江森自控 (JCI) 2005 Q2 法說會逐字稿

Welcome to the Tyco reports second quarter earnings results conference call.

At this point all the participant lines are in a listen-only mode.

However, there will be an opportunity for questions and instructions will be given at that time.

If you need any assistance, please press star than zero and an operator will assist you off line.

And as a reminder, today's call is being recorded.

I would now like to turn the call over to the Senior Vice President Investor Relations, Mr Ed Arditte.

Please go ahead, sir.

Thank you, John, and good morning.

Thanks for joining our conference call to discuss Tyco's second quarter results for fiscal year 2005 and the press release that we issued earlier this morning.

With me today are Tyco's Chairman and Chief Executive Officer, Ed Breen, and our Chief Financial Officer, Chris Coughlin.

Let me remind you that during course of the call we will be providing certain forward-looking information.

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

In addition, we will use certain non-GAAP measures in our discussions this morning and we ask you to read through the sections of our press release that address the use of these items.

In reviewing our operational performance with you we will also present certain non-GAAP financial information for businesses below the segment level in order to provide additional visibility into the particular results at the sub-segment level.

The press release and all related tables can be found on the Investor Relations portion of our website at Tyco.com.

Now, before I turn the call over to Ed Breen, let me quickly recap the GAAP earnings per share from continuing operations for the quarter and the $0.37 of charges we took during the quarter.

As reported, EPS was $0.11 per share and included the following three items -- first, a $573 million charge for the early retirement of convertible securities.

This charge is non tax-deductible and is equivalent to $0.26 per share.

Second, a $202 million pretax impairment charge in the A&E business unit of our Plastics & Adhesives segment.

This charge is mostly non tax-deductible and is equivalent to $0.09 per share.

As you know, we announced earlier this morning that we are exploring the possible sale of Plastics & Adhesives.

And third, a $50 million pretax charge to reflect our current best estimate to settle the SEC enforcement division investigation of Tyco.

This is also a non deductible charge and is equivalent to $0.02 per share.

As we state in our press release, this charge remains subject to satisfactory negotiation of an agreement with the SEC staff as well as final approval by the SEC and Tyco's Board of Directors.

Now with that as background, let me turn the call over to Ed Breen.

Thanks, Ed, and good morning.

I'm pleased to report to you that our second quarter earnings per share were at the high-end of our expectations.

As Ed mentioned, our GAAP earnings per share from continuing operations were $0.11 compared to $0.37 a year ago.

Adjusting for these charges our EPS grew 17%.

Our free cash flow was 1.3 billion in the quarter before dividend payments.

This represented more than 12% of sales and 123% of income from continuing operations before charges.

Organic revenue growth was 3.4% in the quarter.

We had strong growth at Engineered Products which was muted by lower growth at ELectronics and Healthcare.

In Fire & Security, I was pleased to see our growth accelerate modestly in the quarter to the 2% level versus flat sales last quarter.

Operating profit increased 14% year-over-year and the operating margin expanded 100 basis points to 15.3%, again adjusting for charges in both periods.

While we are pleased with our margins in Healthcare and Engineered Products, our margins in Electronics and Fire & Security continue to approve but are not yet at the levels we have targeted.

In Electronics we have been hit with significantly higher raw material costs which we have not been able to offset through higher prices and in Fire & Security we are heavily investing for growth which we are just now beginning to see.

Next, this was a big quarter for us relative to the repurchase of convertibles.

During the quarter we spent 1.5 billion to repurchase 932 million of face value of convertible bonds which reduced our diluted share count by nearly 42 million shares.

When added to our repurchases in the previous two quarters, we have now bought back 1.7 billion of convertibles and lowered our diluted share count by approximately 76 million shares, or 3.4% of our shares outstanding.

Finally, as Ed mentioned, we announced that we are exploring the sale of the Plastics & Adhesives segment and we are in the early stages of the process.

We have a good management team in Plastics & Adhesives and we believe they will do well with an owner who is commit to that industry for the long-term.

Before I turn the call over to Chris to review our operational performance, let me quickly recap some of the important items in the quarter from my perspective.

First our results this quarter were solid.

We made good margin progress and I'm confident that we are doing the right things to continue to improve both our top-line and our margins.

Operationally we continue to invest in growth and productivity with higher capital spending, which is up 175 million over last year through six months, and continued investment in our sales and marketing organization.

We paid for these investments by lowering our G&A expense as a percentage of sales by more than 100 basis points year-over-year.

Next we accelerated our convert buyback in the quarter.

We are taking shares out of the marketplace and using our cash appropriately.

In addition, while the convert buyback is reducing our share count, it is also strengthening our balance sheet which continues to move closer to A rated ratios.

Our decision to explore the sale of Plastics & Adhesives is an important development for Tyco.

This is a continuation of our portfolio refinement and you should expect to see more from us on this front.

Finally, our working capital performance this quarter kept our cash flow from being even stronger.

As you know, we took 15 days out of our primary working capital the past two years and we had expected to improve an additional three days this year.

Based on our current view, we see our primary working capital days being essentially flat year-over-year.

We still see real opportunity in payables but a more meaningful reduction in receivables and inventory will come from continued rationalization of our still inefficient footprint.

Let me assure you, however, that improving our primary working capital will continue to be a priority for this management team.

Now let me turn the call over to Chris to review the operations.

Thanks, Ed, and good morning everyone.

I am delighted to be here on my first earnings call with you and I look forward to spending time with many of you as we move forward.

Let's turn to the segment results.

The segment and sub-segment results I will cover here have been adjusted for charges in both periods to provide a more accurate view of our performance.

Starting with Fire & Security, reported revenue was essentially flat due to divestitures.

Organic revenue growth was 2% in the quarter.

Operating income was $311 million and the operating margin improved 100 basis points to 10.8%.

Included in this improvement was 70 basis points of headwind from higher selling and marketing expenses in the quarter relative to last year.

Looking at our performance by business unit, our Worldwide Security, excluding continental Europe which represented approximately 50% of the segment revenue, was essentially flat organically.

