江森自控 (JCI) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Q2 earnings conference call.

At this time, all participants are in a listen-only mode.

Later we will conduct a question-and-answer session.

Instructions will be given at that time.

If you should require assistance during the call, please depress zero then star.

As a reminder this conference is being recorded.

I'd now like to turn the conference over to our host, Edward D. Breen, Chairman and CEO of Tyco.

Please go ahead.

Great.

Good afternoon.

And thank you for joining Dave FitzPatrick and me today.

Before we start, let me remind you that during the course of the call, we will be giving forward-looking information.

We ask you to look at today's press release and to read through the forward-looking cautionary informational statement that we've included there.

Unless otherwise noted all information discussed on the call will be presented in accordance with GAAP for all periods discussed.

The primary task of our agenda today will be to present a review of Tyco's second quarter results which were released a little while ago.

Dave will discuss our operating results by segment and provide more details on our performance.

After that, we would be happy to take your questions.

I'd like to start by saying I'm sorry to inconvenience everyone by moving up the call, but in light of the story in today's paper, we thought it was important to speak sooner rather than later.

We recognize that it is essential that we put a stop to these leaks and the disorderly reporting process that they cause.

You have my commitment that I will do whatever I can to make sure that significant news is disclosed properly.

Regarding the charges we are announcing today, first let me say that we now believe we have identified all or nearly all of the remaining legacy issues.

I also want to emphasize, as I've said in the past, that we are committed to changing the culture of the company to be more conservative and where we cannot change the culture, we will change people.

I have previously mentioned that there would be a zero tolerance policy here regarding the type of conduct that has given rise to some of the charges we announced today.

As a consequence we expect a number of people will be leaving the company because of the issues that we identified during our internal audits.

Since last summer, we have been doing everything possible to improve our financial reporting culture.

For instance, we've conducted intensified internal audits and operating reviews.

We've changed reporting relationships.

Including the establishment of direct reporting relationships between the segment CFOs and Dave FitzPatrick.

We've implemented new conservative standards for financial reporting which, by the way, accounts for a substantial portion of the charges we are announcing today.

We have instituted a new spirit of transparency with investors and regulators and we've instituted changes to the company's internal culture with new compensation guidelines, and stronger standards of internal disclosure and reporting.

With regard to the internal audits, and operating reviews, we've acted with deliberation, but with a sense of urgency.

We thought that this would take months longer, but the segment finance teams have already reviewed the balance sheets of each of the companies more than 2100 accounting entities.

Our internal audit staff, working with external resources, has conducted follow-up on-site verifications of the vast majority of the company's assets.

At this point, we have done site verifications covering accounting entities representing 85% of the company the assets.

The remaining verifications will continue and we will be completed in the current quarter.

Because the on-site verifications have resulted in minimal changes to our initial work, we take this as an indication that the initial review process was thorough and accurate.

And as I said, we now believe that we have identified all or nearly all of the remaining legacy issues.

Besides these remaining site verifications, we are now not doing any more forensic work.

The charges we've recorded fall into three major buckets.

Approximately 1 billion arising out of the intensified internal audits and reviews.

This amount does include approximately $92 million for a one-time D & O premium.

Secondly, a $365 million pretax charge related to a move to an accelerated amortization method for the ADT dealer accounts.

And third, $7 million for changes in the accounting for the ADD connect fee to dealers with an additional $277 million recorded in the first quarter 2003 results.

The company has not completed discussions with the SEC Corp.

Fin on these accounting items.

Together with our external auditors, we believe the charges announced today, coupled with those in our most recent 10-K are not quantitatively or qualitatively material either in individually or in aggregate to any prior period, and, therefore, do not require restatement of previously disclosed operating results.

Of course, we cannot predict the outcome our discussions with the SEC or that such outcome will not require further amendments or restatements of the company's results of operations.

However, we hope to resolve all issues raised by the ongoing SEC Corp.

Fin review during the third quarter.

Now, let me provide some detail about each of these charges, starting with the internal audits and reviews.

The charges associated with these internal audits fall broadly into six categories.

Investment write-downs.

Relating primarily to Tyco's private investment portfolio and some other investments that we needed to market down to likely realizable values.

Secondly, asset reserves.

These reflect the application of more conservative valuation judgments on items such as inventory, accounts receivable, and other current assets.

Reconciliation items.

These are mostly write-offs associated with out of balance intercompany accounts, unidentified variance between ledgers and book-to-physical inventory adjustments.

Capitalized costs.

