江森自控 (JCI) 2006 Q4 法說會逐字稿

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

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

Later there will be a question-and-answer session and instructions will be given at that time. [OPERATOR INSTRUCTIONS As a reminder, today's conference is being recorded.

At this time then I'd like to turn the conference over to Mr. Ed Arditte.

Please go ahead, sir.

Good morning and thanks for joining our conference call to discuss Tyco's fourth quarter results for fiscal year 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 Electronics and Tyco Healthcare, Tom Lynch and Rich Meelia, who will provide updates on their businesses and also participate in the Q&A session following our remarks.

Tom is participating this morning from Munich, Germany where one of the largest electronics trade shows is currently being held.

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 use certain non-GAAP measures in our discussions 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.

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

Now, let me quickly recap our earnings this quarter.

Our GAAP earnings per share from continuing operations were $0.63 in the quarter which included $0.12 per share of income from special items.

On a basis consistent with our previous guidance our earnings per share from continuing operations were $0.51.

Our GAAP results included a charge of $0.03 per share for costs related to the separation plan, and a charge of $0.03 per share to write off in-process research and development costs associated with the previously announced Confluent and Airox acquisitions that closed in the quarter.

Our results also included income of $0.14 primarily related to benefits the Company will realize from the utilization of prior net operating losses and from a favorable tax ruling, and $0.04 per share of income related to a settlement with a former senior executive that reduced the Company's obligation to pay certain employment-related insurance benefits.

Finally, our free cash flow in the quarter was $1.9 billion which included $65 million of separation costs.

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

Ed will then be followed by Tom, Rich, and Chris who will review our operations in more detail.

Thanks, Ed, and good morning to everyone.

We had a solid finish to the year with good organic revenue growth, operating income improvement, and strong cash flow in the fourth quarter.

Let me take a moment to discuss our operating performance first and then I will update you on the separation after the operations review for each segment.

First, our organic revenue growth was 7% in the quarter as we saw our growth rate accelerate across all of our four businesses.

Electronics and Engineered Products both grew more than 10% in the quarter while our Fire and Security business grew 5%.

Healthcare's organic revenue growth was 2% which was lower than we would have liked.

As you will hear from Rich, however, we continue to work toward improving our Healthcare growth rate in the future.

Along with higher organic revenue growth this quarter, we also significantly increased our operating income.

Fire and Security and Engineered Products increased their operating margin both sequentially and year-over-year, primarily as a result of higher revenue and operating leverage, while Electronics maintained its operating margin despite more than a 300 basis point margin headwind due to higher raw material costs.

Our operating performance translated nicely into strong cash flow.

On the basis of our guidance, free cash flow adjusted for separation costs and legal payments, was $1.9 billion for the quarter and $4.3 billion for the year which was more than 110% of our net income.

With respect to share repurchase activity, we used $625 million of our cash to repurchase 24 million shares which reduced our fully diluted shares by slightly more than 1%.

For the full-year we spent more than $2.5 billion buying back shares and reduced the total number of fully diluted shares by over 4%.

We have approximately $650 million remaining on our share repurchase program and we expect to complete this program prior to separation.

Before I turn the call over to Tom to discuss Electronics, I want to update you on a few other actions that we took that will help strengthen the businesses in the long-term.

First, we have launched a restructuring program across all four business segments and the corporate organization in order to improve operating efficiency.

We expect that the program will cost approximately $600 million over the next two years to streamline some of our businesses and reduce our operational footprint.

The savings from these activities are estimated to be $50 million in 2007 with a full-year run rate of approximately $300 million.

We expect that the net cash out flow in 2007 will be approximately $200 million and we further expect the program to be cash flow neutral in 2008.

Most importantly, this restructuring program will strengthen our competitive position over the long-term.

Next, we continued to refine our business portfolio by pursuing selective acquisitions and divesting businesses that did not fit with our strategic focus areas.

During the quarter, we closed on the Confluent and Airox acquisitions which will help drive growth in Healthcare.

In late October, we closed on the sale of our printed circuit group business in Electronics for $226 million.

As we indicated to you earlier in the year, we expect all three companies will continue to reposition their portfolios for enhanced growth and profitability post-separation.

Now let me turn the call over to Tom to update you on Tyco Electronics.

Thanks, Ed, and hello to everyone from Munich.

I'm going to recap Tyco Electronics fourth quarter performance and discuss our outlook for the first quarter of 2007.

