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Tyco Electronics Ltd. (NYSE:TEL)

Q2 FY08 Earnings Call

May 1, 2008, 8:30 AM ET

Executives

John Roselli

Executive Vice President and Chief Financial Officer

RBC Capital Markets

Jim Suva

Merrill Lynch

Shawn Harrison

Credit Suisse

Ajay Kejriwal

Deutsche Bank Securities

Yuri Krapivin

Vice President, Investor Relations

Tom Lynch - CEO

Terrence Curtin

Analysts

Matthew Sheerin - Thomas Weisel Partners

Amit Daryanani

Citigroup

Steven Fox

Longbow Research

William Stein

Goldman Sachs

Carter Shoop

Lehman Brothers

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Tyco Electronics Reports Strong Second Quarter Results; Increases Full-Year Outlook Conference Call. Now, at this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a remainder this conference is being recorded. And I will now turn the meeting over to our host Mr. John Roselli, Vice President, Investor Relations. Please go ahead.

John Roselli - Vice President, Investor Relations

Thanks, Lauri. Good morning and thank you for joining our conference call to discuss Tyco Electronics second quarter results for fiscal year 2008 and the press release issued earlier this morning. With me today is our Chief Executive Officer, Tom Lynch and 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 you to read through the sections of our press release that address the use of these items. The press release and all related tables can be found on the Investor Relations portion of our website at tycoelectronics.com. On our website, we have also included an 8-K filing containing the historical financials adjusted for the reclassification of our RF Components and Subsystems business from Wireless Systems segment into discontinued operations.

Now, let me turn the call over to Tom for some opening comments and a review of our performance by end markets.

Tom Lynch - Chief Executive Officer

Thanks, John and good morning to everyone. As this is our usual format, I will cover the key highlights for the quarter and then turn it over to Terrence who will walk you through the financial details and then I will wrap up with our outlook.

Overall, we were very pleased with our performance in the quarter. Our top line growth of 14%, which was 7% organically reflects the diversity of our market mix and our balanced global presence and really a similar dynamics as we had in Q1. Our businesses that serve infrastructure and industrial markets, which represent about 40% of our sales and that includes undersea, wireless, networks and the industrial markets served by our Component segment grew 18% organically in the quarter. This more than offset the continued softness we are seeing in certain consumer markets in our Component segment, namely the U.S. portion of our automotive business, appliances, computers and consumer electronics. These markets were about flat in aggregate in the quarter.

We are also pleased with our operating income performance in the quarter. Our 7% organic sales growth delivered an adjusted operating income increase of 17% over the prior year and our adjusted operating margin increased slightly to 14%. Our margins were up significantly in our Undersea and Wireless segments due to the volume growth we had in those businesses along with a more favorable sales mix in both businesses. Our sales mix was unfavorable in our Network Solutions segment as our most profitable market, our Telecom business, experienced a slight revenue decline.

We had another very good cash flow quarter generating $349 million of free cash flow, a 47% increase over the prior year. We used this cash to repurchase over 10 million of our shares in the quarter. We also had another quarter of good progress to become a more focused company with the announcement that we were pursuing the divestiture of RF Components and Subsystems business formerly in the Wireless Systems segment.

Now, I'm going to talk about our revenue performance in several key end markets by segment. Starting with our Electronic Component segment, our sales grew 9% in the quarter or 1% organically and as expected we had low organic growth in the quarter for some of the reasons I mentioned earlier and I will touch on now. Our sales for the automotive markets grew 12% overall and 2% organically. On an organic basis, we grew 3% in Europe where we generate more than half of our automotive sales. As we'd indicated on the last call, we had expected this business to decelerate after the very strong 9% growth we generated in Q1.

In Asia, our sales grew 10% organically lead by very strong growth in China where we have a very nice position. In the U.S. our sales were down 17% in the quarter driven by significant production cuts by the U.S. manufacturers.

Overall, our global order rates for this business remain solid and we expect organic sales growth to return to the mid single digit range in the third quarter.

In the computer market our sales declined 6%, the decline was partially due to the continued exit of the low-margin product line especially in the desktop segment of the market. In addition, we are also being more selective with new projects in this area due to the commoditized nature of this market and this is consistent with the strategy we announced over a year ago.

In our communications market, our sales grew 14% organically in the infrastructure portion of this market, which is about 60% of our revenue, sales grew 5% lead by growth in emerging market. This will offset declines in the U.S. and EMEA, a continuation of the weakness we've seen in those markets for the past couple of quarters.

In the mobile phone market which is about 40% of our communications sales, revenue grew 43% in the interconnect products portion of this market as we continued to gain share in this very, very important market. We expect our sales to continue to be strong in this market for the remainder of the year.

In industrial markets, we grew 26% and 16% on an organic basis, reflecting increased demand in the solar, oil and gas and industrial equipment segments of the market. Our sales to the aerospace and defense market grew 17% including currency or a 11% organically. We continued to build backlog in this market and expect continued solid sales growth for the balance of the year.

In the appliance market, our sales declined 5% organically primarily due to the continued negative impact from the U.S. housing market. This is the continuation of the last several quarters and we do not expect this market to turn up for the balance of the year.

Finally, in the consumer electronics market, our sales declined 20% in the quarter. We do not yet have a significant presence in this market and the platforms where we are strong had low volumes in the quarter.

Let me now talk about our Network Solutions segment where sales grew 14% on a reported basis and 5% organically. Our Building Networks business was up 14% organically as we continued to see increased infrastructure spending, particularly in China and India where we have a leadership position.

In the energy market, our sales grew 5% in the quarter. Growth was solid in EMEA and Asia and this was partially offset by decline in North America, again related to the housing slowdown.

