 compared with 2010
PMT sales increased by 20 percent in 2011 compared with 2010 due to a 16 percent
increase in organic growth, 3 percent growth from acquisitions, and a 1 percent
favorable impact of foreign exchange.
• UOP sales increased by 24 percent in 2011 compared to 2010 primarily driven by increased service,
and licensing revenues and higher unit sales of refining and specialty catalysts, primarily
reflecting continued strength in the refining and petrochemical industries.
• Advanced Materials sales increased by 18 percent (12 percent organically) in 2011 compared to
2010 primarily driven by (i) a 33 percent (18 percent organically) increase in Resins and
Chemicals sales primarily due to higher prices driven by strong Asia demand, agricultural demand,
formula pricing arrangements and increased sales resulting from the acquisition of a phenol
plant, partially offset by decreased volumes primarily due to disruptions in phenol supply and
weather related events, (ii) a 10 percent increase in our Fluorine Products business due to
higher pricing reflecting robust global demand and tight industry supply conditions primarily in
the first half of the year, which moderated in the second half of the year due to seasonally
weaker demand and increased available capacity in the marketplace, and (iii) a 12 percent
increase in Specialty Products sales primarily due to higher sales volume in our armor,
additives, and healthcare packaging products, and commercial excellence initiatives. We expect
Advanced Materials sales growth to continue to moderate during the first half of 2012 due to
39
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slowing global demand and lower prices resulting from increased availability of
refrigerants supply.
PMT segment profit increased by 39 percent in 2011 compared with 2010 due to a
38 percent increase in operational segment profit and a 1 percent favorable
impact of foreign exchange. The increase in operational segment profit is
primarily due to the favorable price to raw materials spread in Resins and
Chemicals and Fluorine Products and higher service, product and licensing
revenues in UOP, partially offset by continued investment in growth and plant
optimization initiatives. Cost of products and services sold totaled $4.2
billion in 2011, an increase of approximately $597 million which is primarily
due to volume, material inflation, the phenol plant acquisition and continued
investment in growth initiatives.
2013 Areas of Focus
Performance Materials and Technologies primary areas of focus for 2013 include:
• Continuing to develop new processes, products and technologies that address energy
efficiency, the environment and security, as well as position the portfolio for higher
value;
• Commercializing new products and technologies in the petrochemical, gas processing and
refining industries and renewable energy sector;
• Investing to increase plant capacity and reliability to service backlog and improve
productivity and quality through operational excellence;
• Driving sales and marketing excellence and expanding local presence in high growth regions;
• Managing exposure to raw material price and supply fluctuations through evaluation of
alternative sources of supply and contractual arrangements; and
• Managing the successful integration of acquisitions related to our gas processing and
hydrogen business unit including capacity and geographic expansion to address rapidly
growing commercial opportunities and existing backlog.
Transportation Systems
Overview
Transportation Systems provides automotive products that improve the performance
and efficiency of cars, trucks, and other vehicles through state-of-the-art
technologies, world class brands and global solutions to customers' needs.
Transportation Systems' products include turbochargers and thermal systems; and
friction materials (Bendix(R) and Jurid(R)) and brake hard parts. Transportation
Systems sells its products to original equipment ("OE") automotive and truck
manufacturers (e.g., BMW, Caterpillar, Daimler, Renault, Ford, and Volkswagen),
wholesalers and distributors and through the retail aftermarket.
Economic and Other Factors
Transportation Systems operating results are principally impacted by:
• Financial strength and stability of automotive OE manufacturers;
• Global demand, particularly in Western Europe, for automobile and truck production;
• Turbo penetration rates for new engine platforms;
• Global consumer preferences, particularly in Western Europe, for boosted diesel passenger
cars;
• Degree of volatility in raw material prices, including nickel and steel;
• New automobile production rates and the impact of inventory levels of automotive OE
manufacturers on demand for our products;
• Regulations mandating lower emissions and improved fuel economy;
40
--------------------------------------------------------------------------------• Consumers' ability to obtain financing for new vehicle purchases; and
• Impact of factors such as consumer confidence on automotive aftermarket demand.
Transportation systems
2012 2011 Change 2010 Change
Net sales $ 3,561 $ 3,859 (8 )% $ 3,192 21 %
Cost of products and services sold 2,939 3,174 2,641
Selling, general and administrative
expenses 159 161 149
Other 31 39 49
Segment profit $ 432 $ 485 (11 )% $ 353 37 %
2012 vs. 2011 2011 vs. 2010
Segment Segment
Factors Contributing to Year-Over-Year Change Sales Profit Sales Profit
Organic growth/ Operational segment profit (3 )% (4 )% 16 % 32 %
Foreign exchange (5 )% (7 )% 5 % 5 %
Total % Change (8 )% (11 )% 21 % 37 %
2012 compared with 2011
Transportation Systems sales decreased by 8 percent in 2012 compared with the
2011 primarily due to an unfavorable impact from foreign exchange of 5 percent
and a decrease in organic sales of 3 percent. Lower sales were primarily driven
by decreased light vehicle production in Europe and lower aftermarket sales
partially offset by new platform launches, including higher turbo gas
penetration in North America.
Transportation Systems segment profit decreased by 11 percent in 2012 compared
with 2011 due to a 7 percent unfavorable impact from foreign exchange and a 4
percent decrease in operational segment profit. The decrease in operational
segment profit is primarily due to decreased volume and unfavorable pricing,
substantially offset by productivity (net of the impact of ongoing projects to
drive operational improvement in the Friction Materials business), net of
inflation. Cost of products and services sold totaled $2.9 billion in 2012, a
decrease of $235 million which is primarily a result of foreign exchange,
decreased volume and increased productivity.
2011 compared with 2010
Transportation Systems sales increased by 21 percent in 2011 compared with the
2010, primarily due to a 16 percent increase in organic revenue driven by
increased sales volume and a favorable impact from foreign exchange of 5
percent.
The sales increase in 2011 as compared with 2010 was primarily driven by (i)
increased turbocharger sales to both light vehicle and commercial vehicle engine
manufacturers primarily due to new platform launches and strong diesel
penetration rates in Western Europe and (ii) the favorable impact of foreign
exchange.
Transportation Systems segment profit increased by 37 percent in 2011 compared
with 2010 due to a 32 percent increase in operational segment profit and a 5
percent favorable impact from foreign exchange. The increase in operational
segment profit is comprised of an approximate 25 percent positive impact from
productivity, net of inflation and price, and 7 percent positive impact from
higher sales volumes. Cost of products and services sold totaled $3.2 billion in
2011, an increase of $533 million which is primarily a result of higher sales
volume, foreign exchange and inflation, partially offset by positive impact from
productivity.
