江森自控 (JCI) 2015 Q2 法說會逐字稿

Welcome to Tyco's second-quarter 2015 earnings call.

(Operator Instructions)

Today's conference is being recorded.

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

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

You may begin.

Good morning, and thank you for joining our conference call to discuss Tyco's second quarter results for FY15 and a 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 discussion, and we ask that you look 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 George and 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.

During the quarter, the Company committed to a plan to sell security monitoring business in China, which was previously reported within the rest of world installation and services operating segment.

This business generated $8 million of revenue in FY14 with an operating loss of $3 million.

Current and historical results related to this business are now classified as discontinued operations.

Recasted financial information for the quarter of FY14 as well as the fiscal first quarter of 2015 is available on the Investor Relations portion of our website.

Additionally, during the second quarter the Company committed to a plan to sell its majority interest in a fire installation joint venture in China.

This business is classified as held-for-sale on the balance sheet as of quarter end, and the Company expects to complete the sale of this business in April.

Annualized sales related to this business are approximately $130 million.

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

Additionally, references to operating margins during the call exclude special items, and this metric is a non-GAAP measure reconciled in the schedules attached to our press release.

Now let me quickly recap this quarter's results.

Revenue in the quarter of $2.43 billion declined 2% year over year on a reported basis.

Organic revenue growth of 2% and a 2% benefit from acquisitions were more than offset by a 6% negative impact related to changes in foreign currency exchange rates.

Earnings per share from continuing operations attributable to Tyco ordinary shareholders was $0.43 and included net charges of $0.12 related to special items.

These special items related primarily to an expected loss on the divestiture of our majority interest in a joint venture, as well as restructuring and repositioning charges.

Earnings per share from continuing operations before special items was $0.55 compared to our guidance of $0.48 to $0.50.

Operationally we were at the high end of our guidance range, with the remaining $0.05 of earnings attributable to lower corporate expense and a lower tax rate.

Now let me turn the call over to George.

Thanks, Antonella, and good morning everyone.

I am pleased with our operational performance in the second quarter as we continue to deliver a strong profitability.

As you can see on Slide 3, we delivered $0.05 of incremental earnings from operations year over year.

This coupled with a $0.05 contribution from share repurchases drove a strong 17% increase in earnings per share before special items for the second quarter.

Before I touch on the progress our teams are making on our strategic initiatives, I want to start with two big themes I know everyone is focused on.

The impact of the strengthening US dollar and the impact of lower oil prices on the oil and gas industry and the associated effects on other end markets.

Starting with the impact of changes in foreign currency exchange rates on Slide 4, the US dollar has continued to strengthen against most of our significant currencies during the quarter, and this trend has continued in the month of April.

The most significant drop has been in the euro which decreased to a recent low of $1.05 and is currently trading a bit higher.

The significant swings in currency during the second quarter and through April are adding an additional $0.02 of pressure to our earnings this year, bringing the full-year impact of foreign currency translation to an $0.18 headwind on a year-over-year basis.

Moving to the oil and gas sector on Slide 5, starting in March and continuing in the month of April we've seen incremental weakness in our oil and gas end market.

As I had mentioned before, our direct exposure to this vertical is about 5% of total revenue, which is across the installation and services businesses and within our global product segment, with the largest exposure within our UK install and services business and our fire protection products business.

Based on what we have seen over the last six weeks or so, we are now expecting a 15% decline in the revenue tied to this vertical.

It's important to keep in mind that a majority of our revenue in the oil and gas space is high margin service revenue, as well as special hazard product sales which tend to carry a higher than average margin.

We expect the recent softness we are seeing in the oil and gas vertical to be an incremental headwind of about $0.06 to our previous full year guidance.

Now let me get into a little more detail as to what we are seeing in the macroeconomic environment across the various parts of the globe on Slide 6. Starting with North America, non-residential construction in the US continues to be better year over year.

We continue to see good order activity, particularly in the retail and healthcare verticals with softness in oil and gas.

As activity in the Canadian market is very much tied to the petrochemical oil and gas industry, we have seen a broad-based slowdown, particularly in Western Canada.

CapEx spending has come more in focus due to the decline in oil prices, which is resulting in some project activity being shifted to the right and delays in new order activity being awarded.

Overall, our North America install and service business is continuing to show nice improvement.

We saw an increase in organic growth as the security business has turned the corner and is now accelerating growth for the first time since separation.

We are also seeing very good traction in our global products business in North America across fire, security, and life safety.

