TYCO INTERNATIONAL LTD /BER/ - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2004
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

001-13836
(Commission File Number)

TYCO INTERNATIONAL LTD.
(Exact name of Registrant as specified in its charter)

Bermuda (Jurisdiction of Incorporation)		98-0390500 (I.R.S. Employer Identification Number)
Second Floor, 90 Pitts Bay Road, Pembroke, HM 08, Bermuda (Address of Registrant's principal executive office)
441-292-8674 (Registrant's telephone number)

Indicate by check mark whether the Registrant (1) has filed all reports to be filed by Section 13 or 15 (d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý No o

The number of common shares outstanding as of July 30, 2004 was 2,008,791,292.

TYCO INTERNATIONAL LTD.
INDEX TO FORM 10-Q

		Page
Part I Financial Information:
Item 1	Financial Statements
	Consolidated Statements of Operations (Unaudited) for the quarters and nine months ended June 30, 2004 and 2003	1
	Consolidated Balance Sheets (Unaudited) as of June 30, 2004 and September 30, 2003	2
	Consolidated Statements of Cash Flows (Unaudited) for the nine months ended June 30, 2004 and 2003	3
	Notes to Consolidated Financial Statements (Unaudited)	4
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3	Quantitative and Qualitative Disclosures About Market Risk	62
Item 4	Controls and Procedures	62
Part II Other Information
Item 1	Legal Proceedings	65
Item 2	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	68
Item 6	Exhibits and Reports on Form 8-K	68
Signatures		69

PART I FINANCIAL INFORMATION

Item 1—Financial Statements

TYCO INTERNATIONAL LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in millions, except per share data)

		For the Quarters Ended June 30,						For the Nine Months Ended June 30,
		2004			2003			2004			2003
Revenue from product sales		$	8,368.8		$	7,505.6		$	24,130.6		$	21,871.7
Service revenue			2,082.2			1,907.0			6,241.3			5,456.8

Net revenue			10,451.0			9,412.6			30,371.9			27,328.5
Cost of product sales			5,397.2			5,015.5			15,870.1			14,699.5
Cost of services			1,250.4			998.2			3,684.9			2,901.7
Selling, general and administrative expenses			2,221.9			2,200.1			6,580.6			6,819.0
Restructuring, impairment and other charges (credits), net			55.6			(9.4	)		135.8			14.7
(Gains) losses and impairments on divestitures, net			(2.8	)		—			82.6			—

Operating income			1,528.7			1,208.2			4,017.9			2,893.6
Interest income			15.7			39.7			55.6			87.3
Interest expense			(223.8	)		(287.6	)		(715.1	)		(876.4	)
Other expense, net			(36.6	)		(151.8	)		(38.4	)		(211.8	)

Income from continuing operations before income taxes and minority interest			1,284.0			808.5			3,320.0			1,892.7
Income taxes			(358.5	)		(241.1	)		(884.6	)		(633.4	)
Minority interest			(2.9	)		(0.9	)		(11.2	)		(2.6	)

Income from continuing operations			922.6			566.5			2,424.2			1,256.7
Income from discontinued operations of Tyco Capital, net of $0 tax			—			—			—			20.0

Net income		$	922.6		$	566.5		$	2,424.2		$	1,276.7

Basic earnings per common share:
	Income from continuing operations	$	0.46		$	0.28		$	1.21		$	0.63
	Income from discontinued operations of Tyco Capital, net of tax		—			—			—			0.01
	Net income per common share		0.46			0.28			1.21			0.64
Diluted earnings per common share:
	Income from continuing operations	$	0.43		$	0.27		$	1.13		$	0.61
	Income from discontinued operations of Tyco Capital, net of tax		—			—			—			0.01
	Net income per common share		0.43			0.27			1.13			0.62
Weighted-average number of common shares outstanding:
	Basic		2,002.0			1,995.0			1,999.3			1,994.7
	Diluted		2,221.9			2,203.8			2,216.2			2,126.2

See Notes to Consolidated Financial Statements (Unaudited).

