江森自控 (JCI) 2013 Q3 法說會逐字稿

Welcome to the Tyco third-quarter earnings conference call.

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

(Operator Instructions)

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.

Thank you.

Good morning and thank you for joining our conference call to discuss Tyco's third-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 discussions, and we ask that you read through the sections of our press release that address the use of these items.

The press release issued this morning and all related tables, as well as conference call slides, which Arun will refer to during his financial section, can be found on the Investor Relations portion of our website at Tyco.com.

Please also note that we will be filing our third-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, all comparisons are to the prior year unless otherwise noted and references to operating margins 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 $0.28 and included charges of $0.22 related to special items.

These charges related primarily to restructuring activities and separation costs.

Earnings per share from continuing operations before special items was $0.50 compared to our guidance of $0.45 to $0.47.

Now, let me turn the call over to George.

Thanks, Antonella.

Good morning everyone.

This was another strong quarter for Tyco.

Our results were $0.03 better than the high end of our EPS guidance range, driven by solid margin improvement across all of our business segments.

Our strategic initiatives to improve the fundamentals of our businesses and position us for greater profitability are generating sustainable results.

Given our strong position in the industry and the opportunities that we have as the new Tyco, we have focused the business on a few key priorities -- accelerating organic growth, executing discipline both on acquisitions and driving productivity initiatives.

Let me give you a quick update on each of these items.

Starting with accelerating organic growth.

We delivered another solid quarter of Service growth.

Service, which includes recurring revenue, represents about 45% of our total revenue, including 3% organically with growth across the globe.

Additionally, our investments in innovation continue to fuel growth in our Global Products business which continues to outpace the market and is reflective of our technology and brand leadership.

Year to date, we have increased our engineering and product development spend by 9%, and we expect to maintain a similar reinvestment level in the years ahead.

This reinvestment has supported recent product launches, which integrate hardware with software, incorporating higher degrees of intelligence, providing us with expanded market access while delivering higher performance and lower cost of ownership to our customers.

For example, in Fire Protection products, we launched a new Fire Class/Fire Detection Panel which will strengthen our position in the tier two mass market by offering easy installation and configuration with reliable and simple alarm management.

We also released a new advanced True Alert Fire Notification Panel, which supports continuous self-testing and remote serviceability, while significantly reducing the cost of installation through simplified wiring and power requirements.

Security products strengthened its position in the high-end access control space with a new release of our C-CURE 9000 Access Control Platform that extends our market-leading capability to easily deploy and manage, from a central location, the worldwide access security needs of large and complex organizations.

This new release allows better protection against unauthorized access to secure areas and sensitive information by providing individuals temporary or event-based access followed by automated deactivation when the event or their need for access has expired.

Lastly, the recently released Emerald Access Control Terminal reflects our development of smart age devices.

This provides customers the flexibility to manage the access control system through the device with its custom touch screen, integrated voice over IP, and live video communications.

These organic growth initiatives are being supplemented with bolt-on acquisitions, our second area of strategic focus.

During the quarter, we closed the previously announced National Fire Solutions acquisition which strengthens our position in the Australian Fire Services market and advances our service growth strategy worldwide.

We also announced a definitive agreement to acquire Exacq Technologies, a leader in video management solutions.

Exacq offers highly scalable intuitive video solutions supported by a strong brand in North America, with an estimated network of over 5,000 integrators and distributors.

The company has achieved significant annual growth in revenue and profitability since its inception in 2005 as customers have migrated from analog to IP-based video solutions.

When we close the transaction, which is expected over the next few days, Exacq will enhance our presence in the network video security market and expand our existing network video solutions by providing a cost-effective, easy-to-use and install network video management solution.

We also have a great opportunity to leverage our global footprint to expand Exacq's addressable market outside of North America.

We expect this acquisition to contribute annualized revenues of approximately $75 million in fiscal 2014, and we will integrate it into our security products business.

As you can see, we have made significant progress on acquisitions with $260 million in cash committed year to date.

We feel good about the acquisitions we have made, and it will continue to be a core part of our growth strategy as we move forward.

Lastly, let me touch on our productivity initiatives, which through simplification and standardization, have significantly contributed to our margin expansion over the last few years, and have had the added benefit of improving our customers' experience.

Today, our brand structure, which makes up a significant part of our infrastructure costs, includes sales, installation, services, back office functions like processing, billing, and collections, as well as customer service and technician dispatch.

In essence, each branch is run almost independently.

As we deploy our Branch-in-a-Box initiative, customer-facing activities such as sales, installation, and service will be performed in a branch office, led by an area general manager who has relationships with our customers as well as their community.

Back office and scheduling will be simplified, standardized, and consolidated to create economies of scale.

For example, in the UK we have made investments in remote diagnostic capabilities, which enables a technician to complete 4 to 6 times the number of inspections compared to someone having to drive to a customer site.

