TYCO INTERNATIONAL LTD.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations

Introduction

        The Consolidated Financial Statements include the consolidated accounts of Tyco International Ltd., a company incorporated in Bermuda, and its subsidiaries (Tyco and all its subsidiaries, hereinafter "we," the "Company" or "Tyco") and have been prepared in United States dollars, and in accordance with Generally Accepted Accounting Principles in the United States ("GAAP").

        The Company operates in the following business segments:

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Fire and Security designs, manufactures, installs, monitors and services electronic security and fire protection systems.



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Electronics designs, manufactures and distributes electrical and electronic components, and designs, manufactures, installs, operates and maintains undersea fiber optic cable communications systems.



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Healthcare designs, manufactures and distributes medical devices and supplies, imaging agents, pharmaceuticals and adult incontinence and infant care products.



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Engineered Products and Services designs, manufactures, distributes and services engineered products including industrial valves and controls and steel tubular goods and provides environmental and other industrial consulting services.



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Plastics and Adhesives designs, manufactures and distributes plastic products, adhesives and films.

Overview

        Although acquisitions of complementary businesses have been an important part of Tyco's growth in the past, our business strategy now focuses on enhancing internal growth and operational efficiency for existing Tyco businesses. We plan to achieve this goal through new product innovation, increased market share, increasing the service and repair components of our existing businesses and continued geographic expansion. We are also implementing initiatives across our business segments to achieve best-in-class operating practices utilizing six sigma measurements. Additionally, we announced that we are evaluating the disposition of some proposed non-core businesses to be effected during the next year.

        Information for all periods presented below reflects the grouping of Tyco's businesses into five segments, consisting of Fire and Security, Electronics, Healthcare, Engineered Products and Services, and Plastics and Adhesives. During fiscal 2003, a change was made to the Company's internal reporting structure such that the operations of Tyco's plastics and adhesives businesses (previously reported within the Healthcare and Specialty Products segment) now comprise the Company's new Plastics and Adhesives reportable segment. The Company has conformed its segment reporting accordingly and has reclassified comparative prior period information to reflect this change. References to Tyco refer to the Company's continuing operations. Also in fiscal 2002, Tyco sold its financial services business (Tyco Capital) through an initial public offering ("IPO") of CIT. The historical results of our financial services business are presented as "Discontinued Operations." See "Discontinued Operations of Tyco Capital (CIT Group Inc.)" below for more information regarding the discontinued operations of Tyco Capital. The Company has conformed its segment reporting accordingly and has reclassified comparative prior period information to reflect these changes.

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        Net revenues increased 3.4% during fiscal 2003 to $36,801.3 million from $35,589.8 million in fiscal 2002. Net revenues increased 4.7% during fiscal 2002 as compared to $34,002.1 million in fiscal 2001. Tyco had income from continuing operations of $1,034.7 million in fiscal 2003, as compared to a loss from continuing operations of $2,838.2 million in fiscal 2002, and income from continuing operations of $3,894.9 million in fiscal 2001.

        Income from continuing operations for fiscal 2003 included net charges totaling $1,832.6 million ($1,566.8 million after-tax) consisting of the following: (i) charges for the impairment of long-lived assets of $814.7 million; (ii) charges recorded for changes in estimates of $388.7 million which arose from the Company's intensified internal audits and detailed controls and operating reviews discussed below (includes net restructuring credits of $72.5 million, of which credits of $12.9 million are included in costs of sales, charges for the impairment of long-lived assets of $10.2 million, charges of $243.1 million included in selling, general and administrative expenses, charges of $123.4 million included in cost of sales, a charge of $75.6 million relating to the write-down of investments and other expense of $8.5 million, both of which are included in other (expenses) income, net, and a charge of $0.4 million included in interest expense); (iii) charges for the impairment of goodwill of $278.4 million; (iv) other loss of $151.8 million related to the retirement of debt; (v) other charges of $148.6 million, of which $34.0 million is included in cost of sales related primarily to product warranty accruals and the dismantlement of customers' ADT security systems, and $114.6 million is included in selling, general and administrative expenses related primarily to uncollectible accounts receivable, internal investigation fees, as well as severance and facility closures, slightly offset by a credit for changes in estimates of charges recorded in prior periods; (vi) a charge of $91.5 million for a retroactive, incremental premium on prior period directors and officers insurance included in selling, general and administrative expenses; (vii) a charge of $11.5 million relating to the write-down of investments; (viii) other interest expense of $2.4 million; (ix) other expense of $0.1 million; (x) income from the early retirement of debt of $24.1 million; (xi) other interest income of $18.7 million; and (xii) net restructuring credits of $12.3 million, of which charges of $2.4 million are included in cost of sales.

        Loss from continuing operations for fiscal 2002 included a net charge totaling $6,762.3 million ($6,091.4 million after-tax), consisting of the following: (i) goodwill impairment charge of $1,343.7 million relating to continuing operations; (ii) charges for the impairment of long-lived assets of $3,309.5 million primarily related to the write-down of the Tyco Global Network ("TGN"); (iii) net restructuring and other charges of $1,874.7 million, of which $635.4 million is included in cost of sales and $115.0 million related to a bad debt provision is included in selling, general and administrative expenses; (iv) a write-off of purchased in-process research and development of $17.8 million; (v) a loss on the write-off of investments of $270.8 million; (vi) a gain on the sale of businesses of $23.6 million; and (vii) gain from the early extinguishment of debt of $30.6 million.

        Income from continuing operations for fiscal 2001 included a net charge of $614.9 million ($546.3 million after-tax) consisting of the following: (i) net restructuring, impairment and other charges totaling $705.4 million; (ii) a write-off of purchased in-process research and development of $184.3 million; (iii) a net gain on sale of businesses of $410.4 million; (iv) a loss of $133.8 million related to the write-down of an investment; (v) a $24.5 million net gain on the sale of common shares of a subsidiary; and (vi) a loss from the early extinguishment of debt of $26.3 million.

        We are currently assessing the potential impact of various legislative proposals that would deny U.S. federal government contracts to U.S. companies that move their corporate location abroad. The legislative proposals could cover the 1997 acquisition of Tyco International Ltd., a Massachusetts corporation, by ADT Limited (a public company that had been located in Bermuda since the 1980's with origins dating back to the United Kingdom since the early 1900's), as a result of which ADT changed its name to Tyco International Ltd. and became the parent to the Tyco group. During the fourth quarter of fiscal 2003, the State of California adopted legislation that purports to limit the eligibility of certain Bermuda and other foreign-chartered companies to participate in certain state contracts. Although the California law provides that waivers may be issued permitting such companies

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to participate in state contracts under certain circumstances, it is unclear how that waiver authority will be exercised. In addition, various other states and municipalities in the U.S. have proposed similar legislation. There also is similarly proposed tax legislation, which could substantially increase our corporate income taxes and, consequently, decrease future net income and increase our future cash outlay for taxes.

        Tyco's revenues related to U.S. federal government and California state contracts account for less than 2% and 0.1%, respectively, of total net revenues for the fiscal year ended September 30, 2003. We are unable to predict, with any level of certainty, the likelihood or final form in which any proposed legislation might become law, or the nature of regulations that may be promulgated under any such future legislative enactments or the impact such enactments and increased regulatory scrutiny may have on our governmental business or on non-governmental customers' willingness to do business with us. As a result of these uncertainties, we are unable to assess the impact on us of any proposed legislation in this area and can provide no assurance that they will not be materially adverse.