These are prior period costs that were inappropriately recorded on the balance sheet such as interest, primarily selling costs at ADT which we are now expensing.

Other accounting adjustments including unrecorded lease payments, improper reserves and some other errors, and additions to accruals, which reflect more conservative estimates of such items as insurance, benefits, warranty and environmental issues.

The tables that are attached to the press release give the detail by segment.

Over half of these charges relate to the application of more conservative estimates and valuations of reserves, accruals and investments while the remainder relate to legacy issues spanning the years 1997 to 2002.

Approximately 60% of the total charges are attributable to the Fire and Security segment, and approximately 20% to the Engineered Products and Services segment.

Next l'd like to discuss the change in accounting for the $200 connect fee that ADT charges for new dealer accounts.

During the quarter, we adopted EITF 02/16, a new accounting standard, which we believe requires the company to recognize the connect fee as a reduction of the dealer account asset, as opposed to a reduction in the cost associated with the program.

The pretax cumulative and first quarter effect of this accounting change was $277 million, which will be reflected in the first quarter of 2003.

Another $7 million has been recorded in the results for the second quarter of 2003.

Separately, we're also accelerating the amortization of the security accounts that we acquire from dealers.

Rather than a straight line 10 year amortization we now use, we will adopt a 200% declining balance method.

The result will be that the accounts will be more rapidly amortized in the first few years with less amortization in the later years.

As noted, the pretax total of this charge is $365 million in the second quarter.

We will continue to commission appraisals on a regular basis to ensure appropriate amortization.

This change will increase amortization expenses a few cents per share in the second half of 2003.

Working with Dave Robinson, our recently announced President for Fire and Security, we have shifted our approach in the ADT dealer program from being geared to top line growth to now focussing on quality of accounts and returns above cost of capital.

Among the most important improvements and changes that we are making in the dealer program are; reducing the amount paid to dealers for new residential accounts by approximately $100.

We are tightening the customer credit requirements to a minimum Beacon score of 625.

We are eliminating the zero money down policy in favor of a minimum $99 up-front customer payment.

We're eliminating the $200 connect fee for new dealer accounts.

We're eliminating renters as new customers and allowing sales only to homeowners.

We're implementing a 100% direct debit as our preferred method of payment.

And we're implementing a program to improve the retention of dealer accounts, including measures to reconnect accounts that disconnect and sell our monitoring services to new customers of premises where disconnects have occurred as a result of a homeowner moving.

As a result of these changes, we expect better ongoing economic performance from reduced up-front cash outlays and improvements in customer attrition.

For instance, under our new retention program, our initial goal is to reconnect 17% to 23% of dealer accounts that disconnect.

Currently, by comparison, we achieve a reconnection rate of approximately 27% in our self-generated accounts.

We also anticipate that our total capital investment in the dealer program will decrease from the $1.4 million last year to, as we stated before, 7 to $750 million in this fiscal year, to below $500 million in fiscal 2004.

We believe that these changes will provide improved short term and long-term returns.

Let's move on to the operational results and I should emphasize that I look forward to this being the primary area of focus in future quarters.

This is the way I kind of sum up our quarter, our revenues continue to be solid, despite poor economic conditions worldwide.

Our operating performance was in line with what we expected and our focus on cash has delivered strong-free cash flow flow.

All of this makes us feel positive about where we're positioned for the long haul.

Regarding our specific results, our free cash flow was outstanding for the quarter.

Under our new definition of free cash flow, we had $833 million in free cash flow compared to $568 million generated in the second quarter of 2002.

Under our prior definition of free cash flow, which excluded spending on dealer acquisitions and purchase accounting, free cash flow was $1.1 billion in the quarter, significantly above our expectation of $450 million to $750 million.

This compares to $1 billion during the prior quarter.

So far this fiscal year, the company has generated $1.5 billion in free cash flow, a significant improvement for the first six months of fiscal 2002 when free cash flow was a negative $850 million.

Again, for the purposes of comparison only, this is using the prior definition of free cash flow.

Revenue for the quarter came in at $9 billion, compared to $8.9 billion last quarter and $8.6 billion from the continuing operations for the same period last year.

Currency fluctuations contributed $468 million or 5% to the year-over-year increase in revenues this quarter.

Prior period acquisitions contributed to revenue growth modestly and organic revenue was down slightly.

I would say, however, excluding TyCom, organic revenue did increase slightly during the quarter.

Our EPS for the quarter was a loss of 23 cents.

This included the impact of the charges that I have discussed which contributed 55 cents to the loss.

