江森自控 (JCI) 2007 Q1 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, thank you for standing by and welcome to the Tyco reports first quarter 2007 earnings results conference call.

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

  • Later we will conduct a question-and-answer session.

  • Instructions will be given at that time. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded.

  • I would now like to turn the conference over to your host, Senior Vice President of Strategy and Investor Relations, Mr. Ed Arditte.

  • Please go ahead.

  • Ed Arditte - SVP Strategy and IR

  • Thank you.

  • Good morning and thanks for joining our conference call to discuss Tyco's first quarter results for fiscal year 2007 and the press release that we 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.

  • Tom is joining us from Beijing where he is meeting with customers, employees and government officials over the next few days.

  • 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.

  • Now as most of you know, Tyco filed a number of separation related documents with the SEC on January the 18th.

  • In those filings we present certain segment information for Tyco Healthcare, Tyco Electronics, and the remaining Tyco International.

  • The results presented in our press release today are based on Tyco's historical presentation and our comments will address both the historical presentation as well as the performance within the new segments of Tyco Electronics and Tyco Healthcare, as shown in their Form 10 filings.

  • The press release issued this morning 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 $0.37 in the quarter.

  • Included in our GAAP earnings per share are charges of $0.03 per share for restructuring and charges of $0.05 per share for separation activities.

  • Our GAAP tax rate for the quarter was approximately 29% and this rate was impacted by separation items.

  • Excluding these special items are our tax rate was approximately 25% for the quarter and on a basis consistent with our previous guidance, our earnings per share from continuing operations were $0.45 in the quarter.

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

  • Ed Breen - Chairman, CEO

  • Thanks, Ed, and good morning, everyone.

  • Let me make a few quick comments before we review our operational results.

  • First, we had a good quarter with all four segments delivering solid operating performance.

  • Overall, we had nice organic revenue growth of 5% and our operating margin, excluding the impact of restructuring and separation related charges, was 13.1%.

  • We were particularly pleased to see our revenue pick up in our Healthcare segment where we had revenue growth of 7% which included 2 points from currency.

  • With the exception of retail, we saw growth accelerate across all businesses.

  • Further, our most profitable business, medical devices, which consists primarily of surgical and respiratory, grew 8% this quarter helped by strong growth internationally as well as the revenue contribution from recent acquisitions.

  • In addition, our imaging business continued to recover with 12% revenue growth.

  • We were also pleased with our progress in improving our operating margin at Fire & Security.

  • Our operating margin of 10.2% this quarter was almost 200 basis points higher year-over-year, mostly due to our increased focus on cost and productivity.

  • Our North America Fire & Security operations, as well as our safety products business, had significantly better operating performance.

  • For Tyco overall, our operating cash flow was $844 million and our free cash flow was $103 million, just about where we had expected.

  • Included in our free cash flow was $85 million for separation costs and $280 million to buyout the lease on the undersea cable ships and Tycom.

  • Adjusting for these items, free cash flow was more than $450 million for the quarter.

  • I am confident that each of our businesses will continue to deliver very strong cash flows as independent companies.

  • We also launched the $600 million restructuring program that we told you about last quarter.

  • We incurred $83 million this quarter in the restructuring expense across the Company and we still expect to complete most of the restructuring program in '07.

  • The payback on these programs is attractive.

  • During the quarter we were also active on the share repurchase front and we completed the $2 billion share repurchase program that we announced last May.

  • We spent $659 million this quarter repurchasing shares which represents slightly more than 1% of our fully diluted shares.

  • Finally, we achieved a significant milestone in our separation process when we filed the Form 10's for Healthcare and Electronics and our other separation related documents with the SEC on January 18th as we had planned.

  • This was a tremendous effort and I want to thank all of our employees for their hard work and dedication.

  • I feel good about where we are in the separation process and I'm excited about the management teams and the boards for each of the companies.

  • Our employees are also excited about the long-term prospects for each of these three businesses.

  • From a timing perspective, our documents are currently being reviewed by the SEC and we expect to move forward with the declaration to stock dividends once we obtain final SEC approval on our filing.

  • While we have been working closely with the SEC to help enable a smooth review, it is important to recognize that this is an extraordinarily complex filing.

  • We anticipate getting initial comments back from the SEC within a few weeks and we will likely have a firmer sense of timing following their first round of comments.

  • Right now, our best guess for completing the separation is early in the second calendar quarter and we are hopeful that we will be able to do this at the end of April.

  • We will hold an Investor Day for all three companies as well as conduct equity road shows and we will announce the detail of these events as we get closer to the separation.

  • With that, let me turn the call over to Rich who will provide a more detailed review of Tyco Healthcare's performance and I'll come back later with a few additional comments.

  • Rich Meelia - CEO Tyco Healthcare

  • Thanks, Ed, and good morning, everyone.

  • I'm pleased to discuss Tyco Healthcare's first quarter performance and in discussing our results, I will speak about our business in the new segment format that was shown in the recent Form 10 filing.

  • Overall, we made good top line progress in the first quarter.

  • Revenue of $2.45 billion was up 7%, or 5% net of foreign exchange.

  • These are our strongest quarterly revenue gains since the third quarter of 2005.

  • Our growth was aided by excellent performance internationally as sales were up 12% with solid increases in Europe, Latin America, and Asia Pacific.

  • Sales also benefited from comparison with last year's results which included the adverse impact of voluntary product recalls in medical devices and imaging segments.

  • Our operating income was $515 million in the quarter, and the operating margin was 21.1%, however, our operating income included a $16 million restructuring charge, an $8 million charge to write-off in-process R&D related to a recent acquisition, and $3 million for separation related charges.

  • Excluding these items, the operating margin was 22.2%.

  • During the quarter we continued to invest in our business to enhance our ability to deliver sustainable, long-term growth.

  • First, we invested an incremental $22 million in selling and marketing, above last year's first quarter, to expand our on the ground selling presence and to further globalize our marketing function.

  • This salesforce expansion, largely outside the United States, is driving the strong international revenue growth noted earlier.

  • Second, while our R&D increased slightly, we reallocated our investments to higher growth, higher margin categories within the portfolio.

  • In 2007 we plan to continue the upward trend in our R&D spending which has more than doubled in the last five years.

  • Now, let's turn to our business segments.

  • Beginning with our largest segment, medical devices, which represents about 60% of our global sales.

  • This segment includes surgical devices, energy-based devices, respiratory and monitoring solutions and patient care and safety products.

  • Sales of medical devices grew 8% in the quarter to $1.5 billion and accounted for two-thirds of our total company sales increase.

  • We registered double-digit growth in energy-based devices, led by the launch of the new Force Triad Energy Platform for electro surgery.

  • Force Triad provides the operating room with one energy system for [electrico] surgical and tissue fusion needs and gives surgeons the ability to deliver precisely controlled energy and improve tissue effect.

  • Surgical product sales were well above the year ago due to strong performance in Europe and Asia.

