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Tyco Electronics, Ltd. (NYSE:TEL)

F3Q09 Earnings Call

July 29, 2009 8:30 am ET

Executives

John Roselli – Vice President of Investor Relations

Thomas J. Lynch – Chief Executive Officer & Director

Terrence R. Curtin – Chief Financial Officer & Executive Vice President

Analysts

Matt Sheerin – Thomas Weisel Partners, LLC

Amit Daryanani – RBC Capital Markets

Shawn Harrison – Longbow Research

Steven B. Fox – CLSA – Calyon Securities

Jim Suva – Citigroup

William Stein – Credit Suisse

Amitabh Passi – UBS

Operator

Welcome to the Tyco Electronics reports third quarter results conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and 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 Vice President of Investor Relations John Roselli.

John Roselli

Thank you for joining our conference call to discuss Tyco Electronics’ third quarter results for fiscal year 2009 and our outlook for the fourth quarter. With me today is our Chief Executive Officer Tom Lynch and our Chief Financial Officer Terrence Curtin. During the course of this 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 statements that we’ve included there.

In addition we will use certain non-GAAP measures in our discussion this morning and we ask that you read through the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables along with the slide presentation can be found on the investor relations portion of our website at www.TycoElectronics.com.

Now, let me turn the call over to Tom for some opening comments.

Thomas J. Lynch

Q3 was a good solid quarter for the company for several reasons. Sales increased 7% sequentially and exceeded our original guidance primarily due to increased demand for our products which served consumer markets especially in the automotive market. While sales are well below last year’s level it does appear that the inventory correction in the consumer markets is largely behind us. As a data point automotive year-over-year was down 36% for us but sequentially us up a little over 25%. Total company orders were up 14% sequentially and the book-to-build ratio was 1.4 excluding the undersea telecommunications business.

The aggressive cost actions that we initiated early this year coupled with our footprint reduction actions have improved our operating leverage and our strategic footprint restructuring actions continue to be on track and at the pace we’re at we’ll be less than 100 facilities by the end of the year. As you know, improving margin flow through in the business has been a very, very critical objective for us and continues to be a critical objective and we’re making good progress.

If you take these productive and cost actions in conjunction with the sales increase this has enabled us to increase our adjusted operating income by $55 million or about 76% sequentially and this exceeded both our original and revised guidance. We also reduced inventory and additional $264 million in Q3 and to date we’ve reduced it about $1.5 billion. This was the primary driver behind our strong free cash flow in the quarter which exceeded $300 million for the second quarter in a row and we now expect free cash flow before restructuring to exceed $1 billion this fiscal year. This is a $200 million increase to our prior outlook.

We strengthened our balance sheet in the quarter by reducing our debt levels by $336 million and in July we completed a tender offer which reduced our debt by an additional $152 million. As of today we have reduced our debt by approximately $725,000,000 this year. Our debt stands right around $2.4 billion today and to put it in a little perspective, if the business were to stay at this range we’d ideally like the debt to be in the $2.0 to $2.2 billion range so we’re closing in on what we think is the appropriate level of debt for this level of business.

As you all know, we completed the sale of our wireless system business for $665 million cash and all-in-all I think we’ve made excellent progress over the past two years focusing the portfolio around our core connectivity business. I really feel good about this portfolio and the growth opportunities we have and how we’re positioned.

This morning we also issued another press release announcing that our board of directors recommends for shareholder approval a dividend of $0.16 per share for each of our first two fiscal quarters of 2010 and this would be in December and March. Shareholder approval of dividend payments is required as a result of our reincorporation to Switzerland. We decided to retain our dividend at this level despite the reduction in business levels over the past nine months because of our strong cash position, the strength of the balance sheet and the progress we have made in reducing costs and improving productivity.

Now, I’m going to turn the call over to Terrence who is going to go through our Q3 performance in more detail.

Terrence R. Curtin

I’ll start by reviewing our sales performance by segment and market and then I’ll get in to earnings, cash flow and liquidity. If you could look at Slide Four of the slide presentation, this shows our overall revenue performance by segment both year-over-year and sequentially. Our total company sales of $2.5 billion were down 34% in the quarter versus the prior year of which the effect of currency translation was approximately 400 basis points of decline. Sales were up 7% sequentially with three out of our four segments showing sequential growth.

In our businesses that serve the consumer markets which are about half of our sales, while we are still down year-over-year, we did see sales increase over 20% sequentially and as Tom mentioned it appears the inventory adjustments in the supply chain are largely behind us. In the industrial markets that we serve we continue to see weakness as sales were down 2% sequentially. These industrial markets are continuing to be affected by lower capital investment levels and we expect this trend to continue in the near term.

Now, let me get in to segment performance by market, please turn to Slide Five. In our electronic components segment versus the prior year sales declined 42% overall and 37% organically and we saw broad based declines across all markets and regions on a year-on-year basis. In the consumer related end markets which are about 70% of this segments sales, we did see revenue growth 20% organically on a sequential basis.

