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Operator
Thank you, ladies and gentlemen for standing by, and welcome to the Tyco third quarter 2004 earnings results conference call.
At this time, all lines are in a listen-only mode.
Later will will be a question-and-answer session, and instructions will be given at that time.
If you do need assistance during the call today, please press the star, followed by the zero.
As a reminder, today's call is being recorded.
At this time, it's my pleasure to turn the conference over to the Senior Vice President of Investor Relations, Mr. Ed Arditte.
Please go ahead, sir.
- Senior Vice President of Investor Relations
Thank you.
Good morning, and thanks for joining our conference call to discuss Tyco's third quarter results for fiscal year 2004 and the press release that we issued earlier this morning.
With me this morning are Tyco 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 that you look at today's press release and read through the forward-looking cautionary information and statements that we have included in the press release.
In addition, we will use certain nonGAAP measures in our discussions this morning and we also ask you to read through \the sections of our press release that address the use of these items.
To get us started this morning, I will now turn the call over to Ed Breen.
- Chairman and Chief Executive Officer
Good morning, everyone.
I'm delighted to report to you this morning that Tyco had another quarter of solid progress.
We had good revenue growth, higher earnings per share and continued strong cash flow.
We are pleased with our progress, but we still have a long way to go overall.
earnings per share were $0.43 for the quarter on a GAAP basis.
These results included $0.02 of net charges from our restructuring and divestiture programs, as well as early retirement of debt.
Net income grew over 60 percent on a GAAP basis and a very strong 27 percent after adjusting for certain charges in last year's third quarter.
The profit improvement was led by engineered products, Fire and Security, Healthcare and Electronics, offset by profit decline in Plastics and Adhesives.
Overall, we had a strong quarter from an earnings perspective.
Our free cash-flow continues to be a real strength for Tyco.
Free cash-flow including $173 million of voluntary pension contributions was 1.3 billion in the quarter, compared to last year's $844 million.
Compared to our guidance of free cash flow before voluntary pension contributions, free cash-flow was over $1.4 billion in the quarter.
Separately, we utilized $1.1 billion of cash in the quarter to further strengthen the balance sheet, as we detailed in our press release.
Revenue growth was a nice story this quarter, as our reported revenue grew 11 percent and organic growth improved to 6 percent .
This compared to 3.4 percent organically in the second quarter and 2.1 percent in the first quarter.
Electronics and engineered products had very good growth quarters, driven by strengthening in their key end markets.
This performance puts us on track to achieve the 4-6 percent organic growth rate we targeted at the start of the year.
Our operating margin improved to 14.6 percent compared with 12.8 percent last year, and 12.5 percent in the previous quarter.
Our Six Sigma and strategic sourcing programs are contributing nicely to our overall margin progress and, where we can, we have implemented price increases to cover rising commodity costs, primarily in Engineered Products, Plastics and Adhesives and in Electronics.
Below the operating line, we are also benefiting from lower interest expense, which declined by $64 million.
Our strong cash flow is allowing to us strengthen the balance sheet , but is also making a contribution to higher earnings through meaningful reductions in our interest expense.
As we look across our businesses, we had a strong profit and margin quarter in Healthcare, although we are not satisfied with our 2 percent organic revenue growth.
We had good growth in Medical, Surgical and International, excluding Japan, but we had revenue declines in retail, respiratory and Japan.
We expect our growth rate to pick up in the fourth quarter, which would bring the full-year growth rate to the 4-5 percent range.
From a profit perspective our margins are benefitting from continued cost reduction activity, which has more than offset increased R&D spending.
We had a good quarter in Electronics, with solid revenue and profit growth.
On the revenue side, we are seeing the market strength that we had forecasted earlier in the year.
We are also seeing improvement in our margins, despite the continued headwind from higher metal prices, which have cost us close to a full margin point versus last year.
The strength in our end markets continue throughout July, and we feel good about our ability to significantly improve margins in this business.
Finally, we had a very good quarter in Engineered Products, with good performance from each of our business units, led by Electrical and Metal product.
We are seeing encouraging signs in each of our businesses and we have 20 percent organic growth on a year-over-year basis.
Even adjusting for the impact of higher steel prices, organically, revenue grew approximately 10 percent in the quarter.
We are also-- continued our debt reduction activities in the quarter, a key objective for Tyco.
Our gross debt declined by $630 million to $17.1 billion in the quarter, and our net debt declined to $13.1 billion.
We will continue to utilize our strong cash-flow to further strengthen our balance sheet over the next several quarters.
On the rating agency front, most of you probably know that our debt ratings were raised by Moody's, S&P and Fitch during the quarter.
The two-notch upgrade by Moody's and the one-notch upgrade by Fitch were especially gratifying because it returned Tyco to full investment grade status.
The third quarter was a good quarter for Tyco with respect to stronger top line growth, improving margins, continued solid cash-flow and further balance sheet improvement.
Now let me turn the call the over to Dave for more details.
- Chief Financial Officer
Thanks, Ed, and good morning.