Finally, our sales for the communications service provider market were essentially flat with growth in North America offset by lower than expected sales levels in Europe. As we mentioned on the last call, we were expecting a seasonally slower quarter in this market but we were also more impacted by fiber... slowdown at fiber rollout by certain characters in Europe and this was a bit of a disappointing quarter for us in this market. We do expect, however, to see this bounce back... begin to bounce back in the third quarter.

For the Network segment overall we grew our backlog in the quarter and we continue to expect organic sales growth in the 6% to 8% range for the year. We had another strong quarter in our Undersea Telecommunications business. Our sales grew 122% in the quarter. Activity continues to remain robust and we booked several large projects during the quarter resulting in a backlog that remains over $1 billion. We'll begin work on these projects in the second half resulting in higher sales levels that we had been expecting.

Finally, in our Wireless Systems segment, which now consists of only our public safety business, our sales grew 24% organically, primarily reflecting higher radio sales related to re-banding efforts for the major customer. We expect Q3 to be another good quarter for this segment.

With respect to the State of New York Wireless project, we concluded our testing on the first region with very good results and we've now turned over testing to the State. Once their testing is complete we will begin to recognize revenue on the project and we expect this will occur in the fourth quarter.

Now let me turn it over to Terrence who will take you through the financials in more detail.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Thanks, Tom. Good morning, everyone and thank you for joining us. Since Tom did go through the revenue trends, I'll go through the P&L then cash flow and a few other items. Our operating income in the quarter was $501 million on a GAAP basis, which included a $36 million gain from the sale of real estate in our Electronic Components segment, $26 million of restructuring costs and $23 million charge related to our portion of Tyco International Security Litigation settlement with the State of New Jersey. Our GAAP operating margin was 13.7%.

On an adjusted basis, our operating income was $514 million, an increase of 17% over the prior-year. The increase in operating income was driven by sales growth, improved productivity and pricing as well as the favorable impact of currency effects. These positive effects were partially offset by higher commodity costs. Our adjusted operating margin was 14%, an increase of 20 basis points over the prior year lead by Undersea and Wireless.

Turning to segment performance, in our Electronic Components segments, the adjusted operating income increased 8% year-over-year on organic sales growth of 1% and the adjusted operating margin declined slightly to 14.4%. Improvements in productivity and pricing essentially offset the margin impact of relatively flat volume and higher commodity costs. Overall, we were pleased with our margin performance in the quarter in light of these headwinds.

Going into Q3, certainly raw material headwinds will persist and this is reflected in our guidance.

The adjusted operating margin in the Network Solutions Segment, we had a decline of 140 basis points to 12% in the quarter. This was primarily due to the mix of sales between end markets including a decline of almost 20% in the communication service provider market in Europe in our sales. That decline negatively impacted our productivity in our operations in this segment.

We do expect our margins for the segment to improve to 13% to 14% range in the third quarter. In our other two segments, Undersea Telecommunications and Wireless Systems, both had a very nice year-over-year margin improvement. Both segments benefited from strong sales increases and a favorable sales mix. In the Undersea segment, the favorable project mix drove our margin higher sequentially, despite the lower revenue.

In Wireless, which now excludes the RF Components and Subassembly business, we expect double-digit margins for the rest of this year. As we talked to you about before, these are both project-oriented businesses, so there will be sales and margin variation depending upon the projects and force and the related timing of our execution on the projects.

Now to non-operating matters, on interest expense, it was $40 million in the quarter. This was down slightly versus last year reflecting lower net debt levels.

In taxes, our income tax expense for the $171 million in the quarter resulting in a GAAP effective tax rate of 36%. On an adjusted income basis, our effective tax rate was 32.6% compared to our guidance of 36% to 37% and this added approximately $0.03 to our EPS related to guidance. The lower tax rate reflects the patchable effect of an improvement in our full-year tax rate based upon some of the planning that we've completed. We now expect our tax rate to be approximately 36% for the next two quarters.

On cash taxes, cash taxes paid in the quarter were $118 million and our cash tax rate on adjusted income was 24%. This was slightly up year-over-year this reflects a $0.09 improvement in our operations, $0.02 from a lower share count, and also a $0.02 benefit from currency effects. These positive effects were offset partially by $0.06 headwind from a higher tax rate.

Turning to cash flow, our statement of cash flow was affected by the final transfer of the Tyco International class action settlement that drove off our balance sheet. While we funded our shares of the settlement last year, it is treated as a cash outflow in our operating cash flow with a corresponding inflow in our investing cash flow. It has no impact whatsoever on our overall financial position or capital structure. When you adjust for this item, our cash from continuing operations was $479 million, an increase of 32% over the prior-year quarter. Also as Tom mentioned, the free cash flow was $349 million, an increase of 47% primarily reflecting operating income levels increases as well as some advance payments from customers in our project businesses.

Looking at our working capital, our receivables and payables were 69 days and 54 days respectively. Our inventory levels increased modestly to 86 days as we built inventory for the expected sequential sales increase in quarter three. On a year-on-year comparison, we are up slightly. Most of that is driven by investment in the State of New York, which is reflected in our inventory balance on our balance sheet.

Now, a few other items I want to highlight. During the quarter, we repurchased 10.3 million shares and where that leaves us at the end of the quarter, we had approximately 650 million remaining on the current authorization. And also as we mentioned in the press release, we're now reporting the results of our RF Components and Subsystems businesses as a discontinued operation. The results of this business were included in our previous guidance for the quarter and the full year. In the second quarter, the business generated $114 million of revenue and $4 million of operating income, which was about $0.005 per share after tax. For the full year, we had expected this business to contribute approximately $0.04 per share.

With that let me turn it back over to Tom.

