漢威聯合 (HON) 2002 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the Honeywell second quarter 2002 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Thank you, Mr. Gallagher.

You may begin your conference.

Good morning, I'm Dan Gallagher, Director of Investor Relations, and with me today are David Cote, Chairman, President, and CEO.

Richard Wallman, Senior Vice President and Chief Financial Officer, and James Gilligan, Vice President and Treasurer.

This call, including the presentation charts, will be webcast from the Honeywell IR website.

After some introductory remarks by Dave, Richard will present the quarters results.

At the end of the call, we'd be happy to answer any of your questions.

Please note the conference call will contain forward-looking statements, involving risks and uncertainties as indicated by the disclosure in today's press release and earnings presentation.

Dave?

Thanks, Dan.

And good morning everybody on the call.

As you know, on June 30th, Larry Boston retired from Honeywell.

It's really impossible to overstate the impact Larry had on Honeywell during 11 years here.

He really positioned as well as the company, and we have really a great path ahead of us because of the groundwork he laid.

He's been a good friend and mentor for me and continues to be.

He managed and handled the transition like the class act all of us know him to be, and all of us here wish Larry all the best.

Before turning to our financial results, just a few observations about the 90 days since our last call.

During the second quarter, I have spent time visited operations in Europe and Asia, in addition to the U.S.

And meeting with customers and with sales and operating people in these regions, in addition to the U.S.

By now, we've had about 20 town hall meetings where we get large groups of people together and have a small speel and then a Q&A, and we've touched about 50,000 employees around the world doing that.

Additionally, I've met with about 200 customers around the world to present and talk about our five key initiatives.

Growth, productivety, cash, people, and (INAUDIBLE) digitalizaion Sigma.

Employees and customers continue to respond very enthusiastically to these meetings to the focus of the five initiatives and all phases of the right one.

I'm really encouraged by the excitement and commitment to Honeywell that I've come across around the world from employees and customers.

We really have something here.

Now, as you'll see in this quarter's results, we have executed most significant cost productivity actions in the company's history, and with a strong productivity culture as a backdrop, the greatest area where focus and activity is growth.

We have to build an equally powerful growth culture.

We've begun to focus on the five areas that can accelerate our growth and the way we define them are, one, exceptional quality, delivery, value, and technology for our customers every day.

The second, superior sales and marketing.

The third, globallization.

The fourth, strong, funded technology road maps for new products and new services.

And, fifth, acquisition.

We have focused on each of these areas during our annual strategic reviews we've just run through and I've had numerous conversations over the last four months with customers and our sales people, and I can assure you, they haven't been shy about providing feedback about what we do well and what we need to do differently to meet and exceed our customer expectation.

But we've been busy.

We've been removing layers and other barriers to respond more quickly and more decisively to our customers.

We've launched some new products, like Experian PKF in the industry solution, just launched this quarter, and we've done things like making sure we have a better understanding of strategies and products that we've put faster, more local decision making authority closer to the customer, better local market customization of sales, the technical information and the products, and simple one, but an important one, just better service levels for our customers.

I'm really confident as a company, Honeywell can make significant improvement in our ability to generate internal growth, and this is going to be a subject that takes up a lot of effort and time and change in the second half of this year and ongoing.

Another area of renewed intention in one of our five initiatives is cash.

We've always had a great potential for strong cash generation, but we haven't always realized that potential.

Now, we're making cash a daily focus.

We're trying to change the mindset of how people and employees think about cash and take action every day.

Every business has a strategic plan on how it can achieve a breakthrough improvement in working capital.

In working capital alone, we have a $3 billion opportunity in our view, but in addition to thinking and planning about it, we're seeing better execution.

I think you saw some of that in the form of the results this quarter.

As Richard will talk about shortly, we hit our earnings packet for the second quarter and beat our cash flow target.

Our productivity in the second quarter was 4%, driven by the significant census and cost actions that we talked about earlier, as well as our ongoing six Sigma programs.

These efforts help maintain our flat operating margins versus last year despite a 7% reduction in revenue in higher margin segment.

We're really very happy with the company's productivity actions this year.

