The opinion of the court was delivered by: Debevoise, Senior District Judge.
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.
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. ¶¶
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.
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., ¶
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
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
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.
At a July 10, 2000 investors' conference Honeywell's Bonsignore
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 ...