        During the fourth quarter of fiscal 2003, we completed a comprehensive review of Tyco's core businesses, and as a result, have initiated a divestiture and restructuring program. As part of this program, we plan to sell the TGN, our undersea fiber optic telecommunications system. The market for the TGN is challenged by significant overcapacity and severe pricing pressure and the industry is in need of consolidation. However, we plan to retain ownership of the construction and maintenance portion of Tyco Submarine Telecommunications. In addition to selling the TGN, we are also starting a broader divestiture program designed to increase the focus on our core operations by exiting certain operations that do not meet our criteria for strategic fit or financial returns. Combined fiscal 2003 revenues for businesses under consideration for potential divestiture within the Electronics, Fire and Security, Engineered Products and Services, and Healthcare segments totaled approximately $2 billion and operating income totaled approximately $55 million (excluding operating loss from the TGN of

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$115 million). Overall, this entire potential divestiture program represents just below 6% of Tyco's fiscal 2003 revenue. We are estimating that the potential proceeds (excluding the proceeds from the sale of the TGN) could be at least $400 million once the program is completed. If we dispose of these businesses, we may not fully recover their recorded book values. At September 30, 2003, however, under the held and used model, the assets of these businesses were fully recoverable. The restructuring program announced in November 2003 is designed to improve our cost structure primarily in the Fire and Security, but also in the Plastics and Adhesives and in the Engineered Products and Services segments and is an important element of building a stronger operating foundation.

        During fiscal 2002, we recorded restructuring and other charges and charges for the impairment of long-lived assets related primarily to the significant decrease in demand in certain end markets within our Electronics segment. Under our restructuring and integration programs, we terminate employees and close facilities made redundant. The reduction in manpower and facilities comes from the manufacturing, sales and administrative functions. In addition, we discontinue or dispose of product lines, which do not fit the long-term strategy of the respective businesses. We have not historically tracked the impact on financial results of the restructuring and integration programs. However, we estimate that our overall cost structure has been reduced by approximately $910 million on an annualized basis, of which approximately $315 million relates to selling, general and administrative expenses, and approximately $595 million to cost of sales. The $910 million estimated overall annualized cost savings as a result of restructuring activities in fiscal 2002 was based on a summary of estimated cost savings. In determining the amount of cost savings, management looked at the salaries and benefits of the people that were terminated to derive the annual savings. As it relates to facility closures, the cost savings represents the rent, plant operating expenses and depreciation on the assets that will no longer be incurred.

        Historically, when we made an acquisition, we began to integrate the acquired company with our existing operations immediately. As part of this integration process, we often eliminate duplicate functions by closing corporate and administrative offices, and we attempt to make the combined companies more cost efficient by combining manufacturing facilities, product lines, sales offices and marketing efforts. As a result of our integration processes, most acquired companies are no longer separately identifiable. Consequently, we are generally unable to separately track the post-acquisition financial results of acquired companies. The discussions following the tables below include percentages for revenue growth or decline that exclude increased revenue attributable to specified acquisitions and that eliminate the effects of period to period currency fluctuations. Revenue growth or decline percentages excluding the specified acquisitions are estimates calculated by assuming the acquisitions were made at the beginning of the relevant fiscal periods by adding back pre-acquisition revenue of the specified acquired companies for both periods in the comparison. A majority of the companies that we acquire operate within the same industry as the segment into which the acquired company is integrated and, consequently, we assume that the companies that we acquire generally have a comparable growth percentage. We calculate segment growth using this methodology because we generally do not have the ability to capture post-acquisition revenues related to individual acquisitions since most companies are immediately integrated upon acquisition. The calculations of the growth analysis, excluding acquisitions discussed in the segment narratives below, include all acquisitions with a purchase price of $10 million or more in the calculation and do not include acquisitions with a purchase price of less than $10 million, due to the relative size of these smaller acquisitions compared to Tyco's operating results and the large number of acquisitions during certain of the periods presented. These smaller acquisitions represent approximately 6% of the total purchase price for all acquisitions during the years ended September 30, 2003 and 2002. Since these estimates are based on pre-acquisition revenues, they are not necessarily indicative of post-acquisition results. This calculation is similar to the method used in calculating the acquisition-related pro forma results of operations in Note 2 to the Consolidated Financial Statements, pursuant to Statement of Financial Accounting Standards ("SFAS") No. 141.

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        In the discussions that follow, we describe the reasons for changes in results for each segment, although we do not quantify the impact of every factor. In order to quantify each factor contributing to a change in operating income and margins, we would need to exclude the results of acquisitions. As previously noted, since acquisitions are generally integrated within our existing operations immediately upon acquisition, we generally do not have the ability to exclude the effect of acquired businesses when quantifying increases and decreases in operating income and margins.

Changes in Estimates

Changes in Estimates Recorded During the Quarter Ended March 31, 2003

        The preparation of consolidated financial statements in conformity with GAAP requires management to make extensive use of estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Significant estimates in the Company's Consolidated Financial Statements include restructuring and other charges and credits, purchase accounting liabilities, allowances for doubtful accounts receivable, estimates of future cash flows associated with asset impairments, useful lives for depreciation and amortization, loss contingencies, net realizable value of inventories, fair values of financial instruments, estimated contract revenues and related costs, environmental liabilities, income taxes and tax valuation reserves, and the determination of discount and other rate assumptions for pension and post-retirement employee benefit expenses. Actual results could differ from these estimates. Changes in estimates are recorded in the results of operations in the period that the events and circumstances giving rise to such changes occur.

        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 settling legal, environmental and insurance obligations. The assessments were based on an analysis of the impact of circumstances 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 management during the quarter, we decided to discontinue existing product lines and terminate an information technology systems 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:

        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

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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 recoverability 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 million, of which $12.9 million is included in cost of sales, related to restructuring charge reversals (see Note 5 to the Consolidated Financial Statements) 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 programs 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 cancellations 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 identified trend data which required the Company to revise its assumptions as a result of an unanticipated increase in the number and changes in the nature of claims incurred and the rate of increase of medical costs, as well as the emergence of previously unanticipated new claims. In addition, the Company experienced an increase in workers' compensation expense, particularly in California, as a result of adverse legal developments 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 considered in making their assessment included investees' inability to raise funds during the quarter, bankruptcy, continued losses by the investees, lack of sufficient future expected cash flows, and lower entity valuations based on recent private financing activity. During the quarter ended March 31, 2003, the Company also recognized other expense of $8.5 million in connection with a bank guarantee on behalf of an equity investee (see Note 20 to the Consolidated Financial Statements). It is possible that the Company may have additional write-downs on other investments if market conditions continue recent negative trends.

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        The $62.3 million for other accounting estimates includes a charge to selling, general and administrative expenses of $17.3 million resulting from the Company's revision in the second quarter of deferred commissions related to long-term contracts, $12.1 million to write-down company-owned properties based on real estate assessments and purchase offers received in the second quarter for assets held for sale, $11.5 million of additional severance related to terminated executives, and $21.4 million of other accounting estimate changes, none of which are individually significant, that were included primarily in selling, general and administrative expenses.

        An increase of $18.0 million due to increased environmental accruals resulting from the finalization of the Company's plan to remediate one of its manufacturing sites in the second quarter, $20.0 million to establish an accrual related to the estimated settlement amount for contractual disputes and other legal matters based on our determination that such amounts became both probable and estimable in the second quarter, and $15.2 million of other miscellaneous increased accrual estimates are primarily included in selling, general and administrative expenses.

        Net revenues in the Fire and Security Services segment increased 6.1% in fiscal 2003 over fiscal 2002, including a 3.4% increase in product revenue and an 8.5% increase in service revenue. The increase in net revenues was due to favorable changes in foreign currency exchange rates ($519.7 million) and fiscal 2002 acquisitions ($213.8 million calculated in the manner described above in "Overview"). Acquisitions included SBC/Smith Alarm Systems in October 2001, DSC Group and Sensormatic in November 2001, and all other acquisitions with a purchase price of $10 million or more. In addition, an increase in net revenues due to customer contracts purchased through the ADT dealer program ($371.2 million) and generated through our internal sales force offset a decline in revenue due to increased attrition rates in worldwide security. The overall increase was also partially offset by a decline in net revenues at worldwide fire protection due to continued softness in the commercial construction market.