Last year, during the same quarter, we had a loss from continuing operations of $1.03, which included $1.53 of charges.

The schedule provided with the press release should assist you in analyzing our results this quarter, both at the segment and EPS level.

To sum up, overall I'm encouraged with our performance this quarter in a difficult environment.

Going forward, we continue to focus on improving the performance of all our businesses so that we are well-positioned to deliver even stronger results as the economy recovers.

Now let me turn over the call to Dave FitzPatrick.

Dave?

Thanks, Ed and good afternoon everyone.

Let's start with the results in terms of looking at the results, let's look at what we liked overall and didn't like in terms of the quarter.

First the positives.

Our free cash flow during the quarter was much stronger than we had expected.

Within the cash flow strength, receivables and inventory generated over $400 million in cash in the quarter.

Additionally, on the cash note, management of accounts payable improved.

Looking at our operating margins, we had sequential operating margin improvements at both Healthcare and Electronics, even with the charges incurred in the quarter.

Now, turning to the negatives.

Obviously we're not happy that it was necessary to both report and highlight charges as a result of the legacy issues.

Also, our margins declined sequentially at Engineered Products and Services and at Fire and Security.

Looking at the businesses in more detail, at Tyco Electronics, sales for the quarter were approximately $2.5 billion.

Essentially level compared to the first quarter and the same period last year.

As a positive impact from foreign currency fluctuations, acquisitions and gains in Automotive were offset by lower revenues in Telecommunications and Industrial Markets.

Specifically, within Electronics, we had $160 million or 6% and foreign currency translation gains year to year.

While Telecommunications revenues declined from $162 million to $29 million as no third-party systems have been built in fiscal 2003.

EBIT for the Electronic segment was $347 million compared to $293 million in the first quarter and a negative $2.6 billion in the same period last year.

Last year's period including nearly $3 billion in charges.

Taking that into account, profits and margins declined year-over-year, largely as a result of reduced volume.

Approximately 5% price erosion.

But increased sequentially due to cost improvement and an improved mix.

In the current period, net of the benefit of reversing prior period restructuring reserves of $20 million, TyCom had operating losses of approximately $17 million compared to losses of approximately $65 million in the first quarter, and $21 million in last year's second quarter.

As we have previously announced, we are continuing to realign the TyCom business and by year-end the cash outflow should approximate the net operating loss.

As we look at Electronics our book to bill for the business was one to one overall in the quarter.

As we look at the commercial and industrial component of the business, book-to-bill was above one.

Moving on to Fire and Security.

At Fire and Security sales were about $2.8 billion, flat with the first quarter and up from $2.6 billion in the second quarter last year primarily due to FX.

Fire and Security lost $703 million in the quarter compared to EBIT of $259 million in the first quarter, $338 million in the second quarter of last year.

This loss includes $936.8 million in charges compared to only $28.1 million in charges in the same period last year.

Excluding the charges, operating income declined by a little over $130 million year-over-year.

Looking at some of the components of that decline, in our Security business increased depreciation and amortization accounted for $48 million to the operating profit decline, reflecting the impact of rapid growth in the subscriber asset and dealer base in recent years, as well as the impact of prior acquisitions.

In the European Security business, the year-over-year decline in operating income was $42 million, primarily reflecting allowance for doubtful accounts and other expenses related to higher than expected attrition rates.

The remainder of the decline in operating income for the segment was attributable to a weaker worldwide Fire and Contracting environment.

Turning to our Healthcare segment, very solid quarter for Healthcare.

Sales for the quarter approximating $2.1 billion.

An improvement from last quarter's $2 billion, as well as the $2 billion reported in the second quarter of last year.

Growth in revenues came from a number of sources.

Overseas we saw sales increases in Europe, Japan and Asia, partially offset bay slight decline in Latin America.

In our Medical division, revenue growth came from the new premier wound contract, strong ultrasound shipments and new product sales within the Sharp Safety Division.

The Consorta contract boosted sales in surgical and in Mallinckrodt, higher volumes were posted each of our pharmaceutical, imaging and respiratory business with strength across the board in Mallinckrodt.

In retail, sales declined slightly as increased demand for adult incontinence products was largely offset by lower diaper sales.

Healthcare revenues also benefitted from $87 million of foreign currency impact and were slightly reduced $9 million from the net impact of acquisitions and divestitures period-to-period.

EBIT for Healthcare was $521 million with margins at 24.4%, a two percentage point improvement sequentially from the first quarter, and an increase of 1.6 percentage points for the same period last year.