The operating margin in the quarter increased 200 basis points year-over-year to 17%.

Revenue in continental Europe security, which represented 7% of segment revenue, declined 5% organically as we continue to work through higher attrition levels from our legacy customer base.

The business generated a slight operating profit in the quarter.

The Worldwide Fire business, which represented 33% of the segment revenue, grew 3% organically and the operating margin was over 5%.

Backlog in North America continues to improve, particularly in our higher margin Electrical businesses, which we anticipate will lead to stronger growth and improved margins in the second half of the year.

Finally Safety Products, which accounted for approximately 10% of segment revenue, generated a mid single-digit organic revenue growth, primarily reflecting strong growth in breathing systems.

Operating margins were in the mid-teens.

We were pleased to see our ADT trailing twelve-month disconnect rate decrease by 40 basis points sequentially to 15%.

The combined effect of lower gross attrition rates and higher resale rates contributed to the decrease.

While we are encouraged by the improvement this quarter, we continue to expect a modest increase in attrition levels over the next couple of quarters as a large number of dealer accounts, acquired in the 2002, hit their peak disconnect period.

Turning to Electronics, revenue grew 10% to $3.1 billion, partially due to the accounting calendar change which shifted this year's slow holiday season into our first quarter.

Organic revenue growth was 2% with modest growth in automotive, computer and consume,r and general industry markets, which was partially offset by weakness in Power Systems and our Printed Circuit group.

From a geographic perspective, growth in Asia/Pacific and North America was partially offset by a modest decline in Europe.

We were encouraged by improved order activity in the quarter and throughout April.

Our book-to-bill ratio finished the quarter at 1.02 versus 0.99 in the first quarter and 0.96 in the fourth quarter of last year.

Operating income in the quarter was $496 million and the operating margin improved 90 basis points to 15.8%, primarily driven by the accounting calendar change.

Higher material cost, copper, gold, and other raw materials, cost us approximately 60 basis points of margin on a year-over-year basis.

In addition, weaker performance at Power Systems, Printed Circuit group and Tycom cost us approximately 30 basis points.

As we look to the third quarter, we see organic revenue growth improving with modest improvement in our operating margin due to operational efficiencies partially offset by continued raw material headwind and expected weak performance in Power Systems, the Printed Circuit group and Tycom.

In addition, we are closely watching the European automotive market, which softened in the third quarter -- which softened in the quarter and continues to be weak.

There has been growing concern over diesel emissions in Europe and a shortage of particle filters has led to a temporary drop in demand for diesel automobiles.

Now turning to Healthcare, revenue grew 4% to 2.4 billion, with organic revenue growth of 2.4%.

High single-digit growth in our Surgical and International businesses was partially offset by declines in Retail and Respiratory.

Our Surgical business continues to gain traction from new products and our International business has solid growth in all major regions led by double-digit growth in Japan.

The decline in our Retail business was driven by our raising prices ahead of our competitors to offset raw material increases.

In terms of operational performance, this was a record quarter for the operating -- for operating income and operating margin.

Operating income increased 19% to $689 million and the operating margin expanded 370 basis points to 29.1%, driven by a higher margin sales mix and continued cost improvements.

The margin also benefit from adjustments to our litigation liabilities and related insurance recoveries which increased income by approximately $20 million.

As we look to the second half of the year we are expecting improved top-line growth as a novation contract ramps up at Surgical and several important new products gain traction in our pharma, respiratory and imaging businesses.

Partially offsetting this growth, we expect continued weakness in our Retail business.

In Engineered Products we had another solid quarter with 11.5% organic revenue growth reflecting strong growth in three of the four business units.

The Electrical and Metal business continued to benefit from higher pricing in the steel market while Flow Control benefited from strengthening markets in North America and Asia.

Fire & Building Products continued to experience strong demand from improving global construction markets.

Operating income grew 23% to $165 million and the operating margin expanded 70 basis points to 10.3% with significantly improved margin in three of the four businesses led by Flow Control.

Operating profit and the operating margin declined at Infrastructure Services primarily due to the project delays and cost overruns on a few projects.

End market demand remained strong throughout the quarter across most of the businesses.

Backlog and Flow Control, our largest business, increased 29% versus a year ago and Electrical & Metal Products and Fire & Building Products continue to perform well.

As we look to the second half of the year we are expecting lower organic growth and lower operating margins mostly due to tightening margins in our Electrical & Metal Products businesses.

You might recall that this segment had a very strong third and fourth quarter last year, primarily due to a rapid run up steel prices.

In Plastics & Adhesives revenue increased 8% to $463 million.

Organically revenue grew 2% in the quarter with growth, again, in three of the four business units partially offset by weakness in our A&E plastic hanger business.

Operating income decreased $23 million -- I'm sorry, operating income decreased 23 million and the operating margin was 3.2% after adjusting for the impairment charges in A&E.

This decrease was primarily due to higher resin cost as well as a significant decline in our plastic hanger business as we continue to transition to a direct sales model in Asia.

So before I turn it back to Ed, I also wanted to update you on a few other items.

You will see that our tax rate was 62.2% for the quarter, primarily due to the charges for early debt retirement, asset impairments and the estimated SEC settlement, most which had no tax benefit.

Adjusting for these items are our tax rate was 27.4%.

Net interest expense declined $34 million in the quarter to 178 million.

Net debt decreased to 11.5 billion from 12.1 billion in the prior quarter.

And our debt to capital ratio improved to 31.3% at the end of the quarter.

The sale of the TGN business is progressing through the approval process and we continue to anticipate closing the sale by the end of the fiscal year.

Approval from the FCC was granted late last week.

Now let me turn the call back to Ed.

Thanks, Chris.

Let's turn first to guidance for the third quarter and full year.

For the third quarter we expect earnings per share from continuing operations before charges to be in the range of $0.47 to $0.49 per share.

We expect the quarter to be led by improved year-over-year profitability in Healthcare, Fire & Security and Electronics, with weaker comparisons in Engineered Products due to the very strong steal market that contributed to unusually high income and added an extra $0.02 of EPS to last year's third quarter and weaker performance of Plastics & Adhesives.