In those cases, where we do have to roll a truck, we have implemented productivity tools, like advanced scheduling and mobility devices.

These improvements allow our technicians to provide same-day quotes to customers and perform more customer visits in less time.

By deploying similar mobility tools in SimplexGrinnell, our North America Fire business, which performs hundreds of thousands of inspections per year, we expect to reduce inspection times by about 15% and provide same-day quotes on deficiencies, which is a win-win for Tyco as well as our customers.

It is these types of best practices, along with the process standardization of functional areas, such as sourcing, human resources, and finance, that we are in the process of implementing across the globe as part of our Tyco business system.

As you can see from the examples I have provided, some of our regions have already started down this path.

This is a journey that will take several years to complete.

This Tyco business system will allow us, as an operating Company, to execute with a common process across all areas, from the design and development of new products and services to the way we perform installations and provide support to customers.

Deploying this standard framework across the globe will enable us to better align our resources and leverage our customer relationships.

In addition, we expect the Tyco business system to further streamline the integration of our acquisitions.

Overall, these priorities strengthen our business fundamentals and position us for profitable growth in the future.

I feel very good about the leadership team we have put in place, the strategy that we have implemented and the tremendous progress that we have made as an operating Company.

Now let me give you a quick overview of our business results and provide some color on the business environment before I turn it over to Arun to go into more details.

In the North America Installation and Services segment, revenue was in line with our expectations as growth in our Fire business was more than offset by an expected decline in security, driven by project selectivity.

More importantly, as we execute our strategic initiatives, the operating margin continues to expand, and we are better positioned to serve our customers.

In fact, Tyco Integrated Security is working with a large financial institution to standardize and centralize their access control and video system platforms globally with our C-CURE 9000 Software House solution, making Tyco the single worldwide integrator.

In addition, we were awarded the service maintenance contract including preventative maintenance activities and IP-based remote testing.

Next, in the Rest of the World Installation and Services segment, the rate of organic growth accelerated to 2%, but we're slightly below our expectations for the quarter due to timing of backlog conversion.

At the same time, the benefits of restructuring and productivity initiatives drove better-than-expected operating margin improvement.

Moving to Global Products.

We continue to see nice organic growth, with growth across all three platforms.

Sequentially, the operating margin improved 300 basis points to nearly 20%, driven by a higher volume of higher margin products and productivity initiatives.

Bringing all of this together, continued revenue growth in Service and Products, coupled with productivity initiatives and the rationalization of our costs and infrastructure, have delivered a segment operating margin, before the special items, of 14% in the quarter.

This was well ahead of our guidance and marks a record high for these businesses.

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

Thank you, George.

Good morning everyone.

As Antonella mentioned, I will be referring to the conference call slides in my comments.

Let me start with an overview of our results for the third quarter, starting with slide 5, and then I will go through the details of our segment performance.

Revenue in the third quarter was $2.7 billion, an increase of 1% on an organic and reported basis.

The benefit of recent acquisitions was offset by the impact of changes in foreign currency and the divestiture of our North America Guarding business.

The Global Products business continues to benefit from our new product introductions, with 5% organic growth in the quarter.

Service revenue continued its positive momentum with 3% growth, while Systems Installation revenue was down 4%, mainly due to continued weakness in Europe and project selectivity in North America security.

Segment operating income with -- before special items was $375 million, and the operating margin was 14%, which is 170 basis point improvement sequentially and a 40 basis point improvement over the prior year on a normalized basis.

A higher mix of Service and Product revenue improved installation margins, and the benefits from sourcing, productivity and restructuring initiatives drove the operating margin improvement.

Overall, orders grew 3% year-over-year, with 11% growth in Products, 4% growth in Service, and a 2% decline in Installations.

As I mentioned on last quarter's call, order rates in the Installation business are very lumpy and can skew the year-over-year comparisons.

A better indicator of future top line performance is backlog, which grew 3% on a quarter sequential basis, excluding the impact of foreign currency.

Given the seasonality of our business, backlog should grow sequentially in the first, second, and third quarter.

We typically see a seasonal decline in backlog in the fourth quarter, as a significant amount of electronic fire upgrade work is performed in schools during the summer break.

We expect this trend to continue in the fourth quarter of this year as well.

Now, let's get into the details of each of the segments.

Starting first with North America Installation and Service, on slide 6, revenue in the quarter of $966 million was down 4% on a reported basis and down 3% organically.

Organic service revenue grew 2% with service revenue in the Fire business continuing to outpace the market.

As expected, Installation revenue was down 8% organically, partly due to the impact of project selectivity as well as a tough compare with the prior year for the Security business.

Operating income before special items in the quarter was $117 million, and the operating margin increased 120 basis points sequentially to 12.1%.

Year over year, the operating margin increased 80 basis points on a normalized basis.