Getting in to the specifics by the major markets we serve, in the automotive market, our sales versus the prior year did decline 36% organically however sequential sales were up 28% organically. We estimate global auto production increased 10% to 15% sequentially and we also benefited from supply chain restocking. Our sequential sales increase was driven entirely by our Asia and European regions. For quarter four in this market we expect sequential improvement in the top line again of mid to high single digit growth on what we estimate to be flat sequential global production and the growth will be driven by further restocking.

In the computer market of the component segment our sales declined 42% organically year-on-year driven by end market declines as well as our continued selectivity on new programs particularly in the commoditized portion of this market. On a sequential basis sales were down slightly. In the communication market, our organic sales declined 28% year-over-year and were up 4% sequentially and as you know, we put both communication equipment and mobile phones in here. The year-over-year decline was driven by the communication equipment market where sales organically were down 34% and except for China the global market continues to be very soft.

In the mobile phone portion of the communications market, our organic sales were down 16% versus prior year but were up 35% sequentially. As expected supply chain inventory stabilized and our revenue decline in the quarter was in line with global OEM production declines. In the industrial equipment markets our organic sales growth was down 51% versus the prior year and down 14% sequentially. As we discussed on the last call, we expected declines in this market due to the reduced capital spending on factory automation and infrastructure globally. We have seen order rates stabilize and we expect sales will be relatively flat in this market sequentially in the fourth quarter.

Finally, in the distribution channel our sales declined 39% organically versus the prior year due to continued inventory reductions by distributors. Orders did big to show some signs of improvement late in the quarter and we expect Q4 sales to be similar to Q3 levels.

Looking at the right side of the Slide to our network solutions segment, versus the prior year sales declined 26% overall and 17% organically driven by capital spending reductions. Sequentially sales were up 6% overall and 2% organically. We do expect segment sales in the fourth quarter to be flat with quarter three. In the markets, sales to the energy market were down 15% organically versus the prior year. Utility customers, particularly in Europe continue to defer spending on upgrades and maintenance. Sales were flat sequentially compared to the second quarter and we did not see the usual seasonal pick up that begins in our third quarter and continues in to the fourth quarter. We expect this trend to continue and we expect quarter four revenues to be flat sequentially.

Our sales to the service provider market declined 12% organically driven by lower spending on upgrades and maintenance of existing networks in the US and Europe and a slowdown of fiber investment in the US. In quarter four we do expect a sequential decline driven by lower fiber network investments in Europe. Lastly, in the enterprise networks market, our sales declined 27% organically reflecting weak US and Europe commercial construction markets and reduced IT spending. We do expect a modest sequential increase in the fourth quarter as a result of some of our program wins we’ve had both in Europe and the US.

Let’s turn to Slide Six to cover the specialty products and undersea telecom segments. Sales in the specialty products segment declined 27% overall and 24% organically versus the prior year. Sequentially sales were down 2% overall and down 3% organically. For the fourth quarter we expect the segment sales to be similar to quarter three. Sales in the aerospace, defense and marine market declined 20% organically versus the prior year driven by both distributor inventory reductions and weaker demand in the commercial aerospace market due to aircraft cancellations and push outs.

In this market we declined 6% sequentially and while we’ve seen order stabilize in the distributor channel of this market, we are seeing signs of weakness in the end markets. We expect quarter four to show further declines versus the third quarter. In our touch systems business, sales were down 33% organically versus the prior year due to continued weak capital spending by retailers. Orders have strengthened in this business and we expect a double digit increase sequentially.

In the medical products area, sales decreased 13% organically versus the prior year and we continue to be affected by capital spending cuts among healthcare providers. We expect this market to be down slightly on a sequential basis in the fourth quarter. Finally, in our circuit protection area, organic sales declined 34% versus the prior year but were up 33% sequentially as sales to the consumer related end market such as automotive and mobile phones showed improvement. Similar to the consumer markets that we serve in our electronic components market, we expect that we’ll continue to see growth in our circuit protection business in Q4 sequentially.

Looking at the right side of the chart, in our undersea telecommunications segment, organic sales increased 15% versus the prior year and 3% sequentially drive by our continued strong execution on projects in the Middle East, Africa and Southeast Asia. In addition, as included in our revised guidance, we also benefitted in the quarter in both revenue and earnings by approximately $20 million due to the receipt of cash from a customer that we previously were concerned may not be collectable. This caused our operating margin during the quarter to be about 23% in the segment which is higher than normal.

We ended the quarter with a backlog of $811 million in this business which was a decrease of $275 million from the end of last quarter. Bid activity on new projects remained solid but the funding for these projects remained uncertain. For quarter four we expect our sales to decline sequentially to about $280 million and we expect our margins to be in the mid to high teens.