Overall we grew 5% organically in North America.

Turning to Europe.

Our team continues to execute well and gain share, despite the increased pressure from foreign currency exchange rates.

The European market shows demand for our integrated solutions, which we expect will help to drive our service growth in the region in the future, and also contribute to margin expansion.

We are seeing nice activity in the general commercial and retail space, the service industry as well as manufacturing, while oil and gas and heavy industrial end markets are noticeably softer, consistent with global trends.

In the UK we have direct oil and gas exposure related to the North Sea offshore oil rigs where we primarily earned service revenue on the maintenance of the fire safety systems.

The impact of lower oil prices has caused a considerable slowdown in non-essential maintenance resulting in delays of service-related activities.

While we do expect some improvement in this vertical later this year due to pent-up demand for the required maintenance of customer sites, this has and will continue to put pressure on the top-line results.

For Europe overall, our current view is that it will be relatively flat to modestly down for the year compared to our previous expectation of modest growth.

Despite the top-line pressure, margin expansion has been strong in Europe as sourcing and productivity initiatives combined with restructuring actions are helping to mitigate the lower volume.

In Australia we are seeing a bit of growth in the general commercial space.

However, this is being more than offset by the downturn in the industrial and mining sectors.

Very similar to last quarter, organic revenue is decreasing in the mid-single digit range driven by a decline in service.

We expect these conditions to continue during the second half of the year, in line with our previous expectations.

In the growth markets we are seeing a slowdown in installation projects related to oil and gas, particularly in Asia.

However, we expect mid- to upper single digit growth for the full year, given the strong level of bidding activity in Asia, Latin America, and our other growth markets in verticals such as general commercial, retail and industrial.

Moving on to our strategic initiatives, I am impressed with the progress our teams are making internally to drive revenue growth, both organically and inorganically, as well as executing on our productivity initiatives.

Starting with the top line, excluding the impact of foreign currency, revenue grew 4% year over year.

Although overall organic growth continues to remain in the low single digits, we are beginning to see some green shoots that indicate growth will accelerate over the longer term.

For example, installation growth in North America accelerated to 3% organically.

And as I previously mentioned, the commercial security business is contributing nicely to growth for the first time since separation.

The teams are doing a great job converting the backlog of strong orders that we received over the last few quarters to revenue.

I have confidence that the growth in our install base, along with strengthening our service capabilities across the globe, will allow us to build our service revenue over time.

In terms of M&A we closed all of the acquisitions discussed in our January earnings call, including Industrial Safety Technologies, or IST, our largest acquisition post separation, which closed at the end of February.

Our teams are diligently working to ensure the integration of these businesses occurs seamlessly and within the expected time frames.

Altogether, these acquisitions totaled about $500 million in purchase price with annualized revenues of approximately $275 million.

We are currently working on a rich pipeline of potential opportunities.

In the aggregate, the purchase price ranges from $200 million to $500 million.

These deals are centered around increasing our service mix and executing on our technology strategy.

They are core to our business and will help drive service growth in the future.

Lastly, we are seeing productivity and cost savings being generated by bringing the fire and security businesses together.

We are driving sourcing and productivity initiatives, simplifying our global footprint and transforming our functions.

We expect that these actions will generate gross savings in excess of $150 million this year, which after offsetting annual inflation we incur related to our labor force and incremental investments in R&D and sales and marketing, we expect to net $60 million to $70 million to the bottom line.

And I'd say that these initiatives will continue far beyond 2015.

We're in the early stages of these efforts and we expect they will continue to support our margin expansion in the years to come.

It is important to keep in mind that we had planned for incremental investments in R&D and sales and marketing of $50 million this year.

We fully expect to make these investments, despite the tougher macro-environment as they are core to delivering on our long term growth strategy.

Overall the investments we are making to expand our capabilities in technology, along with our efforts to further streamline our operations, position us well to deliver strong double digit earnings growth this year.

And I feel even better today about the execution of our growth strategy in delivering on the commitments we made at our November Investor Day.

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 8.

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

Revenue of $2.43 billion declined 2% year over year on a reported basis, including a 6% headwind related to changes in foreign currency exchange rates.

Excluding FX, revenue grew 4% in the quarter with a combination of 2% organic growth and 2% acquisition growth.

Excluding FX, service was up 2%, installation grew 5%, and global products was up 11%.

Organic growth of 2% was a bit below our expectation of 3% due to, as George discussed, the softness in the macro-environment.