We are also carefully watching, as we mentioned, our European automotive Electronics business due to market and regulatory issues in Europe.

For the full year we are narrowing our guidance range of EPS from continuing operations before charges to $1.88 to $1.93.

Achieving the high-end of our previous guidance range now appears unlikely due to the impact of increased commodity costs across the company and the anticipated weakness in European automotive Electronics.

And I will mention the continued sales and marketing investment we are making in Fire & Security, although we are beginning to see organic revenue growth from that business.

With respect to cash flow, our guidance for cash from operating activity and free cash flow is now approximately 6.4 billion and approximately 4.6 billion respectively.

Based on input from many of you, we have revised our free cash flow definition to exclude dividend payments and voluntary pension contributions to create greater comparable to other companies.

The dividend payments will total 625 million for the full year, which represents one quarter at 25 million and three quarters at 200 million.

The reduction in our cash flow guidance is primarily due to our current assessment of flat working capital as a percentage of sales for the full year.

Let me wrap up this morning with a few comments on our operations and our assessment of where we are today.

First in Fire & Security, we are confident we are making the right moves by changing the business model in our security business, taking out G&A expense and reinvesting in the business.

We've made meaningful progress and there is much more progress ahead of us.

Our sales force is now about where we want it and our new package service offerings and improved sales organization should contribute nicely to higher revenue per user.

In our Fire businesses we have refocused our operations on Electrical and higher mechanical installations and we are encouraged by the pickup in end market demand we are now seeing.

In Electronics we've had good margin expansion over the past two years despite the headwind from raw materials.

As Chris mentioned, our results continue to be negatively impacted by the performance of certain business units that are largely tied to the telecom industry.

These operations are masking significant improvement in the rest of the segment over the past two years.

Without these businesses that we've previously mentioned, our margins would now be north of 17.5% for the Electronic segment.

In Healthcare our new product development activity is gaining traction.

Our margins are at record levels with increased investment in R&D as well as higher investment in our selling and marketing organization.

We believe the second half of this year will see a nice pickup in organic growth and we feel the investments that we are making are absolutely necessary to accelerate this growth rate.

In addition, our strength in balance sheet gives us the ability to add to our growth through acquisitions and Healthcare is the top of our list in terms of doing an acquisition.

In Engineered Products we are seeing improvement in a number of our end markets and this is encouraging after an extended period of softness.

Despite the challenging second half comparisons, we see good longer term growth opportunities and margin expansion potential.

For the past two and a half years we have been focused on specific issues in each business segment , as well as on developing a Tyco wide approach to Six Sigma, sourcing, talent management and addressing a variety of other important issues, all designed to turn Tyco into a world class operating company.

These efforts are now increasingly a part of the way we run the company day-to-day and they have played an important role in the progress we have made to this point.

As we look to the balance of 2005 and beyond, we are confident that we are on the right path.

Thanks for joining us on the conference call this morning and with that let's open up the lines for questions.

Operator, if would you please do that.

Certainly.

Ladies and gentlemen, if would you like to ask a question, please press the star then one on your touch-tone phone.

You will hear a tone indicating you've been placed into queue.

To remove yourselves from the queue at any time, please press the pound key.

Once again, if do you have a question, please press star, one.

And first we will go to the line of Jeffrey Sprague with Smith Barney.

Please go ahead.

Thanks, good morning, everyone.

Hi, Jeff.

Morning, Jeff.

I guess a couple of things.

First, just in light of the pressure in Electronics, specifically, I wonder if you guys have kind of recalibrated what you think of the '06 margin targets across the portfolio.

Well, Jeff, just to go back to a couple points that I made, look, we are, we've seen additional 60 basis points of headwind in the business this year.

I would add that's on top of 90 basis points last year.

So it's almost 150 basis point kind of year and a half headwind for materials.

So we are continuing to make progress.

You saw we ended the quarter on a run rate of about 15.8.

Again, eating this other 60 basis points of headwind.

We will continue to make progress this year.

And one other key point I want you to keep in mind, and I don't know want to go too deep on this, but we are entering the stage at Tyco of refining the rest of the portfolio.

We've continued to highlight businesses that we've been watching and as I mentioned a few minutes ago, the progress we've made in our core Electronics business on margins has actually been significantly more substantial than you've seen when you look at the whole picture that's got us from 12% two and a half years ago up to the 15.8.

The point that I just made to highlight that was if you extricate the three telecom businesses that are clearly underperforming in our portfolio, and I would add not that significant a part of our revenue, that business now, the rest of Electronics, is running north of 17.5% if you recalculated the second quarter.

So expect us to continue on our operational improvement initiatives, accelerating our factory footprint moves, which is where we are going to get the acceleration on our margin expansion in the business.

And you probably will see some other activity on us on refining the portfolio in the near future.

Okay.

So addition by subtraction in Electronics.

And then in ADT, the flat organic growth in the non-European piece, is that solely an attrition issue?

Can you put in perspective kind of the attrition versus the RPU and kind of new account growth in the quarter?

Jeff, that's actually, that's -- when you dig into the details it's actually starting to feel pretty good to us.

What's occurring there is simply the attrition that's still at the high levels and we pointed out improved slightly, but it was 15%.

We are pretty much backfilling that now with our new account generation and, again, some of our installation work and retailer business at ADT.

But I would tell you the retailer business was actually a little bit lighter this quarter than it had been running at.

So, we are starting to backfill the attrition pretty nicely on the ADT side which is keeping things around flat right now for us.

But if you look at the trend, and I would say especially the trend as we enter '06, we do expect attrition to continue down while new account generation continues to pick up.

And by the way, some of that is just math and it's been tracking well because we are going to finally be through the big pipeline of the dealer accounts hitting the three-year mark of the contract expiration.

So the fact that the attrition is already kind of settled in where it is while the accounts are picking up and then we kind of get this activity that starts to happen in the beginning of '06, starts to bode well, I think, for the growth rate picking up as we go into '06.

I would also comment, as I mentioned earlier, for all of Fire & Security, and again I'm not bragging about this number, I don't want to overstate it, but 2% organic growth we have not had in Fire & Security since I've been here.