Let's start with a financial review, taking a quick look at each of the segments, then I will finish with a few additional items.
Starting first with Fire and Security, revenue grew 4 percent to $3 billion with organic revenue growth of 1 percent .
As we've mentioned previously, this is a transition year for us on the top line as we build a high quality revenue base to fuel future growth.
Operating income increased to $278 million and the operating margin advance to 9.3 percent .
The net impact of the restructuring and divestiture programs was minimal in the segment during the quarter.
Looking at our operating performance by business units -- and these data are without the impact of restructuring charges and divestitures -- first, our Worldwide Security business, excluding Continental Europe, which represented 47 percent of segment revenue in the quarter, grew 3 percent organically, primarily driven by stronger sales to retailers.
The operating margin in the quarter improved over 100 basis points to 16 percent, led by improved performance in ADT North America, which benefitted from cost improvements and lower bad debt expense.
Revenue in Continental European Security, which represented 6 percent of segment revenue, declined 5 percent organically, with break-even operating performance in the quarter.
Turning to Tyco Safety Products, our manufacturing unit, which accounted for 12 percent of segment revenue, had another strong quarter in this business, with 12 percent organic revenue growth, driven primarily by strength in breathing systems, video surveillance, and access control equipment.
Operating margins were in the mid-teens.
Finally, the Worldwide Fire business, which represented 35 percent of segment revenue, experienced a 3 percent revenue decline, organically.
The operating margin improved more than a half a percentage point year over year, and well over a point sequentially as we are beginning to see good traction from our restructuring and operational intensity activities.
Our trailing twelve-month security disconnect rate improved slightly to 15.8 percent in the quarter, versus 15.9 percent last quarter.
The U.S. rate declined 30 basis points to 15.6 percent, while the rest of the world disconnect rate held steady at 16.1 percent .
Moving next to Electronics, segment revenue increased 13 percent year over year to $3.1 billion, with organic growth of 10 percent .
Our Connector and Cable Assembly business, which accounts for about half of the segment's revenue, grew 16 percent organically, 20 percent on a reported basis, including currency, driven by strong growth in the automotive, communications, computer, consumer electronic and industrial markets.
Growth in these areas was partially offset by continued weakness in sales of power systems products in North America and commercial electronic services.
Operating profit for the segment grew 14 percent year over year to $464 million, and the operating margin improved ten basis points to 15.2 percent , despite 80 basis points of headwind from higher copper and gold costs.
Within the Electronic Components business, we made good margin progress on a year-over-year basis, with margins improving to 15.3 percent in the quarter, despite the headwind from copper and gold.
On a quarter sequential basis, electronic components operating margin improved 30 basis points after absorbing 20 basis points of restructuring charges in the quarter.
We expect to make continued margin progress in the fourth quarter.
Business activity was strong and broadbased throughout the quarter, with higher bookings and backlog in the Electronic Components business.
The book-to-bill ratio was 1.04 in the quarter, despite significantly higher sales and the backlog has grown over 25 percent, year to date, in constant dollars.
We saw continued order strength throughout July, with orders up 16 percent year over year in constant currencies.
Moving to Healthcare, revenue for the quarter increased 4 percent to $2.3 billion, with organic growth of 2 percent in the quarter.
Our Medical and Surgical businesses grew 4-6 percent organically in the quarter and international revenue, excluding Japan, grew 5 percent .
Offsetting this growth were revenue declines in retail, respiratory and Japan.
We expect a stronger fourth quarter with organic revenue growth in the 4- 6 percent range.
Healthcare operating income grew 10 percent and the operating margin expanded 170 basis points to 27.3 percent , driven by a higher margin sales mix and continued productivity improvements.
R&D spending increased $15 million to $54 million in the quarter.
Moving on next to Engineered Products revenue, in this segment increased 41 percent in the quarter.
The reclassification to include certain subcontractor costs as revenue in our infrastructure services business, which we announced and reported last quarter, accounted for 15 percentage points of the growth.
Organically, segment revenue grew 20 percent, driven primarily by higher volumes and increased selling prices due to higher raw material costs in electrical and metal products.
We also hit solid double-digit organic revenue growth in Flow Control and Fire and Building products.
Order activity improved across the segment during the quarter.
Operating profit for the segment more than doubled versus last year and the operating margin was 13.5 percent in the quarter.
Operating profit improved in all four businesses.
It should be noted that a significant portion of this improvement can be attributed to temporary dynamics in the metals markets.
In the fourth quarter we should continue to see top line benefits from higher selling prices, but we are forecasting lower operating margins as higher costs, raw materials and inventory flow through our production system.
We expect the operating margin for the segment to be between ten and 11 percent in the fourth quarter before divestiture and restructuring charges.
Finally, in Plastics and Adhesives, revenue for the quarter declined 2 percent despite a one percentage point benefit from currency.
Weakness in the A&E molded plastics and adhesives businesses was partially offset by growth at our plastic film business in Ludlow.
