江森自控 (JCI) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Tyco reports second quarter 2006 earnings results conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to our host, Senior Vice President Strategy and Investor Relations, Mr. Ed Arditte.

Please go ahead.

Good morning and thanks for joining our conference call to discuss Tyco's second quarter results for fiscal year 2006 and the press release issued earlier this morning.

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

Also joining us for today's conference call are the Chief Executive Officers of Tyco Healthcare and Tyco Electronics, Rich Meelia and Tom Lynch, who will provide updates on their businesses and also participate in the Q&A session following our remarks.

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 have included there.

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

In revealing 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 website at tyco.com.

Let me quickly recap our earnings this quarter.

Our GAAP earnings per share from continuing operations were $0.52.

Our results benefited from a GAAP effective tax rate of 13% in the quarter.

In addition, our results also included $0.01of income due to a net gain from divestiture activity, partially offset by costs associated with the separation of Tyco into three publicly traded companies.

So on a basis consistent with our previous guidance, our earnings per share from continuing operations were $0.45.

Our free cash flow in the quarter was 444 million, which as we previously indicated included over $400 million in cash payments to resolve certain previously disclosed legal matters and separation costs.

Now let me turn the call over to Ed Breen for a few opening comments.

Ed will then be followed by Rich, Tom and Chris who will review our operations for you.

Thanks, Ed, and good morning to everyone.

Our second quarter can best be described as a quarter of progress for Tyco.

We saw a nice pickup in organic revenue growth and our earnings per share were ahead of expectations.

We still have more work to do, but our results this quarter put us on track for a better second half.

You will hear more detail from the others about our segment results in the quarter, so I wanted to comment on a few Tyco-wide items.

First, I was pleased with the acceleration in organic revenue growth in the quarter which improved to 5%.

In particular we saw a nice pick up in Fire and Security and Healthcare as well as continued strength in Electronics and Engineered Products.

Based on the condition of our end markets as well as the efforts we have made in some of our businesses to improve our sales force traction, we see this level of growth continuing into the second half of the year.

Next we made progress on a number of operating issues that arose in the first quarter in both Fire and Security and Healthcare.

Several of these issues are now behind us, and we are on track to resolve the others.

You will hear more from Rich about our efforts in Healthcare, but let me spend a minute on our progress in Fire and Security.

First we made progress in addressing our cost structure in the second quarter in both our worldwide Security and Fire businesses.

Staffing levels were appropriately reduced and we are now operating the business with better cost discipline.

In ADT North America we addressed the structure of our installation and service organization and made it more efficient by reducing layers.

These changes have been well received by the organization, and we feel good about our ability to drive improvements in this area as we go forward.

In addition, we continue to be encouraged by visible signs of improvement in our top line of Fire and Security.

We saw improved productivity from our sales force during the quarter, and our global security account base grew for the first time since the second quarter of 2003 when we made significant changes to our business model.

This is an encouraging sign given the changes we have made to this organization and this improved performance allowed us to modestly grow our recurring revenue base in the quarter.

Chris will have more Fire and Security details in a few minutes.

Turning to cash flow, our free cash flow at 850 million after adjusting for previously disclosed legal payments and cash costs related to the separation was about what we had expected and reflects planned increases in capital spending, the timing of tax payments, and increased working capital due to higher sales growth.

Our primary working capital efficiency measured in days improved slightly on a sequential basis and improved three days year-over-year.

As most of you know, Tyco's second half cash flow is traditionally stronger than the first half, and we continue to feel comfortable that our full year free cash flow will exceed net income.

We also made progress in the quarter on debt reduction and are now at the 10 billion debt level we had targeted for the separation transaction.

Our debt declined by 2.5 billion in the quarter with a combination of actual debt retirement and conversion of the remaining series A convertible debt into equity.

From this point forward we expect to manage our debt level to this $10 billion target.

On the share repurchase front we were active in retiring shares and spent approximately $1 billion retiring almost 37 million shares or approximately 1.7% of our outstanding fully diluted shares.

This completed our existing share repurchase authorization and today we are announcing a new 2 billion share repurchase program.

We continue to believe our shares are a good value at these price levels and intend to use our excess cash to retire our equity.

Finally our activities related to the separation transaction picked up pace during the quarter.

We have a dedicated leader for this project and leaders in each of our segments and for the most part the activity is at the staff level and not at the operating unit level.

As we indicated in our earlier conversations with you, most of the complicated work is in our legal, tax and treasury groups, and we are making good progress in each of these areas.

In addition, we are building out the management teams in Healthcare and Electronics with public company capability, and we have also begun the process of recruiting new independent boards for both companies.

Overall, we are pleased with the progress we're making on the separation.

Now, let me turn the call over to Rich to update you on Tyco Healthcare.

Thanks, Ed, and good morning.

I am pleased to be with all of you this morning to discuss Tyco Healthcare's performance in the second quarter, our progress in addressing some of the operational issues we experienced in the first quarter and our outlook for the rest of the year.

