江森自控 (JCI) 2003 Q3 法說會逐字稿

Ladies and gentlemen, good morning and thank you for standing by.

Welcome to the Tyco International third quarter earnings conference call.

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

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

If you do have a question, please press star and then one on your touch-tone phone.

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And as a reminder, this conference call is being recorded.

I will now turn the conference all over to your host, Senior Vice President of Investor Relations, Mr. Ed Arditte.

Please go ahead sir.

Good morning, everyone.

Thank you for joining our conference all for Tyco's third quarter earnings.

Joining us today for the call will be Tyco's Chairman and Chief Executive Officer, Ed Breen; and our Chief Financial Officer, Dave FitzPatrick.

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

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

Please note that Tyco also issued another press release this morning announcing that we have filed restated financial statements with the SEC.

For purposes of clarity, all financial information provided in this call is presented on a restated basis, unless otherwise noted.

In addition, unless otherwise noted all information discussed on the call will be presented in accordance with generally accepted accounting principles for all the periods discussed.

Finally, where we have used non-GAAP financial measures, reconciliations to the most comparable GAAP measure are provided in the earnings press release issued this morning, along with a disclosure on the usefulness of the non-GAAP measure.

I would now like to turn the call over to Ed Breen.

Thank you, Ed and thanks to all of you for joining us this morning.

I would also like to say a special thank you and congratulations to Ed Arditte who was just speaking for joining the Tyco team.

He's now been with us for six weeks and I hope all of you get to know Ed and his team as we move forward.

The primary task of our agenda will be be to present a review of Tyco's third quarter results which were released earlier today.

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

After of that, we'll be happy to take any of your questions.

Let me start by saying that this was a quarter of progress at Tyco.

Progress in a number of areas, including; cash flow generation, the strengthening of our operating teams and putting some of the basic operating disciplines in place that are needed to build long-term operating strength at the company.

This company has strong businesses with significant potential to deliver consistently strong results.

At this stage in the changes we are making, our progress is very visible to us inside the company, and some of it is clearly visible to you in areas like cash flow, the strengthening of the management team and the fact that we are maintaining our marketing leadership positions in our key industries.

Getting to our goal of building a high performing operating company will take some time.

While we have made progress in a number of different areas, we have a lot more work to do.

You should expect to see us make steady progress toward -- towards this goal.

Regarding our specific results for the third quarter, our cash flow was excellent on the heels of a strong cash flow performance last quarter.

We are managing this business for cash first and we are making good progress.

As stated in the press release we issued this morning, we are increasing our full year cash flow guidance to a range of $2.2 billion to $2.5 billion.

Overall, we reported EPS of 27 cents for the third quarter of '03.

This compares to a restated loss of 20 cents for the third quarter of '02.

Our reported EPS includes the 7 cents per share charge from the retirement of our dealer remarketable securities and just under 2 cents of income from a tax settlement.

While cash flow is our number one priority, we are getting -- and we are getting good traction, our other top priority is earnings and Tyco's profitability is not where I want it to be.

While Healthcare had a great quarter and Electronics performance was also good, we have significant more work to do in Fire & Security, Engineer products, and Plastics & Adhesives.

I am confident that the management teams of these businesses are focused on the right issues and our emphasis on strategic sourcing and Six Sigma will benefit all of Tyco's operations over the next few quarters.

Concerning the legacy issues, we have made good progress during the past quarter.

As Ed Arditte had mentioned, we issued a press release this morning announcing our filing of restated financial statements that address certain charges we pushed back to prior periods.

Also in the third quarter, we continued to round out our management team.

In addition to Ed, who is hosting this call, we added two other members to our senior management team.

Charlie Young joins us from GE as Senior Vice President Communications and Dana Deasy joins us from Siemens as Senior Vice President and CIO.

This pretty much now rounds out the team that will be the direct report team to me and I think we just have a great blend of skills and experience with the team that we've assembled here at Tyco.

Now for an overview of our financial results in more detail, let me turn things over to Dave.

Good morning, everyone.

As Ed indicated, we had some positive developments and some negative issues during the quarter.

The positives were strong cash flow, and continued strength in Healthcare and Electronics.

The negatives, were the operating challenges in Fire & Security, and in Engineered Products.

On balance, however, this was a quarter of continued progress for the company.

For the overall Tyco results, let's start with sales.

Sales for the third quarter increased 3.4%, to $9.4 billion.

Which compares to $9.1 billion last year.

And if we look at things sequentially it's up from $9 billion in the second quarter.

The weakening dollar accounted for all of the increase in the quarter, but I think it's important to point out that we still posted strong revenue in an overall soft industrial economy.

For the year-to-date, revenue grew 4.2%, to $27.3 billion.

Again, foreign currency was the driver accounting for all the top line growth in the first nine months.

Operating income for the third quarter was $1.2 billion, and is not really comparable to last year's operating income due to various notable items recorded a year ago.

Backing out these special charges from last year's results would essentially result in the current quarter being level with last year's third quarter if we look at things on run rate basis.

The weaknesses are where you would expect them to be.

Engineered Products and Plastics, which continue to be challenged both by soft industrial economy, and very difficult raw material commodity pricing.

And Fire & Security, which continues to be be affected by a weak non-residential construction market, and the Continental European security business.

Year-to-date operating income was $2.9 billion, compared to an operating loss last year, due to the numerous special charges.

As Ed mentioned, EPS was 27 cents for the quarter.

