江森自控 (JCI) 2012 Q3 法說會逐字稿

Welcome to the Tyco third-quarter earnings conference call.

All participants have been placed in a listen-only mode until the question-and-answer session.

(Operator Instructions) This call is being recorded.

If you have any objections, please disconnect at this time.

I will now turn the call over to Antonella Franzen, Vice President of Investor Relations.

You may begin.

Good morning and thank you for joining our conference call to discuss Tyco's third-quarter results for fiscal-year 2012 and the press release issued earlier this morning.

With me today are Tyco's Chairman and Chief Executive Officer Ed Breen, and Tyco's Chief Financial Officer Frank Sklarsky.

Also joining us for today's conference call are the Presidents of Fire & Security, ADT, and Flow Control -- George Oliver, Naren Gursahaney, and Patrick Decker -- who will provide updates on their businesses and also participate in the Q&A session following our remarks.

I would like to remind you that during the course of today's call we will be providing certain forward-looking information.

We ask that you look at today's press release and read through the forward-looking, cautionary informational statement that we have included there.

In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items.

The press release issued this morning and all related tables, as well as the conference call slides, can be found on the Investor Relations portion of our website at Tyco.com.

Please also note that we will be filing our quarterly SEC Form 10-Q later today.

Certain items to be discussed during today's call including those related to the Company's proposed separation are addressed in a proxy statement, which has been filed with the Securities and Exchange Commission.

Before making any voting decisions, investors are urged to read the proxy statement regarding the proposed separation and any other relevant documents carefully, in their entirety, because they contain important information about the proposed separation.

Free copies of the proxy statement and other documents filed with the SEC by Tyco can be obtained through the SEC's website as well as through Tyco's website.

I would also like to remind you that we are in a registration period due to the various filings related to the proposed separation and the announced merger of our Flow Control business with Pentair.

As a result, we will not be able to answer questions related to those items and ask that you keep this in mind during the Q&A session.

In discussing our segment operations, when we refer to changes in average revenue per user, backlog, and order activity, these figures exclude the impact of foreign currency.

Additionally, references to our operating margins during the call exclude special items, and these metrics are non-GAAP measures.

Again, these non-GAAP measures are reconciled in the schedule attached to our press release.

Now, let me quickly recap this quarter's results.

Revenue in the quarter of $4.5 billion increase 4% year-over-year, including a 4 percentage point decline related to foreign currency.

Changes in foreign currency exchange rates were more of a headwind than we originally anticipated and cost us about 1 percentage point of revenue growth compared to our previous expectations.

Organic revenue grew 5%.

Earnings per share from continuing operations attributable to Tyco common shareholders was $0.54 and included charges of $0.47 related to special items.

Earnings per share from continuing operations before special items was $1.01.

Now, let me turn the call over to Ed for some opening comments.

Thanks, Antonella, and good morning, everyone.

Overall, this was a very good quarter for Tyco, reflecting solid operational performance across Fire & Security, ADT, and Flow Control.

We had good top-line growth, a 20% increase in operating income, and strong operating margin expansion.

Continued recurring revenue growth in ADT, volume leverage in our manufacturing businesses and Flow Control and Fire & Security, along with productivity, cost containment, and restructuring initiatives all contributed to our 190 basis points of operating margin expansion in the quarter.

We delivered $1.01 in earnings per share before special items, marking the first time since the 2007 separation that we surpassed the $1.00 mark in quarterly earnings.

This represents a 19% increase year-over-year.

Now let me give you a quick overview of our results for each of our businesses.

Fire & Security had another strong quarter.

Operating income before special items grew 4 times as fast as revenue, highlighting the value of a nice mix of service, installation, and product revenue.

In ADT, recurring revenue, which represents almost 90% of ADT's total revenue, grew about 6% in the quarter with an increase in both the account base and average revenue per user.

In Flow Control, increased volume in Valves, execution of Water projects, and increased volume, along with the beneficial mix in the Thermal business, were the key drivers of the third-quarter operating margin expansion.

We surpassed the 13% operating margin we had expected to approach in the quarter and continue to be on track to achieve a 14% operating margin in the fourth quarter.

Before I turn it over to each of the Presidents to review their respective business results, let me give a quick update on the proposed separation.

First, as many of you have probably seen, we have been periodically updating our filings with the SEC; and we expect to be in a position to mail the proxy to our shareholders within the next week.

Second, we have received tax rulings from the IRS and other tax authorities confirming the tax-free treatment of the spinoffs.

Third, we have substantially completed the refinancing required by the separation.

Also, clearance from the US and EU authorities regarding the merger have been granted.

And lastly, the Tyco shareholder vote related to the separation and the Pentair shareholder vote related to the merger will both be held on September 14.

We will hold an Investor Day for both Fire & Security and ADT on September 18 in New York City.

Details regarding the event will be announced in the upcoming weeks.

In summary, we are on track with the timeline we had initially laid out for the separation and the merger of Flow Control with Pentair.

With that, let me turn it over to George.

Thanks, Ed.

Good morning, everyone.

Fire & Security's results for the quarter were highlighted by good revenue growth and strong operating margin expansion.

Our results emphasize the fact that we continue to be disciplined around our costs and confident about our ability to drive efficiencies.

