江森自控 (JCI) 2013 Q2 法說會逐字稿

Welcome to the Tyco second-quarter earnings conference call.

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

(Operator Instructions).

Today's 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 second-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 contain 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 second-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 $0.16 and included charges of $0.26 related to special items.

These charges related primarily to a legacy environmental matter, as well as separation and restructuring activities.

Earnings per share from continuing operations before special items was $0.42 compared to the prior-year quarter of $0.30.

As we mentioned on our last earnings call, EPS this fiscal year is not directly 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 dissynergies 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 $0.35.

Now let me turn the call over to George.

Thanks, Antonella and good morning, everyone.

I am pleased with our second-quarter results and the progress we are making in executing our growth strategy.

In our Installation & Service businesses, Service revenue growth is accelerating.

The margin in our Install business is improving and backlog is growing.

In our Global Products businesses, we continued to benefit from our investments as revenue growth outpaces the market.

Overall, our second-quarter results reflect strong operational performance with a year-over-year increase of 20% in earnings per share before special items on a normalized basis.

Earnings growth during the quarter was driven by a better mix of revenue, as well as the continued strong execution of actions to increase productivity and reduce our cost structure.

Service revenue in both North America and rest of world increased as a percentage of total revenue and the overall growth rate for Service accelerated from 2% last quarter to 3% this quarter.

As we continue to strengthen our discipline as an operating company, we are driving productivity and cost-out and accelerating restructuring.

Additionally, we are benefiting from the sourcing initiatives related to our $4 billion global buy.

As we discussed at our Investor Day back in September, we have consolidated 15 plus procurement groups into a single global organization and implemented a strategic sourcing process that leverages our scale to accelerate savings.

The combined benefit of productivity and sourcing is expected to contribute $150 million of gross savings on an annual basis, which will fund incremental organic investments and offset inflationary pressures for net savings of $50 million annually.

For the quarter, the net impact of these savings was an incremental $0.02 year-over-year.

Overall, I am very pleased with our progress over the last six months as we continue to take a disciplined, focused approach to achieving our growth objectives and strengthening Tyco's position as a world-leading Fire & Security company.

On the acquisition front, we have a very active pipeline of bolt-on acquisition opportunities that we are evaluating.

As we have discussed before, we evaluate each deal against numerous metrics, including above all strategic fit.

From a financial perspective, we are committed to remaining disciplined around the financial metrics of an acquisition.

We look for strong growth potential, EPS accretion by year two and an ROIC well in excess of our risk-adjusted weighted average cost of capital.

For example, let's take a look at the two larger acquisitions we completed a little over a year ago -- Chemguard and Visonic.

Chemguard was acquired by our Fire Products business in September of 2011.

The Company is a leading provider of an extensive line of fire suppression products, services and specialty chemicals with strong R&D capabilities.

This acquisition strengthened our presence in the oil and gas vertical and in high-growth markets.

Today, Chemguard is fully integrated with our Fire Products platform and has been a strong performer since the acquisition delivering against high expectations.

The Visonic acquisition completed in December of 2011 in part of our security products platform expanded our wireless technology platform while complementing our geographic presence in the intrusion market.

I am very pleased with the strong performance of Visonic and our ability to leverage Visonic's technology and geographic footprint to complement our existing intrusion business.

In fact, we have recently integrated Visonic's leading-edge PowerG technology into our existing [BOC] intrusion productline and introduced our PowerSeries Neo hybrid intrusion detection platform, which was recently highlighted at ISC West.

This new platform redefines intrusion security by providing a hybrid solution that combines the flexibility of a hardwired system with the simplicity of a wide range of wireless devices.

We continue to make good progress on acquisitions.

In the quarter, we acquired First City Care, a UK-based Installation & Service provider of active control, video surveillance, intruder alarms and security systems integration.

This acquisition is being combined with our Installation & Services business in the UK, strengthening our security expertise in the banking vertical.

We expect this acquisition to add approximately $20 million of annual revenue.

Additionally, we signed a definitive agreement to acquire National Fire Solutions Group, or NFS, which is a leading provider of Fire Protection services, including installation, inspection and maintenance services in Australia.

NFS provides us with the opportunity to strengthen our Fire Protection portfolio in Australia while advancing our strategy for growth in the global fire industry.

This acquisition is expected to close in the third fiscal quarter and add approximately $65 million of revenue on an annual basis.

We continue to assess the strategic fit of all of our business units and will pursue divestitures that do not align with our long-term strategy.

For example, we recently signed a definitive agreement to divest our guarding business in North America and expect to close the transaction in our fiscal third quarter.

Lastly, we also returned capital to shareholders during the quarter with $70 million in dividend payments and $150 million in share repurchases.

As there were many questions on project selectivity on the last earnings call, let me quickly address that before I turn to our business results for the quarter.

I want to be clear that project selectivity is not a new initiative.

It is the way that we do business, delivering profitable growth.