Before special items, segment operating income was $331 million, which includes a $17 million headwind from FX, and the segment operating margin was 13.6%.

Normalizing for last year's insurance recovery of $21 million, segment operating margin expansion was 50 basis points and resulted from higher revenues, improved execution and the benefits from restructuring and productivity initiatives.

Earnings per share before special items increased $0.08, or 17% year over year.

Operationally we delivered an incremental $0.05 of earnings driven by revenue growth in global products and North America install and services, along with continued productivity initiatives.

A lower share count provided an additional $0.05 benefit, which was partly offset by a $0.03 headwind related to foreign currency translation.

The remaining $0.01 benefit resulted from the net impact of lower corporate expense and below-the-line items, offset by the insurance recovery received in the prior year.

Turning to orders on Slide 9. As I have often mentioned in previous quarterly calls, it is important to keep in mind that order growth, particularly in our installation business, is lumpy and can be impacted by the timing of large projects.

Orders in the quarter increased 1% year over year, with 9% growth in products, 2% growth in service and a decline of 6% in installation, driven by a significant amount of large installation orders in the prior year and softness within the oil and gas vertical.

Backlog of $4.7 billion was relatively flat on both a year-over-year and a quarter sequential basis.

Now let's get into the details of each of the segments, starting first with North America installation and services on Slide 10.

Revenue in the quarter of $944 million increased 1% on a reported basis.

Organic growth increased to 2%, with 3% growth in installation.

Service revenue was relatively flat, due to adverse weather conditions in the quarter as well as some softness in our Canadian business related to oil and gas.

FX negatively impacted revenue growth by one percentage point.

Before special items, operating income in the quarter was $125 million and the operating margin was 13.2%.

The operating margin improved 70 basis points year over year, driven by improved execution and the benefits of productivity and restructuring initiatives.

Overall, orders decreased 2% year over year in North America install and services.

Service orders remained relatively flat while installation orders declined 5%.

Underlying mid-single digit install order growth was more than offset by a $30 million fire order in the prior year, as well as a decline in the oil and gas vertical.

Total backlog of $2.5 billion grew 3% compared with the prior year and was relatively flat on a quarter sequential basis.

Turning to Slide 11, rest of world installation and services.

Revenue of $847 million decreased 10% year over year, driven by an 11% unfavorable impact related to FX.

Organic growth was relatively flat with 1% growth in service revenue offset by a decline of 1% installation revenue.

Acquisitions contributed 1% to revenue growth.

Before special items, operating income was $90 million, which included a $10 million FX headwind.

Normalizing for the $21 million insurance recovery booked in Q2 2014, the segment operating margin was flat at 10.6%, as the benefit of productivity and restructuring initiatives was offset by the mix of geographies contributing to growth.

Turning to order activity in rest of world.

Total orders declined 2% year over year.

Service orders increased 3% and installation orders declined 7%, driven by the timing of large orders in the prior year as well as weakness in the oil and gas vertical.

Backlog of $2 billion decreased 2% on a year-over-year basis and decreased 1% on a quarter sequential basis.

Turning to global products on Slide 12.

Revenue grew 6% in the quarter to $639 million.

Organic revenue growth of 7% was driven by strong growth in the life safety and security products businesses, which was partially offset by softness in fire protection products related to sales in the oil and gas sector.

Organic growth, including a three percentage point benefit from increased shipments of air packs compared to the prior year, a 4% benefit to revenue from acquisitions, was more than offset by a 6% decrease to revenue related to FX.

Before special items, operating income was $116 million and included a $6 million FX headwind.

The operating margin increased 20 basis points to 18.2% on a reported basis.

Increased revenue and productivity benefits drove 120 basis points of margin expansion, which was partially offset by 70 basis points related to incremental investments in R&D and 30 basis points related to non-cash purchase accounting.

Product orders increased 9% year over year.

Now let me touch on a few other items on Slide 13.

First, corporate expense before special items was $51 million for the quarter.

We expect corporate expense in the third quarter to increase to $55 million in line with our normal increase in the second half of the year.

Given the favorability in corporate expense year to date, we now expect corporate expense for the full year to be approximately $220 million versus our previous expectation of $225 million.

During the quarter we raised EUR500 million of debt with a maturity of 10 years and a coupon of 1.375%.

This will result in incremental interest expense of approximately $4 million in the second half of the year.

Moving to tax.

Our effective tax rate before the impact of special items was 11.5% for the quarter.