Now, let me go from sales and turn to the income statement which starts on Slide Seven. Our GAAP operating income for the quarter was $64 million which includes restructuring and other costs of $63 million. These restructuring costs relate to both footprint and headcount reduction actions that we previously initiated and no new plant closures which started in the third quarter. Adjusted operating income in the quarter was $127 million with an adjusted operated margin of 5.1% which is solid improvement from Q2 levels of 3.1%. Adjusted earnings per share for the quarter was $0.17 which is up 21% in the second quarter. While operating income was up 76% sequentially, adjusted EPS was only up 21% due to income tax expense in the third quarter versus tax income last quarter.

Moving on to Slide Eight, beginning in this quarter we have reclassified research and development and engineering expenses out of cost of sales and are showing it as a separate line below gross margin to provide more clarity and we have restated all periods presented for this reclassification change. If you look at the top of the Slide, versus the prior year, gross margins declined 600 basis points from 29% to 23%. Volume declines due to the 34% decline in our sales reduced gross margins by 900 basis points. We also continued to reduce our inventory levels in the quarter which reduced production by approximately 40% compared to the prior year.

The impacts of lower production levels reduced gross margin by 300 basis points. Our cost reductions partially offset the negative effects of the volume and the production cuts. The savings from our implemented actions helped gross margins by 600 basis points. Looking at our gross margin compared to the prior quarter in the upper right hand quarter, margins benefited from 200 basis points associated with volume increases as well as 100 basis points of additional cost savings.

Inventory reductions lowered gross margins by 300 basis points and offset the cost and volume benefits. Operating expenses which are shown in the middle of the Slide and include both RD&E and SG&A were down $101 million year-on-year. Excluding the effects of currency translation, we reduced operating expenses by approximately $70 million through a combination of headcount reductions and spending controls. As expected operating expenses were flat versus the second quarter and we expect that they will be at a similar level in quarter four.

Finally, we continue to be on track for our overall target of removing approximately $300 million of annualized structural cost of our businesses and this consists of $200 million in the manufacturing area and $100 million of operating expenses and we expect to exit the fiscal year at the full savings run rate. As I discussed on the last call, these actions position our company for solid to upper single digit adjusted operating margins at current sales levels.

With respect to our manufacturing footprint, six closures are in process and they’re on track with what we communicated last quarter and we expect we will have less than 100 manufacturing sites by the end of this year. As you may remember, this is down from the 133 facilities when we started the program back in 2007.

Moving to Slide Nine, let me discuss the items on the P&L below the operating line. Net interest expense was $38 million and this was flat versus the prior year. We do expect that this will come down to $34 million in the fourth quarter as a result of lower debt levels. As I discussed last quarter and as I provided in the guidance, the amount and mix of our income by countries where have operations has changed considerably since we ended the fiscal year and this has resulted in a lower than expected tax expense in the third quarter and has created volatility in our tax rate. This is evidenced by the 16% adjusted income tax rate we have in the third quarter.

In the fourth quarter as earnings increase the rate should not be as volatile but will be lower than normal. We expect an adjusted tax rate in the fourth quarter of approximately 25%. Finally, other income which relates to our tax sharing agreement was $5 million in the quarter up from $1 million in the prior year. For quarter four I expect this will be approximately $11 million of income.

Now, let me turn to free cash flow on Slide 10. As Tom stated, our free cash flow was $327 million in the quarter up from $262 million in the prior year quarter. Lower income levels were more than offset by reduced inventories and capital spending. We continued to make progress in managing our working capital. Our days sales outstanding declined three days year-over-year and two days sequentially as we continued to see improvement in our receivables aging from our credit and collection efforts. Our inventory days on hand excluding construction and progress were down six days year-over-year and down 17 days sequentially to 67 days.

On capital spending, we spent $61 million in the third quarter of 63% reduction from prior year levels. On a year-to-date basis our capital expenditures are down 39% which is in line with the revenue declines. For the full year, we do expect capital spending of about $350 million. Cash restructuring in the quarter was $80 million and we continue to expect full year cash restructuring in the range of $300 million. Finally, based upon our strong traction over the past six months, as Tom indicated we are increasing our 2009 fee cash flow before restructuring outlook to $1 billion from our prior outlook of $800 million.

Now, let’s move to Slide 11 to discuss liquidity and debt. Starting with cash we began the quarter with $700 million of cash and ended the quarter with $1.26 billion. During the quarter in addition to free cash flow we received the proceeds from the wireless business sale of $665 million which includes the working capital adjustment under the contract. From a use of cash perspective, we paid off the balance of the credit facility which was approximately $340 million, paid dividends of $74 million and made cash payments related to pre-separation litigation of $15 million. The litigation payment as you may recall was related to the P&L charge of $135 million we took last quarter. We still have $85 million of cash payments related to these charges that we expect to payout through 2010.

Turning to debt, at quarter end our debt balance was $2.6 billion, down from $3.2 billion last year. As I stated earlier, we no longer have anything outstanding on our credit facility and in the fourth quarter our debt will go down by an additional $152 million due to the recently completed debt tender. After the tender we will have about $2.4 billion of debt outstanding. We feel very good about our liquidity position and we will continue to retain additional cash in these uncertain times for flexibility and to make sure we can support all of our strategic options.

