江森自控 (JCI) 2006 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Tyco first quarter 2006 earnings conference call.

At this time, all lines are in a listen only-mode. [OPERATOR INSTRUCTIONS].

As a reminder, today's call is being recorded.

At this time, I'd 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 first quarter results for fiscal year 2006.

And the press release with issued earlier this morning.

With me today are Tyco's Chairman and Chief Executive Officer, Ed Breen; our Chief Financial Officer, Chris Coughlin; and the Chief Executive Officer of Tyco Healthcare, Rich Meelia.

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 there.

In addition, we will be using 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 subsegment level.

The press release and all related tables can be found on the investor relations portion of our Web site at Tyco.com.

Let me quickly recap our earnings this quarter.

Our GAAP earnings per share from continuing operations were $0.39 in the quarter; and in addition, our earnings per share, excluding special items, were also $0.39 per share, due to the fact that there were no significant special items in the quarter.

Our free cash flow in the quarter was $230 million, which included approximately 120 million in cash payments to resolve certain previously disclosed legal matters.

Now, let me turn the call over the Rich Meelia, CEO of Tyco Healthcare.

Rich has joined us for today's call to allow you to hear about the issues in Healthcare and the actions his team is taking to address these issues.

Chris Coughlin will then go over the results of the other business segments.

And then Ed Breen will wrap up with some overall Tyco comments.

Thanks, Ed, and good morning.

I'm pleased to be with all of you this morning to discuss Tyco Healthcare's performance in the quarter and describe the key events that hit us and what we are doing to make our business better in the future.

First, revenue in the quarter was 2.3 billion, with organic revenue growth of approximately 1%, which was below our expectations for a number of reasons.

Operating income for the quarter was 539 million with an operating margin of 23.6%, impacted by a few performance issues.

While our international and surgical businesses had good quarters, our overall operating performance was adversely impacted by voluntary product recalls and quality issues in imagining and respiratory, capacity constraints in pharmaceuticals, and continued weakness in our retail business.

Despite these challenges, we continue to invest in R&D, sales, marketing and quality, all of which are critical to the long-term success of our business.

On a year-over-year basis, we invested an incremental $31 million or 1.4% of sales this quarter on these initiatives, including a 21% increase in R&D investments.

We also executed two key technology acquisitions, which are important to our future growth and profitability.

In late January, we also reached a settlement on all of our existing patent litigation related to pulse oximetry products.

Under the term of the settlement, all pending patent litigation will be dismissed.

As part of the settlement, we agreed to pay a royalty on our new pulse oximetry products for the next five years.

We introduced a new line of pulse oximetry products early in the second fiscal quarter.

Our global pulse oximetry business will generate approximately $500 million in sales this year, and we expect solid operating profit from these sales, net of royalties.

I think it would be helpful for me to take a minute to explain our operating results within the context of our overall business strategy and how it has evolved over the past three years.

In 2003, we began investing more into R&D in order to develop a more robust new product pipeline with the objective of increasing our sales growth.

All along, our plan has been to mitigate margin erosion through strategic sourcing, manufacturing cost reduction programs, and favorable product mix from stronger revenue growth in our higher margin businesses.

Results in 2004 through the first half of 2005 were good.

Sales growth remained at 3 to 5%, while our operating margin actually strengthened to the 26, 27% level due to a favorable product mix, manufacturing cost reductions, and strategic sourcing gains.

To accelerate our sales growth, we began investing in more sales and marketing talent, especially outside the U.S. where we added 300 people in 2004 and an additional 500 people in 2005.

Where we have made these investments, we have seen positive results.

For example, our international business has generated 7% organic revenue growth in each of the past two years.

Over past few quarters, a variety of factors negatively impacted Healthcare's top and bottom line.

Let me comment briefly on these items.

First, as you know, our retail business had a difficult 2005, particularly in the second half of the year.

In the second quarter of fiscal '05, we implemented a price increase to offset higher raw material costs.

Unfortunately, these price increases were not well-received by the market, and we had to rollback our prices to maintain our volume.

While we recaptured the volume, our margins continued to be squeezed by lower prices and rising raw material costs.

In the first quarter, we saw positive revenue growth but lower operating profit, which reduced total Healthcare margins by 90 basis points on a year-over-year basis.

Second, in our imagining and respiratory businesses, we are working through several manufacturing issues and voluntary recalls.

In the past several months, we had three voluntary recalls in our imaging business.

We recalled two products, our DTE Generators and Optison, due to sterility concerns, although there were no incidents in the marketplace and no patient issues.

The third product, NeutroSpec, was recalled due to problems with off-label use.

In respiratory, a quality issue in our Juarez, Mexico, facility resulted in lower sales to the U.S. market.

The combined impact of these issues reduced our first quarter sales by $26 million and our operating profit by $24 million, or 100 basis points.

The profit was impacted by the lost sales as well as cost to conduct the recalls and remediate the underlying issues.

Finally, a delayed ramp in our pharmaceuticals dosage business also accounted for a 15 to $20 million loss in sales this quarter relative to our plan.

We had expected our additional capacity to be operational in the first quarter, and we ran into construction and equipment setup delays.

As a result, the new capacity will become available by the end of the second quarter.

We have moved aggressively to resolve all these issues.