2013 Areas of Focus
Transportation Systems primary areas of focus in 2013 include:
• Sustaining superior turbocharger technology through successful platform launches;
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--------------------------------------------------------------------------------• Maintaining the high quality of current products while executing new product
introductions;
• Increasing global penetration and share of diesel and gasoline turbocharger OEM
demand;
• Reducing manufacturing costs through increasing plant productivity and an improving
global manufacturing footprint;
• Aligning cost structure with current economic outlook, and successful execution of
repositioning actions; and
• Aligning development efforts and costs with new turbo platform launch schedules.
Repositioning and Other Charges
See Note 3 Repositioning and Other Charges of Notes to the Financial Statements
for a discussion of repositioning and other charges incurred in 2012, 2011, and
2010. Our repositioning actions are expected to generate incremental pretax
savings of approximately $150 million in 2013 compared with 2012 principally
from planned workforce reductions. Cash expenditures for severance and other
exit costs necessary to execute our repositioning actions were $136, $159, and
$147 million in 2012, 2011, and 2010, respectively. Such expenditures for
severance and other exit costs have been funded principally through operating
cash flows. Cash expenditures for severance and other costs necessary to execute
the remaining actions are expected to be approximately $175 million in 2013 and
will be funded through operating cash flows.
The following tables provide details of the pretax impact of total net
repositioning and other charges by segment.
Years Ended December 31,
2012 2011 2010
Aerospace
Net repositioning charge $ (5 ) $ 29 $ 32
Years Ended December 31,
2012 2011 2010
Automation and Control Solutions
Net repositioning charge $ 18 $ 191 $ 79
Years Ended December 31,
2012 2011 2010
Performance Materials and Technologies
Net repositioning charge $ 12 $ 41 $ 18
Years Ended December 31,
2012 2011 2010
Transportation Systems
Net repositioning charge $ 28 $ 82 $ 20
Asbestos related litigation charges, net of
insurance 169 146 158
$ 197 $ 228 $ 178
Years Ended December 31,
2012 2011 2010
Corporate
Net repositioning charge $ - $ 11 $ -
Asbestos related litigation charges, net of
insurance (13 ) 3 17
Probable and reasonably estimable
environmental liabilities 234 240 212
Other - - 62
$ 221 $ 254 $ 291
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LIQUIDITY AND CAPITAL RESOURCES
The Company continues to manage its businesses to maximize operating cash flows
as the primary source of liquidity. In addition to our available cash and
operating cash flows, additional sources of liquidity include committed credit
lines, short-term debt from the commercial paper market, long-term borrowings,
and access to the public debt and equity markets, as well as the ability to sell
trade accounts receivables. We continue to balance our cash and financing uses
through investment in our existing core businesses, acquisition activity, share
repurchases and dividends.
Cash Flow Summary
Our cash flows from operating, investing and financing activities, as reflected
in the Consolidated Statement of Cash Flows for the years ended 2012, 2011 and
2010, are summarized as follows:
2012 2011 2010
Cash provided by (used for):
Operating activities $ 3,517 $ 2,833 $ 4,203
Investing activities (1,428 ) (611 ) (2,269 )
Financing activities (1,206 ) (1,114 ) (2,047 )
Effect of exchange rate changes on cash 53 (60 ) (38 )
Net increase/(decrease) in cash and cash equivalents $ 936 $ 1,048 $ (151 )
2012 compared with 2011
Cash provided by operating activities increased by $684 million during 2012
compared with 2011 primarily due to reduced cash contributions to our pension
plans of $706 million and a $344 million increase of net income before the
non-cash pension mark-to-market adjustment, partially offset by higher cash tax
payments of approximately $340 million.
Cash used for investing activities increased by $817 million during 2012
compared with 2011 primarily due to (i) a decrease in proceeds from sales of
businesses of $1,135 million (most significantly the divestiture of the Consumer
Products Group business and the automotive on-board sensor products business
within our Automation and Control Solutions segment in 2011), (ii) a net $117
million increase in investments (primarily short-term marketable securities),
and (iii) an increase in expenditures for property, plant and equipment of $86
million, partially offset by a decrease in cash paid for acquisitions of $535
million.
Cash used for financing activities increased by $92 million during 2012 compared
to 2011 primarily due to a decrease in the net proceeds from debt issuances of
$825 million and an increase in dividends paid of $120 million, partially offset
by a decrease of $806 million in net repurchases of common stock and a decrease
of $33 million in the payment of debt assumed with acquisitions.
2011 compared with 2010
Cash provided by operating activities decreased by $1,370 million during 2011
compared with 2010 primarily due to i) increased voluntary cash contributions of
$1,050 million to our U.S. pension plans, ii) an unfavorable impact from
decreased deferred taxes (excluding the impact of cash taxes) of approximately
$710 million, and iii) higher cash tax payments of approximately $500 million,
partially offset by an $863 million increase of net income before the non-cash
pension mark-to-market adjustment.
Cash used for investing activities decreased by $1,658 million during 2011
compared with 2010 primarily due to an increase in proceeds from sale of
businesses of $1,149 million (most significantly the divestiture of the Consumer
Products Group business and the automotive on-board sensor products business
within our Automation and Control Solutions segment), a decrease in cash paid
for acquisitions of $330 million, and a net $315 million decrease in investments
of short-term marketable securities.
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Cash used for financing activities decreased by $933 million during 2011
compared with 2010 primarily due to an increase in the net proceeds from debt of
$1,734 million and a decrease of $293 million in the payment of debt assumed
with acquisitions, partially offset by an increase of $1,085 million of
repurchases of common stock.
Liquidity
Each of our businesses is focused on implementing strategies to increase
operating cash flows through revenue growth, margin expansion and improved
working capital turnover. Considering the current economic environment in which
each of the businesses operate and their business plans and strategies,
including the focus on growth, cost reduction and productivity initiatives, the
Company believes that cash balances and operating cash flows are the principal
source of liquidity. In addition to the available cash and operating cash flows,
additional sources of liquidity include committed credit lines, short term debt
from the commercial paper markets, long-term borrowings, and access to the
public debt and equity markets, as well as the ability to sell trade accounts
receivables. At December 31, 2012, a substantial portion of the Company's cash
and cash equivalents were held by foreign subsidiaries. If the amounts held
outside of the U.S. were to be repatriated, under current law, they would be
subject to U.S. federal income taxes, less applicable foreign tax credits.