Tom Lynch - Chief Executive Officer

Thanks, Terrence. I'll cover our outlook now for the third quarter and the balance of the year. As you saw in our press release, we are raising our full-year outlook for adjusted EPS to a range of $2.60 to $2.66 per share, which is an increase of 21% to 24% over last year. This compares to our previous guidance of $2.45 per share to $2.55 per share. Our estimate of restructuring costs remains at approximately $130 million or 17% per share for the full year. We expect full-year sales growth of approximately 14% to 16% and we continue to expect full-year organic sales growth in the range of 7% to 9%. And just as a reminder, our guidance does not take into account any additional divestiture activity and it does assume that raw material prices and foreign exchange rates hold at the current levels.

The increase in the guidance is based on our order rates, which remain solid especially in the businesses serving the global infrastructure, industrial and automotive markets. And as a result, our second half backlog is firmed up. This is more than offsetting continued softness in most of our consumer related markets. Again, a continuation of the trend we've seen for the last several quarters. We also continue to get a net benefit from the strength of foreign currencies.

For the third quarter, we expect sales growth of 15% to 17% over prior-year sales of $3.3 billion with organic growth of 7% to 9% and double-digit operating income growth. We expect adjusted earnings per share from continuing operations of $0.66 to $0.68, an increase of 35% to 39%. The year-over-year comparison does benefit from a lower tax rate and higher other income compared with the prior-year quarter. These items favorably impact the comparison by $0.07 per share. Restructuring costs are expected to be in the range of $0.03 per share in the third quarter and including these costs. EPS from continuing operations are expected to be $0.63 to $0.65 per share.

Now, just let me recap our call for today before we go into Q&A. The diversity of our business in global presence is paying off with organic growth of 7%, adjusted operating income of 17% and adjusted earnings per share of 12%. Operating margins are up slightly year-over-year to 14% and we continued to track to our long-term goal of 15%. And as you recall, a year ago, our margin including businesses that we've since divested or announced we're going to divest was about 12.7%. So, we're making good, steady progress in this area.

Our strong cash flow generation was used to repurchase over 10 million shares. We made another significant step forward in focusing our business with the planned divestiture of the Wireless Component and Subsystems business. And all four segments in the company now have double-digit operating margin. And if you add in the Power business and the product lines we've exited in, primarily in computer but also some in a few other market segments, we've divested or announced the divestiture of about $1.2 billion of low-margin in non-strategic revenue today.

And finally, we are increasing our EPS outlook to a 21% to 24% growth over the prior year, again based on strong Q2 earnings and backlog increases in all of our segments along with some FX lift.

So with that, we feel pretty good about the quarter, we are making progress on our longer-term objectives and now we'll open it up for questions.

Question and Answer

Operator

[Operator Instructions] And our first question is from the line of Matt Sheerin with Thomas Weisel Partners. Please go ahead.

Matthew Sheerin - Thomas Weisel Partners

Thank you and good morning. Just a question on the margins going forward, it looks like you definitely had some favorable product mix within both components and your other divisions that helped boost the gross margin. So, going forward, given the mix in the June quarter, are you expecting that to be sustainable or will that be down a bit?

Tom Lynch - Chief Executive Officer

Hello Matt. Yes, we do expect the margin to run in the 14% range plus or minus 20 basis points depending on mix, commodity pricing, currency but we feel like we've got the business up to that 14% range and we should stay in there for the next couple of quarters.

Matthew Sheerin - Thomas Weisel Partners

And if you breakdown gross margin versus SG&A, is it similar to last quarter? It looks like SG&A was up a good bit in the March quarter. So, was that partly currency related or some extra expenses from your other divisions?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Matt, it's Terrence, let me get the SG&A. SG&A is always going to bounce around a little bit. It was a little bit higher this quarter. You will see year-to-date it's right on 12%. I think that is the right long-term rate to think about. There is a lot's of moving parts in there bases up on where sales are, but I think you will always see our SG&A right around 12% and then Tom's point will be around 14% new line and that basically moves up to the gross margin.

Matthew Sheerin - Thomas Weisel Partners

Okay. And then my follow-up also regarding margins and pricing, you talked about materials still being a bit of a headwind that you are offsetting that obviously through cost-cutting and other things, but going forward, have you looked at selective price increases particularly on your Components side? Have you talked to customers about that yet?

Terrence Curtin - Executive Vice President and Chief Financial Officer

We're always doing that that Matt and as you know in the Components business, most pricing is really on a project-by-project basis, but I think we've made pretty good progress in the last year or so in how we go to... how we implement pricing, our overall pricing controls and our price erosion is down from where it has been. So yes, we are constantly working the pricing angle and, I think, making steady progress.

Matthew Sheerin - Thomas Weisel Partners

Okay. Thank you.

Terrence Curtin - Executive Vice President and Chief Financial Officer

You're welcome.

Operator

And our next question from the line of Amit Daryanani with RBC Capital Markets. Please go ahead.

Amit Daryanani - RBC Capital Markets

Thanks. Good morning, guys.

Tom Lynch - Chief Executive Officer

Good morning.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Hi, Amit.

Amit Daryanani - RBC Capital Markets

I guess you... I heard the comments on the Components margins and how it went down about 20 basis points sequentially at least... year-over-year, I'm sorry. But if I look at it sequentially, they were up actually about 50 basis points on relatively flat sales. Could you just talk about puts and takes, I know you had a better mix, but how about 50 basis points from the restructuring benefit that we may be seeing over here?

Tom Lynch - Chief Executive Officer

One of the big things there, as you recall, we had been struggling in our North America automotive business where sales have been down and remained down there. But as we went through some restructuring there, we did have some issues. That began to stabilize and improve in Q2 so that definitely helped the margin, a little bit favorable mix, pricing a little bit better. So those are the three main things that account for the improvement.