The fourth quarter for us was a good solid quarter with $3.4 billion in revenue and organic revenue growth of just over 11%.

The growth was very broad-based and we had double digit-growth in most of our end markets including communications, computers, power utility, building networks, appliances, industrial machinery, consumer electronics, and mobile phones.

In our largest segment, automotive, our sales were up 4% in the quarter, and in a minute I'll give you a little more color on these markets.

Our operating income was $482 million which was a 13% increase over last year's fourth quarter, and we generated this improvement through a combination of volume leverage, productivity gains and importantly, pricing actions which had the effect of more than offsetting about $104 million of incremental material costs, primarily copper.

Just to remind everybody in the fourth quarter of '05, copper costs $1.90 a pound, in the fourth quarter of '06 it costs $3.70 a pound.

In addition, we continued to increase our investment in engineering and research and development by $13 million in the quarter and $60 million for the year.

So, despite the headwind from materials and our increase investment in engineering our operating margin was essentially flat year-over-year and sequentially at 14.3%.

Let me take a minute now to bridge our margin versus last year.

As I mentioned earlier, material costs us about $104 million which was 300 basis points on a growth basis.

We were able to recover a little more than half of that through pricing actions and that had the effect of bringing down our price erosion about two points versus normal levels for our business, leaving us with about 150 basis points of net headwind from material costs.

As I mentioned, we also invested an incremental 40 basis points in engineering, research and development and we did have 30 basis points of option expense.

We were able to offset this with over 200 basis points of improvement from volume, leverage, and productivity to keep our margin flat in the quarter.

Now let me talk a minute about some additional detail on our major business segment, end markets.

Starting with our electronics components business, which is our largest business and focused on OEM customers, our sales to the automotive market grew 4% year-over-year which consisted of 8% growth in Europe, 11% growth in Asia, and this was partially offset by a 13% decline in North America.

In Europe, which is our largest automotive market, our growth significantly outpaced the market.

In Asia, which is our second largest market and represents about a quarter of our automotive sales, our growth was solid but at a lower rate than we've seen over the past several quarters and this was principally due to labor strikes at key customers in South Korea which curtailed production in that region.

Those strikes are now behind us.

In the Americas, which is our smallest region, our revenue decline was driven by significant production cuts by the North American auto producers.

In the computer and consumer electronics market strong demand in content growth and products such as PC's, digital cameras and flat-panel TV's have driven solid growth across these markets for us, and as we have said previously, the consumer electronics market has been a key focus area for us.

It's still a relatively small part of our business but we've had a lot of momentum in this market over the last couple of years and especially in this year.

In the communications market, which includes both infrastructure, equipment and mobile phones, our sales grew about 15% and more specifically, as we've also talked about in prior quarters, the mobile phone market, which is an area that's still is a small market with a lot of opportunity for us, we grew 50% in the quarter which is the second quarter in a row with that kind of growth rate.

A few key other markets to note in the appliance market we grew 13% and our sales to the industrial machinery market grew 24% in the quarter.

Let me now turn to our network businesses, or our network business which is focused on three key areas.

We sell into the communications service provider market, the power utility market and the building network markets.

Growth across this segment was solid again in this quarter.

In the building networks markets, we grew about 21%.

This is driven really by three factors: Increased non-residential construction activity, increased spending on network upgrades in existing buildings as our customers increase capacity and speed in their networks and security, as well as price increases.

Our sales to the power utility market grew 13%, largely fueled by great infrastructure upgrades as well as the buildout of infrastructure in emerging markets.

In the communication service provider market we saw sales growth of 8% which is down from where we've been running as the rate of fiber [rollout] has slowed just a little bit.

Finally, in our wireless systems business we grew 9% in the quarter primarily due to higher sales of land mobile radios and related equipment.

Let me now turn to what we were seeing in our markets and our first quarter outlook.

Our bookings in the fourth quarter and October were essentially flat with year ago levels and we ended the quarter with a book-to-bill ratio of .95.

Within this, our electronics component business had order growth of 3% over the last four months after experiencing growth of 13% for the first nine months of the year.

For the first quarter we expect revenue growth of 6 to 8% driven largely by the strength of our backlog which was up 7% year-over-year in the fourth quarter.

Based on this revenue level we would expect solid operating income growth over the first quarter of last year, and on a sequential basis we expect our revenue and operating income to be modestly lower due to the normal seasonality of our business.

Now let me turn the call over to Rich to discuss Tyco Healthcare.

Thanks, Tom, and good morning, everyone.