With 7% census reductions in our typing control discretionary costs making a difference.

Looking at the year, because the second half of last year included the shock and the backlash following September 11th, we expect much improved comparisons in our forward operating segments in the second half.

We've taken decisive action on cost, as we've just talked about, and we should have significant volume leverage as the broader economy recovers.

I'm sure you also noticed in the corse that we have devested our pharmaceutical fine chemicals and our automation and control consumer products unit, and Richard will give you the particulars on those transactions, also.

These were two of our lower (allied) type businesses and they're part of a deliberate and ongoing process of portfolio upgrade.

Most of our businesses are really just terrific.

They're very good businesses and very good industries, but, as always, some aren't.

We'll focus on and grow the terrific ones and we'll continue working with the ones that aren't so terrific, including divestiture, if it's warranted.

The quarter's results also included (INAUDIBLE) tax restructuring charge of about $93 million, primarily to consolidate our advanced circuit business, ACI.

This will result in a $75 million annualized after-tax benefit, so it was good one for us to do, and Richard will talk about that in more detail.

Finally, let me end with the observation that in the second quarter, our non-aerospace businesses generated about half of our total operating profit.

It is the first time since 1998 that we've seen this kind of balanced earnings power.

While it is due partly to weaker aerospace results, as I'm sure you'll notice, it's also because of the 25% improvement in the profit from the other segments.

And I think it begins to demonstrate the consistency that we, as a company, Honeywell, are able to deliver.

We expect Honeywell's future results will continue to reflect that better, more consistent portfolio.

I know there's also been a lot of discussion, as always, on what the earnings for the year are likely to be.

I thought it would be useful to provide my view on it, for your use.

Earnings per share, in my view, are going to be in the 225 to 230 range, depending upon the nature of the recovery.

If it's flat to the third quarter, meaning that you see really no improvement from what the third quarter economy looks like, we'll be closer to 225.

If it's more robust, we'll be closer to 230.

At the same time, cash flow is looking better than ever, and I believe that looks a lot more like $1.8 billion for the year.

You see we get very nice conversion on the earning.

We're very pleased with how the year is shaping up, particularly in cash, but we sure do wish that economic recovery would hasten, also.

Now, let me turn over the call to Richard who will take you through the quarter's results in more detail.

Richard?

Thanks, Dave.

Good morning, everyone.

I'd like to start with an overview of the second quarter.

Sales were $5.7 billion, down 7%, driven primarily by double-digit declines in commercial aerospace and advanced circuits.

Exiting the (INAUDIBLE) brakes business, cost us two points of growth.

Many of our businesses did experience top line growth including turbine chargers, defense and space, and security and fire.

Versus the first quarter, sales rose 9%, led by double-digit growth in industry solutions, automotive consumer products, our services business and automation and control, and most of our materials businesses, including Nylon, Chlorines, and electronic materials.

Segment profit declined 7% to $687 million.

As Dave mentioned, in spite of the sales decline of 7%, operating margins were up slightly of 12.2% due to agressive productivity actions.

We reduced census by 7% and cut discretionary spending by 30%.

These actions resulted in a 15% reduction in SG&A.

Ongoing net income was $454 million, slightly above last year.

Ongoing EPS was $55 cents, equal to last year.

Reported EPS was $56 cents.

We had a net benefit of one penny, resulting from an after-tax gain of selling two businesses, partially offset by repositioning charges.

Cash flow was $583 million, up 72% versus last year, and the third consecutive quarter of record free cash flow.

We've generated $849 million of free cash flow in the first half of the year, which is a $400 million improvement versus the same period last year.

The next chart provides line item details.

Total segment profit was $687 million versus $735 million last year.

Better results at UOP and other joint ventures contributed to a $20 million swing in equity income.

Interest expense was $15 million less than last year due to lower debt levels and interest rates.

As a result of higher equity income and lower interest expense, a pretax profit reached $618 million.

The affected tax rate was flat with the first quarter but lower than last year, primarily as a result of no goodwill amortization.

We expect the tax rate to remain at this level for the remainder of the year.