As some of you may recall, we implemented project selectivity in SimplexGrinnell, our North America fire business, in fiscal 2011 and within a three-year period, will have increased operating margins nearly 400 basis points.

During this time period, we established minimum margin targets for all installation projects, implemented a second level of review for all large projects to ensure that they could be executed at the expected margin rate and we focused on installation projects that would lead to long-term service.

Today our SimplexGrinnell fire business is growing in line with the market and installation projects are being executed above the margin backlog.

As resources are focused on the right opportunities.

As we previously discussed, we have implemented the same playbook in our North America commercial security business.

In the short term, this will result in revenue compression in our North America Installation & Services segment, but the end result is a more profitable service-intensive mix of revenue, which not only benefits operating income, but also our customers as we focus on providing value-added design, installation and service.

Now let me turn to an overview of our segment results to 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 results.

Starting with our North America Installation & Services segment, overall revenue was consistent with the prior year as growth in SimplexGrinnell was offset by a decline in commercial security.

As expected, the revenue decline will accelerate in the second half of the year.

More importantly, we expect the operating margin to improve on a quarter sequential basis in the back half of the year as planned actions to reduce the cost structure are executed.

In rest-of-world Installation & Services, we continued to see nice growth in Service across Europe, Asia, Latin America and South Africa.

This growth is being partly offset by a decline in Installation revenue during the quarter.

Given our record high backlog, we expect Installation revenue to grow in the second half of the year driven by Asia, as well as other high-growth markets, which will offset the continued pressure on Installation revenue in Continental Europe and the UK.

In Global Products, revenue continued to grow well in excess of GDP rates.

Double-digit growth in the quarter included organic revenue growth of 7% with the remainder attributable to acquisitions.

The operating margins, excluding special items, improved on a quarter sequential basis and we continue to expect improved sequential performance each quarter for the balance of the year.

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

Thank you, George and good morning, everyone.

Let me start with an overview of our results for the second quarter and then go through the details of our segment performance.

Revenue in the second quarter was $2.6 billion, an increase of 3% overall and 2% on an organic basis.

The Global Products business continues its strong growth trend with organic revenue up 7% in the quarter.

Service revenue accelerated to 3% in the quarter while system Installation revenue was down 3%, mainly due to continued weakness in Europe and implementing project selectivity in North America security.

In the quarter, organic growth was supplemented by strategic bolt-on acquisitions, which added $28 million, or about 1 percentage point.

Embedded in our overall revenue increase this quarter is the continued strong performance in the growth markets, which grew 16% in the quarter and 11% on an organic basis.

The growth was primarily driven by Latin America, Asia and the Middle East.

Segment operating income before special items was $321 million, a 10% increase over the prior year on a normalized basis.

Segment operating margin was 12.3%, which is a 90 basis point improvement over the prior year on a normalized basis.

As George mentioned, a higher mix of service revenue, improved Installation margins and the benefits of productivity and restructuring initiatives drove the year-over-year operating margin improvement.

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

Starting first with North America Installation & Services, revenue in the quarter of $953 million was consistent with the prior year.

We continue to see positive traction in our organic Service revenue growth as we prioritize our efforts in this area.

In fact, Service revenue growth accelerated to 2% in the quarter from 1% in the prior quarter.

As expected, Installation revenue declined 3% due to the project selectivity in the commercial security business.

Operating income before special items in the quarter was $104 million and the year-over-year operating margin increased 220 basis points on a normalized basis to 10.9%.

An increased mix of higher-margin service revenue improved execution on installations, as well as sourcing and productivity savings drove the operating margin improvement.

Overall, orders in North America Installation & Services were flat year-over-year with Service orders growing 2% offset by Installation orders, which declined 2%.

Sequentially, the dollar value of Installation orders has stabilized and Service orders have accelerated.

As we mentioned last quarter, order rates in the Installation business can fluctuate extensively quarter-to-quarter as there can be a large order in the range of tens of millions of dollars that can skew the year-over-year compares.

For example, last year, we had a retail order where the bulk of the order was booked in the third quarter, resulting in a 20% increase in Installation orders, which will make for a tough compare in the third quarter of this year.

This is why backlog is the more important metric.

For Q2, backlog was up 2% sequentially to $2.5 billion.

As we move into the third quarter, we expect year-over-year revenue to declined 2% to 3% as the growth in SimplexGrinnell is offset by a decline in commercial security.

On a sequential basis, we expect revenue to increase 2% to 3% and the operating margin to improve to 11.5% as we leverage the additional seasonal pickup.

Given our performance in the first half of the year, we now expect revenue to decline 1% to 2% on a full-year basis versus our original estimate of a 2% to 3% decline.

Additionally, given the accelerated benefits of our sourcing and productivity initiatives, we now expect the full-year operating margin to be in the range of 11.5% to 11.8%, which is ahead of our prior full-year guidance of 11.4%.

Turning to rest-of-world Installation & Services, revenue of $1.1 billion, which was up 1% on both a reported and organic basis.