Operating income declined $22 million, due to tighter revenue spreads in our plastics films business and lower volumes at A&E.
Restructuring charges were $9 million in the quarter, nearly offset by $8 million of savings.
Operationally, the margin for the segment was down slightly versus last quarter, as cost reductions were more than offset by approximately 50 basis points of headwind from higher resin costs.
Before I turn the call back to Ed, let me finish the financial review with a few additional items.
Our tax rate was 27.9 percent for the quarter, putting us at 26.6 percent year to date.
The modestly higher effective tax rate in the quarter was mostly attributable to the early debt retirement charge.
We continue to expect a full year tax rate of approximately 27 percent .
We made good progress on working capital turnover in the quarter.
We reduced our primary working capital by three days sequentially and five days year over year, adjusting for the impact of lower accounts receivable securitization activity.
This continues to be an area of focus for the entire management team.
Capital spending, excluding spending on ADT dealer account purchases, was $236 million.
We were forecasting full year capital spending of approximately $1 billion.
Spending for dealer accounts at ADT will be approximately $250 million for the full year.
Research and development spending was $201 million in the quarter, up 16 percent versus last year.
Year to date, R&D spending has increased 20 percent .
We continue to make progress on our restructuring program in the quarter with charges of $41 million and savings of $34 million.
We have a big fourth quarter planned and we continue to expect the full -year costs and savings to be close to the levels forecast last November.
With respect to the divestiture program we had lots of activity during the quarter but only seven transactions were completed, generating a $3 million gain in the quarter.
Overall, we have exited 17 units and we will make more progress this quarter.
Finally, cash from operating activities on the cash-flow statement was lower than free cash flow this quarter, which is unusual.
This is due to the retirement of $461 million of our accounts receivable securitization programs.
Now let me turn the call back to Ed for a few closing comments.
- Chairman and Chief Executive Officer
Thanks, Dave.
Let me start with our guidance for the fourth quarter.
We believe earnings per share will be in the range of $0.41 to $0.43 for the fourth quarter, which would bring the full year to the $1.61 to $1.63 per share range.
Our earnings per share guidance is before the impact of the restructuring and divestiture programs, as well as any charges incurred for the early retirement of debt.
From a cash-flow perspective we expect cash from operating activities to be $5.2 billion, and free cash flow to be $4.7 billion before voluntary pension contributions.
Let me also comment on our use of excess cash.
We believe Tyco has the cash-generation capability to both strengthen the balance sheet and return capital to our shareholders.
While debt reduction is our first priority, we will be exploring other possibilities, including a higher dividend, share repurchases and modest acquisitions, and we will keep you updated.
Before we open up for questions let me say that we are pleased with our progress through the first three quarters of 2004.
As we look forward, we are confident that we are targeting the key drivers that will enable to us accelerate organic growth, continue to improve our margins and continue to generate strong cash flow.
Thanks for joining us this morning.
Now, operator, let's open it up for the first question.
Operator
Okay, thank you. (Operator Instructions) Our first question comes from the line of Stephen Volkmann with Morgan Stanley.
Please go ahead.
Good morning.
Ed, can I ask you to give us a little more on this comment about the cash redeployment, maybe with respect to some timing or some signposts that we ought to be looking for down the road?
Do we need to wait for certain things to happen?
Is the boat (phonetic) on acquisition pipeline sort of filling now or is this further out?
Just some more detail with respect to that?
- Chairman and Chief Executive Officer
Yes.
Specifically on the acquisition, Stephen, I would tell you we are not targeting anything in the first half of fiscal 2005.
So you might see some activity from us in the second half of the year.
And I would like to stress, as I said in my comments, it would be modest and you won't see a series of those in rapid succession.
That will not happen.
So, sometime in the second half of the year, you might see a couple in the modest-size range.
From a standpoint of cash deployment on the other, we are looking at it very closely.
We know we are approaching the point in time where we are going to be de-leveraged very nicely here .
But I do want to stress to you, as I said, we have a few more quarters of debt reduction being our priority, and clearly, you know, we are investment grade now but we are at the lowest level and we want to move that up a little bit.
So, as we move into '05 you will be hearing more about it from the standpoint of share buy-back and/or dividend move.
Okay.
Great.
If I could just switch over to the medical business, I guess, vis-a-vis my model, the top line growth was a little bit lower, the margins were better.
Do we have any issues with market share in those businesses?
You mentioned some of the areas where you were weak there.
Maybe you could just give us a little more on that.
And then, the outlook for the margins, can they continue at this level or continue to improve?
- Chairman and Chief Executive Officer
Yes.
Look, the issues we had on the organic growth side, let me just walk through, really, the three issues with you.
And I would tell you that most of this was our own inflicted pain during the quarter.
And, quite frankly, we saw a little of this in the second quarter, one of them was the same issue.
In Japan a couple quarters ago, we started moving to a direct sales model from the distributor model, and quite frankly, we have not handled that as well as we should.
We are working our way through those issues.