A greater contribution of higher margin service revenue, improved margins in installations, as well as sourcing and productivity savings drove the operating margin improvement.

Overall, orders in North America Installation and Services were down 8% year-over-year, with service orders growing 2%, offset by installation orders, which, as expected, declined 17% due to a tough compare with a 20% growth rate in the prior year.

More importantly, backlog was up 1% sequentially to $2.5 billion, and we are seeing a nice improvement in security installation backlog margin.

Looking ahead, we expect the fundamentals of our fourth quarter to be similar to the third quarter as growth in the Fire business will be offset by an expected decline in commercial security.

As we have previously discussed, this should result in a year-over-year organic revenue decline of 2% to 3%.

Additionally, the divestiture of our Guarding business will reduce revenue by $20 million for the quarter on a year-over-year basis.

As we continue to operate more efficiently, we expect the operating margin, before special items, for the fourth quarter to improve year-over-year by about 30 basis points and 120 basis points on a normalized basis.

Turning to slide 7, Rest of World Installation and Services revenue of $1.1 billion was up 2% on a reported and organic basis.

Organically, growth in Service revenue of 4% was partially offset by a decline in installation revenue of 1% due to continued weakness in the European markets.

A 2% benefit from acquisitions was mostly offset by changes in foreign currency exchange rates.

Operating income, before special items, was $139 million.

The operating margin of 12.5% improved 150 basis points sequentially and 30 basis points over the prior year, driven by a better mix and the benefits of productivity and restructuring initiatives, which more than offset incremental investments in service sales representatives.

Orders increased 9% year-over-year, with service orders up 5%, and installation orders up 15%.

Backlog reached a record high of $2.6 billion, which is a 3% increase on a quarter sequential basis.

Looking to the fourth quarter, we expect year-over-year organic revenue growth of 2% to 3%, supported by our order rates and record high backlog.

We expect changes in foreign currency exchange rates to more than offset our contribution of about $30 million of revenue from acquisitions.

The fourth quarter operating margin is expected to improve by about 100 basis points year-over-year, approaching 13%.

Turning to Global Products on slide 8, revenue grew 7% in the quarter to $600 million.

Organically, revenue was up 5%, with growth across all three platforms.

Operating income before special items was $119 million, with an operating margin of 19.8%, well ahead of our original estimate of 18.5% to 19% due to better-than-expected productivity gains.

Year over year, the operating margin declined 30 basis points due to a higher mix of high-hazard, high-performance products for the mining and oil & gas end markets in the prior year.

On a quarter sequential basis, the operating margin improved 300 basis points, which sets us up nicely to achieve our full-year operating margin guidance of 18%.

Product orders increased 11% year-over year.

About 3 percentage points of the order increase this quarter was the result of a last chance order opportunity in our Scott Safety business related to replacement products for current generation Air-Pak Self-Contained Breathing Apparatus which is referred to as SCBA, in anticipation of new National Fire Protection Association Standards.

Once the new standards become effective, manufacturers will no longer be able to ship NFPA Certified products that do not meet the new requirements.

Scott Safety has developed a new SCBA, the Air-Pak X3, that exceeds these new standards and continues Scott's 80-year history as the industry-leading, most reliable and durable SCBA on the market.

Looking ahead to the fourth quarter, we expect revenue of $580 million to $600 million, and the operating margin to increase to approximately 20%.

Aggregating the segment guidance I just provided, we expect organic revenue growth for the fourth quarter of about 1% and total revenue of approximately $2.7 billion.

Based on current exchange rates, this includes a $50 million to $60 million year-on-year headwind related to foreign currency, largely driven by the declines in exchange rates for the Australian dollar and the South African rand.

Overall, we expect segment operating margin to improve approximately 100 basis points on a year-over-year basis, and about 150 basis points on a normalized basis.

Now, let me touch on a few other items on slide 9. First, corporate expense, before special items for the quarter, was $62 million.

As we stated on last quarter's call, corporate expense tends to be higher in the second half of the year due to the timing of certain expenses.

This year is no different.

In the fourth quarter, we expect corporate expense to be approximately $65 million.

Next, our effective tax rate for the quarter before the impact of special items was 18.4%.

We expect the fourth-quarter effective tax rate to be approximately 20%.

Lastly, we've repurchased 3.1 million shares for $100 million during the quarter, and $300 million of shares on a year-to-date basis, leaving $500 million available under the existing share repurchase authorization.

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

Thanks, Arun.

Now let me spend just a few minutes on our overall earnings per share guidance for the fourth quarter and what that implies for the full year.

In the fourth quarter, we expect continued strong operational execution, with operations contributing about $0.07 of incremental earnings year-over-year on a normalized basis.

Corporate and below the line items are expected to be a net headwind of $0.01 per share, again, on a normalized basis.

As a result, we expect earnings per share before special items in the fourth quarter to be in the range of $0.50 to $0.52 based on a 472 million share count.

