江森自控 (JCI) 2005 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Tyco fourth 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.

Good morning and thanks for joining our conference call to discuss Tyco's fourth quarter results for fiscal year 2005 and the press release we 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 this call we will be providing certain forward-looking information.

We ask you to review 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, 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.

Now before I turn it over to Ed, let me recap our earnings this quarter.

Our earnings per share adjusted for a variety of items were $0.48 per share.

Our GAAP earnings per share from continuing operations were $0.42 in the quarter, which included $0.06 per share of net charges for special items.

These special items consisted of charges related to: first, a previously disclosed legal matter in Healthcare of $0.08 per share;

Second, a charge for the early retirement of convertible debt of $0.05 per share; and third, a divestiture charge of about $0.01 a share.

Also included in special items was income related to the resolution of certain legacy matters of $0.10 per share and $0.02 of income from our Plastics and Adhesives, segment which is now classified as a discontinued operation and was added back to EPS to be consistent with our previous guidance.

I would also note that we had a number of positive tax developments in the quarter, which reduced our fourth quarter effective tax rate to 21% and our full year tax rate to 24.8%, both adjusted for special items.

Had the full year tax rate been applied to the fourth quarter our EPS would have been $0.46 per share.

And Chris will get into more tax detail later in the call.

To help assist you in understanding our results this quarter, we have attached a series of schedules to the press release and we have posted those and more detailed schedules on the Investor Relations portion of our website.

Now let me turn the call over to Ed Breen.

Thanks, Ed, and good morning, everyone.

As Ed mentioned our earnings per share adjusted for special items and with the lower tax rate were $0.48 in the fourth quarter.

For the full year adjusted for special items EPS was $1.88, a 13% increase compared to last year.

Our organic revenue growth was 2% in the quarter, which was a bit stronger than expected in Fire and Security but weaker in Healthcare, primarily due to the challenges we are facing in our retail business.

Electronics continued to grow at the 3% pace we had anticipated.

Free cash flow was a bright spot for us in the quarter.

We delivered free cash flow of 1.7 billion, which exceeded the high-end of our expectations and resulted in full year free cash flow of 4.7 billion, including the cash flow from Plastics and Adhesives.

The main driver of the strong cash flow in the quarter was significantly improved working capital, particularly in inventory and payables.

Primary working capital generated 418 million of cash flow and our working capital turnover improved by four days sequentially.

We improved our inventory turns and payable days in all four segments in the quarter.

The strong cash flow was after continued growth investment in our businesses with higher capital spending and higher dealer spending year-over-year and sequentially.

Shifting to our equity retirement activities, we continue to aggressively repurchase our equity.

We spent approximately $1 billion in the quarter and through the first two weeks of October repurchased shares.

This included approximately 450 million to retire convertible bonds and approximately 500 million to retire shares in the open market.

Together these purchases reduce our diluted share count by 34 million shares.

Since we began these repurchases in the fourth quarter of '04, we have spent over 4.2 billion to retire 130 million shares or approximately 6% of our total diluted shares outstanding.

As you know, last quarter we committed to a plan to retire 2 billion of equity by the end of the second quarter.

We have now achieved half that plan in one quarter and, based on this progress, we will likely be in a position to consider a follow-on program before the end of the second quarter.

I want to spend a few minutes up-front on developments in Fire and Security, Healthcare and Electronics.

And then Chris will provide additional details in reviewing the operations with you.

First in Fire and Security we saw some good progress in the quarter on a number of fronts.

Our global fire business grew 5% organically in the quarter as we began to see projects in backlog turn into revenue.

We also improved our margins by over 150 basis points year-over-year and sequentially.

In addition, business activity continued to strengthen with our backlog in North America up 26% year-over-year and up 2% sequentially, which bodes well for 2006.

Secondly for the first time in over two and a half years, we generated positive account growth in ADT North America in the quarter.

This growth was largely a function of increased productivity from our new sales force and lower attrition.

Third in Fire and Security, we are pleased that our disconnect rate dropped by 20 basis points sequentially to 14.8%.

We believe that we are past the peak attrition in our legacy account base.

However, we will likely experience a short term uptick in the attrition rate due to hurricane Katrina.

We have approximately 90,000 accounts in the region and we are working to retain as many as possible.

However, excluding the hurricane related disconnects, we believe that the attrition rate for the remaining business will continue to drop throughout 2006, which should improve our ability to grow our account base and generate high margin recurring revenue.

Finally in Fire and Security in the U.S., our new residential accounts are now generating 37.50 per month on average versus $29.60 for our existing base of customers.

This is due primarily to continued adoption of our package service offerings.

While new accounts represent a small portion of our total account base, we view this as a positive indicator for future growth.

