江森自控 (JCI) 2014 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 2014 and the press release issued earlier this morning.

With me today are Tyco's Chief Executive Officer, George Oliver and our 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've included there.

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

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

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

As a reminder, on March 3rd of this year, we signed a definitive agreement to sell our South Korean security business, ADT Korea.

Accordingly, the results of ADT Korea are now reported as Discontinued Operations in all periods presented.

Both current and historical results as well as the forward outlook discussed today refer to Continuing Operations, which again excludes the results of ADT Korea, which were previously reported in the Rest of World Installation and Services segment.

We expect to complete the sale of ADT Korea in our fiscal third quarter.

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 excludes special items and this metric is a non-GAAP measure and is reconciled in the schedules attached to our press release.

Now let me quickly recap this quarter's results.

Revenue in the quarter of $2.5 billion increased 0.5% over the prior year as 2% organic growth and a 2% benefit from acquisitions was mostly offset by the impact of divestitures and changes in foreign currency exchange rates.

Earnings per share from Continuing Operations attributable to Tyco common shareholders, was $0.39, and included charges of $0.06 related to special items.

These special items related primarily to separation and restructuring activity.

Earnings per share from Continuing Operations before special items was $0.45.

Included in these results is a $0.04 insurance recovery related to the improper recording of revenue in China, which we disclosed in the fourth quarter of 2012.

Now let me turn the call over to George.

Thanks, Antonella.

Good morning, everyone.

I am pleased with our second quarter results and the momentum that is building across all three segments as we reach the halfway mark in our three-year growth strategy.

We continue to make progress towards our 2015 goals each quarter and this quarter is no exception.

From a revenue growth perspective, we are starting to see a modest uplift in the top-line as continued growth in service and products is now being supplemented with growth in installation revenue, which has turned positive for the first time in six quarters.

Additionally, the segment operating margin continues to expand as we reap the benefits of private selectivity in our productivity initiatives.

Overall, this resulted in another strong quarter of earnings per share growth.

In addition to strong operational execution this quarter, we announced the divestiture of ADT Korea and the sale of our remaining minority interest in Adcor International.

Let me spend a few minutes discussing these portfolio changes and our plans for the proceeds.

As I have previously mentioned, we are always looking at our portfolio to ensure we have the right mix of businesses to maximize long-term value for our shareholders.

ADT Korea is a good business with nice margins.

However, it required a high and growing capital intensity.

The sale provided us with a unique opportunity to monetize the investments we have made, building the number two security provider in that market.

Our strong position in this market allowed us to command a very attractive multiple for the business.

In addition, the sale of our remaining stake in Adcor, our former electrical and metal products business, allowed us to remove the remaining volatility related to our equity investment.

Combined, these two transactions generate over $2 billion in deployable cash.

Our priorities for deploying excess cash have not changed.

M&A will continue to be our priority, given the right opportunity at the right price.

Although we do not expect any sizable transactions to come to a close in the near term, we continue to actively look at a number of opportunities of varying sizes.

I made a commitment at our Investor Day in 2012 that we would not sit on cash and that we would deliver a 15% earnings per share CAGR over the three-year period.

At that time, our 2012 normalized earnings per share before special items was $1.60.

And I remain firm on that EPS growth commitment.

The net dilution of ADT Korea and Adcor is about $0.20 of annualized earnings per share.

We expect to begin putting the proceeds to work immediately, repurchasing shares, to completely offset this earnings dilution by 2015.

Now turning back to our second quarter results, let me give you a quick overview of the performance from each of our segments.

Then I will turn it over to Arun to provide you with more details.

Starting with our North America Installation and Services segment.

Organic revenue growth turned positive a quarter ahead of plan as continued growth in service offset a moderating decline in installation revenue.

I have seen a lot of turnarounds over my career, but the speed of change I have I have seen in North America security business is second to none.

Beginning in early 2012, we modified our strategy for this business to focus on profitable growth which included putting in place a new leadership team, restructuring the business and most importantly, reorganizing the sales force to be closer to our customers.

We are now more focused on going after the right end markets that play to our strengths, so that we can utilize our depth and expertise to execute successfully and more profitably.

As a result of these changes, not only are we winning the right projects and executing on them better, we are standardizing, simplifying and automating processes to drive speed within the business.

This, combined with strong performance in our Simplex Grinnell Fire business, is what has led to another strong operational quarter in North America.

Turning to the Rest of World Installation and Services segment, we continue to see strong growth in Asia and our other growth markets.

We are encouraged by the continued stabilization in Europe and we expect Europe to be a modest contributor to growth in the second half.

In Australia, the overall economy continues to be soft, which is pressuring our performance in the region.

The mining sector has been significantly impacted and the absence of large commercial and industrial projects is also putting some pressure on our operating margin.

