江森自控 (JCI) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Tyco to report third-quarter earnings results conference call.

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

Later, there 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, I would like to turn the conference over to the Senior Vice President Investor Relations, Mr. Ed Arditte.

Please go ahead, sir.

Thank you, good morning and thanks for joining our conference call to discuss Tyco's third quarter results for fiscal year 2005 and the press release issued earlier this morning.

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

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

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

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 today, 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 it over to Ed, let me just recap our earnings this quarter.

Our GAAP earnings per share was $0.56 in the quarter which included a $0.15 net gain from divestiture activity, partially offset by a $0.09 after-tax charge related to the early retirement of convertible debt.

Adjusting for these special items our EPS was $0.50.

Now let me turn the call over to Ed Breen.

Thanks, Ed, and good morning.

As Ed mentioned, our earnings per share adjusted for special items was $0.50 in the third quarter, an increase of 11% year-over-year.

Our free cash flow was 1.25 billion in the quarter, which equates to 12% of sales and 120% of adjusted net income.

While our overall EPS and cash flow numbers were in line with our expectations, we were not satisfied with our progress in all areas, so let me quickly recap what we liked and what we didn't like in the quarter.

First, let me comment on what we liked.

We saw a nice acceleration in our organic revenue growth in Health Care.

Our investment in new products and the ramping of our International sales and marketing organization are beginning to pay off.

Five of seven business units in Health Care had organic revenue growth greater than 6%, of which Surgical and International had double-digit organic growth.

Second, we also had double-digit organic revenue growth and significantly improved margins in flow control, the largest business unit in our engineered products segment.

Backlog and flow control also remain solid.

And thirdly, we continue to repurchase our convertible debt in the third quarter, retiring 448 million of face-value convertible bonds and reducing our diluted share count by 20 million shares.

Over the past four quarters, we have repurchased 2.2 billion of face value converts, and retired 4.3% of our diluted shares outstanding.

As for what we didn't like in the quarter, we did not see the top-line growth we expected in Fire and Security in the quarter and this muted our margin progress.

We have significantly improved our margins in this business over the past few years, but they are not where we had expected to be at this point.

We have made good progress in our G&A reduction efforts, but there is still more work ahead of us as we streamline our operations over the next several years.

We remain confident in our ability to expand margins from current levels with the benefit of a pickup in growth and continued cost reduction.

I would point out, however, that while we did not see organic growth in the quarter in foreign security, we did see a few positive indicators.

In ADT North America, we saw our new account generation outpace attrition in May and June, and we expect that trend to continue.

Secondly, backlog at SimplexGrinnell, our North American fire business, grew 12% year-over-year and 7% sequentially in the quarter.

So while it has been slow to develop, we remain confident that Fire and Security will begin to show better top-line growth.

Another thing we didn't like in the quarter was 3% organic growth in Electronics.

Our largest markets, such as automotive and telecom, remain soft, and this trend could continue -- will continue in the fourth quarter and possibly beyond.

Weaker top-line growth in electronics makes margin expansion more difficult given the price erosion levels in this industry.

I would point out that we have made substantial margin progress in the segment and without a few underperforming businesses, which we have talked to you about in the past which account for about 10% of sales, our operating margins in this business unit would be approximately 17.5%.

With respect to our capital retirement activities, I am pleased to announce that Tyco's Board of Directors has authorized a 1.5 billion share repurchase program.

This action reflects our continued belief in Tyco's ability to be a strong generator of cash flow.

The share repurchase program, along with our continued repurchase of convertible debt, will allow us to continue to allocate a significant portion of our cash flow to the retirement of equity and we plan to spend approximately $2 billion over the next three quarters for these activities.

Once we have completed this authorization, we will evaluate the amount and pace of a follow-on share repurchase program.

Let me be clear that our current plan is to continue returning the majority of our excess cash to shareholders while maintaining an appropriately strong balance sheet.

Before Chris reviews the operational performance for the quarter, let me also comment on acquisitions and divestitures.

Tyco acquired Vivant Medical for 66 million in early July, which adds a promising new technology to our surgical product lineup.

We view this deal as a compliment to our R&D efforts as we are buying a product capability nearing commercial application.

Further acquisition activity in the other segments would likely fit this model, but let me stress that our spending for acquisitions will not be large from an overall Tyco perspective.

On the divestiture side, the sale process for Plastics and Adhesives is progressing nicely.

As you will recall from our last conference call, we also mentioned a number of other businesses being considered for divestiture.

We are continuing the review of our portfolio and we have identified other potential divestitures, but we are not prepared to discuss the specifics at this time.

The benefit of these actions will be greater focus on our stronger operations where we have more long-term value opportunities.

In addition, these actions will free up underperforming capital that can either be reinvested in the businesses or returned to our shareholders.

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

Thanks, Ed, and good morning.

Let's start with our fire and security business.

Revenue in this segment was $2.9 billion, essentially flat over a year ago on reported and organic basis.

Operating income was $301 million and the operating margin improved 90 basis points to 10.6%.

Operating income included approximately $50 million of increased selling and marketing expenses versus last year.