This is after a 7 cents charge for the doctors, as well as a tax settlement which added just under 2 cents to our earnings for the quarter.

The 27 cents compares to a loss of 20 cents per share in the third quarter of 2002.

There were a number of charges in Fire & Security this quarter that would have increased earnings and we will explain these charges when we review the Fire & Security segment results.

Finally, free cash flow for the quarter, at $844 million, under our new definition, you know, was truly outstanding.

We made progress in taking some inventory out of the system, but as we look at working capital opportunities over the long term, we firmly believe there is significant opportunity to bolster our working capital management.

Turning to business unit results, let's start with Healthcare.

Healthcare, once again had an excellent quarter.

Good sales, good operating income, strong cash flow generation, all in comparison to last year.

Five of the seven Healthcare units within the segment contributed to the sales growth led by the Medical Products business and the Pharmaceuticals business.

Sales were $2.2 billion, up 8% from the third quarter last year.

Year-over-year sales increased $171 million with currency accounting for about half of the sales growth.

Operating income growth was outstanding in the third quarter in comparison to last year.

This growth resulted from both higher sales and improved gross margins due to productivity gains across the entire spectrum of Healthcare businesses.

Indeed, each of the seven business units within Healthcare had improved year-over-year profit.

Operating income grew $144 million or 34%, and the overall margin at 25.5% was up almost 5 percentage points from last year.

If we were to adjust for some of the notable items, primarily restructuring recorded last year, operating income grew 24%, with a 3 percentage point improvement in operating margins.

In a soft economic environment, as we look at Tyco Electronics, the third quarter, you know, we're characterizing as somewhat of a sideways quarter for the business with relatively flat sales;.

However, we improved margins over last year and generated solid cash flow in the quarter.

A number of business units in the Electronics Components business, if we look at the business excluding TyCom had growth in the quarter but there were also some soft spots.

Foreign exchange added 6 percentage points of growth for the quarter, but this was fully offset by general economic weakness which depressed sales in many of the industrial markets despite higher sales to the automotive market.

From an operating margin prospective, margins were 13.8%, versus a loss last year.

The Electronics Components business had margins of approximately 15%, level with last year.

The major issue we were facing on the profit line in this part of the business is pricing.

The environment is difficult and we estimate that pricing, you know, has hurt margins by more than one full percentage point when we look at where margins are versus our plans we laid out earlier this year.

As expected, TyCom had a significant decline in sales to the $30 million level for the quarter and brought its operating loss down modestly to $35 million from $37 million in the second quarter.

Let me add a few additional thoughts on Tyco Electronics.

As Dave had mentioned, the quarter had some good spots and weak spots, but overall I mentioned the book-to-bill finished the quarter at about one to one.

I would say we're an early indicator of business activity and we are not seeing any meaningful pickup in order activity as of yet, but we do have a sense that things are firming up a little bit.

The thing to remember is that more than 70% of our sales are from products where we are a clear industry leader, and clearly as we see the economy strengthen, so too will this business.

The Electronics management team is very focused on margin improvement and we have identified many initiatives that we feel will contribute to margin expansion over the next few years.

This includes the further migration of certain programs to low cost factories in Asia and eastern Europe.

Further rationalizing our manufacturing footprint and the continued rollout of our Six Sigma program.

Dave?

Let's now look at Fire & Security.

If we focus first on the top line sales at $2.9 billion, we're up 5.4% a quarter compared to last year.

Excluding the positive impact of foreign exchange, revenue was essentially level with the period a year ago.

Operating profit for the quarter was $188 million, and a resulting operating margin was 6.6%.

Which includes the accounting changes for dealer amortization and the dealer connect fee we talked about last quarter.

We're not satisfied with the margin, you know, in this business but it's primarily driven by results in our European security business, weakness in Fire Protection, as well as the Safety Products Manufacturing business.

Included in this quarter's results are $29 million of charges for a product warranty reserve and additional small other reserve adjustments needed in our operations.

Additionally, included in the results are $33 million of incremental bad debt reserves of which $26 million -- so $26 million of the $33 is for the Continental European Security business.

Adjusting for these items would add over 2 percentage points to our operating profit margin for the quarter.

As we look at the bad debt issue, I can tell you we are making progress but we're not ready to say that the problem, you know, is entirely behind us.

Cash flow generation, as we look at Fire & Security was clearly a good news story.

Cash flow for the third quarter increased to almost $290 million.

Let's look at some Security business disconnect numbers.

If we look at the overall global security disconnect rate, in the third quarter -- and, again, we look at these on a trailing 12-months basis.

We saw a half a percentage point increase overall in the disconnect rate to 14.9%, up from 14.4% in the second quarter.

Now, as we look at the primary contributor, there are really two.

First in the Dealer program in the U.S. we saw that increase in the third quarter to 17.1%, up a little less than a percentage point from the second quarter.

On the international front, we saw disconnects increase internationally from 14% last quarter to 14.8% this quarter.

Overall, in the U.S. we saw a modest increase from 14.6% to 14.9%.

You know, meaning that we saw, you know, some moderation, you know in the commercial and the residential businesses and Ed Arditte can fill you in on some of those statistics later.

I would like to turn things over to Ed to provide a little more color on this very important business for Tyco.

Let me break down in a little more detail the Fire & Security business.

I think this is a lot more granular than the company has talked about in the past, but I think it's important to lay it out in its pieces so you can see where we're focused as a management team, moving forward to improve this business.