And I will add that we do expect that organic growth next quarter to be over 3%.

So we are feeling comfortable we are going to start to see a gradual, and I say gradual, but it's going to be consistent, climb in the organic side in Fire & Security.

And, look, I'm convinced it was the investment we needed in sales and marketing.

We know that costs us 70 basis points last quarter, which we're maintaining, but the growth feels like it's coming now.

Just maybe one more and I will pass it on.

So on the free cash flow it sounds like it's kind of maybe you've reached some structural boundaries around the footprint and restructuring to kind of get to the next level.

Can you put in the context for us what needs to be done, kind of the timeline in terms of timing or amount of facilities or is there a particular business unit or two that's really the center of attention as you try to unlock the rest of this working capital?

Yes, look, Jeff, this -- we've had a lot of focus on this.

We started -- look, we had a very solid cash quarter.

Let me say that begin.

At 12% of sales, 123% of income, it was very strong.

However, we did think we would get another 150 to 200 million of free cash flow in to make up for some of the what we thought was the shortfall in the first quarter.

And it's all centered, and I think this goes to your question, it's all centered around working capital.

Our working capital in the second quarter Rick stayed basically flat.

Okay?

It did not decline.

It did not degradate on us.

But we didn't make improvement.

So, what we have forecasted for you the rest of the year, and maybe we are being conservative but we know we've got our work cut, is that we are not going to make improvement on working capital for the year and therefore the reduction in our free cash flow guidance is centered pretty much solely around working capital.

If you look at what's occurred.

In the last two years we improved 15 days on the working capital side, just tremendous progress.

We thought we could improve another few days this year.

And, look, I'm telling you we are still very focused on that, but we did not do that in the first half of the year here.

What we now need to do, as we really dig into this and you, I think, stated it perfectly, we've got to continue to work the structural issues in the company and we know there's a lot of opportunity there for improvement.

Jeff, let me give you two examples that were real examples in the quarter that I think put a little color around this.

Our receivables were up and we are collecting in way too many places, but it's quality receivables.

Our aging has not changed.

We're not concerned about that.

And it's up because our sales were up.

But where we normally would have made progress in this quarter would have been on inventory.

And when you look at inventory in two locations -- let me give to you examples.

As Chris mentioned in the call, 29% year-over-year backlog build in Flow Control.

Unfortunately, we have 141 factories in our Flow Control footprint.

We had not seen increases like this since I've been in the company.

We started seeing it last quarter.

I am telling you we are not ordering as efficiently as we can with 141 factories and that cost us some inventory as we dug into the detail.

I will give you another example which goes the other way.

As we mentioned, the European auto softened some exiting the quarter and we are forecasting it to be a little softer this quarter.

I want to point out on that, we don't think it's demand driven as much as it is with this whole filter issue going on with the diesel cars.

But we do expect softness this quarter and here we have got this massive footprint, as we've highlighted before, in continental Europe where most of this is made and we are trying to bring it down a little more rapidly in too many locations and we didn't make the progress we thought we would make.

It just shows you it goes to -- we've got to over the next two years really stay focused on the footprint moves that we've laid out in front of us, I think, to really continue to make good incremental movement on our working capital performance.

If you metric us against any other company, we've closed the gap very significantly but we know there is room for improvement when you look at any benchmark, but structurally we've got to continue to make the changes.

Great, thanks a lot.

Jeff, just let me comment as well to point out one thing that Ed mentioned and I think it's important to understand here, is that we have had no deterioration, again, in our accounts receivable, the quality of those receivables or the aging of those receivables While we haven't seen an improvement in the days, the quality is still there.

Okay.

Thanks.

Our next question is from Steve Oakland with Morgan Stanley.

Please go ahead.

Can I just, just to make sure I understand, your free cash flow target last quarter was 4.5 billion, right?

But that was with or -- can you just give me the kind of like-for-like free cash flow target now as you are calculating it?

Steve, this is Ed Arditte.

Let me take you through it.

The free cash flow target previously was $4.5 billion under the old definition.

The old definition, as I think you know, did not -- deducted -- it deducted dividend payments.

With the significant increase in our dividend payment that was announced back in December, we made a decision, based on interaction with a lot of people in the investment community, to change the definition to the more norm amongst our peer companies, that is free cash flow before dividends.

We are now at $4.6 billion guidance for the full year on that new definition basis.

Okay.

That includes the dividend payment, as Ed talked about during the commentary, was the assumption is $625 million of dividend payments over this year.

So, we are down roughly 500 million -- .

Correct.

Okay, great.

So -- .

And it's working capital as we talked about it.

Got it.

Now given that is a little lower, I'm just wondering, we've talked a little bit about buying back the converts, potentially at some point buying back stock in the open market and potentially also some bolton acquisitions over the summer.

Does the lower free cash flow target change the way you think about redeployment or what we should be looking for on that.

No, Steve, not at all.

Let me just say again, we are working very hard to improve on that free cash flow and improve there from what we just gave as guidance but, this is very strong free cash flow and I think if you look at us versus any peer company, we are way up at the top of the list.

It doesn't change a thing on our strategy.

Let me reiterate.

We are entering a nice phase for us.

You see us announcing plastics today.

You hear me alluding to the fact that we are going to finish off the refinement of the portfolio.

You should expect during fiscal '05 some other announcements there.

I highlight that because we need to all take into account, with the moves we make on the portfolio, we will also be freeing up excess cash that we will be able to redeploy for significant shareholder value over this year and into next year.

Kind of secondly, though directly to your question, we like buying back the converts.

It's still accomplishing two goals for us, reducing debt and taking shares out of the market.

So you hear it directly from me, I think it's a share repurchase program.

That's the way I look at it and I am getting a second benefit to it.

I would expect that as we go through '05 and I would say more towards the end of '05, if we feel we've run the course on the convert buybacks, and it's simply an economic analysis for us, you will hear us talk about a share repurchase program when appropriate.

And I would think that's as we get towards the end of this year.