However, our intent is to permanently reinvest these funds outside of the U.S.
It is not practicable to estimate the amount of tax that might be payable if
some or all of such earnings were to be repatriated, and the amount of foreign
tax credits that would be available to reduce or eliminate the resulting U.S.
income tax liability.
A source of liquidity is our ability to issue short-term debt in the commercial
paper market. Commercial paper notes are sold at a discount and have a maturity
of not more than 365 days from date of issuance. Borrowings under the commercial
paper program are available for general corporate purposes as well as for
financing potential acquisitions. There was $400 million of commercial paper
outstanding at December 31, 2012.
Our ability to access the commercial paper market, and the related cost of these
borrowings, is affected by the strength of our credit rating and market
conditions. Our credit ratings are periodically reviewed by the major
independent debt-rating agencies. As of December 31, 2012, Standard and Poor's
(S&P), Fitch, and Moody's have ratings on our long-term debt of A, A and A2
respectively, and short-term debt of A-1, F1 and P1 respectively. S&P, Fitch and
Moody's have Honeywell's rating outlook as "stable". To date, the Company has
not experienced any limitations in our ability to access these sources of
liquidity.
We also have a current shelf registration statement filed with the Securities
and Exchange Commission under which we may issue additional debt securities,
common stock and preferred stock that may be offered in one or more offerings on
terms to be determined at the time of the offering. Net proceeds of any offering
would be used for general corporate purposes, including repayment of existing
indebtedness, capital expenditures and acquisitions.
As a source of liquidity, we sell interests in designated pools of trade
accounts receivables to third parties. As of December 31, 2012 and 2011, none of
the receivables in the designated pools had been sold to third parties. When we
sell receivables, they are over-collateralized and we retain a subordinated
interest in the pool of receivables representing that over-collateralization as
well as an undivided interest in the balance of the receivables pools. The terms
of the trade accounts receivable program permit the repurchase of receivables
from the third parties at our discretion, providing us with an additional source
of revolving credit. As a result, program receivables remain on the Company's
balance sheet with a corresponding amount recorded as Short-term borrowings.
On April 2, 2012, the Company entered into a $3,000 million Amended and Restated
Five Year Credit Agreement ("Credit Agreement") with a syndicate of banks.
Commitments under the Credit Agreement can be increased pursuant to the terms of
the Credit Agreement to an aggregate amount not to exceed $3,500 million. The
Credit Agreement contains a $700 million sub-limit for the issuance of letters
of credit. The Credit Agreement is maintained for general corporate purposes and
amends and restates the previous $2,800 million five year credit agreement dated
March 31, 2011 ("Prior Agreement"). There have been no borrowings under the
Credit Agreement or the Prior Agreement.
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We monitor the third-party depository institutions that hold our cash and cash
equivalents on a daily basis. Our emphasis is primarily on safety of principal
and secondarily on maximizing yield on those funds. We diversify our cash and
cash equivalents among counterparties to minimize exposure to any one of these
entities.
Global economic conditions or a tightening of credit markets could adversely
affect our customers' or suppliers' ability to obtain financing, particularly in
our long-cycle businesses and airline, automotive and refining/petrochemical end
markets. Customer or supplier bankruptcies, delays in their ability to obtain
financing, or the unavailability of financing could adversely affect our cash
flow or results of operations. To date we have not experienced material impacts
from customer or supplier bankruptcy or liquidity issues. We continue to monitor
and take measures to limit our exposure.
In February 2011, the Board of Directors authorized the repurchase of up to a
total of $3 billion of Honeywell common stock. During 2012, the Company
repurchased $317 million of outstanding shares to offset the dilutive impact of
employee stock based compensation plans, including future option exercises,
restricted unit vesting and matching contributions under our savings plans (see
Part II, Item 5 for share repurchases in the fourth quarter of 2012).
On October 22, 2012, the Company acquired a 70 percent controlling interest in
Thomas Russell Co., a privately-held leading provider of technology and
equipment for natural gas processing and treating, for approximately $525
million ($368 million, net of cash). Thomas Russell Co.'s results of operations
have been consolidated into the Performance Materials and Technologies segment,
with the noncontrolling interest portion reflected in net income attributable to
the noncontrolling interest in the Consolidated Statement of Operations. During
the calendar year 2016, Honeywell has the right to acquire and the
noncontrolling shareholder has the right to sell to Honeywell the remaining 30
percent interest at a price based on a multiple of Thomas Russell Co.'s average
annual operating income from 2013 to 2015, subject to a predetermined cap and
floor. Additionally, Honeywell has the right to acquire the remaining 30 percent
interest for a fixed price equivalent to the cap at any time on or before
December 31, 2015. See Note 21 Redeemable Noncontrolling Interest.
In December 2012, the Company entered into a definitive agreement to acquire
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 for $10 per share in cash, or an aggregate purchase price of
approximately $600 million, net of cash acquired. Intermec is a U.S. public
company which operates globally and had reported 2011 revenues of approximately
$850 million. The transaction is expected to close by the end of the second
quarter of 2013, pending Intermec shareholder approval and following customary
regulatory reviews. The acquisition is expected to be funded with available cash
and the issuance of commercial paper. Intermec will be integrated into our
Automation and Control Solutions segment.
During 2012, the Company made cash contributions of $1,039 million principally
to improve the funded status of our pension plans.
In addition to our normal operating cash requirements, our principal future cash
requirements will be to fund capital expenditures, dividends, strategic
acquisitions, share repurchases, employee benefit obligations, environmental
remediation costs, asbestos claims, severance and exit costs related to
repositioning actions and debt repayments.
Specifically, we expect our primary cash requirements in 2013 to be as follows:
• Capital expenditures-we expect to spend approximately $1.2 billion for capital
expenditures in 2013 primarily for growth, production and capacity expansion, cost
reduction, maintenance, and replacement.
• Share repurchases-under the Company's previously reported $3 billion share
repurchase program, $1.6 billion remained available as of December 31, 2012 for
additional share repurchases. Honeywell presently expects to repurchase outstanding
shares from time to time during 2013 to offset the dilutive impact of employee stock
based compensation plans, including future option exercises, restricted unit vesting
and matching contributions under our savings
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plans. The amount and timing of future repurchases may vary depending on market conditions and
the level of operating, financing and other investing activities.