In manufacturing, we made several management changes, including the overall head of manufacturing for Tyco Healthcare and several manufacturing leaders in the imagining business.

We separated quality assurance from regulatory affairs to ensure more focus on both quality and regulatory compliance.

And finally, we moved one of our top operating people to manage respiratory, a business unit capable of generating much stronger results.

We expect to be shipping the DTE Generators sometime in the April time frame.

And as I said, our dosage capacity in our pharma business should be online at the end of this quarter.

For retail, we expect modest topline growth and slightly better margins on a sequential basis.

I'm confident that the steps we are taking will allow us to put these issues behind us.

As we look to the second quarter, we expect better topline growth on a year-over-year basis than the first quarter, but we will still have lost revenue and higher cost related to voluntary recall and product compliance efforts.

We expect an operating margin similar to the first quarter.

Looking ahead to the second half of the year, we expect most of these issues will be resolved.

As a result, we expect sales growth to be back in the mid-single digit range with operating margins in the mid-20s.

Let me assure you that resolving these issues and continuing to invest in our future is at the top of our management agenda.

Now let me turn the call to Chris to discuss the results of the other business segments.

Thanks, Rich.

And good morning, everyone.

Let me continue our review with Fire and Security.

Revenue in Fire and Security was $2.8 billion with organic revenue growth of 1%.

Operating income was 228 million and the operating margin was 8.2%.

On a year-over-year basis, the operating margin was down approximately 160 basis points.

Stock option expense was $11 million this quarter and accounted for approximately 40 basis points of the margin decline.

The remainder of the operating margin decline was primarily due to lower sales and profits in commercial security, and margin pressure in our worldwide fire services business.

First, let's take a look at our worldwide security business, including continental Europe, which represented 58% of segment revenue.

Organic revenue growth was essentially flat.

Modest organic revenue growth in our residential security business was offset by a modest decline in commercial security.

Operating margin of approximately 12% was 130 basis points lower on a year-over-year basis.

Our margins were adversely impacted by slightly lower revenue and reduced installation productivity in our commercial security business.

While we were pleased with the continued positive momentum in the residential security business, these favorable trends were not able to offset the lower contracting margins in our larger commercial business.

Worldwide fire, which represented 32% of the segment's revenue, had 3% organic revenue growth.

Continued revenue strength in North America was offset by weakness in Europe.

The operating margin was approximately 4%, which was about 100 basis points lower on a year-over-year basis.

The operating margin decline was due to lower margins in our contracting business, resulting from competitive price pressures and higher installation costs.

Finally, safety products, which accounts for approximately 10% of segment revenue, had 3% organic revenue growth and operating margin in the midteens.

Despite hurricane-Katrina related effects, our ADT trailing 12-month disconnect rate continued to improve, falling to 14.3% which reflected the combined impact of lower gross attrition rates and higher resale rates.

This compares to 14.8% last quarter and 15.4% in the first quarter of last year.

Looking ahead, we are aggressively managing our cost structure to improve our margins across all of Fire and Security.

We are focused on improving sales force productivity and our gross margins on new bookings.

We will continue to reduce our overall G&A expense, which has declined over the past three years.

Both Ed Breen and I are focused much of our time and effort on ensuring we return this business to its previous margins and then improving our performance from there.

Now let me turn to Electronics, where our overall revenue growth was 8%, our strongest quarter since the fourth quarter of 2004.

Organic revenue growth in the connector and cable assembly products, which accounts for approximately 60% of our business sales, was 11% in the quarter.

Growth was strong in all our end markets, especially in the communication, computer and consumer electronics, general industrial, and energy markets.

Our global automotive business also grew 6% in the quarter with solid growth in both North America and Asia, which was partially offset by flat sales in Europe.

Order activity in the quarter showed continued strength with our total segment book to bill ratio at 1.02.

Operating income in the quarter was $384 million and the operating margin was 12.7%.

Restructuring costs and options expenses reduced our margin by 60 basis points on a year-over-year basis.

Income from higher revenue was more than offset by margin pressure from higher raw material costs.

Copper, gold, resins and other raw materials continue to rise to recent record highs and cost us approximately 130 basis points of margin.

To partially offset these costs, we are looking at additional pricing increases.

In addition, our restructuring program to close 16 manufacturing facilities over the next two years is now underway.

Looking forward, we expect strong revenue growth to continue through the second quarter, but at a somewhat lower rate than what we saw in the first quarter.

With raw material prices at their current levels and continued softness in the European automotive market, we still expect modest margin improvement in the second quarter on a sequential basis.

Let me now turn to our Engineered Products business, where we had a solid quarter with 8% organic revenue growth.

Three of the four business units, flow control, electrical and metal products, and fire and building products, generate a combined 11% organic revenue growth, which was partially offset by a 4% revenue decline in infrastructure services as we continue to be more selective in bidding for new projects in that business.

Operating income of $169 million was essentially flat year-over-year, with an operating margin of 10.5%.

Options expense reduced our operating profit by 5 million.

There was solid profit improvement in flow control and fire and building products.

However, this was partially offset by tighter steel spreads in electrical and metal products, which reduced operating profits by approximately $35 million, compared to our first quarter of 2005.

End market demands remain strong across the segment.