  • Growth was driven by geographic expansion and incremental salesforce investments we have made in both regions.

  • Sales of respiratory monitoring solutions were above last year, led by strong Oximetry sensor sales.

  • Patient care and safety product sales were higher than a year ago driven by the good performance of our pre-filled syringes and vascular therapy products.

  • The medical device segment revenue was also aided by three 2006 acquisitions, Floreane, Confluent and Airox.

  • We completed the acquisition of Airox during the quarter and are currently integrating that business into our respiratory infrastructure.

  • Now turning to the pharmaceutical segment which includes dosage products, active pharmaceutical ingredients and specialty chemicals, sales grew 15% to $321 million up from $278 million last year.

  • All three categories within this segment registered double-digit sales increases in the quarter.

  • In dosage pharmaceuticals, sales growth was largely due to higher Oxycodone sales volume and the continued increased demand for narcotic pain medicine.

  • In the API business we saw good growth for both narcotics and stronger demand for acetaminophen internationally.

  • Turning now to the imaging business which encompasses radio pharmaceuticals, contrast agents and delivery systems, our sales in this segment increased 12% in the quarter to $224 million up from $200 million last year.

  • As noted earlier, we benefited from somewhat easier comparisons related to the generator recall last year.

  • Growth for both radio pharmaceuticals and contrast agents increased at a double-digit pace.

  • Gains in the radio pharmaceutical business were mostly due to higher sales of Technetium Generators and our trio scan.

  • The growth in contrast agents was primarily due to higher magnetic resonance revenue coupled with increased Optiray sales reflecting our geographic expansion into Eastern Europe.

  • Looking next at the medical supply segment, despite continued difficult market conditions, sales increased 3% above last year primarily due to the timing of distributor orders.

  • The gains I've highlighted in medical devices, pharmaceuticals, imaging and medical supplies were partially offset by a 9% decline in revenue in our retail business.

  • The decline was virtually all in the infant care category, largely attributable to aggressive price reductions by both branded and private label competitors.

  • We plan going forward to exit several low, negative margin private label supply contracts which will put some downward pressure on retail revenues for the remainder of the year.

  • I'd also like to mention the significant progress we've made regarding quality.

  • I believe that the issues that affected our 2006 performance are mostly behind us.

  • One indication of this is that we were just notified that our Juarez, Mexico facility, which has been under an FDA warning letter since February 2005, has passed FDA inspection.

  • This should clear the way for the facilities detention to be lifted and consequently, those affected respiratory products to resume shipping back into the United States.

  • Throughout our global manufacturing footprint, we have upgraded our systems and processes to insure the highest possible quality in the future.

  • Looking forward, we expect that revenue growth for the year will be 4 to 6% in that organic growth will be between 3 and 5% with the second quarter at the lower end of the range.

  • Revenue growth should benefit from our investments in selling and marketing as well as from our three acquisitions in 2006.

  • Operating margin for the second quarter should be in the 21 to 22% range excluding any restructuring charges.

  • We are actively working to increase our gross margins to fund further investments in the growth initiatives needed for improved top line performance and we made good progress in the first quarter in this effort.

  • As you may know, we recently announced the new name we'll have once we separate from Tyco in the spring.

  • Tyco Healthcare will be renamed Covidien and this name will be the cornerstone of our brand new architecture once we are a standalone Company.

  • In summary, we accelerated our sales growth rate in the first quarter and we continued to invest in growth initiatives.

  • In addition, we continued to make good progress preparing for our separation from Tyco.

  • I'm confident that we have the right strategies in place and will continue to execute well against them as we move through 2007.

  • Now, let me turn the call over to Tom.

  • Tom Lynch - CEO Tyco Electronics

  • Thanks, Rich, and good morning from Beijing.

  • Before I turn to our first quarter performance I just wanted to echo Ed's comments regarding our filings with the SEC and tell you that Tyco team worldwide is really excited about becoming our own public company.

  • Now, let me turn to our first quarter.

  • In reviewing our performance today, I will be referring to our new business segments as shown in our Form 10 filing.

  • Our revenue in the quarter was $3.2 billion and organic revenue growth was 6% year-over-year.

  • Our growth was solid in the automotive, industrial machinery, power utility, medical and appliance markets, however, our growth in two of our larger markets, computer and communications infrastructure, slowed from previous levels due to softer demand.

  • On a geographic basis, our performance was mixed as we grew 9% in Europe and 13% in Asia but this was partially offset by a 2% decline in our North America businesses.

  • Our operating income was $413 million which was a 7% increase over last year's first quarter.

  • Including in operating income were restructuring charges of $9 million.

  • Excluding these charges, our operating margin was essentially flat compared to last year at 13.2%.

  • Volume leverage and lower price erosion helped us offset $73 million of incremental material costs, primarily copper, as well as an unfavorable sales mix.

  • We also continued to invest additional funds in engineering, resource and development in the quarter of about $10 million.

  • Now, let me provide you with a little more detail on our business segments and the major end markets within those segments.

  • Starting with our largest segment, electronic components, and this is about 70% of our business, our revenue in the quarter was $2.4 billion, an increase of 7%.

  • Sales for the automotive market grew 6% year-over-year driven by strength in Europe and Asia, partially offset by decline in North America.

  • Our sales to the computer market grew 3% which was a significantly lower rate than we had been experiencing.

  • We expect continued softness in this market in the second quarter and we continue to monitor our order rates closely.

  • Similar to the computer market, our sales growth in the communication infrastructure equipment market slowed to 3% in the quarter.

  • We do view this as a temporary issue and expect demand in this market to improve during the second half of the year.

  • In the consumer electronics market our revenue grew 23% reflecting continued demand strength and increased content in products such as digital cameras, video game systems, flat panel TV's and as we've described before, this is a key focus area for us.

  • Let me turn now to our second largest segment, our network solutions segment, which focuses on the communication service provider, power utility, and building network markets.

  • Our revenue in this segment was $421 million, and organic growth slowed to 2% as we had expected.

  • This compares to 16% growth for the full-year 2006 and 12% in 2005.

  • Within the power utility market, sales grew 6% driven by strong growth in Europe, and the communication service provider market, our sales declined 16% in the quarter.

  • This has been a market where we've been growing at a 20% rate over the past two years due to the buildout of fiber optic broadband networks, but we're now seeing a slowdown in this network investment.

  • We expect the slowdown to continue through the second quarter and then improve in the second half of the year.

  • We feel very good about the underlying fundamentals for this market and I think we're really well positioned with our product portfolio.

  • Finally, our sales for the building network market grew 23% in the quarter primarily driven by continued spending by large corporations to protect and increase the bandwidth of their networks as well as higher pricing on copper cabling products.

  • Now let me move to our wireless systems segment, which is a leading provider of wireless technology for the public safety, communications equipment, and aerospace and defense market.

  • In this segment, our revenue was essentially flat in the quarter at $206 million.

