江森自控 (JCI) 2013 Q1 法說會逐字稿

Welcome to the Tyco first-quarter earnings conference call.

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

(Operator Instructions)

Today's conference 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 first-quarter results for fiscal year 2013 and the press release issued earlier this morning.

With me today are Tyco's Chief Executive Officer George Oliver and Chief Financial Officer Arun Nayar.

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 statements that we have included there.

In addition, we will use certain non-GAAP measures, including normalized earnings per share, in our discussion 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 conference call slides which contains summary financial information, can be found on the Investor Relations portion of our website at Tyco.com.

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

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

Additionally, references to operating margins during the call exclude special items making them non-GAAP metrics.

These non-GAAP metrics are reconciled in the schedules attached to our press release.

Now let me quickly recap this quarter's earnings.

Earnings per share from continuing operations attributable to Tyco common shareholders was $0.34 and included charges of $0.06 related to special items.

These charges related primarily to separation and restructuring activities.

Earnings per share from continuing operations before special items was $0.40 compared to the prior year quarter of $0.26.

As we mentioned on last earnings call, EPS this fiscal year is not comparable to the prior year as the prior year's results include corporate and interest expense associated with supporting the ADT and Flow Control businesses.

Additionally, our 2013 results are being impacted by the dis-synergies associated with the separation of the Commercial Security operations in North America from ADT.

Normalizing last year's results for these items, the comparable prior year earnings per share before special items would have been $0.36.

Now let me turn the call over to George.

Thanks, Antonella.

Good morning, everyone.

We are off to a great start as the new Tyco.

During our first quarter we made a lot of progress in bringing the teams together as an integrated fire and security company and executing on our growth strategy.

We also continued to strengthen our competitive capabilities across our businesses, both organically and through acquisitions, and we have started to see the increased benefits from our productivity initiatives.

Overall, our first-quarter results reflect a year-over-year increase of 11% in earnings per share before special items on a normalized basis, a solid beginning to fiscal 2013.

In line with our growth strategy our Installation & Service segment benefited from increased service revenue across most geographic regions and our product businesses continued to reap the benefits of our focused R&D spend to drive new product introductions.

Additionally, we strengthened our service platform and augmented key vertical markets with recent acquisitions and accelerated our growth rate in high-growth markets.

Before I turn to our business results for the quarter let me quickly touch on each of these items.

First, service revenue, including recurring revenue, represented nearly 45% of total revenue in the quarter.

Given the integration of our Fire and Security businesses we are uniquely positioned to bring differentiated solutions to our combined customer base.

We expect this will allow us to accelerate the rate of service revenue growth to 5% over the next few years.

Second, we continue to fund engineering and product development with double-digit increases year over year.

It is these types of investments which drive new or enhanced product introductions.

For example, this quarter in Fire Protection products we introduced a new liquid vehicle system under our ANSUL brand, which is a new liquid agent system technology for mobile equipment particularly suited for the mining verticals.

It is a holistic approach to fire suppression with early fire detection and fast actuation to control and surprise flames in seconds.

This new technology positions us well for future growth in the mobile equipment market.

In security products we develop the fastest IP camera on the market with improvements in the speed the camera can pan, tilt, and zoom.

This significantly boosts the capabilities we provide for our customers where precision and detail can make all the difference.

On a separate front, we are also upgrading our existing residential panels and keypads integrating the Visonic PowerG wireless technology obtained from our recent Visonic acquisition.

And in Life Safety products we launched the Protege ZM, a new handheld, portable gas detection device which incorporates several technological improvements designed to extend the life of the device and improve total cost of ownership in the portable gas detection market.

Each of these new products have been very well received in their respective markets.

In addition, since the separation, we closed two strategic bolt-on acquisitions for an aggregate purchase price of about $50 million.

These acquisitions are expected to expand our installation and service footprint primarily in the US and the UK and enhance our offerings in the banking and financial services vertical.

We also signed a definitive agreement to purchase a majority ownership stake in Beijing's [Master Systems Engineering] which is a leading systems integrator of building security systems in China.

We expect this acquisition will allow us to further expand our footprint and customer base while opening up additional opportunities in the region by leveraging their grade A license, which is the highest level design in contracting license in China.

The closing of this transaction is subject to customary regulatory approvals.

These types of transactions have helped us expand our position in high-growth markets which represent 13% of our total revenue in the quarter.

Year over year revenue in high-growth markets increased 22%, partly driven by our prior year acquisition in Fire Installation & Services.

Additionally, we are beginning to see the benefits of our sourcing and productivity programs earlier than anticipated, especially in North America.

All of these actions are integral to our strategy and at the outset are getting very good traction.

Before I get into the segment results for the quarter I just wanted to spend a few minutes giving you an update on another key element of the strategy we laid out at our investor day -- capital allocation.

As we discussed back in September, we have a deep pipeline of attractive acquisition candidates that complement our existing businesses.

These potential acquisitions are consistent with our strategic priorities and provide very good long-term financial returns for shareholders.