Let me say at the outset we're pleased with the progress we made in the quarter, and we believe the second half of the year will be a stronger one for Tyco Healthcare.

Addressing the top line first, revenue in the quarter was $2.4 billion with organic revenue growth of 3.6% which was improvement over the first quarter.

We had solid organic growth in our international, surgical and pharmaceutical businesses and low to mid-single digit organic growth in retail and respiratory.

As we expected we had a revenue decline in our imaging business due to previously disclosed voluntary product recalls.

Medical was flat in the quarter following declines in the prior three quarters.

Operating income for the quarter was $579 million with an operating margin of 24%.

This included a $46 million gain from the sale of our Radionics business.

As we discussed on our last call our operating margin continued to be impacted by the cost of addressing some of the first quarter issues, and I would like to provide you with a quick update on the status of those items.

As we said last quarter, the largest impact in the second quarter came from the DTE generator product line in our imaging business.

The issues with this product have been resolved.

We began deliveries to our customer base in early April and expect sales of this product to help the third quarter.

We are also on track in resolving our two other voluntary recalls.

These recalls cost us a full margin point in the second quarter on a year-over-year basis.

Next, the capacity expansion in our pharmaceutical division is now in place and producing product.

Completing this additional capacity expansion will help the second half growth and profitability of our Pharma business as we deliver against existing backlog.

Turning to retail, we grew 3% organically in the quarter, but our margins continued to be impacted by higher material and transportation costs which hurt Tyco Healthcare's margin by 70 basis points in the quarter.

We expect growth to be in this range for the full year with a mid single digit operating margin.

As we look to the second half of 2006, we will be focused on fully resolving the remaining operational issues we have.

We have significantly upgraded our quality and regulatory teams.

We continue to work very closely with the FDA, and our feedback has been positive across all of our businesses.

Our team is confident that the actions we are taking are the right ones and the progress we have made in the quarter substantiates that.

From a financial perspective we expect higher sequential revenue with improved performance in most of our businesses led by our international Surgical and Pharma businesses.

The incremental profit from this revenue along with the decline in the additional costs we have been incurring to address some of the quality issues positions us for an operating margin in the 24 to 25% range.

Looking to the future, I feel good about our growth investments in sales and marketing, R&D, and acquisitions, and we will get good pay backs from these actions.

We invested in incremental $28 million in our sales and marketing capability over the prior year quarter, mostly in international, which has been a key growth driver for us over the past two years.

We also increased our second quarter R&D spending by 34% year-over-year.

Our R&D activity is designed to expand our presence in existing markets and develop new technologies in new markets.

In addition to our internal research and development activity, we recently completed several strategic acquisitions that give us good growth opportunities.

We acquired a surgical company in France with innovative technology that we can leverage throughout our global distribution footprint.

We also acquired a distributor in China that will give us an even stronger position in the high growth Chinese market.

Finally, we acquired an exciting new technology that we believe will significantly expand the existing market for ablation therapy.

We will continue to use these types of acquisitions to supplement our R&D investment and leverage our sales and marketing infrastructure.

All of this provides us with confidence for improved performance in 2007 and beyond.

Now let me turn the call over to Tom.

Thanks, Rich, and good morning.

It is a pleasure to be with you this morning to discuss Tyco Electronics' performance this quarter and our outlook for the balance of the year.

Let me start with our second quarter results.

We had a good revenue quarter with 7% organic growth including 9% growth in our connector and cable assembly business.

Sequentially we grew 6% organically in the quarter.

Growth was strong across most of the business with double-digit growth in the consumer electronic, energy, industrial machinery and communications end markets.

In the automotive market we grew 4% organically which was entirely driven by double-digit growth in Asia partially offset by flat sales in Europe and North America.

Expanding our presence in the higher growth automotive market in Asia has been a key focus area for us, and we continue to win new programs with some of the large Japanese and Korean auto manufacturers.

Our growth in this region significantly out paced the growth of the market, and our automotive business in Asia is now larger than our North America business.

Order activity across the segment was robust throughout the quarter with bookings up 10% and a book-to-bill ratio of 1.6 at the end of the quarter.

Operating income for the quarter was $461 million and our operating margin was 14.2% which was down 160 basis points year-over-year but up 150 basis points sequentially.

Importantly, our gross margin was stable on a year-over-year basis with volume leverage, cost reductions and pricing actions offsetting the higher metal cost.

Metals, mostly copper and gold, cost us an additional 56 million on a year-over-year basis which negatively impacted our margins by 180 basis points.

Our continued focus on cost improvement was able to offset price erosion.

We have been selectively raising prices where we can, but this is only in certain markets and not enough to recover the higher metal costs we have continued to experience.

Our operating margin was also impacted by a number of actions aimed at improving our longer term performance.

First, we incurred 8 million in charges in the quarter to continue the previously announced restructuring of our manufacturing footprint.

As we discussed in last quarter's call, we plan to close or exit 16 facilities in Europe and North America.