These initiatives are benefiting our results and will help accelerate our investments in top-line growth while positioning us well for continued operating margin expansion in the future.

Now let's review some of the details for the quarter.

Overall, revenue for the quarter was $2.7 billion, an increase of 3% year-over-year, including a 4% decline related to foreign currency.

Organic revenue grew 4%, with net acquisition and divestiture activity adding an additional 3.5 percentage points of growth.

To give you a little more color across each of our regions, organic revenue growth was led by North America as well as Asia Pacific and Latin America.

Europe was essentially flat, as growth in products was offset by weakness in systems installations.

Turning to the performance of each of our global platforms, service, installations, and products, let me start with the largest and most stable portion of the portfolio, service.

Service represented about 45% of our revenue and grew 3% organically year-over-year.

Service grew in all geographic regions but was led by growth in Asia Pacific and Latin America.

Systems installation, which represented about 35% of our revenue, was up modestly on an organic basis, as growth in North America, Asia Pacific, and Latin America was partially offset by a decline in EMEA due to continued softness in the nonresidential construction market.

The remaining portion of Fire & Security's revenue comes from our global product businesses, which represented about 20% of our revenue.

Organic revenue grew 10%, following an 11% increase in the prior-year quarter as we continued to experience good demand across fire protection products, life safety, and security products.

Total Fire & Security orders grew 9% year-over-year with service up 4%, systems install up 6%, and products higher by 25%.

Backlog of $4.7 billion increased 1.5 percentage points on a quarter-sequential basis.

Both orders and backlog exclude the impact of foreign currency but include the impact of recent acquisitions.

From a profit perspective, operating income before special items was $356 million, and the operating margin improved 110 basis points to 13.4%.

This improvement was led by increased volume leverage in the product businesses and continued growth of our higher-margin service revenue.

In addition, improved execution in installation projects and the continued positive impact of restructuring and cost-containment initiatives contributed to the year-over-year increase.

Our reported operating margin of 13.4% includes a 30 basis point headwind related to increased investments in R&D, sales, and marketing.

As I highlighted on last quarter's call, we are a technology leader in the industry, and innovation and product development are critical to our future success.

This, along with our global sales and services footprint, differentiates us from our competitors; and it is the strength that we plan to continue to leverage as we move forward.

Looking ahead to the fourth quarter, we expect revenue of approximately $2.75 billion.

Embedded in this guidance is year-over-year organic revenue growth of 3%, a $110 million or 4 percentage point negative impact on revenue due to foreign currency, which will be mostly offset by the positive impact of acquisitions.

Additionally, as we disclosed last year, the fourth quarter of fiscal 2011 included a 53rd week.

This additional week increased revenue by approximately $100 million last year which will not be repeated in revenue for the fiscal fourth quarter in 2012.

From an operating income perspective, we expect the year-over-year operating margin, net of increased investments, to improve 50 basis points.

Finally, as I think about Fire & Security post-separation, I think about our unique position as a market leader in our industry.

Our diverse mix of quality product and service solutions along with our global scale of operations, market-leading brands, and innovative spirit position us well for future growth.

We have an impressive base of stable service revenue that supports attractive free cash flow generation.

And most importantly, we have bright, engaged employees who genuinely care about protecting people and the places that they live and work.

I am very excited about how these businesses have come together and the strong foundation we have built as the new Tyco.

Now let me turn it over to Naren.

Thanks, George, and good morning, everyone.

During the third quarter, we continued our trend of delivering profitable revenue growth with total revenue of $815 million, which is up 4% from last year.

Recurring revenue for the quarter, which accounts for nearly 90% of total revenue, was up 5.6% versus prior year.

Recurring revenue growth was fueled by continued solid performance in gross customer adds, which were up 4.7% year-over-year.

Net adds were up 1.4% during the quarter, as we did see an increase in customer attrition which grew 30 basis points on a quarter-sequential basis to 13.5%.

The primary drivers of this increase were the anticipated headwinds from the price escalations we implemented in the second and third quarters and an increase in disconnects due to relocations as a result of the pickup we are seeing in the housing market.

While these relocations create some short-term pressure, they also create a future opportunity as we look to reestablish relationships with existing customers as they move into their new homes and capture new customers who move into the homes that are already outfitted with ADT systems.

We have a number of targeted programs in place to address both movers and resale opportunities and are investing to strengthen these initiatives.

Our price escalations helped fuel continued momentum in driving higher revenue per customer, which grew 3.6% year-over-year to $38.36.

New revenue per customer in our direct new sales channel was up 5.5% to $45.12, driven by the continued strong performance of our Pulse platform.

Our Pulse take rate in this channel climbed to 39% versus 19% in the prior year.

We also saw continued momentum on Pulse in our small business sales channel, where the take rate improved to just over 19% versus 7% last year.

Nonrecurring revenue, which accounts for about 10% of total revenues, was down 4.3% during the quarter.

This decline was the result of the initial implementation of our business model change, moving towards more ADT-owned systems, which I discussed on our call last quarter.

This change resulted in about $10 million of lower nonrecurring revenue for the quarter and a slight improvement in operating income.

As I mentioned on last quarter's call, this change has virtually no impact on our cash flow or economic returns for these accounts.