We continue to prioritize the use of free cash to execute strategic bolt-on acquisitions.

Given that the timing of acquisitions can vary, the Board approved an increase in our share repurchase authorization to $750 million.

This provides us greater flexibility to be opportunistic in returning excess cash to shareholders.

Further, in support of our capital allocation strategy we recently announced a proposed increase of our annual dividend to $0.64 per share.

The proposed dividend represents about a 7% increase over the post separation annualized dividend.

Our shareholders will vote on this proposal at our annual general meeting in March.

Considering our acquisition pipeline, the $750 million share repurchase authorization, and the proposed dividend increase, we continue to demonstrate our balanced approach to capital allocation.

Now let me turn to an overview of our segment results and give you a feel for the business environment in each of the segments.

Then I will turn it over to Arun to provide you with more details regarding our quarterly performance.

Let me begin with our North America Installation & Services segment, which had better than expected operating results for the quarter.

In Tyco Integrated Security, our North America commercial security business, we are seeing improvement in the execution of installation projects as we work through our backlog as the discipline put in place as part of project selectivity takes hold.

As I mentioned earlier, we have seen the benefits of sourcing and productivity initiatives earlier than expected.

In SimplexGrinnell, our North America fire business, which represents about half of the revenue in this segment, we saw accelerated organic revenue growth and continued operating margin expansion.

Installation revenue grew for the first time in five quarters, reflective of the modest improvement we are seeing in the non-residential construction market.

We expect to see continued installation growth throughout the year.

As I mentioned last quarter, we expect to see revenue headwinds overall in our North American Installation & Services segment in 2013 as we continue to execute project selectivity in Commercial Security.

I will speak a little more about that as we cover our guidance for the second quarter later in the call.

In Rest of World Installation & Services we continue to see nice growth in service across Europe, Asia, Latin America, and South Africa.

Project activity in high-growth markets continued to be more than offset by a decline in mature markets due to project selectivity and weakness in non-residential construction markets.

Year over year acquisitions added 3 percentage points of growth and have strengthened our position in high-growth markets.

For example, the acquisition of Reliance, which was completed in the prior year, enhance our fire systems Installation & Service position in China.

Given our rest of world market position and backlog, coupled with a modest pickup in installation in the second half of the year, we are well positioned for future growth in margin expansion.

In global products, top-line growth was solid at 16% as organic growth of 6% was supplemented with a benefit of past acquisitions.

The operating margin was short of our expectations, primarily due to a charge for an environmental reserve.

Given our R&D investments, order activity, and expectations for the remainder of the year, we feel good about our ability to strengthen our global products margin sequentially each quarter to achieve a full-year operating margin of about 18%.

Now let me turn the call over to Arun to discuss the operating results in more detail.

Thank you, George, and good morning, everyone.

Before I get into the details of our segment performance let me provide an overview of our first-quarter results.

Revenue in the quarter of $2.6 billion increased 5% year over year.

Service revenue growth of 2% and products growth of 6% was partially offset by a 3% decline in systems installation or overall organic revenue growth of 1% in the quarter.

Our organic growth was supplemented by strategic bolt-on acquisitions which added $76 million, or 3 percentage points, to our overall growth on a year-over-year basis.

Segment operating income before special items was $318 million and the operating margin was 12.2%.

The benefit from our productivity initiatives funded incremental investments in the businesses and absorbed dis-synergy costs.

Earnings per share from continuing operations before special items of $0.40 represents a $0.04 increase year over year on a normalized basis, of which $0.03 came from operations.

Now let me get into the details of each of the segments.

Starting first with North America Installation & Services, revenue in the quarter of $976 million increased 1% organically.

Service revenue increased 1% in the quarter while Installation revenue remained flat.

Revenue growth in the first quarter was supported by the conversion of year-end backlog, which decreased 3% on a quarter sequential basis to $2.4 billion.

As expected, overall orders in North America Installation & Services declined 9% including service order growth of 2%.

Operating income before special items was $120 million and the operating margin increased 110 basis points year over year to 12.3%.

An increased mix of higher-margin service revenue coupled with a better than expected retail season and accelerated sourcing and productivity savings drove the operating margin improvement.

These benefits more than offset the increased costs associated with the separation of the North America Commercial Security business from ADT.

On a full-year basis we still expect a 2% to 3% organic revenue decline in 2013 due to our project selectivity strategy.

We anticipate that the benefits of restructuring, sourcing, and productivity will offset the revenue decline and that $35 million of dis-synergies related to the separation, resulting in an overall operating margins similar to the prior year.

Turning to Rest of World Installation & Services, revenue was up 3% overall, mainly due to acquisitions.

Organic revenue was flat year over year as a 3% increase in Service revenue was offset by a 5% decline in Installation revenue.

Service orders increased 5% and installation orders increased 8% year over year.

In aggregate orders increased 6%.

Backlog of $2.6 billion increased 3% on a quarter sequential basis.