I want to start with a review of our fourth quarter results then I'll discuss the progress we've made in several areas that will better position us for the future.

In the fourth quarter our top line performance of $2.5 billion was somewhat better than the previous quarter but growth continued to be below the levels we were targeting.

Our overall growth rate continued to be impacted by the slower than planned revenue recovery in both imaging and respiratory.

As you know, during the beginning of last year, we had some quality issues.

We made significant progress in resolving them and we are now focused on recapturing the market share we lost as a result of supply interruptions.

Recapturing these sales has been slower than we would have liked and rebuilding this revenue is a top priority for us.

Turning to profitability in the quarter, our operating income was $566 million.

This was before the $60 million write-off of in-process R&D from two of our recent acquisitions.

Our operating margin was just under 23%.

This was about a point below the margin we thought we could achieve and it primarily reflects the lower sales volume.

Revenue growth is clearly our number one objective today and it will remain our number one objective as we move forward to our launch as a public company.

That said, we made progress on a number of fronts to position Tyco Healthcare for improved growth going forward.

Let me take a minute to discuss some of the areas of progress in 2006 that enhance our position for the future.

First, the quality issues we experienced earlier in the year were a painful but useful lesson for us from a longer term perspective.

We made changes to our organization and our processes and as a result, we are in much better shape today than when we entered the year.

I am confident that we have come out of this with a much stronger quality function across Tyco Healthcare.

Second, we have made a number of organizational moves to globalize our businesses and this, too, strengthens our long-term growth outlook.

One of the strong capabilities of Tyco Healthcare is our global presence and our ability to market and sell products in both developed economies and emerging markets.

Our business outside the United States now accounts for about 35% of our sales and it is growing faster than our U.S. business.

Of note, our business in Asia Pacific and Latin America grew by 14% and 13% respectively during the fourth quarter.

The globalization of our product platforms is important to both our internal growth and our acquired growth.

From an internal product development perspective, this enhances our focus in developing the right product with the right features and price for each market.

From an acquisition perspective, our ability to capitalize on the regional product line and then sell it around the world is a value-enhancing move that adds to our growth opportunity.

The third area of progress in 2006 is the continued improvement we're making in developing our research and development and sales and marketing capabilities.

We will continue to increase our R&D expenditures both internal as well as through acquisitions with a particular focus on our higher growth and higher return medical device products.

One new platform that we are excited about is the Force Triad energy platform which was developed by our Valleylab business.

The Force Triad system provides traditional monopolar electro surgery, bipolar functionality and Valleylab's proprietary ligasure tissue fusion in a single platform creating both cost effectiveness and efficiency in the operating room.

By providing an integrated surgical solution, Force Triad redefines electric surgery which is used in most surgical procedures.

Force Triad was very well received by the American College of Surgeons at their annual clinical meeting in Chicago last month.

The global market for electro surgery in vessel sealing is more than $1 billion.

Force Triad represents a significant advance in this market and we expect it to be an important new product in the coming years.

The final area of progress in 2006 was on the acquisition front.

Our strategy has been to add product lines and capabilities where we can broaden our product offerings and leverage our market position.

Evidence of this was the four acquisitions we made recently, three in surgical and one in respiratory.

In addition, we are focused on licensing innovative technologies that we can distribute.

To accelerate our progress in this area, we've added resources in business development and licensing and we expect to be very active in this area over the next few years.

As most of you know, Tyco Healthcare generates strong cash flow.

As we've done this year with our acquisitions, we'll make good use of this cash flow to add new products and capabilities to our key product platforms.

As we look to the first quarter we expect that our operating margin will be in the 21 to 22% range as we continue to invest more in our growth initiatives.

Additionally, we expect our organic growth rate in the first quarter to improve slightly over the fourth quarter.

We are aggressively pursuing pricing cost initiatives to improve our gross margins that will help fund higher R&D and sales and marketing expenses.

In summary, we will continue our efforts to transform Tyco Healthcare into a faster growing company.

We've added new talent to our organization in a number of key areas and we will continue to strengthen our team with people who bring significant new growth capabilities.

Overall, I am confident that our strategies and actions are the right ones for the Company.

Now let me turn the call over to Chris.

Thanks a lot, Rich, and good morning, everyone.

Let me begin with Fire and Security where our organic revenue growth was 5% and our operating margin was 11.7%.

We saw improved revenue growth in worldwide Security driven by both our commercial and residential businesses.