In particular, the backlog at flow control grew 25% year-over-year.

As a result, we expect solid revenue growth in the second quarter, and a modest year-over-year operating profit growth despite options expense and the lower steel spreads.

Before I turn it over to Ed, let me comment on the proposed separation of Tyco into three separate companies.

Our process to execute this plan is well underway.

Resources have been dedicated to managing and overseeing this complex task while we focus on the operating issues we have just discussed.

As we mentioned in our last conference call, the tax and legal work required to complete this separation are the most time consuming parts of the process.

We have over 2,000 legal entities around the world, many of which hold assets in multiple businesses across our four business segments.

This process will require a great deal of tax planning, with a country-by-country evaluation and sequential execution.

As a result, we expect to complete the transactions during the first calendar quarter of 2007.

Now let me turn the call over to Ed Breen.

Thanks, Chris.

Now let's turn to our thoughts on guidance for the second quarter and the full year.

For the second 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.

We expect similar topline growth and operating margins compared with the first quarter, as we continue to work through the voluntary recall and regulatory issues in Healthcare that Rich described.

In Fire and Security, our cost reduction efforts will positively impact our sequential results, but we do not expect operating income to match last year's levels.

For the full year, we are confirming our expectations for EPS of approximately $1.85 to $1.92, including the impact of options expense.

We expect to see improvement in our topline revenue growth and significantly better operating performance in the second half of the year, due to the actions that Rich is taking in Healthcare, as well as significant cost reduction activities we are implementing in Fire and Security.

We will also see benefits from our lower interest expense and reduced share count.

Achieving the high end of the range will require growth rates modestly above current levels, as well as improved operating margins in Electronics from a combined combination of price increases and an easing of raw material price pressure.

Demand for our Company's products and services remains strong.

As we move into the second half of the year, we are confident that many of the issues that negatively impacted the first half will be behind us.

With respect to our 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 these cash payments to be approximately 600 million as we resolve a number of previously disclosed legacy legal matters.

Before I open up the call to questions, let me comment on a few additional items.

First, we are obviously not happy with the current performance of some of the businesses.

Electronics and Engineered Products are on track.

In the case of Healthcare, our issues are mostly temporary and Rich and the Healthcare team are actively addressing these issues.

As I previously said, these are our issues, not market issues.

Healthcare is a strong business in an attractive industry, and we expect a good year from this business.

In the case of Fire and Security, our operating performance is not where we want it to be.

We are a global leader in an attractive, growing industry, and we have made good progress over the past few years changing the business model, taking out costs, and investing for growth.

But the progress has been slower than we would have liked, and we are very disappointed with the poor first quarter performance.

We are taking actions to improve sales force productivity and operating margins, which will be accomplished through selective price increases and improved job execution.

In addition, we are aggressively reducing costs during the remainder of the year.

Fire and Security is a very large, complex business which requires additional operating management skills.

We are pleased that John Koch has joined our ADT North American team as Chief Operating Officer, and we're looking for John to help drive operational improvements.

John comes to us from Alltel, a 10 billion wireless and wireline service provider where he served most recently as president of wireline services.

We will also be a adding additional senior-level talent to this organization over the near term to strengthen our operating team.

Finally, our issues in Fire and Security are fixable and we will get them straightened out.

As Chris mentioned, both Chris and I will be spending a lot of our time over the coming months working on this business.

Lastly, I also want to reiterate our thoughts on share repurchase.

As we mentioned in the previous conference call, the primary rationale for separating into three companies is to allow each of the companies to pursue their individual growth strategies, and ultimately create more value for our shareholders.

An essential element of this overall strategy is to provide each of the companies with a capital structure and financial policies that are consistent with investment grade credit ratings, and consistent with each company's peer group.

In addition, we believe our stock is a very good investment at these price levels.

It is our intent to continue to repurchase shares as we generate cash in excess of what is required to achieve the Company's combined debt target of approximately 10 billion.

We have an additional 1 billion remaining on our existing share repurchase program.

We plan to be back in the market shortly, and intend the complete this program over the next several months.

At that time, we will be in a position to communicate a follow-on program.

Again, as we mentioned in the last call, our intention is to use our excess capital to retire shares during the course of 2006.

Thanks for joining the conference call this morning, and with that, we'll open it up for questions.

Operator, if you could open up the lines.

[OPERATOR INSTRUCTIONS].

Nicole Parent, Credit Suisse.

Good morning.

Good morning, Nicole.

I guess just -- since we have Rich on the call to delve a little bit deeper into the Healthcare business, do you have the organic growth by subsegment for the quarter, and based on the management changes at respiratory, does that imply things are, I guess, down more than we would have thought they would be?

Generally speaking, the growth that we saw at surgical was a little lower than we thought.

It had some previous quarter issues, and that will change significantly going forward.

International is doing very, very well and we'll continue to see that at that 7, 8%.

The problems were in respiratory and imagining, and we're fixing those, Nicole.

It's -- they were pretty significant and anytime you have multiple quality issues that leads to recalls and potential back orders, you have a huge distraction for your business.

And a lot of the other good things you want to be doing to make your business better get kind of temporarily put aside while you fix the problems that are staring you right in the face.

But those problems are going to be behind us.