Growth in Service revenue accelerated to 5% on an organic basis while Installation revenue declined by 4% due to continued weakness in the European markets.

In the quarter, acquisitions contributed 1% to revenue growth, which was offset by a 1% decline due to changes in foreign currency exchange rates.

Orders increased 2% year-over-year with Service orders up 4% and Installation orders declining by 1%.

The decline in Installation orders was due to a tough compare with a large mining project in the prior year, as well as continued weakness in Europe.

Operating income before special items was $120 million and the operating margin was in line with the prior year at 11.1%.

Backlog of $2.6 billion increased 5% on a quarter sequential basis.

As we look forward to the third quarter, we expect year-over-year organic revenue growth of 3% to 4% supported by the increased backlog.

Additionally, given the expected close date of recent acquisitions, we expect an additional $25 million of revenue.

We expect the operating margin for the third quarter to be similar to last year as non-cash purchase accounting adjustments, which are typically higher in the first few months after an acquisition, offset leverage on increased volumes.

Turning to Global Products, revenue grew 11% in the quarter to $578 million.

Organically, revenue was up 7% with a double-digit growth in our security products and life safety platforms.

Acquisitions contributed 3 percentage points to growth in the quarter.

Product orders increased 12% year-over-year with growth across all three platforms.

Operating income before special items was $97 million and the operating margin was 16.8%, a nice sequential improvement.

Year-over-year, the operating leverage on increased volumes was more than offset by 80 basis points of planned incremental growth investments in R&D and sales and marketing.

Looking ahead to the third quarter, we expect revenue to increase to a range of approximately $580 million to $600 million and the operating margin to increase to approximately 18.5% to 19%.

I also want to take a moment to discuss a legacy environmental matter at our Marinette, Wisconsin Global Products facility where we have been performing ongoing remediation.

Prior to the acquisition of Ansul in 1990, this site manufactured arsenic-based agricultural herbicides, which resulted in significant soil and groundwater contamination on the site and in sediment in parts of the adjoining Menominee River.

During the second quarter of 2013, the results of a treatability study indicated that additional river sediment would require treatment and off-site disposal to comply with the terms of an administrative consent order that Ansul entered into with the US Environmental Protection Agency back in 2009.

As a result, we recorded a charge of approximately $95 million on a pretax basis as a special item to increase the environmental reserve to reflect our best estimate of what will be needed to comply with the consent order.

We expect that a large majority of the cost will be incurred within this calendar year.

Now let me touch on a few other important items.

First, corporate expense before special items was $54 million in the quarter, a bit better than expected due to the timing of certain expenses.

As many of you know, corporate expense tends to be higher in the second half of the year due to the timing of certain expenses and a number of actuarial valuations that we perform annually.

Therefore, we expect corporate expense before special items in the third quarter to increase to approximately $60 million.

Next, our effective tax rate for the quarter before the impact of special items was 17.9%.

We expect the third-quarter effective tax rate to be approximately 19%.

Now, let me touch on cash and our cash flow expectations for the year.

This year, we continue to expect adjusted free cash flow to be around 90% of net income.

Based on this conversion rate, we expect our adjusted free cash flow for this year to be approximately $800 million with the bulk of that coming in the second half of the year.

This free cash flow phasing is consistent with prior years and the normal seasonality of our business.

During this year, we expect to return about $300 million to shareholders in dividends and the remaining will be used to fund acquisitions or repurchase shares.

Lastly, we are aggressively executing on our plan to integrate our Fire & Security businesses to improve productivity and reduce our cost structure.

We are simplifying, standardizing and automating our operations as we bring together our Fire & Security footprint and execute our Branch in a Box strategy.

In light of the progress we have made in identifying opportunities related to these initiatives, we are increasing our expectations around restructuring and repositioning charges for the year to a range of $75 million to $100 million from our original estimate of approximately $50 million.

The benefit of these actions will deliver significant shareholder value as outlined in our three-year plan.

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

Thanks, Arun.

Let's turn now to our overall earnings guidance for the third quarter and our expectations for the full year.

Based on our current order rates and backlog, we expect revenue in the third quarter to approach $2.7 billion with organic revenue growth of 1%.

In terms of bottom-line results, we expect to see a nice sequential improvement in the third-quarter operating results across all three businesses contributing $0.07 of earnings on a quarter sequential basis.

We expect this to be partly offset by an increase in corporate expense and a higher tax rate in the third quarter, which, when combined, will cost us about $0.03 per share.

In total, these items are expected to result in a net increase of about $0.04 per share on a quarter sequential basis.

With an expected average share count of approximately 472 million shares, we expect earnings per share before special items in the third quarter to be in the range of $0.45 to $0.47.

Now let me update you on our full-year guidance.

Based on current exchange rates, we now have a $75 million headwind to our original revenue estimate, which is expected to be offset by the impact of recent acquisitions.

Therefore, we continue to expect revenue for the full year to be in the range of $10.6 billion to $10.7 billion.