And you are paying kind of a premium here to buy the converts versus the open market common stock?

It's extremely modest.

So I think that the alternative here of buying back the converts, reducing our debt while taking shares out of the market has been the right move and I think we are making great progress toward our A rating analysis of our goal to get there.

As Ed mentioned, I think we are in good shape in terms of cash flow and this working capital change that we've made here will not significantly impact our ability to utilize our cash.

Okay, great.

And then -- .

Steve, just to highlight, because I think you see our actions speak a lot here on this, this quarter alone we accelerated the convert buybacks, 42 million, it was almost 1.5% of our shares outstanding, were taken out of the market just in the quarter we are reporting.

Just finally to wrap that up then, Ed, you've alluded a little bit to some potential for bolton acquisitions over the summer.

Is there any update on that?

Steve, we are focused there.

We've had a fair amount of, I would say, attention put there.

You hear me talking to -- leaning towards Healthcare.

I would say to you if something is to happen it would be towards the very end of '05 or going into the beginning of '06, I think, before you would hear anything from u.

But we are planning on making a move in that area and specifically Healthcare.

Thanks very much.

Our next question is from Bob Cornell, Lehman Brothers.

Please go ahead.

Actually, I'm surprised no one has asked about the SEC decision that you made and provided for in the quarter.

I mean, talk about discussions being active, maybe you could flush out what active means and how far along you are and how confident you are in the number you took in terms of a provision.

Bob, again I can't gauge timing.

I will repeat of words you said, we are in active conversations.

I would hope that means over the ensuing months, so it's not a year, ensuing months that we get this wrapped up and I make that comment knowing where we are in our dialogue with the SEC.

As far as the charge goes, I will say two words, which is the accounting lingo but I think it says a lot, it is estimable and it's probable that it's $50 million and that's why we took the charge.

What about any commentary that might come out of their investigation in this whole issue, can we expect a wrap on the knuckles or anything like that?

Bob, I would prefer not to make any comment there.

I think, look, our announcement today speaks for itself on where we are and we look forward as a company to get this part of our history behind us.

As you know, we are all new management and I'm here almost three years, so we are looking forward to this process ending and hopefully we are down on the final yards of this.

The other question is why Plastics & Adhesives now?

I mean the profitability isn't that great.

There are other of these sorts of products in the marketplace strategically.

Why now to explore the strategic alternatives, as they say?

No, Bob, that's a great question.

Look, we think timing's very good to move on the Plastics things right now.

The market demand for a property like this is out there.

We know that from a lot of our work in G2.

The buyers of this will look past the resin market, which is what's affecting this business on valuing this, and when you look at the core footprint of the moves that we made last year on the restructuring, we significantly improved the factory footprint of this business which was an Achilles heel going into this process.

When you look through kind of where resin is, how you forecast what's going to happen in the business, we feel now is an attractive time to put this up for sale and to move it.

And we will get the price we think we should get for it.

The -- when you gave annual earnings guidance did you assume that the Plastics & Adhesives would be in for the full year?

Yes, we did.

Also, you alluded to fact that you may go further into this whole portfolio repositioning.

If we were to look at the top-line, the 40 billion of sales, ballpark how much of those sales do you think would be included in a repositioning process?

You have approximately, Bob, $2 billion because of Plastics, give or take, and another I would say $2 to $2.5 billion, to give you a range of other actions that we will be taking in '05.

That's a revenue comment again, so about 10% of the company revenues would be affected by that.

It's always hard to model that kind of thing.

Would these actions be accretive, dilutive, how should a shareholder think of that?

I think we are going to -- we haven't announced what we are going to do yet so we will take a look at the economics and clearly this will be done toward providing improved performance going forward.

I'll give you an example, I am not going to say prices, but to give you Plastics specifically, we do not think it's dilutive to our earnings going forward.

Just taking that cash and redeploying it in some share repurchase activity makes this a non-dilutive transaction.

Is that how we should think of it, that the proceeds from Plastics & Adhesives would be in some of the share repurchase program?

Potentially, yes.

And, again, we could also redeploy it, as Ed indicated earlier, on some acquisitions in our core areas where we think we can grow the business at a faster rate.

Okay.

Thanks very much.

But Bob, I guess if you peal into this and this is a -- I know it's a little bit different modeling for everybody over the next couple of quarters, but to really peal out a few of these other pieces that are nonstrategic, and I would just add continue to underperform, and getting the cash from those and redeploying that intelligently is a huge move for us.

And we are at the point where we can now focus on that, do those actions.

Our M&A team or our divestiture team, as you know now, is pretty well through what I considered a very big effort on unloading the 55 smaller companies that represented 2.1% of our -- or 2.1 billion of our revenues.

So now to be able to focus on this over the next six months and take these actions will be very significant for us.

I think it's important that while they contribute a not insignificant amount of revenue, the amount of profit being generated by these businesses we are looking at is not a material amount to the company.

So that gives us the ability to redeploy the cash.

Okay.

Thanks.

Thank you, Bob.

Our next question's from Don McDougall with Banc of America Securities.

Please go ahead.

Good morning, everyone.

Ed, I am going to read between the lines a little bit in your answer to Jeff's question on '06 Electronics margins, but what I heard was that you think you can get into that range, at least on a core basis, and I guess I interpreted perhaps the possibility of some divestitures in that space.

First of all, is that the right interpretation and then secondly, could we also get an update on the other two big segments with respect to how you are thinking about '06?

Healthcare, in particular, you are running way above your '06 targets.

And in the case of Fire & Security we still have a fair amount to go to close the gap between 10.8 and 14 to 16.

Don, let me go back on those.

On Healthcare we are obviously going to run above the guidance range that we gave.

Now don't take that every quarter will be as good as this one.

Mix always plays in this a little bit and mix, for us, was very good this quarter, with Retail being down pretty far and that's our lowest margin business.

U.S.

Surgical being up, one of our highest margins.

But on the other hand, I think you will now see us consistently perform above the guidance range in the Healthcare business.

Let me -- I will go through each one, maybe, because you didn't mention one but I think it's important.