Amit Daryanani - RBC Capital Markets

All right. And then just on the Undersea Telco business, I know you guys said you expect better sales in the back half than you initially expected, but I think it was around $150 million run rate. It's really every time I pick the newspaper, you guys seem to be winning a new order in that segment. Could you just maybe quantify what you expect in the back half and also what sort of margins could this business run at?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Amit, it's Terrence, I will take that. When you look at Undersea, I think, Tom mentioned that, we were... we book new projects like you mentioned at the backlog at the end of quarter one was $1 billion and we've maintained that at end of March. So you're right that the $150 million that we talk about per quarter in Q3 and Q4, I would recommend you keep it more around $250 million in Q3 and more like a $225 million in Q4. On your margin question, the second quarter was almost 15%. That was a very high margin benefited by favorable mix. I would expect you should have more of a 13% to 14% operating margin mindset around that business than where we had it in Q2. So that will be a little bit of a headwind as we go through the rest of the year.

Amit Daryanani - RBC Capital Markets

All right. And just my final question, and hop off after that. On the Industrial segment, it seems really good organic trends over there. I'm not sure if you break it up this way, but if you do, it would be helpful. How much of that business is, sort of late cycle end-market driven, be it energy, oil and natural gas or power versus with the only cycle segments?

Tom Lynch - Chief Executive Officer

Well, our industrial has got a significant mix to it. So, there is a piece of oil and gas per sure. Alternative energy has been very high, alternative lighting, which is still a small business but it's very, very high growth. And then as factories move to Ethernet-based communications and controls that piece. So, there is a number of there and also buried within our industrial is our medical business, which is experiencing nice growth, very brood based.

Amit Daryanani - RBC Capital Markets

But, doesn't sound like there is a lot of residential or light commercial kind of exposure in there?

Tom Lynch - Chief Executive Officer

No.

Amit Daryanani - RBC Capital Markets

All right.

Tom Lynch - Chief Executive Officer

The piece of residential is flat to down.

Amit Daryanani - RBC Capital Markets

Fair enough. Thanks a lot and congratulations on the quarter.

Tom Lynch - Chief Executive Officer

Thank you.

Operator

Our next question is from the line of Jim Suva with Citigroup. Please go ahead.

Jim Suva - Citigroup

Great. Thanks very much. Can you talk a little bit about, I think you had mentioned Wireless expect double digits going forward. When you talk about double digits, are you talking 12% to 16% type thing or as we start to see more of the equipment and the product rollout that the Wireless starts to really increase there?

Tom Lynch - Chief Executive Officer

I think right now, Jim, similar to Undersea, Wireless is going to have some flows based up on how projects are moving. I would right now put it in the low double digits at where we are from a scale. It is a small business. As it grows I think you could see that move up. For my comments really for the rest of the year expected in the low double digits.

Jim Suva - Citigroup

And then on the Undersea, very nice improvement there, but you mentioned that the backlog has remained stable and in essence you have one more business added into the bucket there. I guess it would be fair to say that that Undersea Telecom business should see potentially even margin enhancement beyond the 15%. Is that fair? Are we talking approaching 18% to 20% or I just want to keep expectation realistic there?

Tom Lynch - Chief Executive Officer

Yes, Jim, as I mentioned to Amit, the 15% we saw really was a factor of some product mix that we had in the quarter between contracts. I still think, and how we think about it, it is still 13% to 14% at these business levels.

Jim Suva - Citigroup

Okay. And as a quick follow up. There has been some talks about some fiber optic push outs or delays in Europe or something. Can you talk or give us a little bit of light on that?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Sure. That was the primary reason for our second quarter Telecom portion of our Networks business being under the performance we expected. That business for the last year, I would say, has been pretty lumpy. The underlying characteristics were still very attractive and all of the telecoms we are dealing with over there have pretty robust fiber plans because of competitive requirements. But the rate of deployment tends to be [inaudible]. Nobody stops but sometimes it accelerates and it slows down as they refine each of their on strategy. So mid to long term, we really like our position there and that it can't be a little bit lumpy like it was this quarter for us in the short term.

Jim Suva - Citigroup

Are these just temporary push outs or these are like cancellations or do they come back in?

Terrence Curtin - Executive Vice President and Chief Financial Officer

We're not seeing cancellations. It's more temporary.

Jim Suva - Citigroup

Okay, great. And if my math is right, my last point of clarification here, are you about halfway through of your divestiture plan and seems like it's progressing, in my mind, may be a little bit faster that what you thought for about a three-year run rate?

Terrence Curtin - Executive Vice President and Chief Financial Officer

With the announcement of the most recent one, that would put us about two-third and the two big important ones were Power and RF business. So we focus on those big ones and additionally, as I mentioned, have been exiting some product lines. So, we are two-thirds of 70% there and I'd say we are slightly ahead of plan, Jim.

Jim Suva - Citigroup

Thank you and congratulations.

Tom Lynch - Chief Executive Officer

Thank you.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Thanks, Jim.

Operator

We go next to the line of Steven Fox with Merrill Lynch. Please go ahead.

Steven Fox - Merrill Lynch

Hi, good morning. First question on the Auto business, you've talked about some of the puts and takes and you also talked about reaccelerating of year-over-year growth, but can you talk sequentially how much seasonality factors into that for the June quarter and where it is at and also how the comparisons look versus a year ago?

Tom Lynch - Chief Executive Officer

I think from Q2 to Q3 sequentially versus year-over-year, Steve, it's not so much a seasonality. We had... business was really strong in Q1, particularly at the end of Q1. We expected a little bit of slowdown in Q2 and now our orders have been solid through Q2 and we expect that to go back to the 5% to 6% range in Q3 and for the year, we expect that to run in that range. So, very, very strong growth in China, in particular. Feel like we're gaining share and we're strong in the Japan market and with the new products we've launched in last year, we're growing faster than the market there. We are strong in Korea although that market has been a little slow. You know the U.S. story. And Europe has been pretty solid and we continue to... we think Europe will be a little slower in the second half for automotive than the first half but still going to be solid and third quarter will be better than second quarter.