  • This was primarily due to delays in certain public safety projects as well as a shift in defense spending away from weapons programs where we have significant content.

  • Finally, in our other segment, which includes our power systems and undersea cable business, sales grew 7% organically to $202 million in the quarter.

  • Growth of 18% in our undersea cable business was partially offset by flat revenue in our power systems business, which is also being affected by the slowdown in the telecom infrastructure space.

  • And as we noted in our SEC Form 10 filing, we are performing strategic evaluation of the power systems business.

  • Streamlining our portfolio is an important part of our strategy going forward and you should expect to hear a lot more from us on this after the separation.

  • Let me now turn to our outlook for the second quarter and the balance of the year.

  • We ended the quarter with a book-to-bill ratio of 1.11 which included a large project order in undersea telecom business of about $400 million.

  • Without this order, our book-to-bill ratio in our core businesses was .99 for the quarter and our orders grew 4% over last year.

  • In our largest market, automotive, our orders have been solid outside of North America, however, as I've mentioned, we have seen a slowdown in the global communications and computer markets.

  • In addition, we have seen a slowdown of many of our markets in North America.

  • So based on this first quarter order rate, we expect organic revenue growth of 4 to 5% over last year in the second quarter plus 2 to 3 points of currency.

  • With revenue growth at this level we expect an operating margin in the range of 13.5 to 14% excluding restructuring charges.

  • This would be a slight increase sequentially but a decline year-over-year.

  • This margin decline year-over-year is due to three primary items.

  • First, our year-over-year sales mix will be unfavorable continuing a trend we saw late in the first quarter.

  • The markets where we are seeing most softness in order rates are some of our larger and higher margin businesses.

  • Conversely, one of our lower margin businesses, undersea telecom, will add a full point to our top line growth in the second quarter.

  • We estimate the net result of this lower margin sales mix will hurt our margin by roughly a half a point.

  • Second, as we ramp down our production to adjust to the lower demand in many of our markets, our productivity will be adversely impacted.

  • To give you an example, in our electronics components business in North America, we estimate our production will be down more than 10% compared to last year's second quarter and while we are taking cost out, we can't really catch up with this production decline in the quarter.

  • We estimate this issue will hurt our second quarter margin by 50 to 60 basis points.

  • Finally, over the past eight quarters we have been gradually increasing our investment in engineering to support various growth initiatives including expansion in emerging markets.

  • This will cost us about approximately 40 basis points of margin on a year-over-year basis.

  • I really feel right now that with this investment over the last eight quarters, our engineering is about where we need to be running around 5% of sales.

  • So this should not be a significant headwind going forward.

  • So to recap the second quarter, it will be a challenging quarter for us due to the slowdown in the computer and communications markets as well as North America, however, we are expecting to see improvement in the second half as we return to a more normal sales mix and our productivity improves as we bring production in line with sales.

  • In addition, our growth investment is now at the appropriate levels and raw materials at current prices would become a tailwind in the second half of the year for the first time in three years.

  • So just let me close to talk about what our key priorities are in this business and as we have our analyst day and our road show, we'll be sharing a lot more with you in this area, but we have four main themes: Accelerate growth through innovation, continue to accelerate our growth in emerging markets, improve our margins, we know this is where we're going to create the most value, and last but certainly not least, really get this portfolio streamlined.

  • These are all important steps toward building a stronger, more focused company.

  • I think we're starting to get good momentum across all of them.

  • And now, let me turn the call back to Chris.

  • Chris Coughlin - CFO

  • Thanks, Tom, and good morning, everybody.

  • Let me remind you that the operating results I will discuss today for our Fire & Security and Engineering Products business are consistent with the way we have previously presented these two segments in Tyco's 2006 10-K.

  • We will shift to our new segment presentation once the separation is completed.

  • And all the operating profit numbers we present here exclude restructuring charges.

  • So I'll begin with Fire & Security.

  • Organic revenue growth was 4% driven primarily by continued strength in our worldwide fire business and revenue improvement at safety products.

  • Worldwide security grew 3%.

  • All of the businesses, security, fire, and safety products, reported significant margin improvement year-over-year.

  • Overall, our operating margin, excluding restructuring, improved 200 basis points to 10.2% and our operating profit was more than $70 million higher than last year's first quarter.

  • In our worldwide security business, organic revenue growth was 3% and our recurring revenue grew 3% as well.

  • Our North America business continued to grow modestly while sales in Europe were essentially flat and the rest of the world grew nicely.

  • We continued to see signs of improving business fundamentals as our account base and average revenue per user increased and our trailing 12-month attrition rate continued to decline to 13.7%.

  • Our operating margin of 13.5% improved approximately 160 basis points year-over-year primarily as a result of lower cost and productivity improvements in North America.

  • Next, our fire business had organic revenue growth of 8%.

  • Our operating margin of 6.9% was significantly higher year-over-year as a result of operational efficiency improvements.

  • In our safety products business, organic revenue growth was 4% with strong growth in fire suppression and electronic security products.

  • The operating margin was almost 20% in the quarter.

  • During the quarter we incurred $37 million in restructuring, primarily to consolidate and simplify our European operations.

  • Looking ahead to the second quarter, we expect overall revenue growth to be in the 5 to7% range with organic revenue growth of 3 to 4%, and we expect our operating margin, again, prior to restructuring, in the 10 to 10.5% range.

  • Now let me turn to Engineered Products.

  • In total, organic revenue growth was 4% and our operating margin, excluding restructuring again, was 10.8%, however, the performance varied significantly across the different businesses.

  • Flow control and fire and building products had very strong operating results, with double-digit revenue growth and significant operating margin improvement, while electrical and metal products had flat revenue and a $35 million decline in its operating profit due to lower metal spreads as we had expected.

  • The infrastructure service business continued to experience planned year-over-year revenue declines while its operating profit was essentially flat.

  • Let me just take a few minutes to describe the performance of flow control and electrical and metal products in more detail as these businesses make up approximately three quarters of the Engineered Products group and have very different dynamics.

  • Our flow control business, which is the world's leading manufacturer of valves and related products, represents almost half of the segments revenues with more than $3 billion of annual sales.

  • This business continued to perform nicely with organic revenue growth of 12% in the quarter and an increase in backlog of 45% year-over-year and 19% sequentially.

  • The operating margin also improved significantly to 14% which was more than 300 basis points higher than last year as a result of revenue growth and higher utilization rates.

  • We feel very good about this business and believe it has a lot of opportunity to further improve its market position and increase its profitability through productivity improvements.

  • Now let me discuss our electrical and metal products business.

  • This business is a leading supplier of steel pipe and tubing, cable and conduit products, with annual revenue of almost $2 billion.

  • This is an attractive business that is well positioned to capture growth opportunities in the commercial construction related markets in North America.

  • However, it is important to recognize that the revenue and profitability of this business experiences large swings from one quarter to the next, due to its dependency on metal spreads.