It is important to note that this continued investment in our sales and marketing organization, which impacted operating margins by approximately 180 basis points year-over-year, is building the capability we need to deliver sustainable organic growth in this -- in this business.

Looking at our business -- our operating performance, Worldwide Security, excluding continental Europe, which represented 50% of segment revenue was essentially flat organically and the operating margin was level with last year at 16%.

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.

This business generated a slight operating profit in the quarter.

The worldwide fire business, which represents 33% of segment revenue, grew 1% organically and the operating margin was approximately 6%.

As Ed mentioned, backlog at SimplexGrinnell continues to improve, particularly in our higher margin electrical business.

Finally safety products, which accounted for 10% of segment revenue, was flat organically with growth in breathing systems onset by a decline in access control.

Operating margins here were in the mid-teens.

Our ADT trailing 12-month disconnect rate held steady sequentially at 15%, reflecting the combined effect of lower gross attrition rates and higher resell rates.

In the fourth quarter we are planning for low growth and modest sequential margin improvement for this segment.

Let's turn to Electronics, where revenue grew 2% to 3.1 billion.

Organic revenue growth was 3%, reflecting strong growth in computer and consumer, energy, aerospace and wireless markets, partially offset by continued weakness in our Power Systems and printed circuit board businesses.

Our automotive business grew 3% organically in the quarter, despite a soft global production environment especially in Europe.

Geographically, total revenue in North America grew slightly, which was offset by weakness in Europe.

Our Asian business grew 11% organically.

Order activity was stable in the quarter with a book-to-bill ratio of 1.0 versus 1.02 for the prior quarter.

Operating income in the quarter was $512 million and the operating margin improved 120 basis points to 16.4%.

The operating margin in the quarter benefited by 30 basis points due to the resolution of a legal issue.

Higher material costs, copper, gold and other raw materials, cost us approximately 70 basis points of margin on a year-over-year basis.

As we look to the fourth quarter, we see continued low single-digit organic revenue growth on a year-over-year basis.

Sequentially, we expect revenue and operating margins to be lower in the fourth quarter, resulting primarily from seasonally lower volumes due to customer plant shutdowns in the summer months.

Turning to healthcare, we had a solid quarter with 6.5% organic revenue growth.

Solid double-digit growth in surgical and International and high single-digit growth in respiratory and pharma was partially offset by modest revenue declines in retail and medical.

Our surgical business continues to gain traction from new products and our International business is benefiting from investments in our selling and marketing organizations where we have added over 800 people over the past two years.

Operating income increased 10% to $678 million.

And the operating margin expanded 60 basis points to 27.8%, driven by a higher margin sales mix and continued cost improvements.

As we look to the fourth quarter, we expect top-line growth to be driven by continued strength in surgical, pharma, respiratory, and International, and continue to be offset by continued weakness in retail and medical businesses.

In engineered products, revenue grew 4.4% to $1.7 billion with organic revenue growth of 1.6%.

Double-digit organic revenue growth and flow control in fire and building products was partially offset by revenue declines in electrical and metal products and infrastructure services.

Flow control continued to benefit from strengthening markets in North America and Asia, and fire and building products continue to experience strong demand from improving construction markets.

The electrical and metal products business declined 8% in the quarter as a result of lower volumes and lower selling prices on steel-related products relative to last year.

Operating income declined 21% to $178 million and the operating margin declined 340 basis points to 10.6%.

Operating profit and operating margins improved in three of the four business units, but declined sharply in electrical and metal products due to tightening steel spreads, which reduced our operating profit by $109 million.

End market demand remains strong throughout the quarter in Flow Control and the backlog grew 26% year-over-year and 2% sequentially in constant currencies.

As we look to the fourth quarter, we are expecting low single-digit organic revenue growth and lower operating profit for the segment due to the continuing negative comparisons created by the strong steel market last year.

We estimate that the tightening steel spreads will reduce operating profit by approximately $70 million in the fourth quarter versus last year.

In Plastics and Adhesives, revenue increased 6% to 459 million, with flat organic revenue growth.

Growth in the plastics business was driven by higher selling prices offset by revenue declines in A&E and Ludlow coated products.

Operating income decreased $18 million and the operating margin was 4.4%.

Operationally, income was adversely impacted by declines in A&E and Ludlow Coated Products.

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

The Company sold TGN for $130 million in cash and assumed liabilities, resulting in a pretax gain on the sale of $307 million.

Corporate expenses increased by $33 million year-over-year, primarily due to higher costs related to our SOX compliance efforts and continued spending to resolve legacy issues.

While some of this expense will trend downward in 2006, we will likely be running at an elevated level of spending for the next few quarters.

Our working capital days improved in the quarter with a reduction of three days sequentially.

We are looking for more improvement in the fourth quarter, but it is not likely that we will get back to flat working capital days versus last year.

Most of the slippage this year has been in our receivables, and some of this relates to higher growth outside the U.S. where our sales terms are longer.