This program is well underway and will be completed over the next two years.

Second, we increased our investment in engineering and R&D in the quarter by $10 million.

This is part of our plan to expand our business into higher growth markets where our market position has significant room for improvement and to enhance our capabilities in Asia, especially China.

I will talk about this in more detail in a minute.

Lastly, we divested 2 nonstrategic operations generating a $5 million divestiture loss in the quarter.

These items collectively reduced our margins by almost a full point in the quarter, but they're important for the future of our Company and I feel good about our progress in these areas.

I also wanted to take the opportunity to update you on some of the key growth initiatives we're working on in Electronics.

First, as I mentioned one of our major growth initiatives has been to expand our business into higher growth markets where our market position has significant room for improvement.

These markets include consumer electronics, mobile phones, medical, and military aerospace.

For example, in consumer electronics we have made considerable progress in leveraging our customer relationships, focusing our sales organization, and adding resources to improve our presence in this market.

The results have been very strong so far as our sales to this market have grown at a 28% annual rate over the past three years.

Our share in this market is still relatively low, and we have considerable upside.

Continuing our expansion into these under penetrated higher growth areas will help us diversify our sales mix and accelerate our growth rate going forward.

We also continued to focus investment in rapidly growing emerging markets such as China, India and Eastern Europe.

We are already one of the largest passive component suppliers in China with over $1 billion in local sales and 30,000 employees, but we still have plenty of room for accelerated growth in this dynamic market, and we continue to add resources there.

Similarly, we are adding resources in other emerging markets including India and Eastern Europe.

In total we have added more than 200 sales engineers in emerging markets this year, a 25% increase over last year.

Based on the strong order activity and 1.06 book-to-bill ratio in the second quarter, we expect organic growth to remain strong in the third quarter with operating margins similar to the second quarter.

We expect better volume leverage and cost improvements to offset the incremental head wind for metals.

I would like to conclude by noting we are the global market leader in passive components which is an important and attractive business for us, but we are also much more than a passive components company.

We have exciting opportunities for growth in our non-connector products such as wireless, telecommunications infrastructure, touch screens and circuit protection as well as leveraging these products into new applications and end markets.

You'll hear more about these opportunities in future earnings calls.

Let me turn the call back to Chris to discuss the results of our other business segments.

Thanks, Tom, and good morning, everybody.

Let me start with a review of our performance in Fire and Security.

As Ed discussed earlier, we made progress in a number of areas and improved our performance significantly over the first quarter giving us more confidence for continued improvement during the second half of this year.

From a revenue perspective, we had our best organic revenue growth in a number of years at 3% with improvement across the segment in our security, fire and safety products businesses.

We also had good improvement in operating income with a $61 million increase over the first quarter, and an operating margin just over 10% with sequential improvement in each of the three main areas of the business.

Let's start with a review of our worldwide security business.

Organic revenue growth was 2% in the quarter, a nice improvement over the past few quarters where we experienced revenue declines.

The growth in revenue is due to better contracting activity and improved recurring revenue performance.

Our operating margin in worldwide security improved sequentially due to cost reductions and seasonally lower marketing spend.

While we are encouraged by the better top and bottom line performance, we are still not satisfied with the performance and have action plans in place which we believe will drive continued improvement going forward.

In our worldwide fire business, we had organic revenue growth of 5% and a 60-basis point improvement in the operating margin to 6%.

The better top line performance was due mostly to growth in North America.

We are also encouraged by the overall tone in the market and we saw our fire backlog in North America grow 8% sequentially in the quarter.

We also had a nice quarter in our safety products business with good revenue and income growth.

Organic growth was 5% in the quarter with strength in our fire suppression, intrusion, and video access control product lines and operating margin was in the high teens.

Our trailing 12-month disconnect rate was essentially flat sequentially at 14.4% and we expect to see this metric finish below 14% for the full year.

As we look to the second half of 2006 we are focused on improved execution across all of our Fire and Security business, and we believe the actions we have taken this quarter position us for continued improvement in the second half of the year.

Turning to Engineered Products, we had another solid quarter with 7% organic revenue growth.

We experienced double-digit revenue growth in flow control and fire and building products and modest growth in infrastructure services.

Revenue in electrical and metal products was essentially flat as higher volumes were more than offset by lower steel selling prices.

Operating income grew 16% to $192 million, and the operating margin was 11.4% compared to 10.3% a year ago.

We saw a nice margin improvement in flow control, fire and building, and infrastructure services and again partially offset by modest decline in electrical and metal products due to lower steel spreads which reduced our operating income by $14 million in the quarter.

End market demand remained strong across most of the businesses especially in flow control.

Backlog and flow was up 29% year-over-year and 7% sequentially in constant currency.

As a result, we expect continued solid revenue growth in Engineered Products in the third quarter with an operating margin in the 10 to 11% range.

Before I turn it back over to Ed, let me comment on a few other items.

First, our tax rate in the quarter was 13.4% on a GAAP basis.