In Engineered Products we are comfortable in the range of 10 to 11% right now.

That will grow as we go into next year.

The way that will grow, and you're starting to see it happen, is Flow Control is starting to finally see the nice lift up and we are seeing nice profit improvement in Flow Control.

Right now it's being disguised a little bit by the steel spreads coming down and steel pricing coming down.

It's still very good profits on steel, I don't want to misstate this.

But it's coming down and sequentially from the second to third quarter that's going to cost us $0.01 on steel, just to give you a perspective on that.

But over the next three to four quarters, the Flow Control number starts to overwhelm on the upside the decline that we see on the steel side.

And so we will continue to see nice margin expansion in Engineered Products as we go into '06 and feel comfortable with that.

On Electronics, what I think I was saying earlier, and I will clarify this comment, is we still have all of the cost opportunities in front of us in Electronics to get to our margin expansion goals.

It's going to take us a little longer if it's just that because of the continued increase in raw material prices and, again, another 60 basis points this year.

But all the opportunity we've mapped out is sitting there for us to take advantage of over the next two to three years.

What I was trying to add to that on top of it, I just wanted you to know that the core of what we consider our core part of our Electronics business, as we move forward, has actually made much more substantial progress towards our margin goals, so you haven't quite been able to see it, and the rest of that portfolio without those businesses in is already at 17.5%.

So we are going to be -- because of a couple different actions we can take, we are going to be well in the range for '06 with operational runway in front of us to continue our margin expansion, but I don't want to put a timeline on that.

But we will be able to continue doing that.

Let me just clarify, we will continue to make operational improvements and therefore margin expansion this year without portfolio moves in the Electronics business both in the third and in the fourth quarter.

On Fire & Security we had nice progress this quarter.

We got to 10.8%, so it was a nice move up even sequentially for us in year-over-year a full point.

As you know, in the first quarter, we made the decision to invest heavily in sales and marketing.

We took it up 70 to 80 basis points and, as you see in our numbers, we maintained it at that higher level in the second quarter and plan on continuing to do that.

So, the ramp up to our target will take us a little bit longer and I will just guesstimate right now for you it's a couple quarters longer than we thought.

The way we are going to get there is continued G&A take out, which you are watching us do.

But you are also seeing the organic growth rate start to pickup which we need to happen for us to get to these goals.

And as I said, 2% this quarter, again, nothing to brag about but major progress.

We expect it to be at least 3% next quarter.

So that along with the G&A take out will drive us up into those ranges.

And I don't want to say anything different about '06 guidance of Fire & Security because if we are only a couple of quarters behind where we think on getting to our 12% number, we've got time to get there.

Just a follow up, Ed, on raw material costs.

It was obviously an issue in Electronics, among other areas, but with respect to Electronics in particular, what are you doing on hedging, have you logged in any of the current prices on copper or gold?

No, Don, we have not.

We are looking at it but, although I think I said this to you last quarter, we are thinking we are about peaked out here on some of these raw materials but we are looking at it closely.

Thank you.

Thanks, Don.

Our next question is from John Inch with Merrill Lynch.

Please go ahead.

Thanks.

I guess just sort of a couple of big picture questions.

In terms of the cash flow miss and just the lowered expectations, Ed, how much of this is, in your view, execution versus the macro and just sort of market trends versus expectations?

Well, John, the way I would say it is we did a great job brute forcing our improvement with an awful lot of focus around the world on taking the 15 days out the last two years.

I can tell you the focus is very intense on working capital throughout the company, as you could imagine.

So, part of this is we are kind of hitting the wall at the point where we made tremendous progress and we need some structural change here.

And a couple of the areas I highlighted as examples were probably our two most Draconian areas.

One of it was a good problem to have, one was not a good issue to have.

The European softness is not something we want to see.

The Flow Control major pickup in backlog is a very good thing to see.

They both happen to be two of the areas where the footprint is our biggest issue.

And we are seeing the effect of that.

So we are at the point -- I still think we can brute force more improvement but the bigger improvement here is going to come from us intelligently fixing the structural issues to really make the progress we need to make.

If you go back to my Flow Control example, here's a backlog picked up almost 30%, so you can imagine how we are ordering inventory in and we are ordering it into over 140 facilities around the world with not a coordinated supply chain in the business.

So if we fix that footprint over the next couple of years, that is going to have a huge impact on the way inventory would have occurred in this ramp up.

And that's what we are going to have to get at here.

Now let me just add to that.

We know we can make progress on payables.

That is not just a brute force thing.

That's us intelligently now going back and renegotiating some of our contracts and we are just beginning that process.

And we are hoping to make progress there, so we know that one's sitting in front of us still to move on.

But when it comes to receivables and inventories, we are going to need some structural help here.

You got to emphasize the quality of the receivables does not deteriorate, so the marketplace is not causing us to have a concern about the collectability of our receivables versus what it was in the past.

Well, I'm just wondering as part of what has maybe changed versus original expectation had some of the feel, perhaps, over promised in their estimation of some of the perspective benefits, as you guys had laid out some of your targets.

Oh, John, to that there's no doubt.

We thought we could have a three-day improvement this year.

We were -- obviously, we were too optimistic on that assumption and we are dialing that back and saying working capital days will be flat.

But, no, our internal goal was a three-day improvement across the businesses, communicated to the businesses and to us with a plan and now that we are going through it we are seeing it is more difficult.

So, no, we were clearly too optimistic on this one and we will double down our focus here but we are going to need payables' help, which we are focusing on, and some structural moves.

Right.

And then just the follow-up question then, Ed, is what kind of a macro environment are you assuming in terms of the guidance for the rest of the year?

Meaning how would you characterize the degree of conservatism that now exists in your forecast assumptions both for cash flow and the EPS, considering that we know that the automotive industry doesn't look great, there's probably some macro softening, Europe squishy, how should we be thinking about now how you've laid out expectations versus what you are seeing in end markets and then given this macro backdrop?

John, let me just point out a couple things.

Our sequencing from our second quarter to third quarter guidance is not that dissimilar to last year, especially if you back out the steel upside that we highlighted, the $0.02, and, by the way, I will add the calendar change in there.