On point earnings per share was $55 cents, equal to last year, and, as I mentioned, there was a benefit -- net benefit from gains and charges of a penny, and in the next slide, we'll cover the nonrecurring items.

We had an after-tax gain of $98 million from the divestiture of our pharmaceutical and automation and control consumer products businesses, which was essentially offset by after-tax repositioning charges totalling $93 million.

The charge consisted of $46 million in advanced circuits, primarily to close two plants, and $47 million for contract losses and other impairments.

Included in the $47 million is the impact of the bankruptcy of Fairchild (INAUDIBLE) and the likely cancellation of their new planes as well as the write-off of excess inventory at advanced circuits.

These repositioning actions will yield annualized benefits of $75 million on an after-tax basis.

As we now begin to look at the individual segments, please note that both the positive free tax impact of no goodwill amortization and negative impact of increased pension (INAUDIBLE) are reflected in these results and essentially offset each other.

First, for aerospace -- Revenue was $2.2 billion, down 13% versus last year due to a 24% decline in our commercial segments.

Partially offsetting this was a 13% increase in defense and space.

For the first time since September 11th, aerospace revenue was up sequentially, showing a 6% improvement versus the first quarter.

The sequential trend will continue in the second half of the year.

Also noteworthy, defense and space revenues surged 18% on a sequential basis, and we expect continued strong momentum during the second half.

We implemented aggressive cost actions to mitigate softness in revenues reducing census by 6% versus last year, and cutting discretionary spending by almost 40%.

In spite of these actions, our operating margin fell by about 3.5 points due to volume declines in our high-margin after-market business.

Versus the first quarter, our operating income grew by 19% and margin expanded by 180 basis points.

We expect both margins and income to improve sequentially in the second half.

The first quarter was clearly the bottom of the trough for aerospace, and we expect significantly higher earnings as we continue through the year.

The commercial after-market continued to show gradual improvement during the second quarter, down 16% in air transport, and 15% in business and general aviation.

A sharp reduction in projected deliveries by Boeing and Airbus growth sales declines of 35% for original equipment, where we ship 12 to 18 months before final delivery of the aircraft.

As in the first quarter, platform timing impacted the OE segment, or business in general aviation, with sales falling 38%.

The introduction of our AS-900 and Primeous Epic integrated cockpit will facilitate strong growth in this area next year as we transition from discontinued platforms to the delivery of new platforms from DSO and (INAUDIBLE).

Defense and space experienced impressive gains during the quarter with OE sales up 10% and after-market revenues up 23% due to strengths in the emissions, increased foreign military deliveries, and higher demand for spares.

Increasing defense budgets, and our positions in precision guidance and defense electronics, gives us confidence this segment will post terrific results for the rest of the year.

Now I'd like to turn to automation and control, which continues to execute on widespread cost productivity plans.

Revenue fell 1% versus last year, driven primarily by low, single-digit declines in services, industry solutions and control products.

Increased demand for security-related products drove security and fire up 1%.

Despite this decline in revenue, ACS was able to improve margins substantially.

An 8% reduction in census, a 10% reduction in discretionary spending and other cost productivity actions, resulted in over a two-point improvement in margins.

Now, for materials -- Revenue declined 1% to $870 million, as weakness in performance fibers and circuits more than offset strength in Nylon and other segments.

Versus the first quarter, revenue was up 15% with positive sequential trends in most of our businesses.

Electronic materials grew 29%, Chlorine products 25%, and Nylon, which has experienced improving pricing trends was up 17%.

We expect continued sequential improvement as the year progresses.

Despite the lower revenue, operating margins dipped to a modest 40 basis points to 4%, reflecting the benefits of a 10% reduction in census, as well as other cost action.

Operating margins improved by almost three points sequentially, and we expect continued improvement in the second half of the year.

Our last segment is transportation and power.

Total revenue was down 7% to $810 million due to the divestiture of truck brakes.

Internal growth was positive 2%.

Sparked by higher Asian vehicle production and diesel penetration, turbo chargers errs experienced 5% for the quarter.

This was primarily due to a 70% growth in Asia, which comes on the heels of 30% growth in the first quarter.