And I point out, first, that from an operational standpoint, I think it's important to point out that the ADT Security business, excluding for a moment Continental Europe, which I I will come back to, is quite profitable.

I think there's a little confusion out there about this business.

Let me go through a few details.

The business represents about half of our total Fire & Security segment, and in this quarter margins were above 14% for ADT.

In addition, the Security business generated significant cash flow during the quarter and that's also attributable to us purposefully slowing down the dealer program, which we will continue to do going into next year.

So ADT is a very good business that has solid margins and cash flow but I'm the first to admit we have significant opportunities to even improve upon the margins we now have.

As many of you know, we have implemented an eight-point program or improvement plan for ADT, which we think over time will have meaningful benefit to us.

I would just highlight two of those key changes that are being instituted.

They started last quarter, but, you know, putting it through the whole dealer program takes a little bit of time, but we've instituted a program of no zero down transactions, which we think will clearly help our attrition rates moving forward.

So a minimum of $99 up-front transaction fee to become a ADT subscriber.

And secondly, we have now instituted the resale program on the dealer side of our accounts.

If you remember, I think we talked last quarter, we've had it for quite a while, the resale program on our internally generated accounts and we have about a 30% success rate on resigning accounts on the internally generated side.

We have preliminary results now on the resale program on the dealer side and we look like we're averaging somewhere between 16% to 18%.

Again, this program has just been instituted over the last 60 days, but clearly that over time, if we can keep it that level or increase it more towards the internally generated 30% number, it would have a major impact on our disconnect rate going forward also.

So we're monitoring that and working that very diligently.

So let me turn a minute -- the piece in our Security business that's challenging for us really is isolated into what I call Continental Europe, which is really our Germany, Belgium and France markets, where we had a significant -- what I call aggressive acquisition program over the last few years.

This business represents about 7% of Fire & Securities business, but that part of our Security business had a loss for the quarter, which, by the way, does include the bad debt reserve that we talked about.

Our problem is largely caused by the business model employed in the European Security business over the last few years and really, I would say very specifically, to the no up front cost policy that was in place.

We are obviously changing that, and actively addressing this issue as we speak.

If I really then turn to what I call the other half of the Fire & Security pie ex-ADT, this is really the area that management is intensely focused on to turn around.

It's really broken into two pieces.

The first one is the worldwide Fire Protection business which was also challenged in this current environment, you know, given the importance of non-residential construction to this business.

This business represents approximately 37% of the sales in this segment, and margins are depressed due to softness in the worldwide construction industry.

This has resulted in increased price pressure, particularly from smaller kind of local contractors around the market.

Remember that our Fire Protection business has significantly lower capital requirements than the Security business but it also has lower margins.

In the current environment, with our current cost structure, our margins were mid-single digits.

We have made certain management changes and are approaching the way we go to market in this business in a more strategic fashion by increasing our focus on service, as well as installation.

Service currently represents about half of our revenues, and this is an attractive higher return business than the installation piece of the market.

And clearly, we know we have cost actions that we need to take and we're looking at in this business, as we speak.

And then the other part of the business, which is our Safety Products, what I call our Manufacturing business, also had a rough quarter and really was basically break-even during the quarter.

We believe this is a business that we can fix quickly, and make a more strategic part of both the Security and Fire business.

It's important to point out that this is a collection of businesses that we acquired over the years by Tyco that had never been meaningfully integrated into one global manufacturing organization.

That is changing as we speak, and we expect significant profit growth and margin improvement in this business next year.

Overall, there are a variety of issues within Fire & Security that we need to address, but as I mentioned the core ADT Security business is fairly strong and performing well with a significant recurring revenue stream.

In addition there are reasons to be optimistic about improvements in both Fire Contracting and Safety Products businesses going into 2004.

As you probably know, we did make management changes in this business just four months ago.

Dave Robinson has subsequently made numerous other management changes and this team, along with the corporate team, are focused on running this business for stronger cash flow while we address our operating issues.

Dave, let me turn it back over to you.

Thanks, Ed.

We'll continue on with the last two businesses, Plastics & Adhesives and Engineered Products.

First looking at Plastics & Adhesives, revenue for the quarter was $489 million, essentially level compared to last year.

Volume was down somewhat due to generally weak economic competition, increased foreign competition, as well as what we faced last quarter as the customers stocked in our second fiscal quarter during the Homeland Security alert.

Increased pricing offset the volume decline as a portion of the resin cost increases we faced were passed along to customers.

As we look at things going forward, however, pricing conditions may be affected by both excess industry capacity, as well as competition from imports.

Operating income was down approximately 24% versus last year.

And was adversely impacted by a full 20% increase in resin cost, as well as lower volume absorption in our factories.

We are currently facing significant spread compression.

By spread we mean the difference between our selling price and our cost of resin.

Which creates a particularly tough comparison to last year, a period when we enjoyed a much wider spread.

That said, there is significant opportunity to improve the productivity, profitability, as well as cash flow generation of this business and that's our current focus.

Turning now to Engineered Products.

Engineered Products had a difficult third quarter as we look at things from both the sales and operating income perspective but did have better cash flow this quarter.

The results for the business were clearly impacted by a continued soft industrial economy, higher raw material steel prices and a weaker non-residential construction market.

Revenues slipped 2%, to just under $1.2 billion.

The foreign exchange translation, you know, added about 6 percentage of growth due to the weakening dollar.