Included in that number was a $135 million benefit primarily related to an adjustment to correct prior year tax reserves on legacy tax matters.

We continue to expect our full year tax rate adjusted for such special items to be in the 24 to 25% range.

Next, our corporate expenses were $113 million in the quarter which included $23 million of costs related to the separation transaction.

During the quarter we completed the sale of our plastics and adhesives business, and this is a primary reason for the $58 million loss from discontinued operations.

Finally, the Company continues to make progress resolving legacy issues in a number of areas.

In the SEC settlement, the recent legacy tax items and several legal items settled recently are examples of this.

It is very difficult to predict precise timing of when these items will be resolved, so we have excluded them from our guidance.

As we look forward over the next few quarters, we see the possibility of a few additional legacy items coming to resolution.

To size this for you, we are looking at a few items that could be a few cents per share in either direction, but we are not sure if or when they might be finalized.

Let me be very clear this does not include the shareholder class action lawsuits.

The good news here is the progress over the past three years on these legacy matters has been very significant, and resolution of as many of the remaining items as possible prior to the separation will allow each of the three companies to start the next chapters in their story with minimal legacy overhang.

Now, let me turn the call back over to Ed.

Thanks, Chris.

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

For the third quarter we expect earnings per share from continuing operations before special items to be in the range of $0.46 to $0.48 per share.

As we indicated in our remarks, we see improvement in Healthcare and Fire and Security being the primary drivers of the sequential improvement.

For the full year we expect earnings per share from continuing operations before special items to be in the range of $1.80 to $1.85 per share.

With respect to cash flow in 2006 we continue to expect free cash flow adjusted for a number of previously disclosed one-time legal payments and separation costs 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 and almost all of these payments were made in the first half of the year.

Thanks for joining us on the call and at this point operator we would be glad to open it up for any questions.

[OPERATOR INSTRUCTIONS] First question comes from the line of Jack Kelly of Goldman Sachs.

Please go ahead.

Good morning.

Good morning, Jack.

Rich, you mentioned 24 to 25% margins in Healthcare.

Was that for the full year or looking over the next year or so and what kind of R&D assumption is embedded in there.

Give the incremental investments you're making?

Right.

The 24, 25, Jack, is for the as we get to the third and fourth quarter but that will be the going rate forward for the business.

Once we move beyond all these remediation costs that we're associated with mostly the Mallinckrodt issues and we get the sales growth we're seeing sequentially in leveraging that off our sales structure.

We're very comfortable we can get to that rate.

The R&D assumption, Jack, is about 2.7% of sales which is somewhere around 262 million and will continue to move that up until we get to the rate that is appropriate for these businesses.

Which is 4?

Yes.

That's about right on an aggregate basis.

So when you look ahead to the 24, 25, you're talking second half and then continuing on in the future, and you can sustain that rate even as you ramp up 130 bips on R&D?

We think we can.

We think we have opportunity to improve gross margin through mix, and as we continue to release products in primarily the surgical and respiratory area which are higher margin product areas, you know, that should help offset the investment, increased investment in R&D.

Good.

Chris, just maybe on fire, you mentioned margins were up to 6%.

Can you talk about cost cutting that might have gone on in fire given the comments last quarter about 120 offices and maybe now the cost structure was too high, and what might we look forward to in terms of that 6% in the next couple quarters?

Yes, Jack, again, we did outline that we had some issues during the first quarter in terms of our cost base and adjusting that with our volumes.

We took some fairly aggressive actions in restructuring our installation base in our primarily North America, spent a lot of time, and so I think we're confident that the costs have come out of there, and we see some continued improvement in our margins going forward.

So you think the cost structure is where it should be in fire at this point?

I think particularly in our North American business we're still looking internationally at how we structure that cost base, but certainly in our major businesses we've restructured those businesses in a lined the costs in a more appropriate way.

Again, our backlog is moving up, so again we're making sure we have the resources to install and get those projects completed.

Finally you mentioned backlog in fire was up 8% sequentially.

What would that be year-over-year?

I think at the end of the December quarter it was up 20% year to year.

I don't have that number right here.

Jack, we'll look that up if we don't have that for you by the end of the call.

Thank you.

Next question is from the line of Bob Cornel of Lehman Brothers.

Please go ahead.

Good morning, everybody.

Hey, Bob.

From the sound of the presentation sounds like you're comfortable with momentum across the board and yet you took guidance down a little bit.

When I look at my model, it looks like what you're forecasting is at or better than what I had expected and the guidance came down a little bit.

Maybe you can spell out why -- what was really going on there?

Yes, Bob, there is also certain puts and takes, but mostly across the businesses we're feeling pretty good as we were last quarter when we watched our organic growth rate start to pick up and our backlogs picking up.

There is really only one change that changes our thinking here, and that is that copper has increased since the last time we were on this earnings call by a little over $1 per pound.

It was almost staggering.

Last time I remember on the call we said we've never seen these levels before and literally in one quarter it has gone up approximately 50% from where we sat 90 days ago.