But, long term for us it was the right thing to do to go direct, so we don't question that at all.
But we did have some issues in there.
And Japan is a nice size market for us, so that's where we saw the decline -- our own doing, not the market's doing.
We are seeing that pick up as we are going into the fourth quarter here, so we feel we are starting to turn the corner on that.
The other big one that brought our organic number down was on the retail side of the business.
We had some major adjustments with a couple of our large retailers in the inventory channel there.
And again, that's another problem we worked through in the third quarter and is adjusting well in the fourth quarter.
So, with those two coming back the rest of the businesses in July look like they are tracking well.
Again, we expect by the time we end the fourth quarter, our year's growth rate will be 4- 5 percent, and more like 5-6 percent from the fourth quarter.
Just to your point on operating margins, look, we've had nice cost take-out continue in this business.
We did have some favorable mix this quarter, but our retail was down.
That's our lowest margin business.
And mix helped us a little bit, but the bulk of it was operational improvements.
So, depending on mix going forward, and quarters we will bounce around a little bit, but you could see quarters that are in this operating range going forward.
Great.
That's helpful.
Thanks.
Operator
Thank you.
We have a question from Bob Cornell with Lehman Brothers.
Ed, these questions are getting easier and easier to answer, right?
Actually, how about an update on security, both some of the changes you put in place across the board, North America, a comment on-- it looks like Security Europe dropped back a little bit in the quarter in the start there?
The sales changes you put in place domestically and a little more depth on that perspective.
- Chairman and Chief Executive Officer
Yeah, Bob.
We are feeling good about the Fire and Security business.
I think that you can see by the numbers, we pretty much hit things right along where I think most people expected and certainly what will we were projecting.
We had nice margin expansion across the business.
One of the nice highlights was on, you know, the whole worldwide ADT and Security business, ex- Continental Europe, as Dave mentioned, improved to 16 percent EBIT margins.
So we are seeing nice progress there.
The nice thing that's happening, and we are still in this transition year and it will continue into the beginning of 2005, but we really are getting our sales force redeveloped, rehired and in place.
As I mentioned last quarter to you, we were built back about 70 percent on the sales force.
We basically did a wholesale change-out of our 1300 salespeople to bring in a higher level group, now that we are going for internally generated sales, not as much on the dealer side.
We are starting to see the pay off of that.
But we are not fully built back to where we want to be yet.
We still have another one 150 -200 people that we want to higher back in on the sales side of the business.
And then, you can imagine we are going through immense training with this group as it is pretty much new.
As we get through that pipeline, I think you will see nice organic numbers from us in that business but mostly internally generated.
That would be when, like in next year we would start to see something like that?
- Chairman and Chief Executive Officer
Yeah.
I want to hedge a little bit.
We are kind of planning internally by the second quarter of fiscal '05, we start to see a little more lift.
We are also excited to launch some of these new products more broadly than we've been talking about but we've been waiting to get the organic thing moving properly with the new sales force and then we will introduce a couple of the new products that we've been talking to you about.
So, you'll start to see momentum second quarter of next year and build throughout next year.
I will point out to you one other part of Fire and Security.
Actually, two other comments, that our manufacturing arm had nice organic growth, over 10 percent, and nice margin improvement again.
So that business is really looking nice.
We are finally -- and again I don't want to overstate this -- but we are seeing some indicators on the bid side in our fire business, that things are starting to solidify there.
I would point out, also, just looking at the Dodge reports and all that, it really does look like commercial construction bottomed out during the last quarter.
It looks like it was kind of flat.
It was the last quarter where it didn't keep sequentially dropping.
They are forecasting a slight pick up in the fourth quarter into next year, and we are seeing some indicators of that in this bidding process.
So, hopefully, that's solidifying a little bit now also.
Final thought on TyCom?
- Chairman and Chief Executive Officer
You will see activity on TyCom very soon.
We are expecting that, hopefully, this quarter that we're in that we'll finally have an announcement.
Operator
Okay, thanks.
Thanks, Bob.
Operator
Thank you, and we have a question from Jack Kelly with Goldman Sachs.
Please go ahead.
Good morning, guys.
In terms of electronics, the incremental margin in the quarter was about 16 percent.
Given the strong volume increase you had, the 10 percent organic, I know there was some mix issues there, it looks like that incremental margin should have been higher.
Now, you pointed out the hit from commodities which was a negative 80 basis points.
But whether you or Dave maybe could just kind of go over what the other issues were?
Was it higher costs in terms of ramping up the production, mix, et cetera?
And also, maybe going forward, is that incremental margin going to get better?
- Chairman and Chief Executive Officer
Yeah, Jack.
If you walk through it kind of in its pieces our electronics components business, ex-TyCom, sequentially improved 60 basis points, ex the two sensor or, 20 basis points, excuse me, of restructuring.
So, if you really look at the actual progress, we had about 50 basis points sequential improvement.
If you look at our drop through on the incremental revenue, it was about 23 percent in the quarter, and that's the metal headwind, which, you know, obviously is hitting us.