Steven Fox - Merrill Lynch

Great. And then just to make sure I'm clear, so, the catch up you did in the Carolinas, I guess, last quarter you said you were a little bit behind than where you're planned to be. So, is the restructuring all done in the Carolinas for those three plants having been consolidated?

Tom Lynch - Chief Executive Officer

It's largely done. We're still not running at the productivity level that we would expect to. Now part of that is because the market is down so much. But part of it is because we're just not where we should be but we are doing a little bit better than we did in first quarter, which was better than we did in the fourth quarter of last year. So we're making progress.

Steven Fox - Merrill Lynch

And then, last question on restructuring. So, can you give us an update on plans for Europe? Is there anything that we should be focusing on for second half of the calendar year in terms of accomplishments over there?

Tom Lynch - Chief Executive Officer

No, we can't, as you know, we can't get specific because of the requirements of all these things but if you... we're still estimating that we are going to spend about $130 million for the year. We spend roughly $50 million in the first half of the year and the fourth quarter will be more significant than the third quarter.

Steven Fox - Merrill Lynch

I guess, what I was getting at Tom is there any... in your full-year guidance, now does that have some improvements in Europe from restructuring?

Tom Lynch - Chief Executive Officer

Not significant.

Steven Fox - Merrill Lynch

All right. Thank you.

Tom Lynch - Chief Executive Officer

You are welcome. Thank you.

Operator

And we'll go next to the line of Shawn Harrison with Longbow Research. Please go ahead.

Shawn Harrison - Longbow Research

Hi, good morning. Looking at the Undersea Telecom business, I guess, if you can provide some additional visibility into potential order trends beyond the $1 billion backlog. Is this the peak we're looking at right now and maybe what are you seeing into the back half of '09 and what should margins look like at that point in time?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Shawn, it's Terrence. When you look at the back half of '08, I said the $250 million and $225 million. Certainly order and activity remains robust. We're benefiting this year from the China project called TPE. So this year, when you take where we've been plus the next two quarters, we would be in excess of about $1 million of revenue this year. I would say that that is... it does benefit from that China project. We still see good order activity but right now, I don't think we would expect it to be $1 billion of revenue next year. That's what we see right now.

Tom Lynch - Chief Executive Officer

Just a couple of points to add to that China. I think, clearly if you go back where we expected this business six months ago is stronger than we thought. Really, three or four drivers there, redundancy for systems particularly in Asia, which really didn't have redundancy and if you recall there was an earthquake a couple of years ago of the Taiwan that had some damage, just more bandwidth in Asia because of Internet usage. And business that's always been kind of on again, off again in Africa, in the Middle East, particularly Africa, a couple of systems have started to happen, they've got funding, they've made deposit. So there is clearly more activity. It's hard to gauge visibility beyond '09 right now and that's one of the things we're working hard at a couple of these projects definitely kind of popped up unexpectedly. The good news is we are pretty well positioned with our combination of our technology and our shift infrastructure but I would say, it's pretty hard. We don't expect '09 to be as good as '08. We do expect it to be solid and beyond there it's hard to gain visibility right now.

Shawn Harrison - Longbow Research

If revenues were declined to may be $175 million run rate in the business, what should we expect operating margins to look like?

Tom Lynch - Chief Executive Officer

Low to mid double digits, so probably more like a 12 to 13 verses where it is today. Since we have scaled the business after the Telecom bubble where this type of business activity, I would tend to think, will be in that 12 to 13 range if you're at your $700 million number annually that you quote.

Shawn Harrison - Longbow Research

Okay. SO not much degradation?

Tom Lynch - Chief Executive Officer

No.

Shawn Harrison - Longbow Research

Follow-up question, just on the share repurchase activity, maybe I missed this, but what are you expecting to do during the third quarter, do you expect to finish the plan by the end of the year and what's the likelihood of saying another share-repurchase authorization of a similar size once this is completed?

Terrence Curtin - Executive Vice President and Chief Financial Officer

As we've said, Shawn, we're going to exercise share repurchases at excess capital and that's what we have been doing. So how we exercise the plan really will be a function of our cash generation and whether we have another strategic use for the cash. So we have been exercising under the program as we had very strong cash flow when we came out of last year with excess capital. Where we are now, it's really how we generate cash and how cash comes in will be how fast we look at the program, where something else come from.

Tom Lynch - Chief Executive Officer

And this is obviously a program we review on a regular basis with our Board as we did. In the last Board meeting, they approved the $0.5 billion increase, so I think we need to get through Q3 and see how things are shaping up and see what other options we have and we will go from there which is pretty much the way we've been approaching it.

Shawn Harrison - Longbow Research

I guess that poses a follow-up in terms of acquisition activity. With the divestitures winding down, where are you at right now in building up maybe the potential pipeline for acquisitions?

Tom Lynch - Chief Executive Officer

We are beginning to build up a pipeline. Our priorities still are number one tighten up the operational performance of the company and while we're pleased with the progress we made over the last year, I don't think, you'd find anybody in our company who believes we're anywhere near hitting on all cylinders there. So that's still number one priority and in conjunction with that, continue to make sure, we focus the business and are really driving the products and businesses that make sense for us. So we have put more attention towards building a pipeline in selected industries with selected products. But I don't think you'd expect to see anything from us in the near term, next quarter or so.

Shawn Harrison - Longbow Research

Okay, Thank you.