Operating income for the quarter was $208 million before special items, reflecting a 10 basis point improvement in operating margin year-over-year.

Our productivity programs and the business model change helped to offset the cost of investments we are continuing to make to grow our customer base.

One of the primary growth investments is the continued expansion and strengthening of our direct sales coverage.

On a year-over-year basis, we have increased our direct sales headcount by 8%.

Marketing expenses increased by 2% during the quarter, as marketing and sales productivity largely offset the increase in lead-generation activities to support the additional sales reps and advertising costs increases in our key channels.

As we look forward to the fourth quarter, we expect recurring revenue to continue to grow at the rate we have seen over the past several quarters, approximately 5%, with the underlying recurring revenue growth drivers being consistent with what we saw in the third quarter.

The fourth quarter will also have a full quarter's impact of the ownership model change that I mentioned earlier.

Therefore, we expect nonrecurring revenue to decline between 15% and 20% year-over-year.

As a result, total revenue growth is expected to be about 2.5%.

In terms of operating income, we expect to see about 125 to 150 basis points margin improvement in our operating margins versus last year.

The change to more ADT-owned systems will give us some margin rate tailwind of approximately 100 basis points; and the balance of our margin expansion is driven by our ongoing focus on productivity programs, partially offset by the continued investments we are making to grow our residential and small-business platforms.

Overall, I feel very good about the performance this quarter and our prospects for continued profitable growth as we look ahead to becoming an independent public company.

Our 16,000 employees are passionate about helping customers protect and connect to what matters most -- their families, homes, and businesses.

Building on our nearly 140-year legacy, the industry's most-recognized brand, and an innovative set of offerings such as ADT Pulse, we are all very excited about the future of ADT.

Now I'll turn things over to Patrick.

Thank you, Naren, and good morning, everyone.

This was a solid quarter for Flow Control.

Revenue of $981 million in the quarter grew 6% year-over-year, including a 5.5 percentage point negative impact from foreign currency.

Organic revenue continued to grow at a healthy rate, increasing 10% year-over-year.

Operating income before special items was $130 million, a 23% increase year-over-year.

The operating margin of 13.3% was strong and exceeded our expectations, as increased volume leveraged nicely.

Now let me add a little color to the performance of each business.

In Valve Controls, revenue grew 7% organically, driven primarily from the oil and gas and process end-markets.

The leverage from the increased volume continued to lift the operating margin year-over-year.

Orders growth in the quarter moderated at 5% due to rebalancing of inventories by some of our distributors.

We saw good order growth in July and expect orders growth approaching double digits in the fourth quarter.

In Thermal Controls, organic revenue grew 4%.

Typically the third quarter tends to be Thermal's seasonally weakest quarter; however, increased product sales benefited mix during the quarter, resulting in improved operating margin performance year-over-year.

Orders in Thermal increased 26% versus the prior year.

In Water, revenue grew 26% organically, reflecting execution against backlog.

As you would expect, the increased volume provided significant operating leverage, resulting in an operating margin of 12%.

As you know, this is a project-based business and therefore orders tend to fluctuate from quarter to quarter.

While Water orders declined 16% year-over-year, the current backlog in Water coupled with projects we expect to be awarded over the next couple of quarters, this business is expected to support a continued solid operating margin.

Overall, total Flow Control orders in the quarter increased 5% year-over-year, and backlog of $1.8 billion was in line with the prior quarter.

As we move into the final quarter of the year, we remain confident, based on our existing order backlog and improved conditions in Water, that we can further increase our operating margin to 14%.

Now I'll turn things over to Frank.

Thanks, Patrick, and good morning, everyone.

Let me quickly touch on a few other important items.

First, our cash position and overall balance sheet remain strong.

We ended the quarter with $1.1 billion of cash.

In the quarter, we generated free cash flow of $341 million, which included $91 million of cash paid for special items primarily related to separation and restructuring activities.

Adjusted free cash flow was $432 million.

On a year-to-date basis, adjusted free cash flow of $846 million increased 14% year-over-year.

Over the past few quarters we have continued to invest in the future growth of our businesses, increasing our capital expenditures and dealer spend.

These investments are reflected in the free cash flow results.

Additionally, as you have seen in our quarterly results, management has embraced the opportunity to further rationalize both operational and administrative costs leading into separation.

The lower corporate number in the third quarter is reflective of these efforts, and the result will be more streamlined corporate cost structures post-separation.

In fact, the initiatives we have taken to drive down the corporate cost line will benefit each of the separated companies, and it is expected that these savings will offset the additional costs the companies will incur in order to operate as independent public entities.

As such, corporate expense before special items was $71 million in the third quarter.

The favorable performance in corporate expense before special items compared to our original estimate was also impacted by the timing of certain project expenditures and annual actuarial valuations.

As discussed in detail in our third-quarter 10-Q filing, which will be issued later today, we changed the methodology associated with the assessment of our asbestos accruals.

As a result, we recorded a net charge in the amount of $114 million on a pretax basis as a special item to increase the reserve to reflect our best estimate of what will be needed to discharge these liabilities.

Lastly, following the separation, we continue to believe that the corporate expense and tax rate guidance we previously provided in our filings for each of the three companies remains appropriate.

Now let me turn things back over to Ed to wrap up this morning's call.