We clearly know that that conversion rate should be at least up in the mid-30 percent range, 35 percent range or so.
If you go through our details in the business, the one thing-- I like the margin expansion as to where we're going, but we lost our focus in the last quarter on some of our operational intensity take-out cost programs in the business.
I'm not overly concerned about it, because, you've got to imagine, in this business we are feverishly ramming up in every facility, we have and our number one goal that've we really focused on with the electronics team is not to lose business while the market's ramping up.
We are very focused on our customer delivery statistics.
And I will tell you, if I had the time to go through some of the detail with you, it's very impressive.
Despite the order ramp, we are doing very good against delivery.
But because of the flurry of activity there, we didn't get the cost take out during the last four months or so that we would want.
We are refocused on that and I think it just bodes well for the future.
We are confident in the margin expansion nut continuing in electronics, and sequentially we should not be seeing any more much of the metal price pressure.
On a year-over-year basis it will, but sequentially, it won't.
So that will start subsiding a little bit for us.
Okay.
And just on the disconnect numbers for ADT, Dave, you gave us the U.S.
Could you just break that down to residential and commercial?
And then, just how you see those margins trending.
You had mentioned 16 percent in the quarter.
Can we continue it to ramp up sequentially there?
- Chief Financial Officer
Yeah.
As we look at the disconnect, we'll give you the details in terms of the commercial, residential, in dealer within the U.S.
As we look forward, you'll recall that we had a pretty big spike in the fourth quarter of 2003 in terms of disconnect.
And we had a lot of account clean -up activity.
I think with the gradual progress we saw this quarter, as we've said all along, we would expect things to kind of level out and then start to decline in 2005, and that's still what we expect to see on the disconnect side of things.
With respect to debt margin improvement, we had very good performance at our security businesses, particularly North America.
And as we look at the margin expansion ramp that we laid out for you through 2006, the worldwide security business is a big piece of that overall margin ramp.
So we feel good about our progress to date.
As we look at, specifically, the disconnect rates, the commercial rate was 13.3 percent .
The residential rate was 17.1 percent and the dealer was 17.1 percent , all in the U.S., Jack.
And that bring us to that average of 15.6.
- Chairman and Chief Executive Officer
15.6 in the U.S., 15.8 overall and 16.1 outside the U.S.
Okay.
And just on Continental Europe, break-even was kind of your expectation for this year, that's what you did in the quarter.
What do we need to get that to be a reasonably profitable business from this break-even level from here?
Is it just simply a matter of volume?
- Chief Financial Officer
I think it's a matter of volume as well as focused efforts on a couple of markets.
As we look throughout Continental Europe, some markets are better than others and Dave Robinson's team is really focused on a couple of our key markets, being Germany, number one, Belgium, number two, for improvements, particularly in Germany, which is a big market for us.
- Chairman and Chief Executive Officer
Jack, and just to add to that, it's a very similar story to the USA ADT business.
When you go back two years, or, really, a year and a half ago, Europe was almost exclusive a dealer program, even more so than the U.S., and zero down programs.
So, again, we are actually building a sales force over there.
So we won't see much more volume ramp until with get that completed, and again that happens as we enter the next quarter or two to get that completed.
The other big thing that we did recently in Europe is, we collapsed together our Sensormatic business with ADT, which is a very potent way to go to market with the whole retail marketplace.
We had already done that in the rest of the world and had good results.
Surprisingly, it was never done in Europe or Continental Europe and we put that together now, and therefore we expect to see some improvement from that also.
Thank you.
- Chairman and Chief Executive Officer
Yeah, thanks, Jack.
Operator
You have a question from Jeff Sprague with Smith Barney.
Please go ahead.
Thanks.
Good morning, everybody.
Just to follow on a detail on Fire and Security and a couple other topics.
Dealer spending still kind of running below what you might have thought about a year ago.
Is that reflective of comments that-- you know, kind of moving away from it or is it just kind of the quality of what the dealers are bringing to you?
- Chairman and Chief Executive Officer
Jeff, it's the quality.
We are only going for the quality metrics we want.
That's what we are getting right now.
I would say to you, we are not going to move away from the dealer program.
Quite frankly, if we could spend more to get the quality accounts we want, we absolutely will do it.
I would expect that we can ramp that up some in 2005 from the run rate we are at now, as we are getting the core dealers we want going forward.
We are really focused on working with them on their programs.
If we can enjoy more business there, we want the business, and we do think it will pick up.
So, we are not expecting this thing to keep declining.
Just on Fire, it sounds like it's still early and sketchy on what's going on in the market.
But can you characterize at all, kind of geographically or kind of commercial vertical markets where you might be seeing some signs of life?
- Chairman and Chief Executive Officer
Well, you know, it's basically the broad commercial construction market, is what's affecting that business.
I will point out, we had nice margin expansion this quarter in the business.
So, operationally, Jeff, our operational programs and our restructuring programs are taking hold and we are starting to see some benefit on the fire side from that.