• Dividends-we expect to pay approximately $1.3 billion in dividends on our common stock in
2013, reflecting the 10 percent increase in the dividend rate effective with the fourth
quarter 2012 dividend.
• Asbestos claims-we expect our cash spending for asbestos claims and our cash receipts for
related insurance recoveries to be approximately $480 and $44 million, respectively, in 2013.
We believe it is possible that the effective date of the NARCO Plan of Reorganization will
occur in 2013 so we have included estimated funding for the NARCO Trust in 2013. See Asbestos
Matters in Note 22 to the financial statements for further discussion of possible funding
obligations in 2013 related to the NARCO Trust.
• Pension contributions-in 2013, we are not required to make contributions to our U.S. pension
plans. We plan to make cash contributions of approximately $150 million ($113 million was made
in January 2013) to our non-U.S. plans to satisfy regulatory funding standards. The timing and
amount of contributions to both our U.S. and non-U.S. plans may be impacted by a number of
factors, including the funded status of the plans.
• Repositioning actions-we expect that cash spending for severance and other exit costs
necessary to execute the previously announced repositioning actions will approximate $175
million in 2013.
• Environmental remediation costs-we expect to spend approximately $300 million in 2013 for
remedial response and voluntary clean-up costs. See Environmental Matters in Note 22 to the
financial statements for additional information.
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 businesses that do not fit into our long-term strategic plan based on
their market position, relative profitability or growth potential. These
businesses are considered for potential divestiture, restructuring or other
repositioning actions subject to regulatory constraints. In 2012 and 2011, we
realized $21 and $1,156 million, respectively, in cash proceeds from sales of
non-strategic businesses.
Based on past performance and current expectations, we believe that our
operating cash flows will be sufficient to meet our future operating cash needs.
Our available cash, committed credit lines, access to the public debt and equity
markets as well as our ability to sell trade accounts receivables, provide
additional sources of short-term and long-term liquidity to fund current
operations, debt maturities, and future investment opportunities.
46--------------------------------------------------------------------------------
Contractual Obligations and Probable Liability Payments
Following is a summary of our significant contractual obligations and probable
liability payments at December 31, 2012:
Payments by Period
2014- 2016-
Total(6) 2013 2015 2017 Thereafter
Long-term debt, including
capitalized leases(1) $ 7,020 $ 625 $ 711 $ 863 $ 4,821
Interest payments on long-term
debt, including capitalized
leases 2,798 240 400 357 1,801
Minimum operating lease payments 1,288 305 442 229 312
Purchase obligations(2) 1,783 939 474 223 147
Estimated environmental liability
payments(3) 654 304 200 100 50
Asbestos related liability
payments(4) 1,772 480 769 438 85
Asbestos insurance recoveries(5) (707 ) (44 ) (147 ) (141 ) (375 )
$ 14,608 $ 2,849 $ 2,849 $ 2,069 $ 6,841
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(1) Assumes all long-term debt is outstanding until scheduled maturity.
(2) Purchase obligations are entered into with various vendors in the normal course of business
and are consistent with our expected requirements.
(3) The payment amounts in the table only reflect the environmental liabilities which are
probable and reasonably estimable as of December 31, 2012. See Environmental Matters in Note
22 Commitments and Contingencies of Notes to the Financial Statements for additional
information.
(4) These amounts are estimates of asbestos related cash payments for NARCO and Bendix based on
our asbestos related liabilities which are probable and reasonably estimable as of December
31, 2012. We believe that it is possible that the effective date of the NARCO Plan of
Reorganization will occur in 2013 so we have included estimated funding for the NARCO Trust
starting in 2013. We have accrued for the estimated value of future NARCO asbestos related
claims expected to be asserted against the NARCO trust through 2018. In light of the
uncertainties inherent in making long-term projections and in connection with the initial
operation of a 524(g) trust, as well as the stay of all NARCO asbestos claims since January
2002, we do not believe that we have a reasonable basis for estimating NARCO asbestos claims
beyond 2018. Projecting the timing of NARCO payments is dependent on, among other things,
the effective date of the Trust which could cause the timing of payments to be earlier or
later than that projected. Projecting future events is subject to many uncertainties that
could cause asbestos liabilities to be higher or lower than those projected and recorded.
See Asbestos Matters in Note 22 Commitments and Contingencies of Notes to the Financial
Statements for additional information.
(5) These amounts represent our insurance recoveries that are deemed probable for asbestos
related liabilities as of December 31, 2012. The timing of insurance recoveries are impacted
by the terms of insurance settlement agreements, as well as the documentation, review and
collection process required to collect on insurance claims. Where probable insurance
recoveries are not subject to definitive settlement agreements with specified payment dates,
but instead are covered by insurance policies, we have assumed collection will occur beyond
2017. Projecting the timing of insurance recoveries is subject to many uncertainties that
could cause the amounts collected to be higher or lower than those projected and recorded or
could cause the timing of collections to be earlier or later than that projected. We
reevaluate our projections concerning insurance recoveries in light of any changes or
developments that would impact recoveries or the timing thereof. See Asbestos Matters in
Note 22 Commitments and Contingencies of Notes to the Financial Statements for additional
information.
(6) The table excludes tax effects as well as $722 million of uncertain tax positions. See Note
6 Income Taxes of Notes to the Financial Statements for additional information.
47
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The table also excludes our pension and other postretirement benefits (OPEB)
obligations. In 2013, we are not required to make contributions to our U.S.
pension plans, however, we plan to make cash contributions of approximately $150
million ($113 million was made in January 2013) to our non-U.S. plans to satisfy
regulatory funding standards. The timing and amount of contributions may be
impacted by a number of factors, including the funded status of the plans.
Beyond 2013, the actual amounts required to be contributed are dependent upon,
among other things, interest rates, underlying asset returns and the impact of
legislative or regulatory actions related to pension funding obligations.
Payments due under our OPEB plans are not required to be funded in advance, but
are paid as medical costs are incurred by covered retiree populations, and are
principally dependent upon the future cost of retiree medical benefits under our
plans. We expect our OPEB payments to approximate $149 million in 2013 net of
the benefit of approximately $11 million from the Medicare prescription subsidy.
See Note 23 to the financial statements for further discussion of our pension
and OPEB plans.
The noncontrolling interest shareholder of Thomas Russell Co., one of our
subsidiaries, has put rights that may be exercised causing us to purchase their
equity interests beginning January 1, 2016 through December 31, 2016. The same
interest is subject to certain call rights by the Company. As the amount paid is
based on operating income performance from 2013 to 2015, the actual settlement
amount may be different and has therefore been excluded from this table.