Operating margins expanded by an impressive 560 basis points to 12.9% due to a 5% reduction in census, productivity and six Sigma actions and the elimination of losses at our microturbine business.

And now for cash flow.

Our intense focus on improving cash flow has yielded strong results over the prior two quarters, and the second quarter was no exception.

Despite continued cash repositioning outlays, we generated a record $583 million of cash flow in the second quarter.

We are beginning to experience progress in working capital as it was flat versus the first quarter, even though sales grew 9% sequentially.

We did have cash outflow of $98 million per (INAUDIBLE).

We did benefit in cash flow from lower tax payments that were somewhat higher than the severance.

This benefit occurred because the repositioning actions from prior periods are deductible when the cash is paid.

While we're pleased with this performance, we have actions to drive even stronger performance, we're beginning to drive a daily cash focus, a daily cash mindset combined with six Sigma and digitalization tools, will enable us to improve working capital, and as Dave mentioned, there's a $3 billion opportunity there.

Finally, I'd like to review the highlights of the quarter.

Despite a modest economic environment, we met our earnings expectations.

Our cash flow generation was terrific, and cash flow generation is generally stronger in the second half, and that's why Dave mentioned that we took our forecast stuff.

It's clear an earnings rebound is under way.

The second quarter was the first time since the third quarter of 2000, that earnings were flat on a year-over-year basis.

Driven by easier comparisons or more favorable economy and improving trends in the aerospace aftermarket, we do anticipate strong earnings growth during the second half of the year.

With our significant cost actions and discipline, we're well positioned to reap the benefits of an economic recovery.

Thank you for your time, and we'd now be glad to answer any questions that you might have.

At this time, I would like to remind everyone, if would you like to ask a question, please press star then the number 1 on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

I haven't gotten any questions yet.

I guess you all were blown away by the quarter.

Just one more moment, sir.

Your first question comes from Don McDukel of JP Morgan.

Good morning, everyone.

First question would be just on the -- how the fundamentals are tracking.

It looks like things are pretty much on track, or maybe ahead of plan, at aerospace, maybe ahead of plan at transportation, a little bit behind asbestosic materials and maybe a tad behind in automation and controls.

I guess I'm wondering why we would take down the second-half estimates if most things appear to be kind of where we thought they might be at this point?

Well, I would add, Don -- first of all, thank you for your comment, but I'd also say, while -- I think you have it right in terms of aeroand transportation being on a stronger upward path and ACS, and specialty materials being a little bit behind that, the fact is that the latter two more than offset the benefit of the first two.

Okay.

Okay.

The next question would be on aerospace and the after market, I guess commercial after market being down 16%, flight hours, I think, are down eight or nine, and it's encouraging to see that spread shrinking, but, you know, do you expect to see commercial aftermarket sales move closer towards flight hours moving forward?

Right now, I mean, what I would attribute it to is everybody has been trying to run down their inventories, also, using as much inventory as they can and working that down.

I don't think that'll be a permanent phenomenon once we start -- once the airlines start recovering again.

I'd say, yeah, it's something we have to deal with today, but I don't know it's a permanence issue.

Okay.

Next question, Dave, would be on the $3 billion working capital, an opportunity you mentioned.

Could you maybe give us a time frame as to how long it'll take to harvest that opportunity?

I'm expecting that what we do in receiveables, for example, we should be able to do relatively quickly inventory, to really get the full benefit of it can take four, five years.

But I'll say you'll see the bulk of the benefit within the next two, three years.

Thank you.

I'll turn it over to someone else.

You're welcome.

Thanks, Don.

Your next question comes from Clint Duffer of Lazard.

It is in automation and control segment, we had a sequential increase in revenue, yet margins declined sequentially, and in light of the fact that this is the business that, I guess, is perceived to have the most cost-cutting opportunity, what transpired?

This is Richard.

There are a couple of things that transpired.

We had more growth in lower-margin segments, such as industry solutions and services, and our growth was slower in products, which has better margins.