But if you look at the bid trends that we are seeing, we are most encouraged by the Simplex Grinnell, you know, the U.S. end of the business, we are seeing some good signs there.
I just don't want to overstate it yet, because I still don't see it fully building in our order rate yet, but it is solidifying.
And Simplex Grinnell in North America is a big piece of the business.
We are also in Australia, where we are pretty big in this business, seeing some indicators of the market also picking up.
So, hopefully, that will start to trend better for us this quarter.
But you know, if you go through Tyco's portfolio in total, in most of our markets we started to see a nice pick-up back in kind of the September time frame.
Last quarter was the first quarter we saw a nice pick-up beginning in our industrial businesses, which is engineered products.
And I would point out, it was broad-based against all four businesses.
And now maybe we are seeing the last party of Tyco's portfolio, which is this commercial construction piece starting to solidify.
Right.
I wonder,Dave, you did pension of $173 million in the quarter.
Can you just update us on what your plans are in the fourth quarter and where the funded status of the plans are currently?
- Chief Financial Officer
Yeah.
I mean, we remain underfunded both in the U.S. and outside the U.S., Jeff.
As you'll recall, at the end of our last fiscal year, we were about $1.9 billion underfunded.
We are looking at making voluntary contributions in the fourth quarter, again in the U.S., and potentially outside the U.S. as well, to improve the overall funded status.
As we look at the drivers in addition to contributions and investment returns, as we look at the overall interest rate environment, I think if we set a discount rate right now, it would probably be not much different than it was a year ago.
So that won't have any volatility, at least, if rates hold where they are.
A few months ago, we thought we might get a little bit of a benefit, but it doesn't appear as if that's the case, with rates coming back down a little bit.
Great.
Thanks a lot.
- Chairman and Chief Executive Officer
Thanks, Jeff.
Operator
Thanks.
We have a question in from Don MacDougall with Banc of America Securities.
Good morning, gentlemen.
First question would be on seasonal patterns and the sequential guidance.
You did, if we exclude the$0.02 of restructuring and debt retirement, $0.45 in the quarter.
I would expect it to see maybe less of a sequential decline, given Tyco's seasonal patterns, than what you're projecting to the mid-point of your 4Q guidance.
Is there anything else going on or are my seasonal conceptions of Tyco's businesses not quite right?
- Chairman and Chief Executive Officer
Don, the only piece in there that you'll see a little drop-back on is the steel piece of the business.
You know, we forecasted in our modeling a big part of the lift that we saw in the last quarter.
But, as Dave mentioned, the margins we expected in engineering products in the fourth quarter would be more in the 10-11 percent range in that.
If I could add to that, I would say closer to the 11 percent range.
So that will drop back a little bit.
That's maybe $40 million or $50 million there that we will see from the steel pricing spread.
But, let me highlight to you, there's nothing else really seasonally. the changes in the business.
We are feeling very good about the fourth quarter.
Things are solidifying nicely for us.
So, you know, we are feeling good about where we are.
Great.
And then, a question on electronics.
You had commented that order growth in July was 16 percent , which is encouraging, given a lot of the concerns out there in various end markets.
Could you comment maybe on inventory levels?
Has there been any sign of building, either in your plants or at your customers?
And any other general end-market color that you can provide on what those markets are doing right now?
- Chairman and Chief Executive Officer
Don, it's interesting.
We were looking back during the quarter, because I know a couple of the reports that came out actually had one of the months last quarter where the book-to-bill was below one, I think it was .97 in the reports, and people were a little concerned.
Of course, then the report obviously said it picked up the following-- it was picking up again.
But when you look back at our book-to-bill throughout the quarter each week and each month, really, we did not see any decline or any blip in that June time frame at all.
So it was pretty steady momentum through the quarter, and as Dave pointed out, orders grew 16 percent throughout July.
I can tell you it's broad-based.
We've got a couple of weak spots -- one, our battery business, but it's not really that big in the scheme of things.
And the other one that Dave highlighted was our power-- supply power business, mostly in North America, still weak.
But if you take those two out of it, it's broad-based against all the markets.
Industrial was very nicely up on an order rate during this quarter, but they all were.
So it felt good everywhere.
Okay.
Good.
And one final one, maybe for Dave.
You have paid off $500 million or so on the securitization program.
If memory serves me correctly, there might be another four or five hundred million left on that program.
Where does that rank in priority for future cash-flow allocations?
- Chief Financial Officer
As we look at securitization program, that's something we are looking to continue to pay down, Don.
And as we highlighted in our press release back in late May, use of facility, perhaps of reduced size, is part of our overall liquidity cushion.
So, expect us to continue to pay debt down and perhaps pay it all off in Q4.
So would that take precedent before other debt paydowns or perhaps retiring some of your convertibles?
- Chief Financial Officer
I mean, it's something we are looking to do because we think it's nice to preserve the liquidity there of those facilities.
But that's not the only thing we are looking at in Q4.