Our worldwide Fire business improved due to higher contracting, service, and maintenance activity in North America.

Our operating margin increased both sequentially and year-over-year primarily by growth in SimplexGrinnell.

In our Security business, organic revenue growth was 5% and our operating margin was 14.6%.

Recurring revenue continued to improve and grew 2% year-over-year and we also had higher contracting revenue.

We continued to increase our average revenue per user and our trailing 12-month attrition rate dropped below 14% to 13.8%, the third full-year of decline in the attrition rate.

Next, our Fire business had a strong finish to the year with organic revenue growth of 7% and an operating margin of 9.4%.

While revenue picked up in all regions except Europe, much of the growth was driven by SimplexGrinnell, our North American Fire business, which grew 11%.

We saw continued strengthen commercial construction and in our backlog, which ended the quarter up more than 20% over last year.

We also had a strong maintenance and service revenue this quarter, particularly in electronic fire detection.

Turning to safety products, organic revenue growth declined 1.5%.

Within that, however, we saw a strong growth of 11% in video and access, intrusion, and fire suppression combined.

This was offset by a significant decline in firefighter breathing unit sales which are primarily driven by the flow of funds from the federal government to municipalities.

Delays in federal funding during the past two quarters has negatively impacted our breathing unit sales but we expect this business to pick up in the first half of 2007.

Looking ahead to the first quarter for Fire and Security, we expect good revenue and profit growth over the prior year but lower growth in margin than we saw this quarter as the fourth quarter is typically our strongest quarter with construction projects, service and maintenance often completed during the summer months.

The holiday season and the colder months make for a tougher comparison of the first quarter with the fourth quarter.

Now let me turn to our Engineered Products business and we had a solid finish to the year with strong top line and operating income growth.

Organic revenue growth was 10% and our largest business within Engineered Products, Flow Control, which represents approximately half the segment's revenue, grew 17% organically driven by growth in our emerging markets and strength in our end markets particularly in oil, gas, and water.

Our backlog in Flow Control was up 40% year-over-year.

Electrical and metal products grew 9% and fire and building products grew 12% as a result of price realizations and market share gains, particularly in North America fire protection.

Revenue for infrastructure services declined 4% which was consistent with our expectations.

Operating income for Engineered Products grew 38% to $216 million.

The operating margin improved over 200 basis points to 11.7% due to better pricing, strong volume growth, and increased efficiency across the business as well as higher steel spreads in electrical and metal products.

As we look to the first quarter our end markets continue to be healthy and though we expect our growth rate to moderate somewhat, we expect good top line growth.

From a profitability perspective, we are carefully monitoring steel spreads which have contracted due to a recent decline in steel market prices.

As we have seen historically, steel prices and spreads tend to fluctuate which can cause significant swings in our revenue and profit growth from one quarter to the next.

Given this recent development, we expect year-over-year profitability in our electrical and metal products business to decline in the first quarter.

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

First, you will note that our GAAP earnings per share for the quarter of $0.63 and $1.97 for the full-year were greater than the earnings per share excluding special items that we have previously discussed.

The positive impact of a number of tax items were the largest contributor of the income generated by special items.

While one-time in nature, I think it's important to point out that in 2006, we effectively reported a reduction in our tax liabilities in excess of $400 million can with no cash outlay from the Company.

While this reduction does not significantly impact the effective tax rate of the Company going forward, it represents an important economic benefit to the Company.

Our tax group has been quite successful over the last two years in settling tax matters with a positive result to the Company.

As you know, it has been quite difficult to forecast our tax rate due to the large number of outstanding tax matters the Company is in process of resolving.

Our GAAP tax rate in 2006 was 16% and without the impact of special items was about 25%.

In the first half of 2007 we anticipate that our tax rate will be 26 to 27% before any special items.

Post-separation we expect each of the three companies to initially have tax rates higher than this, most likely a couple hundred basis points of impact.

We expect to take a year or two for tax planning strategies we're implementing in each business to bring our tax rate down to the range we have seen over the last few years.

Second, our separation costs for the quarter were $80 million bringing the total to $169 million so far.

As we previously indicated, the total separation costs are estimated to be approximately $1 billion, the majority of which will be incurred close to the separation date.

With respect to cash flow, we expect first quarter free cash flow to be modest as this is typically our lowest cash quarter.

As I just mentioned, we will also have additional separation costs throughout the first half of 2007.

We have also already made a payment in our first quarter of $280 million related to the termination of a lease on the undersea cable ships in Tyco.