Now turning to Healthcare, we had strong results in our surgical, pharma and international businesses with combined organic growth rate of 8%, partially offset by a 14% revenue decline in our retail business and modest revenue decline in imaging and medical.

Our retail business had a tough year with revenue declining 9% organically and profit down significantly, primarily due to lost volumes and rising material costs in a very competitive market.

Excluding retail, however, our full year organic growth in Healthcare was 5% which was in line with our full year expectations.

Importantly in 2005, we continued our efforts to improve our growth profile in Healthcare.

Our research and development spending grew 11% year-over-year and we expect to launch 57 new products in 2006 versus the 24 we launched in 2005.

These new products are expected to generate 300 million of incremental revenue for us in '06.

Additionally, our selling and marketing spend also grew 9% year-over-year, primarily to strengthen our international sales organization.

We have also started the process of acquiring new products and technologies.

In July we acquired Vivant Medical and we are expecting to launch their first commercial microwave ablation product in the Spring of '06.

Additionally, we acquired a controlling interest in Floréane Medical implants earlier this month which strengthens our surgical product line.

We are confident that these investments will accelerate our growth rate and we expect stronger growth in '06 than in '05.

In Electronics in the fourth quarter, we had seasonally lower revenue and continued organic revenue growth in the 3% range.

Year-over-year declines in the North America and European markets left us with too much unabsorbed high cost capacity.

This absorption issue combined with higher commodity prices resulted in lower margins year-over-year.

For the past six months we have been putting plans in place to accelerate restructuring actions to address our high cost footprint and we are now ready to implement those plans.

We plan to close 16 factories over the next two years at a total cost of approximately $175 million.

We expect to spend approximately 60 million for these activities in 2006, which is included in our guidance.

In addition, we are currently in the process of increasing our prices across most of the businesses to help recover the higher material costs.

With respect to our divestitures, we continue to make progress on the sale of Plastics and Adhesives and we expect to have a transaction announced by the end of the calendar year.

We are also moving forward with several other businesses, but as we said on our last conference call we are not prepared to discuss the specifics at this time.

Finally, before Chris reviews the operational performance for you in the quarter, let me comment on our valuation.

We believe that Tyco's shares are undervalued and, as I mentioned I just mentioned, we have been an active purchaser of our equity.

In our opinion Tyco's intrinsic value is greater than our current share price.

Tyco's operations have made significant improvement over the past three years and we will continue to implement our specific plans designed to improve our revenue growth and profitability.

Should the valuation disconnect persist, we are prepared to take additional actions to address this.

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

Thanks, Ed.

Good morning, everyone.

The segment results I will discuss here have all been adjusted for special items in both periods, so we will begin with Fire and Security.

Revenue in the segment was flat year-over-year at $2.9 billion with organic revenue growth of 1.4%.

Operating income was $327 million and the operating margin was 11.3%, essentially flat year-over-year but up 60 basis points sequentially.

Consistent with our strategy, we reduced general and administrative expenses by $35 million year-over-year in the quarter and used these savings to fund increased selling and marking expenses to drive future growth.

Looking at our operating performance by business unit, worldwide security, excluding Continental Europe, represented 50% of segment revenue and was essentially flat organically with an operating margin of approximately 16%.

Revenue in Continental Europe Security, which represented 6% of segment revenue, declined 6% organically as we continue to work through higher attrition levels from our legacy customer base.

This business generated a modest operating profit in the quarter.

Worldwide Fire, which represented 34% of segment revenue, improved nicely with 5% organic growth as we began to generate revenue from projects and backlog.

The operating margin also improved to over 7%.

As Ed mentioned, order activity remained strong in the quarter and we continue to build backlog even with the better sequential revenue growth.

Finally safety products, which accounted for 10% of segment revenue, had an essentially flat revenue growth in the quarter with growth in breathing systems partially offset by a modest decline in the fire suppression products.

Operating margins were approximately 20%.

Looking ahead we are encouraged by a number of positive indicators in both our Fire and Security businesses as we move into 2006.

For the first quarter we are expecting organic growth at levels similar to the fourth quarter with modest margin improvement on a year-over-year basis excluding options expense.

Turning to our Electronics business, organic revenue growth was 3%.

Modest growth in automotive and computer markets and strong growth in energy, aerospace, communication service providers and consumer markets was partially offset by continued weakness in our printed circuit board business.

Our global automotive business grew 3% organically in the quarter, with growth in North America and Asia partially offset by a 4% year-over-year decline in Europe.

Sequentially our European automotive business declined 9% due to lower production levels and seasonal shutdowns by our customers.

Geographically our total Electronics business grew 15% organically in Asia Pacific, again which was partially offset by 2% year-over-year declines in both Europe and North America.

Order activity improved in the quarter with our book-to-bill ratio improving to 1.03 from 1.0 the prior quarter.