The bigger challenge for the quarter was profitability.

Operating profit at $92 million, compares favorably with the reported loss in last year's third quarter which was mostly due to goodwill impairment; however, if we were to adjust for this charge a year ago, operating profit decreased from an adjusted basis of $177 million last year, to $92 million in the quarter just concluded.

The operating margin was 7.8%, a level we are not happy with and we are focusing on a number of areas for improvement across the Engineered Products businesses.

Let me finish with a few comments on some important financial matters as we look at things, kind of, overall, you know, from the company's perspective, starting with the tax rate.

The tax rate this quarter was 29.8%, and the year-to-date tax rate is 33.5%.

This rate includes the impact of the $152 million charge for the doctors debt retirement, which was not tax deductible.

In addition, the tax rate was favorably impacted by a prior year tax settlement of $22 million.

The tax settlement also resulted in $19 million of interest income this quarter.

The interest income falling into the net interest expense category.

The net interest expense at $248 million represents a small change from last year's level at about $250 million.

Net Cap Ex for the third quarter was $336 million, $22 million below depreciation.

I should note that Cap Ex included $56 million for the purchase of a TyCom maintenance ship previously leased to the company.

As of June 30th, we had cash on hand of approximately $3.9 billion.

Essentially the same level that we had at the end of the second quarter and this is after almost $800 million of debt repayment, you know, during the quarter.

Let me help clarify, you know this debt reduction because it is not readily apparent on our financial statements.

If you look first at our cash flow statement, you would look at a debt retirement figure of $948 million.

That $948 million includes the premium we paid to pay off the doctors in addition to the true debt reduction.

Looking at another financial statement, our balance sheet.

If you are to look at things, kind of on a net debt basis, you don't readily see this $800 million and that's primarily because when you look at restricted cash reported by the company, you will see a $250 million reduction.

However, buried in other components of the balance sheet, other current assets, as well as certain other long-term assets, are additional forms of, you know, restricted cash being classified in those areas.

So if you look at, you know, total restricted cash across all balance sheet line items, indeed that increased about $10 million during the period.

The final component, to help you from analytical perspective in your reconciliation, you know, is foreign currency.

We do indeed, as you know, have some euro denominated debt, which at current currency rates, you know, is a higher figure.

So, indeed the balance sheet strengthened during the quarter.

The resulting debt to capital ratio was 44.3% at June 30th.

This is over a 5 percentage point reduction from the 50.1% debt-to-capital ratio at our last fiscal year end.

I should note that we are adopting FIN 46 in the fourth quarter .

And this adoption will result in a one-time non-cash cumulative accounting charge and an increase in debt on our balance sheet, you know, associated with synthetic leases, you know, we have on our books.

We expect the cumulative charge to be approximately $110 to $125 million pretax for the fourth quarter but our review is not yet finished.

On an ongoing basis, we except the adoption will elevate operating expenses by $25 to $35 million per year on a pretax basis.

Looking at debt on the balance sheet, adoption of FIN 46 will add $517 million of debt to Tyco's balance sheet in Q4.

I should note we have begun our annual process of assessing goodwill under FAS 141 and FAS 142 and we'll have something to report in this regard no later than the time of our fourth quarter earnings release in late October.

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

Good.

Thanks, Dave.

Tyco can generate significantly more free cash flow than we are currently generating and therefore we are increasing our focus on the processes behind better working capital management.

As Dave had mentioned, we still see significant opportunity here for improvement.

Based on all of that, our cash flow results, (INAUDIBLE) and our confidence increasing in our ability to generate cash, we are increasing our free cash flow guidance in the range of $2.2 billion to $2.5 billion for this fiscal year.

With respect to our earnings guidance, we don't expect any help from the economy for the fourth quarter, or our fiscal fourth quarter.

We expect that Healthcare and Electronics will continue to be strong performers, and that we will see sequential improvement in Fire & Security; however, we also expect that the steel and resin raw material pricing challenges will continue through our fourth quarter.

As a result, our current view is that earnings per share for the fourth quarter are likely to be between 32 and 35 cents per share.

This does exclude the impact from the adoption of FIN 46, which Dave FitzPatrick had just mentioned.

Before we conclude let me end on a personal note.

This is the one-year anniversary of the day I joined Tyco.

Since then, I have only become more excited and more enthusiastic about the potential of our company.

Let me remind you of some of the most significant changes, it's sometimes easy to forget where we were just a year ago.

To me the most important accomplishments during the year were keeping Tyco's businesses focused on their customers during the most difficult period in this company's history.

This enabled to us maintain and in many cases strengthen our market leadership position.

And what I would just say here is, this concern, in my mind, is now firmly and fully behind us as a company.

I don't see it as an issue for us moving forward.

Secondly, getting Tyco focused on the importance of cash flow generation, and we have clearly seen that take hold throughout every business in the company, we have hired an entirely new corporate management team.

We've changed the leadership at two of the companies segments Dave Robinson, for head of Fire & Security and Terry Sutter to head up Plastics & Adhesives.

And what I'd say - these people have been in place three or four months and I think you will start to see accelerated change in those businesses, as we lay out plans with them to improve our cost structure across both of those businesses.

We elected an entirely new Board and with the exception of myself, consists of entirely independent Directors.

We issued $4.5 billion in convertible debentures and we put in place $1.5 billion credit facility and I really would say solving our liquidity challenge that had undermined confidence in the company earlier in the year.