Next, our corporate expenses were $55 million in the quarter which included the $80 million of separation charges I just mentioned, $72 million of income from the insurance related settlement with a former executive, and $48 million of income resulting from a reduction in our worker's comp liabilities that resulted from improved safety and claim management programs that we have implemented across Tyco.

Finally, the Company today filed an 8-K summarizing the results of its internal review of its stock option practices.

The review identified a number of issues resulting from incomplete documentation and certain instances where controls at the time in determining the measurement date were not adequate.

The impact of the areas noted have no impact on fiscal 2006 results and less than a penny a share impact on 2005.

We intend to restate our reported results for the prior periods in our fiscal 2006 Form 10-K.

For more information please review the 8-K which has been posted on our Web site.

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

Thanks, Chris.

Let me conclude with a few comments on our guidance and an update on the separation process.

With respect to guidance for the first quarter, we expect earnings per share from continuing operations before special items to be in the range of $0.42 to $0.44 per share which would represent an 8% to 13% increase over last year excluding special items.

As was mentioned earlier, the first quarter is our lowest quarter in profitability and cash flow due to seasonal impacts.

In addition as Chris mentioned, we expect narrowing steel spreads to negatively impact the first quarter both year-over-year and sequentially.

With respect to cash flow, Chris just mentioned that in the first quarter is typically our lowest cash quarter, however, we are confident in each of our businesses ability to generate cash and we expect 2007 to be another strong cash flow year for Tyco.

Before I open up for questions, I wanted to comment on the separation process.

We have essentially completed filling out the management teams and Board of Directors for each of the companies.

Importantly, we also expect to file separation documents with the SEC in mid January.

Included in the filings will be detailed information for each of the three independent companies.

A few weeks following, we will hold an Investor Day in New York where each of the management teams will provide an overview of their businesses.

Our plan is to follow-up with investor road shows a few weeks prior to separation.

The exact timing of the separation will be dependent upon obtaining the SEC's final approval on our documents.

With respect to naming the three companies, we have recently concluded that Tyco Electronics will retain its name and that Tyco International will remain the name for the Company that owns our Fire and Security and Engineered Products businesses.

We are working on a new name for Tyco Healthcare and that name will be announced prior to separation.

Thanks for joining us this morning on the call.

And Operator, if you could open it up for questions we'd be glad to take some.

Certainly it would be my pleasure. [OPERATOR INSTRUCTIONS] And our first question this morning comes from the line of Jack Kelly with Goldman Sachs.

Please go ahead.

Good morning, Ed.

Good morning, Jack.

Rich, just two questions.

One, regarding organic growth in the current quarter.

It appears that given the easier compare year-over-year that organic growth should be something more than maybe just modestly better than 2%.

It seems like you should be back in the 4% plus range.

So that's the first question.

And then secondly, with regard to the existing portfolio that you have at Healthcare, do you think it has the ability to grow in a longer term basis, you know, 5% plus or do we need acquisitions or a bigger ramp-up in R&D to get there?

Sure, okay, Jack.

You know, it comes down, really, to the recovery issues in imaging and respiratory.

We're slowly coming back in imaging.

The progress has been good, albeit the hole we dug was considerably deeper than we had anticipated especially getting out of it, and with respiratory, the plant that was placed under detention for certain product categories remains there as we've invited FDA back, but they have scheduled but it's not until the first quarter of the calendar year so that's kind of working against us.

With respect to being closer the 4%, if you think about it, we went from Q2 down to, in Q3 to 1.1% back up to 2% in Q4.

We're going to get there comfortable, just given the misses we've had relative to the timing and the anticipation of when we get all of that business back.

We're just being a little bit more cautious in terms of when that will happen.

With respect to this portfolio and whether longer term we can grow 5%, if you look historically where we've been with the portfolio, it's been, if you go '02, '03, '04, '05, it's kind of the 3 to 5% range.

Additionally, if you look at the investments we've been making in sales and marketing and R&D, this portfolio, once we get through these problems and eliminate the drag that's been evidenced by businesses declining year-over-year which we think will not occur again, I do feel comfortable this portfolio once we get these problems behind us, have the opportunity to get there, especially when you consider the strength of our international business which is, you know, continues to out perform the domestic businesses and you're going to begin to see the impact of some of these acquisitions, albeit small, they're real good technology and [inaudible] gap fillers that fill critical needs at places like [inaudible] surgical and respiratory.

So hopefully that gives you a better feel, Jack, for what we see longer term.