In our Electronics business, Bob, we buy a little over 50 million pounds of copper every quarter, so in the second half of the year, if you make the assumption that coppers stays now at these new high levels, this is going to cost us $100 million, and gold is up another 20 some percent, so we have to count out $120 million head wind from metals there that we can't totally offset in the second half of the year.

We've already taken all the other cost actions we can take.

That's really the only thing changing in our bind.

We'll watch what these raw materials do.

The single biggest driver is the copper.

Second question it would be a year ago you guys are talking about the issues around cash flow structurally with too many plants in the valve business and issues around payables and receivables.

Maybe you can bring us up to date with structurally how you're dealing with those issues and how far ahead of the game you are now versus last year and where you might be understanding into a separation process.

Well, let me give you a few key areas.

It is a very long conversation, but we continue to hone down our number of facilities across the Company.

I think that's just one barometer to look at it from.

That helps ease up everything, and we're taking out another 500 facilities during this year in the Company which is pretty unbelievable number, but that's what we're on pace for, and we're making good traction against that.

Despite the top line growing, we're still able to take out what I call bricks and mortar throughout the Company, and as we continue to do that, that's just going to help us refine a lot of our supply chain and therefore help us on a free cash flow standpoint.

I guess the metric I look at and we touch on this in our comments is we had about a half day improvement in our working capital sequentially, and we had about a three-day improvement year-over-year, so we continue to make progress there.

The two biggest areas if you look out over the next kind of eighteen months, and you mentioned the one.

It is flow control bringing down their footprint.

There is too many manufacturing or warehouse locations there, and we have a very solid team running that business now with Naren Gursahaney, and Tom honing down his facilities.

As Tom mentioned, we're on track to close down 16 major manufacturing facilities in high cost areas, and they will be two nice steps that will give us a little more increment in this area.

Let me ask one other question.

In Fire and Security margins, I heard that fire margins sound like they're up a bit.

Sounded like safety margins are still good.

Did the global security margins come off a bit in the quarter, and is that a function of the European business?

Yes, they were off a little bit in the quarter, Bob.

It was a little bit on the large commercial side still, although we did as Chris mentioned, we did a major restructuring effort in that whole installation base there also.

We did it in fire and we did it in ADT North America.

We think that obviously helps us as we move into the third and fourth quarter of the year, and yet we continue to have weakness on the Continental European side, but let me point out to you the Continental European ADT side is going to take a little longer to turn.

The contracts are longer.

It is the same dynamic we have in North America.

Chris and I and a team were just over there two weeks ago for a couple days, and you can see the same path that we have in North America.

I want to highlight to you, and I said it in my remarks, but for the first time since I have been in the Company we changed the business model, and we have been gaining traction in our sales forth in North America on the ADT side and we're also bringing down the disconnect rate and also taking up the resale right and finally we crossed ore on a global basis.

Even when you put Europe into there, our account base grew slightly this quarter globally and our recurring revenue base grew during the quarter.

Maybe I will point out one number for you.

In the North America footprint during the quarter our new sales force added about 200,000 accounts.

That's with our dealer spend and our new sales force, and that's been -- that's the best quarter we've had since I've been here.

What we need to do is keep moving that up, moving down the disconnect rate, and the same dynamic will happen in Europe.

It just takes us a little bit longer.

Sounds like you guys maybe have a little bit of a conservative margins there.

Thanks.

Thanks, Bob.

Thank you.

The next call comes from Nicole Parent of Credit Suisse.

Please go ahead.

Good morning.

Good morning.

One quick one for Rich.

Do you know what the impact of the strike was at Mallinckrodt on the results in Healthcare in the quarter?

Sure, Nicole.

It actually had no impact.

We had successfully resolved that strike with the union.

We brought in about 400 employees from R&D and other facilities, and we literally ran that plant with stellar performance by some really heroic employees at Mallinckrodt and we didn't have a service blip.

It was really a great hour for that group of people.

Terrific.

You mentioned just your improving trolls within Healthcare.

How should we think about responses to FDA warning letters and obviously the FDA's kind of looking at everybody in terms of controls.

Which do you expect in terms of additional issues or I guess your response to resolutions?

Yes, what's been very gratifying is since these issues occurred in the kind of November, December time frame, we're living through them right through the second quarter.

Most of the occurrences were then.

I think we talked about all the resources we've applied to fix them and as I said in my comments we're back in business with the biggest issue generators.

Since that time frame we've had seven consecutive inspections by FDA at various facilities, and everyone has been no observation, so any concern that there was Tyco Healthcare wide issue is really behind us.

We've had excellent responses with FDA relative to resolving the warning letters out of the floor one is resolved and the other three are on a very good dialog basis with FDA.

We have zero issues or concerns about those not getting resolved, and feel like we're strengthening our quality systems and I won't refer to this as a perfect storm.

That's for sure, but I can't imagine experiencing anything like this again just because it is just unlikely, and plus we just got much stronger systems than we had before this.

Okay.

Terrific.