If you look at the sequencing, our second to third quarter does not sequence up that much and history, I think, kind of proved that.

However, the third to the fourth quarter does sequence up more.

And I see the same pattern concerning as we've modeled out the rest of this year.

We gave new guidance so I would say we consider that guidance balanced, would be my view, but I will say to you, we feel pretty good about the economy.

It feels generally solid to us and I think you can see that from the comments we made in the different businesses.

We do have two specific issues, though, that are hurting us here sequencing.

Steel is at least another $0.01 sequentially and the European auto and, because it's in our European factories, it's our worst absorption scenario when we see some softness.

Now again, that's one of the footprints I think you know we are very focused on fixing in the next couple of years.

But that softness costs us a lot more at the bottom-line for every revenue dollar than would normally happen, for instance, if our Healthcare dropped off some in Europe.

Again, we know where we got to get at it there but, no, generally economy feels good.

We've got a couple of specific issues that mutes us a little bit, but let me highlight, if you take the midpoint of our guidance range for this year, this is 15% year-over-year earnings growth.

So let's see how the rest of the year goes, but I would say it's a balanced view.

Right.

Thank you.

Thanks, John.

Next go to Jack Kelly with Goldman Sachs.

Please go ahead.

Good morning.

Ed, could you give us a little more help on the working capital as it relates to the footprint.

I know there's no precise formula, if you close 20 plants it would help you by a couple of days, but since that's where we appear to be and you've given that as one of the structural reasons.

As we look out over the next year, can you give us your plans to reduce the footprint and in broad terms what that might mean for working capital improvement?

Jack, let me give you a little, maybe, a slightly longer view because it's the way we've modeled some of our footprint rationalization.

Over the next couple of years, if we make the moves that we think we are going to make on the footprint, and I will add to that we probably will do a little more on the Flow Control side than we were planning on.

As you know, during my almost three years here, we did very little on the Flow Control footprint.

It was more in the other businesses.

With our management team now, the new management team there they are very focused on that, so we will probably make a few extra moves there.

But with that, if you look over the next couple of years, and I am really giving you a ballpark number because we will give new guidance obviously at the end of the year on this, but I would think we can make a five to six-day improvement over those couple of years.

And it kind of tracks back to we think there's another three days we can get anyway.

If we can't brute force it we'll do it with some of these other changes and we'd still be able to make another two to three days on the back end of that in this timeframe.

I am just ballparking that's about what I think we can see, but it's going to take these structural moves.

So the five to six days is total or is that -- that's due to the footprint and you mentioned the other three days, is that something -- ?

That's overall.

Maybe three days over the next period of time and another three days off of that as we make the structural moves and we focus on payables.

So all together I would say conservatively I think that's a good way to plan.

Just doubling back to Electronics.

It sounded like at the beginning of the quarter, based on your comments for the first quarter earnings call, that things were fairly strong in Electronics early in the quarter.

Can you give a sense how it developed January, February, March?

Actually, Jack, pretty good, as we highlighted, our book-to-bill ratio in the quarter was 1.02 and that came off the heels of the prior quarter being 0.99 and the prior quarter before that 0.96.

And April has, I won't get specific we are only a couple weeks into it, but it's above a one book-to-bill.

I don't read a lot into the first couple of weeks because of shipments versus billings, I just would be a little careful, but it feels okay.

The problem we have is we've got one soft spot and maybe we are planning conservatively, maybe it's not soft as long as we think here, but because of European auto we are going to get hit a little harder from an absorption standpoint.

So that's why you are seeing a little bit of a muted guidance from us on that.

But if you kind of just look, ask me a macro question about bookings in Electronics, they feel -- they don't feel phenomenal, but they feel solid at a 1.02 book-to-bill, that doesn't feel bad.

In Electronics you were pretty specific that you are worried about European automotive.

If we look at the three underperformers, I guess two questions, number one, those three underperformers, what percent of the total group comes from those three areas and number two, are they performing a lot worse than you would have thought two to three months ago?

It appears that way, based on what you said.

No, Jack, they do bounce around on their bottom-line, but sequentially they got worse, to your point.

So that clearly hurt us and that hurt us, I think we mentioned this earlier, that hurt us by about 30 to 40 basis points sequentially.

That doesn't mean they stay like that, one or two might flop the other way next quarter.

They are bouncing around at not good performance.

What's kind of interesting in our portfolio -- you look at Tyco in total, the margin expansion we are making is very healthy cross Tyco.

There is not that many businesses left that aren't making progress.

It's a handful.

When you extricate those out, it's pretty amazing what the portfolio looks like when they are not there.

And specifically that's why we highlight the three in Electronics.

Jack, if I give you the number, it's about 10% of the Electronics revenue is represented by those companies.

So it's the other 90% that the margins have actually expanded much further up to that 17.5% that we highlighted.

The last question, is that 17.5 for this quarter, what did that compare with a year ago for the 90% of the businesses?

Jack -- do you have that there?

Jack, we will get that for you but it is a much bigger expansion on margins than you are seeing in the total, but we can get that.

It's continued to improve over a year ago.

We will get you the numbers.

Our next question is from Brian Langenberg with Langenberg and Company.

Please go ahead.

Couple of questions.

First of all, can you just talk a little bit about the pricing dynamic by segment?

Sure.

Brian, I guess the biggest one for us is always the Electronics question and the pricing has not changed.

We are seeing about the same 5% price pressure in the business.

And we've modeled that, I'm not surprised by that, that's what we've planned on.

Pricing in the rest of the businesses is about the same, expect for Plastics where we are getting a fair amount of pricing but we are still leading a fair amount of resin.

That is moderating.

That is moderating.

During the quarter, we did get almost as much price as we did the cost impact that we had and that's -- we had not been running, Brian, at that level before.

Okay.

Just diving into auto a little bit, you were mentioning that Europe there's a, I think it was a shortage of diesel filters.

Is this something that impacted the March quarter or that you are worried about in the current quarter?

When did that start?