I visited Australia a few weeks ago and I am really pleased with all of the actions the team has taken to maintain the fundamentals of the business.

The team is executing well, despite the difficult environment, and I am very confident that the business is well positioned when the economy recovers.

Moving on to Global Products.

Revenue exceeded our expectations and the operating performance was very strong.

I have been a part of these businesses since 2006 and I am very proud to see the positive results our incremental investments in R&D, in sales and marketing are having across our fire protection, security, and life safety businesses.

Lastly, I want to touch on the focus that we are placing on technology.

A key part of our strategy to accelerate growth is driving innovation and technology to create differentiated solutions for our customers.

Our goal is to continue developing technology that will enable us not only to maintain our position as a leader in the fire and security industry, but to leverage our capabilities to create value propositions that deliver growth and returns for our customers and our shareholders.

For example, we recently launched our power series Neo hybrid intrusion detection platform, which integrates designs leading edge power G wireless technology into our existing DSC intrusion product line.

This new platform redefines intrusion security by providing a hybrid solution that combines a functionality of a hard-wired system with the simplicity of a wide range of wireless devices.

Power series Neo caters to a wide spectrum of intrusion industry needs, ranging from residential through commercial applications.

This platform has been designed to decrease installation cost and increase the functionality we deliver to our customers.

In addition to numerous product launches, we recently expanded our global center of excellence in Birmingham, Alabama.

This center develops standards, technical specifications, and detailed work plans leveraging our technology for security systems in 14 different languages.

This enables consistent security installations globally, which allows multinational companies to streamline and standardize their security systems around the world, while having a single point of contact for their global security needs.

Integrating systems and technologies to solve customer problems is central to our growth strategy.

We are driving toward bringing not only security systems but also fire and other building systems together on a common platform to provide customers with the ease and efficiency in controlling their operations as well as providing analytical services on the data collected.

Now let me turn it over to Arun to go through the details of our performance.

Thank you, George.

And good morning, everyone.

You can follow my comments on our financial performance starting with slide four.

Let me start with an overview of our results for the second quarter.

Revenue of $2.5 billion grew 0.5% year-over-year.

Organic revenue grew 2%, which is the highest organic revenue growth quarter since separation, with growth across all three segments.

Products grew 2%, service grew 1.5%, and installation revenue turned positive.

Installation revenue grew 1% organically as growth in Asia and our other growth markets was partially offset by softness in the Australian market and the anticipated decline in North America which was driven by project selectivity.

Our position growth of 2% was more than offset by the impact of divestitures and changes in foreign currency exchange rates.

Before special items, segment operating income increased 15% to $335 million, and the operating margin improved 170 basis points year-over-year to 13.5%.

As Antonella mentioned, included in segment operating income is a $21 million insurance recovery.

Adjusting for the insurance recovery, segment operating income increased 8% with an 80 basis point improvement in operating margins.

Increased revenue, improved installation performance and the benefits from sourcing, productivity and restructuring initiatives drove the operating margin improvement.

Overall, earnings per share before special items increased $0.08 or 22% year-over-year.

This increase consisted of a $0.05 contribution from operations and a $0.04 contribution from the insurance recovery, partially offset by a penny headwind from changes in foreign currency exchange rates.

Orders in the quarter grew 3% year-over-year with 9% growth in products and 3% growth in service.

Installation orders were flat year-over-year, due to the lumpiness of larger orders, which impacted the year-over-year installed order growth rate by 4 percentage points.

In April, we have seen a nice pick-up in orders and have a strong pipeline of bidding activity supporting increased order growth in the second half of the year.

This, coupled with backlog of $5 billion, which increased 6% year-over-year and 3% on a quarter sequential basis, sets us up very nicely for the second half of the year.

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

Starting first with North America Installation and Services on slide 7. Revenue in the quarter of $939 million decreased 1% on a reported basis driven by the divestiture of our Canadian guarding business and unfavorable changes in foreign currency exchange rates.

On an organic basis, revenue grew 1% year-over-year as 2% growth in service was partially offset by a 1% decline in installation revenue.

Before special items, operating income in the quarter was $117 million, and the operating margin of 12.5% increased 160 basis points year-over-year.

A greater contribution from higher margin service revenue improved installation margins, particularly in security, as well as productivity savings drove the operating margin improvement.

Overall, orders were flat year-over-year in North America Installation and Services as service growth of 3% was offset by a 3% decline in installation orders.

As we have said previously, order rates can be lumpy, particularly in the installation business, and can fluctuate from quarter to quarter.

From a dollar perspective, installation orders were higher on a quarter sequential basis.

That is why we often refer to backlog as a key indicator.

In the second quarter, backlog in North America Installation and Services of $2.4 billion increased 2% on a quarter sequential basis.