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

Thomas J. Lynch

Let me now turn to the fourth quarter, if you can flip to Slide 12. In Q4 we expect our sales to be in the range of $2.53 to $2.63 billion and this is up slightly versus Q3. We expect continued improvement in consumer markets and flat sales in industrial markets and this will be partially offset by an approximate 10% decline in our undersea telecommunication segment. As you know, we have been talking about that business slowing down for fiscal ’08 and fiscal ’09. It’s been over $1 billion, we are starting to see a little bit of a slowdown there now as expected.

We do expect our adjusted operating income to be in the $160 million to $200 million range. The significant improvement in sequential profitability is primarily due to continued benefits from our cost savings actions, our ongoing productivity improvement program and the less negative impact on margins from production cuts to balance inventory. Our adjusted operating income margin will be in the 6.3% to 7.5% range in the quarter and that’s up from about 5% in Q3 and about 3% in Q2 so we’re making good progress there. Adjusted earnings per share from continuing operations will be in the $0.22 to $0.29 range which is up from 17% in the third quarter. As with prior years, we’ll provide further insight in to 2010 on our next earnings call.

If you move to Slide 13 now I’ll just wrap up before we open it up for questions. Really importantly we’ve resized the business to improve our operating leverage and have positioned the company to deliver solid mid to high digit adjusted operating margin at the $10 billion sales level and at 12% adjusted operating margin at the $12 billion sales level. This is what we’ve been talking about the last couple of quarters as we’ve gone through the resizing. This is what we thought is the right balance to strike to maintain a good solid performance even in these difficult times, generate significant cash flow but increase our opportunities for growth in the future.

I feel like we’re doing that pretty well. We continue to execute our strategic restructuring and of course maintaining our ability to grow. This restructuring coupled with our increased focus on core productivity is really going to serve us well as growth comes back. As Terrence mentioned the cash flow and balance sheet remains strong and this really enables us to preserve our key strategic options which are increasing our investment in organic growth, we feel there are more opportunities today than there were a year ago: bolt on acquisitions which can leverage our business platform, maintaining our investment grade rating; and of course returning capital that we don’t use for strategic purposes to shareholders through dividends and share repurchase.

With that, we’ll close off this part of the call and open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Sheerin – Thomas Weisel Partners, LLC.

Matt Sheerin – Thomas Weisel Partners, LLC

I guess my question Tom has to do with the margin, the incremental margin contribution, going forward obviously you’re seeing a big step function up in the September quarter on the inventory reduction and the cost kicking in but as you go forward once the restocking period is over, what should we think about the incremental margin contribution or variable margin going forward on incremental dollar growth? And, you’ve stated in the past that your goal is to get to 12% operating margin at a $12 billion run rate, is that still on track or is that $12 billion even lower now given that you’ve seen a big jump up here?

Thomas J. Lynch

No, it’s still on track. I think we’d be getting ahead of ourselves to say that we’re getting ahead of that rate. I mean, we continue to work the opportunities to improve the margin and the margin improvement this year has been largely from resizing in response to the downturn and the benefits of the restructuring that’s been ongoing for a couple of years. We still have more restructuring to do so we have a little bit of lift there. I think the biggest margin improvement we’ll get going forward is we’ll have better flow through on the volumes. That’s been the highest priority I’d in the company over the last couple of years.

We got sidetracked by the decline in the economy but fundamentally to improve the operating leverage so that ties in to that $12 and our ultimate, well not ultimate in a sense, but we have not taken our eye of the goal of 15% margin but we’re tracking now to 12%. I’d say the other way to think about that is last year when were at the $14 to $15 billion sales range, the actions we have now taken over the last 18 months or so position us to have our margins a couple of hundred basis points higher than they would have been at that range. So, we’re making good progress.

Matt Sheerin – Thomas Weisel Partners, LLC

As you do see volumes increase what should we be looking at in terms of additional headcount? As of today, what is your manufacturing capacity and headcount capacity able to produce in terms of revenue?

Thomas J. Lynch

Well, capacity has several elements to it. I would say we have plenty capacity in terms of bricks and mortar. The variable capacity in our business is tooling and people. So, we believe that we could support 5% to 6% organic growth without much growth in our manufacturing work force. That’s really the marching orders we have through the company that we ought to be able to get that kind of productivity. Now, as we grow we’re going to have definitely some costs feed back in, we’ve been in short term work in parts of the world, things like that and the business is picking up so that’s starting to change a bit. But, I don’t feel we have any capacity limiters and I do feel we should get this acceleration in margin as the volume picks up because of that operating leverage I talked about.

Operator

Your next question comes from Amit Daryanani – RBC Capital Markets.