The lower than projected tax rate was due to a one-time benefit related to the realization of certain non-US deferred tax assets as a result of restructuring activities in Europe.

We expect the effective tax rate for the third and fourth quarter to be approximately 18% and the full-year tax rate to be approximately 16.5%.

We ended the quarter with a weighted average diluted share count of 427 million shares and an exit rate of 428 million shares.

For the fiscal third quarter and full year we expect a weighted average diluted share count of 428 million shares.

Finally, I would like to give an update on our restructuring and repositioning activities and the funding of our asbestos liabilities.

To date we have taken restructuring and repositioning actions resulting in approximately $100 million of charges.

Given the macro uncertainties and FX pressures we are facing this year, we continue to identify additional projects that will help to further streamline our structure and improve operations this year and beyond.

As a result, we continue to expect restructuring and repositioning actions to be closer to $150 million, which is at the high end of the range we provided in November.

Regarding our legacy asbestos liabilities, we funded the expected $275 million for Grinnell during the second quarter.

We have received Bankruptcy Court approval and expect to fund the $325 million for Yarway in the third quarter.

Now let me turn things back over to George.

Thanks, Arun.

Let's turn now to Slide 14 for our earnings guidance for the third quarter, starting with the top line.

As we move into the third quarter, we expect organic revenue growth in the 1% to 2% range against a difficult compare in the prior year.

As you may recall, the backlog build-up in our life safety business in 2014 was related to Air-Paks, which were all shipped during our fiscal third quarter.

This resulted in 12% organic growth in global products in the third quarter of last year, of which five percentage points was attributable to a conversion of the built-up backlog of Air-Pak.

The impact of this on Tyco's overall organic growth last year was a full percentage point.

Against that backdrop we expect global products to be relatively flat organically in the third quarter, with North America INS growing in the 2% to 3% range and rest of world INS being flat to up 1% organically.

Acquisitions will offset divestitures and deliver about 1.5 points to overall revenue growth.

Given current exchange rates, we expect growth in revenue to be offset by an eight percentage point, or $205 million year-over-year headwind related to FX.

Taking all of these factors into account, we expect revenue in the third quarter to decline approximately 5% year over year on a reported basis.

We expect the segment operating margin before special items to be relatively flat on a reported basis due to a 30 basis point lift in the prior year margin due to the timing of Air-Pak shipments, as well as the absorption of 30 basis points of non-cash purchase accounting.

Adjusting for these items, underlying operations are expected to improve approximately 60 basis points year over year.

Taking all of these assumptions into account, we expect earnings per share before special items in the third quarter to be in the range of $0.55 to $0.57.

As you can see on Slide 15, year over year we expect underlying operations in the third quarter to contribute about $0.05, which is partially offset by the $0.02 shift in earnings in the prior year related to the Air-Pak.

The $0.05 benefit from the reduced share count is expected to be more than offset by a $0.06 headwind related to FX.

Moving to our expectations for the full year on Slide 16, we expect organic revenue growth in the 2% to 3% range.

Acquisitions will offset divestitures and add an additional point of revenue growth.

We expect $645 million, or a 6% headwind related to FX.

Overall, we expect revenue will decline approximately 3% on a reported basis.

We expect the segment operating margin before special items to expand approximately 50 basis points on a reported basis after absorbing a 20 basis point headwind from non-cash amortization related to the recent acquisitions.

Taking all of this into account, as well as the guidance for corporate expense and below-the-line items Arun provided, we are updating our full year earnings per share before special items guidance from a range of $2.30 to $2.40 to a range of $2.23 to $2.27.

As you can see on Slide 17, our prior guidance is being adjusted for softness in the macro-environment driven by oil and gas, additional pressure from FX, and the net impact related to the divestiture of a joint venture and below-the-line items.

Our revised guidance of $2.23 to $2.27 represents a year-over-year increase of 12% to 14% compared to the prior year earnings per share before special items of $2.

Thanks for joining us on the conference call this morning.

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

Thank you.

(Operator Instructions)

The first question today is from Steve Winoker with Bernstein.

Thanks and good morning.

Good morning, Steve.

George, could you comment a little bit on a couple things?

One is the service growth.

I know you've been looking for that to expand and we have oil and gas pressures.

But again, 2% order growth right now, what gives you the confidence, or where is it going to come from that we should over time expect that to pick up?

And the second one is, could you comment also on evidence of margin expansion in rest of world?

It's really because of all of the puts and takes, it's hard for us to really see that it's real and happening.

Sure.

Let me start with service growth.