This represents an 11% to 16% increase in earnings per share year-over-year on a normalized basis.

With that, we are tightening our full-year guidance range to the high end of our previous estimate.

Our full-year guidance range is now $1.83 to $1.85 per share.

Thanks for joining us on the conference call this morning.

With that, operator, please open the lines for questions.

Thank you.

(Operator Instructions)

Steven Winoker, Sanford Bernstein.

Just maybe a little more color around a few things.

One, on the installation orders in North America.

Maybe just get that out of the way around how much of that you think was project selectivity driven, how much was just a really tough comp that you laid out there?

How should we think about that going forward in terms of your progress on that front?

So I will start, Steve.

When you look at as we guided during the last earnings call, we said in the third quarter, we're going to have a tough compare because we had a retail order last year that was very sizable that we didn't see repeating this year.

In addition to that, there was some opportunistic sprinkler jobs that we had taken on in the Fire business that also didn't recur this year.

So it's right in line with what we expected.

I think what's important, Steve, is if you -- we step back and really look at how the year has played out within North America, so if we start -- at the beginning of the year, we started off with a pretty good backlog going into the year, with -- especially as it tied to the Commercial Security business.

When you looked at the performance in the first half, we certainly -- the revenue that we achieved in the first half was really on the backlog that was there prior to separation.

What's happened here in our order rates, when you look at the order rates sequentially, we're actually stable now, going from the second quarter to third quarter.

And as we look at the fourth quarter going forward, we're going to be able to sequentially improve those order rates.

So when you look at the second half of this year, this is where we're seeing the revenue decline as a result of the project selectivity within Commercial Security on the revenue side.

But the order rates now support the revenue that we see in the fourth quarter, and it does position us now, as we get into next year.

In the first half, we're going to have a tough compare on revenue.

But the order rate that we're seeing now, being able to grow going forward is going to really position us well to be able to deliver growth by the second half of next year.

Okay.

When you talk about that growth, are you talking about low single-digit, mid-single, or how are you thinking about that?

Well, similar to our Fire business so when you look at our fire business within North America, the economic growth is roughly around 2%.

We've been outperforming that 2% in our Fire business, certainly with a focus on service growth and that continues.

As we see that business coming back, it will be similar to Fire.

Now as we see the recovery within non-residential, we're seeing activity in that space today.

That will position us to be able to capitalize on that recovery and be able to accelerate the growth going forward.

Now, I would say, if you normalize, if you were to normalize our North America segment as a result of project selectivity within our commercial security business, so we'll be down -- if you look at the third quarter, being down about 3%.

Without the project selectivity, we'd be in the 1% to 2%.

And if you look at the total Company, that has impacted the total Company by about 1% organic growth.

Okay.

Just second question on -- You mentioned the 5000 integrators and distributors for Exacq.

Is that -- how are you thinking about dealing with that given your current distribution across the rest of the business?

This -- we are very excited about this acquisition.

It's going to play out in a very attractive space within our video business; high-growth space.

And so it adds -- when you look at what it adds, it adds a tier two offering in the high-growth segment.

As I said, it does -- it's a product that's easy to install, easy to use for our customers.

So we see a significant opportunity, not only in being able to leverage our existing distributor base that we have within our Securities Product business, to be able to accelerate product growth, but more important, Steve, is the opportunity to be able to take this technology and really create simple solutions that we can put through our direct channel with our Installation and Services business globally.

And so the opportunity that we have outside of North America is also pretty significant.

Okay.

Well, I'll hand it off.

I like the [TBS] acronym.

Thanks, Steve.

(laughter)

Jeff Sprague, Vertical Research.

Just a couple of things.

First, just on share count, your guiding share count is actually up sequentially in Q4?

Jeff, basically, as you know, each quarter, we have some dilutions that takes place from option exercises and vesting of stock.

In addition to that, we're also seeing some further dilution that takes place as with the stock price.

So we've made some assumptions here in terms of what the option exercises and the vesting would happen in Q4, and that's what takes the [year] share count up to 472 million.

So that type of dilution would occur with what?

Another $100 million of growth share repurchase?

Or are you not doing any growth buyback in the quarter?

The 472 million does not assume any share buybacks, but keep in mind, Jeff, that we still have $500 million of authorization left, and we plan to be opportunistic in terms of how we exercise that authorization.

Okay, and then George, or Arun, I wondered if you could elaborate a little bit more on the backlog margin comment you made.

Obviously, North American systems installed margins look pretty solid this quarter.

I would assume that does not reflect a lot of selectivity help.

Maybe it does but I'm thinking that's maybe just mix, but can you elaborate on the impact of selectivity in the quarter itself and what you were alluding to in the pipeline going forward?

Sure.

So when you think about our installation business, as we look at these jobs through our project selectivity strategy, we make sure -- I mean, a lot of it is how we -- it really starts with how do we scope the job, how to we spec the job.