Finally, looking at our tax rate, which was 21.4% in the quarter, which was reduced by 3.6% -- percentage points due to tax benefits realized from the divestiture of TGN, partially offset by non tax-deductible charges for early retirement of convertible securities.

We expect the full-year tax rate to be between 26% and 27%.

Now let me turn the call back over to Ed.

Thanks, Chris.

Before we open it up for questions, I want to provide some thoughts on the fourth quarter and some preliminary thoughts on 2006.

For the fourth quarter, we expect earnings per share from continuing operations before special items to be in the range of $0.45 to $0.47 per share.

We expect lower sequential operating income in engineered products due to lower steel spreads.

In addition, the summer months are the slowest in the automotive industry, which will result in lower sequential revenue and operating income in electronics.

In addition, we are expecting a sequentially higher tax rate in the fourth quarter.

We are adjusting our guidance for the full year free cash flow to a range of 4.2 to 4.6 billion.

With respect to 2006, our thinking at this point is that our overall organic growth rate will continue at recent levels for the next few quarters.

In Electronics, this view is based on our current assessment of the global automotive market as well as certain parts of the telecom market.

A continuation of recent growth rates in these industries will prevent us from making meaningful improvement in our operating margins and electronics.

Secondly, as I indicated earlier, our margin progress in foreign security has been impacted by the lack of growth.

We are actively working to address the growth issues and we are seeing some positive indicators, as we mentioned.

We are currently planning for modest top-line growth and continued modest margin improvement in foreign security.

In addition to the operating performance, we will have improvements below the operating line in interest expense and shares outstanding.

Adding all of this together would translate into a full year with modest organic revenue growth and earnings per share growth of approximately 10% over 2005 results.

From a cash flow perspective, we would expect to achieve free cash flow greater than our net income.

We will provide additional thoughts on 2006 on our next quarterly conference call, when we review the fourth quarter of '05.

Thanks for joining us on the call.

And operator, if we can open it up for questions now.

Certainly, it would be my pleasure. [OPERATOR INSTRUCTIONS] Our first question comes from the line of Jack Kelly with Goldman Sachs.

Please go ahead.

Good morning, Ed.

Hi, Jeff.

In the last two quarters, Ed, you have lowered the EPS guidance and free cash flow guidance.

Can you give us some feel in terms of -- you know, if -- if the latest guidance happens to be wrong, you know, where might you be most vulnerable.

Or do you feel a lot more comfortable with what you have given us today than you did, you know, three or four months ago?

Jack, the moving pieces here that have moved down on us.

We highlighted these a moment ago.

Let me just touch on kind of the three big ones for you.

The lack of growth in Fire and Security is clearly something that we did not plan on.

We expected to see some growth come this quarter that we just ended, and did not see that materialized.

Underneath that, as we pointed out, we have some trends that are moving positive.

But, you know, at this point, I would say too early to call when we actually see, you know, a significant pickup on the top-line.

If the trends continue, we will improve there, but clearly that is continuing softer and we are planning that to be softer here in the fourth quarter than we had thought previously.

The electronics piece, we are still nervous on the auto side, as we mentioned.

You know sales look pretty good.

If you look across the industry reports, people are saying that U.S. production could be slightly up in the next few months, and going into next year, but European auto is going to be down a few points over the next few months and going into next year.

The European auto one, as I highlighted on last quarter's earnings call, is the one where we've got the biggest absorption issues in our facilities in continental Europe, so -- and by the way, it is 50% of our auto sales.

So we are going to see a little bit more of a hit there because of that.

And, you know, that looks like it trends into next year that way.

And then the other one that is continuing to move down is the steel spreads and tap switch have pretty significant.

Last year it was probably over the top, as we've highlighted, but this year it continues down.

It has been muted, when you look at the results in engineered products, by the improvements in all the other businesses there, especially flow control.

But on the other hand, that appears to be moving down from a steel spread standpoint in the fourth quarter as well.

So I think we have this set now, you know, where we should be based on the facts that we see right now, and, of course, overall, that's planning low organic growth through the fourth quarter with what I just said.

On the cash flow side, Jack, you know, look, we are still shooting to get up towards the higher end of the range, but we have got to make substantial progress this quarter in working capital.

We did turn the corner on working capital performance after the first quarter where we slipped, we had slight improvement in the second quarter.

And this quarter we did have three full days of improvement on our working capital velocity, so the momentum is there again.

The issue is how much momentum do we to get to get all the way back in the fourth quarter.

And I will point out to you that we are expecting that we might be paying out $130 million for two settlements that could happen in this quarter and we are taking that into account.

One of them is a legal matter that we think we are going to get behind us this quarter from a legacy issue.

And other one is the SEC fine that we talked about last quarter of $50 million and those two together add $130 million.

That is the reason for the range that we just gave.

Just a follow-up on the steel swing.

You mentioned $70 million negative swing in the fourth quarter versus 109 in the third.

Assuming the relationships stay where they are, you know, how does that look in the first and second quarters?

And then just secondly on that, the 109, was that a lot worse than you would have thought?

These numbers have been kind of trending this way for some time.

Was the 70 a lot worse than you thought.

No, no.