Operating income before special items was $121 million and the operating margin was 11.1%, relatively consistent with the prior year as a higher mix of service revenue was offset by incremental growth investments.

Moving to global products, revenue grew 16% in the quarter to $534 million.

Organic revenue grew 6% with positive growth across all three platforms led by security products and life safety.

Both of these platforms had double-digit growth as the benefits of R&D investments continue to drive new product introductions and enhancements.

Product orders increased 16% year over year largely driven by acquisitions.

Operating income before special items was $77 million and the operating margin declined 390 basis points to 14.4%.

As we discussed on our last quarter call, we expected the operating margin in the first quarter to be in the range of 16% to 16.5% as the leverage on increased revenue would be more than offset by a 280 basis point incremental investment in R&D and sales and marketing.

In addition to making the planned investments, the quarter was also impacted by $6 million of costs associated with an environmental reserve and lower sales of higher margin products due to the timing of shipments.

We estimate that these two items impacted operating income by about $11 million and our operating margin by approximately 200 basis points.

As we look ahead to the second quarter we expect a sequential increase in the operating margin to 16.5% to 17%, keeping us on a path to an operating margin of about 18% for the year.

Now let me touch on a few other important items.

First, corporate expense before special items was $58 million in the first quarter and we expect corporate expense in the second quarter to be similar.

Next, our effective tax rate for the quarter before the impact of special items was 17.4%.

This was below our annual guidance of 19% to 20% due to the timing of certain items.

Although the tax rate can move around quarter to quarter, we continue to expect for the second quarter and the annual effective tax rate of 19% to 20%.

Lastly, our weighted average share count for the quarter was 473 million shares and includes $50 million of share repurchases during the quarter.

In the second quarter we expect the weighted average share count to be 475 million shares.

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

Thanks, Arun.

Let's turn now to our earnings guidance for the second quarter and our expectations for the second half of the year.

Based on our current order rates, backlog, and the impact of project selectivity, we expect revenue in the second quarter to be in the range of $2.550 billion to $2.6 billion with organic revenue growth of 1%.

Additionally, we expect segment operating margin to be approximately 12%.

From a segment perspective, starting with North America Installation & Services, we see positive growth in service revenues of about 2% offset by a revenue decline in systems installation due to project selectivity.

Overall organic revenue is expected to decline 1% year over year with an operating margin of approximately 10.5%, which represents an 80 basis points improvement year over year.

On a quarter sequential basis the decline in operating margin is due to normal seasonality we see in the business, particularly in retail which typically yields a higher revenue and operating income in the first quarter.

Looking to Rest of World Installation & Services, we expect organic revenue to increase about 1% with an operating margin similar to the prior year.

Moving to global products, we expect to see organic revenue growth in the mid-single digits with acquisitions adding about 3 percentage points of growth year over year.

As Arun mentioned, we expect the operating margin to increase on a sequential basis to 16.5% to 17% as the additional income from higher volume will more than offset incremental R&D and sales and marketing expenses.

Taking all of these assumptions into account, along with the below-the-line items Arun mentioned earlier, we expect earnings per share before special items in the second quarter to be in the range of $0.37 to $0.39.

This compares to a normalized earnings per share of $0.35 in the prior year.

At the midpoint this represents a $0.04 increase in operations year-over-year offset by $0.01 of share dilution.

Within the new Tyco we typically generate 40% of earnings in the first half of the year with 60% achieved in the second half.

Our first-quarter results and guidance for the second quarter puts us in line with our normal EPS savings.

Based on our first-quarter performance and expectations for the second-quarter and balance of the year, we continue to see our full year earnings per share before special items to be in the range of $1.75 to $1.85.

Thanks for joining us on the conference call this morning.

And with that, operator, please open the line for questions.

(Operator Instructions) Ajay Kejriwal, FBR Capital Markets.

Thank you.

Good morning.

Is there a way to kind of look at the North America install business on a normalized basis?

I know you are doing all this selectivity and the security orders are down, but that is kind of expected.

So if you ex that is there a way to look at the run rate as to what the rest of the business is doing?

I think, Ajay, if you look at our 2012 numbers and our 2013, embedded in the 2013 numbers is roughly on an annualized basis about $35 million of dis-synergies.

So if you take those $35 million in dis-synergies on a quarterly basis it is about $9 million a quarter.

That adds about roughly about 30, 35 basis points overall segment margins or about 90 to 100 basis points to the quarterly segment margins.

So when you take a look at Q1 2012 normalized, Ajay, North America was at a 10.3% operating margin which compares to our reported number of 12.3%.

So on a normalized basis we have actually improved the operating margin 200 basis points year over year.

Got it.

Could you give some color on the top line as well?

So the orders declined 19% but obviously due to the selectivity, if we ex this at work you are doing kind of moving away from this lower margin business, what is the underlying growth rate?

Ajay, George here.

When you look at the overall orders we are up about 2%, 2.5% and that was driven by products up 16%, service up a little over 3%, with installation down 6%.

The installation is really driven by North America; the project selectivity that we have been driving is part of the strategy for the Commercial Security business.