We also had some one-time items in the quarter related to relocation of factories and some organizational changes that are of a one-time nature and impacted us in the second quarter, but will not going forward.

Can you quantify that Richard?

It's sort of a -- when I look at it, I think that's a phenomenon that won't continue.

If anything, as control products begins to add stronger performance in the second half, that should reverse.

Can you quantify the one-time issues?

It was about - we are about a couple points of that growth.

All those expenses incurred in the second quarter or is there some more into it?

Yes, yes, we, we -- these were either plant relocation or, whatever, and they're incurred in the quarter.

Okay.

One other follow-up -- Could you give us the revenue impact of the farma divestiture, and Dura craft happened at the end of the quarter, was there any revenue impact there?

No impact in the quarter from either of those two vestitures in the quarter.

They were with us through June 30.

Okay.

And going forward on a quarter or annual basis?

On an annualized basis, I think Duracraft is close to about $300 million in revenue, to $200 and $250, and Farma is about $100.

Thank you.

Your next question comes from Bob Cornell of Lehman Brothers.

Good morning, everybody.

Again, going to the second half comment.

How about the third quarter, particularly basically taking the numbers down a little bit from consensus, do you have a range of expectations for the third quarter at this point?

How visible is that number?

Yeah, we'd say from an earnings standpoint, that will be in the 60, 61 range is our best view at this point, Bob.

Yeah, and sort of a related question, you know in the press release you talk about still expect global (INAUDIBLE) for cover pre-9/11 levels for fourth quarter, is that built into your range, or is that sort of a high sign for a hedge of some sort?

No, we're still assuming that aerospace will -- that aerospace has been what little bit ahead of the six months of what we had anticipated, and we expect that will continue and they'll be fine throughout the year.

Aerospace is doing well overall.

Final question is, you know, Nylon doing so well?

Is that a part of the capital cost takeout, part of the upgrade at the capital facilities?

What's going on that gives the Nylon the performance in the quarter?

Well, I would say Nylon has been, you know, working hard in a difficult environment all year.

The thing that helped them most recently is the volume they've picked up.

Mm-hmm.

Is that industry, or you got some market share, or specific customers?

They were able to work with a couple of customers to improve the overall volume picture for the profiles of their business.

Is that something that's going to be sustained, or is that just a quarterly blip?

Well, we certainly expect it to be sustained.

Customers have a way of doing their own thing sometimes, but we certainly expect it will be sustained.

It's not just a one-time item.

I guess a final question is, you know, you guys did have the big Experian launch and a lot of Hullabaloos, did you find you had the dissipation of orders for some of the existing systems as people anticipate the availability of plants gave 500 and Experian?

Well, first, I would call it more than a Hullabaloo, Bob.

I think this was just a terrific product launch these guys have done, but I might just (INAUDIBLE) with the choice of words on that.

Okay.

We say good things about expeer on, you know that.

But I would say, well we're not seeing any degradation in the orders that we -- for our existing products.

In fact, they've picked up about $100 million in new orders for Experian that has not canibolized anything else.

It's really looking extremely promising.

That is great.

Thank's very much.

Yeah.

We are really pleased with that one.

Thanks Bob.

Your next question comes from Mike Holten of T. Roe Price.

Yeah, good morning.

You know, with Richard's announcement that he'd be retiring, I was wondering if you could talk a little bit about the status of the search for a new CFO, and what's a time frame for maybe announcing somebody to fill Richard's shoes?

Well, I'm toying with making a joke about it, but it's more serious than -- I hate to see Richard leave.

He says I've been retired since he got here.

But it's something we're kind of working.

I wouldn't say that it's something we're intensely pursuing at this point, because Richard is going to be here at least through the end of the year.

So it's something that we're going to make sure we find the right person at the right time, and we'll go forward, and Richard is being more than accommodating, even as he's talking more and more about retiring.

Okay.

So I mean, as you all talk there, there's some speculation it might happen before the end of the year, but it sounds like end of the year is really kind of a good timing?

Well, end of the -- I'm certainly counting on Richard through at least the end of the year.

Okay.

All right.

He may disagree but...

No, I promised I'd get through January, and I bought all my tickets through January, so I'm still here.