Both the 109 was a steeper decline than we thought and so was the 70, Jack, that we saw.

But to your question going forward, we continue to see -- we will continue to see the decline in the steel spreads over the next few quarters, but it will -- our forecast shows that it will continue to come down in size, but we still will see a -- a negative impact from that over the next few quarters.

Thank you.

Thanks.

We do have a question now from the line of Bob Cornell with Lehman Brothers.

Please go ahead.

Good morning, everybody.

Hi, Ed, Chris.

Good morning, Bob.

Just to follow on to the first question.

How much of the issue do you think with the change in the OEX(ph) margin targets is a function of just difficulty getting the operational efficiencies of a company that was made up of so many acquisitions and putting the culture in place, you know, putting the spending in place to drive growth and yet not getting a market growth.

Maybe you could address that bigger picture issue.

Bob, look, that's been a challenge for the last three years, but we've made tremendous progress on integrating what I just call the back office of the Company and have had substantial improvement over the past two and a half years or so.

If -- if I just give you a couple of the specifics, I think this would be helpful.

The electronics businesses, X three businesses that represent 10% of our portfolio, now have the margins at approximately 17.5%.

So we continued to make good progress against the core part of that portfolio.

And in fact this quarter we had pretty nice margins in electronics, as you see.

I think they are the best we have had in the three-year period.

So, you know, we have got that portfolio pretty far up there.

What we need to continue to do -- and, look, this is part of the legacy of Tyco.

We need to continue the consolidation of the factory footprint which is still a multi-year task for us.

We have been on that for three years.

We need to continue it over the next few years.

And that is simply the Company didn't deal with all the factories they had for all the acquisitions and that's part of what we are living with.

So we have got to continue that.

But net net electronics, 90% of the portfolio in pretty good shape.

The other big one that affects us here, and it's the one we have the most work still cut out for us on, is fire and security.

And that's clearly a legacy of not putting anything together in the back office and many of you know all the details behind that.

What we have been able to accomplish in the last three years is significant cost takeout in the business.

You know, we've taken out a full 3 points of G&A in the business.

We continue to take out substantial costs this year, Bob, but what we did this year is add back as -- as Chris had highlighted, 170 to 200 basis points of cost on the sales and marketing side to put in place the internal sales team globally to get us organic growth.

We have not seen the organic growth yet, but we feel we are very much on the right track.

We see the indicators there.

It is taking a little bit longer than we thought.

That, to me, is the two big pieces.

And don't forget in the taps business, we have a lot of work cut out to continue the consolidation of the footprint there at flow control, very similar to what I just described in foreign security.

Chris, you had -- ?

Just a follow-up question --

Let me just add, Bob, that, again, I think, as Ed indicated, we have met most of our cost reduction targets this year in terms of meeting our margin targets.

But where in Fire and Security, again, we are below the revenue that we expected this year and then we are going to grow modestly, as we indicated, off that lower base.

And that -- that year-over-year in both years has an impact on the overall margin structure of that business.

Okay, thanks, Chris.

One other follow-up question.

But did you guys say that engineered products - profit will be 70 million below year-ago levels in the fourth quarter?

Is that what you said?

Bob, that comment was for the steel business alone, not for the entire segment.

And -- okay.

Just calibrate me a little bit on the whole segment in the fourth quarter.

What are you looking for there?

We are not going to give specific segment by segment numbers.

But clearly, as you saw, this past quarter where steel was down a lot, and that was significantly offset by the other businesses doing much better.

We would expect a similar dynamic in the second -- in the fourth quarter where steel will be down a lot, and the other businesses will do better.

Okay.

Thanks.

It still will impact us negatively year-over-year in the quarter.

I got it, thanks.

Bob, just maybe to close out that part of the conversation.

You know, the OpEx piece of the -- of the Company continues with good traction.

The issue now is we need to keep that going, but we need to see some top-line growth pickup in electronics and really we need it in fire and security because it's great fall-through to the bottom-line and that's what we need to stay focused on.

Got it

Thanks.

We do have a question, then, from the line of Don McDougall with Banc of America.

Please go ahead.

Good morning, everyone.

Good morning, Don.

Just curious on the 2006 guidance.

Are there non-core items in there like options expense and 4X implicit in that guidance?

Don, we have not included the impact of -- of stock options in that number.

Obviously, we have included sort of our view of where foreign exchange is going to be in considering it, yes.

Can you give us a sense for what you are assuming from a 4X standpoint as for negative?

Well, I think what -- we are not going to try to be experts in forecasting where all the exchange rates are going to be, but I think that that number would anticipate that we would be about where we are right now.

Okay.

Jumping over to Fire and Security, the view has been that, you know, we start to see a significant improvement in the attrition rate after this year.

Can you update us on your latest thoughts there?

Yes.

You know, Don, one of the indicators this quarter that held nice for us was, as Chris highlighted, was the disconnect rate stayed at 15%.

I think if you go back a quarter, or two quarters ago, it was 15.4.

Last quarter it dropped down to 15 in the second quarter and then held at 15 this quarter.

So we felt good about that.