Thanks, Frank.

Before we open up the line for questions let me briefly touch again on the fourth quarter.

As George mentioned, last year's fourth-quarter revenue benefited from a 53rd week, which on a total Tyco basis contributed an additional $145 million to the top line which will not repeat in this year's fourth quarter.

The revenue and operating margin guidance provided is reflective of segment results as they would have been reported as part of Tyco and not on a pro-forma standalone company basis.

As consolidated Tyco earnings per share including ADT and Flow Control will not be reported due to the pending separation, we will not be providing total Tyco EPS guidance for the fourth quarter.

But let me share some thoughts on our expected performance.

The fourth quarter is our seasonally strongest operational quarter in the year, and this year will be no different.

In fact, given the segment guidance provided, we expect an additional $0.06 of earnings per share from segment operations on a quarter-sequential basis and $0.09 per share year-over-year, despite the benefit of the 53rd week last year.

Given our year-to-date performance and our expectations for the fourth quarter, including our latest view of foreign currency exchange rates, we would expect that consolidated Tyco would be nicely ahead of the earnings per share guidance of $3.65 we provided last quarter.

As you know, it was just over 10 months ago that we announced our plan to separate Tyco into three companies.

In making our announcement we emphasized that this transaction was the next logical step for our Company and our shareholders.

I'm pleased to be able to say today that we have completed substantially all the heavy lifting related to this transaction, and we are now in the home stretch.

On a personal note, this represents my final quarterly earnings announcement as Tyco's Chairman and CEO.

After 10 years of leading this great Company, the time has come to pass the baton to new leadership.

Having watched each of these businesses evolve through the years, I feel a great deal of pride in what we have accomplished together.

Today all three businesses have industry-leading positions, with strong financials, leading technology, exceptional brands, exciting growth prospects, and exceptionally talented employees.

I see a very bright future for these businesses and for all of our people around the world who will contribute to their future success.

I am very proud that our three business Presidents would be stepping into new roles as public company CEOs, with George leading Fire & Security and Naren leading ADT.

I am very pleased to inform you that Patrick will become President and CEO of Harsco Corporation, a global industrial services company, effective September 10.

Harsco made this announcement earlier today.

Having worked closely with each of these leaders through the years I feel a great deal of pride in what they have accomplished and look forward to seeing them achieve continued success in their new roles.

With that, operator, let's open it up for any questions.

(Operator Instructions) Steven Winoker, Sanford Bernstein.

Thanks and good morning, everybody.

You know what?

I think it deserves mention before my questions just to say, Ed, congratulations.

Your 10-year anniversary.

You saved this Company.

I remember 10 years ago when I was at UTX and all of this news broke out, and we really wondered about the future of the Company.

And I just think it is worth merit and mention to say congratulations.

Thank you, Steve.

Sure.

And thank you, by the way, for your comments about Tyco on Bloomberg the other day.

Well, just easy to say; and look, you have made the numbers today.

So I am happy.

Let me ask a couple questions if I could, then transition to ADT.

Naren, could maybe give us a little bit more color on the pricing actions that you took in the quarter, the impact relative to last quarter?

And how many more quarters of this can you sustain?

Well, Steve, as I mentioned in the last call, we are continuously trading off our five value drivers.

We saw an opportunity in the business to be a little bit more aggressive on the pricing side, primarily because during the economic downturn, 2009, '10, and '11, we had been very cautious there and actually held back that.

So we made the decision to accelerate some of our escalations into Q2 and Q3.

In total, it was about 900,000 accounts that we escalated during those two quarters, and I would say we are pretty much caught up at this time.

There is a little bit of a tail there that will carry into the fourth quarter.

But at this stage we will be moving back to our normal annual cycle around price escalation.

So pricing will continue to be an important value driver for us as we look at ARPU; but I would say the acceleration that we did over the past couple quarters will definitely slow down as we look to the fourth quarter and beyond.

Okay.

But you covered -- what is it?

Around 30% of your account base?

Or what percentage of your account base have you covered with the last two price increases?

In total, it was about -- a little less than 30%.

But again, part of that would have been in our normal cycle; the rest of it, like I said, about half of that or a little less than half of that would have been incremental to what we would have normally done.

Okay, all right.

Then the other thing is -- I know I ask this all the time, but I just want to know every quarter.

Any progress from cable and telco perspective in terms of their pricing and share impact?

Are they -- are you experiencing any kind of change in trajectory or impact from the increased investment from those guys?

Well, again, as we have mentioned in the past, we track our progress in those markets where we have the cable competition very closely, and we are looking at our performance every week.

As I look at specifically the third-quarter performance, again, I feel very good about how we are performing in those markets.

There are some specific performance metrics like our Pulse take rate and the upfront dollars that we are getting from our customer that are better in those markets than what we are seeing in some of the other markets.

And that I think is a reflection of the fact that there's more advertising around interactive services there; so there is a little bit of a lift in the water level.

But overall, I still feel very good about our performance.

There is nothing in there that surprises me or has me concerned.

So I still feel very good.

And more importantly, I feel good about both the products and services that we have to compete with those players in the marketplace.

Okay, great.

Well, let me pass it on.

Thanks very much.

Jeff Sprague, Vertical Research.

Thank you.