        Operating income and margins decreased significantly in fiscal 2003 over fiscal 2002 due to charges totaling $512.4 million recorded during fiscal 2003. Included within the $512.4 million are charges of $266.7 million related to changes in estimates recorded during the quarter ended March 31, 2003 (includes charges of $127.6 million primarily related to adjustments to accrual balances such as workers compensation, professional fees, and environmental exposure, a charge of $98.1 million primarily due to adjusting reserves for doubtful accounts and slow and non-moving inventory, as well as a write-off of subscriber systems, charges of $34.5 million for other accounting adjustments primarily related to deferred commissions, and charges of $6.5 million related to reconciling items in the current period) in connection with the Company's intensified internal audits, detailed controls and operating reviews and as a result of applying management's judgments and estimates. Also included within the $512.4 million are impairment charges of $143.0 million primarily related to the impairment of intangible assets associated with the ADT dealer program mostly as a result of increased attrition rates (discussed below), and to the impairment of property, plant and equipment of subscriber systems and other fixed

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assets; net restructuring and other charges of $9.7 million, of which charges of $3.5 million are included in cost of sales and $2.8 million is for the write-off of non-current assets, related to streamlining the business; and other charges of $93.0 million, of which $34.0 million is included in cost of sales and $59.0 million is included in selling, general and administrative expenses, primarily related to uncollectible receivables, product warranty and the dismantlement of customers' ADT security systems. Included within the $143.0 million impairment charge and the $9.7 million net restructuring charge is a charge of $10.2 million and a credit of $2.0 million, respectively, also related to changes in estimates recorded during the quarter ended March 31, 2003. The decrease in operating income and margins was also due to increased depreciation and amortization expense in the security business due to growth in the subscriber asset and dealer asset base as well as the impact of the acquisitions of Sensormatic Electronics Corporation ("Sensormatic") and DSC Group ("DSC") in fiscal 2002; decline in operating income in the continental European security business; and a weaker worldwide fire and contracting environment. The Fire and Security segment expects to incur additional restructuring charges in future periods related to the comprehensive cost reduction program announced on November 4, 2003.

        Attrition rates for customers in our global electronic security services business averaged 15.9% on a trailing twelve-month basis for fiscal 2003, as compared to 13.2% for fiscal 2002. This increase relates to attrition in customer accounts acquired through our worldwide dealer program, as well as internally generated commercial customer accounts in continental Europe and internally generated residential customer accounts in the United States (both of which were partly driven by increased management and control of delinquent accounts). For those account pools experiencing increased attrition, prior lifing studies were re-examined. The Company concluded that existing amortization methods and asset lives continue to be appropriate given the observed actual attrition data for these pools.

        Net revenues for the Fire and Security segment increased 42.4% in fiscal 2002 over fiscal 2001 including a 41.8% increase in product revenue and a 42.9% increase in service revenue, primarily as a result of higher sales volume and increased service revenue in the worldwide security business and, to a lesser extent, our worldwide fire protection business. The increase in net revenues was mostly due to acquisitions as well as a higher volume of recurring service revenues generated from our worldwide security business dealer program and, to a lesser extent, increased sales of fire safety and video surveillance products and access control systems. This net revenue growth was largely due to our focus in prior years on increasing revenues by growing the business through acquisitions (including the authorized dealer program), as compared to our current long-term strategy, which is to grow our existing business. Net revenues for fiscal 2002 also include the effect of the heightened level of security concerns that followed September 11th, which temporarily increased the demand for security-related products. Significant acquisitions included Simplex Time Recorder Co. ("Simplex") in January 2001, Scott Technologies, Inc. in May 2001, the electronic security systems businesses of Cambridge Protection Industries, L.L.C. ("SecurityLink") and Sentry S.A. in July 2001, Edison Select in August 2001, SBC/Smith Alarm Systems in October 2001, and DSC and Sensormatic in November 2001. Excluding the $33.5 million increase from foreign currency fluctuations, our ADT dealer program, the acquisitions listed above, and all other acquisitions with a purchase price of $10 million or more, pro forma revenues (calculated in the manner described above in "Overview") for the segment were level with prior year.

        Operating income increased slightly in fiscal 2002, primarily due to acquisitions. This increase was partially offset by net restructuring and other charges, charges for the impairment of long-lived assets and a charge for the write-off of purchased in-process research and development.

        Operating income and margins in fiscal 2002 include a net restructuring and other charge of $94.9 million. The net $94.9 million charge includes charges of $113.5 million, of which inventory write-downs of $0.7 million and a charge of $18.7 million related to the write-up of inventory under purchase accounting are included in cost of sales. These charges are primarily related to severance and facility-related charges associated with streamlining the business, slightly offset by a credit of

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$18.6 million relating to current and prior years' restructuring charges. Also included within operating income for fiscal 2002 is a charge of $17.8 million for the write-off of purchased in-process research and development associated with the acquisitions of Sensormatic and DSC and a charge of $114.7 million for the impairment of property, plant and equipment resulting primarily from the termination of a software development project and, to a lesser extent, from the curtailment, and in certain markets, the termination of the ADT dealer program in certain non-U.S. markets.

        Operating income and margins in fiscal 2001 include net restructuring and other charges of $84.1 million. The $84.1 million net charge consists of charges of $85.7 million, of which inventory write-downs of $5.4 million are included in cost of sales, primarily related to the closure of facilities that became redundant due to the acquisitions of SecurityLink and Simplex, partially offset by a credit of $1.6 million relating to prior years' restructuring charges. Also included are charges of $2.8 million for the impairment of property, plant and equipment primarily associated with the facility closures.

        Net revenues for the Electronics segment decreased slightly in fiscal 2003 compared with fiscal 2002, including a 1.2% decrease in product revenue and a 1.4% increase in service revenue. Net revenues at the electronic components group increased $426.3 million, or 4.4% due to the favorable impact of foreign currency exchange rates. Net revenues at the segment's submarine telecommunications business declined $535.4 million, or 78.1%, due to completion of third-party undersea fiber optic system installations in fiscal 2002. Overall, the decrease in net revenues at our submarine telecommunications business more than offset the increase in the total segment revenues due to favorable changes in foreign currency exchange rates of $523.9 million, and $68.9 million (calculated in the manner described above in "Overview") due to the acquisitions of Transpower Technologies ("Transpower") in November 2001, Communications Instruments, Inc. ("CII") in January 2002, and all other acquisitions with a purchase price of $10 million or more.

        The increase in operating income and margins fiscal 2003 as compared to fiscal 2002 was due to operating losses in the prior year, primarily as a result of charges totaling $5,679.7 million (discussed below) that were recorded in fiscal 2002. Operating income and margins for fiscal 2003 include net charges totaling $881.8 million. The $881.8 million includes charges for the impairment of long-lived assets of $665.1 million primarily related to the Company's intended sale of the TGN which was entirely written off; charges for the impairment of goodwill of $278.4 million in Power Systems, Electrical Contracting Services and the Printed Circuit Group; and restructuring credits of $90.5 million, of which $19.9 million is included in cost of sales, related to changes in estimates of severance and facilities-related charges recorded in prior years. The net restructuring credit of $90.5 million includes $54.8 million of credits which were changes in estimates recorded during the quarter ended March 31, 2003. Also included within the $881.8 million are charges of $14.1 million related to adjusting asset reserves, $6.2 million related to the adjustments to accrual balances, $8.5 million of reconciliation and other accounting adjustments, which were also changes in estimates recorded during the quarter ended March 31, 2003.