And we really do expect to see more favorable growth in the second quarter; and then as we go to the second half of the year, just about all the segments will be growing -- all off them will be growing better than -- with the exception of international, which is already at a very fast pace -- will be growing significantly better than we've seen in the first quarter3.

So we feel very confident in our fixes, the relationship and the interaction we've been having with FDA's been extremely positive.

We had forewarning letters.

We've closed one out.

Two others are in the process of some very good discussions and really positive interactions and signals we're getting from FDA that they know we're taking these things seriously.

And then the fourth one, it's just -- we're in the early stage of our responses with them.

So significant problems, but significant, I think, gains made just in the last three to four months.

Great.

And how should we think about the incremental spend?

You're now talking about R&D combined with compliance and regulatory issues.

Will the incremental spend take away from R&D investment?

And I guess, bigger picture, when we think about the R&D investment in the business, relative to the targets you put forth a couple years ago, you're trending a little bit below plan, how should we think about the R&D ramping as you are a stand-alone entity?

The -- we realize we set a goal of about 4% of sales by the end of 2007, and we've been slow to get there.

And I think we underestimated what it took to ramp, number one, our typically very disciplined approach to making investments maybe get in the way of getting that going a little bit faster.

We've used the acquisition and the licensing approach, such as Vivant and several licensing deals, which I wouldn't have the time to get into here, are bringing us new technology.

And then finally, we just, within the last eight to ten months, we've added about 40 upstream marketing or strategic marketing people who do nothing but look at where these businesses could go.

They're not dealing with day to day marketing issues and we've doubled our business development staff in order to be more aggressive in finding what's outside of what we know right now.

So we've gotten off to a slow start, but if you were to look at the curve now, it's starting to ramp up significantly faster than before.

How much will the incremental spend be on compliance and regulatory?

There -- it's a combination of some one-timers and some fundamental investments.

It's probably -- when we split quality and regulatory, we added significant head count in order to just give us the focus.

I think we saw through this period, the cost of noncompliance.

And so we'll put 15 to 20 million, probably in the business in quality.

There's also a lot of consulting work that we've done and you'll see it in Q1, Q2, but that will go away.

As we brought in lots of consultants, and this is -- and these are former FDA people, many of them, and I think it was our very proactive response to these problems that has put us in, what we believe is a very responsible relationship with FDA.

Great.

And one last one, just on the number of products in the pipeline for '06 and '07, and estimated incremental revenue you might have.

'06, we expect about 300 million in revenue from new business. '07, I don't have that number in front of me.

Thank you.

You're welcome.

Jack Kelly, Goldman Sachs.

Good morning.

Good morning, Jack.

Ed, just trying to zero in on the Electronics side.

We had 140 basis point drag from raw materials, up from 80 or 90 in the prior quarter.

So I guess, the first question is, if we were to assume that prices -- copper, gold, et cetera -- flattened out from here, in your judgment, how long would it take to recoup the 130 basis points?

And then secondly, since you're selling into different markets, different industries, can you, in broad terms, give us some buckets of your sales where you're having more success getting price increases and less.

So 30% coming from automotive, I'm sure you're kind of locked in there for a while, but if you could give us some color on pricing maybe by segment, and what you see over the next couple of months.

Jack, let me take that.

Let me just say overall, we obviously feel good about the Electronics momentum with the 8% organic quarter we had, and as Chris had mentioned, the 1.02 book to bill.

So we're feeling good about the topline momentum, but I think you're on the key issue here is the pressure, again, from the raw materials.

And obviously, we have option expense pressure that is a compare a year-over-year, but if I take that out, the real issue is the raw material up 130 basis points.

We really have two things that we can significantly do in this business to help turn the margins and move them up as we go through the year.

And certainly as we go into '07.

The one is a longer-term item, Jack.

It's the thing that Chris mentioned we finally got started this quarter.

It's the closing down of 16 major facilities that we have at high-cost locations.

That's the long-term best thing for the business to do because that really permanently starts to fix that cost structure problem that we have.

Now, by the way, this business, as you know, has done a lot of that already, but when you look at a piece of paper, you'd say you got a lot more to go, and the 16 factories.

We're starting one right now that we started to do this quarter, start to impact that nicely for us.

But that takes time.

The the other thing we can do, which is the more immediate one which goes, I think, directly to your question is to go get price.

And this business, you have to look at it as you said, by the segments.

We have some short cycle businesses like consumer products, and I would even say some of our industrial businesses where we can go get price on a quicker basis.

And selectively, we started that at the end of last quarter.

We give about 60 days notice so some of that is just kicking in.

But we have a longer cycle to get price in some of our other key markets, for instance, auto being the biggest example of that, which is about 35% of our profits in the business because it's a -- A, it's a long cycle business.

We're locked into contract so we're looking at, as contracts come up and maybe more importantly -- I'd say it this way, as new products are introduced, getting our pricing through that means, in that market.

But again, unfortunately that takes us a little bit of time.

However, let me say, the auto business is a very healthy, nice business with nice profitability for this Company.

So we happen to be in a tough time right now, stuck with this raw material pressure.

But on the other hand, it is a very nice business, and over time, we can work the price angle there.

We just can't introduce it all in one day.

So that to you is a couple quarter kind of phenomenon, assuming, again, if prices flattened out --

Jack, I would say that is a this-year phenomenon.