Both second quarter totals include about $8 million in charges.

The improvement sequentially and year-over-year are largely the result of higher sales, favorable cost absorption in our factories with a higher volume, as well as focussed cost-containment throughout the business.

Moving on to Engineered Products and Services, sales were approximately $1.1 billion, down from $1.2 billion last year and essentially level with the $1.1 billion realized in the second quarter of 2002.

Engineered products experienced an operating loss of $73 million in the second quarter, a sharp decline from the first quarter when it posted EBIT of $137 million and down from the second quarter of last year, when EBIT was $153 million.

The second quarter included $178 million in charges.

The remaining profit decline and erosion in margins is the result of weak commercial construction and industrial markets, higher steel costs impacting our tube business, low margins on commodity valves and a thermal control project completed during the first quarter.

Looking at Plastics.

Sales in the Plastics and Adhesives segment were $489 million, an improvement from the $451 million in the first quarter this year and the $479 million posted in the last year's second quarter.

Year over year, revenues were favorably impacted by $9 million foreign currency benefit and from higher selling prices in plastics, which in part related to rising raw material prices.

Higher sales volumes of plastic sheeting and duct tape sold were offset somewhat by the impact of general economic weakness felt across the retail, food service, industrial, and HVAC markets.

EBIT for the quarter was $20.4 million compared to $44.2 million in the first quarter, and $47.9 million in the second quarter of 2002.

The declines resulting from charges recorded this period.

Additionally, we saw rising raw material costs and less favorable selling or sales mix, I should add, which were offset by lower SG&A expenses.

Turning back to Tyco as a whole, our tax rate for the quarter was a somewhat anomalous 5%, resulting from the charges in the quarter and the tax impact of those charges around the world.

As we look forward to the third and fourth quarter, we expect the tax rate to be back in the 28% range for those quarters, consequently, for the year we expect the tax rate to approximate 33% with an underlying run rate tax rate of 28%.

Net interest expense for the quarter was $283 million, up significantly from $226 million in the year ago quarter, reflecting primarily a falloff in our interest rate swaps, which we had to unwind as a result of the company's credit declines last year.

Corporate expenses for the second quarter of 2003, I should note, included approximately $17 million of costs associated with the ongoing accounting review and related matters.

That $17 million absorbed in our operating results, as well as $92 million to maintain and extend liability coverage under the company's D&O insurance program.

As we noted before, free cash flow for the quarter of over $800 million under our new definition.

Reflecting strong working capital management, particularly through reducing past-due receivables and better management of inventories.

Net CAP EX for the quarter was $281 million, approximately $85 million below depreciation for the period, and down significantly from the $419 million reported in the year-ago quarter.

As of March 31, we had cash on hand of approximately $4 billion compared to cash on hand of approximately $5.7 billion at the end of the first quarter, and approximately $6.2 billion at the end of fiscal year 2002.

We repurchased $1.4 billion par value of our zero coupon bonds that have a November 2003 put option, at a purchase price of approximately $1.1 billion.

Approximately $2.5 billion par value of the security remains outstanding.

Other debt repurchases during the quarter amounted to approximately $40 million.

A gain of $23 million is included in other income this quarter as a result of the debt repurchases during the quarter.

Not included in the cash balances above is restricted cash of $460 million, $8 million less than reported last quarter.

In addition, we are holding short-term investments of $372 million which are for the benefit of certain insurance arrangements.

This number was $253 million at the end of last quarter and increased as a result of utilizing cash collateral rather than letters of credit to support these insurance arrangements.

We have no draws under our new 364 day $1.5 billion credit facility and we are in compliance with all of our covenants.

Based on our quarter-end cash balance and our free cash flow outlook for the next three quarters, we will be able to meet all of our obligations comfortablably.

We executed guarantees from Tyco International SA or TYGSA, for the benefit of Tyco International Limited, zero coupon bonds due 2020 with a put option in November of 2003.

In addition, we have put in place intercompany guarantees representing about two-thirds of consolidated tangible assets, primarily from our U.S. operating subsidiaries in favor of TYGSA which should address the structural subordination concerns of S&P.

S&P is in the process of reviewing all the information that we have given them in this regard and we expect a positive outcome from them in the review of our credit in the near future.

Now, why don't I turn things back to Ed for guidance and a wrap-up.

All right.

Thanks, Dave.

Our business traditionally have their strongest performance in the third and fourth quarters of a fiscal year.

We believe that this will again be the case for this year.