I would also like to mention that our M/A-COM division was recently awarded a large contract from the State of New York to build a statewide private wireless network.

We did not include this contract in our book-to-bill ratio.

Operating income in the quarter was $430 million and the operating margin was 14%.

The operating margin in the quarter was adversely impacted by several items.

First, a continuing pressure from higher material costs.

Copper, gold, resins and other raw materials cost us approximately 90 basis points on a year-over-year basis.

Additionally we took a charge related to the bankruptcy filing of a large customer which equated to approximately 30 basis points.

The remainder of the margin decline was primarily due to lower volumes in Europe and North America, where we have higher fixed cost manufacturing.

As Ed mentioned earlier, we are taking actions to improve our margins by accelerating the restructuring of our manufacturing footprint and increasing prices where we can.

As we look to the first quarter we expect an environment similar to the fourth quarter with organic growth in the 3% range.

Our margins in the quarter will impacted by restructuring charges of some $10 to $20 million as well as the expensing of options.

Now let's turn to Healthcare, where revenue in the quarter was 2.4 billion with organic revenue growth of 1%.

We continued to see strength in our surgical, pharma and international businesses, which grew 8% collectively.

As Ed mentioned, we had a very difficult quarter in retail with a 14% revenue decline.

Our focus on new products and the recent GPO contract win continues to strengthen our surgical business while investments in sales and marketing have helped fuel growth in our international businesses.

Our pharma business continues to benefit from recently launched products.

Operating income for the quarter was $615 million and the margin was 25.5%.

The sharp profit decline in retail, due to lower volumes and the higher material costs, adversely impacted our total Healthcare margins by 180 basis points or $43 million on a year-over-year basis.

As we look to the first quarter we expect continued strength in surgical, international and pharma businesses, partially offset by continued weakness in retail.

In total we expect improved growth in the first quarter.

In Engineered Products our revenue grew slightly on an organic basis.

Three of the four business units, flow control, electrical and metal products, and fire and building products, generated a combined 7% organic revenue growth, which was mostly offset by a revenue decline in infrastructure services.

This revenue decline in infrastructure services was primarily the result of a strategic decision to be more selective in bidding for new projects, which will result in fewer but more profitable projects.

Operating income of $157 million was essentially flat versus last year and the operating margin was 9.5%.

Flow control and fire and building products posted strong operating profit improvement but this was mostly offset by tightening steel spreads in electrical and metal products which reduced the operating profit by approximately $60 million compared to the fourth quarter of 2004.

End market demand remained strong in the quarter with a full control backlog up 20% year-over-year and flat sequentially, even with the strong sales growth.

Demand in fire and building products remained strong as well.

As we look to the first quarter we are expecting modest top-line growth and a slight improvement in operating profit, excluding the expensing of options.

We expect good profit improvement in flow control and fire and building products but this again will be partially offset by continued headwind from lower steel spreads compared to last year, a dynamic that will likely persist through the first half of next year.

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

First, let me comment on our income taxes.

We have made great progress on this front during 2005.

As we mentioned in our press release, during the fourth quarter we were able to reach conclusion on a number of legacy tax matters.

As a result, we were able to reduce our estimated liabilities, thereby increasing our earnings by $0.07 per share in the quarter.

These positive developments are non-recurring in nature and have been included with the special items we outlined.

Our tax rate, excluding special items for the full year, was 24.8%, an improvement from our rate of 25.6% last year.

The finalization of the full year tax rate resulted in a fourth quarter tax rate of 21%.

Looking at 2006, I think it's reasonable to assume that our tax rate, excluding special items, will be in the same range as 2004 and 2005.

With respect to cash flow in 2006, we expect free cash flow, adjusted for a number of one time legal payments, to exceed net income for the full year.

We expect cash payments of approximately $500 million for previously disclosed legal matters and the anticipated settlement with the Securities and Exchange Commission.

As most of you know, our first quarter is our seasonally weakest cash flow quarter and to the extent that we make some of these payments in the first quarter, they could consume a large portion of our cash flow.

On another topic, I'm very pleased to report that we have almost completed our SOX's 404 certification process.

And while our auditors have not yet completed their audit assessment, management's process is essentially complete and we do not anticipate any material weaknesses.

This was a major undertaking for this company, which consumed a tremendous amount of time and resources and I'm very proud of the efforts of our team in this area.

Finally, as you know, we will be adopting FAS 123 R related to the expensing of stock options beginning with the first quarter of 2006.

We estimate this expense will reduce our earnings per share by $0.06 to $0.07 per share in the full year 2006.

This expense will result in a reduction to our operating margins at the segment level.

So let me quickly run through the estimated full year impact by segment.