We've made a ton of moves on the corporate governance front.

We have a senior officer reporting to me on corporate governance.

We've adopted governance programs for management, our employees, our directors.

We just recently established stock ownership guidelines for senior executives and directors and we totally revamped the bonus program throughout the company to align our payment with what I think the core goals are and the growth of things with our shareholders moving forward.

And last, but certainly not least, because this is where we are now focusing most of our efforts, we've initiated a number of proven programs to drive operating intensity across the company and improve our returns in profit margins.

These actions include implementing Six Sigma and Lee Manufacturing programs, and I would mention specifically that Fire & Security is very focused on this as we speak.

Pursuing supply chain integration across Tyco and across one Tyco combined to realize significant additional savings; and we are developing a plan for consolidating our manufacturing and facility footprint, which will also address excess head count, and capturing additional cross segment - cost savings opportunities.

The last year has been a solid year of progress for us.

And with many of these legacy issues now moving towards resolution, we're able to turn our full attention to the process of creating an operating company from a holding company.

The pace of change has been fast over the past year, that pace will accelerate over the next year.

That concludes our formal remarks, Dave FitzPatrick and I would be happy to take any questions that you would have.

Uhm, Operator, if you could open up the lines for Q&A.

Thank you.

We certainly can.

Once again, if do have a question, please press star one on your touch tone phone at this time.

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

You may remove yourself by pressing the pound key.

Again for questions, please press star one.

The first question in queue is from the line of Michael Regan from CSFB.

Please go ahead.

Thanks.

Good morning.

Dave, have you spoken with the rating agencies and what's their reaction to the FIN 46 500 some odd million of debt that comes back on the balance sheet.

Well, I think, indeed, Michael we have indeed spoken with the rating agencies in terms of the restatement matters, as well as a little bit of color, you know, on the quarter.

You know, with respect to the synthetic, you know, leases and the debt coming on the balance sheet, inasmuch as the agencies consider that as debt, even though it was off balance sheet we don't see that as being an issue.

Okay.

So you feel they were counting it even though it was off of balance sheet.

They most definitely were.

And Ed, talking about Electronics, one of the questions that continues to come up is just how to think about Automotive over the next couple of quarters as builds both in the U.S. and Europe look like they'll be difficult .

It sounds from your comments like you are not seeing any real rebound in orders on the electronics side.

My sense has always been automotive has been very profitable.

Should we be concerned about that for the next two or three quarters?

Well, I think we've already seen some of the dropoff in autos so far, yet our numbers have held fairly constant in that business.

I would also mention, I think more importantly in our Auto business is the increased content that's going into the automobile.

We have just a lot of new programs in that area, where our content is rapidly increasing over the next, kind of, 12 to 18 months.

So one of our key goals is to make sure we're getting the new wins in that area because content will help drive some of maybe the softness on actual vehicle units.

I would also just mention that, without saying specifics on the number, we've seen some preliminary numbers in July, and our book-to-bill ratio is slightly above one, but I would leave it at that across the whole components part of the business.

So, again, kind of holding around, you know , this kind of one-to-one that we've been at the last three quarters.

Okay.

Thank you.

Thanks, Michael.

Your next question is from the line of Chet Louie from Barclay’s.

Please go ahead.

Good morning, gentlemen.

First of all, congratulations on your third quarter free cash flows.

That was great.

Thank you.

First, can you talk a little bit about how free cash flows will be higher despite the downward earnings guidance?

Is this mostly due to better working capital management?

Well, I think, Chet, as you look at the cash, I mean, indeed we are seeing, first, you know, earnings come through, you know, fully with cash.

As you look at the -- you know the underlying, you know, cash flows so that the earnings, you know, content, you know, is bringing cash with it.

We really, as you look at our guidance for the remainder of the year, we really don't have what I will call meaningful working capital improvements, you know, embedded in there.

So, you know, if indeed, we get some improvements of any significance on working capital, you know, that could indeed be further upside.

Additionally, I'd add two points to what Dave had said on cash.

I think as you can see we've managed our Cap Ex spending to about the run rate we thought we could run it at.

I would say with that number, Dave and I have not been holding back on any key programs for future growth in the company from a Cap Ex standpoint.

So we've built our confidence that we can run those levels going into '04 where we are now at and you might note also you can see the dealer program coming down some more during the quarter.

Our goal is to run that slightly below $500 million on a run rate basis next year from, kind of, the $750 million level that we ran at this year.

Great.

Thanks.

And you've mentioned in the past that asset sales could constitute about 10% of sales.

Any updates in asset sales and do you have any asset sales target for fiscal year '04?

Yeah, we are at in the process, we're going through a strategic review right now with our businesses.

In fact, today we're leaving for a review with one of our large segments on, kind of, our strategy process.

It culminates in a Board meeting of two-day strategy Board meeting we are having in late September, where I would assume that the company will make some preliminary decisions on -- out of that.

I would highlight, as I said before, that I don't see any of the core businesses of this company being for sale, what I mean one of the five big segments.

That is not the case.

I expect that we will sell some pieces, or put them up for sale underneath those five big pieces and that it would not represent more than 10% of the company's revenue.

Okay, great.

Thank you.

Thank you.

The next question is from the line of Lee Cooper from Omega Advisors.

Please go ahead.

Yeah, good morning and thank you very much.

As you spend more time at this, Ed, and become more familiar, you and Dave, what is your sense of where earnings would normalize out at, when you kind of implement all the programs you are thinking about?