The Fire and Security changes in amortization, however, will result in a few cents higher expense for the second half of the year, but even with this, we will strive to achieve the low end of the range we set for the second half of the year on our March 13th investor meeting.

Additionally, we expect that our free cash flow will be at the top end of the range discussed at the March 13th meeting.

To wrap up, I believe we had a solid quarter.

We identified what we believe are the remaining legacy accounting issues, we had strong free cash flow, our revenues were solid, and our operating performance was in line with what we expected.

We continue to believe that we have solid base of high potential operating businesses at Tyco, even as we have worked to finish the process of identifying legacy accounting issues, we have remained focussed on improving the performance of our businesses in order to strengthen our profitability, return on capital and shareholder value.

That concludes our formal remarks.

Now I'll be pleased to take any questions.

By the way, in addition to Dave and myself, we do have some other senior executives in the room with us.

Operator, if you could please open up the lines for questions.

Thank you.

Ladies and gentlemen, if you wish to ask a question, please press the 1 on your touch-tone phone.

You will hear a tone indicating you have been placed in queue.

If you pressed 1 prior to this announcement, we ask you please do so again at this time.

You may remove yourself from queue at any time by pressing the pound key.

If you're using a speakerphone, please pick up the hand set before pressing numbers.

Once again, if you have a question, please press the 1 at this time.

One moment, please for our first question.

And our first question is from the line of John Inch with Merrill Lynch.

Please go ahead.

Thank you, good evening, I guess.

Could you give us the, if you look on your balance sheet, what are today, in the Security business, what are the capitalized costs of acquisition and installation, and what kind of margin, you know, run rate, do you see in this business?

It looks like it's done, sort of a high single digit run rate.

Where do you think the margins trend?

Let me take the margin part of that.

You're right, John, the margins are in the high single digits.

And I would say with the changes we're making, that we announced today, we still feel we'll be right in about the same range next quarter.

And with the actions we're putting in place, that I kind of reviewed with you today, along with other cost containment actions, we feel like we'll have a slight increase in our margins through the rest of the year.

But I will say it will be very slight in the third quarter, a little bit more in the fourth quarter.

Thank you.

Yes.

Thank you.

Our next question come from the line of Bill Reed with Deutsche Banc.

Please go ahead.

Yes, thanks.

I just wanted to get a sense of whether or not you anticipate changing your free cash flow guidance, given the strong performance that you've received versus what you shared with us in March, March 13th.

I think for 2003, you were under the new free cash flow definition, you were showing, I think it was $1.65 billion and I was wondering if you'd expect that to change?

As I mentioned in my remarks, we're clearly saying we're at the very top end of the range now and we're comfortable with making that comment.

I'd like to leave it at that and we'll watch our performance during the third quarter.

But we're clearly right at the top of that range.

And I think under new definition, on an apples to apples comparison I think the number would have come to about 1.85.

We'll check that -- yeah, I think that that is the right number.

Old definition, the very top end of the range would have been 3 billion.

New definition, the top end of the range is 1.85 billion.

Okay, thanks.

One followon question.

I know you can't speak for the SEC, but are you comfortable in your ongoing discussions with the SEC that the kind of charges or changes you've made are reasonably in sync with what their expectations are or are you just not that far along with them at this point or not getting the kind of feedback you'd expect?

Well actually, we've been in ongoing dialog with the SEC, by the way, the things we've announced today, we have obviously notified both the Corp.

Fin side of SEC and the enforcement side of SEC.

So we've had detailed dialog with them.

However, as I mentioned, we have not concluded with them on the changes that we made and we plan on doing that very quickly now.

Thanks very much.

Thank you.

Thank you.

Our next question comes from the line of Jack Kelly with Goldman Sachs.

Please go ahead.

Yeah, good afternoon.

Ed, just come back to that cash flow number again, in the original number range you gave, which was 1.45 to 1.85, I thought the assumption on CAP spending was that it would be flat in '03 versus '02.

So somewhere in the 1.7 area.

It looks like it's, you know, running at least a couple hundred million dollars below that.

So if that assumption was correct, that in itself gets you to the high end of the range.

And then it looks like you did a little bit better on working capital.

I know you've kind of been conservative on that, but it looks like you're kind of almost beyond it now, unless we're missing something.

And then secondly, with regard to Electronics, if I exclude the loss on TyCom, it looks like margins -- and TyCom revenues, it looks like margins were about 14.8 versus 14.3 in the December quarter.

At your meeting you talked about getting to 17% by the fourth quarter.