Fair enough.

Thanks.

You're welcome.

Your next question comes from Jeff Sprayg of Solomon Smith Barney.

Hi, good morning.

Dave, although the guidance change is minor, will you just circle back to where we started the Q&A and just give us a little bit more color on precisely, you know, what you see different relative to where the previous guidance was?

Well, you're right, we did summarize some of this in that I'd say -- if I think about aerospace and transportation, I would suspect that they'll do a little bit better than what all of us had anticipated.

Automation and controls and specialty materials will not do as well as what any of us had anticipated, and the latter two will more than offset the benefit of the first two, and it's really -- it's really as simple as that.

There's no more to it than that at this point.

Revenue has been a little light, so we'd expect it in those two businesses to probably stay that way.

So you do view it as a -- excuse me -- more of a revenue issue as opposed to executing on the cost program in those businesss?

Yeah, just really -- it has to do -- we've talked a lot about the slope of the recovery curve, and the slope of the recovery curve is just not quite as sharp as we'd hoped and anticipated, and where we see that the most is in automation and control, and in specialty teefrls materials.

Oh, great.

Could you also give us -- or maybe Richard -- on the free cash flow, is there any proceeds from the divestitures counted in the way -- in the way you calculate --

Absolutely not.

We don't count proceeds from divestitures of businesses.

Can you give us some color on what the cash proceeds were?

We don't disclose that.

We have an agreement with the buyers, so, no.

Gotta honor those commitments.

He kind of sugar-coated it for you.

Yeah, okay.

Line it up with proceed, but we're glad that the businesses are in different hands.

On turbochargers, you know, the story's always been kind of Europe, you know, no comment on Europe in the quarter, and, instead, pointing to strength in Asia.

Could you give us a little color on what's going on in Europe?

It sounds like it must have been flat to down.

Well, Europe is actually continuing to, I think, just kind of moderate.

We wouldn't say we see it going crazy in either direction, it seems to be moderating, so we suspect vehicle builds to hold fairly consistent or constant.

We don't see a big move one way or the other.

From where it is today.

Okay, great.

Thanks a lot.

You're welcome.

Your next question comes from Harriet Baldwin of Deutsche Bank.

Good morning.

Hi.

On the materials side, talk a little bit that obviously the revenues are not quite as fast a bounce-back as you had expected but moving in the right direction.

Do you feel that the electronics side has actually stabilized here?

It sounds like that was up slightly sequentially.

Do you think that that's going to stay where it is?

Well, the electronics materials business, one selling into the semiconductor industry, is actually doing very well.

And their book to bill ratio has improved, so that's actually been a real bright spot for us.

Even though it's still down a lot, year overyear, I'm assuming?

Yes.

And on the Nylon side, it sounds like it's moving in the right direction again, is that also where you're assuming the slope to be slower or do you expect that to stabilize at some point?

I would say the former.

We're expecting -- either that business has had troubled times, that they've had to deal with, and we say we're past the bottom on that one, they've got good volume coming their way, and we expect that that will continue to get better.

And then you mentioned the release capacity utilization, is it uniformly high across materials, or is it bouncing around a little bit business to business?

I'd say that we're -- utilization is really good in nylon, and just about everything else, I'd say we have room for more sales.

And do you anticipate the need to increase your production at Nylon, either through upgrades or tweaking the processs?

I'd say the capacity looks pretty good right where it is, and if we can improve capacity through low value, low-cost six Sigma projects, that's fine.

I don't have a lot of intention to add it there.

Great.

Automation and controls, you talked a fair amount about industrial trends.

Give us a little bit more insight, color-wise maybe, on the home and building side?

I'm sorry, I don't quite follow.

Well, you know, on the industrial side, obviously, the Experion launch is helping on the order side and things are starting to look a little bit better, even if it's not quite as you anticipated, and I think you know more about the HBC controls, is that improving?

Is that kind of stuck at high levels?

Do you receive any great weakness from we have seen from the commercial built starts slowdown here?

Here's the way I put it.