Our Healthcare business, we expect a 50 basis points impact;

Electronics and Fire and Security, 40 basis points; and Engineered Products, 30 basis points.

Had we implemented this standard in 2005, it would have had essentially the same impact on segment operating margins and earnings per share for the company.

Now let me turn the call back over to Ed.

Thanks, Chris.

Now let's turn to our thoughts on 2006 and the first quarter.

For the full year we are confirming our expectations for EPS growth of approximately 10%, excluding the impact of options expense.

As we mentioned earlier, this guidance includes approximately $0.02 per share of restructuring charges in Electronics.

We expect free cash flow for the full year to exceed net income, excluding special items and the one time legal payments Chris just outlined.

I would also note that Plastics and Adhesives is excluded from our guidance for earnings and cash flow.

For the first quarter we expect earnings per share from continuing operations before special items to be in the range of $0.40 to $0.42 per share.

This guidance includes approximately $0.02 for the expensing of options and compares the $0.40 per share last year when adjusted for special charges and options expense.

Thanks for joining us on the call this morning and, operator, if you would please open up the lines for questions we would be glad to take them.

Certainly, it would be my pleasure. [OPERATOR INSTRUCTIONS] Our first question this morning comes from the line of Jeffrey Sprague with Citigroup.

Please go ahead.

Thanks, good morning, everyone.

Ed, I wonder if first you could elaborate a little bit around your comments around valuation?

I'm sure what you can say is somewhat limited but there is a disconnect, I think, between the value of the company and the price of the stock.

Should we think of gradual more significant actions or at some point is there just something more dramatic that needs to happen if there's a true valuation disconnect?

Well, Jeff, as I said also and you just said there's clearly in our mind this disconnect in value.

It's persisted now for six or seven months in our mind.

As I said before we won't live with that forever and I would like to stick with the comments that I made a few moments ago, we will not sit with a long-term disconnect in the value of this company.

I don't want to get into specifics, but we have clearly discussed specific alternatives consistently at the board with management.

And we have not concluded any actions, but at the time we would we certainly would talk about those.

But at this point in time I just don't want to go into any more details on it.

I just want you to know, we take our obligation seriously that we are here to create long-term shareholder value and that's what we plan on doing.

And again, if we see a disconnect persist there are alternatives we could take to address it.

Related to this topic, if we go back to '03, '04, '06 might have been the view of when some of the larger legal settlements happen, aside from what you already talked about, but the class action lawsuits and such.

Do you, in fact, think that could happen and would it be difficult to do something large strategically, dismantling the company in front of that liability?

In other words, would it create some type of legal issue of where the resources would come to maybe settle those obligations if the company was smaller or in some different shape or form?

Well, Jeff, I'm not going to comment on your leading part of the comment about dismantling the company.

Obviously, I will leave my comments where they were on that.

But I guess the key is we are really down to now, my opinion, the class action litigation being our big legacy item that needs to be resolved.

Again we are not quite there on the SEC, as you heard.

You know we have taken the $50 million charge.

We think we are extremely close to having that resolved.

And I'm very proud of the progress we made this year and I would say really in the second half of this year with Chris and the team on the legacy tax matters.

And as you can see, we are starting to knock off those items and they are having a positive impact for us at this point in time, not a negative impact.

So for I think many of you, that was another one on the legacy list that I think would had some concern out there and we are feeling extremely good about that.

So we are down to the class action litigation.

Again, I can't put a definitive timeline on it but if I'm sitting where I'm sitting, knowing what I know, I would think during the next year potentially we could get this resolved.

But I would not put 100% confidence around that comment.

But hopefully maybe that's an '06 event for us.

I would just say I think anything we would want to look at strategically in a company class action litigation will not stand in the way.

Just maybe I will just throw one more business question, can you give us a sense in Fire and Security what the gross account growth is?

We have got all the puts and takes, attrition, new accounts, if we just look at gross account growth where are we at in the -- ?

Jeff, this quarter was the first crossover quarter and I don't want to pound our chest hard on it.

We just crossed over on an aggregate during the whole quarter, so it was less than 10,000 accounts on a net add basis, would be the way to say it.

But the momentum continues to move up both on the close rate of the sales force.

The resale rate is holding up at a very nice level.

We worked that up and that's holding.

Again, we think as we go through '06, in fact fairly confidently, that our disconnect rate continues down, sitting aside maybe a little blip here on the Katrina thing.

I would also say it was three years ago where we had the big dealer spend of 1.4 billion.

We are now coming to the end of that, but I would give this a quarter to a quarter and a half before you might see more of a drop on disconnect there because these accounts -- this is kind of where they figure out they are at the end of their three years and do they disconnect, do you hold on to them or not kind of gets worked in this three to four-month window.