Off-Balance Sheet Arrangements
Following is a summary of our off-balance sheet arrangements:
Guarantees-We have issued or are a party to the following direct and indirect
guarantees at December 31, 2012:
Maximum
Potential
Future
Payments
Operating lease residual values $ 51
Other third parties' financing 5
Unconsolidated affiliates' financing 12
Customer financing 9
$ 77
We do not expect that these guarantees will have a material adverse effect on
our consolidated results of operations, financial position or liquidity.
In connection with the disposition of certain businesses and facilities we have
indemnified the purchasers for the expected cost of remediation of environmental
contamination, if any, existing on the date of disposition. Such expected costs
are accrued when environmental assessments are made or remedial efforts are
probable and the costs can be reasonably estimated.
Environmental Matters
We are subject to various federal, state, local and foreign government
requirements relating to the protection of 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 and
that our handling, manufacture, use and disposal of hazardous substances are in
accordance with environmental and safety 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 and safety matters, including past
production of products containing hazardous 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 or jointly, with other potentially
responsible parties, to determine the feasibility of various remedial techniques
to address environmental matters. It is our policy (see Note 1 to the
48
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financial statements) to record appropriate liabilities for environmental
matters when remedial efforts or damage claim payments are probable and the
costs can be reasonably estimated. Such liabilities are based on our best
estimate of the undiscounted future costs required to complete the remedial
work. The recorded liabilities are adjusted periodically as remediation efforts
progress or as additional technical or legal information becomes available.
Given the uncertainties regarding the status of laws, regulations, enforcement
policies, the impact of other potentially responsible parties, technology and
information related to individual sites, we do not believe it is possible to
develop an estimate of the range of reasonably possible environmental loss in
excess of our recorded liabilities. 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
remediation liability, personal injury and property damage claims, regulatory
approval of cleanup projects, execution timeframe of projects, remedial
techniques to be utilized and agreements with other parties.
Remedial response and voluntary cleanup costs charged against pretax earnings
were $234, $240 and $225 million in 2012, 2011 and 2010, respectively. At
December 31, 2012 and 2011, the recorded liabilities for environmental matters
was $654 and $723 million, respectively. In addition, in 2012 and 2011 we
incurred operating costs for ongoing businesses of approximately $84 and $102
million, respectively, relating to compliance with environmental regulations.
Remedial response and voluntary cleanup payments were $320, $270 and $266
million in 2012, 2011 and 2010, respectively, and are currently estimated to be
approximately $300 million in 2013. We expect to fund such expenditures from
operating cash flow.
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 or operating cash
flows in the periods recognized or paid. However, considering our past
experience and existing reserves, we do not expect that environmental matters
will have a material adverse effect on our consolidated financial position.
See Note 22 Commitments and Contingencies of Notes to the Financial Statements
for a discussion of our commitments and contingencies, including those related
to environmental matters and toxic tort litigation.
Financial Instruments
As a result of our global operating and financing activities, we are exposed to
market risks from changes in interest and foreign currency exchange rates and
commodity prices, which may adversely affect our operating results and financial
position. We minimize our risks from interest and foreign currency exchange rate
and commodity price fluctuations through our normal operating and financing
activities and, when deemed appropriate, through the use of derivative financial
instruments. We do not use derivative financial instruments for trading or other
speculative purposes and do not use leveraged derivative financial instruments.
A summary of our accounting policies for derivative financial instruments is
included in Note 1 Summary of Significant Accounting Policies of Notes to the
Financial Statements. We also hold investments in marketable equity securities,
which exposes us to market volatility, as discussed in Note 16 Financial
Instruments and Fair Value Measures of Notes to the Financial Statements.
We conduct our business on a multinational basis in a wide variety of foreign
currencies. Our exposure to market risk from changes in foreign currency
exchange rates arises from international financing activities between
subsidiaries, foreign currency denominated monetary assets and liabilities and
anticipated transactions arising from international trade. Our objective is to
preserve the economic value of non-functional currency cash flows. We attempt to
hedge transaction exposures with natural offsets to the fullest extent possible
and, once these opportunities have been exhausted, through foreign currency
forward and option agreements with third parties. Our principal currency
exposures relate to the U.S. dollar, Euro, British pound, Canadian dollar,
Chinese renminbi, Mexican peso, Indian rupee, Korean won, Czech koruna, Hong
Kong dollar, Singapore dollar, Romanian leu, Swiss franc, Swedish krona, and
Thai baht.
49
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Our exposure to market risk from changes in interest rates relates primarily to
our net debt and pension obligations. As described in Note 14 Long-term Debt and
Credit Agreements and Note 16 Financial Instruments and Fair Value Measures of
Notes to the Financial Statements, we issue both fixed and variable rate debt
and use interest rate swaps to manage our exposure to interest rate movements
and reduce overall borrowing costs.
Financial instruments, including derivatives, expose us to counterparty credit
risk for nonperformance and to market risk related to changes in interest and
foreign currency exchange rates and commodity prices. We manage our exposure to
counterparty credit risk through specific minimum credit standards,
diversification of counterparties, and procedures to monitor concentrations of
credit risk. Our counterparties are substantial investment and commercial banks
with significant experience using such derivative instruments. We monitor the
impact of market risk on the fair value and expected future cash flows of our
derivative and other financial instruments considering reasonably possible
changes in interest and currency exchange rates and restrict the use of
derivative financial instruments to hedging activities.
The following table illustrates the potential change in fair value for interest
rate sensitive instruments based on a hypothetical immediate
one-percentage-point increase in interest rates across all maturities, the
potential change in fair value for foreign exchange rate sensitive instruments
based on a 10 percent weakening of the U.S. dollar versus local currency
exchange rates across all maturities, and the potential change in fair value of
contracts hedging commodity purchases based on a 20 percent decrease in the
price of the underlying commodity across all maturities at December 31, 2012 and
2011.
Estimated
Increase
Face or (Decrease)
Notional Carrying Fair in Fair
Amount Value(1) Value(1) Value
December 31, 2012
Interest Rate Sensitive Instruments
Long-term debt (including current maturities) $ 7,020 $ (7,020 ) $ (8,152 ) $ (555 )
Interest rate swap agreements 1,400 146 146 (67 )
Foreign Exchange Rate Sensitive Instruments
Foreign currency exchange contracts(2) 8,506 20 20 361
Commodity Price Sensitive Instruments
Forward commodity contracts(3) 17 - - (3 )
December 31, 2011
Interest Rate Sensitive Instruments
Long-term debt (including current maturities) $ 6,896 $ (6,896 ) $ (7,896 ) $ (578 )
Interest rate swap agreements 1,400 134 134 (74 )
Foreign Exchange Rate Sensitive Instruments
Foreign currency exchange contracts(2) 7,108 (26 ) (26 ) 274
Commodity Price Sensitive Instruments
Forward commodity contracts(3) 59 (9 ) (9 ) (10 )
--------------------------------------------------------------------------------
(1) Asset or (liability).
