Tyco Intl. Ltd. mini-case

(Free Cash Flow)

Following is the press release announcing 2001 fiscal year (September) results for Tyco, Ltd. The company announced strong earnings growth and cash flows of $4.75 billion for the year. Free cash flows have become an increasingly more important indicator of corporate performance in the wake of earnings scandals. Defined basically as net cash flow from operations less capital expenditures (there are several variants), free cash flows figure prominently into security valuation as the flows discounted to arrive at estimated stock price in DCF models.

Cash flows are generally viewed as unquestionable and incapable of manipulation. While it true that cash cannot be manufactured, companies can and do move it around in the statement of cash flows. As a result, operating cash flows reported in proforma earnings announcements may neither represent the actual cash flows of the company, nor may they reflect the true cash flows from operations. This mini-case is designed to give you a deeper understanding of proforma earnings announcements. The bottom line is this: read the fine print.

Instructions:

  1. Read the earnings announcement from Tyco’s 2001 fiscal year end. Pay close attention to the areas I have highlighted.
  2. Examine the excerpts from the Tyco 2001 10-K.
  3. How does Tyco arrive at its $4,740.2 million of free cash? How does Tyco arrive at its starting value of $7,623.5?
  4. What adjustments might you consider to Tyco’s free cash flow number if your objective is to accurately forecast future free cash flows for valuation purposes? (hint: look at the footnotes to the free cash flow computation table.)
Press Release

TYCO INTERNATIONAL REPORTS 86 CENTS PER SHARE, A 34 PERCENT INCREASE IN FOURTH QUARTER EARNINGS PER SHARE BEFORE ACCOUNTING RULE CHANGES AND OTHER NON-RECURRING ITEMS