But having said that, we think a gradual decline in disconnect rate will occur in the business.

The dynamics are all moving nicely for us now in the North America footprint.

I want to clarify, the European footprint, as Chris mentioned, we are still losing accounts there.

We had 6% loss of accounts but it's the same dynamic we had going on in the U.S. but the contracts in Europe are a year and a half longer than the contracts we had in the U.S.

So we are going to live with this legacy issue a little bit longer there but we are watching the new accounts we are generating.

We feel good about the return on them.

We feel good about the -- we will keep those accounts, they are good, sticky accounts and we are just living through that same issue over there that's going to take a little longer.

Thanks a lot.

We do have a question now from the line of Jack Kelly with Goldman Sachs.

Please go ahead.

Good morning, Ed.

Just following up on your comment about the buyback, which I think you had indicated originally was going to be a nine-month buyback which would be the end of March, and you mentioned is going to probably be a little bit earlier than that.

In terms of order of magnitude, again, don't expect a precise answer, but given the $2 billion buyback that you authorized in the June timeframe, Ed, can we look forward to something as big as that or what's your general thinking in terms of reauthorization?

Look, Jack, let me just say overall, and I hope you are seeing this, we are being aggressive on buying back our shares here and, as we mentioned, we spent over 4.2 billion basically in a little more than a year buying back 6% of our shares.

And we bought back almost 2%, 1.5% to 2% here in the past quarter.

So we had a pretty good rate going and I think you can see trend-wise we plan on being share repurchasers here.

Especially with our stock price at these levels, we are going to be buying as much as we feel we can.

I also want to point out to you, as we said to you last quarter, we have targeted our net debt rate to be around 10 billion.

We actually got below that this quarter.

We will use our balance sheet when appropriate here.

We are not going to keep just reducing debt as debt payments come up and the converts come up in January.

So we are going to have cash available to us to have our flexibility here.

On top of, I don't know that the timing of actually getting cash on hand for sale for Plastics but we have the Plastic sale coming up here also.

So from a whole balance sheet perspective and where we are sitting it's a real bright spot for us and we have got a lot of flexibility coming here over the next six months.

On the Electronics side had you mentioned the pressure on margins due to commodity costs.

This has been kind of a continuing issue for you guys.

It seems like many other company's, I'm talking more broadly than just connectors, have at least caught up or maybe gotten ahead of their raw material cost issue.

Why hasn't that really happened with you guys?

You have the market share to do it.

Typically that keeps companies in pretty good stead.

Maybe just give us a little color on why it hasn't happened in the last two or three quarters.

No, Jack, look it's a great question and there's really in my mind two big things we are doing in Electronics right now.

One we've been planning for quite awhile, as I mentioned, and that's the factory footprint issue.

I think we've highlighted to you over the last couple of quarters we were very worried about the European auto environment and, bingo, we were 9% down sequentially from the third quarter to the fourth quarter, which really hammered us from an absorption standpoint in our high cost facilities.

I would also point out Chris had mentioned that we had 3% organic growth in the business, but it was 14% in Asia, actually down in the U.S. 2% and down 2% overall in Europe.

I'm not just talking auto now.

So the plans we've been putting in place have really -- not once and for all, but maybe that's the right term, is to take the rest of the footprint we are concerned about in high cost locations that we want to deal with and move them out of our portfolio.

And we have plans to put low cost facilities in a few different countries around the globe to offset this.

So that will really fix the absorption issue that we know was still remaining in the company.

Having said that, our Electronics team has done a great job in the last few years moving a significant part of their base.

The problem is we still knew we had this issue looming there and it's clear from this quarter that we did have it.

So, we are going to address that very aggressively.

And as I mentioned, we are getting started on that restructuring as we speak.

On the pricing side, Jack, just to address that, we had not raised prices during the past year in this business.

I don't want to get into the details of strategically and competitive issues there, but we have taken the step to raise prices across the board.

We are doing that right now, also as we speak, in the Electronics business.

So we did not lead on price increase but we are following through with a price increase at this point in time.

Just a final question.

Electronics you had talked about a couple of quarters ago of selling maybe roughly $1 billion worth of businesses in Electronics.

Where is that process generally, Ed?

We are in that process, but I don't want to talk any specifics or details.

When we get to the point of announcement we will announce it, Jack.

But to your question, and we mentioned this last quarter, those businesses, and you're right, they are about 1 billion to 1.2 billion of our revenue, they are bringing down our margins in Electronics by approximately 150 basis points.

So the 14 we had this quarter, if you take out the bankruptcy pieces, but try to get a kind of an operating level, was 14.3, and you could add back 150 basis points if we were to exist a few of those businesses that are on the list that we are working.

We have a question now from the line of Don MacDougall with Banc of America Securities.

Please go ahead.