From the time we originally gave our full-year EPS guidance of $1.75 to $1.85, we now have a $0.05 headwind primarily related to changes in foreign currency exchange rates and share count.

Despite these headwinds, and the uncertainty in the economic environment, we are increasing the low end of our guidance as we are confident in our ability to deliver on our second-half expectations.

We now expect full-year earnings per share before special items to be in the range of $1.80 to $1.85, which represents an earnings per share increase of 12% to 15% over fiscal 2012's normalized base of $1.60.

Thanks for joining us on the conference call this morning and with that, operator, please open the line for questions.

(Operator Instructions).

Jeff Sprague, Vertical Research Partners.

Thank you.

Good morning, everyone.

George, just to elaborate a little bit more on the outlook, obviously, you have always kind of a seasonally back-end-loaded year.

It seems like this year's maybe a little bit less back-loaded than normal, I guess, because of the selectivity thing.

But just give us a little bit more color on how that plays out Q3 versus Q4 and where kind of the upside versus downside to your guidance might be.

Yes, what I would do, I would start by saying, Jeff, when you look at our performance quarterly and then look at first half to second half, typically, when you normalize our performance, it is about 45% in the first half, 55% in the second half.

Now, when you look at this year's third and fourth quarter, when you look at our full-year guidance of $1.80 to $1.85, it is wrapped around the consensus of $1.83 and what is important here as you look at the underlying operations going forward in the third quarter that really we are driving very strong operational performance.

Now, in the third quarter this year, we do have, when you look at last year during the third quarter, we had a very strong retail quarter with high margins and when you look at the compare there year-on-year, we have a mix of about $0.01 to $0.02 that has given us a little bit of a headwind in the third quarter.

And typically -- last year when you look at our third and fourth quarter, typically, our fourth quarter is the highest.

Last year, during the third quarter, we had a very strong third quarter because of that retail business.

So typically, we do get the lift in the fourth quarter, so it is a little bit of an anomaly last year.

But I think we are positioned very well in spite of the economic environment with the productivity and cost-out that we are achieving.

That, in addition to the restructuring that is being completed, we are going to be very well-positioned to be able to deliver on our guidance.

Great.

And I was also just wondering, on the acceleration that you are seeing in some of the Service revenue numbers, what is actually behind that?

Is it prior install business that is now coming into the Service stream, is it people picking back up on service they deferred?

Is there any kind of common theme there to take away and what does it imply for the next year or so as we look out?

Well, I'd start with project selectivity.

So if you go back and really think about our project selectivity that we have had in place now in Fire for the last couple years and we are implementing that within commercial security, that in itself yields projects that have higher Service revenue attached to those projects over the lifecycle of the projects.

So when you look at our split between Install & Service, we are growing Service 3% with Install slightly down.

That suggests we are getting a higher level of service that will be installed on the Install projects that we are performing.

In addition, Jeff, we are increasing our capabilities in Service and expanding our footprint.

So when you look at our Service sales reps year-on-year, we are up 8% and so we are investing similar to what we are doing in our Products business, reinvesting in technology.

In Service, we are reinvesting in capabilities and footprint to make sure that we are going to be positioned to be able to accelerate the Service growth.

And so it is really the combination of those two that has positioned us well to accelerate Service 3% to 4% this year and I think we will be well-positioned for next year to get to the 5% Service growth.

Great.

Thank you very much.

Nigel Coe, Morgan Stanley.

Thanks, good morning.

Yes, the backlog trends were somewhat better than I expected in both North America and rest of world, and I am wondering if maybe you could just add some color in terms of the end-market conditions and are we seeing some more product activity breaking free, but maybe a bit more retrofit activity?

Any color on the end markets this quarter versus previous quarters would be really helpful.

Sure.

Let me start with the global GDP.

I think we are seeing what everyone else is seeing with that global GDP down about 30 basis points.

Now, as we look at our business, it's a big element of our business, nonresidential construction, that has a big impact on us.

Now when you look at that space, the ABI, the Architectural Buildings Index is a lead indicator and over the last -- it's been about six or seven months, Nigel, that it has been improving and so we have seen some of that with the activity that we see in the market, but a little bit of a concern that it has slowed over the last couple of months.

And what is important to us is that in spite of what is happening within the macroeconomic environment, we are driving very strong productivity and cost-out controlling what we can control to make sure that we are going to be positioned to be able to deliver on our commitments.

And so when you look at that, I think the reason why the backlog -- going back to the initial part of your question -- when you look at backlog on our Install orders, we are up above 2% in total.

Now that is similar type performance within North America and rest of world.

Now as you look at our backlog, sequentially, we increased our backlog 3%.

And we expect, based on our order activity, we expect that to continue to increase in Q3.

And what is important now is knowing what is within that backlog, that we are going to be able to be positioned not only to deliver on the growth in the second half, but also being able to deliver on the margin commitment over the next two quarters also.

Okay, no, no, it's good performance.