Is this a corporation in a normal environment capable of earning the $1.25 we're now earning or is it capable of earnings of substantially more money and do you have a view what substantially more means?

I'm not worried about current earnings but more where are we heading to, in terms of normalized earnings?

You know, Lee I would go back to, I guess, it was in March when we had our investor analyst meeting, and you know, we feel over the intermediate or the long term, the goals we have laid out are very achievable by this company.

You know, despite some of the issues we have, my confidence is building and I zero in on one very key area, and that's Fire & Security.

As I - I gave a little more color commentary this time.

We clearly have issues in that business but when I look at the underlying problems that we have, they are very -- you know, I just say on a scale of difficulty, they are easier to fix in many cases than I think are apparent. , By and large we don't have a business model problem in ADT.

It's performing pretty well and, again we're putting some programs into place that I think will have some significant improvement for us over the intermediate term.

And the pieces we have to fix in that business are kind of, what I call the manufacturing footprint and contracting piece which, you know, we are well along a plan to start addressing that with the new management team.

So, again, there we need a big shift, in kind, of margins over the immediate terms from clearly where we are running at now.

But no reasons we can get the Fire & Security margins into the mid-teens.

You know, Healthcare, we have our margins kind of where we said we could get them to, you know, as we reported this quarter.

We're 25% and we think we can maintain that.

We need sales growth ramp in that business over time,and good international growth and we're beginning to see that.

Electronics side, we know there's room for upside, the kind of 20 plus range.

You know, core Electronics this quarter was 15, Lee.

But we still have the TyCom issue that we need to deal with that depresses it down to 13.8%.

So, again, I think with the actions we can take there, we can get there on that business.

And actually on the Engineered Products, we need a little lift on the industrial commercial side of the business but there's also restructuring actions in that business that we are -- we will take and are working through with the team there.

So when I break it into pieces, it's very doable for us to get to the goals that we've outlined, you know, back at our meeting and, you know, again, it's gonna take us a little time to get there.

But, you know, my confidence is clearly built that we can get there in the immediate term.

So if we go back and look at the handout that you had at that meeting and we look at 2004, we could rely upon that, kind of, rough guidance or objectives as reasonable expectations on the part of the company at this point?

Well, I wouldn't say, Lee, it's all 2004.

But it's clearly, we'll build to that over the next few years.

And, you know, a good part of it, I hope we get through, you know, as we get through '04, I wouldn't put it all in the '04 range.

But, you know it was, kind of, our three-year projection.

Lee, I would also add, if we can get any wind behind our back on the economy here.

You know, the way we're getting Electronics restructured if we could just get some lift on the order -- you know the order sales side there, that would become very significant for this company.

Again, I think we're very much bottomed out in Electronics and I think you can see it from a our sides and the book-to-bill running around one to one but a little lift there would be very helpful.

Again, we're not counting on that right now, but certainly that would help.

Good luck and thank you very much.

Thank you, Lee.

Thank you.

Next question is from the line of Jeff Sprague from Smith Barney.

Please go ahead.

Thanks.

Good morning.

Thanks for all the incremental detail in Fire & Security.

I'm wondering, just to help us get a sense of how quickly you may turn around in Europe, is there a way to look beneath, you know, beneath the acquisitions or beneath the dealer accounts and get a sense of what, kind of, normalized run rates should be there, and, you know, how long it may take to, kind of, work through those type of issues?

Let me make a few comments and, Dave, you might want to jump in on this also.

The Continental Europe Security business, I would say kind of higher level, it will take some time to turn around because we've got the embedded base of accounts.

Jeff, what I would point out, which is just, you know, kind of interesting, as I mention continental Europe, I do exclude our UK business, because the UK business, by the way, is running very well and, kind of, more in line with the results I talked about in the rest of ADT.

And I would also mention that we've now consolidated the whole European, south African UK operation into one business managed by our UK team, which has run a very good business over the last few years.

The single biggest thing we can do moving forward is to really do away with this zero down policy and if anything, in that market, if you look at competitive kind of rates on what you charge up front, it's much more significant than in the U.S.

So we have now literally just instituted an up-front fee that is pretty significant; although it varies by different market.

And that will help us over time in the business, but because of that embedded base, it's gonna take us a little longer to turn that relative to Safety and Fire part of the business.

At a minimum, would you say that, given the changes that you've made, that we should be at the low water mark here and it's a matter of just, kind of, slowly grinding out of the trough as some of these things work through?

Yes, I would say so.

I don't want to overstate this but to go to a couple of comments, I think Dave gave a little more detail.

We are dealing with, in this quarter and you saw, and again, I won't declare victory that we're out of it, but we did have a couple of percentage points of charges, bad debt reserve and all, that we did have to take in Fire & Security.

So hopefully we're working our way through that as quickly as we can also and then working our way back up.

And separate question on tax.

I think, you know, after the SEC, maybe one of the larger things that some of us are worried about is just, kind of, the IRS review.

I find it interesting that in this quarter you actually had you a favorable tax settlement.

You had you one a couple of quarters ago.

I don't recall now off the top of my head what it was about, but can we draw or do you draw any comfort from actually, you know, having some favorable results here on the tax side?

Does it give us any insight on what to think about going forward?

Well, I think, Jeff, as you look at the tax situation, and we have a number of audits going on.

Some of these audits do indeed date back to pre-acquisition company periods and that's one of the things we're dealing with this quarter.

