ADT 2003 Annual Report Download - page 119

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Changes in Estimates Recorded During the Quarter Ended
March 31, 2003 During the quarter ended March 31, 2003, the
Company intensified a process whereby internal audits and
detailed controls and operating reviews were conducted. As a
result of this process, the Company recorded $388.7 million of
pre-tax charges relating to new information and changes in
facts and circumstances occurring during the quarter. The
process included assessing the continued recoverability of assets,
including accounts receivable, inventory and installed security
systems and equity investments, and the estimated costs of set-
tling legal, environmental and insurance obligations. The
assessments were based on an analysis of the impact of circum-
stances that occurred during the quarter and on our assessment
of the recoverability of certain assets and costs to settle certain
liabilities. The assessments include changes in judgments relative
to the adequacy of reserves and contingent liabilities. Concurrent
with this review process and resulting assessments by manage-
ment during the quarter, we decided to discontinue existing
product lines and terminate an information technology sys-
tems implementation project. As a result of these decisions,
inventory and other asset balances were written down to their
net realizable value.
The impact of the $388.7 million of net charges recorded in
the second quarter and included in the Consolidated Statement
of Operations for fiscal 2003 is as follows:
Cost of sales $(110.5)
Selling, general and administrative expense (243.1)
Restructuring and other credits (charges), net 59.6
Charges for the impairment of long-lived assets (10.2)
Operating income (304.2)
Other expense, net (84.5)
Income from continuing operations before taxes
and minority interest $(388.7)
The net charges of $388.7 million include $139.6 million
related to asset reserve valuations, $95.4 million of increased
cost estimates for insurance accruals ($49.3 million for workers’
compensation accruals and $46.1 million for product and
general liability insurance accruals), $84.1 million related to an
other than temporary decline in the value of investments, $62.3
million for other accounting estimate changes described below,
environmental accruals of $18.0 million, legal accruals of $20.0
million, other various accruals of $15.2 million, $16.4 million
for account write offs included primarily in selling, general and
administrative expenses, where we concluded that the recover-
ability of various asset balances had become doubtful and $10.2
million write off representing capitalized external costs of a
European financial computer system based on the Company’s
decision in the second quarter to discontinue the new system
under development and continue to use the existing system.
The above charges are partially offset by credits of $72.5 mil-
lion, of which $12.9 million is included in cost of sales, related
to restructuring charge reversals (see Note 5) that arose during
the second quarter of fiscal 2003.
The $139.6 million of adjustments for asset valuations
includes a $76.4 million write down of inventories, $51.9 million
increase for allowance for doubtful accounts and $11.3 million
write off of subscriber systems. The inventory charge of $76.4
million was primarily due to the finalization of plans regarding
the disposition of inventory in connection with curtailed pro-
grams and product lines and the Company’s decision during
the second quarter to exit certain product lines in our fire and
security business. The increase in the allowance for doubtful
accounts of $51.9 million and the write off of subscriber systems
of $11.3 million was primarily due to the further deterioration
in the accounts receivable aging and increased customer cancel-
lations in certain non-strategic European security businesses
during the second quarter. The inventory charge and subscriber
systems adjustments are included in cost of sales and the
allowance for doubtful accounts is included in selling, general
and administrative expenses. We do not expect these changes to
have an adverse impact on future operations.
The workers’ compensation and product and general liability
changes in estimate are based on third-party actuarial reviews
of insurance liabilities. The charge of $95.4 million is included
in selling, general and administrative expenses ($65.2 million),
and cost of product sales ($30.2 million). This adjustment
relates to changes in facts and circumstances occurring during
the quarter ended March 31, 2003 which necessitate a change in
assumptions and estimates. In particular, the Company identi-
fied trend data which required the Company to revise its
assumptions as a result of an unanticipated increase in the num-
ber and changes in the nature of claims incurred and the rate
of increase of medical costs, as well as the emergence of previ-
ously unanticipated new claims. In addition, the Company
experienced an increase in workers’ compensation expense,
particularly in California, as a result of adverse legal develop-
ments toward employers.
The $84.1 million investment write down, included in other
(expense) income, net, primarily consists of a $75.6 million loss
on various equity investments. It became evident in the quarter
ended March 31, 2003 that the declines in the fair values of the
investments were other than temporary, primarily due to
depressed economic conditions. Factors that management con-
sidered in making their assessment included investees’ inability
to raise funds during the quarter, bankruptcy, continued losses
TYCO INTERNATIONAL LTD.