And then making sure that we have the fundamentals in place so that as we book those jobs, we have a pretty good idea or pretty good predictability on how those jobs will be executed.

And so as we have launched project selectivity across all of the other businesses, we -- this is typically what we see.

Where the backlog has improved, the backlog margin has improved about 100 basis points but in addition to that, Jeff, as we execute on these projects, what's also contributing to our margin expansion is that we're executing these projects better.

So think about it as a discipline that goes in the specification of a project, and then as we then position ourselves to execute, we're executing better.

So there's two elements that actually drive the margin expansion within the business.

It's typical of what we've seen when we deploy project selectivity across the other businesses.

And then just one last one, and I'll move on.

Corporate, what is the outlook there going forward if you hit your projection here in Q4?

That would be two quarters in a row where it's actually drifting up.

Some of us thought it might be actually drifting down going forward.

What's the opportunity there?

Jeff, basically -- let me start by saying that, as you know, we are transitioning from a holding company to an operating company.

In this transition, there are certain costs that they face, as we're trying to, to George's comments.

Centralized, standardized, consolidates are some of the functions that are HR, and finance, and sourcing, IT, et cetera.

You see some charges incremental that to what would be in a holding structure.

Now going forward, clearly we will start to see the benefit of having consolidated these corporate functions.

So Jeff, it's really right in line with what we had estimated or guided last quarter for the total headquarter' s costs.

I think as we look at the simplification that's occurring across the overall enterprise, it's over the next year, as we get through the final separation, it would be somewhat in the same range.

But going forward, the success of the operating system that we put into place is going to position us to be able to, to really know, going forward from there, be able to continue to take [that] down.

Deane Dray, Citi Research.

Just to start, maybe George, you can clarify your comment on the year-over-year comparison.

You said there was a big retail on the orders, you said there was a big retail order that was not expect to repeat, but then you also added that there was an opportunistic sprinkler job.

Maybe just to clarify how that might have been different from what would be other sprinkler installations?

Yes, when you look at the overall order rate, so the overall order rate was down roughly -- was it 17%?

17% year on year.

That compares to being up last year 20%.

So to be clear, certainly, the majority of that was a very large retail order that we had last year, third quarter, which actually also delivered revenue last year third quarter as a result.

What we wanted to be clear was that there is lumpiness n our orders, even within the Fire business, especially, actually, within the Fire business.

As a result, we had a difficult compare there also as a result of those orders.

So going forward, when you look at the backlog in North America, the backlog actually grew 1% across both Fire and Security.

Sequentially, now it's stable, and we feel very good about continuing to grow the orders in the fourth quarter, which then, when you look at that and how that plays out in 2014.

As I said earlier, we'll have a tough compare in the first half on revenues, but our orders, sequentially, will continue to get better, and that by the second half, we're going to be positioned to deliver some nice growth.

Great.

And then maybe if you could comment on the major geographies opportunities in the next couple of quarters.

China, specifically, and maybe on India; expectations, big changes and fire regulations?

Is there an opportunity for Tyco there?

So the best way to look at this is if you look at the Rest of the World Installation Services, that's where most of the growth markets are reported within.

And so if you look at that, I did say that we're slightly behind on revenues in the third quarter.

But what's important there is when you look at the order rate, we're up about 9% in the third quarter, right?

And that now has positioned us not only to be able to continue to accelerate our organic growth in the fourth quarter, but then going forward position us well for growth in 2014.

I would say, even in the third quarter, the service strategy that we've deployed is actually playing out very nicely.

We're up about 4% in service in the Rest of the World, which is also tied to some of those growth markets.

Now you talked a little bit about India, China.

Relative to these markets, we play a very important role in how standard codes and standards are developed.

We're very active within those markets in developing those codes.

It does take time.

It's a multi-year development that occurs, but I can assure you that we're making the investments locally, organically, as well as we're making some nice acquisitions that create the depth and expertise that we need locally to be able to capitalize on those markets longer term.

And so that's where a lot of our investments are occurring, positioning us for some nice growth as we look forward.

And then just last one for me before I hand off.

A question on pricing.

As you add more technology to your service offerings, but importantly, in the -- when you do the wireless installations on Intrusion, you're doing them 3 or 4, maybe 5 times faster than the wired technology.

Are you -- do you have to give any price give back on these because the installers are doing it quicker, or do you still get the same price because you're adding more features and functionality?

is there any -- do have a dynamic there?

So when you look at our portfolio, it really does -- the price is driven in three key categories.

So you have installation, you have service, and you have products.

In the installation space, it's really driven by our project selectivity strategy, making sure that we understand the costs.

We have objectives relative to the margins that we're going after, and then making sure that as we're driving productivity in the solutions that we're installing, that we're now taking that increase in margins to the bottom line for ourselves.