Just coming back to the first quarter, Rich, so whatever improvement we see, this modest improvement, is that simply a function of a much easier year-over-year compare or are we talking about a sequential improvement in imaging and respiratory?

Certainly in imaging you'll see, overall you'll see a sequential improvement, definitely in imaging.

In respiratory, I think you'll see somewhat of one but once again, we won't even have a chance to review that detention with FDA until the January time frame and that's a piece of our problem there, so we've got to get through that.

And just, Tom, one question.

There's a lot of focus on pricing vis-a-vis copper costs and it appears they're going the right way, but to the extent we can just step back from the copper issue, can you discuss in some of your key end markets what's happening with pricing?

And I guess I'm going back to two or three years ago where pricing seemed to be declining 2 to 5% versus maybe some increases now because of copper, but what's happening in the end markets?

Can you get better pricing in terms of value-added products, et cetera, again, putting aside the copper?

Sure.

Our historical erosion is in the 4 to 5% range.

As I mentioned, we ran a couple hundred basis points better than that in the quarter and what that really represents is I'd say several things.

One, in certain markets we've been able to get price increases actually.

In other markets, it's not so much price increase but it's not giving what the customers typically expect is a price reduction.

As you can imagine in consumer electronics, mobile phones, things like that where you have a more accelerated price curve, we've been able to hold off price reductions or give reduced price reductions so we've made progress in, you know, the consumer markets and the industrial markets.

Where we've made little progress is in the automotive market.

We have not been able to pass very much on into that market.

Now part of that is because the contracts are longer, for sure, so when we get designed into a model we're typically in 3 to 5 years.

Part of it is it's just tougher to get price increases into that market but as we look forward at this rate as we bid new pro projects, we're going to be more aggressive on our pricing into that market.

Now the other thing about that market is typical price erosion is a little bit less, too, in automotive.

And are there any major roll offs of contracts in automotive in FY '07 that would change the pricing dynamic there?

No, I don't think so.

Thank you.

Thanks, Jack.

Thanks.

And we have a question then from the line of Nicole Parent with Credit Suisse.

Please go ahead.

Good morning, guys.

I guess just a quick follow-up for Rich.

Could you give us a sense, I guess I'm a little bit surprised in terms of the margin forecast for the first quarter given the easy comps that you have in respiratory and imaging, and I guess maybe to connect the dots could you give us a sense of what the R&D should be in the quarter and maybe for the year, that the bulk of the difference in the decline or how should we think about that?

Yes, the margin projection is tied almost entirely to continued, in some cases accelerated investment, not just in R&D, Nicole, but sales and marketing.

We identified a while back that we needed to strengthen our investments considerably in this area in order to provide a stronger growth rate for this healthcare company going forward so that's what we've continued to do.

In terms of R&D, we have been steadily increasing and it was up 20% '05, about 15% last year and I believe it's in that similar range, maybe about 20% going forward.

Our goal is to get our spend more consistent with our peers in the medical device field and we will gradually do that.

One of the areas that I mentioned we made some investments in business development, we're looking to do a better job of trying to identify through the voice of the customer and scouting various technologies of better capability, bringing new ideas into the pipeline especially within the medical device imaging and [pharma] businesses.

Great.

Thanks.

And I guess maybe just a big picture question for Ed or Chris in terms of the restructuring number you gave, I realize it's sensitive.

I'm a little bit surprised that Fire and Security is getting 45% of the restructuring number.

Could you just, I guess, maybe big picture help us think about it in terms of organic growth improving, you're starting to get some nice margin recovery there, what's left to do in that business?

Yes, Nicole, you know, just historically, and we've talked about this a lot.

Fire and Security is, out of the four key segments we have in the Company, it's the one that still has the most inefficiency in the footprint, the highest G&A expenditure, the most real estate facilities, et cetera, et cetera, so it's still the most inefficient when you look at it from any metric so there's just more opportunity over a multi-year period there to continue to wring cost out of that business.

If you look at a little bit more detail of what we're planning on doing, a big chunk of that spend in Fire and Security on the restructuring is going to happen in our European operation and, as you know and many people know, that is, clearly, our most inefficient of all our Fire and Security businesses and our lowest margin business.

We're ready to now tackle that.

We mentioned last call we have a very good management team running the business now.

We've beefed it up and we've been planning the restructuring over there for the last six months and we're ready to go.

So a big chunk of that will be integrating the back offices, the IT, the G&A structure of the European footprint.