(2) Changes in the fair value of foreign currency exchange contracts are offset by
changes in the fair value or cash flows of underlying hedged foreign currency
transactions.
(3) Changes in the fair value of forward commodity contracts are offset by changes in
the cash flows of underlying hedged commodity transactions.
The above discussion of our procedures to monitor market risk and the estimated
changes in fair value resulting from our sensitivity analyses are
forward-looking statements of market risk assuming certain adverse market
conditions occur. Actual results in the future may differ materially from these
estimated results due to actual developments in the global financial markets.
The methods used by us to assess and mitigate risk discussed above should not be
considered projections of future events.
50--------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
The preparation of our consolidated financial statements in accordance with
generally accepted accounting principles is based on the selection and
application of accounting policies that require us to make significant estimates
and assumptions about the effects of matters that are inherently uncertain. We
consider the accounting policies discussed below to be critical to the
understanding of our financial statements. Actual results could differ from our
estimates and assumptions, and any such differences could be material to our
consolidated financial statements.
We have discussed the selection, application and disclosure of these critical
accounting policies with the Audit Committee of our Board of Directors and our
Independent Registered Public Accountants. New accounting standards effective in
2012 which had a material impact on our consolidated financial statements are
described in the Recent Accounting Pronouncements section in Note 1 Summary of
Significant Accounting Policies of Notes to the Financial Statements.
Contingent Liabilities-We are subject to a number of lawsuits, investigations
and claims (some of which involve substantial dollar amounts) that arise out of
the conduct of our global business operations or those of previously owned
entities, including matters relating to commercial transactions, government
contracts, product liability (including asbestos), prior acquisitions and
divestitures, employee benefit plans, intellectual property, and environmental,
health and safety matters. We recognize a liability for any contingency that is
probable of occurrence and reasonably estimable. We continually assess the
likelihood of any adverse judgments or outcomes to our contingencies, as well as
potential amounts or ranges of probable losses, and recognize a liability, if
any, for these contingencies based on a careful analysis of each matter with the
assistance of outside legal counsel and, if applicable, other experts. Such
analysis includes making judgments concerning matters such as the costs
associated with environmental matters, the outcome of negotiations, the number
and cost of pending and future asbestos claims, and the impact of evidentiary
requirements. Because most contingencies are resolved over long periods of time,
liabilities may change in the future due to new developments (including new
discovery of facts, changes in legislation and outcomes of similar cases through
the judicial system), changes in assumptions or changes in our settlement
strategy. For a discussion of our contingencies related to environmental,
asbestos and other matters, including management's judgment applied in the
recognition and measurement of specific liabilities, see Notes 1 Summary of
Significant Accounting Policies and 22 Commitments and Contingencies of Notes to
the Financial Statements.
Asbestos Related Contingencies and Insurance Recoveries-We are a defendant in
personal injury actions related to products containing asbestos (refractory and
friction products). We recognize a liability for any asbestos related
contingency that is probable of occurrence and reasonably estimable. Regarding
North American Refractories Company (NARCO) asbestos related claims, we accrued
for pending claims based on terms and conditions in agreements with NARCO, its
former parent company, and certain asbestos claimants, and an estimate of the
unsettled claims pending as of the time NARCO filed for bankruptcy protection.
We also accrued for the estimated value of future NARCO asbestos related claims
expected to be asserted against the NARCO trust through 2018 as described in
Note 22 Commitments and Contingencies of Notes to the Financial Statements. In
light of the inherent uncertainties in making long term projections and in
connection with the initial operation of a 524(g) trust, as well as the stay of
all NARCO asbestos claims since January 2002, we do not believe that we have a
reasonable basis for estimating NARCO asbestos claims beyond 2018. Regarding
Bendix asbestos related claims, we accrued for the estimated value of pending
claims using average resolution values for the previous five years. We also
accrued for the estimated value of future anticipated claims related to Bendix
for the next five years based on historic claims filing experience and dismissal
rates, disease classifications, and average resolution values in the tort system
for the previous five years. In light of the uncertainties inherent in making
long-term projections, as well as certain factors unique to friction product
asbestos claims, we do not believe that we have a reasonable basis for
estimating asbestos claims beyond the next five years. We will continue to
update the resolution values used to estimate the cost of pending and future
Bendix claims during the fourth quarter each year. For additional information
see Note 22 Commitments and Contingencies of Notes to the Financial Statements.
We continually assess the likelihood of any adverse judgments or outcomes to our
contingencies, as well as potential ranges of probable losses and recognize a
liability, if any, for
51
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these contingencies based on an analysis of each individual issue with the
assistance of outside legal counsel and, if applicable, other experts.
In connection with the recognition of liabilities for asbestos related matters,
we record asbestos related insurance recoveries that are deemed probable. In
assessing the probability of insurance recovery, we make judgments concerning
insurance coverage that we believe are reasonable and consistent with our
historical experience with our insurers, our knowledge of any pertinent solvency
issues surrounding insurers, various judicial determinations relevant to our
insurance programs and our consideration of the impacts of any settlements with
our insurers. Our insurance is with both the domestic insurance market and the
London excess market. 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. Projecting future events is
subject to various uncertainties that could cause the insurance recovery on
asbestos related liabilities to be higher or lower than that projected and
recorded. Given the inherent uncertainty in making future projections, we
reevaluate our projections concerning our probable insurance recoveries in light
of any changes to the projected liability, our recovery experience or other
relevant factors that may impact future insurance recoveries. See Note 22
Commitments and Contingencies of Notes to the Financial Statements for a
discussion of management's judgments applied in the recognition and measurement
of insurance recoveries for asbestos related liabilities.
Defined Benefit Pension Plans-We sponsor both funded and unfunded U.S. and
non-U.S. defined benefit pension plans covering the majority of our employees
and retirees.