And so we do take that into account as we specify and then execute on installations.

That's how we drive margin improvement and installation.

In services, it's really driven by the escalations that we have within our contracts.

And so we take into account commodity inflation.

We make sure that as we look at the horizon, that we're now putting the right escalations within the contract to be able to offset any headwind that we might have on commodities or any other costs.

We've got a very strong track record in being able to execute on that price increase.

And then you mentioned on products.

What's happening in products?

We're very disciplined around the new technologies that we're developing and we're acquiring within the product businesses.

And so as we think about the new product introductions, the value that, that creates for our customers, the significant opportunity to be able to then get the right price in line with the value that we're creating.

And so what you'll see within the products business, not only are the new product introductions helping to drive or sustain some nice growth, we're about 5% this quarter, but we're also seeing the lift in the margin rates combined with the productivity and restructuring that's been occurring there within the business, which is helping drive margins.

Gautam Khanna, Cowen.

Great quarter.

Good morning.

Thank you Gautam.

So I was wondering if you could just step back and give us any update to your fiscal '15 targets, just given you're one year in now from you first provided them?

Global products up 8% to 9% CAGR over that period and we're seeing some deceleration.

If you could just talk to the segments and see if anything has changed relative to your year-ago expectation?

Let me start just with an overview.

When you think about the three year plan that we put together, a significant amount of that plan was really dependent on what we could execute ourselves within the operations.

And so it's hard to predict what's going to happen within the different economies that we compete in.

But I can tell you that the progress that we've made in setting up the operating company supported by the Tyco business system, we're going to be well-positioned to deliver on the margin expansion that we committed as part of that three year plan.

And so when you look at the segments in the guidance that we provided back during our Investor Day, and you look at the three year plan, in North America, we're -- right now, we're right on line with what we saw happening in North America.

As you all know, that we're going to get a significant impact in the first year because of product selectivity and commercial security; that's played out exactly how we expected it.

And then we're going to be positioned now to generate growth, some incremental growth next year, and then be able to accelerate from that in 2015.

We will be positioned to be able to offset the dissynergies that are occurring in North America and deliver on the margin improvement that we committed.

When you look at the Rest of the World Install and Service, as I said, we're on the lower end of where we guided the first year, but we're starting to see the traction of the investments we're making in growth, service growth as well as the footprint that we're establishing within the growth markets.

I do believe, based on what we're seeing, that we're going to be positioned to be able to deliver on the revenue growth.

And then, again, that is where we're putting a lot of investments to create the capability to achieve that growth, but still will be positioned to be able to deliver on the margin improvement.

Then the Global Products, I think that we've got a nice track record here over the last few years where the strategy that we had in the products business was to continue to invest.

And this year, we increased our investments about $30 million in engineering and innovation, which is really is what's fueling the new product introductions, that why, we believe, that given the environment that we're competing in, we're actually outperforming from a growth standpoint.

So the new products, and then with the ability to be able to continue to leverage the operating system to drive productivity and cost though is going to position us to be able to sustain and continue to grow the margins that you're seeing today.

And so when you look at the productivity, which was part of the overall plan, we are going to achieve $150 million a year of productivity that's somewhat offset by the headwinds and escalation that we see in our labor.

But that also supports $50 million of reinvestment, supporting the growth, and then that's what funds the margin expansion of 80 to 100 basis points over that period.

So I feel very good about the progress that we've made this year, and establishing the foundation to be able to execute on that three year plan going forward.

Okay.

If you wouldn't mind just commenting on trends within the verticals, from commercial, institutional on down.

Have there been any big variances over the last three months, maybe six months, in terms of forward indicators?

(multiple speakers)

What I would reflect on is to give you really an update on the -- there's really six verticals that I talked about at EPG.

I'd start with commercial and institutional, those are two big markets, end markets that are critical to our installation business.

As you know, we saw a little bit of a slowdown in North America, although it's still growing; earlier in the year, there was a little bit of a slowdown.

There's still continued challenges across Europe.

We've been able to offset that with the ability to accelerate service growth, and that's been a big focus area for us.

But I wouldn't say, as we are beginning to see -- I think what everyone else is saying in line with the ABI Index.

For seven or eight months, it's been positive.

There was one data point on the commercial side that it dropped, but overall, we're beginning to see that activity, and we're going to be well-positioned to capitalize on the recovery that does take place.

But right now, it's been relatively low as far as the revenue from that.

Like I said, we've been offsetting it with service.

Institutional is a very strategic end market for us.

We do very well, and we're beginning to see some opportunities there across universities, hospitals, and the like that I think is going to bode well for us going forward.

But again, short term has been a focus on service.

Residential, small business, that's when we look at our business globally, it's certainly an area that provides great opportunity for us to grow with that subscriber base businesses.