Great.
Thank you.
- Chairman and Chief Executive Officer
Thanks, Don.
Operator
We have a question in from Brian Langenberg with Langenberg & Company.
Thank you very much.
In electronics, in your connectors and cable assemblies, you gave us an overall number of up16 core in end markets.
Could you please drill down into those end markets?
Given that the margin variances can be pretty significant, tell us what the year-on-years were for auto, communications, et cetera?
- Chief Financial Officer
Brian, we are not going to get into that kind of detail.
We will do that from time to time when we do an investor meeting, but on a quarterly basis, that's probably more detailed than we are prepared to provide.
You do know that over the last couple of quarters we have been providing additional detail, relative to connectors and cable assemblies overall, how it has grown as a percentage of the business and how that overall components business has grown, of which connectors and cable assemblies is a piece.
So hopefully with this additional information that we've been providing over the last few quarters, that's helpful enough to give you a sense as to how we are doing overall in these key markets for us.
- Chairman and Chief Executive Officer
Brian, I would point out, you know, one area we've been more focused on in the last few quarters is, and in our R&D efforts with the slight increase that you are seeing there, we are putting it towards the commercial end of the business.
That was not Tyco's biggest strength area in the connector business.
We are starting to see some really additional progress in that area during this quarter in some wins that we have.
I meant consumer, not-- consumer, not commercial, yeah.
So we are seeing some nice business there.
You will hear a couple announcements out of us, most likely as we go through this next quarter.
So we are feeling good about that one starting to grow nicely for us, also.
Okay.
I appreciate that.
Just one follow-up question.
In engineered products and services, should we interpret the comments you guys made about the steel prices and say, if we took the fiscal third quarter revenue base and put a normalized 1-11 percent level margin on, basically it sounds like material pricing and inventory pass-through timing gave you about$0.02s in the quarter, which basically offsets the $0.02 charge?
- Chairman and Chief Executive Officer
Yeah, I would put it in the range of $0.02.
It's $40 million, $50 million.
We expect it to do very nicely for us this quarter and the following, but I would put it in about that range.
I would also just highlight to you, though, we are starting to see, as we pointed out, the rest of the business has started to ramp nicely.
And just from a margin expansion standpoint, in the first quarter of this year we were at 7.7 percent of the business, second quarter, 9.1 percent.
And, yeah, if I take out that little bit of blip in the third quarter, we are seeing close to 11 percent in the fourth quarter.
So, we are seeing nice margin expansion across that business.
We would plan on that to continue as we've given guidance through '06 on.
Oh, no complaints on this end.
Thank you very much.
Operator
Thanks.
We have a question then from Lee Cooperman from Omega Advisors.
Good morning, thank you.
Congratulations, you're doing a fine job and appreciate your efforts.
I have really two questions, I don't know if you want to get into them.
I wonder if I could try to press you to prioritize with a little more specificity your use of free cash-flow.
Basically, at the end of the quarter we had net debt of $13.1 billion. $4.5 billion of that is-- converts well into the money, admittedly can't be called for another couple of years.
So, that gives you net debt currently of $8.6 billion.
We had the lowest interest rates in 50 years, so I personally don't see the rush to pay down debt, and you are generating free cash flow of $4.7 billion a year, which is frankly equal to maybe two years to pay down all your outstanding debt.
Do you have in mind a targeted level of debt?
Because right now, if I took your converts of $4.5 billion and put them into the equity base, your debt to capital ratio would be slightly under 20 percent already.
Do you have a target that you would like to achieve or is it kind of touchy-feely at this point in time?
That's my question one.
- Chairman and Chief Executive Officer
By the way, thanks for your opening comment there.
I'd say it's a little more than touchy -feely.
We are targeting to move down into the $10-12 billion range, probably more leaning towards the ten.
I understand the math also with the converts and all.
It's getting to be a very nice picture for us.
We will be de-leveraged where we want to be real quickly here.
I just don't want to comment more on cash redeployment until we get to the end of the fiscal year and do our whole next quarter.
But I want to stress again, we have commitments with the rating agencies.
We are very focused on that.
And so we will continue for a few quarters, and I say primarily use our cash.
That doesn't mean all of it, but primarily use cash to continue the debt reduction and then we will pretty much be where we need to be.
Got you.
Not to nitpick you, but basically you are already below $10 billion if you take the converts as equity.
I realize-- I guess one convert is callable on January 18 of '06 and the other one is January 23 of '08.
So you're looking at it as in debt until you get it into equity, is that correct?
- Chairman and Chief Executive Officer
That's correct, Lee.
Okay.
Second, is there any progress report that you can give us on the shareholder litigation status going on there?
- Chairman and Chief Executive Officer
Nothing new at this point in time.
You know, obviously, we've been in some conversations, but nothing that I can report to you.
Keep running with the good work.
Thank you very much.
Operator
Thank you.
We do have a question in from John Inch with Merrill Lynch.
Please go ahead.
I want to ask you about restructuring and divestitures and how we should be thinking about this.