It would take us through the next few quarters to be able to do that systematically across the board.

Okay.

So by the end of the fiscal year, possibly?

Yes.

And then secondly, and it relates the plant closing --

And by the way, Jack, just to make a point, because you said it, that's if raw material flattened out here.

We went into the year with copper, it's now up another -- how much, Ed? -- 40%, I think, if I look the numbers the other day from what we went into the year at.

And look -- maybe -- I don't know about planning here, but we were thinking we were about peaking out, but it's up 40% so we have to go get price.

And this related to the plant closings, the 14. -- 14.4% margin, ex-raw materials.

And obviously it's down from what you guys had talked about in the past.

Where do you see that going when this program of plant closures is done?

Well, as we've always said, we've had targets for this business, Jack, that are up in the -- between 15 and 20% margins.

Two of the biggest impacts there are the reduction of this factory footprint.

That's one of the big levers that gets us there.

One of the other things -- we didn't mention on this call, but we've talked about on many of the other calls is, we do have three businesses in Electronics that if they were not -- they represent a little over $1 billion of annual sales out of the 12 billion and they do not perform well at all.

Those three businesses, if you took them out of this quarter, just to give you the comparison, our margins would be up 200 basis points.

So there's both portfolio moves to come, along with the rationalization of the footprint that really drive the margins.

And to the prior conversation, shorter term over the next few quarters is pricing.

Okay.

Last question.

If we could zero in on contracting in Fire, you talked about cutting costs, et cetera.

Is it a matter that the backlog you have, which I guess is up nicely in Fire, just isn't priced properly, and/or are you not executing well on the contracts?

And maybe it's one in the same, I don't know.

Well, no.

Let me walk you through that, Jack.

It's a combination of things, but it's mostly execution in the field.

As we've been highlighting for about three quarters now, our backlog has been growing in every quarter for the last three we've told you.

It's up about 25% and we continue to see globally nice backlog build.

So we're feeling good about that business going forward from a backlog standpoint.

Our team put in place a lot of extra head count and resources in the field to execute on these installations moving forward.

But if you look at the results in this quarter, our growth rate globally was only up 3%.

It should have been up much more significantly than 3% with a backlog that's been building like that for the last three quarters, so we did not close out enough of the projects to get the billings in during the quarter as we should have.

Now in our backlog, as we analyze it, we have had some modest price degradation in there, but historically we've always been able to outperform the margins in our backlog.

So we weren't -- and we continue to be not overly worried about that, because it was modest, but the issue is our execution in the field.

And, again, we put all these people into place and we didn't get the projects closed out.

I'll also point out -- I don't know if I said this on our call the other week, but as we analyzed the performance in the quarter -- and let me just give you North America as an example.

We have about 110 regional offices around the country for SimplexGrinnell.

When you analyze it, we have about 20 of them that significantly underperformed on closing out projects and really getting these things through the pipeline.

And Chris and I and the team at SimplexGrinnell Fire and Security, we're very focused, obviously, on the cost structure of the whole business, but really digging into those 20 underperforming regions that we had.

Okay.

Thank you.

Thanks, Jack.

Bob Cornell, Lehman Brothers.

Good morning, everybody.

Good morning, Bob.

A big picture question, first of all.

I mean, your -- you charted a course to split the Company up, at least Electronics and Healthcare, all these operational issues, I mean, it makes me wonder how you're able to maintain the focus in these units?

And as Rich is here, maybe you could help the answer.

How can you keep people focused this year on operating discipline when a big part of the effort is preparation for a split company a year from now down the road?

What's the incentive for current operating management to maximize current year results when they're likely to be independent companies down the road with a whole different set of investors and parameters?

Bob, this is Chris.

Let me take that first, and then we can ask Rich to comment as well.

I think the way that we have organized the work that is entailed in separating these companies is we've set up a separate team under a project management office here in Princeton, which is mostly the corporate functional experts in tax, treasury, legal, et cetera, that are required to execute this transaction.

And most of the work that takes this year-long effort to do will be coordinated by that group.

This will really enable us to focus on running our businesses, both the corporate management as Ed said here, as well as the business segments Rich and his team.

So, again, we've tried to set up a separate organization here that will spend the -- essentially all of their time over the next year working on the execution and transaction that will enable us to stay focused on running the business.

Yes.

From a -- this is Rich.

From a Healthcare perspective, we've been together as a Tyco Healthcare organization since 1994, and I think if you followed the Healthcare business, we've had a pretty good record in terms of our ability to run our business and keeping it productive and efficient.

And we just got hit with a perfect storm this year.

And we just are doing everything we can to fix it.

Because we just don't like being associated with these kinds of metrics.

And the people that need to fix it, they're in our plants, they're in the quality group, they're in the sales and marketing group, and they, while aware of what's going on and probably feeling good about the opportunity to be a stand-alone public company, their time is not being consumed at all and their incentives are tied to what they do this year based upon their plan.

So we feel -- we feel like we've got our arms around it and we're totally focused on fixing these problems.

Because we realize that we need to have these fixed if we want to separate as a company with momentum that would attract investors.

Okay.

Thanks, Rich.

A question on cash flow.

Ed, you mentioned free cash flow this year would be above net, except for 600 million of legal expenses.