The margin related to installation backlog in our commercial security business continues to be strong and improved 120 basis points year-over-year, reflecting the benefits of project selectivity.

Turning to slide 8, Rest of World Installation and Services, Revenue of $943 million was flat year-over-year.

Service revenue grew 1% and installation revenue grew 3% for total organic revenue growth of 2% in the quarter.

A 4% benefit from acquisitions was more than offset by the impact of divestitures and changes in foreign currency exchange rates.

Before special items, operating income was $109 million, and the operating margin increased 190 basis points year-over-year to 11.6%.

Softness in Australia, which is a large and profitable region for us as well as incremental investments we have made in our growth markets was more than offset by the $21 million insurance recovery.

In the second quarter, overall orders increased 3.5% year-over-year in Rest of World Installation and Services.

Service orders increased 4% and installation orders increased 3%.

Backlog of $2.3 billion increased 11% year-over-year and 4% on a quarter sequential basis.

Turning to Global Products on slide 9. Revenue grew 5% in the quarter to $605 million.

Organic revenue grew 2% and acquisitions contributed 3 percentage points to growth.

Operating income before special items was $109 million, and the operating margin expanded 120 basis points to 18%.

Leverage from increased revenue, coupled with a greater mix of higher margin products, as well as productivity benefits, drove the operating margin expansion.

This was partially offset by a 30 basis point headwind from non-cash purchase accounting related to the acquisition of Exacq Technologies.

Product orders increased 9% year-over-year with growth across all three platforms.

As we discussed in last quarter's earnings call, the National Fire Protection Association delayed the implementation of new standards related to self-contained breathing apparatuses, including our new Scott Air-Pak X3 until early April.

In late March, we did receive approval to begin shipping our new Air-Pak X3.

As we look ahead to the third quarter for Global Products, we expect to ship the X3's that were delayed from the first half of the year, which is expected to result in organic revenue growth of approximately 11% in the third quarter.

We expect the operating margin before special items to be approximately 20.5%, representing a 70 basis point improvement in operating margin, year-over-year.

Again, this includes a 30 basis point headwind related to non-cash purchase accounting for the acquisition of Exacq Technologies.

Now let me touch on a few other items on slide 10.

First, corporate expense before special items was $54 million for the quarter.

We expect corporate expense in the second half of the year to be at a slightly higher level which is consistent with prior years.

For the full year, we now expect corporate expense to be $225 million.

Given the proceeds from ADT Korea and Adcor, we now expect net interest expense for the full year to be approximately $85 million.

Next, our effective tax rate for the quarter before the impact of special items was 16.9%.

We expect the effective tax rate for the third quarter and full year to be approximately 18%.

As George mentioned, we expect to begin repurchasing shares in the near term.

Given that we are more than halfway through our fiscal year, share repurchases will have a minimal impact on fiscal 2014 earnings per share but will set us up nicely in fiscal 2015 to cover the net earnings per share dilution related to the sale of ADT Korea and our remaining interest in Adcor.

We expect to purchase approximately 30 million shares in the second half of the year, resulting in a weighted average share count of approximately 466 million shares for the third quarter and 465 million shares for the full year.

Now let me turn things back over to George.

Thanks, Arun.

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

We expect revenue in the third quarter to increase 4% year-over-year to approximately $2.65 billion, with organic revenue growth in the range of 3% to 4%.

Additionally, the net benefit from acquisitions and divestitures is expected to contribute a point of revenue growth.

This is expected to be partially offset by a $20 million year-over-year headwind related to changes in foreign currency, given current exchange rates.

We expect continued strong operational execution resulting in year-over-year expansion of segment operating margin before special items of approximately 80 basis points.

Taking these assumptions into account, along with the below-the- line items Arun mentioned earlier, we expect earnings per share before special items in the third quarter to be in the range of $0.52 to $0.54, compared to $0.45 in the prior year, reflecting EPS growth of 16% to 20%.

Let me update you on our full-year guidance.

We now expect revenue for the full year to be approximately $10.35 billion, with organic revenue growth of 2% to 3%.

Included in our revenue guidance is a net benefit of acquisitions and divestitures, which is expected to be fully offset by a $90 million headwind related to changes in foreign currency exchange rates.

Due to the reclassification of ADT Korea to Discontinued Operations, as well as the softness we are seeing in the Australian market, we now expect full year organic growth in Rest of World Installation and Services to be in the 2% to 3% range, with an operating margin of approximately 11%.

At the beginning of the year, we indicated that we expected earnings per share before the special items to be in the range of $2.05 to $2.15 for the full year.

This included a net $0.20 of earnings per share from our ADT Korea business and remaining interest in Adcor.

As ADT Korea is now reported in Discontinued Operations for all periods, and we have sold our remaining interest in Adcor, our revised full year guidance would be in the range of $1.85 to $1.95, which again excludes the operations of ADT Korea and Adcor.