Amit Daryanani – RBC Capital Markets

I had a question, if I look at the auto business for the June and September quarter you guys are obviously benefitting from some supply chain restocking helping you guys out but as you sense that post September most of this restocking benefit will be behind us and from there on auto sales for Tyco should reflect end demand, is there any concern that much of the strength you see in the first half in June and September is really due to the scrapage laws in Europe that are probably pulling in demand from the back half to the first half?

Thomas J. Lynch

I think your first point Amit is a very fair point, that’s what we feel is by September we’re going to be pretty much through the inventory balancing in the supply chain. We do see, to your point, some lift around the world, I think it’s for different reasons, there’s a little bit of benefit from stimulus. It’s hard to get exact figures around that but I think that’s definitely – we’re not concerned about it, we’re happy about it but I think in terms of how we manage the business we’re not anticipating the kind of sequential increases we saw in Q2 to Q3.

I think we anticipate kind of a more normal growth coming back and as we talked to all of our customers, in fact, there was just a note today that Denso, who is a big supplier to the OEMs is now going back to full work week so I think there’s a lot of signs out there but not enough to feel like demand is really getting back at a fully robust rate but it’s better than it was for sure.

Amit Daryanani – RBC Capital Markets

Then another question on your dividend policy, there’s been some discussion there and I realize today that since you’re committing to two more quarters of dividend payouts but as yearend demand continues to hold the way it is, is there a desire or commitment to maintain the current dividend deal? And, is there any talks about possibly restarting the buyback program we have?

Terrence R. Curtin

When we look at it Amit one thing is when we look at it, when you use the word dividend yield, we look at it from cash generation and where is our balance sheet and our cash generation. So, when we look at it that is our earnings and our cash generation to it. So, from a yield perspective, while that’s something we look at that is not the way we set it. I want to make sure on the dividend side –

Thomas J. Lynch

It’s more of a payout ratio is the way we think about it, to Terrence’s point.

Amit Daryanani – RBC Capital Markets

Maybe I just missed it but I’m trying to get a sense on the 61st and annual dividend payout we have, if demand remains the way it is, is there a commitment to maintain that beyond the two quarters we’re talking about?

Thomas J. Lynch

Yes, the intention is to maintain it at $0.16 per quarter. One of the little complexities of Switzerland is opposed to a Bermuda company or most companies where the board approves dividends rather, shareholders approve is so it makes the process more encumbersome, that’s why we’re doing two quarters but we’re also not doing a full year and our next annual meeting will be in the February/March timeframe next year. Our intention would be to get back on sort of annual cycle but yes, our intention is to keep the dividend. If business got worse or didn’t get any better or if we were going to be in a low period, of course we’d revaluate it but that’s now how we feel right now and that’s why we’ve continued it through this year.

Amit Daryanani – RBC Capital Markets

Then just a question, are we possibly looking to restart the buyback program?

Thomas J. Lynch

I would say eventually, probably subject to the board approval but not in the short term. I think we want to maintain our flexibility in the short term. I mentioned earlier when I talked about the debt level, we made great progress bringing it down. If the business doesn’t improve we have a little bit to go on the debt so we need to keep that flexibility. We also want to keep flexibility for the bolt on acquisitions that fit in to the strategic sweet spots that we would like to fill out. But, having said that, I think you know from our track record that we’re not going to let cash build up and we’re certainly not going to let it burn a hole in our pockets. So, as cash build ups if we don’t have better options we would certainly reinstitute the buyback program that we have in a sense on the shelf now. We have $600 million left on the program that was approved by the board last year.

Operator

Your next question comes from Shawn Harrison – Longbow Research.

Shawn Harrison – Longbow Research

Two questions on just incremental savings rolling on, should we expect the entire inventory drag, the 300 bips or about $75 million to essentially roll off as we move in here to the September quarter, is that what the guidance implies?

Terrence R. Curtin

If you look at there will be a little bit carrying in but the vast majority is like we said we’ve made better progress these past two quarters and we will get some pickup in quarter four but it will be essentially behind us.

Shawn Harrison – Longbow Research

So it could be a $60 million plus?

Terrence R. Curtin

Yes.

Shawn Harrison – Longbow Research

Second, on the restructuring savings, I know that you had previously talked about $150 million of savings incremental in 2010. Is that the number we should be using to model or is that something a little bit lower now?

Terrence R. Curtin

We look at that from a footprint perspective, from a run rate off of quarter four there is just taking quarter four the run rate, there is from some of the factory items that we’re wrapping up there is about $60 million incremental off of the quarter four run rate.

Shawn Harrison – Longbow Research

So $60 million annual off the quarter four run rate?

Terrence R. Curtin

Yes.

Thomas J. Lynch

[Inaudible] Shawn was really the full benefit on an annualized basis of the original program.

Shawn Harrison – Longbow Research

Then how much incremental are we seeing fourth quarter from third quarter?

Terrence R. Curtin

It’s about 100 basis points and it’s mainly in the gross margin as I stated. Operating expenses we’ve been able to get that down but on the cost side Q3 to Q4 it’s about 100 basis points.