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        Net revenues for the Electronics segment decreased 22.7% in fiscal 2002 compared with fiscal 2001, including a 23.6% decrease in product revenue and a 4.3% increase in service revenue, as a result of a severe decline in demand for undersea telecommunications systems and surplus capacity available and a decline in demand for our electronic components group products in the communications, computer and consumer electronics industries across all geographic regions. Net revenues at the electronic components group (which consists of Electronic Components, Wireless, Electrical Contracting Services, Power Systems and Printed Circuit Group) decreased $1,931.3 million, or 16.5%, reflecting a significant decrease in demand in certain end markets. Sales were impacted mostly by the market decline in the telecommunications and computer industries and, to a lesser extent, the industrial/commercial industry. The market decreases were partially offset by growth in our product sales into the automotive industry. Net revenues at Tyco Submarine Telecommunication's business declined $1,150.2 million, or 62.6%, due to lack of demand for new cable construction and very weak demand for capacity sales on the TGN. Excluding the $16.7 million decrease from foreign currency fluctuations and the acquisitions of CIGI Investment Group, Inc. in October 2000, Lucent Technologies' Power Systems business in December 2000, Transpower, CII, and all other acquisitions with a purchase price of $10 million or more, pro forma revenues (calculated in the manner described above in "Overview") for the segment decreased an estimated 29.6%.

        The operating loss in fiscal 2002 was primarily due to the impairment of long-lived assets and goodwill as well as the restructuring and other charges in addition to the decrease in revenue. In the electronic components business, the significant decrease in demand related to the telecommunications, computer, consumer electronics, and the industrial machinery and commercial aerospace industries. The overall decrease in demand resulted in much lower manufacturing volumes which increased per unit costs. In the Submarine Telecommunications business, margins were impacted significantly by the lack of capacity sales on the TGN and a significant reduction in third party system builds.

        Operating loss and margins for fiscal 2002 include net restructuring and other charges of $1,504.5 million. The $1,504.5 million net charge includes charges totaling $1,530.8 million, of which inventory reserves of $608.2 million are included in cost of sales and a bad debt provision of $115.0 million is included in selling, general and administrative expenses. These charges primarily relate to initiatives taken to reduce fixed costs, due to the significant downturn in the telecommunications business and certain electronics end markets, including facility closures, headcount reductions, inventory reserves and purchase commitment cancellations. These charges were slightly offset by a restructuring credit of $26.3 million primarily relating to a revision in estimates of current and prior years' severance and facilities charges. Total inventory charges of $943.6 million include $608.2 million of inventory write-downs and $335.4 million of supplier contract termination fees. In fiscal 2002, $19.9 million was originally included in the inventory written down and was recorded as a restructuring credit to cost of sales in fiscal 2003. To the extent that any of the bad debt provisions are not utilized the excess amounts will be reversed as a credit to the selling, general and administrative expenses line in the Consolidated Statements of Operations and will be separately disclosed as a credit. Also included within operating loss and margins for fiscal 2002 are charges of $3,150.7 million for the impairment of property, plant and equipment, primarily related to the TGN, and goodwill impairment charges of $1,024.5 million related to Tyco Submarine Telecommunications. For additional information regarding our accounting for goodwill impairments, see "Accounting Policies—Goodwill" below.

        The significant restructuring charges recorded in fiscal 2002 were primarily related to the restructuring of the Submarine Telecommunications business to address the significant overcapacity in the market and resulting lack of demand for new system construction. In the fourth fiscal quarter of 2002, management decided to focus the business for the foreseeable future on maintenance revenues and capacity sales on the TGN, to discontinue future additions to the TGN, and limit construction activities to small projects that were cash flow positive with at least breakeven earnings. As a result of this strategy, management devised a plan to significantly downsize the manufacturing footprint, decrease project management staffing, reduce the research and development function and minimize

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staffing and expense in all other administrative areas of the business to decrease cash outflows and losses to the maximum extent possible. This plan was carefully crafted to ensure that both the technical and construction competencies of the business would be preserved in the event industry conditions improve.

        Operating income and margins in fiscal 2001 include restructuring and other charges of $383.8 million primarily related to the closure of facilities within the communications, computer and consumer electronics industries in response to the severe downturn experienced. Included within the $383.8 million are inventory write-downs of $74.1 million and charges of $51.7 million for the write-up of inventory under purchase accounting, both of which are included in cost of sales. Operating income and margins for fiscal 2001 also includes charges of $98.5 million for the impairment of property, plant and equipment associated with the facility closures.

        Net revenues for the Healthcare segment increased 8.5% in fiscal 2003 over fiscal 2002, including an 8.5% increase in product revenue and a 7.4% increase in service revenue. The increase in net revenues resulted primarily from organic growth and favorable foreign currency exchange rates and, to a lesser extent, acquisitions, net of divestitures. Organic growth was due to the following: increases in the surgical sector concurrent with the award of a major contract and continued organic growth within certain surgical stapling lines; increases in the medical sector resulting from the award of a significant wound care contract, coupled with the exit of a major competitor from the traditional wound care business, new product launches and higher demand in the ultrasound market; increases in pharmaceuticals and imaging due to higher volumes and increased market share, and; strong sales within the respiratory division. These sales increases were partially offset by a decrease in the diaper product segment of the Retail business largely resulting from the adverse impact of the industry-wide down-count issues, and a decline in the International division due to lower sales in continental Europe and Latin America. The increase in net revenues also resulted from favorable changes in foreign exchange rates ($268.2 million) and incremental revenues generated from the acquisition of Paragon Trade Brands ("Paragon") in January 2002 ($123.8 million calculated in the manner described above in "Overview"), slightly offset by a decline in revenues ($48.1 million) related to the divestiture of Surgical Dynamics, Inc. in July 2002.

        The 15.2% increase in operating income and increase in margins in fiscal 2003 compared to fiscal 2002 were due primarily to favorable margin impact as a result of higher sales and favorable manufacturing variances as a result of increased production volumes, a shift to a more favorable product mix, and cost savings as a result of the closure of certain Paragon facilities, back office consolidations and our continued focus on optimizing operating expenses. Slightly offsetting the effect of those items were increased legal fees, insurance and pension expense, and higher sales and marketing expense as a result of program development aimed at supporting organic growth initiatives. Also contributing to the increase in operating income and margins were favorable fluctuations in foreign currency exchange rates and the impact of acquisitions and divestitures. During fiscal 2003, we recorded net credits totaling $3.3 million. Included within the total credits of $3.3 million are charges

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of $11.7 million related to asset reserves for inventory and charges of $0.7 million for adjustments to accrual balances related to workers compensation, which were changes in estimates recorded in connection with the Company's intensified internal audits, detailed controls and operating reviews and as a result of applying management's judgments and estimates. Also included within the $3.3 million are restructuring credits of $9.2 million, of which $0.2 million is included in cost of sales, due to costs being less than anticipated and a credit of $6.5 million included in selling, general and administrative expenses related to an insurance reimbursement for certain legal fees associated with product liability cases. The restructuring credits of $9.2 million include credits of $4.7 million which were also changes in estimates recorded during the quarter ended March 31, 2003.

        Net revenues for the Healthcare segment increased 11.8% in fiscal 2002 over fiscal 2001 including a 11.8% increase in product revenue and a 10.1% increase in service revenue, primarily as a result of increased sales volume resulting from acquisitions in our U.S. healthcare businesses and, to a much lesser extent, increased revenues from our domestic and international healthcare businesses. Excluding the $11.2 million decrease from foreign currency exchange fluctuations and the acquisitions of Mallinckrodt Inc. ("Mallinckrodt") in October 2000, InnerDyne, Inc. in December 2000, Paragon, and all other acquisitions with a purchase price of $10 million or more, pro forma revenues (calculated in the manner described above in "Overview") for the Healthcare segment increased an estimated 2.9%.

        Operating income increased 22.4% in fiscal 2002 compared to fiscal 2001 primarily due to a decrease in charges recorded in fiscal 2002 as compared to fiscal 2001, as well as the impact of acquisitions and operating efficiencies realized from cost reductions at Mallinckrodt. This increase was partially offset by lower margins of businesses acquired at Tyco Healthcare.