Is that the kind of progress you expected on your way to 17%?

Jack, let me take both parts of that there.

The CAP EX is clearly at the low end that Dave and I have been highlighting now, I think, for two quarters.

If you annualize the CAP EX spent, I think was 280, 281 this quarter and annualize it, it's about the low end of where Dave and I thought we could get the run rate.

Probably this year and by the way going into next year without impeding any of our future growth.

I will just repeat, yes, you could probably say we're being conservative.

I will stick with the comment that we are extremely comfortable with the high end of the cash range.

That is also one of the components as to why we're comfortable with it.

We know we can manage CAP EX at that range.

I think your analysis you did on Electronics there on the margins, again, you're excluding -- I think when you say that, you're excluding the charge - any charge.

But there wasn't much in Electronics.

And that is the percentages were at.

So we have now built through both quarters, the fourth quarter, the first quarter and the second quarter in Electronics on the margin side.

And our plan for the year is, I think you know, that sales will remain relatively flat.

You can see they were again this quarter, remain relatively flat the rest of the year.

Maybe a slit pickup on the revenue line.

But that the margins will continue to build in the third and fourth quarter.

I would only add, Jack, that if you look at Electronics performance, you know, in the quarter against our operating plan, they nailed it.

So the ramp, you know, that we were looking at, which admittedly is more significant in the second half than in the first half, they performed in accord with plan this quarter.

Just finally it looked like Fire had an organic growth of about 4%.

If that's right, that seems like it's a little better than one would have expected.

Yeah.

I mean, that's true.

And where we saw it, you know, in terms of the improvement was more on the -- it was more on the Fire side of the business.

Okay.

Thank you.

Thanks, Jack.

Thank you.

Our next question comes from the line of Blair Brumley with American Express Financial.

Please go ahead.

Thank you, good afternoon.

I'm a little surprised at the speed with which you guys have done your internal audits.

In New York, in March the expectation was by year-end all these things would be tied up.

And I guess my concern is that there's the potential for a trade-off between speed and accuracy.

Can you give me some help here in explaining how you managed to get all this work done so quickly?

Well I mean, as we looked at, you know, the process, Step 1 in the process was leveraging the breadth of the financial organization of Tyco globally.

You know, the thousands of finance associates that we have globally, many of them have spent much of the past, you know, six weeks-plus embarking on a very thorough balance sheet review, you know, of every Tyco entity.

Additionally, we've diverted all internal audit resources as well as supplemental external resources to beef up the internal audit capability to perform, you know, the on-site verification work that Ed highlighted.

That on-site verification work covered 85% of the company's tangible assets.

We will continue some of that on-site verification work, but I think, you know, with respect to process, there was absolutely no compromise between speed and quality.

I would characterize it as, you know, quality first, but let's divert our resources as much as possible to get this done in a quality fashion as expeditiously as possible.

Up to now, you focussed on the pieces of the business that, at least early on, you suspected would have the greatest potential for manipulation under the old regime.

I would assume that that was a great part of the means of setting priorities in terms of going out and making your visits in this regard also.

Oh, absolutely.

We conducted a risk assessment.

I should also add that in our Fire and Security business, in addition to a new business unit President, we have a new CFO of the business.

To assist in the verification process, Mark Schmitz undertook a peer review within Fire and Security.

So the business controllers globally, in addition to some of the on-site verification work, had peer reviews of their balance sheets.

So we took the extra step there in line with your point in terms of risk assessment.

Thank you very much.

Thank you.

Thank you.

Once again ladies and gentlemen, if you do wish to ask a question, please depress the 1 on your touch-tone phone.

And our next question comes from the line of Jeff Bunswick with RCB Investment Management.

Please go ahead.

Good afternoon, gentlemen.

Two quick questions.

One, could you review where you stand on looking at the portfolio of businesses?

You mentioned at the New York meeting that, you know, once you got through with this stage, you'll be looking at "X" amount of the portfolio that may not be a keeper.

What's your general thoughts on that?

And the second question is, I want to make sure I understood right.

You're changing the ADT amortization for all accounts not just ones purchased from outside dealers; is that correct?

It's changing only with the dealer accounts.

With the outside dealers, okay.

Yes.

Yeah, and Jeff, your first point, there's really no change.

We're going through a portfolio assessment now being led by Martina and her team at the company and we've come to no conclusions yet.

We do plan on coming to some preliminary conclusions, clearly, before we end this fiscal year.

And I would put the range, just so you don't think we're doing something larger, that what we're looking at would not affect more than 10% of the portfolio of the company and that would be at the high end.

