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IN RE HONEYWELL INTERN.

January 15, 2002

IN RE HONEYWELL INTERNATIONAL INC. SECURITIES LITIGATION.


The opinion of the court was delivered by: Debevoise, Senior District Judge.

  OPINION

This is a securities class action on behalf of all purchasers of the stock of Honeywell International Inc. ("Honeywell") between December 20, 1999 and June 19, 2000 (the "Class Period"), asserting claims under §§ 10(b) and 20(a) of the Securities Exchange Act of 1984 the ("1934 Act") Rule 10b-5. The defendants Honeywell and seven of its senior officers (the "Individual Officers"), have moved to dismiss the consolidated complaint (the "Complaint") and plaintiffs have moved to strike exhibits submitted in support of defendants' motion to dismiss the complaint and all references thereto.

Defendants' motion will be granted in part and denied in part. Plaintiffs' motion will be denied as moot.

I. The Complaint

Defendants challenge the Complaint, claiming that rather than being a "short and plain statement of the claim" in conformity with Fed.R.Civ.P. 8 it is "puzzle pleading" that fails to meet the requirements of Rule 9(b) and the Private Securities Litigation Reform Act (the "Reform Act"). The Complaint certainly is not short, but if it is a puzzle, it is meant for a child and can be assembled readily. The issues are whether plaintiffs plead actionable misrepresentations with sufficient particularity and whether plaintiffs adequately plead scienter on the part of Honeywell and each Individual Officer.

There is pled one overarching misrepresentation and omission, namely the financial success or failure of the Honeywell-Allied Signal, Inc. ("Allied") merger. There are pled a number of subsidiary individual misrepresentations and omissions alleged to be components of the overarching misrepresentation and omission. A summary of the allegations of the complaint follows:

In early 1999 Honeywell and Allied announced that they would merge, creating a huge 12,000 employee, $20 billion per year world wide conglomerate. ¶ 2. The combined companies would sell aerospace products and services, control technologies for buildings, homes and industry, specialty chemicals, fibers and plastics, and electronic and advanced materials. Id. The combined entities would be known as Honeywell and would have four strategic business units: Aerospace Solutions, Automation & Controls, Performance Materials, and Power and Transportation Products. Id.

The merger became effective on December 1, 1999. ¶ 2. The investment community was skeptical of the merger fearing that it would be difficult to integrate successfully the two companies' far-flung and diverse operations and to achieve immediately significantly accelerated revenue and earnings per share ("EPS") growth in 2000-2001 which Bonsignore had been representing would occur after the merger. ¶ 3.

Thus Bonsignore and his management team were under great pressure to show the merger succeeding, that promised merger synergies and savings were being achieved, and that Honeywell would immediately achieve strong EPS gains due to both accelerated internal growth and acquisitions, thus pushing Honeywell's stock price higher. ¶ 5. In addition the Individual Officers were under an additional pressure in that their compensation was tied directly to Honeywell's EPS, revenue growth and stock price — they would receive millions in compensation only if Honeywell's EPS, revenue and stock price increased to certain target levels. ¶¶ 5, 39. An increased stock price would also allow the Individual Officers to sell hundreds of thousands of shares of their personal Honeywell stockholdings at a huge profit. ¶¶ 5, 44.

Throughout the Class Period (December 20, 1999 — June 19, 2000) the Individual Officers and, through them, Honeywell, made it appear as though the merger was highly successful and that new Honeywell was doing very well. The defendants repeatedly represented that the integration of Allied and old Honeywell was going very well; that integration was on or ahead of schedule; that the merger would cause substantial operational synergies and $750 million in cost savings during 2000-2002 — $250 million more than they had earlier predicted; that the merger would generate $250 million in cost savings in 2000 alone and that merger synergies and savings would accelerate as 2000 unfolded. ¶¶ 6-8, 57, 64-64, 75, 81-83, 94, 96, 99.

Defendants announced that Honeywell had "record" financial results for the fourth quarter in 1999, year end 1999 and first quarter 2000 due in part to a strong performance by Honeywell's Home and Building Control business. ¶¶ 64, 82. They represented that Honeywell would have an impressive EPS for 2000, and that Honeywell would have EPS growth of 20% in 2000, 17% in 2001 and 15% in 2002, with a compounded growth of 18% going forward. ¶¶ 57, 64-65, 78, 82-83. They represented that Honeywell would also have free cash flow of $1.9 billion in 2000. ¶¶ 90, 96.

Defendants represented that Honeywell's post-merger growth-by-acquisition strategy was going well, as they had acquired a company named Pittway Corp. They represented that the acquisition of Pittway was a success and would not dilute Honeywell's EPS growth in 2000, but would boost Honeywell's cash flow during 2000 and would materially boost EPS in 2001-2002. ¶¶ 65, 96, 99.

Defendants represented that Honeywell's Performance Materials unit, which was previously slumping, had been turned around because Honeywell had implemented price increases which "were holding up well." ¶¶ 65, 71, 90-92, 96.