Given our year-to-date performance and our expectations for a stronger second half of the year, we are tightening our guidance to the high end of the range and increasing it for the impact of share repurchase.

We now expect earnings per share before special items for the full year to be in the range of $1.93 to $1.97.

This represents an earnings per share increase of 18% to 20% over fiscal 2013's base of $1.64.

Thanks for joining us on the conference call this morning.

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

Thank you.

(Operator Instructions).

The first question today is from Deane Dray with Citi.

Thank you.

Good morning, everyone.

Good morning, Deane.

It was interesting, unlike some of the companies take are reported so far this quarter, you heard the term weather interruptions.

I can't help but think in some of your truck rolls on installations had to have been, had some interruptions.

Any chance you can size for us what you think that's was and what the pace is for next quarter about recouping that?

Sure, Deane.

Let me start by saying when you look at our Installation and Services business in North America, it's roughly about $4 billion, pretty significant business for us.

Second quarter is typically our seasonal low quarter to begin with, as there are normally weather-related issues that we experience.

I would say that this year was a little bit worse than what it has been historically.

And I think when we sum it up, it's hard to put an exact number on it; but it's probably headwind of about $0.01 for us within the quarter.

Great.

And then for Arun, I don't try to pin you down too specifically on this.

But on the buybacks where you'll be offsetting all of the dilution from South Korea and the joint venture, at what point do you think you hit that offset?

You said 2015.

Is that an exit run rate?

Is it a mid-year?

Any chance you can be more precise at this stage?

Deane, we plan to buy back shares as quickly as we can.

And as I mentioned in my remarks, our expectation is to buy back about 30 million shares during FY14.

We will continue that effort into 2015.

And our expectation is for the full year of 2015, we would be able to offset the entire net $0.20 of dilution from the sale of ADT Korea and the remaining interest in Adcor.

Great.

Just lastly, one clarification.

When you commented on April and seeing the nice pickup, was that on installation orders or was that broadly for Tyco as a whole?

I was referring to Tyco as a whole, but clearly the bidding activity that we are seeing is more on the installation orders.

Got it.

Thank you.

Thank you.

The next question is from Jeff Sprague with Vertical Research.

Thank you.

Good morning, everyone.

Good morning, Jeff.

Just a couple things.

First, George, your commitment to the 2015 plan was pretty clearly stated there in your opening comments.

Obviously, the composition of margins will look different with ADT caps out of Rest of World.

Can you give us kind of a framework of what we should expect for margins in that business now going forward, how much room for recovery is left there?

Let me start, Jeff, by if I go back to the 2015 plan that we put into place.

When you look at the macro environment that we had forecasted at that time, we have seen additional softness from that period of time, mainly in Europe and then more recently in Australia.

That all being said, from an operations standpoint, we've been delivering very strong operations, being able to offset some of that macro pressure that we've seen over the last couple years.

On the margin rate, when you look at the Korean business, it certainly was a nice contributor to revenue.

It's been running roughly mid-single to upper-single digits from a growth standpoint.

When you look at the margin rates, it has an impact on the Rest of World by about 140 basis points.

So overall, it's very attractive business.

That being said, the growth was slowing.

It was requiring a higher level of capital to maintain that business, which is ultimately what led us to divest the business.

When you look at the update on the segment, it would impact the segment by, like I said, 140 basis points.

But for the whole Company, we now instead of 15% to 16% segment operating margins, we'd be positioned to deliver 14.5% to 15.5%.

So it's roughly about a 50 basis point impact on the total Company.

But we're very confident.

When you look at the pipeline of productivity that we have in bringing these businesses together, the continued execution of our business system and being able to standardize our processes and get the leverage up to scale that we perform, very well-positioned to be able to deliver on that three-year plan, which was based off of the one, like I said, the $1.60 in 2012.

Okay.

And then on North American install, do we see the revenue inflection there in the third quarter?

Are we kind of right at that inflection point at this juncture?

What I would say, Jeff, when you look at orders, let's look at orders because when you look at what's most important, it's the backlog.

So our backlog year on year in total for the Company is up 6%.

It's up 3% on a sequential basis.

These quarterly compares are tough because of the lumpiness that we see within our install orders.

When you look at the dollar value of the orders that are being generated, they've been higher than the average that we've had here over the last couple of years.

So that's what's building the backlog.

And so in the quarter, we delivered 1% organic growth in North America, which was a little bit better than what we originally thought.

The order rate that we see coming through and the pipeline that we're looking at for the second half, we feel very good about.

And that supports our ability to be able to originally in North America, we said we were going to be somewhat flat for the total year -- being down in the first half, up in the second half, flat.

With the progress we've made in the second quarter, with the order pipeline that we're seeing, now we're going to be able to deliver at least 1% organic growth in the North America business.