  • This quarter, for example, revenue was flat year-over-year and down 16% sequentially while operating profit declined $35 million year-over-year and almost $45 million sequentially.

  • This profit decline represented an 850 basis point drop in margin from last year's first quarter and 740 basis points from the previous quarter.

  • Again, as I indicated, while these margin swings are large, they are not uncommon.

  • Having said that, this business has consistently produced an operating margin between 10 to 20% and generates strong returns on capital and solid cash flow.

  • Finally, let me turn to our second quarter outlook for the Engineered Products group.

  • We expect there will be continued pressure on revenue growth and operating margin in our electrical and metal products business due to the lower metal spreads and we are currently forecasting 30 to $40 million year-over-year profit decline in the second quarter for this business.

  • However, we believe that the continued strength in our flow control and fire and building products businesses will partially offset the negative pressure from metal spreads, therefore, we expect revenue growth in the 6 to 7% range with organic revenue growth of 3 to 4%.

  • We expect the operating margin, again excluding restructuring, to be between 9.5 and 10%.

  • Before I turn it back over to Ed for some closing comments, let me comment on our separation and a few of the items contained in our filings.

  • I'd first like to address corporate costs.

  • Corporate expenses for the three companies post-separation have been a significant area of focus for us over the past year.

  • The planned increase in corporate expenses in Healthcare and Electronics will be significantly offset by a streamlining of the corporate function at the remaining Tyco as it becomes a smaller company.

  • Our estimate is that by the time each company reaches its expected corporate expense run rate, which we will believe will be toward the end of 2007, the net combined cost increase for the three companies in total will be in the 70 to $100 million range.

  • Next, we currently anticipate the initial tax rates for the three companies, excluding any impact of special items, to be in the following ranges at the time of separation: for Tyco, 22 to 25%, for Healthcare, 30 to 32%, and for Electronics, 31 to 34%.

  • As we discussed last quarter when we provided some tax guidance, these tax rates represent approximately a 29% on a blended total Tyco basis.

  • We are confident that the three separate companies will implement tax planning strategies that will drive these tax rates down over time.

  • We would expect to see some benefit from that work as we exit 2008.

  • From a cash perspective, Tyco finished this past quarter with $2.6 billion of cash on hand.

  • We expect our cash at separation to be approximately $2 billion after separation costs and restructuring.

  • As we separate the Companies the cash will be allocated to the three companies subject to certain adjustments with approximately $1 billion remaining at Tyco and approximately $500 million each going to Healthcare and Electronics.

  • With respect to debt, as shown in our filings, Tyco was targeted to have $4 billion of debt at separation, Healthcare and Electronics are targeted to have $3.2 billion and $2.8 billion respectively.

  • Our final plan for managing our existing debt will be communicated to the markets as we get closer to our separation date.

  • Let me also comment on our estimate for separation cost to conclude the transactions.

  • Back in January of 2006 when we announced our planned separation, we estimated that the total cost to execute the transactions would be approximately $1 billion.

  • This was our estimate of the net economic costs for things like tax restructuring, debt refinancing, advisory and transaction fees, and it remains our estimate today.

  • In our separation filings on January 18th, we indicated that the current estimate for the accounting impact of these separation costs was 1.2 to $1.6 billion.

  • Without going into too much detail, the difference between the accounting impact and the estimated economic cost arises as a result of items such as retiring debt securities at market prices which exceed our book value.

  • I want to assure all of you that we are carefully managing these costs and most will be incurred in the weeks just leading up to the separation.

  • Finally, we have asked our shareholders to approve a one-for-four reverse stock split, and this proposal will be voted on by our shareholders at a special general meeting of Tyco's shareholders that will be held immediately following the regular annual meeting on March 8th in Bermuda.

  • As we said in our proxy, we anticipate the Board of Directors will execute the reverse stock split at or near the time of separation.

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

  • Ed Breen - Chairman, CEO

  • Thanks, Chris.

  • Let me conclude with a few comments on our guidance and then we'll open up the lines for your questions.

  • With respect to the second quarter, we'll be providing guidance on organic revenue growth and operating margin overall as there will be many separation related items that will make it very difficult for us to accurately predict certain items below the operating line as we head into the separation, particularly our tax rate.

  • Overall, we feel good about our performance this quarter and our momentum going into the second quarter with the exception of two areas.

  • As Tom mentioned, we are seeing some softening in some of our end markets and electronics, in addition, we believe that metal spreads in our electrical and metal products business will continue to be a drag on our operating profit next quarter.

  • Therefore in total, we expect our revenue growth to be in the 6 to 7.5% range with organic revenue growth in the 3.5 to 4.5% range and we expect the operating margin after corporate expenses and excluding special items to be between 12.5 and 13%.

  • Thanks for joining us on the call and at this point, Operator, we'd be glad to take any questions.

  • Operator

  • Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from the line of Jack Kelly from Goldman Sachs.

  • Please go ahead.

  • Jack Kelly - Analyst

  • Good morning.

  • Ed Breen - Chairman, CEO

  • Good morning, Jack.

  • Jack Kelly - Analyst

  • Rich, just on your comments about the operating margins at Healthcare in the second quarter, going back to the 21to 22% range versus an adjusted 22% plus, if you could just give us the thought process there, why should margins back off?

  • And then secondly, looking out over the next couple quarters, can we move back up to the 24, 25% account level?

  • Rich Meelia - CEO Tyco Healthcare

  • Yes, Jack, we're continuing to make investments in R&D and selling and marketing.

  • They're paying off so we don't want to abate that whole process.

  • I think we've identified before that as you look at us compared to our competitors and our peer group, we needed to make those investments in order to get the more sustainable long-term top line growth so we're pretty committed to that program.

  • We think it's starting to pay off.

  • You saw the strong growth internationally where most of the headcount had been added, and then as we go forward, we see that we'll be in that range and as we add additional expense for a public company, you'll probably see a drag on that.

  • So I think it's between the 20 and the 21 as a standalone company and 21 to 22 as a segment of Tyco.

  • Jack Kelly - Analyst

  • Good.

  • And just on electronics, you mentioned a couple times the slowdown.

  • But I think the conclusion was things pick up in the second half so what's going to turn in the second half to get growth growing faster than 4 or 5%?

  • Tom Lynch - CEO Tyco Electronics

  • Yes, Jack, I think the big thing contributing to the, well there's a couple things contributing to the slowdown.

  • One of them is inventory's built up in a couple of channels, a little bit in distribution and in the [EMF] channel particularly related to the computer business.

  • Also, I think we've seen some disruption as a result of all of the merger activity related to the telecom infrastructure business and that stuff seems to be settling down, the signals we're seeing are a little more positive now and we expect the inventories in the channels to get balanced through the second quarter and early third quarter so that will give us a little lift in volume.

  • Jack Kelly - Analyst

  • Okay.

  • Great.

  • And just finally, Chris, on the electrical area, can you just tell us where the spreads were and shouldn't we be running fairly soon either this quarter or next against some easier comparisons versus a year ago?