Great, thank you.

Thanks, Jeff.

Thank you.

And our next question comes from the line of John Bollin with (phonetic) Capital Management.

Please go ahead.

Just a quick clarification on the charge today.

Was any of that, does any of that charge affect goodwill outstanding and in your review of the different businesses, is there any chance for goodwill impairment at some point in the near term?

Well, John, as we noted, I mean, the charge was almost entirely, you know, noncash.

I will add that, in addition to the balance sheet and operating reviews, we did take a look at the cash flow performance of the company.

We also, you know, going forward, we also took a look at the reconfigured segment structure at a high level.

We did not conduct what I'd term an in-depth FAS 141, 142 analysis, looking at detailed valuations with respect to goodwill, but we wanted to look at our Plastics business because that's now broken out as a separate segment and we have some refinements in the reporting units for purposes of the impairment analysis.

And we looked across some of the other businesses as well.

And nothing appeared to be an issue with respect to, you know, goodwill.

Both in terms of where the business is today, as well as the nature of these charges.

Our, kind of date, you know, in terms of annually looking at the FAS 141, 142 work was coming up the first of July.

And we will complete that work, but we certainly do not expect any impairments at this stage.

Okay.

I guess the -- looking at it another way, your cash on hand and cash flow for the next -- for the balance of the year, will be almost entirely consumed by debt coming due within the next nine months.

Is there any risk that you might not be able to get back into the credit markets in time or that you would figure your debt covenants and exacerbate a cash situation?

No, we're very comfortable, John, with the liquidity outlook for the near term.

Thank you.

Thank you.

And our next question is coming from the line of Brian Jacobi with Morgan Stanley.

Please go ahead.

Brian, your line is open.

Why don't you take the next one, operator.

Our next question comes from the line of Barry Bannister with Legg Mason.

Please go ahead.

Yes, hello.

A question about capital spending.

I'm not sure I'm comfortable with what's going on there.

CAP EX, ex-TyCom, looks like it's about 25% below your depreciation and your operating lease payments for the last two years have been growing at 30 to 40% per year.

Last year, in fact, your operating lease payments were about half again as much as your total CAP EX, ex-TyCom.

So I'm wondering if you could tell us, is Tyco really more capital intensive than the nameplate CAP EX numbers would imply thus affecting my free cash flow views?

Would you also discuss the operating lease usage going forward, how much you expect to incur in '03 and '04?

And then lastly, on that $848.9 million you paid last year is there a chance of exiting some of those leases if you really insist that you don't have that much capital spending needs?

I mean, I would characterize, Barry, the dynamics of capital, you know, and operating leases.

I would certainly not say that, you know, the improvement in CAP EX or I should say the reduction, is disguysed in 2003, you know, as additional operating leases.

I think some of what we saw in 2002, you know, by virtue of some of the liquidity tightness of the company was facing, you saw a step-up in the rate of operating lease activity.

However, you know, as we look at operating leases coming due, we'll have to look in detail at this and get back to you.

I would not anticipate, you know, much would be coming due over the next year or two.

And so I don't see there really being much of an opportunity to look at what you suggested.

But one of the things -- I mean, in terms of some of the financial disciplines that Ed mentioned we're putting in place, I mean with respect to the capital decision, we're looking at leases as well as capital.

And my view is the first step is whether to invest.

And then the second step becomes the financing decision, you know, with respect to lease or purchase.

But in our capital approval and expenditure processes, we're putting in place, we're looking at both leases and capital spent.

You can't tell me the dollars you're going to spend on operating leases this year in terms of --

Let us get back to you.

I can't at this stage.

All right.

Then not having an answer to that question, let me get another question.

Fire and Security, could you give me with all these changes in the accounting, what I can expect the full cycle operating margin to be from bottom to top?

And also the full cycle tax rate since it's jumped around quite a bit?

Yeah, I think Barry on the margin, I'd say the quarter you just saw from an operating performance standpoint is at the bottom.

And what we think is going to occur with our plans here and what we're implementing is slight improvement in the second half of the year.

As I said earlier, very slight in the third quarter, a little more in the fourth quarter.

So there's puts and takes here, a little bit more compression, I would say, because of the accounting change we made on the amortization schedule.

But we're taking other actions, including cost actions.

And by the way, some restructuring action is going on in that business as we speak that will allow us to keep that at the level we're at and grow it slightly.

Obviously, we're going to put plans in place to get, over the three to five-year period, a very significant improvement in the margins across Fire and Security as we talked back at the investor meeting.