And then maybe one for Arun.

I have got to say I wasn't expecting to hear the word arsenic on the Tyco call.

Just to what extent do you believe that this is sort of capping the liability and that this won't escalate from what you reserved this quarter?

Nigel, first of all, you are right.

This is something that goes back to the '40s and '50s.

It's part of the acquisition that we actually did in 1990, but the arsenic word in producing the herbicides was done very early last century actually.

So in terms of your second question that you had, the point is that we finished the treatability study.

We did extensive work in coming up with the reserves that we have put on the books right now and keep in mind that this work is going to be completed in the next 12 months and so it is not a very long period that we are looking at and that is what gives us the conference that we should be able to get this done within the reserves that we have put up.

Okay, thanks, guys.

Steven Winoker, Sanford Bernstein.

Thanks and good morning.

First question, if you did look at the project selectivity, sometimes you have some thoughts about how much that actually did hold back organic growth in the timeframe and I think it has often been a couple of points.

What do you -- if you had to take a look, what do you think -- how much do you think that probably took away from growth this quarter?

So Steve, the way that I would look at this is that, as we have discussed before, though we have capacity to do design and be able to spec jobs that are more strategic to what we are trying to accomplish, which is the Service growth and so it is really now -- it is refocusing that activity, that resource with much more discipline around the projects that we put that capacity on, which then positions us to be able to get the recurring revenue longer term.

So a lot of that is really just a reallocation of our resources and making sure that we are focused on the right spaces that drive those type of projects that create a Service base for us longer term.

And so I think in line with what we are seeing from a nonresidential construction standpoint, you would say that our overall Install performance is in line or maybe a little bit above what we are seeing from a nonresidential construction standpoint.

Right and surely it would have been higher otherwise I guess is just what I am trying to get at.

I think if you think about it, Steve, our Fire business, like George has said before as well, is growing in line with market and as you look at what we are trying to do is get our Security business in the same place.

So once we get through those lapping issues, we should be growing the Security in line with market and today, the market is around the 2% to 3% if you look at US GDP.

Perfect, perfect.

The other question is on -- you used to talk about growth in net cost efficiencies of somewhere about -- I think it was something like $170 million to $100 million and reinvesting about half of that in growth investments.

Another quarter in, some acceleration, taking additional restructuring, how are you thinking about those sorts of numbers now?

What I would say, Steve, is, across the board, we are seeing good results on all of our initiatives -- productivity, cost-out and then the Branch in a Box and simplifying our infrastructure.

We are very confident in the goals that we laid out back in September to get the $150 million plus of growth savings.

We are putting a lot of that back into the organic investment as we have discussed in R&D and then positioning to make sure that we have a Service franchise that can accelerate growth.

We are offsetting the inflationary pressures and then the net result is $50 million being generated that is going to the bottom line.

And what I would say is, on the sourcing side of that activity, on the $4 billion buy, we are seeing now accelerated progress.

We now have the single global sourcing organization in place.

We have strategically gone after each category.

We are getting an acceleration now of savings within each category.

That is going very well.

The Branch in a Box on the infrastructure, this is something that is going take a little bit longer term.

We are in the early innings of Branch in a Box.

What I always say is we are making great progress as far as how do we take the commercial Security businesses, combined with what we had within the Fire Protection businesses and really begin to synergize that footprint and that capability so that we are going to be positioned more competitively to be able to accelerate growth.

Okay, very helpful.

I will pass it on.

Thanks.

Scott Davis, Barclays.

Hi, good morning, guys.

You spent a fair amount of time at the beginning of the presentation just talking about acquisitions and cash redeployment and such.

Obviously, that is very important in a low-growth environment, but when you think about your pipeline, I mean you announced a couple of small deals.

I mean do you have enough of a pipeline and the confidence that you can move the needle and I guess how I would define moving a needle is probably kind of adding $300 million or more to revenues per year?

Yes, Scott, let me take that.

When we look at our pipeline, we are focused on acquisitions that enhance our technology capabilities, fill any gaps that we have within our products.

We look to strengthen our service capabilities, extend our service footprint globally and making sure that we have got the right footprint within the emerging markets.

So that is really the focus of our acquisitions and we continue to be very disciplined on the returns that we expect on these acquisitions.

So we have a pipeline that is very robust.

We have historically been able to complete acquisitions that I think, if you looked out last year, we had about $400 million of revenue that were associated to the acquisitions that we had done in the previous 12 months.

And we are in a similar range with the pipeline that we are pursuing today.

Now I would say that we have recently looked at a large acquisition that we walked away from because it didn't meet our financial hurdles and then knowing that acquisitions tend to be lumpy, they are not linear over the course of the year, we have also said we are not going to sit on cash.

And so in the quarter, we did $150 million of share buybacks and we still have $600 million of share repurchase authority in place.

Okay.

And just to be -- just to back up a little bit, I know the selectivity issue was very topical last quarter and when you look at these numbers, it really didn't influence the results hardly at all really.