Good morning, Ed.

A question for you on Healthcare.

Could we get a little more detail on the retail business and what's going on there with respect to your comments about that being a little bit lower than you had planned?

Was that a share issue?

Was that a cost issue?

Was that just an overall retail environment?

Yes, yes.

I mean, look, we've highlighted to you about a quarter ago that we -- going back to the last question, it's kind of interesting, we took the lead on a price increase of some significance and led the market on it and we got clobbered on it a little more than a quarter ago and we've been living with that consequence.

We've lost some business as a result of that.

And we are obviously facing raw material headwinds in that business, also, but the bigger issue was we led with an increase.

We got clobbered on it, vis-a-vis mostly the branded players.

I will note to you, and you have probably noticed this, that the branded players recently did announce some price increase and we are working hard, obviously, to get our position back in a couple of areas where we lost it.

As an overall comment, we are a very large player in that business for the retailers out there with their brands on it and they like their brands on the product.

I mean that's a very important part of the consumer coming to their store.

So we feel good about the business building back here, but it's going to take us a little bit of time.

By a little bit of time do you mean a few quarters?

Yeah, a few quarters.

It won't happen in one quarter.

Jumping to the other part of Healthcare that performed a little bit better, you had mentioned some new products you expected to impact next year, I think $300 million.

Was there a similar impact this year from some new products introduced this year, if you had a number?

And then also could you talk to us a little bit about Novation and what kind of traction you say on that contract?

Yeah, Don, as we mentioned, we are expecting 300 million from new product launchings this year.

It was about half that amount last year from the 20 some products that we launched last year.

So it will double this year, approximately $150 million more from it.

It's also interesting to see that where we are putting the R&D dollars and where we have increased the sales expense is where we are seeing the higher organic growth rates.

We've done a lot in international.

We've added over 800 people internationally during the past 18 months and we are seeing very nice growth rates as we mentioned.

That's been up in that 8% range.

Surgical we are seeing that also and that's where we added a fair amount of sales and R&D also, and we put the R&D in the pharma and that's where we are seeing it.

And that's some of our higher-end product areas.

We have put R&D and we are continuing to add salespeople in our respiratory and imaging side.

They are growing at a lower rate.

However, those product introductions take a little longer to happen.

The R&D cycle is longer on those products, so we would expect more of that to hit towards the second half of '06 that has not hit yet.

But we are feeling very confident about that.

The Novation contract is building up, but it doesn't build up to the run rate we think we will end up at for still about a year here.

We build up throughout this fiscal year '06.

But we are feeling good about the business we are getting there.

We are getting what we thought we would get out of it and that will hit our surgical business.

As I also pointed out, just to add, with these couple of acquisitions we've done, Vivant will launch this spring.

We think we have got a nice product line coming there.

And as we close on the Floréane deal, a nice addition to our surgical product line there which will also help our growth.

One final one, just goes back maybe to Jeff's question and some comments that you had made in your opening statement.

When we think about options to maybe close the perceived valuation gap, at one extreme we could go from splitting the company up into constituent pieces and maybe at the other extreme being much more aggressive on retiring equity.

Should we come out of this call thinking that the full range of that spectrum is something that's under consideration or is it something maybe a little less dramatic?

I would say the full range is being considered.

Thank you.

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

Please go ahead.

The valuation question is going to rule the day later [INAUDIBLE], Ed.

A couple of questions.

On Electronics, the growth in North America and Europe down a couple percent.

Could you just give us a little more of an idea of what's going on there and then what the book-to-bill suggests for the current quarter in those markets?

Bob, it's really -- if you just look at it it's the continuing shift of our customer base into Asia.

And we track it very closely.

Since I've been in the company it's been very consistent.

A lot of their facilities have moved into locations in Asia.

I think we are very good at doing design in and living next door to our customer and therefore we've been moving with them.

It's the reason we have 30,000 Tyco Electronics employees right now in China in 21 locations.

Having said that, going back to my factory footprint issue, we've always told you we were under 50% of our factory footprint moved, if it was Utopia, moved to how we want it and now we are going to take a very big step.

When I say 16 facilities, I'm talking 16, by and large, large manufacturing locations that we will move here to fix the rest of that issue.

And again it's part, and most of it is simply because our customer base continues to shift where we are making our end location sale to.

And so that's what continues to on there and I would expect that trend to continue.

Got it.

By the way to the book-to-bill, I don't want to get overly optimistic about this yet and we are not forecasting this, we are forecasting 3% organic now.

But as Chris mentioned, our book-to-bill this past quarter picked up the 1.03 and I would say, I don't want to get into specific numbers, but since the close of the quarter our booking rate has continued to feel much better than it did during the summer months.

So if that would continue, that would be awful good for us for '06.