You're right in the first quarter we did, indeed get a refund that helped our cash position, you know during the quarter but, I mean, there's really nothing new in terms of updating you on in terms of the overall, you know, tax reviews.

I see that as a couple of year process, you know, as it -- as it plays out.

Okay.

And just one last one on -- on pension.

Can you give us any update on, just kind of, plan performance?

You made the comment about a possible contribution, just what your state of thinking is around the issue?

Yeah.

I mean, as we look at the over all pension situation, I mean we're looking at, you know the funded position, potential additional charges to equity, largely due to the lower interest rate environment.

You know, as we look at overall returns on our numerous -- I mean we're dealing with many, many tiny plans in the U.S. and around the world.

Kind of like our tax position.

There isn't one big, know Tyco U.S. plan.

You know, as we look at performance in terms of our assets plan year, you know, year-to-date going back to October 1st, you know, we're seeing more or less level, you know, performance overall in our assets with returns pretty much matching benefit payments, you know, that we've made during the year.

Indeed, at the end of last year we had a $1.7 billion underfunded position, and with the strength we're seeing in cash flow, you know, we think the contribution, you know, to the plans may indeed be a prudent use of cash this coming quarter.

We'll have more to say about it later.

Thanks.

Thanks, Jeff.

Our next question is from the line of Brian Jacobi from Morgan Stanley.

Please go ahead.

Good morning.

Yeah, if you could provide us, perhaps, maybe an update on the capital structure as you go towards fiscal year-end and perhaps some of the milestones that are coming up with maturities.

And what opportunities do you guys see given the free cash flows?

What is, kind of, the next step with respect to what you intend to do on the debt reduction side and, you know, again as we move in the fiscal fourth quarter, do you expect to kind of come out with, when you give guidance for next year, perhaps what you intend to do on the debt reduction side?

Thanks.

Okay.

Brian, I think generally we heard your voice is a little lighter on there, you know what is kind of our plans on cash usage and debt repayment over the next year.

As we look at cash flow, Brian, as well as debt maturities, we have approximately $1.1 billion maturing in Q4.

We have about $2.5 billion remaining in the November Lyons which are most likely to be put back to the company.

Our plans with respect to cash deployment is to continue to pay down debt, you know, in the near term and those are some of the most significant milestones as we look out, at least a couple of quarters.

And Brian, just to add on, and I think it's apparent with what Dave said, but clearly to get investment grade rating back with the agencies as quickly as we can is a key goal for the company.

Okay.

And then with respect to the -- you know, the $2 billion in bank debt, I mean -- I take it the last time we spoke you said that eventually that's an item you will address.

Is there a game plan in place that, you know, when we hear you at fiscal fourth quarter earnings call, that you will have comments maybe with respect to that in terms of what the strategy will be or is that something that's perhaps further out in fiscal '04 that we'll hear more on?

I think as we look at our bank lines and the facilities in that regard, Brian -- I mean, as we look forward, you know, we have the 364, you know, expiring early next calendar year.

I would suffice it to say at this stage, I mean, anything we want to look at in terms of bank lines we'll be looking at the 364, kind of in combination with a five-year assessed, from an overall strategic standpoint, you know our credit facility.

So, you know, given the timing, I doubt you will really hear much in the fourth quarter, you know, in that regard.

Maybe more to come in the first quarter of our next fiscal year.

Okay.

Great.

Thank you.

Okay.

Our next question is from the line of Bob Dunn from FAM Investment.

Please go ahead.

Thank you.

Along with the strong free cash flow, some people have speculated that you might pay a dividend or a higher dividend eventually.

Do you think that's a possibility down the road?

Bob, I would say it's clearly possible down the road but it's not a consideration at this point in time for us.

As you can tell we're very focused on debt repayment, working through that and maybe redoing these bank lines and, you know, we'll look at that as we get down the road.

But, I mean, I think it's starting to be clear to people that the cash generating ability of this company is significant.

We know we can improvement it and hopefully we'll be having those discussions, you know, somewhere in the future.

Thank you.

Next question is from the line of Steve Serril from Accounting Asset Management.

Please go ahead.

Yes, I'm just wondering with United Technologies now as a sizable competitor in the security business, how you to plan to respond to that or if you are making any changes in anticipation of that?

I'd like to comment but I'm gonna let Dave FitzPatrick handle this one.

Can't really go back to the future on that one.

But I look at the UTX movement in the security business, you know, as a -- a move in terms of -- you know, from one dimension, kind of validating, in our perspective, what is an outstanding business opportunity.

We look at our -- our strength in leadership globally in the Security business, as well as the Fire business and, I guess, when I look at good secular growth trends in the industry, wonderful margins in many aspects of the business, with clear opportunities, you know, for significant, you know, operating margin enhancement over time.

I think the thing is we look back at the Security business and, you know, even our participation -- I mean, it has been characterized in the late '90s as a very, very, capital intensive business, and I think, you know, the challenge for all of us, particularly us, you know, in the industry is dramatically to improve return on invested capital.

The eight-point plan that Ed talked about in terms of, you know, modifying our dealer program was precisely aimed, you know, at a model that delivers capital returns well in excess of our cost of capital.

So, I see this as a, you know, validation of what we think is a very, very, attractive market for many, many years to come.

Steve, I would also just add that, you know, what is interesting about this market, despite our size and then United Technologies getting in in a significant way, it still is a very fragmented market out there with a lot of growth opportunity for some of the key companies.