I mean it was fairly muted.

I mean is this more of the type of -- I guess another way to say it is, selectivity, is it a little less selective now or is it just that you got through one really tough quarter last quarter and from here on, it is a modest hit to the top line, but not the kind of magnitude we saw last quarter?

Let me start by saying not at all.

I mean we were very disciplined, very focused in how we are growing our Installation business, positioning ourselves to be able to accelerate Service and then being able to execute on those Installation projects as planned.

Now as we have said, the orders are very lumpy.

Now as we look into the third quarter, as Arun mentioned during his comments, that we have a very large retail order that we had last year third quarter and we showed 20% order growth last year.

That was in the prior year.

Now as we look at third quarter this year without being able to repeat a similar order, we are going to have some pressure on our order rate in the third quarter.

And so they tend to be lumpy.

What is most important is that you are focused on backlog.

And what is very attractive here is our backlog continues to increase.

We have increased 3% on a quarter sequential basis and we do expect, with the order activity that we see today, that we expect that the backlog will continue to increase in the third quarter.

Okay, that's actually very helpful.

Thanks for the clarification.

I will pass it on.

Thanks.

Steve Tusa, JPMC.

Hey, good morning.

Yes, so just for the fourth quarter, I guess, to get to the -- I kind of understand the third-quarter bridge, but I guess -- and just looking at the way consensus stacks up, you have got -- you are a little bit below consensus for the third quarter, but you are kind of like revising your estimates higher for the rest of the year, which means the fourth quarter is going to be revised up substantially when it comes to consensus.

So I am just curious.

I think the high end of the range gets you to $0.57 using the midpoint or something like that for the third quarter.

Is there another moving part like a tax rate a little bit lower now for the year to kind of bump that number up?

I know you kind of beat by a couple pennies this quarter, so maybe I am just struggling a little bit with kind of the fourth-quarter dynamics and what is implied there.

So let me start by looking at the third quarter.

So third quarter, as we said, will -- we have a $0.07 additional earning from operations on a quarter sequential basis.

So we are making some real nice progress operationally quarter-to-quarter sequentially and that will continue third to fourth quarter.

Now in the third quarter, as I said, we have a little bit of a headwind because of the retail revenue that we had last year, which is about $0.01 to $0.02 impact.

And then we also have the negative swing in Corporate and Other line item, which is about a $0.03 impact.

So the net sequential improvement was about $0.04.

Now when you look at our guidance, to the midpoint of our guidance, it would assume $0.54 in the fourth quarter.

And based on our performance and the plans we have in place with the revenue and the orders that we have in place for the remainder of the year, extremely confident that we are going to be able to deliver not only on the revenue, but be able to deliver the improvement in operating margins for the total year.

Okay.

And so what would be now the annual corporate and tax rate guidance?

So Steve, the tax rate we are guiding still to the 19% to 20%.

We expect we'll probably end up in the lower end of the 19% to 20%.

But that is -- the guidance is still the 19% to 20%.

In terms of Corporate, we may be a little bit higher than the 225 that we had guided to, but keep in mind the interest expense will be a little bit lower than what we had guided to.

So the two together should be in the same -- as a combination, should be the same as before.

Okay.

And is there anything in the revenue comps for these businesses that swings around a little bit or it is pretty much in line with expectations?

I mean is there -- just Products pick up.

It looks like Products picks up a little bit in the fourth quarter.

Is there anything there?

I am just backing into what you use for the annual guidance.

No, we are right in line with the annual guidance.

As far as the split between the segments, Steve, is that what you're asking?

Yes, yes, yes.

We are pretty much -- Arun talked a little bit that we are maybe a little bit better in North America, but, on average, we are about in line with the guidance that we have provided and in line with the margin rates also with the activity that we have, with the productivity cost-out and restructuring that supports that for the remainder of the year.

Yes, and, Steve, the only thing I would add is the comment that both George and Arun made is that you will continue to see sequential improvement in the margin across the board in all three segments going into the third quarter and going into the fourth quarter.

Okay, great.

Thanks a lot.

And Steve, one thing to note there is with the restructuring, based on the current economic environment and positioning not only for the second half, but for next year, we have accelerated some of the restructuring programs.

Great, thanks.

Gautam Khanna, Cowen.

Thank you.

Hey, can you calibrate us on what percentage of the revenues today come from new non-resi and maybe some color on the verticals in non-resi where you are seeing more RFP activity and when those might convert to orders?

Yes, when we look at our Install business, in the downturn, there was a much higher percentage that was tied to upgrades, repairs and that type of business.

Now, as we go forward with the new new business, we'll start to see a shift in that, but we really haven't seen a change in that mix since the downturn.

I mean recognize that the non-resi construction space really hasn't had much of a recovery and then, therefore, we are anticipating that we are going to start to see a pickup, but it is about in line with what historically you have seen over the last couple years.

Okay, and in terms of kind of RFP activity, which verticals are you starting to see kind of the ABI stuff actually manifest in quoting activity?