Shawn Harrison – Longbow Research

Then I know last call we talked somewhat about copper not really being a benefit to you anymore. With copper at $2.60 probably having worked through most of your raw material inventory now, should we not expect any incremental benefit from lower raw material prices in the back half of the calendar year?

Thomas J. Lynch

As you indicated we did fix positions late in ’08 that we worked off and they’ll be worked off through basically the end of this fiscal year. We are averaging if you take the year between those fixed positions and where we do do some market purchases, we’re at a $2.60 to $2.70 level so right now the benefit rolling over will be fairly minimal and we are starting to look at fixing in positions in to 2010.

Shawn Harrison – Longbow Research

Then one last question given the commentary on copper, what are you seeing in the broader interconnect pricing environment? And maybe if you can talk about pricing in some of the other businesses as well?

Thomas J. Lynch

In the core interconnect business lots of desire for price reductions from customers, not anything that is really new but no real change in price erosion. I think what’s balancing that is there’s been a lot of stress on a number of the suppliers to the OEMs in various industries during the last nine months so a lot of effort is around making sure I have suppliers that can get me through this period of time. Certainly, I’d say that’s one of our strong - as well as keep investing in development. So, we haven’t experienced any really change in price erosion.

Terrence R. Curtin

I mean Shawn it’s still about 1.5% just to give you a number and that really has not moved. It sort of varies by market but it really has been very consistently now basically this year and last year. So, it really has not moved to Tom’s point.

Shawn Harrison – Longbow Research

That was 1.5% annual?

Terrence R. Curtin

Correct.

Operator

Your next question comes from Steven B. Fox – CLSA – Calyon Securities.

Steven B. Fox – CLSA – Calyon Securities

A couple of questions, getting back to the auto can you isolate on the trends in auto demand in Asia how much of that was restocking versus real growth? Then also if you can talk on auto about what the mix of the content looks like per vehicle, if there’s anything that you’ve been able to dissect on that, that would be helpful?

Thomas J. Lynch

Well, let me talk mix a little bit, there’s a slight change in mix I would say and we kind of estimate it at a couple of dollar impact on content. Right now there’s a little bit higher proportion of smaller cars with less features being sold. We do believe that’s something that will work its way through and its happened in the past during maybe circumstances that weren’t maybe this crazy as the last nine months so, slight so far there Steve. I would say in terms of Asia, I mean definitely China that had a month or two of declining auto sales stimulated quickly through a number of ways, change taxes on certain priced cars and that business is really very robust again, we’re very strong there Tyco Electronics.

Getting a little bit better in Japan I would say both in the local market as well as the exports. That feels more inventory correction related. I was in Korea a couple of weeks ago, I would say a little bit of both, a little more inventory still. I’d say in general in all of the consumer markets, the sequential benefit is definitely in the two thirds to three quarters inventory but there is some improvement in end demand.

Steven B. Fox – CLSA – Calyon Securities

Then on the network solutions business looked like it had a little bit more leverage quarter-over-quarter than I would have expected. Can you talk about how you got the improvement if there are any one offs and what we should be looking for on networking solutions margins going forward?

Terrence R. Curtin

A couple of things, both in specialty products and network solutions you saw nice sequential increases. They both had benefits of our cost actions, our cost actions were across all our businesses except UT, not just the electronic components. They also did bring down inventory so they both did get the benefit of some of the inventory burn turning as well as cost actions. The incremental that you do see in network solutions has to do with a little bit of a favorable mix because the service provider market grew a little bit faster so there is a little mix but there isn’t any other one offs there.

Steven B. Fox – CLSA – Calyon Securities

Then lastly, if you were going to look at a tax rate for next fiscal year, any suggestions on what to use?

Terrence R. Curtin

Tax rate when you look at it certainly our tax rate, like I said, has been very volatile as the business has swung through these income levels it certainly impacts pretax income. When we started the year we told you about 30%. We have continued to work on planning and we’ll give you full guidance in the next call but I think right now using in the 28% to 30% range pending our formal guidance and insights for next year I think is a reasonable assumption.

Operator

Your next question comes from Jim Suva – Citigroup.

Jim Suva – Citigroup

When you guys talked about the destocking of inventory is pretty much over, I just want to be clear for the September quarter are you envisioning a restocking or just stability?

Thomas J. Lynch

I’d say more stability Jim. There’s a little bit of restocking going on but inventories were so much higher than the level of business as the market collapsed so quickly particularly in automotive. I don’t think we’ve seen – certainly everybody got a little tighter than they would normally be on inventory but I can think of just how we’re managing our own inventory, we’re not going in to restocking mode, our reductions are starting to flatten out. I think that’s the way we see it with most of our customers.

Jim Suva – Citigroup

Then on the automotive side you guys have done a lot to right size your business, cut down costs and things like that, for the September quarter what type of annualized global automotive run rate are you running the business for, for the September quarter?