That's about what we thought because we are still, as you know, in the -- in the part where the big -- the very biggest period of the dealer program spend is hitting us.

As we go into '06, we should start to see a decline in the disconnect rate.

I wouldn't say it just happens to hit in the first quarter, because this stuff bleeds over with all the accounts you are talking to, you know, when the contract ends you're talking to them and all that.

So, as we get into kind of the second quarter and all, I would say that just trend-wise, it looks now that it should continue to drop and decline at that point in time.

I wouldn't forecast yet where we think it gets to at the end of the year, but we think we will have somewhat of a drop begin to happen as we go into the year.

And, again, as we pointed out, what we have to continue here, and what we were able to do in the third quarter, was offset the attrition even at these levels with new account sales.

And as I mentioned, May and June is the first time that we crossed over.

Now, we didn't have a lot of net gains.

Don't take that as a big comment.

But we did cross over where we added more in those two months then disconnected and as you know that is the first time that's happened in three years here.

That is the new sales force getting in place, starting to get a little traction under them, but we need to see a few more months of that continued traction in the sales force performing to build our confidence there.

Okay.

One more.

Just jumping over to Electronics.

Ed, I think you had said 70 basis points of raw material headwind.

Does that translate into any ability to get pricing with customers or to maybe stem the price degradation that you have to live with in this industry day in and day out.

Don, we have seen very slight change in the price erosion, but I have seen very slight.

We are running between 4% and 5% closer probably on an average to 5%.

So, no, we have not been able to get price in the business.

The one raw material that is really hammering us in that business that makes up a big part of the 70 basis points is copper.

You know, copper is in all our connector line and we were thinking that maybe that thing was plateauing, but as you've watched even in the last few months here, it has continued to climb up.

Over a two-year period, we have eaten 70 basis points of raw material headwind in that business this year on top of 100 basis points that we got hit with last year.

So, you know, we have worked through that with productivity improvements in the business because we didn't get it on the price side.

Thank you.

Don, one last comment on the stock option question.

We do anticipate that that will be about $0.05 to $0.06 next year, similar number that would have been this year.

Thank you.

Thanks, Don.

Thanks.

We do have a question then from the line of Steve Volkmann with Morgan Stanley.

Please go ahead.

Good morning, guys.

Hi, Steve.

Just a couple of clean-ups and then a bigger one.

But, how much of the share repurchase add the $2 billion that you mentioned is kind of baked into your guidance?

Is that in there already?

Yes, we baked that in.

And then presumably you are going to get some sort of proceeds from various divestitures, and I guess those will be slated likely for share repurchase?

I don't want to put words in your mouth but -- .

Go ahead, Chris.

Yes, I think what we'll do is as we -- as we go through the time period here, we'll believe that we're going to acquire both with the converts and the buyback about $2 billion over the next three quarters.

And at that time, we will have a better idea of where we are on the divestitures and we'll re-evaluate that program in the middle of '06.

And why, it strikes me, that you are going to run through this share repurchase authorization and then I guess in about three quarter, why would the board start with such baby steps?

Well, again, I think we have a number of things that we are looking at in terms of divestitures and I think the prudent way to go is to do something we know we can execute over a period of time and then re-evaluate it then and again, as Ed indicated, our plan would be to return excess cash right now to our shareholders.

Okay.

And then, Ed, you mentioned sort of growth problems a few times and, I guess, this has been going on for a little while now.

What are -- what are the chances that we just need to really step-up some internal spending initiatives, you know, maybe there is some legacy issues here or whatever.

But, you know, at what point do you really have to kind of step up and spend some money to drive the top-line here.

Steve, I think we did that this year in a very significant way.

You know, it's taken a little longer than we thought, but, you know, if I just take you all back to the -- the healthcare scenario.

We have been spending heavily to increase R&D and International sales and marketing, as Chris mentioned very significant numbers in that business, and we have been at it now for a little over two years.

And we are feeling very confident now, and I think this quarter was a nice indicator that we are beginning to see it.

So it takes some time.

In Fire and Security, as we mentioned, almost 200 basis points of increased spending on the sales and marketing side.

You know, if I can equate it to you, here is a company with 12 billion in revenue.

It is like a, especially the ADT side, it is like being a big wireless account or a big cable operator and you didn't have a sales team because we did it through third-party dealers,.

And now we have had to put this massive global organization in place, and it's -- it took us a fair amount of time.

We have been at this now for about a year and a half building it up.

We think we have the spend level as of last quarter where we want it at, so we are not continuing to take it up.

We are now training the sales group, getting them, you know, organized and hopefully get their hit rate up on their closures as we go out over the next few quarters.

And so we have spent very significantly against it.

Okay.

And then just a quick follow-up.

You've mentioned, I think, that on the working capital side, you know, further improvements may require some, you know, some lowering of the footprint in various areas or some system changes or so forth.

And that, I guess, the same question there.

Do we have to spend some money on that in order to get some progress there?

Yes, we do.

We've increased our spend next year on some restructuring.

I would say modestly increased our run rate, but we have in the forecast, though, that we put out.