        Operating income and margins for fiscal 2002 reflect net restructuring and other charges of $44.8 million. The $44.8 million net charge includes charges of $48.7 million, of which inventory write-downs of $0.5 million are included in cost of sales. These charges primarily relate to severance associated with the consolidation of operations and facility-related costs due to exiting certain business lines, and are partially offset by a credit of $3.9 million relating to current and prior years' restructuring charges. Operating income and margins for fiscal 2002 also include a charge for the write-off of long-lived assets of $2.5 million primarily related to the impairment of long-lived assets.

        Operating income and margins for fiscal 2001 include net restructuring and other charges of $48.4 million primarily related to the closure of several manufacturing plants. Included within the $48.4 million are charges of $64.0 million, of which charges of $35.0 million for the write-up of inventory under purchase accounting and inventory write-downs of $5.0 million are included in cost of sales, partially offset by credits of $15.6 million related to the merger with U.S. Surgical. Operating income and margins also include a charge of $184.3 million for the write-off of purchased in-process research and development associated with the acquisition of Mallinckrodt and charges of $14.2 million for the impairment of property, plant and equipment related to the closure of the manufacturing plants.

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        Net revenues for the Engineered Products and Services segment remained essentially level in fiscal 2003 as compared to fiscal 2002, including a 1.3% decrease in product revenue partially offset by a 4.5% increase in service revenue. Net revenue decreased year over year, as the increase in net revenues due to favorable changes in foreign currency exchange rates ($233.1 million calculated in the manner described above in "Overview") and the effect of acquisitions ($41.2 million) was more than offset by continued weak conditions in major markets at Flow Control and Electrical and Metal Products, most notably in non-residential construction. Also contributing to the overall decrease was lower levels of capital spending and increased pricing pressure, resulting in lower selling prices. The $41.2 million effect from acquisitions included Century Tube Corporation ("Century") in October 2001, Water & Power Technologies ("Water & Power") in November 2001, and Clean Air Systems ("Clean Air") in February 2002 and all other acquisitions with a purchase price of $10 million or more.

        The 40.7% increase in operating income and the increase in margins in fiscal 2003 compared to fiscal 2002 were due to lower than usual operating income in the prior year period, as a result of recording charges of $379.5 million (discussed below). During fiscal 2003, we recorded charges totaling $56.7 million. Included within the $56.7 million are charges of $33.1 million related to changes in estimates recorded in connection with the Company's intensified internal audits, detailed controls and operating reviews and as a result of applying management's judgments and estimates (including $19.0 million related to adjustments to workers compensation, $1.0 million primarily related to reconciling items in the current period and $13.1 million associated with asset reserves). Also included within the $56.7 million are net restructuring and other charges of $7.8 million, of which $6.1 million is included in cost of sales, due to changes in estimates of costs being less than anticipated, and charges for the impairment of long-lived assets of $2.2 million relating to manufacturing and distribution consolidation at Flow Control and cost reduction projects, and other costs of $13.6 million included within selling, general and administrative expenses primarily related to the reorganization and consolidation of a manufacturing facility and certain business offices. Operating income and margins were also negatively effected by the lower sales discussed above, competitive conditions in major markets for valves and controls, thermal controls, and electrical and metal products, and increased raw material costs, mostly steel. The Engineered Products and Services segment expects to incur additional charges in future periods related to the comprehensive cost reduction program announced on November 4, 2003.

        Net revenues increased 12.9% in fiscal 2002 over fiscal 2001 including a 13.1% increase in product revenue and a 12.0% increase in service revenue, primarily as a result of acquisitions and, to a much lesser extent, increased revenues at Flow Control, which was largely due to increased demand of industrial valve and control and thermal control products. However, offsetting this increase in demand of valve and control products was the decline in general economic conditions, as well as a slow-down in the commercial construction market. Acquisitions included Pyrotenax in March 2001, IMI Bailey Birkett in June 2001, Century, Water & Power, and Clean Air. Excluding the $9.2 million decrease from foreign currency exchange and the impact of the acquisitions listed above, and all other

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acquisitions with a purchase price of $10 million or more, pro forma revenues (calculated in the manner described above in "Overview") for the segment were level with the prior year.

        The 64.2% decrease in operating income and the decrease in operating margins in fiscal 2002 over fiscal 2001 was primarily due to goodwill impairment charges in addition to the impact of lower margins at Electrical and Metal Products and Flow Control, decreased royalty and licensing fee income from divested businesses and reduced market activity due to continued softness in demand and worldwide competitive pressures. This overall decrease was slightly offset by the results of acquisitions and by savings realized from cost-cutting initiatives at Flow Control and Infrastructure Services.

        Operating income and margins for fiscal 2002 reflect restructuring and other charges of $50.8 million, of which inventory write-downs of $6.2 million are included in cost of sales, primarily related to severance and facility-related costs associated with streamlining the business and charges of $9.5 million for the impairment of property, plant and equipment associated with the closure of facilities. Also included are goodwill impairment charges of $319.2 million relating to Tyco Infrastructure Services. For additional information regarding our accounting for goodwill impairments, see "Accounting Policies—Goodwill" below.

        Operating income and margins for fiscal 2001 include restructuring and other charges of $57.3 million, of which inventory write-downs of $9.7 million are included in cost of sales, and charges for the impairment of property, plant and equipment of $3.4 million, primarily related to the closure of facilities.

        Net revenues at Tyco Plastics and Adhesives increased slightly in fiscal 2003 over fiscal 2002 due to the effect of favorable changes in foreign currency exchange rates ($29.3 million) and acquisitions ($21.0 million calculated in the manner described above in "Overview"), which included LINQ Industrial Fabrics, Inc. ("LINQ") in December 2001 and all other acquisitions with a purchase price of $10 million or more. Sales increases were achieved by higher selling prices as a result of higher raw material costs, increased sales volume of plastic sheeting and duct tape products as a result of the heightened level of security related to the potential likelihood of terrorist attacks, and a strong residential construction market for Ludlow Coated Products. These increases were more than offset by increased competition and decreases in our Corrosion Protection business, which has been negatively impacted by a slow down in the oil and gas pipeline construction markets created by uncertainty in the Middle East and Venezuela, and a decline in hanger sales due to weak demand in the retail garment industry.

        The significant decrease in operating income and decrease in operating margins in fiscal 2003 over fiscal 2002 were primarily due to increased raw material costs (mostly polyethylene) and increased pricing competition driven by excess production capacity and an increase in lower priced imported goods. During fiscal 2003, we recorded net credits totaling $1.4 million. Included within the $1.4 million are charges of $5.6 million related to changes in estimates recorded in connection with the Company's intensified internal audits, detailed controls and operating reviews and as a result of applying management's judgments and estimates (including $3.2 million for adjustments to accrual balances, $2.6 million related to asset reserves for inventory and a credit of $0.2 million related to reconciliation items). Also included within the total credits of $1.4 million are restructuring credits of $1.0 million due to costs being less than anticipated and a credit of $6.0 million, which is included in selling, general and

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administrative expenses, related to the settlement of a lawsuit. The restructuring credits of $1.0 million include a credit of $0.4 million also recorded in connection with the Company's intensified internal audits. The Plastics and Adhesives segment expects to incur additional restructuring charges in future periods related to the comprehensive cost reduction program announced on November 4, 2003.

        Net revenues for the Plastics and Adhesives segment increased 7.5%, or $130.9 million in fiscal 2002 over fiscal 2001. The increase was solely due to the effect of acquisitions. In addition, net revenues for fiscal 2001 included $9.9 million related to our ADT Automotive business, which was sold in October 2000. Excluding the $4.5 million increase from foreign currency exchange fluctuations and the acquisition of LINQ Industrial Fabrics, Inc. in December 2001, and all other acquisitions with a purchase price of $10 million or more, pro forma revenues (calculated in the manner described above in "Overview") for the Plastics and Adhesives segment decreased an estimated 13.0%.

        Operating income decreased 30.5% in fiscal 2002 compared to fiscal 2001 primarily due to decreased margins as a result of volume shortfalls, a shift in the product mix, lower selling prices in certain areas and unfavorable manufacturing variances. In addition, the segment incurred increased expenses mostly relating to inventory write-downs and uncollectible accounts receivable.