Housing starts in the U.S., anything going into that still looks good, and any place where we sell into that industry, we're doing fine.

If we take a look at European home building, and we have a big European presence, as you know, that's down quite a bit.

Germany is down 8% or 10% this year, and that hurts us, and industrial investments is down everywhere, both Europe and the U.S., and that hurts us, also.

So overall we end up, while U.S. home building is a prit spot, everything else causes some hurt for us.

Great.

I'll let somebody us bug you now.

Thank you.

Okay.

Thanks, Harriet.

Your next question comes from Tyrone Panna of Wellington Management.

I was wondering if we could just touch on the whole pension issue, particularly given the significant decline in the markets and what your expectations are, and as a follow-up to that, there's obviously been a lot of talk about expensing options and I was wondering what the impact is on Honeywell, if that was to be implemented at some point in the future?

With respect to options, we had disclosed that in our proxy and in our 10K, and I think we estimated it at about $10 cents would be the impact.

With respect to pensions, as we had indicated, pension and (INAUDIBLE) essentially offset each other in the quarter and for the year.

You know, we're going to evaluate the assumptions for pension as we get closer to the end of the year, and we'll make a determination as to what are the right assumptions.

Thank you.

Our next question comes from Phil Friedman of John Levin.

Well, this is Jack Murphy from John Levin.

Sorry.

Sorry about that, Richard.

Hey Dave, I have a couple questions on this guy...

...The returns would be better, we wouldn't have this problem, so, you know, would you get our return up for us?

Thanks, Richard.

Yes, you're welcome.

Just a question on this guidance thing.

You had, you know, as a new CEO, you had the chance to take the guidance down, if you wanted to, and you took it down, but you only took it down by, you know, a little bit.

And, you know, I mean, you could have probably, you know, taken -- you know, maybe bone as well as fat and made your 236, or, you know, could you have taken the guidance to two bucks and had plenty of fire power to load your balance sheet up going forward, and, you know, why is this the right level?

Or do you see the economy right around the corner, but it's not in '03?

How do you pick 225 to 230?

Well, here's the way -- I think you probably heard me say this before, but I think one of the most important things for a CEO and for a company is credibility, that if we tell you something, you have to be able to believe that it's real and that we're executing that way, and it's going to happen.

It doesn't mean that everything always happens exactly sas we say, but there's some reliability there.

Coming into it, in seeing the way sales have been going for the year, 236 just didn't seem to make sense.

Yeah, you know, to your point, we probably could, if we did some things that would really do the wrong thing for the long term, but maybe look good for the short term.

When we looked at the right balance of all of that and said what's the right way to run the company, both for the short term and the long term, so that we're doing the right thing today and the right thing tomorrow, that's what seemed to make the most sense, and that's where we ended up.

At the end of the day, I'd like to know that I'd delivered and given you a number, that we actually deliver on, that also is doing the right thing for the company long term, and that's how we got there.

So, I mean, the way to look at it -- is the right way to look at it, then, your cash flow is where you want it to be, so the earnings are probably fairly high quality?

I'd like to think they're more than fairly high quality.

Okay, you know --

Very high-quality earnings, and I do believe that while not 100% correlation, cash flow and earnings, there is a strong correlation, everybody ought to look at.

Right.

And I think you said from the balance sheet you could take $3 billion out of working capital.

Is that right?

That's the target we've set for ourselves that we think is possible.

Does that mean you can grow the top line 5% and take out $3 billion of working capital?

Or is that how much -- is too much working capital on the balance sheet right now, realizing if you grow, though, you'll have to take your normal turns out of that $3 billion?

I'd say the way I put it, Jack, because you never know where sales are going to go, the way we tagged it was to say based on today's sales, if sales were flat, what kind of working capital do we think we can take out?

Okay.

So, yeah, you'd have to say, you know, working capital could come up $3 billion if sales doubled, would we add some working capital?

Probably.

Right.

And let me ask it this way, you'll have $3 billion conceivably of working capital, sell $1 billion of assets, or some number like that, you know, if you take that debt off your balance sheet, your balance sheet's stocked.

What do you want to do with that leverage?