And then just finally, your comment on share repurchases is pretty straightforward.

It does appear that you're not planning on deploying all of the caps and Adcor proceeds here before year end, presumably saving some powder for deals.

But it would seem that you have some powder just on the balance sheet to do deals.

Am I correct though that you're holding back some cash for M&A, and maybe a little color on what the pipeline looks like?

Yes, I would start by saying that we're focused every day on creating the long-term shareholder value.

Now, the priority is M&A; and we continue to review a pipeline of potential deals at varying sizes.

We're always going to be very disciplined in our approach to doing these deals.

And with the timing, Jeff, timing is a factor.

And we don't see any sizable deals in the near term which has led us to we're going to try you to do as much of the buyback as we can in the second half.

We'll continue to have capacity to be able to support the deals that we have in the pipeline, which we believe is the best allocation of capital for the future.

We're not going to sit on cash, which is ultimately what led to the estimate of about 30 million shares in the second half.

But we certainly are confident that if we have a deal come up that we're going to be positioned to be able to execute on it.

And Jeff, just kind of building on that point, clearly we will have capacity as well.

So our intention is to use as much of the cash as fast as we can that's a practical and smart way of doing the buyback, and then leaving capacity on our balance sheet for transactions in addition to that.

Okay.

Thank you very much.

Thanks, Jeff.

Thank you.

The next question is from Nigel Coe with Morgan Stanley.

Thanks.

Good morning.

Good morning.

Yes, so just wanted to dig into a bit more into the April order pickup.

And it sounds like it's mainly North America; correct me if I'm wrong, or is it more broad than that.

To what extent do you think this is project shift from Q2?

It doesn't feel like it is.

Secondly, if you could give us any color in terms of verticals where you're seeing that strength in pickup.

I would say, Nigel, the pickup that we see is really across the board.

It's across North America, Rest of World, as well as our product businesses continue to perform very well.

Let me just -- I'll spend a little bit of time on each segment.

If you look at North America, we've been seeing a pickup on the front end of the business -- the recovery of the nonresidential construction.

And that's been mainly in our fire business, and that continues.

If you look at the ABI, the ABI suggested it went down again.

But the feedback that we get from the field is that the activity is strong; we've got a nice pipeline; we're executing.

And we see that continuing in North America.

If you look at Europe, we continue to perform very well.

There's been modest organic growth in the second quarter.

That's been service continuing to grow, products continuing to grow; install was relatively flat.

But I think we've got those businesses now repositioned to be successful.

With whatever recovery happens there, we're going to be well-positioned to be able to capitalize on that.

We talked a little about Australia.

It is a big market, first.

It is about 7% of our total revenues.

Without Korea, now it's about 20% of our Rest of World.

It's a split of both fire and security, with about 70% service.

Mining, the mining industry in Australia is down, I think, like about 30%, 35%.

And that's one of the strongest verticals that we have in that market.

That has positioned us to be down double digits for the year.

But as I said, I've been with the team there.

And we're executing all of the initiatives to really be positioned to maintain the fundamentals and then be able to capitalize on the recovery when it does happen.

And so the last is in the growth markets.

China, we continue to execute well in China.

We're up about 20% organically in the second quarter.

It's a relatively small business for us.

We had nice pickup in install as well as products.

We're continuing to make the investments that are needed to be able to capitalize on that market, and we think that that growth rate will continue with the business that we have there.

So overall, we've seen a lot -- with the exception of Australia, we've seen a pretty good pick-up in orders across all of the business across the regions.

Then maybe, George, can you just talk about some of the counter measures you're taking in Australia to maintain the fundamentals as you put it.

Digging into the mining business specifically, 70% of that business as you mentioned is service.

It sounds like the big dip we saw this quarter is more temporary than structural.

Could you maybe comment on that as well, please?

What I'd say is that as we drive the productivity initiatives -- which deliver about, like we said from day one, $150 million plus of productivity on an annualized basis -- all of the initiatives that we have in place, they've been executing well across every one of them.

So optimizing the branch network, driving sourcing savings, driving functionalization locally so we can then be able to reduce the structure that we have there in line with the revenue decline that we've seen.

I would say across all our initiatives, they're executing extremely well, maintaining the fundamentals in spite of the decline of the revenues that we've experienced.

That being said, we've got a tremendous business there. ¶

Mining is a very attractive vertical.

We've got suppression systems that not only get mounted to the heavy equipment, but then we get the service over the life cycle and maintaining those systems.

It's a tremendous business for us.

Our mix in Australia is about 70% service.

And so we have seen an impact on the service there short term.

But once that starts to pick up again, that service will come back.

And that service business has an impact of about -- when you look at our service growth rate, about 1%.

It's actually about 1% to 2% of our growth rate within Rest of World on the service side.

