Tyco: The Long Haul

Cleaning out the executive suite, and identifying breakdowns in financial control, are a start; now Tyco must adhere to a long-term blueprint for change. One in a series of ''corporate cleanup'' profiles.

By one measure, Dennis Kozlowski helped clean up Tyco International. The indicted ex-CEO gave laser-sharp focus to his successor, making it easy for new CEO Edward Breen to identify his top remediation task: restore investor confidence by exorcising Kozlowski’s inner circle.

Breen, formerly president of Motorola, wasted little time. Immediately following his July 2002 appointment, he ousted about 50 executives who worked for Kozlowski — as well as the entire board that had hired Breen himself. Breen then assembled his own clean team, installing nine independent directors (Breen, the chairman, is the tenth), bringing aboard former United Technologies CFO David FitzPatrick as Tyco’s new finance chief, and hiring Eric Pillmore, former CFO of Multilink Technology Corp., as chief governance officer.

Breen displayed good governance know-how, say experts, by having Pillmore answer to the board’s nominating and governance committee, rather than another C-level executive. Tyco management maintains that the reporting structure, which they believe is unique, bolsters the board’s oversight power.

Breen’s mighty, swift sword encouraged interested observers. As brand expert and Lippincott Mercer senior partner James Bell tells it, Tyco is a capital markets brand, not a consumer brand, so cleanup efforts had to start with distancing the new Tyco from the old, corrupt Tyco.

Indeed, the Tyco tarnish was heavy. In January 2002, an in-house probe revealed major breakdowns in financial controls, including transparency problems in the plastics division and suspect operating income, related to dealer accounts, at the ADT unit.

Eventually Kozlowski and former CFO Mark Swartz resigned after being indicted on personal tax evasion charges — but not before the duo allegedly pilfered $600 million from the company. Federal charges chronicled lavish living by Kozlowski and his lieutenants at the expense of shareholders. The main offenses: abuse of executive loan programs, self-dealing transactions, unapproved bonuses, unauthorized pay, and fraudulent stock sales.

In short order, Breen expanded the ongoing internal audit into a full-scale, independent investigation that kept 25 lawyers and 100 accountants busy for five months. The forensic team uncovered breakdowns in the control processes associated with executive compensation, and problems with reported revenues, profits, cash flows, use of reserves, and non-recurring charges, among other financial shortcomings.

So far, several repair measures have been implemented, says a Tyco spokesman Gary Holmes, including splitting up the plastics group into two reporting segments, changing the definition of free cash flow to include cash paid for the acquisition of new dealer accounts, detailing free cash flow by reporting segment, and providing details of how “organic growth” is calculated.

Planning for the Long Term

Recall that growth at Tyco under Kozlowski and Swartz was anything but organic. It was a “smash and grab mentality,” says research analyst Brian Langenberg, a principal at Langenberg & Co in Chicago. “The focus was to make short-term gross margins, and they did,” but Kozlowski and Swartz never wanted to spent time on integrating companies to extract efficiencies, says Langenberg. “They weren’t hitting their numbers the right way.”

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