TYCO INTERNATIONAL LTD.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in millions, except share data)

			June 30, 2004		September 30, 2003
Assets
Current Assets:
	Cash and cash equivalents		$	4,025.3	$	4,186.7
	Restricted cash			53.3		141.8
	Accounts receivable, less allowance for doubtful accounts ($595.3 at June 30, 2004 and $726.2 at September 30, 2003)			6,400.0		5,714.8
	Inventories			4,531.0		4,292.2
	Deferred income taxes			803.0		855.2
	Other current assets			1,658.6		2,048.8

		Total current assets		17,471.2		17,239.5
Property, Plant and Equipment, Net				9,786.2		10,299.8
Goodwill				26,149.5		25,938.7
Intangible Assets, Net				5,419.2		5,790.0
Other Assets				4,129.0		4,277.0

		Total Assets	$	62,955.1	$	63,545.0

Liabilities and Shareholders' Equity
Current Liabilities:
	Loans payable and current maturities of long-term debt		$	2,014.1	$	2,718.4
	Accounts payable			2,741.8		2,716.7
	Accrued expenses and other current liabilities			4,339.6		4,326.7
	Deferred revenue			785.1		810.5

		Total current liabilities		9,880.6		10,572.3
Long-Term Debt				15,070.6		18,250.7
Other Liabilities				8,336.2		8,239.7

		Total Liabilities		33,287.4		37,062.7

Commitments and Contingencies (Note 11)
Minority Interest				67.8		113.3
Shareholders' Equity:
	Preference shares, $1 par value, 125,000,000 shares authorized, none outstanding at June 30, 2004 and one share outstanding at September 30, 2003			—		—
	Common shares, $0.20 par value, 4,000,000,000 shares authorized; 2,008,148,737 and 1,998,189,621 shares outstanding, net of 14,412,249 and 21,144,265 shares owned by subsidiaries at June 30, 2004 and September 30, 2003, respectively			401.6		399.6
Capital excess:
	Share premium			8,284.5		8,161.4
	Contributed surplus, net of deferred compensation of $120.7 at June 30, 2004 and $45.5 at September 30, 2003			15,313.5		15,120.1
Accumulated earnings				5,310.3		2,961.2
Accumulated other comprehensive income (loss)				290.0		(273.3	)

		Total Shareholders' Equity		29,599.9		26,369.0

		Total Liabilities and Shareholders' Equity	$	62,955.1	$	63,545.0

See Notes to Consolidated Financial Statements (Unaudited).

TYCO INTERNATIONAL LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in millions)

					For the Nine Months Ended June 30,
					2004			2003
Cash Flows From Operating Activities:
Income from continuing operations					$	2,424.2		$	1,256.7
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
	Non-cash restructuring, impairment and other charges, net					20.8			39.5
	Non-cash losses (gains) and impairments on divestitures, net					78.3			(0.6	)
	(Gain) loss on investments					(4.2	)		75.6
	Depreciation					1,118.1			1,084.5
	Intangible assets amortization					537.6			548.2
	Deferred income taxes					222.5			386.0
	Provision for losses on accounts receivable and inventory					247.5			399.1
	Debt and refinancing cost amortization					44.7			90.4
	Loss on the retirement of debt					—			151.8
	Loss (gain) on the early extinguishment of debt					42.8			(24.1	)
	Other non-cash items					63.6			64.6
		Changes in assets and liabilities, net of the effects of acquisitions and divestitures:
			Accounts receivable			(181.4	)		184.6
			Decrease in sale of accounts receivable programs			(533.1	)		(55.9	)
			Contracts in progress			14.2			(103.7	)
			Inventories			(254.5	)		197.9
			Other current assets			(5.5	)		(113.5	)
			Accounts payable			(43.6	)		(554.5	)
			Accrued expenses and other current liabilities			14.2			(248.1	)
			Income taxes			172.3			113.1
			Deferred revenue			(82.0	)		13.0
			Other			36.5			65.2

				Net cash provided by operating activities from continuing operations		3,933.0			3,569.8
				Net cash provided by operating activities from discontinued operations		—			20.0

				Net cash provided by operating activities		3,933.0			3,589.8

Cash Flows From Investing Activities:
Purchase of property, plant and equipment, net						(673.9	)		(904.1	)
Construction of Tyco Global Network						—			(118.4	)
Acquisition of businesses, net of cash acquired						(13.9	)		(34.6	)
Acquisition of customer accounts (ADT dealer program)						(187.1	)		(506.2	)
Cash paid for purchase accounting and holdback/earn-out liabilities						(83.0	)		(227.3	)
Disposal of businesses, net of cash retained by businesses sold						144.7			8.0
Decrease (increase) in short-term investments						411.3			(351.4	)
Increase in long-term investments						(18.5	)		(12.2	)
Decrease (increase) in current and non-current restricted cash						302.9			(202.6	)
Other						(11.9	)		72.3

				Net cash used in investing activities		(129.4	)		(2,276.5	)

Cash Flows From Financing Activities:
Net repayments of debt						(4,020.0	)		(3,608.1	)
Proceeds from exercise of share options						124.2			7.8
Dividends paid						(75.1	)		(75.6	)
Other						(20.7	)		(7.7	)

				Net cash used in financing activities		(3,991.6	)		(3,683.6	)

Effect of foreign currency translation on cash						26.6			111.3
Net decrease in cash and cash equivalents						(161.4	)		(2,259.0	)
Cash and cash equivalents at beginning of period						4,186.7			6,185.7

Cash and cash equivalents at end of period					$	4,025.3		$	3,926.7

See Notes to Consolidated Financial Statements (Unaudited).