So looking at the second quarter, service growth of -- it was 2% ex-FX.

Now, acquisitions are helping to offset some of the double digit declines that we're seeing in Australia, as well as now more recently in the UK in the oil and gas vertical.

And when we forecast the total year we're still going to be positioned to deliver 2% for the total year.

Now longer term, we've been working and focusing on technology and commercial investments that are going to significantly change the profile of how we drive service growth going forward.

So we've had lots of projects being brought to market, it's going to enhance the capabilities that we have, it's going to embed new technologies and that's going to create the platform to be able to bring new services, create new value for the customers that we support, and ultimately project our service growth to support the three-year plan that we outline back in November.

Now, relative to the margins in rest of world.

What I would say is I would start by saying the external macros have been extremely difficult but the fundamentals of how we're driving the businesses are extremely strong, very strong operational performance.

We're offsetting FX headwind of $10 million.

We're offsetting mix that -- a significant mix with a decline in services in the UK and Australia, and that equates to about 80 basis points year on year.

And at the same time we're investing in our growth markets, which we believe are absolutely critical to be able to build the business and deliver growth to support the three-year plan that we outlined back in November.

This all now has, when you normalize it without the $21 million of insurance recovery that we got last year, will deliver relatively flat margin year over year.

But what's built in that overall margin is significant productivity offsetting a tremendous amount of headwind.

Okay.

Arun, could you maybe just comment quickly on the adjusted free cash flow of 65% versus, I guess, 150% last year?

I think I saw contracts in progress, inventory, prepaid, AP.

Maybe just give us a sense for what's going on there and whether we should expect normalization?

Yes, Steve.

All I can say is not happy about it, where we are right now.

But given the level of transformation that we are going through in the Company that George has alluded to across all our functions, which includes the order to cash function as well, it's not surprising.

But having said that, it's all related to working capital.

The teams are all over it.

And we are working on a number of fronts to get this metric back to the 90% conversion rate that we expect for the full year.

All right.

Thanks.

Thank you.

The next question is from Nigel Coe with Morgan Stanley.

Thanks, good morning.

Good morning, Nigel.

Just wanted to fill in some of the gaps on the oil and gas.

What was your prior expectation for your oil and gas vertical for 2014?

And then if you could just add on some of that, what you saw during 2Q and what the implied second-half guidance embeds?

Yes, so when you look at the -- Nigel, when you look at the change in the macroeconomic environment, it's been mainly the oil and gas.

And as we said in our prepared remarks it's about 5% of our revenue, is very high mix.

Now right through the first quarter, and actually through January, we didn't see any significant drop-off.

And for the year, I think it was just modest decline for the total year in our original forecast.

What we've seen here in March, and it has continued in April, we've seen a pretty significant drop-off.

And now based on what we're seeing, we're projecting that we're going to see about a 15% decline for the total year in the oil and gas vertical.

So it is a significant drop-off.

It's being driven by our fire protection products business where we provide special hazard solutions, both upstream and downstream, as well as our UK and Canada, mainly Western Canada, business where we do significant installations as well as we have strong service businesses that are going to decline about -- just about double digit.

And so the combination of that has got a pretty significant drop in the second half which positions us to see about a 15% decline for the total year.

Okay and given the $0.06 impact, which I understand primarily on this dynamic, it seems that your margins in this area would be in the mid-20s.

Is that the right sort of ballpark?

The oil and gas vertical is our highest margin vertical across the Company.

And so the impact that this decline is going to have on us for total Tyco, it's about 20 basis points.

In our products segment, because it's the highest mix we have in our fire protection products business, will impact global products by 40 basis points.

Rest of world will be impacted by about 30 basis points, mainly driven by the UK and a little bit in Asia.

And North America, like I said mainly Western Canada, will impact the margin rate 20 basis points.

So it is significant mix for us, mainly high margin products and high margin service that we provide into that vertical.

Okay, and then just one more on the topic.

I think we all knew you had some oil and gas exposure, but we all assumed it was more production focused.

And as far as we were aware, the [NPs] are still pumping oil.

So are they deferring maintenance, and could this come back a little bit sharper than perhaps we think?

I mean, what we see when a vertical, when you get into a decline like this, certainly all of the discretionary expenses start to get pushed to the right.

So that could be done for a period of time, but at a point in time the maintenance is going to be required.

So what we're seeing, especially -- although there's some oil rigs that are being shut down, a lot of the platforms that we support are still in operation.

So although the discretionary expenses get pulled back, eventually the maintenance and the service is going to be required.