But let's see a little bit more time go by at these higher rates.

A couple of follow-up questions.

You took the provision for the SEC settlement back in the March quarter and nothing has happened.

Why has there been a delay?

Bob, finalizing paperwork takes time, let me just leave it at that.

As you see, there's no change to the amount of the charge we took.

We are working our way through to conclusion.

Those things take time.

As you know at the SEC it goes to the full commission to approve it, so there's a process here and a timeline, but we are confident we are extremely close.

And there's also been some people changes there that have impacted the timing.

Another question for you, Chris, on the tax matters, I mean, in the settlements you have reached have you closed other years?

When we were talking about the '97 to '00 tax years, have you concluded anything in other years?

As you know, we are still open on those years, and in fact redoing many of the returns, so these have not closed out total years, but we have come to resolution on a number of issues globally where we were able to come to an agreed upon conclusion at less than the liability we had and that was the $0.07 a share.

And additionally, as we said, our full year run rate for our income tax came in a bit better than last year at just under 25%, at 24.8%.

So again we are feeling pretty good that we have the issues identified.

We have our positions well documented.

And we hopefully will continue to close out additional legacy items as we get into '06.

Okay, thanks.

Thanks, Bob.

We have a question now from the line of Nicole Parent with Credit Suisse First Boston.

Please go ahead.

Good morning.

I just wanted to delve a little bit deeper into the Healthcare businesses.

You indicated surgical, pharma and international were up 8% in aggregate.

Could you just give us a sense of what medical, what [kendall], what respiratory?

In the answer to Don's question you talked about the R&D coming through, but could you give us a sense by sub-segment where we were in the quarter?

We were, Nicole, we were down, as we indicated, slightly in the quarter in imaging, in medical and in respiratory.

And again our imaging business continues to grow globally.

We are seeing slower growth in the U.S.

In fact slightly negative in the quarter.

And we would expect that in imaging, medical and respiratory we will continue at a lower growth rate here as we go into, into the year and then have it start to pick up as we have some new product introduction that is we talked about earlier.

Okay.

And I guess any additional color on the warning letter situation?

And how you guys are handling that?

Nicole, look, we are working through it.

There's a lot more warning letters coming out in general.

I mean we track this.

We track it vis-a-vis every person that we compete with.

Having said that we take it extremely serious.

We are working them hard.

But I'm not saying we won't get another one, but we work them very hard and I am not -- as long as we take the steps we need to take here we will close those out.

And I guess just one follow-up on Fire and -- .

Nicole, just as a point overall on Healthcare.

What continues to benefit us here, despite the drag this quarter on retail, is because the R&D and the sales focus has been more obviously on our higher-end product areas, as you've watched our last year mix has helped us in this business and as we acquire some technologies we are acquiring on the higher-end of our portfolio range, which should help us also from a mix standpoint.

Okay.

And I guess just in the context of Fire and Security, it's small as a percent of revenue but the Continental Europe business you didn't give us the margin there, I think you said it was modestly profitable.

Could you just talk about how we should be thinking about that business?

Is that something that we are not going to focus on until we actually [INAUDIBLE] business.

The margins are about 3% in the business and they've kind of bounced around that range for -- it was extremely unprofitable two and a half years ago.

We've got it in that range and the real issue now is generating new accounts.

We are doing the same thing we did in the U.S., although we are behind the U.S.

We are building up our own internal sales force throughout Continental Europe, not in the U.K., we already had a very stabilized sales force there.

And so it's kind of the same pattern as in the U.S.

And then as I mentioned earlier, the accounts have a longer contract cycle over there, so we are going to deal with -- we are dealing with this drop off.

It's going to take a little bit longer in the legacy account base.

As we work through that I would think we have the same dynamic we've seen in the U.S. and other parts of the world, except the move up in margins will be more gradual.

Don't expect them to jump up into the mid-teens here.

It will be a more gradual move up as we work through the legacy base.

Great.

Just one last one on Electronics, how would you characterize the order book out of the Frankford order show, better, in line or worse than expected?

Well, as we mentioned, our overall auto order rate was actually up 3% this quarter.

The problem was we had a significant decline, and maybe that's to your question, on the European side.

We are sensing some stabilizing of it.

And that was a little bit to my point earlier.

It's part of our book-to-bill looking a little bit better right now.

On the other hand, I would like to see a couple more months of that continuing before I would declare we are running at a higher rate.

Great.

Thank you.

Operator, we have time for two more questions.

Our next one will come from the line of Scott Davis with Morgan Stanley.

Please go ahead.

Good morning, guys.

Since it's my first call I can ask all the dumb questions, I guess.

As long as we do it quickly, we are okay.

Good.

I didn't hear you mention anything about dividend increase.