Exactly -- could you calibrate us there a little bit on what you mean in terms of free cash flow above net, and maybe flush out the 600 million legal -- cash flow issue?

Bob, it's Ed Arditte.

The guidance has been all along free cash flow in excess of net income, and again, as we repeated in the press release and in the call, we'll leave it at that for now.

How much in excess is obviously a function of how the year progresses.

Relative to the $600 million that we referred to, a good portion of that has already been expensed both in the first quarter -- it's all been charged to the P&L, and so what we're doing is we're paying out under existing liabilities and a very significant portion of it between the first quarter and the second quarter will have been paid out.

The biggest, obviously, of the group was the Masimo settlement that Rich spoke to, and which was largely funded this quarter.

There are a couple of other items as well.

And obviously, the one item that we've spoken to you about in the past that we have not yet paid out, but we have accrued and expensed, is the $50 million fine from the SEC.

Yes, I mean, how much of this is a function of the bump in accrued and other liabilities that you see in the statements today?

I'll take you through that -- I'll take you through that offline in terms of the details of that, but that is some portion of it.

Okay.

Thanks.

Talk to you later.

Bye.

Jeff Sprague, Citigroup.

Thanks.

Morning.

First, maybe just start with Rich.

And -- I mean, Rich, without kind of assigning blame or pointing fingers -- there's a lot of water under the bridge over the last several years, but when you do kind of go down the list of thinking, organic growth, recalls, qualities, sterility, capacity not in place, I mean, it all in one way, shape, or form kind of goes to underinvestment or not enough hands on deck to kind of deal with the issues at hand.

And so -- I mean, in this quarter, we're kind of drilling into a couple of visible things, and it sounds like you've got visibility on turning those around.

But -- I mean, to what degree do you think we have the risk of something else cropping up as you try to kind of fortify the investment and fortify the management team?

And just maybe a little bit more color on your comfort level as you look into the second half and kind of hope to see that improvement.

Yes.

There -- in terms of underinvestment, we are adding that 15 to 20 million in the quality and the regulatory.

We'll probably beef up manufacturing engineering a little bit, but not to that degree.

I don't think that this underinvestment was the cause of these problems.

If -- at another time when there was more time, we could go through each one and they were just kind of strange events, things that had been done and processes that'd been in place for years, suddenly there was a problem.

And it was detected early on and never a problem in the field, but they were problems and these problems need to be fixed.

It just so happens that they occurred simultaneously within two to three months of one another.

And primarily in imagining and respiratory.

And we'll fix those, Jeff.

And I don't think it's going to take a significant amount of additional investment, other than what we've already made.

And I don't think that -- in the healthcare environment you read the papers, you see problems with good companies that have recalls.

And this is part of being in this business.

And sometimes they're spread out and sometimes they happen all at the same time.

And if you were to look at our record of warning letters and recalls compared to the metrics of the industry as a whole, we're right where everybody else is, so I think this was just a matter of unfortunate timing.

We have jumped all over this incredibly aggressively.

And I feel very confident that we'll emerge from this in the second half more like the Company people are used to seeing.

And with an opportunity to cap those growth initiatives that we're not backing off on, start to kick in as you've seen with the results in international.

So we feel very, very strong that we'll get through this, and by the second half of the year, we'll be looking like the old kind of growth rates and problem-free kind of manufacturing quality.

Jeff, I would also comment that we have seen the cost of compliance and regulatory and compliance really increase across the entire industry.

That is not a Tyco-specific of historical underinvestment.

I think you can see across any of the companies that you know or that compete in the sectors that we do, they have all had to increase their investments here over the last two to three-year period.

And I'd also say in terms of the capacity constraints, this is, in fact, a good news story in that over the last few years, that pharmaceutical business has increased its volume significantly as they have moved up the value chain.

And we just haven't -- again, with the time factors to get the lines up and running and validated is a time-consuming process.

And we essentially exceeded our own internal expectations as to growth.

So that will be on board, and that's actually a very good news story.

And just to switch gears then, on Fire and Security, Ed, given the fact that the Security -- I'm sorry, the residential attrition rate is drifting lower, are we actually getting a -- kind of a margin lift on that, and we just have kind of the commercial stuff offsetting that, or really what is the margin dynamic of the attrition moving lower?

Is it just the elimination of a revenue head wind, or should we expect some margin benefit from that?

No, Jeff.

It's margin benefit also, but I think you summarized it well.

The commercial is more than offset this quarter.

The resi piece of the business.

It's interesting to note that this quarter is the first time we had positive recurring monthly revenue growth, and that's a global comment by the way.

So this is not now just North America, but globally, we have positive RMR growth for the first time in over two years.

And when I say that, that's actually residential and commercial recurring monthly revenue.

That's the first time we've done that, so we continue to track, we feel, very well in that business.

Again, attrition came down to 14.3% and our ARPU, or monthly monitoring fee that we get, was -- just to give you the overall number, this is not the net new adds, but the actually installed base, last year at this time was 29.17 per month and new we have it up to 30.05 -- $30.05.

So that is a resi comment, by the way.

If you put commercial in, it would be higher.

So all the metrics, as we mentioned last quarter, are continuing to point up in this business.

And the closure rate on new business with the sales force is looking much more robust to us.