        Operating income and margins for fiscal 2002 reflect net restructuring and other charges of $10.1 million, of which inventory write-downs of $1.1 million are included in cost of sales. These charges primarily relate to severance associated with the consolidation of operations and facility-related costs due to exiting certain business lines. Operating income and margins for fiscal 2002 also include a charge for the write-off of long-lived assets of $2.6 million primarily related to the impairment of long-lived assets.

        Operating income and margins for fiscal 2001 include net restructuring and other charges of $8.3 million primarily related to the closure of several manufacturing plants. Included within the $8.3 million are charges of $4.0 million related to inventory write-downs, which has been included in cost of sales. Operating income and margins also include a charge of $1.2 million for the impairment of long-lived assets related to the closure of the manufacturing plants.

Corporate Items

Foreign Currency

        The effect of changes in foreign exchange rates for fiscal 2003 compared to fiscal 2002 was an increase in net revenues and operating income of $1,574.2 million and $192.1 million, respectively. The effect of changes in foreign exchange rates for fiscal 2002 compared to fiscal 2001 was an increase in net revenues of approximately $0.9 million and a decrease in operating income of approximately $48.2 million.

Corporate Expenses

        Corporate expenses were $400.6 million in fiscal 2003. Corporate expenses for fiscal 2003 include charges totaling $178.9 million. Included within the $178.9 million is a charge of $91.5 million for an incremental increase in directors and officers insurance and charges of $38.5 million related to internal investigation fees. Also included is a charge of $19.9 million primarily related to a severance accrual for corporate employees and a restructuring credit of $10.6 million due to costs being less than anticipated, both of which were changes in estimates recorded in connection with the Company's intensified internal audits, detailed controls and operating reviews and as a result of applying management's judgments and estimates. Also included within the $178.9 million are net restructuring charges of $9.0 million, other net charges of $16.0 million included in selling, general and administrative expenses, and charges for the impairment of long-lived assets of $14.6 million primarily related to the closure and relocation of corporate offices and severance. Corporate expenses were $419.7 million in fiscal 2002. This amount includes net restructuring, impairment and other charges of $199.1 million primarily related to the write-off of investment banking fees and other deal costs associated with the terminated breakup plan

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and certain acquisitions that were not completed, costs incurred for the internal investigation, and severance. Corporate expenses were level in fiscal 2003 as compared to fiscal 2002, excluding all of the items noted above. Corporate expenses were $243.9 million in fiscal 2001, and included a charge of $3.4 million related to severance. Corporate expenses were down slightly in fiscal 2002 as compared to fiscal 2001 due to an overall decrease in compensation expense and lower than expected advertising costs and expenses for charitable giving. However, these decreases were partially offset by increased insurance costs, legal and accounting fees, and other costs associated with the business disruptions that began during the second quarter of fiscal 2002.

Amortization of Goodwill

        Amortization of goodwill was $543.0 million in fiscal 2001. In accordance with accounting rule changes, goodwill is no longer amortized beginning with our fiscal 2002 year. See Goodwill and Other Intangibles within Note 1 to our Consolidated Financial Statements for a discussion of these accounting rule changes.

Other (Expense) Income, Net

        Tyco has repurchased some debt prior to scheduled maturities. In fiscal 2003, the Company recorded other income from the early retirement of debt totaling $24.1 million, as compared to $30.6 million in fiscal 2002, and a loss from the early retirement of debt totaling $26.3 million for fiscal 2001.

        During fiscal 2003, the Company repurchased all of its 6.25% Dealer Remarketable Securities ("Drs.") due 2013. The total Dollar Price paid was $902 million based upon the $750 million par value of the Drs. The portion in excess of par of $151.8 million was recorded as a loss on retirement of debt.

        During fiscal 2003, the Company recognized a charge of $87.1 million relating to the write-down of various investments accounted for under both the cost and equity methods, of which $81.3 million was recorded, when it became evident that the declines in the fair value of the investments were other than temporary, primarily due to the continuing depressed economic conditions specifically within the telecommunications industry. Included within the $81.3 million is $75.6 million recorded in the second quarter (see Changes in Estimates Recorded During the Quarter Ended March 31, 2003). The remaining $5.8 million charge adjusted a portion of the remaining portfolio to its net realizable value based upon estimates received in conjunction with our decision to sell such investments. During fiscal 2002, the Company recognized a $270.8 million loss on various investments, primarily related to its investments in FLAG Telecom Holdings Ltd. ("FLAG") when it became evident that the declines in the fair value of FLAG and other investments were other than temporary. During fiscal 2001, the Company recognized a $133.8 million loss on various investments, primarily related to its investment in 360Networks when it became evident that the declines in the fair value of the investments were other than temporary.

        During fiscal 2003, the Company recognized other expense of $8.6 million in connection with a bank guarantee on behalf of an equity investee (see "Off-Balance Sheet Arrangements—Guarantees" below for further information).

        During fiscal 2002, the Company sold certain of its businesses for net proceeds of approximately $138.7 million in cash that consist primarily of certain businesses within the Healthcare and Fire and Security segments. In connection with these dispositions, the Company recorded a net gain of $23.6 million. In fiscal 2001, the Company sold its ADT Automotive business to Manheim Auctions, Inc., a wholly-owned subsidiary of Cox Enterprises, Inc., for approximately $1.0 billion in cash. The Company recorded a net gain on the sale of businesses of $410.4 million after deducting commissions and other direct costs, principally related to the sale of ADT Automotive. This gain is net of direct and incremental costs of the transaction, as well as $60.7 million of special bonuses paid to key employees.

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Interest Expense, Net

        Interest income was $107.2 million in fiscal 2003, as compared to $117.3 million and $128.3 million in fiscal 2002 and 2001, respectively. Interest expense was $1,148.0 million in fiscal 2003, as compared to $1,077.0 million in fiscal 2002 and $904.8 million in fiscal 2001. Interest expense in fiscal 2003 includes a charge of $0.4 million related to changes in estimates recorded during the quarter ended March 31, 2003, and a charge of $2.4 million related to the interest component of a state sales tax charge. Fiscal 2003 interest income includes $18.7 million related to interest received on a tax refund. The increase in net interest expense in fiscal 2003 over fiscal 2002 is primarily the result of the negative impact of the cancellation of certain swaps in fiscal 2002, a decrease in capitalized interest due to the completion of TGN, an increase in the weighted-average interest rate year over year, in addition to a decrease in interest income as a result of the collection of a note receivable. Slightly offsetting this overall increase was the favorable impact of a lower average debt balance during fiscal 2003. The increase in fiscal 2002 as compared to fiscal 2001 was due to a higher average debt balance for the year, which more than offset the decrease in our weighted-average interest rate during fiscal 2002. The weighted-average rates of interest on our long-term debt outstanding during fiscal 2003 and 2002 were 4.7% and 4.5%, respectively. Our weighted-average rate during fiscal 2003 increased due to the continued effects of the credit downgrades that began in February 2002 including the exiting of the commercial paper market and the retirement of lower interest rate debt.

Income Tax Expense

        Income tax expense was $764.5 million on pre-tax income of $1,802.8 million for fiscal 2003 as compared to income tax expense of $208.1 million on pre-tax loss of $2,628.7 million for fiscal 2002 and income tax expense of $1,172.3 million on pre-tax income of $5,114.7 million for fiscal 2001.

        Our effective income tax rate was 42.4%, (7.9%) and 22.9% during fiscal 2003, fiscal 2002 and fiscal 2001, respectively. The difference in the rate from fiscal 2002 to 2003 is primarily the result of a decrease in the non-recognition of tax benefits on impairments and a decrease in other non-deductible charges. The difference in the tax rate from fiscal 2001 to fiscal 2002 was primarily due to the non-recognition of tax benefits on significant impairment charges, which occurred in fiscal 2002.