Terrence R. Curtin

If you look at it right now Jim, when you look at it global production in the fourth quarter is going to be about 13.5 million units is our estimate. We do see that having the potential to inch up about 60 million units for next year as we’ve told you just as the consumer and production get back in line which is pretty flat production quarter-on-quarter from Q3 to Q4 so our production estimate is about 13.5, our capacity is above that but that’s right now how we’re seeing it and we do expect to grow about 6% to 7% sequentially.

Jim Suva – Citigroup

Then if we go from 13.5 more towards and annual run rate of 60 million, you would likely see more benefit from the positive leverage flow through?

Terrence R. Curtin

Exactly. If you look at it, Tom talked about our component business getting to profitability and around these business levels we think it’s a mid single digit profitability but then you get the volume leverage that we believe will be very significant that Tom talked about.

Jim Suva – Citigroup

My last question is, and not for guidance, but you guys have done a lot of divesting of businesses throughout the several quarters. Can you help us understand the normal seasonality of your company in aggregate now kind of as the quarter’s progress through the fiscal or calendar year?

Thomas J. Lynch

It’s tough to say what’s normal after what we’ve been through this year Jim. A lot of seasonality has been thrown out the door. Our wireless business, really from a seasonality, the wireless business that we sold, the only thing that was unique about that was it always had a big September quarter. If you look at the rest of the business without that and assuming a return to what we did historically, typically our third quarter will be out strongest. We do get impacted in the other quarters by holidays and seasonality but still quarter four and quarter one maybe 5% off of that but quarter three which is our June quarter would be our strongest in a normal time.

Jim Suva – Citigroup

The last point, along that line, you mentioned stepping away from some of the computer businesses, the commodity side, is there still more to go on that or is that pretty much behind us?

Thomas J. Lynch

I think most of it is behind us Jim. As you know, we’ve been working on that for a couple of years to get out of the real low value add. I mean, our products still span the range I would say of complexity and there’s still pretty wide margin ranges across the portfolio and it’s not our goal to get out of every low end product. What we wanted to get out of was products that we didn’t really add any engineering or manufacturing to it because we can’t distinguish ourselves that way and we’d rather have those resources on other projects because as you know we’re a project intensive business. So I guess the simple answer is yes, most of that is behind us.

Operator

Your next question comes from William Stein – Credit Suisse.

William Stein – Credit Suisse

I’m wondering if you can give us a brief update on the M&A strategy going ahead? You talked about potentially doing something to fill in some holes in the portfolio, any comments on how that might progress going forward?

Thomas J. Lynch

As you know the last couple of years the focus has really been get the portfolio much tighter and I feel like we’ve done that around our core connectivity business that serves devices and automotive and networks. So now that we have that – at the same time we have looked at acquisitions and have been building a pipeline that has been derivative of our strategy and I’d say our pipeline is pretty robust right now. We’re scanning and looking at a number of things but it’s focused in a couple of areas.

As we’ve said before, areas that would compliment us. We like energy for sure, we like medical, we have good positions there, we’d like to build on those positions. I think generally speaking it’s rounding out markets where we don’t have a full product line and that’s how we think about it. When I think about what percentage of our business, it feels like a 2% to 3% of our revenue and obviously maybe one year it will be one and maybe one year it will be 5% will make sense when we look at where we want to go strategically and what’s out there.

We haven’t done any yet, we’ve been active in a few, we passed on a few because either it turned out as we got in to them they weren’t what we thought or we weren’t willing to pay the premium but I think it’s definitely an important part of our strategy going forward.

William Stein – Credit Suisse

Any chance that you’d do something bigger than that and maybe even a public company or is that officially out of the cards?

Thomas J. Lynch

I would never say never, I would say is there a chance? Yes. Is it at the top of our priority list? No, because if you go across the markets we’re in and the technology we have and again, we’re more than just a connector company, we like what we have. Our biggest opportunity to create value is to leverage what we have and augment it so I really feel like M&A in the midterm for us is more of an augmentation strategy not necessarily a big deal, transform the company, strategy. But, I’d never say never because things come up and you get smarter as you go. But, that’s how we’re thinking about it right now.

William Stein – Credit Suisse

Then an update on the distribution strategy please?

Thomas J. Lynch

As you know, about a year or year and a half ago we felt like we needed to be much more strategic and frankly much more effective through that channel so we’ve been on a pretty intense program to do that. We’re making good progress, we have reduced the number of distributors over the last three months that we serve. We still serve them with our products but I think most of those customers and partners will be better off as we simplify our channel and therefore we can focus our efforts on the bigger distributors and do a better job. So, I feel good about that.

You can’t really see it in the numbers yet because obviously the business has been down and the channel has been correcting inventories and Terrence talked to that a little bit, we think that’s largely behind us. But, I definitely feel like our relationships with strategic partners in that channel around the world are better than they were a year ago.

Operator

Your next question comes from Amitabh Passi – UBS.