Now again, it takes time to kick in and see it in our numbers with the big base we have, but all the indicators are feeling good there.

Commercial weakness offset what you're feeling there.

And just one final clarification on cash flow.

I was under the impression that -- also your comment about free cash flow at least meeting net income also would be excluding the tax and other kind of separation costs that you might be incurring.

Is that the case or not?

Yes, Jeff, that's definitely the case.

That excludes the cost of -- breakage cost, as we call it, from the proposed transaction.

Share repurchase is going to real -- really more track the actual free cash flow as opposed to kind of the adjusted excluding unusual items cash flow.

Yes.

Great.

Thank you.

Thanks, Jeff.

John Inch, Merrill Lynch.

Thanks, good morning.

Good morning, John.

So, I want to ask you, the first half, if you take the midpoint of your guidance as $0.80, to do the midpoint for the year implies a 36% sequential second half ramp.

I think consensus is up 29.

I get from the Healthcare, if you eliminate the issues you called out in Pharma and the OP drag from the Juarez issues, I mean, you get about $0.03 to $0.04 on that basis in second half.

Would it be fair to say, Ed, you're more comfortable with the low end of the guidance range for 2006?

It -- John, let me walk you kind of through that a second.

If you go to the second half, the ramp that has to occur, we need some stronger topline growth overall.

Now, we obvious expect we will get that from Healthcare.

Coming off a 1% quarter is not where we're expecting that business to run in the second half of the year.

So for Rich, it's both a -- having a mid single digit organic run rate, which would be significant for us, the profitability that would drop through, and then number two, as you just mentioned, John, getting kind of these legacy cost of fixing our issues out of the way.

So it's both there.

In addition, we are planning on significantly -- significant cost reduction activities, as we mentioned, across Fire and Security.

Now, we're eating some of that in the second quarter, taking a hit.

Some of that's attrition, but some of that we'll eat the expense of and get that realigned because of the problems we had this quarter.

And we would expect that business to ramp up again.

We probably won't get back to where we need to be until the second half of the year, but we will continue to ramp up there.

And we're expecting nice order rates on Electronics.

As we mentioned earlier, we don't think it'll run quite at the rate we obviously had in the first quarter, but we're expecting good run rates through the year there, and obviously that should help us on fall through on the P&L also.

So that's how we get there.

To get, John, to the high end of the range, I guess, maybe to your question, organic growth would have to be higher than what I kind of just described.

In other words, Electronics stay up at the -- kind of the barn burner we had in the first quarter.

We're not quite sure that will happen, although it's feeling good.

And we would have to have improved margins, back to Jack Kelly's question earlier, in Electronics and that would be us putting price increases through as fast as we can and getting them to stick in some significance, and/or a reduction in raw material costs.

They would kind of be the big levers.

If a combination of that would happen, we could get up in the range more.

John, I'll just make a comment as well.

And certainly as Ed had said, we're feeling much better than we have in about a year in terms of our revenue outlook, and we will be a seeing a revenue year-over-year in the second half increase.

So it is a matter of us managing our costs, which we're doing quite aggressively right now, and I'll also comment that we'll have a favorable benefit in the second half of the year both from reduced interested expense as well as the reduced share count.

So if you add it all in, and considering sort of where the business has tracked in January and so forth, I mean, does that put you on track?

Because, Ed, you basically are suggesting there'll have to be some incremental things to hit the high end.

Does the trajectory of everything together, including the cost initiatives, put you on track sort of for the middle point, or for the low end, understanding you didn't actually change the range?

I think if we track to what we just said you would probably get midrange somewhere in there.

You won't get to the high end of the range.

We would need some help on the Electronics side to get to the high end.

Okay.

And then on Electronics, I don't think I heard pricing in the quarter.

Could you just talk about what happened overall and sort of what -- kind of how things progressed maybe as you saw the quarter end?

Pricing was in the 3 to 4% range, John.

And obviously, there's a dynamic between the price erosion side and the raw material side.

In some places obviously, we've been able to, in some end markets, pass through a little bit of the raw material.

But if you net the two against them, it's still -- against each other, there's still a profit squeeze from those two.

Yes.

And I might just point out because I think it's important to say also that on the Electronics side, all our businesses were very hot from a bookings and sales standpoint this past quarter, except if you heard in our proposed remarks, the auto industry in Europe was flat.

It was the only one that really didn't grow.

And unfortunately, as we've highlighted to you, that's our biggest piece of our auto business with our high fixed cost footprint in place that we are, as we said, beginning to address that we started this quarter.

So if that business would pick up, that would substantially help us, but we're not counting on that.

No.

I understood.

And just lastly, maybe a little more color on the 16 plant closings.

I mean, how far into this, my understanding is the preponderance of these plants are in Europe.

I mean, I guess you guys -- I'm assuming your eating these costs.

How is there not maybe a disruptive risk associated with that process this year?

And what kind of -- what kind of a cushion do we have baked in for something like that?

Let me just first of all point out, this team in Electronics has closed many more factories in the time frame we've given them to do these 16.

These happen to be fairly large, high-cost facilities, so it's good to get out.

But this team has executed on a -- a list of facilities, certainly, since I've been at the Company that's larger than this, although these are very key ones.

