Honeywell International Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unless otherwise noted, amounts are U.S. dollars in millions. Honeywell reported four segments: Aerospace; Home and Building Technologies; Performance Materials and Technologies; and Safety and Productivity Solutions.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $10,919 | $10,078 | $21,311 | $19,570 |
| Income before taxes | $1,999 | $1,778 | $3,908 | $3,502 |
| Net income attributable to Honeywell | $1,267 | $1,392 | $2,705 | $2,718 |
| Diluted EPS | $1.68 | $1.80 | $3.57 | $3.51 |
| Gross margin | 30.3% | 30.3% | 30.5% | 30.7% |
| Effective tax rate | 36.0% | 21.3% | 30.1% | 22.0% |
- Q2 sales rose 8%; management attributed the increase to volume (+4%), price (+2%) and foreign currency translation (+2%). First-half sales rose 9%, with volume and price each contributing 4% and currency 3%.
- All four segments increased sales and segment profit year over year in both periods. Q2 segment profit was $918 for Aerospace, $427 for Home and Building Technologies, $597 for Performance Materials and Technologies, and $267 for Safety and Productivity Solutions. Safety and Productivity Solutions had the fastest Q2 sales growth (+13%) and segment-profit growth (+25%).
- Q2 attributable net income fell 9% and diluted EPS fell 7%, despite higher sales and segment profit. The filing cites spin-off-related tax costs and separation costs, higher repositioning and other charges, and offsets from segment profit growth, pension income and a lower share count. First-half diluted EPS increased 2% while attributable net income was approximately flat.
- Operating cash flow was $2,997 for the first half, versus $2,387 a year earlier. Capital expenditures were $339; cash dividends paid were $1,116; and share repurchases were $1,704. Investing activities provided $1,605, including net reductions in investments; financing activities used $3,486. Cash and cash equivalents increased by $1,023 to $8,082.
- At June 30, cash and short-term investments totaled $9,850. Commercial paper and other short-term borrowings were $4,447; current maturities of long-term debt were $133; and long-term debt was $12,504. No borrowings were outstanding under the credit agreements. Current assets were $24,779 and current liabilities $18,018.
- Cash dividends per share were $0.745 for Q2 and $1.49 for the first half, versus $0.665 and $1.33 in the prior-year periods.
Material changes and accounting
- On January 1, 2018, Honeywell adopted the new revenue-recognition standard using the modified retrospective method. Adoption reduced opening retained earnings by $75. Under the prior accounting method, the company estimates Q2 and first-half 2018 revenue would have been approximately $75 and $195 lower, respectively; therefore, reported year-over-year comparisons are not fully on the same accounting basis.
- The company also changed pension-cost presentation: non-service components are now reported in Other (income) expense. This affects presentation and comparability among income-statement lines.
- The effective tax rate included $291 of tax costs from internal restructuring of Transportation Systems ahead of its anticipated spin-off. The company said tax-reform accounting remained provisional and had no material measurement-period adjustments through June 30.
- Gross margin was unchanged in Q2 and down 0.2 percentage point for the first half. Management cited higher repositioning charges as a factor; Q2 segment margin improvements offset the charges’ effect.
Outlook, management commentary and risks
- Honeywell described planned spin-offs of its Homes and Global Distribution business and Transportation Systems business. Separation costs were $63 in Q2 and $118 for the first half. The filing cautions that proposed spin-offs could change or be abandoned.
- Management expected approximately $300 of cash spending on repositioning actions in 2018, funded from operating cash flows; $166 had been spent in the first half. The company also planned approximately $140 of contributions to non-U.S. pension plans in 2018, including $99 of marketable securities contributed in January. It reported no required U.S. pension contribution for 2018.
- Repositioning and other charges were $265 in Q2 and $458 for the first half. These included $127 of probable environmental liabilities in Q2 ($184 for the first half), asbestos-related litigation charges net of insurance of $48 in Q2 ($99 for the first half), and $29 for the required wind-down of Iran activities.
- Recorded environmental liabilities were $703 at June 30. Honeywell said ultimate costs and timing cannot be determined and could materially affect results or operating cash flows when recognized or paid, though it did not expect a material adverse effect on financial position based on experience and reserves.
- Recorded asbestos liabilities were $1,528, with $433 of related insurance recoveries. Estimates depend on future claim experience and insurance recoveries. The filing also describes a retiree healthcare dispute: if an adverse ruling on past “full premium” damages is upheld on appeal, Honeywell estimates damages of at least $12 million.
- Other disclosed risks include uncertainty in contract cost and revenue estimates, inflation and foreign-currency effects, and the timing and costs of spin-offs. Management said there were no material changes to the risk factors in the 2017 Form 10-K or to market-risk disclosures. Disclosure controls were deemed effective.
- The filing provides no clear general full-year sales, earnings or EPS guidance in the text provided.
Investor verification priorities
- Track spin-off timing, separation costs, tax consequences and whether the proposed transactions proceed as planned.
- Assess underlying organic growth and margins by segment, distinguishing operating performance from currency effects and revenue-standard adoption.
- Monitor the unusually high effective tax rate and completion of accounting for U.S. tax reform and the Transportation Systems restructuring.
- Compare operating cash flow with working-capital movements, investment activity, share repurchases and planned repositioning and pension spending.
- Review developments in environmental and asbestos claims, insurance recoverability, and the UAW retiree healthcare litigation.