        The tax effect on purchased in-process research and development, restructuring and other credits (charges), charges for the impairment of long-lived assets, charges for the impairment of goodwill, net gain on the sale of businesses and investments, net gain on the sale of common shares of a subsidiary and accounting change was a benefit of $265.8 million during fiscal 2003, as compared to a benefit of $670.9 million during fiscal 2002 and a benefit of $68.6 million in fiscal 2001.

        The valuation allowance increased by approximately $249 million due to the uncertainty of the utilization of certain non-U.S. deferred tax assets (see Note 10 to our Consolidated Financial Statements). We believe that we will generate sufficient future taxable income to realize the tax benefits related to the remaining net deferred tax assets on our balance sheet. The valuation allowance was calculated in accordance with the provisions of SFAS No. 109 which requires a valuation allowance be established or maintained when it is "more likely than not" that all or a portion of deferred tax assets will not be realized.

        The Company and its subsidiaries' income tax returns are periodically examined by various regulatory tax authorities. In connection with such examinations, certain tax authorities, including the Internal Revenue Service, have raised issues and proposed tax deficiencies. The Company is reviewing the issues raised by the tax authorities and is contesting certain proposed tax deficiencies. Amounts related to these tax deficiencies and other tax contingencies that management has assessed as probable and estimable have been accrued through the income tax provision. Further, management has reviewed with tax counsel the issues raised by these taxing authorities and the adequacy of these accrued amounts.

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        During fiscal 2003, the Company reached an agreement with the Internal Revenue Service relating to the examination of one of its subsidiary's income tax returns. As a result, the Company recorded a tax benefit of $22.4 million.

        Except for earnings that are currently distributed, no additional provision has been made for U.S. or non-U.S. income taxes on the undistributed earnings of subsidiaries or for unrecognized deferred tax liabilities for temporary differences related to investments in subsidiaries, as such earnings are expected to be permanently reinvested, or the investments are essentially permanent in duration. A liability could arise if amounts were distributed by their subsidiaries or if their subsidiaries were disposed. It is not practicable to estimate the additional taxes related to the permanently reinvested earnings or the basis differences related to investments in subsidiaries.

Cumulative Effect of Accounting Changes

        As discussed in "Off-Balance Sheet Arrangements—Variable Interest Entities" below, the Company has three synthetic lease programs utilized, to some extent, by all of the Company's segments to finance capital expenditures for manufacturing machinery and equipment and for ships used by Tyco Submarine Telecommunications. During fiscal 2003, the Company adopted FIN 46 and, accordingly, restructured one of the synthetic leases to meet the requirements of FIN 46 for operating lease accounting. The Company has reclassified the remaining two leases as capital leases and consequently, recorded a cumulative effect adjustment, a $75.1 million loss after-tax ($115.5 million pre-tax) in fiscal 2003 in accordance with the provisions of FIN 46. In addition, four joint ventures within Tyco Infrastructure Services met the consolidation criteria set forth in FIN 46. As a result of both the synthetic lease reclassifications and the joint venture consolidations, the Company has increased property, plant and equipment, net, by $433.8 million and total debt by $562.2 million (effective July 1, 2003).

        In December 1999, the SEC issued SAB 101, in which the SEC expressed its views regarding the appropriate recognition of revenue with respect to a variety of circumstances, some of which are relevant to us. As required under SAB 101, we modified our revenue recognition policies with respect to the installation of electronic security systems (see "Revenue Recognition" within Note 1 to our Consolidated Financial Statements). In addition, in response to SAB 101, we undertook a review of our revenue recognition practices and identified certain provisions included in a limited number of sales arrangements that delayed the recognition of revenue under SAB 101. During the fourth quarter of fiscal 2001, we changed our method of accounting for these items retroactive to the beginning of the fiscal year to conform to the requirements of SAB 101. This was reported as a $653.7 million after-tax ($1,005.6 million pre-tax) charge for the cumulative effect of change in accounting principle in the fiscal 2001 Consolidated Statement of Operations.

        During fiscal 2003 and 2002, the Company recognized $249.4 million and $294.2 million, respectively, of revenue that had previously been included in the SAB 101 cumulative effect adjustment recorded as of October 1, 2000. The impact of SAB 101 on net revenues in fiscal 2001 was a net decrease of $241.1 million, reflecting the deferral of $520.5 million of fiscal 2001 revenues, partially offset by the recognition of $279.4 million of revenue that is included in the cumulative effect adjustment as of the beginning of fiscal 2001.

        We recorded a cumulative effect adjustment, a $29.7 million loss, net of zero tax, in fiscal 2001 in accordance with the transition provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."

Critical Accounting Policies

        The preparation of consolidated financial statements in conformity with GAAP requires management to use judgment in making estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. The following accounting policies are based on, among other things, judgments

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and assumptions made by management that include inherent risks and uncertainties. Management's estimates are based on the relevant information available at the end of each period.

         Long-Lived Assets— Management periodically evaluates the net realizable value of long-lived assets, including property, plant and equipment and amortizable intangible assets, relying on a number of factors including operating results, business plans, economic projections and anticipated future cash flows. We carry long-lived assets at the lower of cost or fair value. Fair values are based on assumptions concerning the amount and timing of estimated future cash flows and assumed discount rates, reflecting varying degrees of perceived risk. Since judgment is involved in determining the fair value of long-lived assets, there is risk that the carrying value of our long-lived assets may be overstated or understated.

        The Company generally divides its electronic security assets into various asset pools: internally generated residential systems, internally generated commercial systems and accounts acquired through the ADT dealer program (discussed below under " Amortization Method for Customer Contracts ").

        With respect to the Company's depreciation policy for security monitoring systems installed in residential and commercial customer premises, the costs of these systems are combined in separate pools for internally generated residential and commercial account customers, and generally depreciated over ten years. The Company concluded that for residential and commercial account pools the straight-line method of amortization over a ten-year period continues to be appropriate given the observed actual attrition data for these pools.

        The determination of the depreciable lives of subscriber systems included in property, plant and equipment, and the amortizable lives of customer contracts and related customer relationships included in intangible assets, are primarily based on historical attrition rates, third-party lifing studies and the useful life of the underlying tangible asset. The realizable value and remaining useful lives of these assets could be impacted by changes in customer attrition rates. If the attrition rates were to rise, the Company may be required to further accelerate the amortization.

         Goodwill —Effective October 1, 2001, the beginning of Tyco's fiscal year 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible Assets," under which goodwill is no longer amortized but instead management assesses goodwill for impairment at least as often as annually and as triggering events occur. In making this assessment, management relies on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, and transactions and market place data. There are inherent uncertainties related to these factors and management's judgment in applying them to the analysis of goodwill impairment. Since management's judgment is involved in performing goodwill valuation analyses, there is risk that the carrying value of our goodwill may be overstated or understated.

        We elected to make July 1 the annual assessment date for all reporting units. Goodwill valuations have historically been calculated using an income approach based on the present value of future cash flows of each reporting unit. This approach includes many assumptions related to future growth rates, discount factors, future tax rates, etc. Changes in economic and operating conditions impacting these assumptions could result in a goodwill impairment in future periods.

        Disruptions to our business such as end market conditions and protracted economic weakness, unexpected significant declines in operating results of reporting units, the divestiture of a significant component of a reporting unit, downgrades in our credit ratings, and market capitalization declines may result in our having to perform a SFAS No. 142 first step valuation analysis for all of our reporting units prior to the required annual assessment. These types of events and the resulting analysis could result in additional charges for goodwill and other asset impairments in the future.

         Amortization Method for Customer Contracts —The Company purchases residential security monitoring contracts from an external network of independent dealers who operate under the ADT dealer program. The purchase price of these customer contracts is recorded as an intangible asset (i.e., contracts and related customer relationships).