So, you know, I think the runway in front of us here is pretty significant and will be for some of our competitors also.

Thank you.

Thank you.

Your next question is from the line of Bob Cornell from Lehman Brothers.

Please go ahead.

Yeah, thanks, guys.

You know, you gave a lot of detail on the quarterly operating results.

I was just wondering if you could sort of consolidate some of the thoughts about head wind, tail wind for '04.

I mean, you talked to Leon about that a bit.

FIN 46 we know about, but with regard to the pension, you know, what is the, sort of, range of pension expense head wind?

What about the possible head wind with regard to restructuring the footprint?

How much of expense might you see in results there?

You know, TyCom is going to be a favorable swing, tax rate, possibly, a favorable swing.

Could you just, sort of--you know, we're all gonna go back and model out to '04 after this call, maybe just sort of give us a little bit of a piece of guidance there.

Well, I mean, as we look look at, you know, issues that are gonna have an impact, Bob on on our results both positively and negatively, you know, as we look at '04, I mean, on the tax rate, you know, side of things let's start with that one first.

You know, as we said back in March, you know, we see the 28% kind of run rate, you know, as being the rate for the next couple of years.

Obviously, from a planning perspective we want to do everything possible, you know, to work that down, but I mean I would look at -- for the next couple of years, you know, at least as we've outlined, kind of, a level, you know, rate environment in that regard.

You know, with respect to pensions, you know, we're going through kind of our actuarial reviews, there could indeed be, you know, a little bit of head wind there but I don't think, you know, it would be appropriate to comment as we're completing, you know, our overall, you know, studies in that regard.

You know, obviously a contribution would indeed have some positive impact, you know, offsetting, you know, you know, some of the head wind we may face with respect to pensions.

You know, other areas, I mean, you know, in terms of things that are necessarily as you look at overall, you know, insurance, Healthcare, Property and Casualty trends but, I mean when we look at providing, you know, guidance in '04, what we're lay out is, you know, information that takes those kinds of factors into account.

Ed anything more you want to add in terms of the economy?

Bob, I just - you know, we're not counting on economy improvement right now but, you know, things feel like they are going to improve for us as I think most other companies are highlighting and, you know, not to repeat but if we have a little leverage, you know, wind behind behind our back and I really look towards Electronics.

I think Healthcare we're gonna have a nice growth through next year.

I think we get good leverage through the bottom line 'cause we have had pretty significantly restructured there.

Although there are more actions we are taking.

And Fire & Security, I put, we need commercial industrial construction to improve some as we go through next year, because both on the Fire& Securities side and Engineered Products side, I'd say if you really look at our weakness, it's related to those industry sectors.

So it would be nice to get a little wind behind our back there and, look we're probably at eight to nine year depressed lows in that sector right now.

So I think we're at the bottom of bottoms, but, again some lift there would be helpful.

And as we continue, Bob -- and I think we'll lay out more at end of fourth quarter.

I think you can tell we're looking at additional restructuring actions that we would take.

But I think you got to balance against where we come out on asset sales and as we, kind of, wrap that together for you and our investor base, you know, maybe towards the end of the fourth quarter of this year.

Final comment on TyCom, Dave, you know the Cap Ex there was more than I thought.

I mean, have you finished the Pacific?

Are you getting any circuit sales?

Has the loss gone down?

Yeah, I mean, what that represented was more transfer of construction work in progress, Bob, to Cap Ex.

So, yeah, we're, we're - we're done in terms of the network side of things.

And we are actually putting capacity sales on.

We've turned the network over.

There are capacity sales going on the Pacific leg, Bob as we speak.

What does that mean for the loss looking forward?

No different than what I think we forecasted to you from a run rate basis going into next year.

We'll still have that cash burn next year of $120ish million and probably an EBIT loss.

By the way, assuming we don't do nothing elsewhere the network, just leave it in a form factor that it's in right now.

But I think, as we've said before, this is one that we are looking around.

We're talking in the marketplace to see if there are opportunities with this business.

Okay.

Good luck, thanks, guys.

Thank you, Bob.

Operator, we'd like to take one more question as we're coming up on the hour.

Very good.

And our next question is from the line of David Bleustein from UBS.

Please go ahead.

Good morning.

Can you -- how much working capital do you expect to remove over the next 18 months?

Basically can you talk through what you believe it will take to make some progress with payables and what is the tone of discussions with your vendors?

Yeah, Dave, our working capital, I think you've heard us, we think there's room for nice improvement pretty much in every business.

Across the board and I -- I would just say we have traction now.

We have the operating teams in the company very focused on all of these metrics and we're -- you know, we're really grading the team against it, so I think you will see a continued improvement.

You know, we'll lay out more as we talk about next year guidance on next quarter but we have clear room in front of us for improvement there and it really is in every business.

But hit the payables, it looks like that was a place where you did not make much progress.

What is the tone of discussions with vendors?

Well actually, the tone of discussions, David, overall on the payables side, indeed we have seen cash outflow for the quarter, and for the year-to-date.

You know, as we look at, you know vendors there are, I would say, select, but not numerous issues, mostly outside the U.S. where we may be on, you know, short pay or credit insurance, you know, indeed, maybe an issue but, I think you're on to something that we see as opportunity going forward in terms of arresting that.

All right.

Thanks.

Thank you, everyone.

Thanks for joining us today.

Operator, we'll end the call.

Very good.

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