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2 0 1 6 a N N U a L R E P O 2016 ANNUAL REPORT Shareowners Letters—2017 As the old saying goes, “The days go by slowly and the years go by fast.” Concluding my 15th and final year as CEO, I can certainly say that’s true! It sure was nice to wrap up 15 years with another year of outperformance, even in a slow global and slow industrial economy. On sales of $39.3 billion (up 2% reported, down 1% core organic), we were able to grow earnings per share by 8%1, once more ahead of our industrial peers. We achieved that short-term outperformance even while investing heavily for the future in capital expenditures (average of 160% of depreciation for 3 years), R&D at 7.5% of sales, the addition of 1,500 sales people over the last two years, an additional $360 million in restructuring projects, and a $250 million increase in Aero OEM (Airframers) incentives associated with the significant number of new platforms we have won over the past few years. As a reminder, unlike many of our peers, we expense all those OEM incentive payouts, a policy we went to early on because it was more conservative. We don’t put them on the balance sheet. That $250 million increase represents 4 points of EPS growth. Said differently, EPS2 growth would have been 12% if we didn’t expense these incentives as they were incurred. Quite a difference. Free cash flow3 of $4.4 billion, while good, is still below 100% conversion4 of net income because of the significant plant investments we are making for the future. This year (2017) will be the last of those increase years where we spend at more than a 150% reinvestment rate. It is certainly nice to wrap up a 15-year tenure with a successful year. Looking back over that 15 years is, I gotta say, quite satisfying. We had an unimpressive beginning with $8 billion in write-offs over the 4 previous years, a failed merger attempt, warring cultures, unrecognized unaddressed environmental and asbestos liabilities, a significantly underfunded pension fund, an empty pipeline of new products/geographies/services/process improvements, and free cash flow conversion of under 70% for the previous decade. In other words, for a decade, for every dollar of net income, we generated less than 70 cents of cash… not good. To summarize the general view, it was, “We’re not sure this can be turned around, and if it can, we’re not sure this is the guy who can do it.” Yes, I know, perhaps I’m kvetching a bit, but it is the truth. So what happened? Using 2003 as the base year given it was my first full year and not burdened by significant write-offs, here’s the 15-year result. 2003 2016 Increase Sales. .................................................... $ 22.1B $ 39.3B 78% EPS........................................................ $ 1.51 $ 6.605 337% Free Cash Flow6 ............................................ $ 1.5B $ 4.4B 185% Stock Price ................................................. $24.00 $115.85 383% Market Capitalization . ...................................... $ 20.5B $ 88.1B 330% Dividend/Share. ............................................. $ 0.75 $ 3.117 315% Number of Executive Bands . ............................... 740 667 (10%) 1 EPS V% excludes pension mark-to-market and debt refinancing expenses 2 EPS excludes pension mark-to-market and debt refinancing expenses 3 Cash flow from operations less capital expenditures 4 Free cash flow divided by net income attributable to Honeywell, excluding pension mark-to-market and debt refinancing expenses 5 EPS excludes pension mark-to-market and debt refinancing expenses 6 Cash flow from operations less capital expenditures 7 Includes cash dividends and AdvanSix Inc. share dividend Fifteen Year Total Return S&P 500 Honeywell 239% 579% 2.4X Outperformance Please note we accomplished all this even though we have fewer leaders (from 740 to 667) than we started with, and we invested ~$3.5 billion to resolve legacy environmental issues. We now get awards for financial and environmental performance—something no one predicted 15 years ago. Overall, not too shabby! We did it by driving our business model comprising three parts… portfolio, process, and culture. We steadily improved the growth profile of our portfolio with 97 acquisitions for ~$20 billion, adding ~$14 billion in sales, along with 66 divestitures for ~$5 billion in sales, generating ~$5 billion in cash proceeds. We also invested heavily in new products, services, geographies, and improving processes—all processes—in the company. Better processes made us more productive and faster. We steadily improved our performance culture (for customers, investors, and employees) because that’s where sustainability of performance comes from. Focusing on the customer, One Honeywell, The Trick Is in the Doing, doing two seemingly conflicting things at the same time… all part of the fabric of the company. The most important element of our culture, though, is the ability to evolve. Whether you are a country, a company, or an individual, you have to keep evolving. The world changes too fast to ever take a breather. We have a lot of strengths to build upon, but it won’t matter unless we keep evolving. Our next step in the Honeywell evolution is the transition to our incoming CEO, Darius Adamczyk. I do not feel I am turning over a perfect company to Darius. There is still lots of upside just in making us a better company. I completely support the change agenda Darius has put forward. Darius is the right guy to propel us to another decade of outperformance. Fifteen years ago, I was asked what I wanted my legacy to be. I said three things. First was that anyone associated with me whether they were investors, customers, suppliers, or employees could say they made a lot of money while I was here… check! The second was that we would be a go-to source for leaders of every stripe, but people would tend to stay here because they did well and could accomplish great things… check! The third was that I wanted to own my shares ten years after I left because the portfolio, process, and people continued delivering… and because we had selected the right successor. We will know for sure ten years from now, of course, but I’m really confident we got this one right. We started working on succession about ten years ago, more deeply five years ago, and intensely during these last three years. My guess is Darius would say he experienced that intensity. I was surprised to see that most of the succession literature out there is rubbish. Some of it was good like The CEO Within by Joseph L. Bower, most was not. I interviewed retired CEOs to see what had worked or not worked in their process. We developed criteria for what a successful CEO has to be able to do. And we put people into big leap, intense jobs to see how they would do. Sounds all straightforward, not so easy to do. We settled on six criteria. First was an intense desire to win, to succeed. An ability to motivate a large group, pick the right direction, and get everyone moving in that direction. Second was being smart and analytical. The future has an amazing way of evolving differently than everyone forecasts. A CEO has to be able to figure it out. Third was the ability to think independently and not get caught up in the fad surfing that is always popular. Thinking independently goes a long way toward helping you avoid problems. Fourth was the courage of conviction, especially in difficult circumstances when consensus and unanimity are unlikely. You still have to make a decision despite varying inputs and opinions. Fifth was an intense curiosity about everything that could maintain “freshness” for at least ten years. Sixth was an ability to focus on having the best people in the company, organized the right way and motivated. While a short list, it’s not an easy one. It’s not an easy job. We have the right leader in Darius to continue evolving. Born in Poland, emigrated to the U.S. at age 11, and spoke no English at the time. Graduates with degrees in electrical and computer engineering from Michigan State University, a master’s in computer engineering from Syracuse University, and an M.B.A. from Harvard University. Is successful in small companies and large ones before coming to Honeywell about 10 years ago when we acquired Metrologic to build out our bar code scanning business. He ran every Honeywell business with an eye on the long term while delivering the short-term results. Always driving both organic sales growth and margin expansion. He truly is “The CEO Within,” well prepared to run a company with the breadth of Honeywell. Darius is the right leader to evolve the company to the Software-Industrial that he refers to in his strategy while also building and developing our non-software-dependent businesses. There is so much opportunity for us still to grow sales, improve margins, become a Software-Industrial, and become faster and more effective in everything we do. This is an exciting time to be a part of Honeywell. The external changes will accelerate, and that is good for us. With Darius’ leadership, the foundation built, and the upside still available, I couldn’t be more excited about the future of Honeywell. Thank you for your support for 15 years. I know you will be just as pleased about the next 15 years. DAVID M. COTE Chairman and Chief Executive Officer The upcoming year will certainly be exciting for Honeywell as well as for me personally. I could not be more thrilled and thankful to Dave and the Board for selecting me to lead this incredible industrial powerhouse called Honeywell.
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