Amitabh Passi – UBS

Just a couple of questions, the first one being for you Terrence, on the balance sheet once you’ve redeemed the $150 million plus or so of debt would you be largely done with most of the balance sheet restructuring or do you think you’ll probably continue to pay down debt further?

Terrence R. Curtin

Tom mentioned, where we are today, we’re probably at the high end of the range if we stay at the revenue where we are now and as you saw in the tender we went out with a $350 tender, we had a $150 submitted so there could be a couple of hundred million more that we do depending on business levels. So, there could be a little bit more that we do, that’s why Tom talked about the flexibility of holding more cash in these uncertain times but we are close to being done.

Amitabh Passi – UBS

Then how do you foresee working capital movements in the fourth quarter?

Terrence R. Curtin

Working capital in the fourth quarter, on the revenue we do view we will take a little bit more out of inventory but other than that we expect working capital to be fairly flat quarter on quarter.

Amitabh Passi – UBS

Then Tom just for you a couple of sort of strategic questions, I guess the first one was just any thoughts on the recent acquisition of [SCI America] by [Hubble], does that from your perspective indicate anything on one of your competitors or just curious to see what your thoughts were on that?

Thomas J. Lynch

We obviously were aware of what was going on there but other than that we really don’t have too much to add. As I said, we’re active. You could call us active and selective.

Amitabh Passi – UBS

Then just one final question, on your network solutions, I’m just trying to understand, what is the value add for you to remain invested in some of the businesses like building networks and the comp service provider where there are certainly much larger competitors in that space, I mean is that an area you remain fairly committed to? Then, how do you see the synergies flowing out with the rest of your sort of interconnect and component business?

Thomas J. Lynch

I think the networks business is one of the things that makes us much more and we like this a lot, sort of a device interconnect company. Of course, that’s our core business but if you look at our core technologies and out of our networks business we really lead with our kind of material science expertise and in our connector business we lead with our mechanical and contact physics expertise but they come together and they definitely come together in the enterprise business.

We’re one of the top three players in the world and our enterprise or net connect business, that’s a $400 to $500 million business, very attractive business for us, a business that we have a lot of momentum in. Those technologies come together in our energy business which is in the neighborhood of $1 billion in normal times, it’s down a little this year. We’re strong around the world in the energy business and we really love the prospects for that business.

In the telecom portion of the business or what we sometimes call our outdoor plant business which is copper and fiber interconnect business in the outside plant and we sell to companies, the big carriers around the world, that’s been a very good business for us. It’s been down and lumpy the last couple of years and it tends to fluctuation with the acceleration and deceleration in fiber deployments. But, we like all three of those businesses and the technologies are very linked so we like being this very broad based connectivity business. Those network business is roughly $2 billion in sales with historically very attractive margins and in the future we believe very attractive margins and have been very solid during this last year.

Amitabh Passi – UBS

I do have one final one, on the aerospace and defense, you talked about some weakness in the end market, I suspect some of that was driven by commercial aerospace weakness and likely [inaudible] continued to destock. I’m just curious what you’re seeing on the defense side of that business?

Thomas J. Lynch

Relatively flat, that’s holding up better than the commercial aerospace business. This is another business that we like a lot, we invested in over the last few years, we broke it out as its own standalone business unit a few years ago. I think we mentioned on the call last time that we have significantly increased our content on all the new platforms on commercial aerospace and the two big providers there and we’ve also increased our content in the defense side on a lot of the new military vehicles. Now, that’s not showing up in sales yet, that will show up as the platforms begin to shift but we like that business. As you know, that’s attractive businesses, it’s long cycle, it’s hard to be displaced from that business and it requires a lot of technology. A lot of our advanced material technology starts there and then moves in to other parts of our business.

Operator

Your last question comes from Amit Daryanani – RBC Capital Markets.

Amit Daryanani – RBC Capital Markets

I had a quick follow up guys, on the computer segment, sales were down a little bit sequentially, could you just quantify how much of that was due to these programs that we exited?

Terrence R. Curtin

How much of the decline?

Amit Daryanani – RBC Capital Markets

Yes, because in general right most of the computer PC supply chain is doing fairly positive as we’ve seen from good sequential growth so I’m just trying to understand the delta, how much of this is because of businesses that you walked away from?

Thomas J. Lynch

Most of it is from us exiting the business. The lion’s share of that is from existing the business. We’re doing pretty well in our core platforms in that business but all the potpourri of all the other things we had either – we raised prices basically the last couple of years and most of that has gone away which was our intention, if we couldn’t keep the price.

John Roselli

Thank you very much for the time and [inaudible] and myself will be around all day for any follow up questions you have. Thanks for joining us.

Operator

Ladies and gentlemen this conference will be available for replay after 10:30 Eastern Time today through August 5th. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 105486. International participants dial 320-365-3844. Those numbers once again are 1-800-475-6701 or 320-365-3844 with the access code 105486. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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Source: Tyco Electronics, Ltd. F3Q09 (QTR End 06/26/09) Earnings Call Transcript
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