We will spend that money in electronics on some more footprint moves.

We will spend the other, I'd say, big piece of it in the Fire and Security back office.

The Fire and Security piece is not really -- the Electronics is factories, fire and security is us tying together the IT Systems which are very broad and not connected in the business so that we can start to reduce the back office footprint in the business.

We did, I think I've mentioned this before, we did slow the fire and security activity down in the second half of the year because of SOX.

We didn't want to make major IT changes in the middle of our SOX certification here.

We did slow that down some.

We plan on being very focused on that in 2006, so then we can start to collapse some more of the back office together.

Okay, great.

And Chris, any quick read on what pension, positive or negative in '06?

Pension is not going to impact us too much in '06.

Great, thanks, guys.

Thanks, Steve

Thanks and we do have a question now from the line of Jeffrey Sprague with Smith Barney.

Please go ahead.

Thanks.

Good morning, everyone.

Hi, Jeff.

Going to drill in a little bit more on Fire and Security.

I obviously understand your caution given you have come up short here a little bit the last couple of quarters, but it does, you know, sound and feel like you actually are at the cusp of the turn with, you know, three years ago this quarter was kind of the dealer peak.

You just said you added more new accounts than attrited away.

The backlog growing.

It would sound to me like your visibility in the business should be better here than it was a quarter or two ago.

You know, can you give us a little bit maybe more color on, you know, the attrition dynamics as you look forward to the next couple quarter or what you are expecting maybe out of the fire business, for example, is that perhaps muting your view on the growth outlook.

Jeff, the reason -- look, I think on the ADT side, let me just say, when we see it, we will let you know.

You know we don't want to get ahead of ourselves on that.

The dynamics do feel, to your point, like they are moving in the right direction here.

We want some more traction under our feet here before we say that it is permanent and we see it coming.

On the fireside, as we mentioned in SimplexGrinnell, yes, the backlog is building.

The backlog had built a quarter ago.

You might remember we highlighted that.

We need to turn that into sales.

We need our Global team and North America team to get those projects moving faster, get them through the pipeline, and until we see that, again, we don't want to declare that the growth rate is picking up substantially.

Indicators are there, I agree with you, let's see it happen first.

I think you said -- or Chris said that Fire margins were 6%.

Do you have, you know, visibility on better margins in the Fire backlog?

Yes, I think, you know, we have seen slightly increasing margins in that business.

And as we complete these, I would think that we would continue with some modest improvement.

But, again, this is not a high capital-intensive business either.

So our return on that lower margin is fairly significant.

And, Jeffrey, just to Chris's point, the margin sequentially in the Fire business did pickup some, so we are seeing a slight trend in the positive direction there, but we need the growth.

We've got the infrastructure.

To Steve's question a moment ago, we have the people in place.

We are getting the sales and add in.

We need to get it out the door now.

Again, it's the growth piece that will really give us the acceleration down the road.

Just a question on Healthcare, you know, clearly a bright spot in the quarter.

What's your -- your confidence of kind of continuing maybe not 7% every quarter but 6 plus moving out and any particular reason why medical is a little bit weaker?

Yes.

Jeff, look, obviously we feel very good about the Healthcare business and where it's at.

I don't think that the fourth quarter will have a 6% north growth rate but it's not going to be real low either.

I think as we modeled it out it dips some here.

However, as we go into '06, we do feel confident that the organic growth rates continues to stay up at a pretty nice level now.

It gets to be more consistent, let me say it more that way.

We feel that way because the International side looks to be building to some consistency on the organic side that was higher than it ever ran in the past.

And the higher end of the portfolio, U.S.

Surgical, the Mallinckrodt end, the Valley Lab end, all look to be building some consistency on the organic growth rate.

And I would add on that the Novation contract is beginning to kick in in the business.

The medical side of the business has kind of been low growth or slight decline the last couple of quarters.

It is our lower margin business just to highlight that to you, and there is just more competition on that.

And that's kind of the lower tech end from the GPOs and all that.

It is just more competitive there and it does grow slower.

I mean, if you look at the dynamics of its it is going be a slower growth business than some of these newer technologies.

So I don't think that one will ever be a grower more than a couple points as we move out over time.

But when you blend it all together, I think organically we are picking up and consistency will be there.

One final question.

You know, I mean, you've called out plastics.

You are not going to name names on the other businesses, but I am wondering if you have moved beyond kind of, you know, evaluating moves, you know, in some of these other businesses or is there actually a process going on now?

Yes, there is a process going on now.

So we are past studying it and thinking about it.

We have begun a process.

Thanks.

Thanks, Jeff.

Thank you.

We do have a question then from the line of Brian Langenberg from Forsythe Research.

Please go ahead.

Thank you very much.

Just a couple of things following up on Jeff's question about medical.

Understanding it's not the sexy part of the business.

You know, how much of the difference, as far as you can tell, is the effects of price versus volume.

Then if we could get the attrition detail on the security counts between residential, commercial, et cetera.

Yes.

We will pull that out, Brian.

Just for the first part of your question.

There clearly is more price pressure on the medical side, but I don't want to overstate that.