Well, a little bit across the board.

There is some commercial.

On the commercial vertical, we are starting to see activity.

Oil and gas is another that we are starting to see activity.

Healthcare is one that we have, depending on where we are, we have got a strong position.

So it will be the ones that you would expect given the activity in the market.

Okay.

And George, just one last one.

Can you remind us when you kind of realigned the salesforce incentives to align with that project selectivity initiative?

Was it in the September quarter, was it at the end of it, so the optics will improve when?

In the December quarter with respect to year-over-year orders?

Yes, we changed the incentives as we planned for the combined company starting in September.

We planned our incentive systems in line with our strategy and that is when we had the full implementation of project selectivity and commercial security.

Now we continue to work to get -- as we think about the combination of Fire & Security to have very common standardized incentive plans in place across the globe for 2014.

Got it.

So we lapped -- December will be the first kind of clean quarter where we have --?

There might be some comparability variability in the first quarter because we implemented all this in the first quarter this year, but clearly as we progress through the other quarters of '14, clearly the lapping issue is far behind us.

Thank you.

Just recognize we had two different structures before, so we had a commercial security structure and a fire structure.

There were incentive systems in place.

Within those systems, we realigned those to the strategy of project selectivity driving revenue growth or driving profitable growth, both revenue and margin.

And so now as we think about the combination of the businesses, as we have discussed, we have begun to now integrate these businesses regionally.

So now we are going to one standard platform that enables us to be able to incentivize no matter where our people are with the same system, with the same metrics to be able to deliver on our growth strategy.

Thanks a lot.

Ajay Kejriwal, FBR.

Thank you, good morning.

So maybe if you can talk a little bit about service in Europe.

We saw both [Niscair] and Chubb kind of seeing pressure here, but looks like your service revenues were up nicely.

So maybe talk about what you're seeing there and is there any favorable shift in share for you?

I would start out by saying, overall, we continue to perform very well relative to the economic environment that I think everyone is seeing.

So when you look at our overall performance, organic growth was down just modestly in the second quarter.

What is pleasing to us is that the growth in Service is plus 3%, so at 3% and Products was also positive 3%, which was offset by a decline in Installation which was high single digits.

Now what I would say is that the combination of the strategy, the focus on project selectivity and making sure that we are focused on the end markets and the type of projects that lead to service revenue is a big part of this success.

We have also been investing in new products and new platforms within our Product businesses to be able to serve the European market and the combination of the two really have positioned us well in spite of the economic environment to be successful.

And I also would say is that if you go back three or four, five years, there was a lot of restructuring that took place within the old Tyco and really getting the fundamentals of these businesses back in line so that we would be positioned to be able to reinvest in the businesses to be able to accelerate growth.

So it's a combination of those activities.

Got it.

So you did, in terms of restructuring, what your competitors are doing now a couple years ago.

So you are much better positioned.

Is that kind of what is helping you?

Absolutely.

I would say we have done a lot of restructuring and now, in the combination -- with the combination we have with commercial Security and Fire, we are continuing to do more restructuring, but I would say that we restructured the businesses to get to very attractive fundamentals in previous years and now we are continuing to get the benefit of additional restructuring to support our growth as a new company.

Got it.

And delivering double-digit margins across Europe (multiple speakers).

Of course, of course.

And then in the context of portfolio review, maybe update on two things.

First, the stake you have in TEMP and then I know you have very nice guarding businesses in Korea and South Africa.

So how should we be thinking about those two businesses in light of the divestiture here in North America?

Well, I will start by -- we look at all of our business units all the time looking at the strategic nature of the business and as we think about our growth strategy how they fit within that growth strategy.

So we are constantly looking at our businesses, which led to the divestiture that we announced within North America of our guarding business.

And so what I would say is we are going to be constantly looking at that to make sure that the assets that we have support the overall growth that we are trying to achieve as the new Tyco.

Now I will turn it over to Arun to talk a little bit about TEMP and then we can talk about how we think about any other aspects.

Yes, so on the TEMP, as you know, it was December, Q1 of 2011 when we spun off 50% of TEMP to CD&R.

And so we have a slightly under 50% interest in that company.

And the intention was that when there is a resurrection of the non-resi commercial market, that business would pick up and we would, at that point in time, sell our interest either to CD&R or to a third party.

And we continue to evaluate that.

The market hasn't recovered as quickly as we all know as we had expected and at the time it is appropriate, we will -- that is something we have as an option to divest at the appropriate time at the appropriate value.

And then relative to your question about South Africa and Korea, the difference there is that the guarding business is part of a business that actually has very attractive recurring revenue.

And so as we look at all of our assets, we make sure that the businesses -- a big part of our strategy is being positioned to accelerate Service growth, which accelerates the ability to be able to deliver returns to our shareholders.

And so as we look at these businesses, that is what we are looking for.

Very good.

Thank you very much.

Deane Dray, Citi Research.