And then when you look at industrial and energy, we talked a little bit about the pressure we had in our Fire Protection Products business because we've got a great business that really brings a [pressure] to high-hazard operations within mining and oil & gas.

There has been a little bit of a slowdown in mining, as you know.

We're seeing a little bit of an impact on that.

But we're well-positioned with our capabilities, as that recovers going forward, to capitalize on that.

Retail is another big space for us.

We're -- in spite of some of the challenges globally, our retail business continues to perform very well.

That's, again, in line with the new products that we are developing in our ability to be able to create more value for our customers with some of the new solutions that we're bringing to the market.

And then on government, when you look at government, there has been some pressure there.

But recently, we've actually been seeing some opportunities where we're now putting together some specifications and proposals around some government jobs.

So overall, I would say it's -- from where we were last quarter, it seems to be better.

We're seeing activity in the market, and as I said, we're going to be very well-positioned to be able to execute on this strategy right from project selectivity, being able to expand our services, and really, leverage, the technology that we have within our product businesses.

Thank you.

Good luck.

Steve Tusa, JPMorgan Chase.

The -- you guys have spent a little bit on restructuring this year.

What would be, to add them up, the total savings looking into next year from that?

Just see basically all of the restructurings that we go through have a fairly quick payback period.

So most of the restructuring activities that we have undertaken this year have a payback of less than two years.

So if you think about it, we expect about $100 million for restructuring alone and we should get the payback over a two-year period.

Will you -- will that continuing practice next year to [glob] that expense every year and will be pulling it out, or is there a view on when that becomes more clean?

Steve, the way that we've looked at this, as we have defined the new Company.

When each set of businesses came together, as we've talked about before, it's really a merger of two very large operating segments that were part of the old Tyco.

So what we've done, as part of our strategy, define this operating company structure, we're developing the business system to be able to execute within that structure.

You can imagine, as we've done that, we've identified significant opportunities to improve.

We saw this when we originally laid out the plan.

So initially, as we said last quarter, we accelerated some of the restructuring this year because of the work that's being done in defining the business system.

That will position us to be able to then deliver on the margin expansion that we committed over the next couple of years overall.

And so it's in line with what we suggested was going to be needed to be able to deliver those benefits.

Right, but so for next year, there will be more, or this is basically what you've done what you need to do?

Well, in the first two years, we said there was going to be roughly $75 million a year.

Okay, okay, okay.

What --

(multiple speakers) we said was we pulled some of that forward this year, knowing that we have significant opportunities as we're developing this system.

Perfect.

And then a couple other housekeeping items.

The Forex headwind of $60 million, and there was a lot of these currencies have been moving around quite a bit.

That seems to be a reasonably large number relative to what you put up in the third quarter.

So when you look out to next year, if you could just hold rates where they are today, do we think about the $60 million being here for the next couple of quarters, beyond the fourth quarter, and then fading in a linear fashion, or have they been -- the currency has been so volatile that there is -- it's always tough to tell with you guys because you have a bunch of different currencies, that outside of the Euro, that we have to track.

Basically, bottom line, is Forex for next year?

So basically, Steve, if you think about the FX, it really started hitting us -- the headwind started hitting us late into the third quarter.

Now we're seeing the full impact of it in the fourth quarter.

The currencies, as you know very well, have been extremely volatile.

If you look at them, we have six big currencies that account for something like 60% of our revenues.

Sorry -- yes pretty close to it, About 60% our revenues.

These currencies, the Aussie Dollar, the British Pound, the British Pound has been extremely volatile as well compared to when we started the year to where we are today.

The same applies to the South African Rand, and the Canadian dollar, so all of the currencies we deal have been volatile.

It's difficult to predict what the full-year impact would be.

The way we go about it is we're going to be -- come up with our guidance.

We look at the exchange rates at that point in time, and the pluses or minuses we take as we go along.

Got you.

So we shouldn't just take the 60 and multiply that by 3 and then tweak it down, and you know there's different comp issues and stuff due next year?

Right.

Steve, if you keep in mind, when we first started the year, we gave guidance back in November, we were actually projecting that foreign currency was going to be a tailwind for us at that time in the $25 million to $50 million range.

Now it's at $125 million swing from November until now.

So like I said, you never know which way rates are going to go.

Right, and then one last question, just on tax rate.

As you guys got to the low end of the range this year over time, is that 19% a good solid run rate in the next year?

I think as we look into next year, I would say the 19% to 20% is still solid for next year.

Okay.

Thanks a lot.

Steve, a note on the fourth quarter.

In our guidance, the $0.03 operationally is net of $0.01 headwind that we had on FX in the fourth quarter.

The $60 million is a reasonably big number.

So I just wanted to make sure that I was modeling that because it will be a headwind, obviously, if rates stay where they are, if you got hit late in the third quarter for next year, right?

Right.

Absolutely.

Ajay Kejriwal, FBR Capital Markets.

So just on global products.