Now Dave, you mentioned that the fourth quarter is going to be a large -- I'm assuming -- expenditure quarter for restructuring.
But if you go back to your guidance, you thought you were going to do 280 this year, you've done 150.
We were expecting 50 divestitures, you've divested 17.
I guess my question is, what do you think is the likelihood that these programs spill into '05?
Because I was sort of under the impression that '04 is the transition year and that '05, there won't be any of the, when it times to providing your guidance, there won't be any of these sort of pro forma treatments vis-a-vis these charges?
Just any kind of color around that.
- Chief Financial Officer
Sure, John.
I mean, I think clearly, in terms of the restructuring, we are looking at doing in 2004 what we said we were going to do in 2004.
So, yes, indeed, we are expecting a big quarter in the fourth quarter.
And we are still looking at overall charges in the range we laid out last November, which would put the fourth quarter well over $100 million.
With respect to the divestiture program, a lot going on.
I guess that's one where-- could there be some spill-over into '05?
Yes, but we'll have more to say as we move through that.
But a lot more is going on in that area than is reflected in the 17 transactions that have closed to date.
- Chairman and Chief Executive Officer
John, just to clarify, also, we will not have any call-out restructuring next year.
It will be a big fourth quarter.
Dave and I have reviewed it with every business in the last couple weeks.
We are on track for the big quarter, and so we will hit the numbers, both on the cost side and the savings side this year, and it will not spill into next year.
Okay.
And then, in terms of sort of where we are at as we roll to the end of the fiscal year, you know, the raw materials were 80 bits with headwind.
And I want to kind of put this into a context.
The organic growth seems to be moving up nicely.
But, Ed, how do you think about sort of where we are at versus the 2006 forecast assumptions that you guys laid out at that analyst meeting in March, vis-a-vis the margin targets, the revenue targets?
Maybe you could give us a little bit of color in terms of how you think we are progressing towards those expectations.
- Chairman and Chief Executive Officer
John, on the sales side, let me just make one point -- and we are having nice continuing sequential improvements, organically.
But I will highlight one point to you, as we talked about a little earlier on this call.
On the Fire and Security side, we only had 1 percent organic growth.
And, again, we are purposely -- and I shouldn't say totally , but because of the transition we are going through, you know, $12 billion of our $40 billion portfolio is not having the growth that we know it can have.
So, hopefully, as I mentioned, as we get into '05 and kind of the middle of '05, we start to see more of a ramp there and we are very focused on that happening.
So that should continue to help us on the organic side from one of our big businesses we haven't been seeing it on.
On the margin expansion side, I think we are tracking very well.
I would-- and so what we said out there in '06, you know, we stick with those comments.
I would adjust one caveat, though, and that's with the accounting change we had to make in engineered products to go from net to the gross revenue that we talked about we did last quarter, and we saw it in the numbers this quarter.
That does bring down the margins from what we forecasted by kind of 1.2 to 1.6, as we move out into the future.
I think you ought to model that in.
However, that does not make a change to the absolute profitability, it's just to the margin percentage in that business.
And just finally, you feel, vis-a-vis the electronic margin targets that you guys laid out for 2006, that, given raw materials and sort of the 23 percent profit conversion, that we are still tracking toward that 20-- well, I guess, the high teens expectation?
- Chairman and Chief Executive Officer
Yeah, I mean, look, hopefully, we start to get some, you know, over the next couple years the pressure from metals subsides some.
So, you know, obviously, we did not count on this kind of pressure in that area.
I don't think anybody could have forecast that.
But we know if we get this conversion rate at least up into the mid-30s and we are focused on that, that we will be in good shape.
Okay.
Thank you.
- Chairman and Chief Executive Officer
Operator, we will take one more question.
We are almost going on the hour.
Operator
Very good, sir.
That question comes from Steve Tusa's line with J.P. Morgan.
Please go ahead.
Good morning, guys.
I don't know if you talked -- sorry if I missed it -- if you talked about pricing in electronics.
There's been some news of some of the smaller competitors putting some pricing through, and you guys sounds very, very positive on what's going on there.
Maybe just some comments on the pricing.
- Chairman and Chief Executive Officer
Yeah, Steve.
As I had mentioned, we put some pricing through on-- I don't want to get into specifics where and all that, but this is the first quarter we started to institute a little bit what I'd call more systematic price increase in the business.
However, as we have every other quarter during the last few quarters, we had about 5 percent price pressure in the business.
So we did not see that subside yet.
As I said last quarter, you would think we might see some, although we haven't really modeled all of that into our thinking at this point in time.
So, we are seeing a little bit of pricing that we can put out there, but we are still seeing the percent decline, at least last quarter.
Okay.
Great.
That's it.
Thanks.
- Senior Vice President of Investor Relations
Thanks for joining us for the call.
Any questions, please feel free to follow up.
We look forward to reporting to you on our fourth quarter three months down the road.
Thanks for joining us this morning.
Operator
Thank you.
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