Good morning, everyone, and let me add my thanks and congrats, Ed.

Hope you get some good time off; but also hope you resurface somewhere where we can see you soon.

Thanks, Jeff.

Just back to Naren for a follow-up on ADT and Pulse.

I think the $45.12 number you threw out is your dealer account ARPU, and I guess that is a blend of Pulse and non-Pulse.

Can you just give us a little color on where your actual Pulse ARPU is running, in kind of that -- I forget if you call it gold, silver, or bronze.

But those kind of price levels, how people are breaking into those different buckets.

Jeff, just to clarify, the $45.12 number I gave you, that was new sales ARPU for our direct channel.

So that was not a dealer number.

The Pulse ARPU is consistent with what we have seen over the past several quarters, hovering right around that $50.00 range.

And I would say the mix between the different Select, Advantage, and Premier again is pretty consistent.

About 70% in the Select and then building up from that.

But no significant changes either on the ARPU side or that mix between Select, Advantage, and Premier.

Great.

And just flipping over to George.

George, can you share a little color on what drove the product strength in your business?

Sure.

I mean if you go back, Jeff, we have been investing pretty heavily into these businesses for a number of years now, and I think that investment really now is beginning to pay off.

We're not only extending the portfolio but making sure that we are positioned within the growth markets, both the emerging markets as well as vertical markets, to be able to capitalize on the growth opportunity.

So the organic piece -- we have also done some nice, strategic bolt-on acquisitions which have really complemented our portfolio, enabling us to better serve the customer base that we serve with our current channels, as well as capitalize on the new channels that they have brought to the business.

So it's a combination of the two that really is driving that strength.

Then just on Europe, have you been able to defend or even improve those margins, despite the fact that you are now hitting some revenue headwinds there?

If you go back -- and over the last few years we have done a tremendous amount of work restructuring these businesses and making sure that we are focused on how do we grow profitably within these markets.

And I can say, across the board when you look at our current performance, our products are up modestly relative to the growth.

Service is relatively flat, with install just slightly down.

So overall, given what is happening within Europe I would say we are performing pretty well.

And I think the work that we have done in restructuring these businesses, the investments that we are making now focused on profitable growth is really paying off.

And across the board now we are operating with double-digit margins.

And, Jeff, I would just add that if you take a look back, remember that those margins in the EMEA region were once at that mid single-digit range and now they're in the double digits.

And all that progress happened during an economic environment where we weren't getting any growth in the Europe region.

All of our businesses, Jeff, within the UK, within Continental Europe, across Security as well as Fire now is operating with double-digit returns.

No, that's great.

I remember when there was a minus sign in front of the margins (multiple speakers).

So do I, Jeff.

Me, too.

Next question, please.

Ajay Kejriwal, FBR.

Good morning and thank you.

And, Ed, I will join the chorus, and congratulations on a tremendous 10 years with Tyco.

Thank you.

Great.

Then, Naren, maybe just following up on that ARPU discussion, is it possible to parse that growth between mix and price?

I know you had a very nice price increase on accounts this quarter.

But any color?

How much was mix versus price?

Well, when you look at the increases that we gave in ARPU that should give an indication.

It is not just price, but the ARPU growth of 3.7% would be reflective of the price escalation.

As well as, as new customers come on board, they are coming on at a higher rate because they are taking additional services.

And then you obviously have the account growth at about 1.4% adding to that.

Good.

Where I was going to was -- what is sustainable?

So you have had very nice ARPU growth the last few quarters and you're guiding to about mid-single next quarter as well.

The end-markets growing low-single digits; obviously you are doing much better than end-market.

But you're a big piece of the market here.

So I guess, any thoughts on what is the sustainable ARPU growth rate would be helpful.

I think Pulse, while escalations may have been a significant driver over the past couple of quarters, in the long-term the Pulse take rate is going to continue to fuel that growth.

So as we bring on new customers and as we upgrade our installed base to Pulse, I think there is a nice opportunity there.

I still think that there is a strong unit growth opportunity.

You've got to keep in mind only 20% of US households have a monitored security system today.

So I think there is tremendous penetration opportunities.

Again, with the benefit of some of the new players coming in, the advertising and the awareness that they bring, we hope and believe that there will be an increase in penetration.

And also as we bring more new capabilities to those customers to make the value proposition more attractive.

Good.

Then maybe George, just one on the bolt-on acquisitions.

Sounds like you did a couple in the quarter.

In terms of the opportunities, any thoughts on what are the opportunities you see, whether they are outside the US?

Anything you see in Asia Pacific or Latin America?

Sure.

A big part of our strategy was continuing to look at bolt-on acquisitions.

If you recall and you look at our market, although there are a couple of large plays, it is very fragmented across the globe.

So we are constantly looking at it, with our strategy of being a technology leader, expanding our service capabilities, positioning ourselves in the emerging markets, and strengthening some of our vertical solutions.

Those are the priorities that we are looking at with these bolt-on acquisitions.

We have got a nice pipeline of opportunities that we continue to work on, similar to what you have seen over the last 12 or 18 months.

And that is certainly going to be a big part of our strategy as we go forward.

Thank you.

Very helpful.

Scott Davis, Barclays Capital.

Hi, good morning, guys.

I'm going to ask one question for each, Naren and George, but let's start with you, Naren.