And so when you look at North America, North America is down about 8.5%, Rest of World is up 5%, and product is up 16%.

So this is very much in line with the strategy that we have deployed as we took the commercial security businesses and began to integrate those with the fire businesses that I had responsibility for.

Now when you look at the execution on margins I think it is an output of they -- we are integrating the businesses, we are driving accelerated sourcing benefits, we are looking at really synergizing the back offices.

So we knew that we had the $35 million of dis-synergies this year and they will be recurring, but our task was to how do we now accelerate our productivity to try to offset that in the first year of operations there as a stand-alone.

And so it is very much in line in the back -- we get the question on the margins in backlog, given that project selectivity that we have deployed is progressing very nicely.

With that backlog we are up over 100 basis points in backlog which projects that we are going to be able to continue to improve margins through the course of the year.

Just to add to that, George, like we have said that the investor day as well, in the long run if you look at what we have done to the fire business over the last couple of years, the fire business -- we did the project selectivity for the fire business a couple of years ago when George you are running it at the time.

Now the business is stabilized and it is growing at GDP-plus rates.

SO once we get over the project selectivity phase on the security business we should see the same algorithm for the security business as we have for the fire business.

Ajay, the only thing I would add to the point on the orders, they were up 2% for the quarter but if you kind of normalize out that project selectivity our order growth rate would be in that 5% to 6%, which is kind of similar to where we were last quarter.

That is very helpful.

Then on the global products business, you kind of called out the timing of high-margin product sales.

How do we think about it?

Is that business that shows up in the second quarter or is it more spread out over the rest of the year?

It's business we pick up in the second quarter.

A lot of that was timing of our chemical suppression systems which typically are higher margin and it was really at the end of the year.

And so we will pick up some of that margin.

Right now we are still looking to be mid-single digits, mid- to upper-single digits here in the second quarter within our product businesses, so we will pick up some of that in the second quarter.

Is it possible to quantify what was the impact here in the first quarter because of that?

I think we were looking at roughly around $10 million of revenue that was sitting in the docks and the timing of the shipments didn't make it to the year-end closing.

Good.

Maybe one last one for me before I pass it on.

So update on the purchasing and sourcing; you mentioned that you are ahead of plan.

Any color on just how much have you achieved?

You had talked about $1 billion in spend that you are targeting initially, so where you are and then what needs to be done and what should be expecting for the rest of year.

Thank you.

Ajay, as we said back during the investor day, this is certainly a big element of our cost structure.

It represents about $4 billion of our cost.

We have put a big sourcing leader in place, Vivek Kamath, and we have got an organization now that is totally aligned across the enterprise.

Now what we have done is we have split that buy up into categories.

We have got very experienced category leaders with targets in each one of those and we are beginning to now see the benefits of the accelerated savings now leveraging all of our combined base across the enterprise.

Where historically we have had multiple organizations sometimes buying similar type products or services.

So as we go forward we are going to be able to better quantify that acceleration with what we believe we are going to be able to see now in the second half and beyond.

But I can tell you that by putting the structure in place, setting the targets, putting a real strategic sourcing process in place across the enterprise we are starting to see some real nice traction in our ability to be able to generate those savings.

Excellent, thank you.

Jeff Sprague, Vertical Research Partners.

Thank you.

Good morning, everyone.

The color on margin and backlog is helpful.

George, just thinking about the whole selectivity thing though, just as you manage it through the P&L.

Obviously when you ran that playbook in Europe you were starting with -- and maybe not you personally, but the whole turnaround in Europe you were starting with negative margins.

So margin improvement on selectivity clearly overwhelmed any headwind from revenues driven by that selectivity.

As we look at you running through that playbook now with margins decent, room to go up but decent, just how do we think about that hand-off through the year?

You guided Q2 margins.

Should we clearly be kind of coming up through the remainder of the year as we progress with kind of a healthy looking exit rate into 2013, or is there some other way we should think about that?

Sure.

Jeff, let me start with the overall project selectivity strategy and how that has been deployed.

Then I think specifically you are asking about North America.

When you think about that especially we are beginning to see there are some positive signs that the non-residential construction market is going to come back.

The ABI index has been positive now for five months and so we are seeing some of that.

What is important is that as we look at our end markets that we are focusing on the end markets that play to our strengths where we can develop differentiated solutions that ultimately lead to the recurring revenue.

So a lot of that is just the discipline in how we approach the market, because, as you know, we incur a lot of costs upfront in how we develop those projects which then ultimately leads to recurring revenue.

So what is most critical is the service growth.

And so as we have seen, in spite of the project selectivity on the installation side, we are seeing positive service growth across the globe.

And that ultimately is really a big part of the overall strategy, making sure that we are getting that service growth.

Now relative to North America, certainly we were anticipating the dis-synergy cost that we are going to incur with the separation of the ADT residential security business.

We took that into account as we outlined our strategy, our cost strategy which we are focused on not only the sourcing element of it but also the infrastructure element.