In terms of, you know, the tax rate, do you want to come at me one more time, Barry, just to make sure I address the question specifically?

Yeah, you gave the full year, but I'm just trying to figure out on a go-forward basis as North American construction recovers and other issues come about, what are we going to expect, if I'm trying to model out your '04 and '05 earnings, what are we expecting for a tax rate?

For a tax rate, as we've said previously, we're looking at very little change in the '04-'05 time frame from the 28% that we announced at the beginning of the year.

And that assumes the successful execution of the back-to-basics strategy that we've articulated as well as no significant, you know, reshaping of the portfolio.

Thanks, I'll get back in queue.

Thank you.

Our next question comes from the line of Jeff Sprague with Smith Barney.

Please go ahead.

Hi good afternoon.

Hi, Jeff.

Can you give us a sense of what the attrition rates look like as you exited the quarter?

And the dealer program?

And I'm also wondering, can you characterize us going to the double declining balance, you know, what that implies for amortization relative to the recent experience.

In other words, does the new approach move you from maybe being what was marginally acceptable a couple years ago, to just being, you know, dramatically conservative, if you give us some sense of what that spectrum might look like?

Sure.

I mean, Jeff as we look at the dealer program, you know, as we look at, you know, layering on the second quarter 2003 experience to what we showed to you back in March, you know, we have seen an uptick in attrition under the dealer program for the 12 month period ending the second quarter.

We're a little above 16.5% on that program.

In terms of looking at 200% declining balance, I would characterize that as, you know, reasonably conservative as you look at the conservatism spectrum, particularly in the early years.

What we are seeing, really in terms of what Dave Robinson and the Fire team are really working on, what we've experienced as we talked a little bit in March, is a pretty significant increase in attrition around the end of the initial three-year contract term.

So what the Fire and Security team are working on are programs to proactively stem some of that erosion.

So when you look at a double declining balance over a 10-year life, in the early years of the program, you know, the amortization is significantly greater than where we were on the 10-year life.

Great.

Operator, we're coming up on the hour, why don't we take one more question.

Thank you.

We have time for one more question from Phil Marriott with Arnold & (indiscernible).

Please go ahead.

Hi.

Good evening.

Just a follow-up actually on that declining -- double declining amortization question.

At what point does this adoption -- I would assume at some point, given that you're planning on spending less on acquisition of accounts, that it will flip over and provide benefit to the reported margin.

Could you give us a sense of when you would expect that to happen?

Yeah, I mean, when Ed talked about the head wind in the second half of the year, the biggest impact we're looking at with the volume declines is the first full year.

But as we look out, you know, over the 2003 fiscal year, as well as modeling out in '04 and '05, we are seeing, you know, headwind throughout that period.

But the headwind we see in 2005 is about half the headwind, you know, that we expect in 2003.

So it does not turn for, you know, the planning horizon, if you will, but it does decline in terms of the adverse impact.

I see.

And just one follow up related is, you only changed your policy with respect to acquired accounts.

Could you address the decision-making behind not making any changes to internally generated account activity?

Sure.

I mean, in terms of our internally generated accounts, both residential and commercial, we recently completed reviews of a very, very thorough lifing study of those businesses.

And in part, because of, you know, the success that we have had in terms of getting customers on our internally generated business to extend, if you will, or people moving into residences where previously the owners were ADT customers.

We've seen, you know, some pretty good movement in terms of extension in life.

We compared the lifeing study and the revenue curve associated with the lifeing study, and, you know, those curves are significantly above the 10-year straight line.

So we've concluded that the 10-year straight line was appropriate for those businesses.

I see.

I'd also add, as we put these new programs in place that we talked about on the ADT side, there are certainly competitors out there and others that run programs similar to some of the things we've talked about.

An there's no reason attrition rates shouldn't decline in both pieces of our portfolio on the residential side.

And you look at some of the competitors out there, they're clearly a few points lower with these in place.

I think as we start adding new ones we'll be seeing that dynamic also.

Thank you everyone for joining us today.

Again, I apologize we had to move this up but thank you for participating.

Thank you.

Ladies and gentlemen, this conference will be available for replay after midnight tonight through May 8th.

You may access the AT & T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code of 681923.

International participants please dial 320-365-3844.

The numbers again are 1-800-475-6701, and 320-365-3844, access code 681923.

That does conclude our conference for today.

Thank you for your participation and for using AT & T Executive Teleconference.

You may now disconnect.