A couple questions for Tom on Electronics.

You talk a little about the European automotive business.

I think a couple of your competitors were out with some nice strength in that business.

What specifically I think you said they were flat.

Are there pricing issues and more specifically on the PCB business, any update on the divestitures and/or what that business did in the quarter?

Sure.

Our European business which is our singly largest part of your automotive business at about half the size of it was flat, and that market continues to be flat in terms of autos sold.

No unusual activity in price there.

It is very difficult to get any price increase into the auto makers as I am sure you know.

As far as the PCB business, we did during the last thirty days were able to sell our European operation there, a smaller piece of our operation.

It is worth about 10, 15 million sales a quarter and was a very slight money loser.

That's the update on PCB.

Did the business grow in the quarter?

The printed circuit business?

Yes.

Grew a little bit, marginally profitable but pretty much where it has been running over the last several quarters.

Terrific.

Q1 last one on fire and security.

As you look at the strength of North America, I am guessing could you just break out a little in terms of commercial versus residential what you're seeing from a market perspective?

I think we're still seeing again some continued softness in the commercial business.

We've seen some recent pickup in some of the orders and our residential business again I think we're pleased in how that business is starting to move.

We're seeing again as Ed mentioned before increase in the number of our accounts for the first time, so we're pleased with how that's going in our improvement in our disconnect rates.

Okay.

Residential we're up about 3%.

Okay.

Great.

Thank you.

Thank you.

The next question comes from the line of John Inch of Merrill Lynch.

Please go ahead.

Thank you, good morning.

Good morning, John.

Question, Ed.

The $2 billion additional share repurchase authorization, would you expect to complete that before the end of the calendar year and if so, doesn't that add sort of kind of $0.03 or so to the annual EPS and would that have been -- you still guiding the numbers lower despite that.

How do you want us to think about that dynamic and why shouldn't be that a little bit of a buffer to the raw material drag you called out?

John, look, we're going to spend the money as we have the free cash flow, so as that comes in we plan on spending the money, and, look, it will be spent -- we didn't put a time frame on it.

Honestly I think you can tell by our comments we plan on spending it by the time these companies are broke apart.

Let me clarify, I said any excess free cash flow will go to share repurchase.

Whatever we have and if we can perform better, we'll maybe make another comment to you guys about that, so we'll spend at least the 2 billion that we talked about on the authorization and again performance could dictate what we end up actually doing.

John, when you really average those numbers across the quarters, when you look at it, it doesn't add up to that much when you actually buy it back and by the time you get accounted it doesn't add up to $0.03 and just so you know obviously in our thinking we knew we were going to be more share repurchase throughout the year.

We have been planning on that all along and got the board to authorize it just the other day and are announcing it.

The EPS impact you will get next year.

You get that full impact in the following year.

That makes sense.

It is just the averaging issue, John.

And Ed, you actually raised the cash flow issue.

If we add back the legal cost up flows in the first half, you're sort of looking at a 1.2 billion of free cash number, the six months versus almost a 1.8 billion last year, there is an awful lot of puts and takes on your cash flow.

I know you called out cash should be close to your net income.

Working capital was a continued drag.

I know it made a little improvement.

Continued drag yet you think the organic growth is going to remain as steady as she goes type of thing.

Whereas the cash just generally speaking not a little stronger and would you hope for improvement in the back half and in so where do you think that's going to come from?

Let me make one overall point.

It always is much, much stronger in our third and fourth quarter.

If you look at it on percentage basis relative to how we're delivering our earnings this year, it is really no different than the couple previous years.

It is running kind of percentage wise to net income the same as it has.

Let me also point out one of the things that we know here that the kind of has a dynamic first half and second half is our cash taxes the way our payments fell were higher in the first half of the year and clearly higher in the second quarter, and we know that's not the case in the second half of the year.

We also had higher CapEx in the first half of the year and in the second quarter it was up 120 million year-over-year.

We are not planning that for the third and fourth quarter.

There is projects we wanted to get a kick start on, and that will not happen the second half of the year.

We also expect as we seem to be able to do we have a good focus on working capital, and we expect that to improve additionally in the third and fourth quarter, so when you take those items plus it is our normal percentage trend.

You get to that number.

Okay.

Just in terms of dismantlement you touched on a little progress that had been made.

Do you think that there is a chance that dismantlement, the complete separation of Tyco could occur in calendar 2006?

John, there is no way that it can happen in the year 2006.

Again, the separation of these operations is extremely complex transaction, set of transactions.

A lot of internal transactions globally giving legal structures put in place as well as the audits, the regulatory reviews that have to go on with the SEC, so we think in our plan is actually aggressive and we're on track with what we said before in the first calendar quarter of next year, but I would not -- I would say there is no way that it is going to be quicker than that.

Well, just lastly, Chris, you mentioned shareholder litigation.

Is there any more of an update that you prospectively provide since you talked about it in the November call, just maybe how would you hedge the chances that perhaps we can get this under our belts or out of the way before dismantlement occurs?