Am I to suspect that you will probably be raising the dividend here shortly?

We will be looking in the near-term at our dividends.

And again as Ed indicated, our cash flow position is very good.

Our debt position is good.

So I think we continue to evaluate, as we said, both the stock buyback as well as the dividends.

And a couple quick ones on the fire business.

It looked like volumes picked up a good bit but margins still stuck around 7%.

If you could talk to that?

And then also talk to the 26% backlog that you are seeing, give us some context of over what timeframe you would expect that to be realized.

Scott, the fire business actually had better margins this quarter both year-over-year and sequentially, so the fact that we were able to convert more of our backlog in fire into actual revenue in the quarter helped our profitability.

So we are pleased with what we are seeing there after a number of years of being flat to down.

Building backlog and better revenue is helping our profitability there.

Now the second part of your question was what?

Understanding how fast that backlog converts into revenues?

It really depends on the nature of the underlying contract.

In some instances we will get a contract in our fire business for a project that is just in development or in the early stages of construction.

In other instances we will get a contract that is for a project further along in the process.

So it really depends on the underlying projects that we are winning.

But I think the key, Scott, is we were building backlog for a few quarters in this business and we weren't seeing it come out the other end of the pipe.

And now we are starting to see that flow come out.

Again, because some of these projects are three months, six months, nine months and you know how you build these things when it's project type accounting.

So it's starting to flow through now.

Scott, I would also like to add that while the fire margins are below the total margins for Fire and Security, the return on our invested capital in that business is extremely high due to the contracting nature of that business.

That's very helpful.

Thank, guys.

Operator, this will be the last question.

The next question comes from the line of Lee Cooperman with Omega Advisors.

Please go ahead.

Thank you.

Just to give you a little comfort because you guys are a little bit younger than me, in this value creation thing a bunch of companies preceded you in this game, ITT, Litton, Ind, Teledyne, Walter Kidde, Gulf + Western, City Investing, all found in the end that disaggregating created more value.

But let me get to a few financial questions if I may.

One, what are the converts, amount of converts currently outstanding, because in the buyback I don't know how much of the money was directed towards the converts?

At the last quarter the 2.75s had 1.67 billion, do you know what that number is?

And the 3.125s were 847 million.

We are about 2 billion, Lee.

I will get you the specific numbers after the call.

If you would call me on that because basically the 2.75s are callable on January 20th of '06, the convertible at 22.78.

So I would assume, given what you said this morning on the call and your results, that there is no guarantee that they are likely to be put into the equity base on January 20th.

The Series A is about 1.2 billion.

I'll get you the exact numbers after the call.

The next question is directed towards debt capacity.

If you had 9.4 billion of debt at September 30th and you are saying that there's about $2 billion of debt in the two converts, which are both in the money, so I look at that as equity.

And let's say hypothetically, I have no idea that you sell Plastics for $1 billion basically, your net debt, your real net debt presently is about 6.5 billion.

Your free cash flow is running in excess of 4 billion a year and your EBITDA is probably close to 8 billion.

What level of debt to EBITDA would you guys feel comfortable with?

What I'm really asking is what your un-utilized debt capacity.

As you pointed out we are in a very strong position right now.

Our cash flow looks good.

We've said that we want to stay in about this $10 billion range.

We will not remain with a very unleveraged balance sheet.

We will be able to use our balance sheet.

So I think we are seeing as we look forward continuing opportunities here in the use of our balance sheet.

A suggestion I would make, and you in an open microphone told the world, and I don't know if you're right by the way, but you told the world you think your stock is significantly undervalued and you are committed to take measures to generate that value, whether it's spinning or disaggregating or whatever you have in mind.

If you have confidence in that statement, given the amount of your free cash flow, given your existing debt to EBITDA, it would seem to me that we should shrink the equity more aggressively before you create all this value, rather than create the value, have the stock go up and then be like a lot of other jerks, buyback a lot of stock at high prices.

We started the repurchase program when the converts and the stock was in the mid-30s.

We are now at 27.

Logic would suggest we should be more aggressive rather than less aggressive.

All I was saying, I don't expect an answer, I'm just giving you an idea and a thought.

If you really believe your stock is meaningfully undervalued and you really are committed to generate that value, since you said that publicly, I would suggest that you examine what you feel comfortable is a reasonable level of debt to EBITDA.

You seem to have a large amount of un-utilized debt capacity, this convert is coming off the balance sheet shortly, and I think it's something that you could create a lot of value for your shareholders by taking out the nonbelievers and focusing on the believers.

No answer necessary.

Just a little food for thought.

Talk to you soon.

Thank you, Lee.

I appreciate your comments.

Thanks everyone for joining the call.

Look forward to talking to you, reporting on our next quarter in early February.

Thank you very much.

Thank you.

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