So that we can, as quickly as we can, offset those dis-synergies to be able to make sure that from a margin standpoint in total that we can be able to deliver increased margins.

So for the total year we are going to be positioned for increasing our margins 20 to 50 basis points.

I know when you look at from operations we are actually getting, from an EPS standpoint we are getting about $0.18 from operations which is ultimately an output of the project selectivity, the increased service growth, and then the overall margin improvement that was seen across the globe.

So in North America, although we came out very strong because of the acceleration of our productivity and cost-out initiatives, we will have pressure with the reduced revenue over the course of the year which will put some pressure on those margins.

But as I said during the investor day and during the last quarter call, we are going to continue to work to accelerate our productivity programs to try to offset as much of that as possible.

And, Jeff, just if we look at our full year, even though we are kind of looking at a similar margin for North America as prior year, but if you normalize it and you take the dis-synergies into account it is 100 basis points, close to 100 basis point improvement in the North American margins on a year-over-year basis.

So that is reflected in this project selectivity that is in place now.

And just switching gears to a completely different topic, the bolt-ons, when you are doing deals this size are you able to achieve relatively immediate accretion?

Obviously the deals aren't that big so they don't move the needle so much initially, but are they quickly accretive?

And what you have in the pipeline would you view as relatively quickly accretive?

Jeff, basically when we do the deals the first year we have to deal with issues like purchase accounting which we cannot keep within our guidance numbers.

But once you get back into the full-year run rate that is what we have said in the past as well; they are going to be accretive year two onwards.

The other thing is we do these transactions where the ROIC is going to be -- we have kind of maintained a minimum ROIC standard than a weighted average cost of capital.

So it should be shareholder value enhancing acquisitions.

Those are the pricing and the financial disciplines we put the transactions through.

In the early stages, Jeff, they are a little bit of headwind initially on the margin rates but we are quickly working the integration plans to be able to get to similar fundamentals as our core businesses.

We have been able to demonstrate fairly quickly we can achieve that.

I would anticipate a little margin headwind.

I thought maybe given their small size and small companies you may not -- the actual net operating profit might be accretive in year one, but it sounds like it still is and it's more of a year two thing.

Yes, for the most part.

We have had some that we have been very successful in integrating quickly and seeing the benefits early.

And that is certainly our goal, but we also want to make sure that we stay disciplined to ultimately being positioned to achieve our longer range plan for the acquisition.

Okay, great.

Thank you, I will pass the baton.

Scott Davis, Barclays.

Good morning, guys.

I just want to go back to the selectivity issue and only because I think it is really that important to talk through.

We don't have a lot of other companies with this type of a headwind and see it pretty rarely.

But give us some background here.

Are you implying that you have competitors out that are still being irrational in the marketplace?

Is it a function of your cost position in different geographic locations where you don't have quite the cost position to be able to bid on certain things in certain areas?

I guess help us understand why at this point in time, presumably right in front of -- after a 60-plus month construction recession and in front of presumably recovery, why is the market that unattractive where you have to pass on such a large amount of pieces of business?

Let me try to summarize here.

So when you think about the mix of the business within the new company here we are at 20% products, about 35% installation, and 45% service.

That installation piece it is all around the priority of the strategy, making sure that we are now developing -- because we incur a lot of cost up front, developing projects that ultimately are important that we get positioned for the recurring revenue, Scott.

And so in the past -- and it is also making sure that we have the right aligned incentives within not only our sales teams but across the enterprise to make sure that we are prioritizing the projects within the end markets that ultimately lead to that recurring revenue.

Previously, within some of the commercial security businesses we didn't have that alignment and, therefore, were taking on projects that ultimately did not lead to the recurring revenue.

And so as we have refocused the business it is now making sure that we are prioritizing those projects that ultimately position us now to be able to grow service long term with that recurring revenue.

And so it is a short period of time of an adjustment.

We went through this within our fire service businesses two years ago.

As we went through that we repositioned very nicely to be able to capitalize on the non-residential construction growth and still be positioned as the industry leader to gain the share that we have historically been able to get but with a richer mix of service revenue that is tied to those installations.

And so what we are doing, especially now that we start to see a recovery, making sure that as we are developing our capabilities that we are focused on the right projects that ultimately will lead to that longer term service revenue on a recurring revenue.

Sure, okay.

That is actually very helpful.

I get it finally.

The next question really relates to the buyback and the timing.

It sounds like, based on slide 10, that you are expecting a weighted average share count about the same really as 2Q versus 1Q.

Why would you not be in there now buying back stock such a large buyback?

And maybe said a slightly different way, given the pressure that your old sister company ADT was under, is there any sense of urgency to make sure that you have a more efficient capital structure and kind of keep the critics at bay?

Scott, let me take a first crack at it.

First of all, our capital strategy, the capital allocation strategy that we laid out still holds very strong in the sense that the highest priority of allocation of our capital is to organic and inorganic growth, both through organic and inorganic.

And we are very excited.

Like George said in his opening comments, we are very excited about the pipeline of potential acquisitions that we are looking at right now.