As I said, we're not expecting that that would be concluded.

Again, we're focused on it.

We've got resources dedicated to it, and clearly we like to get it behind us as quickly as we can, but we're going to do this on the proper economic basis and aren't going to rush through anything.

I wouldn't expect you should plan on anything happening this year.

Just understand are you getting -- do you feel like you made progress and getting closer to a resolution or just the same sort of -- sort of the same time line you had envisioned before potentially.

Let me just say we're in and out of conversations, but I don't want to say anything more than that.

It would be inappropriate when we're in the middle of trying to get some thing resolved.

Understood.

Thank you.

Thanks.

Thank you.

The next question comes from the line of David Bleustein of UBS.

Please go ahead.

Good morning.

Good morning, David.

On share count can you do a brief reconciliation between what the ending diluted share counted was at the end of December and where the ending share count is at the end of the March quarters?

David, I will take you through that off line.

Let me say that our share repurchase activity in the quarter as we talked about in the past was back end loaded.

We had the separation announcement in January, and then we had earnings in early February, so our activity was much more heavy in the month of March and then into the early part of April, so the impact on share count from an averaging perspective was lesser.

Again, the benefits of it will show up as we move through the year and certainly the benefits will show up in 2007.

Were there any shares added due to acquisition?

No.

There were shares added due to the converts, so if you look at where we ended last year and where we ended the second quarter, you're not going to see much difference, and the reduction will come through in the second half of the year as the impact of the share repurchase, again which was somewhat offset by the converts in the first half.

Thanks, Ed, I will catch you off line.

Okay.

Thank you.

The next question comes from the line of Steve Tusa, JP Morgan.

Please go ahead.

Can you go through the margin dynamics in engineered through the rest of the year?

Was a pretty nice increase in the second quarter, and if you could just talk about the moving parts there.

I think you said it was going to be flat for the rest of the year.

Steve, the one issue we're watching there is the steel spreads.

That's still costing us, and we're still a little concerned about that in the back half of the year.

That was the reason for the guidance saying don't expect it to be more than what it was in this quarter, but a lot of this will depend on we're seeing good order rates in flow control and if we can get additional leverage there, that helps us.

We continue to see good order rates in our fire and building product business.

In what I call the industrial stuff, the order rates have been he very hot.

We will see the volume pick up there and a little bit of leverage.

But on the other hand we got the steel thing still moving against us somewhat.

We're just hedging there a little with it and the reason for the 10 to 11% in the third and fourth quarter.

Lastly on Healthcare, you talked about the 24 to 25 as being sustainable run rate.

Is the difference between that and the 26 that you used to talk about, is that just R&D or what's the difference there from a going forward perk approximate active?

The biggest piece is retail.

It was once operating around 20% operating margins, and it is down around 6 now.

That's about a pointed and a half.

Retail staying particularly weak.

We planned it as Rich made his comments, Steve, we're saying make the assumption now it stays at mid single digit margins.

Is there any visibility as to if that business can get kind of back on its feet?

It is just got a lot of head wind from raw material and transportation charges and tried to pass price on as a private label or label and that didn't go so well so now I think if the branded would go with a price increase, then the private label or store brands could possibly follow.

That's about the only thing we see as potential upside.

Are you worried about downside here?

No, I don't think -- no, no.

We've been running -- we saw precipitous slide now that kind of stabilized.

Thanks a lot.

Appreciate it.

Operator, we have time for a couple more questions.

Thank you.

The next question is from the line of Brian Langenberg of Foresight.

Please go ahead.

Good morning.

Good morning.

A couple questions I would like to explore with you.

First of all on the Electronics side, understanding that copper is an issue, but we look at the public companies.

They seem to be managing through and delivering solid margins and results, and everybody's mix is a little different but just as you do your own internal benchmarking, what are some of the other things we need to be thinking about?

You’re three times the size of the next largest competitor.

The second thing on the free cash flow, understanding lots of puts and takes for the balance of the year but if we're looking at free cash flow exceeding net income, should we think of that in round figures as 2 billion less $500 million of separation and other before any settlement of class action, would that be a way to think about it?

Let me take the free cash flow one first and Tom will take the questions on Electronics.

The costs associated with the separation, Brian, are excluded from our cash flow guidance.

Right.

Maybe we can go through your numbers off line, but none of the costs associated with the separation transaction will hit the pre cash flow numbers that we talked to you about and we guide to.

Understood, when you first announced the separation you were thinking the separation and everything will be about a billion dollars of cash.

Whether it shows up on your cash statement or not, it is money that gets spent.

Fair to say you're looking at spending maybe roughly $500 million through the balance of the year on that stuff?

You know, it is hard to predict how much will actually flow out between now and September 30.

The two big things that we have ear marked for that billion dollars are taxes and costs associated with refinancing the debt, and both of those will happen later in the process rather than earlier in the process, so I think our estimate is back end loaded because the reality is that's when we will start to spend that money, so we would think that the 20, approximately $25 million that we had this quarter will grow in the next quarter and grow more in the ensuing quarters, but it will be back end loaded.