But based on my visit there, I feel very good about the business.

The team is doing all of the right things, and we're going to be very well-positioned to be able to capitalize on the recovery.

George, any visibility on when it might come back?

Could it be in second half of this year, or are we looking at 2015?

We're not sure that we've seen the bottom yet, although it seems to be slowing.

The decline seems to be slowing.

We've put a lot of resources in making sure that we're positioned to capitalize on other growth within the market.

But I would say our feeling is that in the second half, hopefully, we get into more of a stabilization; and that will start coming back in 2015.

Thanks.

Talking about the bidding activity that we're looking at in April and the pipeline over there.

There are one or two large orders that we're looking at in Australia that may not impact the revenue stream in 2014, but certainly will set us up nicely for 2015.

Great.

Thanks a lot.

Thanks, Nigel.

The next question is from Steve Winoker with Sanford Bernstein.

Thanks and good morning.

George, congrats on the sale of ADT Korea.

Great timing.

Thanks, Steve.

So on the service growth rate, you guys have talked for a while strategically about moving that growth rate up from 3% to 4% to 5%.

Just this one quarter, I guess we're looking at 3% to 4% orders rate growth.

Could you maybe give us some color on the progress you're making and conviction you have about being able to move that up and the kind of timing of that?

Sure.

When you take out Korea from the Rest of World and out of the Company, that revenue was full service revenue within the Company.

So you take that out; the impact that that has on our annual is growing at mid- to upper-single digits.

And so the impact that that business has on our service growth rate is roughly about 1%.

So that would get us instead of getting to a 5% growth rate by 2015, we'd roughly be in the 4% range.

Now, if you combine that with the impact that we've seen in Australia with our service business there because of the decline, that also has had a pretty significant impact on our service.

Now, that will come back over time.

But by 2015, we see our service growth rate to be somewhere around 3.5% to 4%.

The initiatives that you're taking within driving more out of the installed base, are you -- what kind of progress are you seeing there?

Well, all of our strategy starts with making sure that we're focused on projects that play to our strengths, that we embed technology where we can then derive the service longer term over the life cycle of that installation.

The second part is that we've been putting additional capacity in place across all of our markets.

And that's making sure that we fill gaps that we have with technicians.

We're adding salespeople in areas that maybe we didn't have good penetration before.

So all of the initiatives, combined with getting a better installed base, expanding our footprint of service, is what ultimately leads to getting to that growth rate in service to 3.5% to 4% by 2015.

Okay.

Great.

Arun, could you maybe remind us of your return on capital hurdles and metrics for the M&A that you are going to do?

I mean, I know you guys have been very explicit about your desire to do that, took advantage of the current environment to sell assets.

But given pricing levels may be continuing to elevate, it would be helpful to understand what those are, that flow-through again.

Sure, Steve.

As we have talked about in earlier calls, we go through a string of financial metrics as we look at any transaction.

And just as a matter of fact, as we look at this past quarter, there are a couple of transactions that we were kind of at fairly advanced stages of discussion but we did not conclude because it did not meet our criteria.

So we are deploying this financial discipline with rigor on a daily basis.

There are a number of things we do, we talk about the ROIC being excess of WAC.

We talk about the EPS accretion being there by the second year.

But more important than anything else is the fact it has to be a strategic fit with our long-term strategy.

And just to remind me, when you do do these deals that are out of plan, you do change the plan incentives to adjust for the deal impact?

Yes, we do.

We do make the changes to the incentives for the year.

Great.

Great.

Sorry, one last thing.

Just given the service growth on the install side, as you sort of see that progressing and you've talked a lot about focusing on the backlog, et cetera, but should this North American recovery pick up speed to kind of a historical level where you've been through this before?

Where might that installation growth head?

Is it mid-single, high-single digits?

How do you think about that?

It's rather tied to how the non-resi recovery comes about and the speed with which it comes about.

So it's difficult to say how it's going to do it.

As we look at 2014, as George mentioned, initially we were talking about being flattish for North America.

Now we're looking at about 1% organic growth for North America, just based on where we are today with the backlog and the order activity.

Going into 2015, it's going to be more driven by the speed of the non-resi recovery.

Great.

Thank you.

You're welcome.

Thanks, Steve.

Thank you.

The next question is from Scott Davis with Barclays.

Good morning, guys.

Hi, Scott.

Guys, this goes back a couple years, but we used to talk about trying to find some opportunities in corporate expense to have that be another lever to pull.

And when you think about taking some assets off the books, like ADT Korea and such, is there an opportunity to slim down a little bit on the corporate expense line?

It still seems a little larger than some of your peers.

Yes, Scott, let me take that one.

When you look at our total cost structure that we laid out back during our Investor Day, going from what we would have described as a holding Company before to an operating Company, has changed as we look at how we functionalize the Company, the mix of that headquarters cost.