We recognize net actuarial gains or losses in excess of 10 percent of the
greater of the market-related value of plan assets or the plans' projected
benefit obligation (the corridor) annually in the fourth quarter each year (MTM
Adjustment) and, if applicable, in any quarter in which an interim remeasurement
is triggered. Net actuarial gains and losses occur when the actual experience
differs from any of the various assumptions used to value our pension plans or
when assumptions change as they may each year. The primary factors contributing
to actuarial gains and losses are changes in the discount rate used to value
pension obligations as of the measurement date each year and the differences
between expected and actual returns on plan assets. This accounting method also
results in the potential for volatile and difficult to forecast MTM Adjustments.
MTM charges were $957, $1,802 and $471 million in 2012, 2011 and 2010,
respectively. The remaining components of pension income/expense, primarily
service and interest costs and assumed return on plan assets, are recorded on a
quarterly basis (Pension Ongoing Income/Expense).
For financial reporting purposes, net periodic pension income/expense is
calculated based upon a number of actuarial assumptions, including a discount
rate for plan obligations and an expected long-term rate of return on plan
assets. We determine the expected long-term rate of return on plan assets
utilizing historical plan asset returns over varying long-term periods combined
with our expectations on future market conditions and asset mix considerations
(see Note 23 Pension and Other Postretirement Benefits of Notes to the Financial
Statements for details on the actual various asset classes and targeted asset
allocation percentages for our pension plans). The discount rate reflects the
market rate on December 31 (measurement date) for high-quality fixed-income
investments with maturities corresponding to our benefit obligations and is
subject to change each year. Information on all our major actuarial assumptions
is included in Note 23 Pension and Other Postretirement Benefits of Notes to the
Financial Statements.
The key assumptions used in developing our 2012, 2011 and 2010 net periodic
pension expense for our U.S. plans included the following:
2012 2011 2010
Discount rate 4.89 % 5.25 % 5.75 %
Assets:
Expected rate of return 8 % 8 % 9 %
Actual rate of return 13 % - 19 %
Actual 10 year average annual compounded
rate of return 8 % 6 % 6 %
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The discount rate can be volatile from year to year because it is determined
based upon prevailing interest rates as of the measurement date. We will use a
4.06 percent discount rate in 2013, reflecting the decrease in the market
interest rate environment since December 31, 2011. We will use an expected rate
of return on plan assets of 7.75 percent for 2013 down from 8 percent in 2012
due to lower future expected market returns.
In addition to the potential for MTM Adjustments, changes in our expected rate
of return on plan assets and discount rate resulting from economic events also
affects future pension ongoing expense. The following table highlights the
sensitivity of our U.S. pension obligations and ongoing expense to changes in
these assumptions, assuming all other assumptions remain constant. These
estimates exclude any potential MTM Adjustment:
Impact on 2013
Pension Ongoing
Change in Assumption Expense Impact on PBO0.25 percentage point decrease in Decrease $9
discount rate
million Increase $565 million
0.25 percentage point increase in Increase $7
discount rate
million Decrease $545 million
0.25 percentage point decrease in Increase $35
expected rate of return on assets million
-
0.25 percentage point increase in Decrease $35
expected rate of return on assets million
-
Pension ongoing income for all of our pension plans is expected to range from
$50 to $75 million in 2013 compared with ongoing pension expense of $36 million
in 2012. The increase in pension ongoing income in 2013 compared with 2012
results primarily from an increase in the plans' assets at December 31, 2012
compared with December 31, 2011 due to contributions and strong asset returns in
2012. Also, if required, an MTM Adjustment will be recorded in the fourth
quarter of 2013 in accordance with our pension accounting method as previously
described. It is difficult to reliably forecast or predict whether there will be
a MTM Adjustment in 2013, and if one is required what the magnitude of such
adjustment will be. MTM Adjustments are primarily driven by events and
circumstances beyond the control of the Company such as changes in interest
rates and the performance of the financial markets.
In 2012, 2011 and 2010, we were not required to make contributions to satisfy
minimum statutory funding requirements in our U.S. pension plans. However, we
made voluntary contributions of $792, $1,650 and $1,000 million to our U.S.
pension plans in 2012, 2011 and 2010, respectively, primarily to improve the
funded status of our plans which has been adversely impacted by relatively low
discount rates and asset losses in 2011 and 2008 resulting from the poor
performance of the equity markets. In 2013, we are not required to make
contributions to our U.S. pension plans, however, we plan to make cash
contributions of approximately $150 million ($113 million was made in January
2013) to our non-U.S. plans to satisfy regulatory funding standards. The timing
and amount of contributions to both our U.S. and non-U.S. plans may be impacted
by a number of factors, including the funded status of the plans.
Long-Lived Assets (including Tangible and Definite-Lived Intangible Assets)-To
conduct our global business operations and execute our business strategy, we
acquire tangible and intangible assets, including property, plant and equipment
and definite-lived intangible assets. At December 31, 2012, the net carrying
amount of these long-lived assets totaled approximately $6.7 billion. The
determination of useful lives (for depreciation/amortization purposes) and
whether or not these assets are impaired involves the use of accounting
estimates and assumptions, changes in which could materially impact our
financial condition or operating performance if actual results differ from such
estimates and assumptions. We periodically evaluate the recoverability of the
carrying amount of our long-lived assets whenever events or changes in
circumstances indicate that the carrying amount of a long-lived asset group may
not be fully recoverable. The principal factors we consider in deciding when to
perform an impairment review are as follows:
• Significant under-performance (i.e., declines in sales, earnings or cash flows) of a business or
product line in relation to expectations;
• Annual operating plans or five-year strategic plans that indicate an unfavorable trend in
operating performance of a business or product line;
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• Significant negative industry or economic trends; and
• Significant changes or planned changes in our use of the assets.
Once it is determined that an impairment review is necessary, recoverability of
assets is measured by comparing the carrying amount of the asset grouping to the
estimated future undiscounted cash flows. If the carrying amount exceeds the
estimated future undiscounted cash flows, the asset grouping is considered to be
impaired. The impairment is then measured as the difference between the carrying
amount of the asset grouping and its fair value. We endeavor to utilize the best
information available to measure fair value, which is usually either market
prices (if available), level 1 or level 2 in the fair value hierarchy or an
estimate of the future discounted cash flow, level 3 of the fair value
hierarchy. The key estimates in our discounted cash flow analysis include
expected industry growth rates, our assumptions as to volume, selling prices and
costs, and the discount rate selected. As described in more detail in Note 16 to
the financial statements, we have recorded impairment charges related to
long-lived assets of $22 million and $127 million in 2012 and 2011,
respectively, principally related to manufacturing plant and equipment in
facilities scheduled to close or be downsized.