  • Chris Coughlin - CFO

  • Yes, I think that the steel spreads of, as we said, have contracted and we believe we see some strengthening in the second half, but we don't anticipate that will again be in the quarter and we've got to work off some of the higher cost inventory that we have right now.

  • So we believe, again, we've got bad comparisons here in the first half and again, we've seen these swings before.

  • If you look at this business over the last three years, we have seen these margins between quarters go from 10% to well over 20% in one, [where] we actually had it up to 30%, so again, we have a bad year-over-year compare here in the first half, we are seeing some positive signs that things should improve.

  • I don't think they're going to improve over second half of last year, however.

  • Jack Kelly - Analyst

  • Okay.

  • So if spreads stay the same, by the June quarter, would we be getting a flat year-over-year comparison?

  • So if spreads for the December quarter persisted through June, would it start turning --

  • Chris Coughlin - CFO

  • I would say modestly down but we expect them to, we're seeing some signs that they'll improve slightly.

  • Jack Kelly - Analyst

  • Okay.

  • Good.

  • Thank you.

  • Operator

  • Your next question comes from the line of Jeffrey Sprague from Citigroup.

  • Please go ahead.

  • Jeffrey Sprague - Analyst

  • Thanks.

  • Good morning.

  • Hopefully it's not too premature but I was hoping Tom and Rich and maybe even you, Ed, could give us a little bit of a preliminary view on forward capital allocation at the companies.

  • Sounds like Tom has got his R&D where it needs to be, maybe Rich is going a little bit higher.

  • And then Ed, as it relates to foreign security in particular, just a question of whether it's growth or some other inquisitive growth, organic growth, kind of what the approach will be as independent companies.

  • Ed Breen - Chairman, CEO

  • No, Jeff, I'll take that.

  • I think you summarized the others pretty well.

  • Tom, the good news is Tom has his R&D where he wants it now, as he mentioned in his prepared comments, so that won't be a headwind going forward but 5% of sales is a very big number for a $13 billion company.

  • So they have, I think their growth initiatives where they need to be and they're maybe a little closer aligned from a capital structure to potentially what we are going to do at Tyco International where Rich, I think, is a little different.

  • Rich is going to be continuing to be focused on incremental spend on growth initiatives, sales, marketing, R&D, some licensing deals and some acquisitions and they feel very good about the opportunities that sit out there.

  • For us at the Tyco International, I mean, one of the things I like about this part of the portfolio is we're going to have very consistent recurring free cash flow, so I feel good that we'll be generating good cash moving forward.

  • The balance sheet is exactly where we want it.

  • It's where we want it for all three companies going out, and we will look at, I think you've watched our track record.

  • We will be, what I'll call, shareholder friendly and we're not planning on sitting on a lot of cash and letting things build up.

  • We'll spend it on growth initiatives.

  • We have things to do there.

  • We will look at some bolt-on acquisitions.

  • You know, we haven't done anything in these businesses in five years now.

  • There's some things we will look at but we still think we'll have nice excess free cash flow and we will not waste it.

  • Jeffrey Sprague - Analyst

  • And just wondering if you could elaborate a little bit more about growth.

  • Under kind of prior management, acquiring security accounts proved problematic and it looks like the attempts you guys have made to kind of upgrade the salesforce and do it organically has gotten some traction but probably fair to say has been modestly disappointing.

  • Is there a way to kind of strategically reorient the business maybe away from resi towards commercial or some other angle to try to organically get the growth rate going a little bit better?

  • Ed Breen - Chairman, CEO

  • Jeff, I think some of the growth is still disguised with a couple of the negatives which had been the disconnect rate of the Company.

  • Look, I'm the first to say the take up on growth has been slower but if you're looking at it consistently now every quarter, it's happening and what I call the recurring revenue juggernaut is starting to grow.

  • Remember, that did not grow for 3 to 3.5 years as we were losing accounts on a net basis.

  • We are now, for the last couple quarters, we're adding accounts globally, by the way.

  • That's not just the North America comment.

  • When you roll it up globally, we're starting to add accounts so if you look at our performance, our recurring revenue grew about 3% in the quarter.

  • That was negative.

  • That was zero last year, now we're starting to creep it up, so we think we can continue to keep that moving up.

  • Again, disconnect keeps coming down.

  • New sales adds continue to occur and that number continues to grow.

  • So I think it's going to be slow and steady but I think you've been seeing it now for about six quarters in a row.

  • You saw it again this quarter and I think that will continue.

  • The residential business is a very attractive return on invested capital business.

  • It is a very nice business, so it's a business we want to grow faster than 3, 4%, so we don't want to discount that at the expense of the commercial.

  • But commercial's a nice business, too, but the recurring's one of our best return businesses that we have.

  • Jeff, the biggest piece to watch I think on the security side that what I would call it, that's still our drag on our performance, is the European, continental European operation.

  • It's a couple years behind what I'd call the North America turnaround.

  • We've put the right management team in place.

  • If you notice most of our restructuring dollars on the program we started are focused on streamlining the operations in Europe and that's going to be a big help to us as we get through that in '07 but the same fundamental drivers are in place.

  • Our own salesforce now, we're going after the right accounts with the right metrics and that one will turn.

  • We're tracking those metrics in detail.

  • You can see it starting to happen.

  • Again, it will be slow and steady but as that one picks up, that will help the overall results out.

  • Jeffrey Sprague - Analyst

  • Maybe just as a final really to elaborate that last point, can you, it does seem like the biggest part of the take is through the pipeline as it relates to the aggressive deal or purchases in '01 and '02 but it sounds like the Europe is really the drag.

  • I'm wondering if just looking at the core North American disconnect rates can give us some color on maybe where the total company's going, if you could give us a little color there maybe?

  • Ed Breen - Chairman, CEO

  • Yes, Jeff, let me just add one other comment on that.

  • With Europe being the drag, it really is a continental Europe comment.

  • Our U.K. business is not quite where we want it but it's a very nice, steady, profitable business and improving.

  • Our South Africa business is in good shape.

  • Our Asia businesses are in good shape, so it really is globally the security businesses feeling good, ex the performance still of where we are on the European side of it.

  • You know, as we mentioned on the disconnect rate, we were down I think last quarter, we were at 13.8, we dropped globally down to a 13.7 this quarter and Ed Arditte, you could maybe just read out the North American number which is lower.

  • Ed Arditte - SVP Strategy and IR

  • Yes, Jeff, we were at, in North America 12.9 at the end of the quarter.

  • That's actually a U.S. number, not North America, 12.9.

  • That compares to 13.7 overall in terms of the Company's global attrition rate, and that 12.9 compares to, that's about 50 basis points better than we were a year ago, so we're seeing progress in North America but we're also seeing progress in the rest of the world as well.

  • Ed Breen - Chairman, CEO

  • Yes, and Jeff, just to highlight also, some of our European contracts were longer than these three-year dealer ones.