1. Basis of Presentation

Basis of Presentation—The unaudited Consolidated Financial Statements include the consolidated accounts of Tyco International Ltd., a company incorporated in Bermuda, and its subsidiaries (Tyco and all its subsidiaries, hereinafter "we," the "Company" or "Tyco").

The financial statements have been prepared in accordance with the instructions to Quarterly Report on Form 10-Q and do not include all of the information and note disclosures required by Generally Accepted Accounting Principles in the United States. These financial statements should be read in conjunction with the consolidated financial statements contained in the Current Report on Form 8-K filed on March 10, 2004, which present segment information previously included in Tyco International Ltd.'s Annual Report on Form 10-K for the period ended September 30, 2003 to reflect the reclassification of information regarding the transfer of a business division from one segment to another and to present the results of the Tyco Global Network business held for sale within Corporate and Other segment data.

The Consolidated Financial Statements included herein are unaudited, but in the opinion of management, such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary to summarize fairly the Company's financial position and results of operations. Certain prior period amounts have been reclassified to conform with the current period presentation. All references in this Form 10-Q to "$" are to U.S. dollars.

Revenue Recognition—In providing services under certain contracts, Infrastructure Services (a business unit within the Engineered Products and Services segment) incurs sub-contract and other costs that are paid by Infrastructure Services and re-billed to their customers. These costs have historically been treated as "pass through" and were therefore not included in reported revenue nor cost of revenue of Infrastructure Services. Effective January 1, 2004, retroactive to October 1, 2003, the Company began reflecting these sub-contract costs in both net revenue and cost of revenue for Infrastructure Services, resulting in incremental revenue and cost of revenue of $180.6 million and $528.4 million for the quarter and nine months ended June 30, 2004, respectively. The Company has not adjusted net revenue or cost of revenue for the quarter and nine months ended June 30, 2003 because such change was not material. Further, such adjustment would have no impact on previously reported operating income, net income or cash flow.

Employee Share Option Plans—Tyco measures compensation cost in connection with employee share option plans using the intrinsic value based method and accordingly does not recognize compensation expense for the issuance of options with an exercise price equal to or greater than the market price at the time of grant. Had the fair value based method been adopted by Tyco, the effect

on net income and earnings per common share for the quarters and nine months ended June 30, 2004 and 2003 would have been as follows ($ in millions):

		For the Quarters Ended June 30,						For the Nine Months Ended June 30,
		2004			2003			2004			2003
Net income—as reported		$	922.6		$	566.5		$	2,424.2		$	1,276.7
Add: Employee compensation expense for share options included in reported net income, net of tax			3.2			1.1			7.2			3.8
Less: Total employee compensation expense for share options determined under fair value based method, net of tax⁽¹⁾			(66.3	)		(87.6	)		(172.7	)		(228.0	)

Net income—pro forma		$	859.5		$	480.0		$	2,258.7		$	1,052.5

Net income per share:
	Basic—as reported	$	0.46		$	0.28		$	1.21		$	0.64
	Basic—pro forma		0.43			0.24			1.13			0.53
	Diluted—as reported		0.43			0.27			1.13			0.62
	Diluted—pro forma		0.40			0.23			1.07			0.52

⁽¹⁾: The fair value was calculated using the Black-Scholes option pricing model with a volatility of 46%, a risk free rate of 3.3% and an expected option life of 4 years for the quarter ended June 30, 2004; a volatility of 64%, a risk free rate of 2.5% and an expected option life of 5 years for the quarter ended June 30, 2003; a volatility of 47%, a risk free rate of 2.5% and an expected option life of 3.9 years for the nine months ended June 30, 2004; and a volatility of 64%, a risk free rate of 2.8% and an expected option life of 5 years for the nine months ended June 30, 2003. In addition, expected annual dividends per share of $0.05 was utilized for all periods presented.

Accounting Pronouncements—In November 2003, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board ("FASB") reached a consensus on EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," regarding the issue of disclosures for marketable equity securities and debt securities accounted for under Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The EITF also provides guidance for evaluating whether investments are other than temporarily impaired and requires additional quantitative disclosure related to unrealized losses, specifically presentation of the aging of such losses. It also requires additional qualitative disclosures to help users understand why the quantitative disclosures are not other-than-temporarily impaired. The adoption of this EITF is effective for Tyco in the fourth quarter of fiscal 2004.

