Why did Honeywell's net income swing from a loss in 2002 to a profit in 2003?

The main driver was the decline in special charges. Repositioning, litigation, business impairment, and other charges fell from $3,059 million in 2002 to $278 million in 2003. 2002 included a $1,548 million asbestos charge and an $877 million business impairment charge, neither of which recurred. Underlying segment profit was roughly flat at $2,519 million, and the company also recorded a $38 million pretax gain on non-strategic business sales.

What is the outlook for the Aerospace segment, and how exposed is Honeywell to it?

Aerospace accounted for 38% of 2003 sales. Its commercial air transport original equipment sales fell sharply, and aftermarket spare-parts demand remained weak, though management noted early signs of stabilization and increased military activity. Commercial OE sales were 7% of total company sales and commercial aftermarket sales were 15%. Management expects further growth in aircraft orders and deliveries, but the Aerospace segment's ratings-agency negative outlook was tied to this exposure.

How significant are asbestos and environmental liabilities for investors?

They are the most material long-term risk in the filing. Honeywell had about $3.0 billion of asbestos liabilities, mostly tied to NARCO (refractory products) and Bendix (friction products), against roughly $1.4 billion of probable insurance recoveries. It expects about $730 million in asbestos payments and about $130 million in insurance recoveries in 2004. The NARCO plan of reorganization is expected to be approved in 2004, but the outcome of insurance disputes, claim filing rates, and possible federal legislation could change the estimates. Environmental liabilities stood at $593 million at year-end 2003, and the company said an adverse outcome in the Jersey City case could be material to results.

What changes to pension costs should investors expect in 2004?

Honeywell expects U.S. net periodic pension expense of about $380 million in 2004, up $241 million from 2003. The increase reflects a lower discount rate (from 6.75% to 6.0%) and the continued recognition of about $3.2 billion of unrecognized net losses. The company made $670 million of voluntary U.S. pension contributions in 2003 and does not expect to need further contributions if plan assets earn the assumed 9% return. A 0.25 percentage point change in the discount rate would shift annual expense by about $50 million.

HON 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 4, 2004. Cited figures are marked; the original filing is the authoritative source.

Honeywell International's 2003 Form 10-K shows a company recovering from a difficult 2002.

Net sales rose 4% to $23.1 billion^a, driven mainly by acquisitions (+3%) and favorable foreign exchange (+3%), while volume and price were flat. Net income swung to $1.32 billion ($1.54 per diluted share) from a $220 million loss in 2002, largely because repositioning, litigation, and impairment charges fell from $3.06 billion to $278 million. Segment profit was roughly flat at $2.52 billion, and gross margin edged up to 21.1%.

Operating cash flow was $2.2 billion^b, modestly down from $2.4 billion, mainly because of a $540 million increase in voluntary U.S. pension contributions. The balance sheet strengthened, with shareowners' equity rising to $10.7 billion from $8.9 billion, largely from currency translation gains and the removal of a prior-year pension-related equity charge. Total debt was roughly flat at $5.2 billion.

Honeywell ended the year with $2.95 billion^c in cash and no commercial paper outstanding. Aerospace, the largest segment at 38% of sales, remained under pressure from the commercial air transport downturn. Segment profit there fell 7%, and the three rating agencies kept negative outlooks on the company's credit ratings.

The key risks for investors are asbestos and environmental liabilities. Asbestos cash payments were expected to reach about $730 million^d in 2004, against roughly $1.4 billion of insurance recoveries still probable.

The Jersey City chromium case could require excavation costs that the plaintiff's expert estimated at $400 million, and Honeywell is appealing. Pension expense is also set to rise by about $241 million in 2004, to $380 million.

02—Key points

Key Highlights

Net income rose to $1,324 million ($1.54 per diluted share) from a $220 million loss in 2002, mainly because repositioning, litigation, and impairment charges dropped from $3,059 million to $278 million.
Net sales grew 4% to $23,103 million, with acquisitions (+3%) and foreign exchange (+3%) offsetting divestitures (-2%); organic price and volume were flat.
Aerospace (38% of sales) saw segment profit fall 7% to $1,221 million as commercial air transport OE sales dropped sharply, while defense and space sales grew.
Shareowners' equity increased to $10,729 million from $8,925 million, supported by $551 million of currency translation gains and a $369 million pension-related equity adjustment.
Operating cash flow was $2,199 million, down from $2,380 million, after a $540 million increase in voluntary U.S. pension contributions. Year-end cash rose to $2,950 million, with no commercial paper outstanding.
Asbestos exposure remains significant: about $3.0 billion of total asbestos liabilities against roughly $1.4 billion of probable insurance recoveries, with about $730 million in cash payments expected in 2004.
The Jersey City chromium litigation (Interfaith) is under appeal. The plaintiff's expert estimated excavation costs at about $400 million, and a $235 million environmental charge was taken in 2003 for related matters including Onondaga Lake.

03—Questions

Frequently Asked Questions

Why did Honeywell's net income swing from a loss in 2002 to a profit in 2003?
The main driver was the decline in special charges. Repositioning, litigation, business impairment, and other charges fell from $3,059 million in 2002 to $278 million in 2003. 2002 included a $1,548 million asbestos charge and an $877 million business impairment charge, neither of which recurred. Underlying segment profit was roughly flat at $2,519 million, and the company also recorded a $38 million pretax gain on non-strategic business sales.
What is the outlook for the Aerospace segment, and how exposed is Honeywell to it?
Aerospace accounted for 38% of 2003 sales. Its commercial air transport original equipment sales fell sharply, and aftermarket spare-parts demand remained weak, though management noted early signs of stabilization and increased military activity. Commercial OE sales were 7% of total company sales and commercial aftermarket sales were 15%. Management expects further growth in aircraft orders and deliveries, but the Aerospace segment's ratings-agency negative outlook was tied to this exposure.
How significant are asbestos and environmental liabilities for investors?
They are the most material long-term risk in the filing. Honeywell had about $3.0 billion of asbestos liabilities, mostly tied to NARCO (refractory products) and Bendix (friction products), against roughly $1.4 billion of probable insurance recoveries. It expects about $730 million in asbestos payments and about $130 million in insurance recoveries in 2004. The NARCO plan of reorganization is expected to be approved in 2004, but the outcome of insurance disputes, claim filing rates, and possible federal legislation could change the estimates. Environmental liabilities stood at $593 million at year-end 2003, and the company said an adverse outcome in the Jersey City case could be material to results.
What changes to pension costs should investors expect in 2004?
Honeywell expects U.S. net periodic pension expense of about $380 million in 2004, up $241 million from 2003. The increase reflects a lower discount rate (from 6.75% to 6.0%) and the continued recognition of about $3.2 billion of unrecognized net losses. The company made $670 million of voluntary U.S. pension contributions in 2003 and does not expect to need further contributions if plan assets earn the assumed 9% return. A 0.25 percentage point change in the discount rate would shift annual expense by about $50 million.

04—Continue

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