When you think about these relocates, I mean, I think about the long-term history of ADT wasn't necessarily all that great at capturing when somebody moved into a new home and capturing as a customer.

What are you doing differently now that allows you to capture?

And do you have any stats of what your capture or recapture rate is and such?

Steve, I think it's a great question -- excuse me, Scott.

What we are trying to do and what we have done is we are really building the relationship with that customer much earlier in the process.

So we are actually partnering with companies like HGTV and building our reputation for the safe move, building a program around the safe move.

So we interact with our customers very early in that process of the decision to move out of their existing home, and we partner with them throughout that whole process.

So I think we have seen some good success there.

And part of that success is reflected in the momentum that we are seeing in our gross adds, which are up strongly in the 5% range this quarter.

But also year-to-date we are running significantly above that, in the high single digits.

So I think we are making some good momentum, seeing some good momentum there.

Well, so just to follow up on that, any sense of when somebody moves and they're an existing ADT customer, what the percentage chance you are to pick them up again?

I would say that one is, they do have that predisposition to use a security system, and we're making sure that they've got the financial incentives as well to stay with us.

I don't have a specific percentage capture rate there, but I think we are making very good progress there.

And we see that as a continuing opportunity for us.

Okay, fair enough.

(multiple speakers) the assets that are sitting in the home, we want to make sure that we capture the new people who are moving in through our resale program.

Sure, sure, makes sense.

Okay.

And one for George.

George, can you give us just a sense -- I mean, you said all regions grew, but can you give us a sense by geography where the differences in growth rates were around the world?

Sure.

When you look at the geographic footprint that we have, North America we actually grew very nicely across both of our Fire & Security businesses.

As I said in EMEA, overall when you look at just pure Europe, we are relatively flat.

EMEA was up just modestly, and that included South Africa performance.

So, overall, just up slightly in EMEA.

And that was driven, as I said, continued strong product growth in spite of the soft economy there, relatively flat services, and install just modestly down.

Then when you look at Asia Pacific we're up in total.

Obviously strength in Asia, in China, and then across the board overall.

Good performance across the region, and that is how we measure it.

So overall -- and then Latin America, when we segment Latin America we continue to see nice growth across both of our Fire & Security businesses there in Latin America.

So, overall we think the work that we are doing with our strategy, the investments we have made with the bolt-on acquisitions, I think are positioning us well to be able to differentiate and be able to serve the customer base and continue to grow, in spite of some of the economic challenges.

Okay, good.

Thanks.

I will pass it on.

Good luck, guys, in your final quarter.

Nigel Coe, Morgan Stanley.

Yes, thanks.

Good morning.

Ed, I am glad you managed to break the dollar mark before separation.

(laughter) Thanks.

So, just wanted to come back to the products growth.

10% is pretty impressive.

The gap between products and installs, I'd expect those at some point to recouple.

The differential, is that more geographic?

Is there some pricing in there as well as inventories?

I mean what does explain that gap between products growth and installations?

When you think of our portfolio, in our direct channel we have about $8.5 billion of revenue; and then on the product side, we distribute through an external channel about $2.5 billion.

At the end of the day, it is really making sure that we've got good coverage across all of the markets regionally.

So we utilize where we have our focus with our direct channel, making sure we are differentiating the offerings that we have; and then we utilize partners and distributors to bring our technology to the rest of the market through our external channel.

There is also -- when we look at our external channel, we serve a lot of the higher hazard end-markets.

Therefore initially there is not a lot of service.

So in the direct channel we are constantly focusing on our project activity where it leads to recurring service revenue within our direct channel, because that ultimately is what drives our overall performance.

So we are constantly looking at the mix and making sure that we've got the right channels to be able to get the product placed, and then being positioned to be able to gain the service revenue over the life cycle of that installation.

Nigel, the one thing I would add to that is that we have been and continue to be selective on the installation side.

We will continue to do that as we move forward.

So as you could see, we were definitely getting the pull-through on the product side; and as George mentioned, we are trying to capture then the service side once the install is done.

Okay.

No, that's clear.

Then switching to Flow, Patrick, it looks like Valves softened a little bit in 3Q but then seemed to perk up again in July.

Is there any reason why that would be the case?

Why you saw some softness, but then a reacceleration in July?

Yes, sure, Nigel.

I think it was just the general tepidness in the distribution channel around what was going on in the general macro environment.

People were looking at inventory levels, etc., on the distribution side.

But I think now we have seen very strong order pickup in July.

So it seems to have abated, and we have a pretty robust outlook for the next quarter.

Any intelligence on where --?

No change in outlook on project activity.

It is still a pretty robust market out there.

How do you feel about channel inventory levels within Valves?

Feel good.

Feel fine.

It was not an issue in terms of being too much out there.

I think it was just a general tepidness in terms of the economy and financials.

Okay, great.

And, Patrick, congratulations on your new role.

Thank you.

I appreciate it.

Deane Dray, Citi Research.

Thank you.

Good morning, everyone.

I wanted to follow up with Patrick on Flow; and I might have missed this.

The double-digit orders expectation for the fourth quarter, how does that break out between the three businesses or maybe directionally?

Yes.

So, it is really a Valves commentary.