Having said that there is the acquisitions themselves can be lumpy and to the extent that we are sitting on cash we will deploy that cash to buy back shares.

Now let me give you an overall view of how the cash allocation looks like from our vantage point today.

To begin with we are looking at about $800 million of cash flow that we expect to generate this year.

Of that about $300 million, just short of $300 million, is going to be in the form of our dividends.

Then we have roughly about $300 million, $200 million from last year and $100 million incremental this year, relating to separation activities that we have to deploy.

Then we have potentially, we do not know the timing of this, another $175 million relating to the legacy tax payments.

We do not know exactly when it is going to happen.

Could be in 2013, could move into early part of 2014.

So if you look at all these cash outflows that are already accounted for, and we expect about $200 million to $300 million of M&A activity, from a cash flow standpoint that doesn't leave you too much for share buybacks.

But as I said, the M&A can be lumpy and to the extent that it gets deferred into 2014, the timing of it gets deferred, we would have the opportunity to conduct share buybacks.

And the new authorization gives us the flexibility to do that.

I totally get it, but presumably you are still underlevered by a minimum of several hundred million dollars and not closer to $1 billion.

Is that not something to be taken into account?

Scott, again, this is what we have said in the past as well that for us we like the A- credit rating that we have.

As you know, it is on the lower end of where our peers are and as we compete for long-term service contracts it is important for our clients that we maintain that strong investment grade rating.

With that rating we have very little marginal incremental debt capacity today.

Now that will grow.

In 2014 as our EBITDA grows, the debt capacity will grow as well.

And we definitely want to have a capital structure which is in sync with that credit rating that we have targeted.

Fair enough.

Thanks, guys, for your answers.

Nigel Coe, Morgan Stanley.

Just wanted to dig into the North American organic growth, because obviously we had this confusion over the products in that (inaudible).

But can you just delineate the organic growth between the North American security and fire businesses?

Explain -- what are we trying to get at, Nigel, the North America commercial security?

Yes, if you can just call out what the fire organic growth was in North America?

Fire was up a couple, about 2% or so in the first quarter and I would say North America was relatively flat.

The reason why North America was relatively flat, because this will not be the pattern you see in future quarters, is because we had the conversion of year-end backlog.

So that is what helps maintain the revenue level on the security side.

Then as Arun had mentioned, the fire business is pretty much growing in line with a little bit of GDP, GDP plus.

Okay.

I'm just trying to figure out the impact of this activity initiative because fire is more aligned with installation business.

It's more the new builds exposure than security, so I am wondering if you weren't going through this process, maybe the normalized growth rate, that security would be, I don't know, 5%?

Would that be about right?

(inaudible)

I would say both fire and security are aligned to new build as well as retrofit and upgrade, and I wouldn't really make a big distinguishment between the fire side and the security side in regards to that extent.

Where, clearly, you will see the impact of project selectivity more is going to be on the systems install side of security as we move forward.

I mean we do expect that from a service perspective we would at least maintain and even grow a little bit on the service side.

Where you see the impact of project selectivity again is really on install on the security side only.

Okay, okay.

And think about this, Nigel, because there is a lot of work in the security and fire space where it is purely installation, just contracting.

Now at the end of the day our strategy is to make sure that we are positioned to be able to leverage the technology that we are developing in our product businesses, differentiating solutions that are focused on the key end markets that we see as being most attractive, and ultimately getting at that recurring revenue.

We incur a lot of cost in developing these projects right up front within the installation phase.

And so when we looked at the mix of projects that was in the backlog it certainly was not in line with the strategy longer term.

And that is why back at the investor day we are right in line with what we communicated back then relative to where we were then, how now this is playing out, and what we see going forward, especially as we look to now accelerate the service growth that is an output of those project installations.

Understood, but what I'm trying to figure out is that once it's get done, this phase of backlog management, to what extent do we spring back in 2014?

And is the baseline, normalized baseline [is only] 1%, 2% maybe a bit better than in 2013' then 2014 could be 3%, 4%, 5%.

That is what I'm trying to figure out here.

When we went through this process within fire it was somewhere around 12, 15 months relative to as we got through the backlog and actually started to build the new backlog with the new focus, with how we are driving projects that ultimately drive service.

And so it will be the better part of this year that we are going through that.

What you will see is that by the end of the year we will start to see the acceleration of service as an output of the projects that now we are developing.

Then if you look over the three-year horizon, maybe to put it in this perspective, clearly you will see the decline in North America this year in the 2% to 3% range as we mentioned.

As we laid out, we do expect over the three-year period for this segment to grow 1% to 2%.

So you will start to see some of that growth in 2014 and you will obviously see more accelerated growth in 2015 that will get us to that 1% to 2% CAGR over the three-year period.

Okay, great.

That is very clear.

Then switching gears to products.

You called out the year-over-year decline in margins there in your 1Q guidance.

Obviously it came in a bit weaker.

I'm just wondering what drove the big increase in R&D and marketing in 1Q.