Tom Lynch - Chief Executive Officer

Thank you.

Operator

We'll go next to the line of William Stein with Credit Suisse. Please go ahead.

William Stein - Credit Suisse

Great. Thanks. You spoke a little bit about capacity restructuring in the Carolinas and addressed the question in Europe. Can you remind us where we are in that process overall, what the plan was as of the spin and where we are today in terms of number of facilities?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Sure. Thanks Will. About a year ago, we estimated that based on everything we wanted to do at the time, we saw this being in the range of $500 billion builds to do this restructuring with about a three-year payback. The plan really kicked in the fourth quarter of last year when we did $40 million to $50 million. So we are about $100 million to $120 million in it pretty much about where we have expected, there has been in that period of time about 21 since we have announced. Some are large, some are small, some are medium and then as I mentioned earlier this would be an ongoing thing for the next couple years. So, still a fair amount of work to do for sure.

Tom Lynch - Chief Executive Officer

The one thing I would add to that, when we announce an action it does take for a sizable action about a year to execute on. So there will be some delay in savings from execution announcement and getting through. So that is one thing that I want to make sure you understand

William Stein - Credit Suisse

21 actions but not 21 plant closures, in other words.

Tom Lynch - Chief Executive Officer

Correct. And those could be migrations of product lines where the facility would still be in place.

William Stein - Credit Suisse

Okay, great. Next, I am wondering if you can remind us of the distribution strategy in Components. I think there has been an adjustment there during last quarter. Any comments you can make on plans for distribution there?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Sure, about 15% of our total business goes through distribution and that is really in our Components in our Networks business. Yes, we did... we went through an assessment of our effectiveness in the channel for about three months with our various business leaders and then recently we have announced a new position in company of Vice President of Global Distribution who reports into, [inaudible], the new Vice President of Marketing and our goal there is to become more effective through the channel. I would say, we do a decent job. We have a long history there. We are well represented, but there are clearly opportunities to put it into the operational execution category for us to do better through that channel and through our each channels. So that's what we recently announced to our distribution channel partners.

Matthew Sheerin - Thomas Weisel Partners

Appreciate it. One more quick follow-up, if I can, can you remind us of how raw materials might be impacting the Network Solutions business? I think there is a lot of copper that flows through there, correct me if I am wrong, but I'd like to know what the margin impact might have been in the quarter and how you think about that, how you manage it?

Tom Lynch - Chief Executive Officer

Our Network Solutions, well, we serve three markets, as you are aware, communication service provider, the energy and power utility as well as building networks. Really where metals impact the markets the most is really in our building networks, where we actually sell cabling. I mean that... in that market we actually have the ability to pass on copper prices. So, while it does impact us, we are able to pass that through. So it really doesn't have any impact on overall operating income.

Matthew Sheerin - Thomas Weisel Partners

Great, thanks very much.

Operator

We will go next to the line of Ajay Kejriwal with Goldman Sachs. Please go ahead.

Ajay Kejriwal - Goldman Sachs

Good morning, gentlemen.

Tom Lynch - Chief Executive Officer

Good morning, Ajay.

Ajay Kejriwal - Goldman Sachs

Maybe just a quick follow-up on the automotive business in North America, 17% decline in revenues. Wondering if you could pass out [ph] what was volume versus pricing and also may be a... if you could relate that to the underlying production cuts that you're seeing in North America. To me it looked like a little more than production cuts. So, wondering if there was any inventory draw down or any issues with the restructuring or consolidation that you have mentioned.

Tom Lynch - Chief Executive Officer

Sure. Thanks, Ajay. The vast majority of our issue is volume, although I will say that is the market where we are being more selective outside of the Connective productive line. We love the Connective product line and we would be more selective outside of that. So, we did decline with the North America suppliers a little more than they had production, which I believe is in the 11% to 12% range.

Ajay Kejriwal - Goldman Sachs

So, the decline more than the production cuts was because of non-core product lines, is that a right way to think about it?

Tom Lynch - Chief Executive Officer

That's the right way to think about it.

Terrence Curtin - Executive Vice President and Chief Financial Officer

And just to add to what Tom said, the other thing there is the mix of customers. The big three production was down more than overall production in North America. That number was more like minus 15. The most of our business in the U.S. is related to the big three and our mix of business within the big three also had some impact on that decline as well.

Ajay Kejriwal - Goldman Sachs

Got it. So, in terms of your expectations for the second half, I know, you mentioned overall for the business you expect mid-single digit but if you could help us with what are your expectations for North America auto?

Tom Lynch - Chief Executive Officer

I would say running similar to the rate we're at. We are not... we're certainly not baking in or expecting any recovery in the second half.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Ajay, if you look at production for the year is going to be down including all manufacturers, not just big three, it is going to be down 5% for the year in the latest JD Power and that's our expectation based upon where our businesses with that production.

Tom Lynch - Chief Executive Officer

And I think the comps get easier as you get further into the year.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Right.

Tom Lynch - Chief Executive Officer

So, without things improving the percentage decline may not be quite as large.

Ajay Kejriwal - Goldman Sachs

Got it. Maybe, just a question on the guidance, and if you could help me with the numbers here, $0.13 increase midpoint versus what you were previously. So, how much of that is from a lower tax rate now? You said, you're looking at 36% in the second half, first half was obviously much lower, so if I do my math correctly, the lower tax rate is about $0.08. Is that about correct or it there a different number?