It is not that significant.

Brian, we are -- where we don't sell as much on the medical side, and you know the medical is the gauze and that end of our product line.

Right.

We have a lower growth rate Internationally there.

There is just a lot more people in the business that you compete with.

So that mutes it a little bit more as one of the reasons for the growth rate there.

And a little bit more price competitive in some of the markets in that business, but not significant.

And overall in healthcare, pricing pressure is really not an issue.

Has that dynamic changed a lot in the last, say, three, six, nine months?

The reason I ask that it has always pretty much been a very good business for Tyco, with some nice margins and part of International strategy, I suppose, has always been selling more gauze overseas, to be simple about it.

Has there been a change in the dynamic or is there perhaps simply less emphasis on the kind of lower-end stuff by Tyco?

No, Brian, I would say -- there's no change in emphasis.

And I would say, quite frankly, if you look back over the past year, there's really not a big change in -- in where the business is and how it is growing.

Don't take my comments wrong.

It is a very nice business with very nice margin, it is just a lower grower than the rest of the healthcare portfolio and I expect it will be.

But it has been.

And then before we get the detail on the attrition, on that 1.5 billion share repurchase, is there any flexibility for you to use it on converts instead of the common if you find that is attractive or is that 1.5 billion will be spent on common and anything else on converts?

Yes, we anticipate in addition to the 1.5 we will be buying back some converts.

Our total program we estimate at this time would approximate 2 billion.

So, half a billion on the convert side, approximately, and a billion and a half on the straight share repurchase program.

Understood so that 1.5 will be applied toward common.

Yes.

Okay.

And on the attrition stuff, gentlemen?

Ed, why don't you read that.

Brian, just real quick here.

Yes.

And this is June compared to March.

In commercial, U.S. commercial 12 versus a 12.2 last quarter.

Residential in the U.S. 13.2 versus a 13.5.

Dealer 19 versus 18.8 last quarter so up two-tenths of a point.

That equates to total U.S. this quarter at 14.3 versus 14.4.

Last quarter the non U.S. operations 16.2 this period versus 16.0.

Europe is driving that.

Right.

And then overall, 15, 15.

Great, thank you.

Thanks, Brian

Thanks and we have a question now from the line of Robert McCarthy with CIBC World Markets.

Please go ahead.

Good morning, gentlemen.

Good morning, Rob.

I don't know if you can comment on the litigation settlement in Electronics that created the 30 basis points of headwind -- or actually of benefit rather.

Well, it's a settlement, a positive settlement.

We wouldn't name the specific situation.

Okay.

And then just talking about acquisitions, obviously you are much more muted in terms of earlier commentary.

I think you suggested that key areas would be healthcare to kind of reignite the organic growth rate which you've displayed this quarter and then on the electronics side.

You would say the change of the margin there is perhaps that your ambitions are much more limited with respect to that for the foreseeable future?

No, Robert, I don't feel any different on the acquisition side than I have felt for quite a period of time.

We are looking at some other acquisitions.

What I just wanted to stress to you was that the type of deal we just announced, the Vivant deal in Healthcare is the type of deals we are looking at in some other areas.

And we find them attractive technologies that fit into our portfolio with a great global footprint to go sell them.

So that's where we are looking and we think there is some attractive opportunities there for us, but in the scheme of the size of Tyco, they will not be big.

Understood.

That's kind of where we are headed.

Understood.

Thank you for your time, gentlemen

Thanks, Robert.

Thanks and we do have a question then from the line of Lee Cooperman with Omega Advisors.

Please go ahead.

Thank you.

One just housekeeping and the other more substantive.

The housekeeping one.

You didn't make any comment about free cash flow in fiscal '06.

This year we are talking 4.2 to 4.6.

You gave earnings guidance.

What is your best guess regarding free cash flow for '06?

What we said, Lee, was that we expected our cash flow to be in excess of our net income next year as it has been, and we are not more specific on that at this time, and we will give more guidance on -- you know later in the year.

Okay.

So you're not prepared to say whether it will be more or less than '05, just be greater than net income.

Right.

The second question is more substantive one.

I asked this question in the last call and I didn't get a good answer, either during the call or a follow-up.

Any company could buyback stock.

It doesn't take any genius to do that.

The question is, why are we buying back stock and is that the best way to return money to shareholders?

For example, you could take -- you could take a dividend for $0.40 to $1.00, an increment of $0.60 on a 2 billion shares, 1.2 billion is less than you are spending on stock repurchase and that may be a better use of your money than buying back stock that is overvalued.

I would like to know how much work has the financial management of the Company and the board done in trying to determine the valuation of the business to justify the stock repurchase?

Not that it is all that large, because, you know, thus far, your stock repurchase program, it is hard to gauge because it has been largely directed toward converts.

Argue you are retiring debt, you haven't bought back stock.

But before you were bragging that you bought back stock and it was in the mid-30s, equivalent of the conversion price.

And the stock this morning was trading south of 28.

I myself don't get any great thrills out of buying back stock that is not undervalued.

The trick in buying back stock is to buyback stock that is significantly undervalued.