Is acquisitions an 18-month priority, two-month priority, or a five-year priority?

Yeah, I'm looking forward to that problem, actually.

It would be nice to have a -- we already have a very good balance sheet, and we think to your point that our cash flows and the deals that we do have in progress can really help our balance sheet even more, and start to give us alternatives.

There's more things we can do.

I'm not trigger happy when it comes to acquisitions and feel like we just gotta have them, because overpaying for them, as you know, is the road to perdition when it comes to stock price.

We'll be careful about that.

But, you know, it's a nice alternative to have.

There's a lot of things we can do, whether it's dividends, stock buy-backs, acquisitions, nothing.

Is the pipeline a deal acreative?

I'd like to think any deal we did is acreative, however, I would have to say looking at the new accounting rules and the writeoffs required in the first year, I do have my doubts about how anybody does that now.

Okay.

And we know you can get a new CFO, and you can't replace Richard.

Richard is irreplaceable.

Thank you Jack.

I feel better about you.

Your next question comes from Eli Garden of HD Wayne Wright.

Good morning.

Hi.

A quick question, 26.5% tax rate for this year I guess for this year that you're talking about, does that continue next year?

I would say that I would expect it to go up somewhat next year.

You know, we'll work through that as we go through our tax planning.

But I would probably see a point higher.

And we've talked about -- I had a question on the acquisition -- potential acquisition, those of us who have hung around Honeywell and Allied Signal for a while had a rather, you know, significant list of divestitures that the company had talked about, debated about, pre -- you know, both independent, when the merger first happened and the G phenomena.

Are we going to see accelerated action in getting the businesses up to snuff or go through the multiple billion dollars of divestitures that have always been on that list in the next 6 to 12 months?

Well, the way I describe it is, you know, Chris, we do have our list of things that we're going to work on, but I'm generally not going to provide too much information on what they are or timing on them, because I think that's a good way to drive bad deals.

If people know that we're up against a deadline or that there's something we have to get done because of public expectations, I think it's just a bad way to run the railroad.

So we'll get those things done.

We've teed them up.

We know what we need to do.

We will get them done, but on a time schedule that makes sense and gets the best dollar for our own shares.

Is that an area we'll start emphasizing for a change, because it's been a couple of years since we've had these listed from the companies, and nothing's been done, and neither have the businesses improved markdly.

Yeah, I can't talk too much about --

nothing specific.

The question is, is that one of the major focuses of the 6 to 12 months, taking a strategic look at what businesses should be in and not be in?

Yes.

That I can agree with that.

Finally, can you talk a little bit about pricing, of course, more particularly, in materials, where your pricing always lags through raw material increase, did that catch up?

Will we see any benefit or is price competition that bad (INAUDIBLE) factors in the fourth quarter?

Pricing is always intense in that business, probably so capacity utilization gets up to a hundred, and I'd say that benefit effects from pricing and raw materials was a negative for us this quarter also versus last year.

And it's supposed to stay year over year like that?

I will say it will be difficult through the year.

Are the other businesses on the price pressure at this point?

Not so -- I wouldn't say it's intense.

It's never easy in any of them, but it's not as intense as I'dsay what you feel in specialty materials.

All right.

Thank you.

And good luck, Rich.

Thank you.

Your next question comes from David Bloomstein of Warburg.

Good Morning.

Your free cash flow stated before dividend, right?

Yes.

What are your thoughts on dividends and are you comfortable with dividends being roughly a third of that -- this year's free cash flow?

Yeah, I'm comfortable with the dividends being a third of this year's free cash flow.

I think it actually might be a little less than that.

I don't have a big concern about that.

Okay, terrific.

Thanks.

You're welcome.

There are no further questions at this time.

Mr. Gallagher, do you have any closing remarks?

Yes, I just -- thank you for joining us today, and, as always, myself and my press room will be available to answer any other questions you may have.

Thank you for participating in today's teleconference program.

This call will be available for replay beginning at 1:00 p.m. eastern time today, July 17th, 2002.

Through midnight on Wednesday, July 24th, 2002.

Thank you for your participation.

You may now disconnect.