In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R further explains how to identity variable interest entities ("VIE") and how to determine when a business enterprise should include the assets, liabilities, noncontrolling interest and results of VIE in its financial statements. The Company adopted FIN 46R as of March 31, 2004. As a result, the joint ventures that were previously consolidated under FIN 46 were deconsolidated effective March 31, 2004. The adoption of FIN 46R did not have a material impact on our results of operations or financial position.

In December 2003, the FASB issued a revision to SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," to improve financial statement disclosure for defined benefit plans. This statement requires additional disclosures about the assets (including plan assets by category), obligations and cash flows of defined pension plans and other defined benefit postretirement plans in our annual report. It also requires reporting of various elements of pension and other postretirement benefit costs on a quarterly basis. Generally, the disclosures required are effective for interim periods beginning after December 15, 2003; however, information about foreign plans are effective for fiscal years ending after June 15, 2004. Tyco adopted the revised SFAS No. 132 during the quarter ended March 31, 2004. See Note 12 for disclosure on retirement plans. The adoption of SFAS No. 132 did not impact our results of operations or financial position.

In December 2003, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin ("SAB") No. 104, "Revenue Recognition," which supercedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." The issuance of SAB 104 reflects the concepts contained in EITF 00-21; the other revenue recognition concepts contained in SAB 101 remain largely unchanged. The issuance of SAB 104 did not have a material impact on our results of operations or financial position.

In May 2004, the FASB issued FASB Staff Position ("FSP") No. 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." FSP No. 106-2 provides guidance on the accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") on postretirement health care plans that provide prescription drug benefits. FSP No. 106-2 also requires certain disclosures regarding the effect of the federal subsidy provided by the Act. FSP No. 106-2 is effective for Tyco in the fourth quarter of fiscal 2004. The adoption of this standard is not expected to have a material impact on our results of operations or financial position.

2. Consolidated Segment Data

During the first quarter of fiscal 2004, our Precision Interconnect business was transferred from the Healthcare segment to the Electronics segment. Additionally, during the first quarter, the results of the Tyco Global Network ("TGN") business held for sale were reclassified from the Electronics segment to Corporate and Other. The Company has conformed its segment reporting accordingly and has reclassified comparative prior period information to reflect these changes.

Selected information for the Company's five segments is presented in the following table ($ in millions). Operating income by segment shown below includes net restructuring, impairment and other charges, and net (gains) losses and impairments on divestitures as described in Notes 3 and 4.

		For the Quarters Ended June 30,						For the Nine Months Ended June 30,
		2004			2003			2004			2003
Net Revenue:
	Fire and Security	$	2,980.1		$	2,857.2		$	8,930.0		$	8,386.1
	Electronics		3,057.8			2,704.5			8,742.0			7,805.7
	Healthcare		2,259.6			2,173.3			6,723.9			6,241.3
	Engineered Products and Services⁽¹⁾		1,669.2			1,185.0			4,550.4			3,459.9
	Plastics and Adhesives		478.5			489.4			1,408.3			1,428.5
	Corporate and Other⁽²⁾		5.8			3.2			17.3			7.0

Net revenue from external customers		$	10,451.0		$	9,412.6		$	30,371.9		$	27,328.5

Operating income:
	Fire and Security	$	278.3		$	188.3		$	749.6		$	227.1
	Electronics		463.6			407.3			1,267.9			1,125.1
	Healthcare		615.8			557.4			1,734.2			1,514.1
	Engineered Products and Services		226.0			92.1			455.2			285.2
	Plastics and Adhesives		32.0			54.1			52.6			139.4
	Corporate and Other⁽³⁾		(87.0	)		(91.0	)		(241.6	)		(397.3	)

Operating income		$	1,528.7		$	1,208.2		$	4,017.9		$	2,893.6

⁽¹⁾: Includes $180.6 million and $528.4 million for the quarter and nine months ended June 30, 2004, respectively, to reflect sub-contract costs in net revenue and cost of revenue at Infrastructure Services. These adjustments had no impact on operating income (See Note 1).
⁽²⁾: Revenue relates to the TGN business held for sale (See Note 4).
⁽³⁾: Includes operating loss of $16.0 million and $32.6 million for the quarters ended June 30, 2004 and 2003, respectively, and $47.4 million and $89.8 million for the nine months ended June 30, 2004 and 2003, respectively, related to the TGN business held for sale (See Note 4).

3. Restructuring Activities and Impairment Charges

Restructuring activities and impairment charges are as follows ($ in millions):