That is the business that really is much more of a backlog business.

The Water and Thermal businesses are choppy by definition because of lumpy projects that fall in and out of a quarter.

So we feel good about the outlook from both of those businesses.

And Valves, Valves is the business that we were really referring to when we said it would be approaching double digits.

What were the Water projects that you said you had increased visibility on?

Yes, there is still a fair amount of infrastructure being built in Australia on the large-diameter water transmission needs that are out there.

These are long-cycle projects.

We track them over many years.

We've had visibility into these for quite some time, and we feel very well positioned to see a number of them coming down the pipe here.

Great.

Then for Frank, on the change in the asbestos reserve, just remind us what the time frame was on the previous reserve and how far this new reserve takes you.

Yes; no, that's a good question.

By the way, there will be some more extensive disclosure you will see in the 10-Q today.

But basically the consistency in the data and the confidence in the trends have allowed us to look at the look-back and look-forward periods.

So we went from 5 years look-back to 3 years look-back, because we see more consistent data over that period of time.

And now we have gone looking forward from 7 years to 15 years.

So the new one is 3 back, 15 forward.

And we think that the accrual that we have now on the books is adequate to discharge our liabilities at this point.

Has there been any change in your insurance assets?

Well, what we have done is we've taken a look at the whole ball of wax here in terms of the liabilities as well as assets.

And we have identified significant amounts of insurance.

So what you will see in totality is a gross liability about $436 million and a net liability, net of insurance, of $154 million.

So when you look at it in totality, that $154 million, you're looking at 15 years; you're not going to see any exposure in any given year that is really material to Tyco in total.

But yes, we have taken a good, hard look at all the insurance assets.

And that is all part of the analysis.

Yes.

And from our perspective, anytime we see a company take a reserve out 15 years it is usually a good sign in terms of reduced claims and better visibility on the claims outstanding.

Is that fair?

I think it's a fair point.

Great.

I know I should know this, but where is the asbestos liability?

Even though it now looks fully reserved, where does that go on separation?

Yes, the vast majority of that is going to be over in Fire & Security.

Great.

Okay, thank you very much.

Gautam Khanna, Cowen and Company.

Thanks for taking the question.

And, Ed, congratulations on a great run.

Thank you, Gautam.

Look forward to seeing where you end up next.

I just wanted to follow up on the Fire & Security product orders again, just for more context.

Because I think I recall in the March quarter the number was up huge as well, 33%.

Could you characterize what the year-ago compares were that might explain it?

And perhaps if there was inorganic contributions in that number.

Yes, this is George again.

Going back through the orders, we are seeing about -- when you look at the order rates that we talked about, which is driven by products up 25%, there is about half of that that is attributed to the acquisitions that were made over the last year.

So when you look at the -- it would be roughly, would be up about 5.5% organically on orders.

When we look at the base of that, that is achieved because -- if I go back and we look at the growth that we are seeing, it is really organically based on the investments we've made in our ability to expand distribution and make sure that we are positioned to capitalize on all growth markets.

Then it is complemented by the acquisitions that have been made that not only strengthen our portfolio but also open up additional channels to be able to bring our current product to the market, to be able to capitalize on that growth.

So it is really a combination of the two that is positioning us well to not only grow organically but to be able to supplement that with the acquisitive growth that has been achieved.

And as you have seen the revenues, about $100 million per quarter on revenues that we are seeing with the bolt-on acquisitions, has really come together nicely with the base businesses that we have.

And Gautam, the one thing I would add, the growth that we are seeing this quarter in orders, up 25%, is on top of the 10% accelerated orders growth we saw third quarter of last year.

Okay, that's helpful.

Switching to ADT, you mentioned the attrition up 30 bps in part due to the relocations.

I wonder if that is a trend you anticipate will continue for some extended period.

And if so, could you quantify what the impact was on that 30 bps in the quarter?

Well, based on how the housing market has bounced around, I hesitate to speculate on what it might look like going forward.

I think if we continue to see a strong housing market out there, that will drive incremental relocations.

Again, because of the way we track attrition we follow the asset, we follow the home versus the customer.

So when we lose that customer in their current home that hurts our attrition number; when we capture them in the new home, that helps our gross add number.

But I think we're all going to be watching the housing market very closely.

June was good but not as good as May, and we will watch to see what happens in July and August.

Could you characterize how much of that 30 bps came from relocations in the quarter?

Yes; it is about half.

Just stepping back a bit, higher level, at Fire & Security where do you think we are in this cycle?

Do you think we're in the third or fourth inning, or are we in the fifth or sixth?

Where do you see this?

Where do you see where we are relative to the cycle?

Well, there's two big metrics that we follow.

So the first is what is actually happening in the market; so that is measured by the Dodge Reports and McGraw-Hill reports that show that the actual level of activity is actually this year down about 5%.

So that is actually what is happening in the market.

Now the indicator of what is going to happen going forward is the ABI index, which at 50 or above suggests that there is going to be future growth over the next 9 to 12 months.

That index was coming up nicely up to about two quarters ago.

Then what has happened here is now softened here in the last quarter or two to roughly about 47%.

So it suggests that although it is holding on, there is not a projection that there is going to be a lot of growth within the non-resi construction market going forward.

And recognize that it is 35% of our revenue base within Fire & Security.

