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Online Extra: For Breen, "A Heck of a Foundation"


Since Edward Breen took over from the disgraced L. Dennis Kozlowski in August, 2002, as CEO of Tyco International (TYC), he has been busy trying to overcome the accounting, ethical, and governance scandals that have tainted the company and deeply depressed its share price. On May 6, Breen talked with BusinessWeek Boston Bureau Manager William Symonds about the progress he has made so far, why Tyco's accounting is still under scrutiny, and the challenges he sees ahead in what he calls a "transition year." Following are edited excerpts from their conversation:

Q: How would you assess where you are in your efforts to turn Tyco around?

A: I would put it this way: Every week and month that goes by, we're knocking off more of the issues [that faced this company when I arrived]. If you look at the concerns people had eight months ago, we've addressed a lot of them.

The reason I was so excited to come to Tyco is that the underlying foundation is so strong. If you look across our portfolio, we're in good businesses for the next 5 to 10 years. Look at health care, for example: With the aging population, it should grow way above GDP. And in the industries we serve, we're the No. 1 or 2 player. This is a portfolio that you don't create overnight.

Q: Still, Tyco's earnings have fallen sharply from where they were a couple of years ago. On Apr. 30, you reported a net loss of $468 million, which included accounting-related charges of about $1.1 billion.

A: [Setting aside the charge for the moment,] our operating results for this quarter were where we wanted to be. Our revenues were up 4% [to $8.6 billion] on a year-over-year basis. And we're showing the marketplace that we can generate a lot of cash. We've had two definitions of cash flow. Under the new definition [adopted in March], we generated $833 million in free cash flow this quarter -- which is way above what was forecast. That's a heck of a foundation.

Still, this is a transition year. We're showing where baseline earnings are. Right now, we're facing difficult market conditions. But we're solid, and we will generate a lot of cash going forward.

Q: Why have so many accounting problems surfaced since last December, when attorney David Boise produced an in-depth report that many observers believed would be the final word on Tyco's accounting?

A: What we did was continue aggressive auditing [of Tyco's books] after [the Boise investigation ended]. We're trying to go through the balance sheet of every company and accounting center that we have. We have reviewed 2,154 separate balance sheets. Now we have done the balance-sheet review of 100% of our entities, and we're going back and verifying all of our work. We're about 85% through the verification process.

Q: Your critics worry that the Securities & Exchange Commission -- which is still conducting a review of Tyco's accounting -- will require you to restate your earnings.

A: We've been working very closely with the SEC and are in constant communication. They have to verify the work that we did. We assume that we will close that process this quarter. As for a restatement, we've done the analysis, and we don't see that as being needed. But the SEC will have to sign off on that.

Q: Many critics also argue that the $26 billion worth of goodwill on Tyco's books -- built up during the acquisition spree -- is way overblown and will have to be written down.

A: We did an analysis four-five months ago, and there was no goodwill impairment. We owe our next analysis at the end of June. But if you go through the numbers, the goodwill is supported by the numbers.

Q: Another big concern centers around Tyco's taxes. In the Kozlowski era, Tyco was one of the most aggressive companies in avoiding taxes by moving income offshore. Will the ongoing IRS audit now require you to pay huge sums in back taxes?

A: The tax audit is still in the preliminary stages. It started about 60 days ago and will be fairly lengthy. They're looking at our taxes from 1997 [when Tyco moved to Bermuda] forward. It will be a long process. But we have a new head of tax at Tyco. He has already been through [the prior years' returns]. We're very comfortable with it, and I don't expect [any penalties or back taxes] to be significant.

Q: Tyco is also facing many lawsuits from shareholders who lost money as a result of the some $90 billion drop in Tyco's market value since the beginning of last year. Some warn that Tyco will have to pay billions of dollars to settle these.

A: I expect the shareholder suits will be consolidated into one class action. I can't comment on it [beyond that], since this is a legal issue. But the timeline [for resolving these suits] is probably pretty lengthy and won't be this year.

Q: Some analysts argue that you should sell some significant businesses -- such as ADT -- to raise cash, so that you'll be better able to deal with all these problems.

A: We're not planning on doing that. Any sales of assets would take place because they don't fit [into our portfolio]. But we won't sell any major units, and [any units we sell will together] amount to less than 10% of our sales of $36 billion. You have to put the risk factors into context. We can generate good amounts of cash, so it won't be necessary to sell a major unit.

Q: Clearly, Tyco's days as one of the nation's most acquisitive companies are over. So what kind of growth do you expect to achieve without the added fuel of takeovers?

A: Going forward -- and this is very doable -- we can grow revenues 4% to 6% a year and grow our bottom line 10 to 12% a year, over the next 3 to 5 years.

We have also put in place a lot of Six Sigma cost initiatives that will drive a lot of cost savings. We're very focused on those initiatives, which will improve margins. So we should be able to grow those quite nicely.


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