Thank you, good morning, everyone.

Hey, was hoping to get a little more color on the mix in your Security orders.

Can you talk a bit about what you are seeing in terms of contribution from new products?

Visonic has been a big success, we can see, but are there any themes that you are seeing playing out conversion to digital and maybe adoption of wireless?

Well, what I would say -- I mean I think you saw some of the success that we have had with the new products we have brought to market at the ISC West.

And I think in line with that, there is a trend to be more digital, to be more IP, the ability to be able to integrate multiple capabilities to provide solutions that get at what customers want that drive value for our customers, drive security.

So there is a trend and what we are doing within our platforms is making sure that we have got the platform not only to bring the individual technology within specific products, but be able to be successful in integrating those technologies into broader solutions.

So I think there is a trend with that happening and the investments being -- the investments we have made in our security products platform, as you know, we made some significant investments over the last three or four years organically in the intrusion platform, as well as we made the Visonic acquisition to complement the organic investments that we have made and we are getting very nice returns on the combination of those investments.

And in the security products, both orders and revenues growing at solid double-digit growth rates.

And do you have a sense -- I'm not sure whether you have started measuring the vitality, so how much of these orders are being reflected of these new products?

Yes, we look at vitality across all of our Global Products and there is about a third of our revenue that are tied to investments we have made over the last three years.

Now the Security product has a higher vitality because of the nature of the business being electronic and our Products business has a lower vitality.

But, on average, it is about a third of our products are tied to investments we've made over the last three years.

Great.

And then just last for me for Arun, can you comment on the payback on this additional restructuring?

And then I might have missed this, on the environmental remediation, is that charge net of expected insurance proceeds and what is the insurance factor in the charge that you are taking?

The two questions there, the first one in terms of the payback period, everything that we do for restructuring in the organization has a payback of two years or less.

And that is a discipline that we deploy in every dollar that we spend for that matter.

On the environmental matter, sorry, what was your question on the environmental matter?

It wasn't clear whether the charge you are taking is net of expected insurance.

Oh, yes, sorry, on the insurance coverage, yes, there are no insurance recoveries on this matter.

The insurance has been exhausted completely.

Oh, I see.

So it is exhausted.

Is it an opportunity for a Superfund?

No, it is not.

Okay.

Thank you.

Shannon O'Callaghan, Nomura.

Good morning, guys.

First, can you just clarify a little bit on the available cash here?

I mean you're talking about the $800 million of adjusted free cash.

You have a $300 million dividend, but now I guess you would probably have higher cash restructuring and also the environmental.

So can you give us like -- I mean is there really a spare $500 million or are you going to take a little more debt on the balance sheet or just maybe walk me through that.

We are still looking at the spare $500 million to be spent between acquisitions and share buyback, Shannon.

Keep in mind that we had a slightly larger-than-expected opening balance when we started on October 1 as the new Tyco.

We were expecting a balance of $400 million.

We actually started with $800 million.

And so that incremental $400 million is available for things like the environmental issue here, things like the separation cash flow that we need to cover for the expenses that we took in 2012, but the cash is flowing out in 2013.

And for other legacy matters, particularly we talked about the tax legacy payment that we expect to pay around $175 million for.

Okay, great.

That helps.

And then on Global Products, just a few questions.

The margin expectation for the year now, what is that and what are you assuming for this ramp in R&D and sales within that number and also if you have the organic order growth for Products this quarter?

Thanks.

Yes, let me start by saying, as you know, in these businesses, we have been -- over the last -- it's been four or five years -- we've continued to increase our investments in R&D and we are seeing the resulting success with double-digit growth here over the last couple years and very strong growth this year.

Now when you look at the investments this year, it is about an incremental $30 million and a lot of that -- it was heavier in the first half than what it is going to be in the second half.

So that will have an impact on the second-half performance.

Also, when you look at the mix, we are going to have a higher mix of higher-margin Security, as well as life safety products in the latter part of the second half.

So when you look at our performance that we are projecting for third and fourth quarter, we will continue sequentially to increase the margin each quarter and then with the volume and leverage we get also in the second half of the year, that will also contribute to being positioned to be able to deliver margins for the year about 18%.

And that also is being assisted -- when you think about the productivity, so sourcing -- the sourcing initiative focusing on the $4 billion buy, that impacts all of the three segments.

We are getting benefits that are enabling all three segments.

And so that combined with some of the additional restructuring also is going to make sure that we are going to be positioned to deliver on the 18% for the year.

Okay, and then did you have the order organic (multiple speakers).

So we expect the continuation of the order intake at the mid-single digits that we talked about.

Both orders and revenue should be in the mid-single digits.

And that is what they were this quarter too?

They were as well this quarter.

This quarter, 7% is the organic growth on the revenue side and the same on orders.

Okay, great.

Thanks a lot.

Operator, I believe that concludes our call?

Thank you.

This does conclude today's conference.

Thank you very much for joining.

You may disconnect at this time.