Tom Lynch - Chief Executive Officer

That 's a little heavy. Let me give you a little bit of a walk here and then Terrence can talk about taxes. So about 6% of the improvement is what we did in Q2. Then you have to back out the business that we discontinued which had $0.04 in our full-year and then we picked up about a little bit of improvement across the other business of about $0.05, $0.02 to $0.03 for Undersea Telecom, $0.03 to $0.04 for foreign exchange. That'll give you rough idea. We did get benefit in Q2 for tax. Now let Terrence talk to that.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Ajay, the tax benefit we have for the year really relates to what we saw in quarter two as we were guiding to a 36% to 37% for the year at the low end. But that was really $0.03 here in the quarter, may be in your $0.08 you're not including the other income impact as that is also coming down which when I talk tax includes also the other income reduction that we are seeing as well which will be a negative.

Ajay Kejriwal - Goldman Sachs

Okay, so that net effect of tax and other income is the $0.03 to $0.04?

Terrence Curtin - Executive Vice President and Chief Financial Officer

$0.03, yes.

Ajay Kejriwal - Goldman Sachs

For the full year?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Yes.

Ajay Kejriwal - Goldman Sachs

Great. Thank you.

Tom Lynch - Chief Executive Officer

You are welcome.

Operator

And we go next to the line of Carter Shoop with Deutsche Bank. Please go ahead.

Carter Shoop - Deutsche Bank Securities

Good morning, guys.

Tom Lynch - Chief Executive Officer

Good morning.

Carter Shoop - Deutsche Bank Securities

Wanted to first clarify something on the computing division within Components where we're continuing to walk away from businesses there or that comment more regarded on the year-over-year impact?

Tom Lynch - Chief Executive Officer

That's primarily year-over-year. I think we're... I don't see any more significant tuning there. I mean, we kind of think of our computing businesses tree in big block, laptop, desktop and server storage. We like the server storage space, we like the most of the laptop space, the desktop has really become a commodity and we've been retrenching from there and our share is down significantly in that space.

Carter Shoop - Deutsche Bank Securities

Moving over to the handset markets, can you discuss where you're gaining share, not necessarily by customer or by region but rather buy product, type of connector, just to clarify?

Tom Lynch - Chief Executive Officer

Well, I'd just say the share gains mostly in the connector space and we've introduced some new products around battery connectors, which have been pretty successful. So that has helped us. And we've grown our customer base for a long time. We are kind of re-energized in that business with Japanese handset makers, the we move to the Korean handset makers, and then we move to the European handset makers, though there is opportunity for us there to grow and we're pretty bullish about our prospects to continue our momentum in this category.

Carter Shoop - Deutsche Bank Securities

When I think about the handset market I think of it becoming increasingly commoditized like the computing market and I know there is a lot of different connectors that go into handset and some of the antennas and hence connectors are a little bit less commoditized than others, but what is your view longer term for that market and in regards to growth and why is it so important for you guys to be a larger player in this market?

Tom Lynch - Chief Executive Officer

Well, it's 1.1 billion units a year. So it's a very big market, I'd say that it is very different from the computer market and I expect it to largely stay that way because increasingly the way the handset makers compete is through design. And design means differences in the way the phones look. Of course the other thing that's helpful is as you jam more features in into the footprint of a particular handset design, you need the connectors to be able to work within that footprint. So there still is an awful lot of customization, in fact I think it's much as there has ever been, if not more customization in those markets. And as you start pumping through higher data rates you need more sophisticated antennas. You'll probably see an evolution to fiber optic connectivity in there with higher data rates. So there is a lot of innovation obviously by our customers and that means we need to stay with this. So that's why we are bullish.

Carter Shoop - Deutsche Bank Securities

Moving up a little bit, can you discuss your longer-term outlook for organic growth within the Components division, maybe over the next kind of three to five years, how do you think about that?

Tom Lynch - Chief Executive Officer

I still think it's in the 5% to 7%, 6% to 8% range as we laid out our three-year goals last year. We talked about 5% to 7% growth range and that deals make a balanced rate of growth given our size in the market and given the market's historical growth rates and given where we see, increase in electronic and certain categories. For example, as you put hybrid systems in the cars, you have a significant increase in connectors at the same time we've been backing off on the commodity side. So I think 5% to 7% feels like the rate... growth rate for our business and I think there is, as we continue to improve operationally, there is a good deal of operating leverage that will come with that.

Carter Shoop - Deutsche Bank Securities

Great. Two more quick questions, if I may, in regards to the State of New York contract and the testing at the State level, can you help us better understand if there is any risk associated with that testing or if it's more a matter of [inaudible]?

Tom Lynch - Chief Executive Officer

Well, I'd say with any big system, there is always risk and until you get that final sign off you don't have it. Having said that, I have been really pleased with our test results, the test results we get on call quality, which is really, really important of course in that industry have been the best we've ever seen and the State was very, very demanding and was really setting a new standard, not only for interoperability and for the ability for calls to be maintained when a fireman or a policeman is going five storeys down in a building which historically has been a problem in that industry.

A bar was being raised and the coverage rates was being raised and we just completed three or four months of very, very expensive testing in the first two regions and did very well. The second phase of that as we turn it over to the customer and they go through two phases of testing and right now that testing is showing consistent results with our testing. So we feel good. First we've been working on the system for a couple of years. So we are anxious to get the first one up and running. The customers we deal with, I think, are really getting excited about bringing the first region on, but there is still timing risk, although I think it's slow right now. I really do, I think with everything we've progressed through in the last three to four months, our risk is down, but until we get that final sign off and turn it on and send the bill and get paid, we will still be a little bit anxious.

Carter Shoop - Deutsche Bank Securities

That's helpful. In regards to the wireless division and being able to sell that to other states, are we getting to the point now where you can use this as a selling or marketing point to other jurisdictions or do we need to wait until the system is up and going before we can really leverage the work that you guys have done here in the State of New York?