The Complaint alleges that these representations created the illusion that Honeywell was doing well post-merger, achieving record financial results and poised for 18% compound EPS growth. In truth, the complaint alleges, the facts were otherwise.

Contrary to proceeding successfully, defendants were encountering serious and persistent problems integrating and continuing the operation of the two companies ¶¶ 29-23. There were major problems combining the financial and accounting systems and controls and obtaining financial information necessary to forecast accurately Honeywell's operations. This resulted in increased costs and no merger synergies. ¶¶ 12(n)-(o).

In addition, in connection with the merger. there were huge reductions in workforce and many key sales personnel were laid off. As a result, new Honeywell was losing significant orders from customers who were reluctant to sign contracts because of the chaos created by the massive layoffs. Honeywell lost $200-$500 million in contracts from customers that decided not to purchase because of the layoff-related chaos. ¶ 72(p). The merger was also adversely affecting new Honeywell because defendants had used pooling accounting for the merger, which prohibited it from selling off four money-losing, poorly-performing businesses (polymers, chip packaging, pharmaceuticals/Specialty Chemicals and friction materials) which were adversely affecting Honeywell's financial results. ¶¶ 12 (p), 29, 63(p), e.g., 72(q).

Further, the Pittway acquisition was not a success as represented by defendants. but rather was having a negative effect on Honeywell. While defendants were making positive statements about Pittway. they were aware of contradicting facts, such as that Pittway had artificially inflated its revenues and profits by creating millions of dollars of sales on commercially unreasonable terms to uncreditworthy customers, which created over $200 million in past due and difficult to collect receivables, and that this adversely affected Honeywell's 2000 cash flow (as opposed to boosting it as defendants represented the Pittway acquisition would). e.g., ¶ 12(e).

Defendants knew that attempts to integrate Pittway were not going well. By February 2000 and March 2000, several Pittway managers had left, its sales had fallen by almost 50%, there was an upsurge in past due accounts receivable, and Pittway's revenues and profits were significantly below forecasts, due, in part, to three large customers (ADT, Protection One and Chubb) curtailing purchases or buying lower-margin items, thus causing Pittway to be dilutive to Honeywell's 2000 EPS, contrary to defendants' representations. e.g., ¶ 12(f)-(h).

With respect to the Performance Materials unit, the announced price increases were not holding up well but were being met with extreme customer resistance, contrary to defendants' representations. While some customers were initially paying the increased prices, they did so only under protest, and were simultaneously seeking alternate sources of supply. e.g., ¶ 12(b). Most customers were rejecting the price increases outright because the units products had become commodities on which Honeywell had lost the ability to raise prices. e.g., ¶ 12 (c). As a result, Honeywell was losing many customers and had to give its remaining customers' secret discounts and price concessions to keep them, thus adversely affecting revenue and profits. This, combined with increasing raw materials costs, was destroying the unit's margins, had an adverse effect on Honeywell's financial results, and was preventing Honeywell from achieving its 2000 EPS growth forecasts. e.g., ¶ 12 (b)-(c).

There were other undisclosed problems which defendants covered up so that they could perpetuate the illusion that new Honeywell was thriving. For example, while defendants publicly represented that Honeywell's Aerospace Solutions Unit was doing well (¶ 8) and would contribute strongly to Honeywell's 2000 EPS ¶¶ 64-65, 91, they contemporaneously knew that the unit (which accounted for 37% of Honeywell's sales and was its most profitable unit) was suffering from serious and persistent problems in obtaining printed circuit boards ("PCBs") from an outsourced supplier named EFTC, as well as electronic control units ("ECUs"), to meet demand from Boeing and other aircraft OEM customers. ¶¶ 12(i), 63(i), 72(i), 80(i), 93(i), 102(i). Defendants were aware that these shortages would not be fixed until at least the fourth quarter 2000, and would prevent Honeywell from meeting its projected EPS for 2000. Id.

Defendants also concealed that Honeywell's Power & Transportation Products unit was troubled. The unit had weak sales of its friction materials, serious component shortages for Honeywell's important new Turbocharger products, and sharply lower truck builds, especially in Europe. e.g., ¶ 12(j). These products caused the unit to perform below expectations, delayed the ramp-up of the new Turbocharger products (causing the loss of $80-100 million on this operation) and adversely affected Honeywell's financial results. Id. At the same time Honeywell was experiencing these shortages which delayed the ramp-up of the Turbocharger products that caused the loss of $80-100 million in sales, defendants falsely told the public that revenue growth in 2000 would come from Turbocharger sales and that they expected a successful roll-out of the products. ¶¶ 64, 97.