Good pop in the margins there, and obviously the work you're doing on productivity is helping.

But then it sounds like you got a lift from the Air-Pak business, the NFPA standards.

So maybe just a couple there.

Do you expect this pre-buy to continue into fourth quarter, and then maybe also talk about the sustainability of the margins?

When you look at the products business, so let's start with on the revenue side, there was no additional lift within the products business in the third quarter.

When you look at the order rate, the order rate in the third quarter was 11%.

Organically, it was roughly about 9%.

So it was about 2 to 3 percentage points that were tied to the last chance order of the old Air-Pak.

so as this plays out, there will be -- when we look at order rates, there will be some pressure on the order rates in the fourth quarter.

But we're well-positioned with the new Pak.

As we introduce the new Pak in the -- it will actually be introduced in the first quarter, we're very well-positioned to be able to continue to sustain the current performance going forward.

And so there will be -- you will see a little bit of pressure on the order rate in the fourth quarter because of that last chance order that we did in the third quarter.

Ajay, on your margin question, clearly margins vary from quarter to quarter.

But overall, if you look at the full year, we -- you should expect margin expansion year over year.

So -- got it.

So it sounds like you got a lift in orders in the quarter that turns into revenues next quarter.

Do you expect more of those revenues into the following quarter or you would be booking all of that in the fourth quarter?

The order rate was, like I said, we -- because of the last chance, some of that revenue will play out longer.

But the idea -- we're in a position now within the setup -- the product businesses, to continue to sustain about mid single-digit growth across the businesses.

We don't see any significant change in that profile as we look at fourth quarter or beyond.

It was just really the timing of this last chance order on the old generation Air-Pak.

Got it.

That's helpful.

And then maybe if you can elaborate on the incremental R&D and investments that you manage to making in products?

So should we expect that to taper here a little bit on a year-on-year basis, or would you expect that to continue at that same rate into next year?

The way I would look at that, we feel very good about the reinvestment rate.

As you look at these set of businesses, and you went back five or six years, we have more than doubled the reinvestment rate.

And at the rates that we're at, we feel very good about our position, not only in our position but continuing to strengthen our position and be able to sustain the growth that we forecasted.

So as a percent of revenue, I think it'll stay somewhat consistent now going forward.

So we'll continue to grow.

We'll continue to increase R&D, innovation in line with that growth.

But we won't be expanding as a percentage going forward as much as we have over the last two or three years.

So the incremental dollars would be less next year?

Is that right?

No, the dollars will expand in line with the expansion of revenue.

Operator, we have time for one more question, please.

Shannon O'Callaghan with Nomura.

One question on the Rest of the World business.

The installation orders were up 15%, and the service orders were up 5%.

Given how you're trying to tie service to install, I was a little surprised to see how much install was up.

Does that -- do our those install orders actually include a service attachment that just doesn't show up yet or can you explain that a little bit?

That is correct.

When you look at the way that we -- the business model works, actually, that 15% order growth in install is a good sign because that positions us to be able to create an installed base that typically, over the first year or two, if it's a Security installation, when we typically get the monitoring contract at the time of installation.

If it's a Fire contract, there's typically a delay, a delay in getting that service revenue.

And so the whole focus of project selectivity is to work on projects that we have high confidence, high predictability that we're going to get the service revenue to support that installation over the lifecycle.

And so there is -- you don't always get that service order right upfront.

But it does position us to get the service now over the lifecycle of that installation.

Okay.

So that boost in install orders, while historically, it might have been lower margin, just install, you're basically saying that this business you've booked in the quarter, you have high confidence you're going to attach service to that?

Yes.

There's -- we don't always get 100%, but there's a probability that we have in the projects that we develop that we're going to get a fair degree of that service revenue over the installation that we perform.

Okay, and then just last one.

Any given where deals are right now, and pricing and things, any change in your preference versus acquisition versus buyback, as you look into next year?

What I'd say is in line with our strategy is that we we are seeing -- we still have a nice pipeline of opportunities within -- for acquisitions.

Now they tend to be lumpy.

They don't always come through the way that you might like.

So we want to make sure that we're going to be positioned to execute those as they become available.

Certainly, we're going to be positioned to support the acquisitions and then be opportunistic with the buybacks as we have been through the course of the year.

I think, Shannon, the other thing is we continue to maintain the same discipline that we have talked about in the past as well in terms of the financial criteria that we look at.

Acquisitions that we are looking at that are still in our pipeline do meet the financial criteria.

So I think that you will see more activity on that front as we go forward.

All right.

To wrap up, I want to thank everyone for joining us this morning.

I'm very pleased with the performance that we've achieved this quarter.

As you can see, we're very well-positioned for a solid first year as the new Tyco.

I do look forward to seeing many of you over the next few months.

So on that, operator, that concludes our call.

Thank you.

This concludes today's call, you may disconnect at this time.