Tom Lynch - Chief Executive Officer

Two things. Yes, we have been definitely using it and in the sense that one it's marked [ph] key customer and we bring people and to see that as well as by the way the State of Pennsylvania, which we completed over the last couple of years. And other thing is the system itself, which is pretty robust and has... it really has the state-of-the-art features for the early responders. It is being pretty well received out there. There are, in the last couple of quarters the orders in this business have been two of the best we've had ever. And I think we are on the verge of taking the business to another level because of New York, but also that's going to benefit us in other areas. We have to obviously deliver that into results. But I feel the best about this business for sure the two years I've been here.

Carter Shoop - Deutsche Bank Securities

Great. Thanks a lot and congratulations on a good quarter.

Tom Lynch - Chief Executive Officer

Thank you.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Thank you, Carter.

Operator

And we will go next to the line of Yuri Krapivin with Lehman Brothers. Please go ahead.

Yuri Krapivin - Lehman Brothers

Good morning.

Tom Lynch - Chief Executive Officer

Good morning, Yuri.

Yuri Krapivin - Lehman Brothers

I wanted to ask you another question about your raw material exposure, so I believe you effectively hedged your corporate exposure probably at around 350 per pound through the end of June via some of the contracts with your suppliers. Obviously currently the copper is about 350. So what are your plans in that regard? Are you planning to rollover those contracts through the end of the calendar '08?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Yuri, it's Terrence. We have been actively fixing with our suppliers and we, at this point, have in excess of 50% our requirements fixed through the end of our fiscal year right now. We will continue to evaluate what copper is when we look at going into next year, but our guidance includes the copper rate where it is at right now, 390 plus what we expect.

John Roselli - Vice President, Investor Relations

And just to add what Terrence said, Yuri, it's John. Gold is not an area where we are doing any hedging. So we're up year-over-year significantly on the pricing of gold and that is something that's been absorbed in our numbers. So when we talk about headwind it's really more of a gold discussion now than it is copper.

Yuri Krapivin - Lehman Brothers

Okay, well that side are you planning to hedge gold?

John Roselli - Vice President, Investor Relations

We have not yet, we will continue to evaluate that, Yuri.

Yuri Krapivin - Lehman Brothers

Okay. And then my other question has to do with this other category within your Electronic Components segment. So the other piece, I think, comprises about 25% of the total segment and the growth rate there has been fairly lackluster for the rest... for the last several quarters and it looks like that other categories sort of consistently and it deforms the overall segment growth rate. So could you comment please on what do you have in that other category and what's happening there?

Tom Lynch - Chief Executive Officer

Sure, that's primarily our sales through distribution, Yuri. And that business has been relatively flat overall for the last year, I think largely reflecting market conditions and inventory in the channel. But I mean clearly we see there as an opportunity as I mentioned earlier for us to improve. That's what primarily in that 25% number.

Yuri Krapivin - Lehman Brothers

Okay, thank you. And finally, you took a charge in the quarter for the litigation segment with the State of New Jersey, any other potential settlements that you see on the horizon that could trigger charges?

A - Terrence Curtin>: Hi, Yuri, it's Terrence. When you look at the charge in the quarter, as you are aware [inaudible] responsible of the two-shared things as a result of shareholder lawsuits from the [inaudible] taxes. What we did last year was big class action settlement of $3 billion was finalized here in February and that's out. We have some opt-outs [ph] in that. State of New Jersey was part of that which continues to move that item, but there are a handful of other cases that were normal and overtime we could see some charges, but right now we have to defend our position on those, but [inaudible] there could be some other small charges.

Yuri Krapivin - Lehman Brothers

Okay, great. Thank you.

Tom Lynch - Chief Executive Officer

Thank you.

Operator

And our final question will be from the line of Amit Daryanani with RBC Capital Markets. Please go ahead.

Amit Daryanani - RBC Capital Markets

Thanks. Guys, couple of follow-ups on, could you just talk about what sort of lead times are you getting from your customers on the Components side, but really the connector side especially? One of your peers actually talked about visibility shrinking to two weeks or so on their call, so, could you just talk about that?

Tom Lynch - Chief Executive Officer

Our typical lead-time, I think, when you average is about a month. That really hasn't changed too much and of course it depends by end market. But we haven't seen any significant change there.

Amit Daryanani - RBC Capital Markets

All right. And then I may have missed this, but I know you guys bought 10 million shares up until the end of March quarter, could you just talk about how much you bought so far in the June quarter?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Yes, when you look at the June quarter since [inaudible] exhausted the first authorization to 750 basically is where we are at right about now.

Amit Daryanani - RBC Capital Markets

About 100 million incremental from June?

Terrence Curtin - Executive Vice President and Chief Financial Officer

Correct.

Amit Daryanani - RBC Capital Markets

All right. And then just finally, I think there was a press release out a few days ago on the $4 million settlement you had with the State of New York. Just to clarify that has nothing to do with the State of New York project, which you guys are underway right now, correct?

Tom Lynch - Chief Executive Officer

That's correct. We have been supporting, serving the state of New York in public safety for a long, long time and that was something we said is related to prior business.

Amit Daryanani - RBC Capital Markets

Perfect. Thanks.

Tom Lynch - Chief Executive Officer

You're welcome. Thanks, Amit.

John Roselli - Vice President, Investor Relations

Okay, we have no further questions?

Operator

Speakers, back to you. We have no questions.

John Roselli - Vice President, Investor Relations

Okay, great. Well, thanks everyone for joining the call. Keith Kolstrom and myself will be around for the rest of the day with any other questions.

Tom Lynch - Chief Executive Officer

Thank you.

Terrence Curtin - Executive Vice President and Chief Financial Officer

Bye-bye.

Operator

Ladies and gentlemen, that does conclude our conference call for today. Thank you for your participation and for using AT&T's Executive Teleconference Service. You may now disconnect.

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