Defendants also concealed other problems which were adversely affecting Honeywell's performance: the Specialty Chemicals business was performing poorly. It had lost its competitive position (especially for its Naproxin drug) and had $40-60 million in losses. It was doing so poorly that Honeywell was going either to abandon or sell it. e.g., ¶ 12(k). Still, defendants represented that revenue growth in 2000 would come from Specialty Chemicals. ¶ 64. Similarly, Honeywell's chip packaging manufacturing operation was troubled. Its pilot manufacturing operation for Honeywell's ASTI technology had failed because it was unable to produce commercial yields of product. This caused $40-60 million in losses and later resulted in a $100 million write-off. e.g., ¶ 12(1). Contrary to these facts, defendants represented that this operation would contribute to 2000 revenue growth. ¶ 64. Defendants also concealed and did not disclose that Honeywell had sold hundreds of millions of dollars of products on special, unusual terms — including extended payment terms — in first quarter 2000 in order to artificially boost its revenues for that quarter. As a result, Honeywell had accumulated over $400 million in past due receivables which was adversely affecting its cash flow and causing it to be lower than forecast. e.g., ¶ 12 (m).

In order to cover up all of these problems which were negatively affecting Honeywells financial results, defendants deliberately falsified Honeywell's financial statements issued during the Class Period in violation of Generally Accepted Accounting Principles ("GAAP"). ¶¶ 12 (q), 72(r), 80(r), 93(r)., 108-29. Rather than accurately report the financial problems described above, defendants manipulated Honeywell's revenues, expenses and reserves, and failed to make important disclosures (id.), in order to report falsely that Honeywell was achieving "record" financial results (¶¶ 64, 82), when in fact it was not.

Defendants caused Honeywell's Home and Building Control business to create phony revenue by recording revenue from fictitious clients and non-existent jobs, by billing customers for work that had not been performed, and by abusing the "percentage of completion" method of recognizing revenue through prematurely accruing revenue. ¶¶ 110-20. Defendants also deliberately understated Honeywell's expenses through the Home and Building Control business by holding invoices from suppliers and subcontractors while not recording or paying those invoices and by shifting current period costs from sales to lease jobs. which costs were then amortized over five to ten years, thereby drastically and improperly reducing Class Period expenses. Id. Defendants also boosted Honeywell's first quarter 2000 EPS by improperly reversing millions of dollars of merger reserves-excessive reserves that should not have been set in the first place, and which had no purpose other than to allow defendants a reservoir to draw down on to secretly pump up Honeywell's first quarter 2000 results. ¶¶ 121-24. Furthermore defendants had imposed price increases on customers of Honeywell's Performance Materials unit. While this led to a very short term increase in revenues. defendants knew that the increase would only last during first quarter 2000, as customers were rejecting the price increases and would be buying elsewhere in the next quarter, thus leading to a huge decline in future quarters' sales. ¶¶ 125-29. Notwithstanding a duty to make disclosures warning investors of this development under SEC rules and GAAP, defendants did not do so. Id.

Because of these many problems defendants knew that their forecasts of EPS, EPS growth and cash flow were false when made, as Honeywell could not attain such results. ¶¶ 12(r)-(s), 63(q)-(r), 72(s)-(t), 80 (s)-(t), 93(s)-(t), 102(r)-(s).

Defendants positive statements, and their concealment of adverse facts, caused Honeywell's stock price to soar. By April 25, 2000, Honeywell's stock price reached $58 7/16 per share (very close to its Class Period high of $59 1/8). ¶¶ 9, 101. The strong upward movement in Honeywell's stock price was remarkable given that stocks generally declined very sharply during April 2000. ¶ 9. However, notwithstanding their representations that new Honeywell was succeeding and was supposedly on track to achieve several years of accelerating revenue and EPS growth, which presumably would lead to further increases in Honeywell's stock price, defendants Bonsignore, Ferrari, Redlinger, Johnson, Porter and Kreindler, six of the seven Individual Officers, unloaded more than 338,000 shares of their personal stockholdings, selling most of it as the stock approached its then Class Period high in late April 2000, pocketing more than $18 million in illegal trading proceeds. ¶¶ 10, 44.

Having completed the sale of 338,000 plus shares in April 2000, defendants in June of that year began disclosing a less happy picture of the state of the merger. On Monday, June 19, 2000 they disclosed that Honeywell would miss its second quarter 2000 EPS forecasts. They attributed this failure to component parts shortages for Honeywell Aerospace operations, which hurt revenues and the adverse impact of rising oil prices and interest rates on its other operations. The investment community recognized that there must be much more serious difficulties with the merger, but Honeywell declined to provide more detailed information until an analysts' conference to be held July 10, 2000. Honeywell's stock had already declined from $59 1/8 on June 2 to $48 33/64 on Friday June 16. It dropped to $40 1/2 at the close of June 19 and was $34 11/16 at the close of June 23. Between June 2, 2000 and June 23, 2000 Honeywell lost $16.87 billion in market capitalization. ¶ 103.

At a July 10, 2000 investors' conference Honeywell's Bonsignore admitted:

Honeywell's entire management team is painfully aware that it has a credibility gap to overcome. Bonsignore would be the first to admit that Honeywell did not react as quickly as a hilly integrated company might have to compensate for Honeywell's delayed and lost revenue or income disappointments. Honeywell's second quarter 2000 cash flow was $339 million down from $513 million in second quarter 1999. This shortfall was driven primarily by poor performance in ...

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