  • They were four to five years so the fall off effect of that disconnect rate coming down it's happening now versus a year ago, year and a half ago when we started to see it in the North America business.

  • Let me just also point out, because we keep talking about the kind of the metrics turning here.

  • Our ARPU went up again this quarter in the business, it's at the highest level that it's been at during this whole period, too, so, again, that's the new salesforce selling a better package of services and we're starting to get some traction there also.

  • Jeffrey Sprague - Analyst

  • Can you tell us how much ARPU was up and I'll stop there.

  • Thanks.

  • Ed Breen - Chairman, CEO

  • ARPU was up about $0.40 on a combined basis.

  • With commercial and resi it was about 44, $44.50 per account.

  • And we could break that Jeff out for you in more detail if you want later, residential versus commercial.

  • Ed Arditte - SVP Strategy and IR

  • It's kind of a 3 to 4% annual growth in ARPU that we've been seeing the last handful of quarters.

  • Ed Breen - Chairman, CEO

  • Operator, next question?

  • Operator

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

  • Please go ahead.

  • John Inch - Analyst

  • Yes.

  • Thank you.

  • Good morning.

  • Ed Breen - Chairman, CEO

  • Good morning, John.

  • John Inch - Analyst

  • Just a couple questions on taxes to start.

  • Now correct me if I'm wrong.

  • I thought we thought taxes were going to be north of 26, 27 in the quarter.

  • Why were they 25, and what do you think taxes do for the second quarter just based on your outlook?

  • Chris Coughlin - CFO

  • Yes, John, what we had indicated last quarter was that we expected our normalized tax rate for [all] cost standalone Tyco to be in a 26 to 27% range for the full-year.

  • The 25% reflects that annual rate, however, there were a couple of timing items that just happened to hit within the first quarter but we would still expect the annualized, what I'll call standalone rate, of Tyco to be in that 26, 27%.

  • Difficulty here is that we're not going to be in that standalone condition and that's why we've provided you the guidance that we have is that we expect sort of a 200 basis point impact in total as we go through the separation.

  • There are some activities that we would normally undertake right now as it relates to tax and the managing that tax rate, that because of the separation we're not able to do, so again, we're going to be driving, that tax rate will be going up and I think the things to focus on are what are those tax rates as we come out of separation.

  • John Inch - Analyst

  • No, I agree with that but just so I understand, you're saying 26 to 27 is inclusive of the expected step up post- separation?

  • Chris Coughlin - CFO

  • No, it's not.

  • John Inch - Analyst

  • It's not.

  • Okay.

  • Chris Coughlin - CFO

  • Okay.

  • So that would be just a standalone Tyco rate this year compared to, say, the 25% that we had a year ago, we saw that going up and we signaled that on a standalone basis for the full-year we would have been 26 to 27.

  • Because of the separation happening when it is, that rate will go up by approximately 200 basis, let's say, 29% as I indicated in my prepared remarks, and there are differences within each of those business units.

  • John Inch - Analyst

  • Yes, no, I understand.

  • Okay.

  • So if I look at the three companies, could you provide, Chris, maybe a little color in terms of why the differential between sort of pro forma tax rates?

  • I mean, why for instance, is Tyco International so much lower versus the other companies?

  • And then how does that dove tail with, I think Ed Breen your sort of assertion that you hope following separation to, or you intend to sort of tax manage the rate materially lower, would that apply kind of comparably to Tyco International given the fact that it's already off a much lower base than the others?

  • Chris Coughlin - CFO

  • Well, yes, let me comment first on the last piece.

  • I do think there will be more opportunity initially obviously in Electronics and in Healthcare in driving the rate down, but again, the tax planning that have been done obviously for and the way the Company was managed was on a combined company basis.

  • So there are things such as how we finance our international subsidiaries and the interest and interest income and how that's allocated as we pull apart those businesses, as well as there are items as where our manufacturing is done and the tax impacts of that where trademarks are held.

  • So there are innumerable number of items that impact these, but I do believe, again, that all three will have opportunities to reduce the tax rates going forward as they will be able to initiate strategies that are designed specifically for those businesses.

  • So while it looks like we're coming out at a much higher rate than we've seen historically, I think over time we can get that back down and in fact, we will, our structure will still be an advantage for us.

  • On a cash basis, I'll comment that we had about $900 million in cash taxes last year.

  • We expect that to go up a little bit this year.

  • I would say now our planned increases are probably in the 250 to $300 million range.

  • John Inch - Analyst

  • Okay.

  • That's fine.

  • I appreciate that.

  • Still, it's just a little bit surprising that the stub company tax rates are that much lower versus the others.

  • Just a quick follow-up.

  • I want to talk about goodwill.

  • You've taken some goodwill impairments with the filings and, you know, the old management always emphatically denied impairments were likely.

  • I'm just wondering how should we think about kind of how we're going to see goodwill given that you've taken impairments, I think you've talked about [lucent] power's maybe 450 of additional impairments.

  • Does this have any kind of bearing in terms of your capacity to refinance your debt or how you're thinking about sort of the businesses or kind of what your suppliers or creditors have said?

  • Maybe just a little bit of commentary there.

  • Chris Coughlin - CFO

  • Yes, it's a good question.

  • Obviously we still have a very significant amount of goodwill as well as other intangibles, actually about $30 billion in total, and you know, they are complicated accounting rules that apply as we are separating the Company and changing the segments.

  • And so what happens is that under the accounting rules, your goodwill gets allocated actually to businesses that had nothing to do with that creation of goodwill, so we have gone through in conjunction with the separation some significant analysis related to it and any impacts that we see in the foreseeable future around goodwill have been reflected in the filings.

  • I will say it has absolutely no impact on our ability to refinance.

  • There's no questions or concerns of any significance that I've heard from any of the rating agencies or our banks, so again, the cash flow for all three businesses remain strong and I don't see any economic impact of this goodwill going forward.

  • John Inch - Analyst

  • Thank you.

  • Chris Coughlin - CFO

  • Thanks, John.

  • Operator

  • Your next question comes from the line of Glenn Reicin from Morgan Stanley.

  • Please go ahead.

  • Glenn Reicin - Analyst

  • Good morning.

  • Thanks for taking my call.

  • Ed Breen - Chairman, CEO

  • Yes.

  • Glenn Reicin - Analyst

  • Question's really on Healthcare.

  • It's somewhat of a philosophical question.

  • When you ask Ed Meelia about spending and the question is allocation of capital, when you ask Ed about whether he can spend more money in a productive way, either on SG&A or R&D, the answer is absolutely yes.

  • When I look at your results, it looks like you're walking this tightrope between managing the P&L for the near-term and continuing to invest in both SG&A and R&D at the same time.

  • Why wouldn't you just up the investment dramatically this year and benefit from that leverage in the outer years instead of trying to walk that tightrope?

  • Rich Meelia - CEO Tyco Healthcare

  • Yes, Glenn, it's Rich.