And then maybe relate that to -- everybody has to make assumptions, but what auto demand assumptions for Europe do you actually have built into your guidance at this juncture?

Brian, the European auto hit us in the last month of the fiscal quarter we just reported, we started to see it.

Again, there might be a little bit of demand here going on, but I don't know if you've read about this, it's all over the papers in Europe.

There is regulations out that you need to have lower emissions standards out of diesel cars and therefore requires a filter.

There's no -- it caught everybody, I think, a little back on their foot.

Therefore, the supply chain was not getting these fitters and it slowed things down and it hit everybody pretty quickly.

We are planning that that continues to hit us over the next four or five months as we kind of build through those filters coming out on the diesel cars.

And diesels are a very high percentage of sales in Europe, especially in Germany.

In Germany this regulation has had a lot of attention.

A little bit of demand driven, but more so we are thinking over this issue the way we are reading it and therefore we are planning that to continue.

Again, I don't see that continuing into '06.

Right.

But clearly somewhere it's a third quarter and a partial fourth quarter issue for us is kind of the way we've planned it.

And so by giving you an overall number, we are counting on maybe production units being down in the 5% potentially 7% range.

For the full year or balance -- ?

For the balance of the year.

Balance of the year, okay.

As we've said before, you've seen some of the news in the U.S., a couple points or two down is not the biggest thing in the world because we've got content increasing.

But we get up towards the 7% down, that is going to affect us.

It does hit.

Then last question -- .

Brian, let me interject.

We are getting short on time so one last quick one and then we'll take one more question.

I will make it quick.

You got 2.9 billion in cash, wondering how much of that is overseas and then you are going to this A rating, obviously, a high priority but my question is this, at what point is your stock so cheap that it could make sense, giving that you are covering interest like ten times, to go buyback more of your common even before paying down some debt?

Just think through that for us.

Again, as Ed indicated earlier, we have been in fact taking shares out of the marketplace with the repurchase of converts and, as our cash flow continues through the back half of this year, we are going to reevaluate where we are.

Again, we feel very good about our overall debt situation, where our ratios now are in comparison with the ratings that we are looking to get on a long-term.

We will be looking at that very clearly as we continue on here.

But we have been, again, taking a fair number of shares out of the market.

And your cash, how much of that is overseas versus in North America, the 2.9 billion of cash on your balance sheet today?

Most of it is overseas.

Okay, thank you.

Remember, though, that a sizeable portion of our operations are overseas as well.

Yes.

Operator, we are going to take one last question.

And that's from the line of Lee Cooperman, Omega Advisors.

Please go ahead.

You've been returning money to shareholders and it seems to me just common sense would suggest that stock repurchases make sense when the stock is undervalued and dividends are more appropriate when the stock is properly valued.

If I calculate this correctly, we've spent 2.6 billion buying back 76 million shares.

We paid an average of $34.21.

As I look at my screen the stock is trading $27.55 as we speak.

So it's almost 25% below what you paid on average.

I'd like to kind of understand the management's thought process in this buyback and what you think you are buying back when you buyback the equivalent of stock.

Before you answer, let me just explain that the two converts you are buying back currently each yield 2% in the market.

Their nominal coupons of 2.75 and 3.125, both of which are tax deductible, two-year treasuries are 3.63%.

So you could really defease that debt by just piling up cash earning 3.6% against coupon that, like I said, are 2.75 and 3.125.

I would like to understand the thought process of the board and management in this repurchase.

What do you think you are buying back in the way of value that leads you to keep emphasizing stock repurchase as opposed to paying out a large recurring dividend and not buying back stock that seems to go down.

Lee, this is Ed Arditte.

Let me respond.

I think as we've said, very consistently, when three quarters ago we began to repurchase the converts, that at that point in time because of our balanced view towards not only shareholder returns but also ratings issues, the right thing for us to do at that point in time was to begin the process of buying in the converts.

We -- .

Excuse me for interrupting, why couldn't you buy higher coupon straight debt?

We did and over that period of time, first thing we did was we went after, and if you look at our numbers you will see, we went after our higher coupon straight debt wherever it was economic to do so.

We also retired securitization facilities that we had in place.

We made voluntary pension contributions.

So if you go back in a few quarters, you will see that when we began these actions we went after all of the more expensive things first and then we began to go after the converts.

And in going after the converts at that point in time, we were not in a position where we felt it was appropriate for us to do a share repurchase activity.

But what we found, as we looked at it, was that buying into converts was effectively the same thing as a share repurchase activity.

We were buying the converts at a very, very small premium over the intrinsic value of the stock.

And while the accounting is different for that, the economics are essentially the same.

So now -- .

You are not addressing my question.

It's a question to Ed and the board.

No problem, I'm a big fan, historically, of stock repurchase when it's practiced by companies that are buying back significantly undervalued stocks.

So my question is, we paid 34.21, the stock last sale is about 27.50, what do you guys think you are buying back when you buyback $2.6 billion worth of stock, because, frankly, you could be piling up the cash and retire the debt and you have a positive carry because where treasuries are yielding versus what your converts are yielding.

I'm trying to get an articulation of what you think the values of the businesses are that are leading toward the repurchase.

Not a problem, just want to see how you handle that.

Lee, I would answer it the way Ed just did, but let me just add at the prices we were buying back converts at and will continue to and, I will add, somewhere here institute a share repurchase program, we feel these are very attractive prices for us to be taking shares out of the market at.

And I would expect, because we are alluding to the fact that there will be a share repurchase program coming, I'm not putting a time frame on that, but the fact we are talking about it you know we are there in the fairly near-term, we find these attractive prices and if we are trading down a little it's more attractive.

From a board and a management standpoint, we find a path towards repurchase of our shares, whether it's the converts or straight share repurchase, very attractive and we certainly did it very forward.

We're going to feel that way right now and that doesn't say we won't do a mix of a few other things, as we said potentially an acquisition toward the end of the year.

But you will see us probably pretty heavy on the throttle.

Okay?

Thanks for joining the call.

We look forward to reporting to you on the next quarter which will be the early part of August.

Thank you very much.

Ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and you may now disconnect