Goodwill and Indefinite-Lived Intangible Assets Impairment Testing-Goodwill
represents the excess of acquisition costs over the fair value of the net
tangible assets and identifiable intangible assets acquired in a business
combination. Indefinite-lived intangible assets primarily consist of trademarks
acquired in business combinations. Goodwill and indefinite-lived assets are not
amortized, but are subject to impairment testing. Our goodwill and
indefinite-lived intangible asset balances of $12.4 billion and $725 million,
respectively, as of December 31, 2012, are subject to impairment testing
annually as of March 31, or whenever events or changes in circumstances indicate
that the carrying amount may not be fully recoverable. This testing compares
carrying values to fair values and, when appropriate, the carrying value is
reduced to fair value. In testing goodwill, the fair value of our reporting
units is estimated utilizing a discounted cash flow approach utilizing cash flow
forecasts in our five year strategic and annual operating plans adjusted for
terminal value assumptions. This impairment test involves the use of accounting
estimates and assumptions, changes in which could materially impact our
financial condition or operating performance if actual results differ from such
estimates and assumptions. To address this uncertainty we perform sensitivity
analysis on key estimates and assumptions.
We completed our annual impairment test as of March 31, 2012 and determined that
there was no impairment to our goodwill and indefinite-lived intangible assets
as of that date. However, significant negative industry or economic trends,
disruptions to our business, unexpected significant changes or planned changes
in use of the assets, divestitures and market capitalization declines may have a
negative effect on the fair values.
Income Taxes-Deferred tax assets and liabilities are determined based on the
difference between the financial statements and tax basis of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Our provision for income taxes is based on
domestic and international statutory income tax rates in the jurisdictions in
which we operate. Significant judgment is required in determining income tax
provisions as well as deferred tax asset and liability balances, including the
estimation of valuation allowances and the evaluation of tax positions.
As of December 31, 2012, we recorded a net deferred tax asset of $2,473 million,
less a valuation allowance of $598 million. Net deferred tax assets are
primarily comprised of net deductible temporary differences, net operating loss
carryforwards and tax credit carryforwards that are available to reduce taxable
income in future periods. The determination of the amount of valuation allowance
to be provided on recorded deferred tax assets involves estimates regarding (1)
the timing and amount of the reversal of taxable temporary differences, (2)
expected future taxable income, and (3) the impact of tax planning strategies. A
valuation allowance is established to offset any deferred tax assets if, based
upon the available evidence it is more likely than not that some or all of the
deferred tax asset will not be realized. In assessing the need for a valuation
allowance, we consider all available positive and negative evidence, including
past operating results, projections of future taxable income and the feasibility
of ongoing tax planning strategies. The projections of future taxable income
include a number of estimates and assumptions regarding our volume, pricing and
costs. Additionally, valuation allowances related to deferred tax assets can be
impacted by changes to tax laws.
54
--------------------------------------------------------------------------------
Our net deferred tax asset of $2,473 million consists of $1,422 million related
to U.S. operations and $1,051 million related to non-U.S. operations. The U.S.
net deferred tax asset of $1,422 million consists of net deductible temporary
differences, tax credit carryforwards, state tax net operating losses which we
believe will more likely than not be realized through the generation of future
taxable income in the U.S. and tax planning strategies. The non-U.S. net
deferred tax asset of $1,051 million consists principally of net operating loss,
capital loss and tax credit carryforwards, mainly in Canada, France, Germany,
Luxembourg, Netherlands and the United Kingdom. We maintain a valuation
allowance of $598 million against these deferred tax assets reflecting our
historical experience and lower expectations of taxable income over the
applicable carryforward periods. As more fully described in Note 6 to the
financial statements, our valuation allowance increased by $7 million in 2012,
decreased by $45 million in 2011 and increased by $58 million in 2010,
respectively. In the event we determine that we will not be able to realize our
net deferred tax assets in the future, we will reduce such amounts through a
charge to income in the period such determination is made. Conversely, if we
determine that we will be able to realize net deferred tax assets in excess of
the carrying amounts, we will decrease the recorded valuation allowance through
a credit to income in the period that such determination is made.
Significant judgment is required in determining income tax provisions and in
evaluating tax positions. We establish additional reserves for income taxes
when, despite the belief that tax positions are fully supportable, there remain
certain positions that do not meet the minimum recognition threshold. The
approach for evaluating certain and uncertain tax positions is defined by the
authoritative guidance and this guidance determines when a tax position is more
likely than not to be sustained upon examination by the applicable taxing
authority. In the normal course of business, the Company and its subsidiaries
are examined by various Federal, State and foreign tax authorities. We regularly
assess the potential outcomes of these examinations and any future examinations
for the current or prior years in determining the adequacy of our provision for
income taxes. We continually assess the likelihood and amount of potential
adjustments and adjust the income tax provision, the current tax liability and
deferred taxes in the period in which the facts that give rise to a revision
become known.
Sales Recognition on Long-Term Contracts-In 2012, we recognized approximately 16
percent of our total net sales using the percentage-of-completion method for
long-term contracts in our Automation and Control Solutions, Aerospace and
Performance Materials and Technologies segments. These long- term contracts are
measured on the cost-to-cost basis for engineering-type contracts and the
units-of-delivery basis for production-type contracts. Accounting for these
contracts involves management judgment in estimating total contract revenue and
cost. Contract revenues are largely determined by negotiated contract prices and
quantities, modified by our assumptions regarding contract options, change
orders, incentive and award provisions associated with technical performance and
price adjustment clauses (such as inflation or index-based clauses). Contract
costs are incurred over a period of time, which can be several years, and the
estimation of these costs requires management judgment. Cost estimates are
largely based on negotiated or estimated purchase contract terms, historical
performance trends and other economic projections. Significant factors that
influence these estimates include inflationary trends, technical and schedule
risk, internal and subcontractor performance trends, business volume
assumptions, asset utilization, and anticipated labor agreements. Revenue and
cost estimates are regularly monitored and revised based on changes in
circumstances. Anticipated losses on long-term contracts are recognized when
such losses become evident. We maintain financial controls over the customer
qualification, contract pricing and estimation processes to reduce the risk of
contract losses.
OTHER MATTERS
Litigation
See Note 22 to the financial statements for a discussion of environmental,
asbestos and other litigation matters.
55--------------------------------------------------------------------------------
Recent Accounting Pronouncements
See Note 1 to the financial statements for a discussion of recent accounting
pronouncements.
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