So I would like to know what the financial management and, you know, the board is thinking in terms of valuation since you have access to information that we, the public, don't have.

Again, Lee, I think that our belief is that, you know, we have done quite a bit of analysis on our business.

What we expect that the business be able to generate, the growth prospects that we have which are, as we have indicated, somewhat less than they have been.

The ability of these businesses to continue to generate cash, and we believe right now that where our stock is trading and where we see some of the potential going forward that this is a -- this is the right thing to do with capital.

We will be looking at our dividend as we -- as we get into early next year, but we believe that right now it's -- that's the right way to return our capital.

It's the right way because as you look at the summary -- .

Because with the valuation and where we are trading, we believe that it's a good value.

Lee, let me just add to Chris's point.

At $34 a share, we thought it was a great buy to get the stock back in.

And at the prices we are at now, we think it is a screaming buy to buy the shares back in.

And the program we announced, which is still, let me highlight again, $2 billion through this quarter and the first two quarters of '06, is running at a very substantial pace if we accomplish what we said we were going to accomplish and as we highlight it, knowing where we are at midyear divestitures, free cash flow and all that, we will readdress the share repurchase and what our activity is moving forward.

So I think they are watching us.

We are very heavy on this one and we believe anywhere in those price ranges is a good buy for us to get it back in.

All right, thank you.

Operator we will take one more question

Thanks.

That question comes from the line of Steve Tusa with JP Morgan.

Please ho ahead.

Sorry to beat the fire and security question to death here, but what gives you guys the confidence that you are not just throwing money down a hole here in investing in this business.

You know, it is a hot area.

There's a lot of new players.

You know, is there some sort of competitive issue here that, you know, no matter what you do with the investment that it is just going to be very hard to overcome and get to those, you know, what would now turn out to be particularly aggressive targets going forward for the margin.

Look, Steve, just overall, the fire and security market is a growing market.

You know, we can look at all kinds of data out there, but it is a growing market and a nicely growing market.

So we are playing in a segment that has growth dynamics to it.

Our competitors out there, although some of the assets are owned by different people, they are no different assets than we have been competing with, you know, in the past.

It is the same great companies we have been up against.

On the security side, let's not forget we are 7 to 8 times bigger than the next player out there with a substantial base all over the globe.

Our issue, and our biggest issue, has been living through the legacy of the way they went about getting business in the past and that's the attrition that we are dealing with in the business and the fact that we did not have a sales and marketing arm in this Company of any size to go out and get growth.

So we're living with a legacy of losing business on the tail, and -- and putting in place the growth dynamics to go get business.

If you look at some of our other smaller competitors on the security side, they have well-honed sales forces.

They have done it internally for years and they are growing and you can look at a couple right now that report are growing right now.

That's what we just put in place.

That's what we are expecting to see, and we are seeing, as I said the indicators, but we don't want to declare it here until we actually see it in the top-line percentages.

And then in electronics, I mean, you mentioned, I guess, incrementally, you know, the latest revision to guidance that European auto -- again, you highlighted that as a weak area.

But it seemed to me that you had some pretty conservative assumptions coming out of the second quarter in that business.

Has there been -- you know, has it been even worse than you expected?

It seems like it has, but all the indicators out there -- I know it is soft, but it doesn't necessarily line up with something that is necessarily worse than you guys had put out there at the end of the second quarter.

Yes, Steve, as we highlighted in the third-quarter results, auto -- we actually grew the auto 3%, so it was -- we thought -- it was better than we thought in the quarter, but we continue to be nervous on the European side right now.

This is the month that we are in right now, entering August, where they do their plant shutdowns and I know a couple of the auto guys, without getting into specifics, are looking at a little bit longer shutdown than we maybe saw in the year or two past.

So, that's what has us a little muted still.

We did get the growth last quarter, but we are saying, I don't think it is there this quarter.

We think production is going to be down this quarter, which is what is going to affect us.

Now, if the auto guys are starting to bleed off some of their inventory like the U.S. guys have been with these programs, maybe that bodes better as we move out into '06.

But right now in the quarter we are in, especially with the shutdowns we are seeing, that's why you are hearing these comments from us.

Steve, let me just add.

We are using for purposes of modeling, we are using JD Power to help us with European.

We are using their numbers.

And we are using Wards for U.S. production.

Okay.

And then lastly -- oh, yes, I'm sorry.

Corporate expense.

You said it was going to be running at a little bit of a higher rate than historically.

I think the average of the last six quarters before this one was like $90 million.

Can you just give us a frame of reference for a quarterly run rate for corporate expense because it just seems a little bit higher than expected?

Yes.

I would think for the next few quarters you ought to think about it being in sort of the range that it is in this quarter, is what we've indicated.

So north of 100?

Yes, and then we'll ease it down after that, but legacy and SOX.

Great, thank you.

Thank you, Steve.

Okay.

Thanks for joining the call.

We look forward to talking with all of you in the coming days.

And obviously our next conference call will be to report on the fourth quarter, which will be in the early November time frame.

Thanks for joining us today.

Thank you.

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