And so we're in the middle of deploying what we call the Tyco business system and really driving functionalization that's allowing us to be able to create shared services that we can leverage in a much bigger way across the scale that we perform.

And so we're in a major transformation from a functional standpoint.

That being said, we're getting to a stage where we can then begin to reduce that.

As we've been enabling the segments to be more efficient with their functional cost, going forward we're going to be able to do the same at the headquarters level going forward.

So you're going to look at the total structure that exists within the segments and within headquarters, and the net of that is the productivity that we're achieving.

That's fair.

And then just trying to get a sense of your mindset here.

One could argue that if you knew you were going to sell these assets and there's going to be some dilution, that you would get ahead of it and start buying back stock about the time that either the deal is announced or maybe even before then anticipating.

You have some room in your revolver and such.

Did you think at all about that and taking a chunk of that to get ahead of the curve on the buybacks, just to offset the dilution?

Scott, keep in mind that we've been working on this ADT Korea transaction for a while now.

And while we've been working on it, we've been kind of prevented from being in the market.

Oh, okay.

That's the big factor.

That's a fair point.

And just to be clear, when I look at -- just a final quick point clean-up here.

If you look at slide 7, install orders -- and I know you've talked about this -- but are we going to -- they were down 3% this quarter.

Will fiscal 3Q with those orders turn positive?

Is that what we're saying?

North America, yes.

Backlog and orders.

When we look at our pipeline of orders and the activity that we currently see, that's going to continue to get positive.

That will continue to be positive.

What's critical here, Scott, is when you look at the pure dollar volume and not the delta year on year, that continues to expand.

And that's what's enabling us to be able to build the backlog.

It's up year on year.

We continue to deliver very nice orders.

The pipeline that we currently have is as good as I've seen over the last couple years, that we're currently working on.

Okay.

That's great color.

I'll pass it on.

Thank you.

All right.

Thanks.

Thanks, Scott.

Thank you.

The next question is from Steve Tusa with JPMorgan.

Hey, good morning.

Good morning, Steve.

So could you just help us -- there's a lot of moving parts here -- but basically just walk us from the midpoint of the prior range to the midpoint of this range?

And I guess I'm just thinking about the $0.04 of the insurance settlement; the $0.02 of accretion; the $0.01 from, I think, interest expense or corporate or something like that.

Are those kind of all the items that are contemplated?

Is there any kind of change?

Some headwind, obviously, from the Adcor sale; so are those kind of all the moving parts, maybe just operationally?

Do you guys change your guidance outside those items?

Steve, it's Antonella.

Let me take that one.

When you take a look at our previous guidance that we had put out there, it was the $2.05 to the $2.15.

Like we said, the net impact of Korea and Adcor is about $0.20 of dilution.

And really what we're doing -- that gets sp to the revised range of $1.85 to $1.95.

And you add the $0.02 of share repurchase, it gets you to $1.87 to $1.97.

We've tightened it up to a $1.93 to the $1.97 range.

The other puts and takes that you mention, keep in mind the insurance recovery was really a matter of timing that we had in the year.

And we got the recovery related to that policy in the second quarter.

So that is was kind of always part of the guidance that we had put out there.

Yes, interest expense did go down a bit because we now have the proceeds.

But keep in mind FX is now a headwind to us from about $0.02 from where it was at the beginning of the year.

So really, the below-the-line item is really offset.

So your two main drivers, again, of really the previous guidance to the current guidance, is Korea and Adcor and then the share repurchase.

Okay.

And then you've given us organic for North American install, and I think you've given us some visibility on the Rest of the World stuff.

Any other kind of updates on the segment guidance for margins or revenue growth that you want to call out to give people kind of set into the final two quarters here?

So from the North America perspective, George and Arun both mentioned we were originally at flat for the year and now expect to be up at about 1%.

I would say the margin expansion we had put out there continues to hold.

We expect to be up somewhere in the range of 100 to 130 basis points for North America, and our guidance for Global Products has not changed.

As you know, we've had some shifts within the quarters with the delay of the new standard.

But we were always at mid-single digits organic growth with an operating margin around 18.5% or so, and that we continue to stick with a as well.

One last question.

You mentioned you feel good about the April order rates.

What does feel good mean?

Maybe you could give us a little bit more precision, just in the context of you did 4% against an easy comp last quarter.

You did 3% against a little bit of a tougher comp that you highlighted this quarter.

There's some noise around lumpiness.

Maybe, how good is April?

And is that really kind of a clean number given all the noise around, I don't know, Easter and whatever else is going on out there?

Steve, what I would say is, again, it goes back to when we look at the dollar volume of orders that we're generating and you look at the month of April, in line with what we saw in the first quarter, second quarter continues to improve.