FREE CASH FLOW REACHES $1.7 BILLION FOR THE FOURTH QUARTER AND $4.75 BILLION FOR THE FISCAL YEAR
FISCAL 2001 REVENUES RISE TO RECORD $36.3 BILLION
Pembroke, Bermuda, October 18, 2001 -- Tyco International Ltd. (NYSE-TYC, BSX-TYC, LSE-TYI), a diversified manufacturing and service company, reported today that diluted earnings per share for its fourth quarter ended September 30, 2001 were 86 cents, a 34 percent increase over earnings of 64 cents per share for the same quarter last year. Revenues for the quarter rose 29 percent to $10.1 billion compared with last year's $7.8 billion. These results are before non-recurring charges and credits, extraordinary items, and the adoption of Staff Accounting Bulletin No.101 (SAB 101). After giving effect to such items, diluted earnings per share for the fourth quarter of fiscal 2001 were 70 cents, compared to $1.12 in the fourth quarter of fiscal 2000. Included in the prior year's $1.12 is 59 cents resulting from a gain on the issuance of shares by subsidiary.
For fiscal 2001, income before non-recurring charges and credits, extraordinary items, and the adoption of SAB 101, rose to $2.81 per diluted share, a 29 percent increase over last year's diluted per share earnings of $2.18. After giving effect to such items, diluted earnings per share were $2.17 for fiscal 2001 compared to $2.64 in fiscal 2000. Included in the prior year's $2.64 is 59 cents resulting from a gain on the issuance of shares by subsidiary. Revenues for the twelve months increased to $36.3 billion, 25 percent higher than last year's $28.9 billion.
"Tyco's diversified mix of businesses once again showed that we can indeed continue to grow through both good and bad economic environments," said L. Dennis Kozlowski, Chairman and Chief Executive Officer of Tyco.
"In this tough environment, I am pleased to report that our mix of businesses continues to perform very well. Included in our business mix are businesses such as Healthcare, Fire and Security, and Tyco Capital, which are less affected by economic conditions and can provide consistent results and outperform in difficult times. Additionally, strong cash flow generation throughout all of our businesses funds further investment in these businesses and provides the means to opportunistically expand them as circumstances allow. We have taken immediate cost reduction actions in our Electronics business, which will allow us to continue to deliver strong earnings results despite weak end markets and will position us ahead of the curve in taking advantage of eventual economic recovery."
TyCom Ltd.'s (NYSE:TCM;BSX:TCM) overall revenues decreased due to delays in timing on third-party systems projects and capacity sales on the TyCom Global Network. At the same time, margins increased due to project completions and certain reduced accruals required due to lower profitability levels for the fiscal year and certain contractual settlements.
On the capacity side, the TyCom Transatlantic system now has 400 gigabits of capacity lit, with nearly 50% of this allocated to customers. TyCom is ahead of schedule on a planned upgrade to 560 gigabits. As previously announced, Tyco has offered to acquire the outstanding 11% minority interest in TyCom.
Revenues for the quarter reflected improved lending margins and strong fee generation. Equipment lending and leasing volumes were flat sequentially, while commercial finance volumes were strong as a result of tighter bank lending and demand for restructuring financing. Factoring volume was also up for the quarter as a result of seasonal increases. Margin improvement reflects lower short-term interest rates, tighter market liquidity and the sale of non-strategic assets. Including today's announced sale of the recreational vehicle portfolio, asset sales for the year now exceed $5 billion. Credit losses and reserves trended up slightly, principally as a result of a weaker economy.
FREE CASH FLOW
Free cash flow, excluding operating cash of Tyco Capital and before spending of approximately $940 million related to the TyCom Global Network, was approximately $1.7 billion in the fourth quarter of fiscal 2001. For the fiscal year, free cash flow was approximately $4.75 billion, which represents 92 percent of income before non-recurring charges and credits, the adoption of SAB 101, and extraordinary items. Included as a reduction of operating cash flows in the quarter is $102 million and in the fiscal year is $216 million, related to cash spending on restructuring and other non-recurring items. Tyco refers to the net amount of cash generated from operating activities, excluding those of Tyco Capital, less capital expenditures (excluding spending related to the TyCom Global Network) and dividends as "free cash flow."
In addition, the Company paid out in cash $299 million during the quarter and $766 million during the fiscal year, related to purchase accounting spending. Free cash flow is calculated before these expenditures.
Tyco is reiterating its earnings per share guidance for fiscal 2002 of $3.70, in a range of $3.50 to $3.90. The earnings range reflects uncertainty about the near-term outlook for the Electronics end markets. While we see likelihood of further weakness within these end markets, our incremental cost reduction actions are designed to allow us to achieve our earnings target. Guidance for the first quarter of fiscal 2002 remains $0.72 per share. This guidance includes the impact of SAB 101 and SFAS 142.
CONFERENCE CALL
The company will discuss fourth quarter results on a conference call for investors today at 8:30 am EDT. Interested parties, including investors of TyCom Ltd. (NYSE:TCM;BSX: TCM), may access the conference call live today, or by replay through October 25, 2001, at the following website: investors.tycoint.com/medialist.cfm.
Tyco International Ltd. is a diversified manufacturing and service company. Tyco is the world's largest manufacturer and servicer of electrical and electronic components; the world's largest designer, manufacturer, installer and servicer of undersea telecommunications systems; the world's largest manufacturer, installer and provider of fire protection systems and electronic security services and the world's largest manufacturer of flow control valves. Tyco also holds strong leadership positions in medical device products, financing and leasing capital, plastics and adhesives. Tyco operates in more than 100 countries and had fiscal 2001 sales of approximately $36.3 billion.
FORWARD-LOOKING INFORMATION
This release contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may vary materially from the expectations contained in the forward-looking statements. The forward-looking statements in this release include statements addressing the following subjects: future financial and operating results and timing and benefits of acquisitions.
Economic, business, competitive and/or regulatory factors affecting Tyco's businesses are examples of factors, among others, that could cause actual results to differ materially from those described in the forward-looking statements.
More detailed information about these factors is set forth in Tyco's filings with the Securities and Exchange Commission, including Tyco's Annual Report on Form 10-K for the fiscal year ended September 30, 2000, TyCom's Annual Report on Form 10-K for the fiscal year September 30, 2000, Tyco's Annual Report to Shareholders and CIT's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. Tyco is under no obligation to (and expressly disclaims any such obligation to) update or alter its forward-looking statements whether as a result of new information, future events or otherwise.

Excerpts from Tyco’s 2001 10-K:

BH note: there is a $15.3 difference between the $6,186.8 referenced in this table and the $6,202.1 referenced in the income statement as operating income.