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        As discussed above in " Long-Lived Assets ," the Company generally divides its electronic security assets into various asset pools: internally generated residential systems, internally generated commercial systems and accounts acquired through the ADT dealer program. Intangible assets arising from the ADT dealer program described above are amortized in pools determined by the month of contract acquisition on an accelerated basis over the period and pattern of economic benefit which is expected to be obtained from the customer relationship. The Company believes that the accelerated method that presently best achieves the matching objective described above is the double-declining balance method based on a ten-year life for the first eight years of the estimated life of the customer relationships converting to the straight-line method of amortization for the remaining four years of the estimated relationship period. Actual attrition data is regularly reviewed in order to assess the continued applicability of the accelerated method of amortization described above.

         Revenue Recognition —Contract sales for the installation of fire protection systems, large security intruder systems, undersea cable systems and other construction related projects are recorded on the percentage-of-completion method. Profits recognized on contracts in process are based upon contracted revenue and related estimated cost to completion. The risk of this methodology is its dependence upon estimates of costs to completion, which are subject to the uncertainties inherent in long-term contracts. Revisions in cost estimates as contracts progress have the effect of increasing or decreasing profits in the current period. Provisions for anticipated losses are made in the period in which they first become determinable. If estimates are inaccurate, there is risk that our revenues and profits for the period may be overstated or understated.

         Income Taxes —Estimates of full year taxable income of the various legal entities and jurisdictions are used in the tax rate calculation, which change throughout the year. Management uses judgment in estimating what the income will be for the year. Since judgment is involved, there is risk that the tax rate may significantly increase or decrease in any period.

        In determining income (loss) for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. SFAS 109 also requires that the deferred tax assets be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods.

        In evaluating our ability to recover our deferred tax assets we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions including the amount of future state, federal and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses.

        We intend to maintain this valuation allowance until it is more likely than not the deferred tax assets will be realized. Our income tax expense recorded in the future will be reduced to the extent of offsetting decreases in our valuation allowance. The realization of our remaining deferred tax assets is primarily dependent on forecasted future taxable income. Any reduction in estimated forecasted future taxable income including but not limited to any future restructuring activities may require that we record an additional valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in such period and could have a significant impact on our future earnings.

        In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.

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Discontinued Operations of Tyco Capital (CIT Group Inc.)

        On July 8, 2002 the Company divested of Tyco Capital through the sale of 100% of CIT's common shares in an IPO. Accordingly, the results of Tyco Capital are presented as discontinued operations for all periods. Prior year amounts include Tyco Capital's operating results after June 1, 2001, the date of acquisition of CIT by Tyco.

        Operating results from the discontinued operations of Tyco Capital through July 8, 2002 were as follows ($ in millions):

⁽¹⁾

Average earning assets is the average of finance receivables, operating lease equipment, finance receivables held for sale and certain investments, less credit balances of factoring clients.

        During fiscal 2003, Tyco recorded income from discontinued operations of $20.0 million. The $20.0 million represented a restitution payment made by Frank E. Walsh Jr. (see Note 18 to the Consolidated Financial Statements). Tyco Capital's revenues were $4,068.7 million for the period October 1, 2001 through July 8, 2002, consisting of finance income of $3,327.6 million and other income of $741.1 million. Tyco Capital's revenues for the period June 2 through September 30, 2001 were $2,011.6 million, consisting of finance income of $1,676.5 million and other income of $335.1 million. As a percentage of AEA, finance income was 11.9% and 12.8% for the period October 1, 2001 through July 8, 2002 and for the period June 2 through September 30, 2001, respectively. For the period October 1, 2001 through July 8, 2002, Tyco Capital's loss before income taxes and minority interest was $5,958.7 million. For the period June 2 through September 30, 2001, Tyco Capital's income before income taxes and minority interest was $451.1 million.

        Interest expense totaled $1,091.5 million and $597.1 million for the period October 1, 2001 through July 8, 2002 and for the period June 2 through September 30, 2001, respectively. As a percentage of

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AEA, interest expense was 3.9% and 4.6% for the period October 1, 2001 through July 8, 2002 and for the period June 2 through September 30, 2001, respectively.

        Other income for Tyco Capital was $741.1 million and $335.1 million for the period October 1, 2001 through July 8, 2002 and for the period June 2 through September 30, 2001 respectively, as set forth in the following table ($ in millions):

        Included in fees and other income are miscellaneous fees, syndication fees and gains from receivable sales.

        During the period October 1, 2001 through July 8, 2002, Tyco Capital recorded charges of $355.0 million relating primarily to a weakness in the competitive local exchange carrier industry included within its telecommunications portfolio and the economic reforms instituted by the Argentine government that converted Tyco Capital's dollar-denominated receivables into peso-denominated receivables. These charges have been included in the provision for credit losses. The provision for credit losses was $665.6 million, or 2.4% of AEA, and $116.1 million, or 0.9% of AEA for the period October 1, 2001 through July 8, 2002 and the period June 2 through September 30, 2001, respectively. Financing and leasing portfolio assets totaled $40.7 billion at September 30, 2001, while managed assets totaled $50.9 billion at September 30, 2001. Managed assets include finance receivables, operating lease equipment, finance receivables held for sale, certain investments, and finance receivables previously securitized and still managed by Tyco Capital. The reduced asset levels reflect the sale and liquidation of under-performing assets in industries expected to continue to have low margins coupled with lower origination volumes due to the soft economic environment and funding constraints arising from Tyco Capital's increased costs of borrowing.

        During the quarter ended March 31, 2002, we experienced disruptions to our business surrounding our announced break-up plan, a downgrade in our credit ratings, and a significant decline in our market capitalization. During this same time period, CIT also experienced credit downgrades and a disruption to its historical funding base. Further, market-based information used in connection with our preliminary consideration of the proposed IPO of CIT indicated that CIT's book value exceeded its estimated fair value as of March 31, 2002. As a result, we performed a SFAS No. 142 first step impairment analysis as of March 31, 2002 and concluded that an impairment charge was warranted at that time.

        Management's objective in performing the SFAS No. 142 first step analysis was to obtain relevant market-based data to calculate the estimated fair value of CIT as of March 31, 2002 based on its projected earnings and market factors expected to be used by market participants in ascribing value to CIT in the planned separation of CIT from Tyco. Management obtained relevant market data from financial advisors regarding the range of price to earnings multiples and market condition discounts applicable to CIT as of March 31, 2002 and applied these market data to CIT's projected annual earnings as of March 31, 2002 to calculate an estimated fair value and any resulting goodwill impairment. The estimated fair value was compared to the corresponding carrying value of CIT at March 31, 2002. As a result, we recorded a $4,512.7 million impairment charge as of March 31, 2002, which is included in discontinued operations.

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        SFAS No. 142 requires a second step analysis whenever a reporting unit's book value exceeds estimated fair value. This analysis requires that we estimate the fair value of the reporting unit's individual assets and liabilities to complete the analysis of goodwill as of March 31, 2002. We completed this second step analysis for CIT during the quarter ended June 30, 2002 and, as a result, recorded an additional goodwill impairment of $132.0 million. During the June 30, 2002 quarter, CIT experienced further credit downgrades and the business environment and other factors continued to negatively impact the likely proceeds of the IPO. As a result, we performed another first step and second step analysis as of June 30, 2002 in a manner consistent with the March 2002 process described above. Each of these analyses was based upon updated market data at June 30, 2002 and through the period immediately following the IPO, including the IPO proceeds. These analyses resulted in a goodwill impairment of $1,867.0 million, which is also included in discontinued operations. We also recorded an additional impairment charge of $126.4 million in order to write-down its investment in CIT to fair value for a total CIT goodwill impairment charge of $2,125.4 million. This write-down was based upon net IPO proceeds of approximately $4.4 billion, after deducting estimated out of pocket expenses, and is included in the $6,282.5 million loss from discontinued operations. During the fourth quarter of fiscal 2002, Tyco recorded a loss on the sale of Tyco Capital of $58.8 million.