And so when you average that, we'd be kind of in the mid- to upper-single digits relative to the activity that we see.

And then we have a very strong pipeline of projects that we're currently working on that we feel confident that we're going to get more than our fair share, and that will bode well for setting up 2015.

Okay.

So April orders up mid- to high-single digits is what you're saying?

Like for like, relative to the 3% to 4%?

On a normalized basis, it would be like mid-single digits.

Okay.

Mid-single digits.

Okay.

Great.

Thanks a lot for the detail.

Appreciate it.

Okay.

Thanks.

Thank you.

The next question is from Julian Mitchell with Credit Suisse.

Hi.

Thanks.

Yes, I just had a question on the Rest of World clean kind of operating margin.

I think it was down about 40 bps in Q2, off a flat sales number.

And I guess your guidance for the second half implies slight year-on-year growth in the second half in the margin with a similar organic growth as what you had in Q2.

So I just wondered, how confident are you that that margin can swing around?

And is that something that we see in Q3, or it's more towards the back end of the fiscal year?

Yes, let me start.

When you look at the growth, it actually was 2% organic growth in Rest of World.

And as we look at the business on the operating margin, there's always going to be puts and takes.

And so we certainly got this $21 million insurance recovery, but that's been somewhat offset by the softness that we've seen in Australia.

We've seen a double-digit decline, a strong double-digit decline in the second quarter.

For the total year it's going to be double-digit.

But I believe that we're going to be well-positioned to be able to recover when that economy recovers.

Now, at the same time, with the pressure on revenue, we've continued to make investments in our growth markets.

And so we have not stopped the investments we're making, which is going to position us well to be able to capitalize on that growth opportunity going forward.

So there's really no concern as far as being able to get to the margin rates longer term that we committed for 2015.

It's really an output of all of the productivity initiatives that we're driving, sourcing, simplifying the branch network, being able to functionalize our functional cost.

And then with that leverage, with the volume coming back, we'll be well-positioned to be able to deliver on the margin targets.

Thanks.

And then on the acquisition outlook, you sound fairly confident that European and US non-res markets are at trough.

And yet you say you can't see the rationale behind doing a big acquisition.

So I just wondered, is that because it's an issue of valuations?

It's an issue of you don't want to risk upsetting the cost reduction with the distraction of a big deal?

Or is it because you're kind of still figuring out strategically where you want to put the majority of your M&A money?

Well, it does start with the strategy; so the size of the acquisition isn't really an issue.

It's really our focus on the strategic value and then making sure that we're getting that for the right price.

When we look at our industry, there are some changing market dynamics.

There's an increased focus on technology which we want to make sure we stay ahead of, as well as the expanding demand of our customers and the type of solutions that they're asking for.

And so our focus is to stay ahead of these market trends, making sure that we're leveraging the depth and expertise that we have within fire and security, and certainly be well positioned to be able to capitalize on the growth going forward.

So like we said, we're going to continue to be very disciplined with the deals that we do do, with the approach that we take; and it's going to be regardless of the transaction size that we pursue.

Understood.

Just very quickly and lastly, the mix boost to the margin in Global Products that you talk about in Q2, was that related to the Air-Pak X3, or that was related to other products?

Our product businesses are performing extremely well across all three platforms: fire products, security products and life safety.

So the 2% organic growth originally we thought would be somewhat flat.

That performance was driven by a strong performance across all three businesses.

Now, there was minimal shipment of the X3s late in March; but that was pretty insignificant.

Now, because of that, with the backlog that we had at the end of the quarter, we expect to have low double-digit organic growth in the third quarter as a result of those Air-Paks.

Now, when you look back, the Air-Paks had a 2% impact in the first quarter on our organic growth.

It had 3% in the second quarter.

Now we'll be able to deliver, let's say, about 11% organic growth in the third quarter, with the total year now being on target to deliver the mid-single-digit organic growth.

The margin, we're getting tremendous execution not only in executing on new products within all three platforms.

We're executing on pricing, and we're executing the productivity initiatives extremely well.

That is what is contributing to the margin expansion, and that's allowing us to make the reinvestment while we're continuing to expand the margins as you've seen.

And so we're going to be well-positioned to be able to deliver not only on the mid single digit organic growth, but margins that will be roughly about 18.5% for the year.

Thank you.

Operator, I think that's going to conclude our Q&A.

I do want to pass it over to George Oliver for a couple of closing comments.

Thanks, Antonella.

Thanks again for joining our call this morning.

I want to reiterate that I am very pleased with our second quarter performance which caps off a strong first half of the year.

This foundation puts us on a great path to achieving not only our full-year guidance for 2014, but delivering on our promise of a three-year, 15% earnings per share through 2015.

Operator, that concludes our call.

Thank you.

This concludes today's conference.

Thank you for participating.

You may disconnect at this time.