What we are doing and the reason we've paced this one.

We've said this goes also into next year, this restructuring, is because in many of these cases, we literally have customer sign-offs on the moves that we are making with these facilities, so it's a very deliberate process, hand-in-hand with our customer to accomplish it.

Again, normally if we wanted to close 16 factories, we could probably crunch this into a 6, 7 month time frame.

The reason we talked about this being longer is that very issue.

So we'll be very deliberate, very careful and the number of one kind of goal here is not to disrupt our customer base at all.

These are very critical customers to us.

A lot of them are our auto customers, as you could imagine, and we will not let that happen.

So we'll pace it based on our progress with our customers and getting sign-off and moving those facilities.

But it did start -- again, you didn't see much of a charge this quarter, it was was 6 to $7 million, but we did get the program started during this quarter.

Thank you.

Operator, we're getting close to the bottom of the hour.

We have time for one more question.

Carter Shoop, Deutsche Bank.

Great.

Thanks.

Just want to flush out the guidance for the Electronic division here for the full year.

It appears that there's several head winds that are on the horizon here and despite that, it sounds like you guys are still forecasting pretty aggressive growth on the both topline and operating income line to get to the midpoint of fiscal year '06 guidance for the entire Company, and I just wanted to kind of walk through some of the head winds.

One would be the restructuring, so 6 million in the quarter.

What are you expecting in regards to restructuring charges for the next three quarters?

About 50 million.

50 million.

Okay.

And then also the auto business being up 6% on a year-over-year basis, that's pretty good given what's going on in North America right now.

And if you're not expecting Europe to increase at all, how is that going to continue to be at that high level on a go-forward basis?

Wouldn't that come down quite a bit?

Well, Asia -- Asia's a very significant portion and in this past quarter actually surpassed North America for us for the first time in the terms of the size of our business.

Our Asian business grew almost 20%.

So we see continued strength in that market.

Obviously, North America is a market that we read about every day, and we did have good growth in the North American market, as Ed referred to a few minutes ago.

What we're watching most carefully is the European market, given our cost structure there.

And content continues to increase as well with each auto.

Yes, Carter.

Let me just clarify.

I mean, we ran flat this quarter in Europe.

I'm not saying that can't grow, 2, 3, 4% depending on the quarter, we're just not counting on much as we model it out.

But I would expect with the oil customers we have there, we could see some upside as we happened to see this quarter in the other two regions.

Okay.

And then also, an earlier comment on the Electronics division sounded like you guys are expecting that raw material prices moderate and that you guys will be successful in passing along price increases.

In regards to raw material prices, everybody was trying to draw a line in the sand figure out exactly where those are going, and it's been -- a lot of people have been disappointed with the continued price increases for copper, et cetera.

But how can you guys assume that that's going to level off, and why do you make that a base case scenario?

Why don't we be a little bit more conservative, maybe lower fiscal year '06 guidance altogether, and assume that these price increases that have been going on for two or three years continue, instead of forecasting them to moderate all of the sudden?

No, Carter.

I don't know that they're going to moderate here.

What I said is for us to get to the top end of the range, we would need a combination of that moderation or more price increase than we think we're going to get.

That's how we'd get up there.

We are putting through -- in fact, we are doing a detailed analysis right now of our next round of price increases in the business.

Again, to the comments earlier, we can't -- we have to stage it through the year depending on where our contracts by that time are at.

But the issue is can we get more on the price side also than we've gotten in the past.

Let me point out, the price increase we talked about last quarter is really the first time in quite a while that we actually put a price increase through.

So we had not been doing it over the last couple years.

We were eating it, and eating it, and eating it, and felt that was the right decision from a market share standpoint and all.

Now we're seriously looking at a kind of a fork in that road and a change and saying, Let's look at pricing and how much can we get.

And you'll -- expect to see more from us on that.

Again, we don't have all the details yet as to when it sticks and to what time, but we're working through that.

I've actually been hearing kind of the opposite.

I've heard that you guys have been one of the most aggressive in raising prices in connectors over the past couple of years and that you've been increasing prices kind of on a 6 month -- every 6 months or so.

No.

We -- the only place that we have been increasing prices on a, if you will, spot market basis, or on a catalog basis would be in the -- to the distribution market.

It's 10% of our business.

Which is only 10% of our business.

And not into industrial at all?

No.

Obviously -- I mean, obviously, every product is different.

We have over -- thousands and thousands and thousands of products, but as a general rule, no.

And then just lastly, on the full year guidance, I just don't understand why -- I mean, it sounds like it's a pretty low probability event that you guys are going to come in at the high end of range.

Why don't we lower the guidance now, take the medicine now, see the stock price -- sell off a little bit more today, and then go into the market and buy shares instead of buy shares now with a probability of having to reduce that '06 guidance at some point in a later date, which would be a negative event for the stock?

Again, we feel good that a number of the issues that we have seen in the first quarter and will continue through the first part of the second quarter will be behind us, and that we're feeling pretty good about the second half of the year.

So, again, we're comfortable with that range.

Okay.

Good luck, guys.

Thank you, Carter.

Thanks, everybody, for joining us.

Look forward to talking to you again on our second quarter earnings conference call, which will be in the first couple of days of May.

Thanks for joining us.

Thank you.

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