  • We began this investment process about three years ago.

  • We started putting more into R&D and we started adding, we've added about 1,400 salespeople in the last three years and one thing that we've found is that you can, you need to manage these investments at a certain pace, otherwise it gets out of control.

  • And we recognize that we've got additional opportunity in both selling, marketing and R&D in order to be capable of competing with our peer group and in order to generate that higher sales growth that we think these franchises can generate.

  • We added, we'll be adding over 200 salespeople this year, mostly in the U.S.

  • We will add another $40 million in R&D this year.

  • That's about a 15% increase.

  • We've built out these global marketing and strategic and business development functions so that we have visibility to more opportunity.

  • So we've put a lot of investments for growth in place and there's been a clear directive to all of our global business unit Presidents if they have any opportunities for growth that need to be funded that are beyond our current funding plans, bring them to our attention and we've been covering this with, we've had support from Ed and Chris here at Tyco and we've been covering this with our new board, too.

  • So we'd like to go faster and maybe we can go a little faster but we have learned that there's just a certain pacing issue here that just needs to be, you need to pay attention to it, but I understand your point.

  • Glenn Reicin - Analyst

  • So I just want to clarify, are you basically saying that you can't spend any faster and that's the reason these investments are not occurring this year?

  • Rich Meelia - CEO Tyco Healthcare

  • We're spending pretty quickly, pretty aggressively and is there a margin up or down, yes probably, but I don't think a significant difference would exist.

  • Glenn Reicin - Analyst

  • Okay.

  • And then as we go into the remainder of the year, would you expect R&D as a percentage of sales to increase dramatically?

  • Rich Meelia - CEO Tyco Healthcare

  • Yes, well, dramatically, I mean the forecast has it going on up 15%, so our goal is to get with our current mix of products, about 2 to 3 years from now, this portfolio of products may look differently but as it's been constructed today, we need to be between 4, 4.5, 5% in total, and so R&D will continue to go up over the next several years.

  • Glenn Reicin - Analyst

  • Okay.

  • And the R&D as a percentage of sales today what is that number?

  • Rich Meelia - CEO Tyco Healthcare

  • 2.7 I believe.

  • You know, and that's because you got retail and supplies which can consume very, very little, less than a percent and then in the medical devices, pharma imaging, we need to be up around the 6%, 5, 6% target, and which is where we've been with the energy-based devices and you're seeing some very nice sales growth and profit improvement in that area.

  • Glenn Reicin - Analyst

  • Okay.

  • So have you come to a conclusion about what the story is for margins over the next three years or are you still working through that?

  • Rich Meelia - CEO Tyco Healthcare

  • We're working through that.

  • We're hoping to have an opportunity for an Investor Day before the separation and that's where we'd like to layout our vision.

  • Glenn Reicin - Analyst

  • Fair enough.

  • Thank you.

  • Rich Meelia - CEO Tyco Healthcare

  • Okay.

  • Thank you.

  • Ed Arditte - SVP Strategy and IR

  • Next question?

  • Operator

  • Your next question comes from the line of David Bleustein from UBS.

  • Please go ahead.

  • David Bleustein - Analyst

  • Good morning.

  • Just a couple clean ups.

  • Tom, the first one for you.

  • How much copper do you buy in a normal year?

  • Tom Lynch - CEO Tyco Electronics

  • About 200 million pounds.

  • David Bleustein - Analyst

  • Okay.

  • And what is your average cost by quarter from last year?

  • Tom Lynch - CEO Tyco Electronics

  • By quarter from last year it was $2.03 in Q1, $2.25 in Q2, $3.38 in Q3, and $3.54 in Q4, on average of about $2.80 for the year.

  • David Bleustein - Analyst

  • Okay.

  • And the current quarter?

  • Tom Lynch - CEO Tyco Electronics

  • The current quarter ran about $3.20.

  • David Bleustein - Analyst

  • $3.20 Okay.

  • And are there any significant hedges we should know about?

  • Tom Lynch - CEO Tyco Electronics

  • We have hedged about 20% of the out quarter, so it's not that significant in the grand scheme of things but we're doing a little more of that as we said earlier as we become our own company, the risk profile of our company is different and obviously associated with copper is bigger than it is in the international conglomerates, so we have done a little bit of that.

  • David Bleustein - Analyst

  • Okay.

  • Terrific.

  • Thanks.

  • Ed, where do you feel you are with your current manufacturing footprint at flow control and is the strength of demand delaying a restructuring program there?

  • Ed Breen - Chairman, CEO

  • Yes, the restructuring that we announced last quarter and we just talked about part of that as being spent in the flow control business and it's right on the manufacturing footprint that you talk to.

  • We have a long ways to go there, and I would say yes, we are a little slowed down because how hot this market is.

  • I mean you see our backlog is up almost 50% over levels of last year and our sales growth rates are really ticking along so it's slowing us a little but we know the plan for '07, we know the dollars we're spending against it and we'll get a chunk of that taken care of.

  • But by the way, if you look at the working capital performance in that business, we've made great improvements in it, but when you look at it, the biggest, one of the biggest opportunities, if I look across all of Tyco, is the inventory levels still in flow control.

  • They've brought them down about 17 days in the last two years but they're still, if you looked at it on an absolute basis, they're at unacceptable levels from where you'd want to run it when you were streamline and that's part of having too many factories and distribution centers.

  • So we will continue just chipping away at the footprint over the next three to five years, but a very detailed plan laid out for '07 in the restructuring spend.

  • David Bleustein - Analyst

  • Understood.

  • And then Chris, I know these rules are tricky too, but can you try to walk through the practical limitations on divestitures or other types of M&A transactions over the next two years?

  • Chris Coughlin - CFO

  • Yes, there has been, I think, a little bit of confusion around that.

  • Let me summarize it this way.

  • On a practical level, there's virtually no restrictions, so that businesses, and we talked about that the three companies will all go through portfolio changes as they go off on their own and separate, and so as we've designed and laid out our legal structure, we've made sure that we have done so that there's no restriction on the Company in terms of divesting any of its non-core, non-strategic businesses.

  • Similarly with things like share repurchases, normal share repurchases, share repurchases, even to the extent that Tyco has done them, which have not been insignificant as we know over the last couple years, each of the companies would be free to do those type of share repurchases.

  • If, for example, somebody, if we wanted to do a share repurchase of 50% or more in a very short period of time, that may cause some additional work to be done to make sure that that could be structured appropriately.

  • Similarly, with acquisitions and particularly acquisitions for cash, there are no restrictions and particularly the type of acquisitions that we have talked about for each of the three companies.

  • So I would say on a practical level, you'll see no difference in what each of these companies is able to do post-separation to what they would be able to do within Tyco.

  • David Bleustein - Analyst

  • Perfect.

  • Thanks a bunch.

  • Ed Arditte - SVP Strategy and IR

  • Operator, time for two more questions.

  • Operator

  • Okay.