Super.

And I guess one last one.

Just as we think about full-year '07 I realize it's a little bit challenging as you roll forward and get the documentation and filings prepared but is there a sense you can give us in terms of business, maybe who grows, who might not and who could expand margins?

Well, you know, look, we're not giving full-year guidance as you saw.

We're doing it quarter-by-quarter because of the split out but just a couple high level comments.

Generally speaking, we are feeling good about the global economy.

Things feel pretty good to us right now as I think you can see from the results that we had this quarter.

If I just gave you a flavor on a couple of them, you know, in Tom's business in Electronics, we're seeing the orders a little bit lighter here.

I don't read a lot into that right now.

If Tom gave you a little more color, his team is feeling pretty good about how things look going forward and I'm hoping also that copper certainly is not getting worse, it's subsiding some.

I think yesterday it was at $3.10 down from the levels Tom had just talked about so, there should be earnings momentum in Electronics going forward throughout the year.

We are just, one other one I'll mention because it's a big part of the portfolio.

As you saw in Fire and Security all of those second tier metrics are continuing to gradually move in the direction that we thought they would, you know, revenue per user, attrition rate continuing down, recurring revenue growth rate continuing to pick up, we're not losing accounts now, we're net adding some accounts.

So things are starting to track and when that business turns, it's going to be gradual but it's a little bit of a juggernaut when you get it positioned and going in the right way.

And then if you go over to Engineered Products, the Flow Control business is feeling good to us and that's 50% of that portfolio.

As Chris had mentioned, the backlog's up 20% year-over-year and it's pretty broad in all three of the different regions around the world.

The one, you know, negative that we have just started to see the last 60 days or so is, and by the way, this happens in our portfolio with our electrical metal businesses, the steel spreads are going to cost us in the first quarter relative to the fourth quarter.

I don't know how that played out during the year, that can turn pretty quickly.

But in the first quarter we're seeing the steel spread issue and we're also seeing the volume a little lighter there.

I think some people holding off because of the price there.

That usually doesn't hold long-term but we'll see as we go.

Great.

Thanks.

That's very helpful.

Thanks.

Thanks.

And we have a question now from the line of Lee Cooperman with Omega Advisors.

Please go ahead.

Hi, good morning.

Just three questions.

Easiest one first.

What are the actual shares outstanding at the end of September and currently?

One.

Two, it's commonly believed that if a corporation has not engaged in any discussions regarding corporate transactions that would break up of the kind that your undertaking takes place that literally, almost immediately, anybody could buy any of the pieces as long as you've not been in discussions.

Could you represent that we've had no substantive or no conversations that would prohibit anybody from coming in, assuming somebody wanted to come in, to buy one of the three pieces?

And thirdly, is there any debt in the existing capital structure that is an impediment to the breakup that has to be dealt with?

Thank you for your help.

Hi, Lee, Ed Arditte.

I'll take the first one.

I will come back to you with actual shares.

I don't have that here with me in the conference room but I will get back to you with that number.

And Ed Breen can handle the other two.

Yes, Lee, I'm not going to comment on any specifics on that but there is, look, there's no impediment to anybody at any time approaching us, pre-us separating or post-us separating.

You know, if there was anything significant to report, we would have said something publicly about it.

That's not really the question.

The question is: Historically, there's been a two-year Safe Harbor period after split up to avoid any adverse tax consequences.

That two-year period is not relevant if a corporation had not engaged in any conversations regarding sales of the businesses.

So my question is, and maybe the best analogy is Cendant.

Cendant is taking the position that they have not had any conversations regarding sale of any of their divisions and, therefore, if anybody wanted to buy any of these businesses post the breakup they can come in virtually immediately.

So my question is, are we in a similar clean position that we've not had conversations of such if somebody showed up and it was attractive for all of the shareholders that there's no impediment that we don't have to wait the two years.

That's the question.

Lee, we are in a clean position, if that answers your question, but let me also point out, as I've said many times, I'm personally looking forward to these companies pursuing their strategies so we've laid out with our Board all three of these companies a very nice plan over the next three years and I think it's going to pay off handsomely for us as we execute against it.

But having said that we are in a clean position.

Terrific.

And in terms of the debt structure?

In terms of the debt structure, Lee, there's nothing that we see in terms of our debt structure that would slowdown or in any way inhibit the separation plan as we've laid out.

Terrific.

Good luck and thank you very much.

Thanks, Lee.

And next we'll go to the line of Michael Dimler.