What we have done nicely is we're very selective in the projects that we have been taking on, and with that making sure that it is positioning us to be able to accelerate service growth which as we discussed we were able to achieve 4% growth this quarter.

It's a critical piece of our -- making sure that we get the right projects that ultimately drive service is what's most important.

I think, Gautam, just to add to George's comments, the team has been posting these results, both orders and growth rate, without in the last 4 years non-resi helping us at all, as all of you know.

It is down 50%, 60% from peak levels before the recession, and it has not picked up yet.

So we're feeling good about the performance.

But the key driver, commercial construction, is not helping us yet at all.

Go back to the downturn.

Since the downturn it's actually down, there has been no recovery net through this period since 2008.

And down -- we thought this year was going to be the beginning of the recovery.

I believe it is going to be down somewhere around 5% or 6%, the non-resi construction activity.

So all the work that's gone on, on rationalizing the cost structures, is going to bode well for big operating leverage uplift on when it inevitably recovers at some point.

All right.

Thank you.

I appreciate it, guys.

Steve Tusa, JPMorgan.

Hey, good morning.

Congratulations, Ed.

Way to go.

Thank you.

On the fourth-quarter Flow revenues -- I don't think you guys gave a number on that.

You gave numbers on everything else.

No, we didn't provide a specific revenue number for Flow Control.

We just really put out at this point an operating margin guidance number.

Any reason why that is the only one that is not --?

Is that because that is going to be a Pentair --?

Yes, as you know, the results of Flow will be included as part of Pentair.

We did want to conclude on the margin target we had previously put out regarding the operating margin and approaching the 14% by the end of the year.

So we just wanted to confirm that we are still on track to achieve that.

But, Steve, there is no anomaly there.

Our backlog is near an all-time high in Flow.

Our orders were decent; our July orders were better.

But there is nothing going on there.

Okay, great.

(multiple speakers) that will get the margins up another -- up to 14%.

Then I guess there is some news coming across saying that you are departing as CEO, Chairman.

There is no change to you sitting on any of the boards of any of these new companies you talked about prior, right?

Yes, Steve, no change whatsoever.

Okay, Great.

Thanks a lot.

Congratulations again.

Operator, we have time for one more question.

Shannon O'Callaghan, Nomura.

Good morning.

Congrats, Ed.

A lot of heavy lifting over 10 years.

Thank you much.

So, the CapEx was up pretty decently in the quarter.

Can you maybe break that out by the segments?

Was it mostly ADT?

Are you doing some things in the other pieces?

I mean it would be broken out between ADT and in the Fire & Security piece of the business that we have.

A bulk of it would relate to ADT, because as you know the majority of all the dealer goes into the ADT residential business.

And then on the regular CapEx side a piece of it would be within ADT and a piece of it would be in Fire & Security.

When you do see the updated Form 10 filing for ADT, you will see the exact amount that is allocated to resi; and you will know exactly how much was Fire & Security.

Okay.

Just a commentary on that on the dealer side.

We are continuing to invest there as we see opportunities; it is driving both our unit growth, but also ARPU.

As we get higher ARPU there, we have a higher funding level.

Similarly on the direct side, I would say the only anomaly there is that business model change does put more dollars into the CapEx, our subscriber CapEx number.

Again it doesn't change the cash flow overall, just moves it from one bucket to another.

I think the message you are hearing -- that it's the vast majority of CapEx is going toward growth.

And in Fire & Security, most of our -- all of our capital expenditures, in line with our growth, we're continuing to reinvest in the business.

Naren, do you know how much that accounting change impacted the internal CapEx for ADT in the quarter?

It was between $5 million and $10 million.

Okay.

Again, it was a $10 million revenue impact.

A piece of that is the sale and comp side of that; so that would have gone on the balance sheet.

Okay.

Then, can we just -- maybe a little bit more color on the Valves piece, maybe by some of the verticals, and maybe how much visibility do you have into those distribution channels, just to give us a little better feel.

It seemed like a decent slowdown in the quarter and then a snapback, yet the macro hasn't really felt like it has gotten a lot better.

So interesting, why it is picking back up.

I guess why it came in so much and why you think it is picking back up so much into 4Q.

Yes, I think first of all, as we have said in the past, this is a fairly choppy project environment in the markets that we serve.

So I wouldn't read too much into any one quarter.

I realize that it appeared to be a little bit of a pullback from what we have seen in terms of growth rate.

But I would also remind everyone that we are lapping some pretty impressive growth numbers last year.

But two, I think there was just a general tepid response in June to what is going on in Europe and other things.

But we saw that bounce back in July.

If I look at it by industry, oil and gas continues to be very impressive growth.

I would say we had a little bit of volatility in mining, which is bouncing back in terms of growth there; but again, that is a watch and see.

I think the power markets have obviously been toggling back and forth from what happened in Japan.

But again we feel good about the long-term aspects there.

And then process, which is really driven by chemicals, is obviously tied to GDP and what is going on generally in the overall economy right now.

So that I think is where we really saw more of the pullback in June; and it bounced back in July.

Okay, great.

Well, thanks a lot.

Operator, that concludes our call.

Thank you.

This does conclude today's conference.

Thank you very much for joining.

You may disconnect at this time.