Is that getting ahead of a new product launch cycle?

And what is causing R&D to be quite lumpy, because normally that is quite a stable expense line?

Nigel, when you go at -- if you go back over the last few years on a year-on-year basis we have been continually increasing our R&D double digits.

I think you have seen the output of that reinvestment over the last couple years with consecutive years with double-digit growth, revenue growth.

And so this is very much in line with that strategy.

As we look at our position, whether it be in fire protection products, in suppression, whether it be water or chemical, or if you look at our security products business, in intrusion, access video, or in our life safety business, the position we have in fire services or supporting the industrial space or military and civil defense, in every one of those markets we have a very detailed pipeline of products that we are investing in and ultimately know what the projection of the revenue growth from those investments will be going forward.

And so I shared some of the highlights of the ones that recently we brought to market, but I can tell you that we have a lot of discipline in making sure the investments we are making we are actually beginning to see the revenue up tick as we have seen over the last couple of years.

I think the other thing is, Nigel, that this is not a one quarter thing.

We embarked on this incremental spend on R&D, higher spend rate and growing it at this double-digit rate that we have seen over the last couple of years now.

So for this year, for instance, we spent in incremental R&D and sales and marketing of about $13 million to $15 million in Q1.

We expect another $11 million, $12 million in Q2 and it is more like $45 million to $50 million for the full year.

So this is something which is an ongoing thing for us and we are seeing the results in the mid-single digit organic growth that we are seeing in our products businesses.

Nigel, this is part of -- as we look to achieve over $100 million net productivity each year this is part of the reinvestment that we have put back to be able to accelerate our organic growth.

It has obviously been great so keep investing.

Thanks, guys.

Julian Mitchell, Credit Suisse.

Thanks a lot.

I guess, firstly, can you just talk a little bit about the phasing of the free cash flow?

Obviously, on an adjusted basis it was, I think, negative $30 million.

How quickly do you anticipate that getting back towards a sort of net income type number over the course of the rest of the year?

Julian, good morning.

Yes, this is very typical of our first quarter.

Typically in the first quarter we do have a negative cash flow and then it builds up during the course of the year with the highest cash flow coming in the fourth quarter.

So you would see a progressive improvement in the cash flow.

Our objective is that for the full year we should still convert to about 90% of our net income, which is about $800 million or so of cash flow that I was referring to earlier.

Got it, thanks.

Then just secondly, on the orders I know that they were up 2% ex-currency.

What were they up excluding acquisitions?

So ex-FX, ex-M&A what was the organic order?

Well, we have the orders actually.

As you mentioned it excludes FX.

It actually does include the impact of acquisitions.

But I would say acquisitions, really the biggest impact they had was on the product side of the business.

I don't have the exact number on the organic side, but I think it was a little bit below where our organic was for the quarter.

So let's say it was in the lower single digits on the product side on an organic basis.

The other two segments I don't think were really that impacted by acquisitions.

Got it.

Then is there any kind of clarity you can give around price versus volume in that backlog or in the order intake, going back to your point on selectivity?

Is there any kind of overall number you can put on price versus volume in orders, or not really?

Julian, you have to look at all three pieces.

So when you look at products we are very disciplined with our strategic pricing, especially as it relates to our new product introductions that we bring into the market.

And so we have demonstrated here over the last few years that we continue to get price within our product businesses.

When you look at installation it is more around making sure that we are disciplined in not only how we price the project but how we execute on the margin within that project.

Then service we build that into our contracts and so we have escalation built into the contracts, in line with other escalation.

We are getting price automatically with those contracts.

Okay, thanks.

Steve Tusa, JPMC.

So I just wanted to -- I know everybody has asked these questions today but I just wanted to get a little more detail.

Can we assume that the North American install business, which I think is 50% of that segment, a little over half of that is security?

Just looking back at kind of the old numbers you guys have given us over time.

I think, generally speaking, for North America it is about half and half between fire and security if you look at it right now with our project selectivity going on in the security business.

Okay, so that means security had (multiple speakers)

-- less than half.

So security is half of it and that is where most of the project selectivity is does that mean security was down like 40% or something like that, if you look at the install orders down 19%?

No.

I think someone actually asked earlier from an organic growth perspective in the first quarter the fire business was up a couple points and organically North America security was actually flat.

Because, remember, we had the benefit -- the orders are not going to necessarily coincide with your revenue line.

No, I meant orders, I meant orders.

I meant orders.

I meant orders; not revenues, orders.

So from the order side really that 19% decline in systems install was predominately driven by the security side.

Yes, so security had to be down dramatically if fire was flat.

That means security had to be down 40% or something like that to get to the down 20%, right?

Yes, I mean security was down more.

(multiple speakers) Just a note on that when you compare.

Because installation projects are lumpy with how they actually come through orders they compare on that also.

We had a peak in the orders on the compare a year ago within the security segment.

So I guess what were these guys bidding on?

When you got in there were you just like shocked as to how uneconomic of an approach they were taking?