  • Your next question comes from the line of Shannon O'Callaghan from Lehman Brothers.

  • Please go ahead.

  • Shannon O'Callaghan - Analyst

  • Good morning, guys.

  • Ed Breen - Chairman, CEO

  • Good morning, Shannon.

  • Shannon O'Callaghan - Analyst

  • Just a little bit more on Healthcare.

  • Nice to see some recovery in some of the trouble areas there.

  • I mean how about the margins by some of the sub pieces?

  • I mean, imaging came down from, I think, 24 to 14, with the recalls.

  • Are you seeing improvement in margins there yet and can you just give us a little feel for that, aside from these investments you're making, are you starting to see some improvement from the hit you took last year?

  • Rich Meelia - CEO Tyco Healthcare

  • Yes, Shannon, we are.

  • We had actually improvement in this quarter on the imaging business, both gross margins and operating margins were up.

  • There's a huge focus throughout the Company on gross margin improvement and throughout the Company and as a whole, we increased 30 basis points in the first quarter alone, so it's a huge focus for the organization.

  • We lost some gross margin last year and we're committed to finding ways to recapture that margin, and we're starting to see it in the imaging as well.

  • Shannon O'Callaghan - Analyst

  • And I guess you probably see some in respiratory as you get out of detention there too?

  • Rich Meelia - CEO Tyco Healthcare

  • That will help.

  • That was about a $15 million sales problem, but I think most important there, that was the last remaining kind of quality issue that we had with the FDA and so they're pretty much completely behind us.

  • Shannon O'Callaghan - Analyst

  • Okay.

  • And then Ed, just on security, I mean, the 3% of recurring revenue is starting to tick up here, I mean from 0 to 2 now we're at 3.

  • Some of the improvement under the surface there is starting to show through.

  • In terms of, you know, you made a comment of wanting to grow residential more than 3 to 4.

  • What are you really thinking about for all of security in terms of growth?

  • And then just second one on security is just where is sort of the Europe operating margin in the quarter and where do you think they can go over what time period?

  • Ed Breen - Chairman, CEO

  • I mean, look, I think overall, if you look at our foreign security business, and this is an over time comment.

  • I'm not talking one quarter we get there.

  • This business should grow organically kind of in the 5 to 6% range, and we should be able to get the recurring revenue piece, or the residential piece, up in that range, and by the way, there's a competitor or two that you can track that are up actually maybe a little higher than that range depending on the business model they're pursuing, so we think we can continue to creep this up and get a consistent kind of 5 to 6% going in the business.

  • And to a question earlier, we now have a nice mix of dealer business.

  • It's never going to be the predominant part of it, but if we can get good business through a dealer, it's very attractive, the returns are good on it so we would continue to creep that up if we get the right metrics associated with it while our own salesforce continues to gain traction, but eventually getting this thing kind of running north of 5% for us.

  • Chris Coughlin - CFO

  • Shannon, just to respond on Europe on our security business there, that's been sort of a mid single-digit kind of an operating margin, so again, our restructuring program focused on that.

  • We've also put in some new marketing programs in trying to increase the recurring revenue piece because that's obviously the higher margin piece of that business and piece of our U.S. business.

  • It's not as extensive in Europe, so we see some ability to certainly get that up in the double-digit range over time.

  • Ed Breen - Chairman, CEO

  • Yes, and to Chris's point that getting that to double-digit would be nowhere near the North America performance but that would be significant improvement from where we are.

  • So we're not counting on it matching our performance elsewhere.

  • We're kind of mid single digits to double-digit.

  • So, I mean, is that, I mean North America, I think's what, 16 to 17%.

  • Shannon O'Callaghan - Analyst

  • I mean is there a structural impossibility of ever getting Europe there or is that just sort of your initial target and you'll move on from there?

  • Is there anything structurally why it always will be less than North America?

  • Ed Breen - Chairman, CEO

  • Not structurally, but for the next few years as we work up, we obviously wouldn't get to those levels but it's a mix issue.

  • The mix between residential, commercial is somewhat different than the U.S.

  • That doesn't mean it has to be that way forever and we can work on that, but that would be a multi-year period.

  • Shannon O'Callaghan - Analyst

  • Right.

  • Ed Breen - Chairman, CEO

  • So that would be the only other driver there, but look, you're right.

  • Our margins, look at North America.

  • They're nicely up there in the teens and not to down put the EBITDA margins are over 30%, so it can be a very attractive business and we'll get the European one right.

  • We know how to do it.

  • We know the blocks that get us there.

  • We're just, you know, it's behind the process here for the reasons we talked about.

  • Shannon O'Callaghan - Analyst

  • Okay.

  • Thanks a lot, guys.

  • Ed Arditte - SVP Strategy and IR

  • Okay.

  • Operator, last question?

  • Operator

  • Your last question comes from the line of Nicole Parent from Credit Suisse.

  • Please go ahead.

  • Nicole Parent - Analyst

  • Good morning, guys.

  • Thanks for taking my question.

  • I guess first just big picture for Rich.

  • What do you think the impact of HGA and Triad going private will be on kind of contract by buying groups over the long-term and do you see these getting even more competitive over time?

  • Rich Meelia - CEO Tyco Healthcare

  • Are you talking about Consorta and Health Trust?

  • Nicole Parent - Analyst

  • Yes.

  • Rich Meelia - CEO Tyco Healthcare

  • That creates challenges for all of the suppliers, Nicole, because then there's, they look at the multiple agreements and there's going to be winners and losers, so those kinds of things are just issues for all the manufacturers to deal with and it's hard to predict which way they'll fall.

  • It depends upon who's in what position within the portfolio and what the pricing is and what the compliance are and the different contracts, so it raises a lot of questions in that area.

  • Nicole Parent - Analyst

  • And I guess just one last one for Chris.

  • What is your view on the likelihood that the House and the Senate widen the scope of the language in the minimum wage bill related to corporate inversions to include all companies in favorable offshore tax jurisdictions?

  • Chris Coughlin - CFO

  • Yes, I know that there have been some recent talk about inversions.

  • Again, I would say that we are different from many of the other companies that have been targeted in this in that we did not invert, that we are, had the ADT business that had been headquartered in Bermuda, so we keep talking to our people in Washington and keep close to this issue, but I think we're confident in our position.

  • Nicole Parent - Analyst

  • Okay.

  • Great.

  • Thank you.

  • Chris Coughlin - CFO

  • Thank you, Nicole.

  • Ed Arditte - SVP Strategy and IR

  • Okay.

  • Thanks, everybody for joining us.

  • I would suggest that over the next 30 to 60 to 90 days there will be a fair amount of activity here relative to the separation.

  • Stay tuned from time to time, there will be public notification of things like investor meeting and road show and so on, so we'll be in touch with everybody that has any follow-up questions, obviously over the telephone, and look forward to seeing all of you when we do ultimately hold our Investor Day and road show meetings.

  • Again, thanks for joining us on today's call.

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