Please go ahead.

Hello?

David Bleustein with UBS.

Please go ahead.

Good morning.

Now that we're getting closer can you break down the billion dollars of separation costs into component parts?

No.

We haven't broken it down in any kind of detail other than we have said it is made up primarily of tax related costs as well as some debt costs and the separation sort of advisory costs.

In that order.

Yes.

So tax leakage is the largest, debt --

Well it's tax and debt primarily.

Think of it that way.

Terrific.

Thank you.

We'll go to the line of Ted Wheeler with Buckingham Research.

Please go ahead.

Good morning, Ted.

Two questions.

On the Electronics situation and comments on the first quarter, could you discuss your view of the channel inventory, if there's been any change over the last few months?

Sure.

And how it is in relation to normal?

Yes.

I don't think we've seen any significant change in the channel, but let me give you the benefit of some of the discussions we've been having over here in Munich since all of our customers are here and we have our management team here.

We've been here for a couple of days and I would say as we've talked to them about what are they seeing, three themes really emerge.

They feel pretty good about the level of the business, of course coming off a really good year but still feel '07 will be healthy.

The other theme is it's going to be healthy but it's probably not going to be as hot as '06.

I mean, '06 was a very, very hot year, or the hottest in recent memory in our industry and, of course, they caveat it with the third point which is, hey, we all have two to three months visibility so it's really hard to make a call out in later '07.

But those are three consistent themes we've gotten.

In terms of our inventory in the channel, it's pretty flat I think with where it was through most of Q4 because we've had the benefit of talking to all of our channel partners here, too, and they're kind of sending the same messages of themes I just described.

Wasn't there a little bit of building during this last fiscal year that contributed to the growth or is that not right?

Well, you know what, I think there's a natural build of sales growth.

Okay.

We're all building our inventory.

Our inventory went up as you ramp-up your production to drive higher sales but I don't think it's anything unusual.

In other words, we're not hearing that our distributors are going to go through some large correction.

Yes, that was kind of the question.

And another question I had would be that I noticed that as you've advertised, the debt has been flat now, you know, since March.

Interest expense seemed to go down a little bit more than I thought it would sequentially.

Is there anything in that and how does it look going forward in terms of interest expense?

Yes.

Our interest expense has gone down as, again, our debt did ramp down during the year so you get some comparison there as well as our improved cash flow, we had additional interest income.

Well just, I guess, I meant quarter-to-quarter sequentially.

The debt really was pretty flat in the September quarter and interest did go down sequentially.

Yes, but as our improved cash flow came in we had additional interest income.

Okay.

So that should continue presumably?

Well, it will continue, again, as we will be using some additional cash on things like our share repurchase program.

Yes.

And we also have separation costs.

I mentioned that we had the finalization of one of our ship leases that will reduce cash in Q1 so Q1 tends to be our lowest so you could see a reduction in interest income in Q1.

Perfect.

Thank you.

Good quarter.

Thank you.

Operator?

Are there any other questions in the queue?

Our final question today comes from the line of Michael Dimler with UBS.

Please go ahead.

Hi.

Thanks for taking my question.

I just wanted to follow-on some of the balance sheet restructuring questions and ask about the specific plans for the debt with respect to whether you're looking to do completely clean balance sheets on all three companies post-separation or if you would be looking to just clean the balance sheets up on the two spinoffs?

Well, I'm not sure that I understand the question in terms of clean balance sheet but, again, we plan to go out with very strong balance sheets for each of the three companies as we have indicated with our gross debt target at about $10 billion and that has not changed.

We haven't discussed the type of debt yet that will be on each and we will be talking more about that later.

What's the approximate time frame for that kind of decision-making?

Well, we're making those decisions but I think that's going to be close to the separation date.

And if I could ask a more detailed question, are you being advised at all or can you comment as to whether you're being advised about the, whether the separation would constitute substantially all of the assets of the Company under the terms of the indenture?

You know, I don't want to comment on our particular indenture agreements as we are in review with our debt holders right now and how we're going to refinance and finance these three companies.

Okay.

Thank you.

Okay.

All right thanks for joining us.

Look forward to talking with all of you individually in terms of follow-up.

Our next quarterly conference call should be scheduled for the end of January where we will report our first quarter and we certainly hope to talk to you before then once we have filed our documents relative to the separation.

Thanks for joining us this morning.

That concludes our conference for today.

Thank you for your participation and for using the AT&T Executive Teleconference.

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