Very back end loaded towards the separation time period.

Understood.

Probably falling into fiscal '07, and if we can go back and talk about Electronics a little bit, it just seems that copper, materials and things like that are hitting your guidance more than others.

Kind of benchmark what things you are running into that others are not.

Yes, Brian, I think the best way to start there is let me step you through a quick reconciliation from our last year's second quarter operating margin which was 15.8%.

We were impacted 180 basis points on the negative side due to the metal costs we mentioned, and the combination of restructuring, the divestitures and the increase in engineering in R&D which I put in the category of investing in the future to improve our performance was about 100 basis points.

Our piece of the stock option expense was 40 basis points, and so those three combined were 320 basis points on the negative offset by volume and cost improvements which pretty much offset our price erosion.

That was positive 160 basis points.

If you look at our organic growth, the other piece of that, we ran 7% solid lower than others had reported, and the reason for this that is our end market mix.

In our business 30% of our end market in the component segment or the connector and cable assembly segment is automotive.

That's a very good business for us, but it is only growing 4%, not too far off average run rates.

We are by far bigger than anybody in that segment.

It is a very good business.

If you go past that business and look at the other major segments we serve, we're growing at our better than market rates.

Just to give you a couple examples in the mobile phone segment which has been very hot for the last several quarters, we grew 50% which is, we think we gained market share in that segment.

It is still only 2 to 3% of our revenue in the consumer Electronics segment we grew over the last three years on average just under 30%.

That's only 3 to 4 % of our business, and it kind of puts the whole thing in perspective in the connector and cable assembly space the automotive segment is the biggest market segment in the industry, and we're by far the biggest player there.

I don't think we're experiencing anything unusually different from anybody else in the space.

It just happens to be the combination of factors that are holding our revenue growth down a little bit lower, but.

Can you talk a little about margins, either structurally or ramp-up costs as you move more production to Asia?

Do you think the margins you historically enjoyed in North America and Europe are attainable there or you can get anywhere close to those margins?

How are you thinking about that and where you now on margins?

Our overall margin is a little north of 14%.

As we mentioned in the past, we have three businesses that account for about 1.5 billion in revenue that aren't contributing.

That's holding our margin down about 170 basis points.

We have been over many years migrating our manufacturing footprint.

Over the last six or seven years, over 100 manufacturing locations have been closed and/or relocated into lower cost operations and having said that, we have a lot more to do.

There is 16 on the list right now.

We clearly see a path, and we're on that path to maintaining the historical margin in this business.

I feel positive about that.

Do you think the overall auto margins can be equal to what they've been historically once you got the moves done?

Yes, I do.

Thank you very much.

Thanks, Brian.

Operator, this will be the last question.

Thank you.

The last question comes from the line of Ted Wheeler, Buckingham Research.

Please go ahead.

Good morning, all.

Good morning, Ted.

Just again a couple.

On a corporate expense side you talked about I think 23 million of break-up costs in the number.

Correct.

What would those expenses be in the second half?

Well, as I said to an earlier question, we see the costs associated with the separation increasing in the third quarter and increasing again in the fourth quarter.

We're not at a point now where we can put a full year estimate on those separation costs, and as we talked about earlier, that's one of the reasons why we excluded from our guidance.

Our overall estimate remains a billion dollars.

We think that there is a good chance that the two big items, taxes and the costs associated with refinancing our debt will happen very late in the process and probably a good chance that most of that happens in the next fiscal year.

Okay.

The reason income statement impact from break-up in addition to the billion which I guess I had thought was a non-income effect of below the line and not in guidance.

Most of that billion dollars will be an income statement impact item.

Okay.

Below the line.

The 23 million is in the $0.45.

No, it is excluded.

If you look in the press release in the first paragraph, it is one of the items that's excluded from the $0.45.

You did exclude that.

Okay.

Apologies.

Last question on the commodity issue of not offsetting 120 million.

Is that a this-year comment or are you thinking that we're forever going to not be able to pass on commodities?

We have raised prices, and it has hit about 15 to 20% of our base.

Again, it is historically these are markets that experience price erosion in the 4 to 5% range.

The combination of some price increases and really trying to stem the tied of emotion has reduced our erosion into the 3 or 4% range.

We don't -- nobody expected copper to be at this level.

I think we have to keep watching it and assessing what we have to do.

Every day we're looking at how do we optimized within that situation?

Would there be contracts that come up year end and then opportunity perhaps to recapture some of this later?

We are working through that.

I don't want to leave you with the impression we're going to recapture the majority of this.

These are markets that don't lend themselves to passing everything on.

Okay.

Great.

Thanks.

Okay, everybody, thanks for joining us for this conference call.

Look forward to talking to you over the ensuing days and look forward to talking to you again when we report or third quarter which will be in the middle of the summer.

Thanks for joining us this morning.

Thank you, ladies and gentlemen.

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