And I guess just mechanically maybe a couple of anecdotes, because we weren't able to go and attend your roadshow meetings and I think you talked about this a little bit.

But what are some of the anecdotes about what you are actually changing and how economic they were actually approaching?

Because that is just a massive decline, comps or not.

What it comes down to, Steve, when you look at the install and service businesses what is most important is making sure that you are applying your resources and cost to projects that ultimately lead to service.

And so when you looked at the backlog of projects, although they were large and there was a lot of installation contracting type work, it ultimately did not lead to the service pickup.

Which ultimately -- when you look at it from an economic standpoint, when you take on these projects it is very important that from a probability standpoint you get some of that mix of service.

And so what we have done is gone back and refined the strategy, making sure that as we are now proceeding we are looking at the overall economics and that we are prioritizing our investments, our resources, into projects that really do position us to be able to accelerate that recurring revenue.

All right.

I got you and so (multiple speakers)

It is simple as making sure that now in the operating company that we have put together from fire and security we have got similar incentives now that are aligned to not only growth, but also making sure that we are positioned to execute on our margin growth.

And making sure that when you look at the parts of the strategy that when we execute they are all aligned to ultimately achieve that.

Okay.

Then one other question.

You mentioned you had seen some signs; you mentioned the ABI, you had seen some signs of non-resi picking up a little bit.

Maybe just again maybe a couple of specific anecdotes as far as customer behavior is concerned.

I think there is a lot of debate out there around non-residential construction.

Just curious as to a couple of data points from you guys on that front.

Yes, the data points we have is that certainly there is activity.

The ABI suggests there has been -- and we also see that over the last four or five months that there is activity.

And that I think, for us, we are getting -- I mean we are seeing some good opportunities in the pipeline that we are working as a result of that activity.

So we are in the early stages of really claiming success, but we are starting to see some of that come through the pipeline.

Another thing, as we mentioned in our comments as well, Steve, first quarter in five quarters for the fire install business to show a positive organic growth.

So that is just a -- we don't want to make a trend out of this yet, but certainly there are some green shoots out here that are encouraging.

Okay, great.

Thanks.

Operator, we have time for one more quick question.

Gautam Khanna, Cowen & Co.

Yes, maybe two quick ones.

You mentioned that the North American install selectivity had a tough comp in the quarter.

Could you remind us what the compares were, when this began, so we can calibrate how these orders are going to look as we move through the year?

We began to -- if you go back last year when we announced the separation a year ago September, we began to integrate the commercial security businesses with the Fire Protection businesses back a year ago January.

And so when we began that process is when we -- as we looked at the integration and really did a deep dive on strategy, really now positioning to leverage our combined capabilities, not only on the technology side but within our footprint of installation services, is where we began to work that and start to really start to change the strategy with our approach, especially as we think about installation.

And so it was during the first -- it would have been the second quarter last year and then third, fourth, and now we are into the first quarter.

So it has been about a year.

Gautam, I wouldn't want to necessarily forecast orders because, quite honestly, they are very hard to forecast.

But, clearly, based upon what we have seen so far and what we saw when we deployed this strategy in fire you could clearly expect that as we move quarter by quarter throughout fiscal 2013 we are clearly going to see that organic decline get steeper each quarter as we progress.

And, clearly, the elements are going to be they are going to continue to have service revenue growth, but you're going to see that decline in install get more of a decline each quarter as we progress through the year.

Okay.

Then just perhaps could you just -- because the magnitude of the decline is fairly large for explainable reasons, but do you have any data on whether your win rates or anything of that nature declined as well?

So that means are you comfortable that there is absolutely nothing we should infer regarding market share?

No, this isn't being able to not be competitive or win rates.

This is more around -- this is right in line with the strategy that we defined back during the investor day.

We are right on track with that in making sure that we have got the right discipline in how we are approaching the projects that become available in the market, and with that we have been very successful.

I think if you go back and look at the SimplexGrinnell business, our fire service business in North America, we have been extremely successful in deploying that strategy which has positioned us to be able to accelerate service growth and from an installation standpoint be much more disciplined and predictable in how we execute installation projects.

Gautam, going back to the earlier comments as well, this is a very fragmented market.

And so it is not that we are losing any jobs, it is just that we are focusing on those projects that have the right margin for us.

Now the fact is being a fragmented market there are other local players they don't have the same demands and return on investment and return on capital as we do, so they may be willing to take on jobs at a different margin rate.

Our focus is to get the jobs at the right margin for us and then to turn that into a service contract at the end of the project.

So those two combined together; we are winning the jobs that we are going after that is the important thing for (inaudible).

If you look at the projection that we had for three years, what is important here is, although this year we will be down 2% or 3% in North America, which this is a big part of, we will be positioned to be able to accelerate over the next two years to get to a CAGR, a growth of CAGR of 4% to 5%.

And from an operating margin standpoint be positioned to continue to improve operationally our margins by 80, 100 basis points a year.

Okay.

I appreciate the color, thank you.

Thank you.

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.