So we do believe that later in the year we'll start to see a pick up of that type of service going forward.

Where we've seen a significant decline, Nigel, is on the capital expenditures in this space.

Our order rates in the oil and gas space right now are significantly down year on year in each one of these markets.

And on that 5%, George, roughly how much would you say is CapEx driven?

Short term, what I'd say, most of the impact short term has been the products, the special hazards products that we put into that vertical as well as the immediate slow-down of service.

Now, we're projecting that we're going to see in the second half an accelerating decline now in the revenue that we're going to be achieving within that vertical because of the decline in orders that we saw in the second quarter.

Okay.

That's very helpful, George.

Thanks a lot.

Thanks, Nigel.

Thank you.

(Operator Instructions)

The next question is from Deane Dray with RBC Capital Markets.

Thank you.

Good morning, everyone.

Good morning, Deane.

I was hoping we could clarify your earnings contingencies at this midpoint in the year.

It sounded -- Arun said you all could be moving to the high end of your restructuring range at $150 million, but it was unclear whether that $60 million or $70 million of net savings from restructuring actions, was that at the lower restructuring rate or does that inclusive of $150 million in restructuring?

Yes, I'll take that one, Deane.

This year is going to be our strongest year for productivity, in excess of $150 million bringing $60 million to $70 million to the bottom line.

We, during the course of the year, we knew that there was significant headwinds that we're going to experience and we began to accelerate our restructuring and costs out to try to offset those headwinds.

Given the current macro-environment, we aren't going to ultimately be able to do that.

But I have confidence that we're going to continue to be able to execute better.

That's going to position us well to be able to deliver the second half and then be able to be positioned for a strong year in 2016.

So all of the restructuring actions that we accelerated is actually going to benefit us in the second half where not only did it help us offset some of the pressure at the end of the second quarter with the pressure in oil and gas, but as we now project the second half we'll see accelerating benefits as we get through Q3 and then Q4 with significant benefits in the fourth quarter.

So all of that has helped us be able to mitigate, be able to offset some of the headwinds.

And more important now position us well to be able to deliver 2016 and continue to be able to execute on the three-year plan that we had committed.

What's the carryover benefit into 2016 of the restructuring actions you'll do in the second half?

Well, for total restructuring this year, assuming that we go to the upper end of $150 million, now remember that is restructuring and repositioning in there.

So really where the get the benefit is on the restructuring side, the two-year payback that we typically talk about.

We are expecting, because we did pull it forward earlier in the year, we'll probably get about 60% of that payback this year and the remaining 40% payback next year.

Great.

And then just last question for me.

On the divestiture pipeline, so the fire installation JV in China, are there others that you're contemplating?

And could you maybe comment on the timing.

What's the decision as to when do you pull the trigger on these divestitures?

Sure.

We're constantly looking at our portfolio, Deane, to make sure that as we're investing in the Company we're investing in segments that we see the opportunity to not only grow but grow more profitably.

These businesses are businesses that we felt that we shouldn't be putting capital into.

We should be getting out and remixing the Company towards technology and technology services.

And so to date it's been relatively [even] and relatively small.

What we see today as we're going through, we're constantly looking at the portfolio.

It's a relatively small percentage of our overall revenue base.

Thank you.

Thank you.

The next question is from Jeff Sprague with Vertical Research.

Just to pick up on that China comment.

I understand that particular business might not have been net profitable.

I thought you needed some of those businesses for a toehold in that market, right?

You're relatively small in China.

Is this indicative of a little bit of a retreat from that market kind of in general?

Not at all Jeff.

At the same time that we're divesting this, our share of this joint venture, we've been investing in technology and products.

We completed the Jindun acquisition which gives us a very strong platform for our product to be able to serve that market.

So by no means does that change the direction that we're taking within the China market, where even though we've seen a slight decline here in the last quarter it was mainly driven by a large hospitality project in Macau and then some of the oil and gas weakness that we are experiencing.

The general market is good for what we're investing in and how we're positioning to grow.

Today it's still only about 3% of our total revenues.

But we're continuing to make strong investments, both organically and inorganically to be able to capitalize on this market going forward.

And then shifting gears.

It would seem like we wouldn't have needed to talk about oil and gas today if kind of the non-res markets were actually picking up a little bit more strongly than apparently they are.

I'm sure you're aware, there's been some pretty constructive comments by a bunch of companies recently, including this earnings season, that things do seem to be gaining momentum.

And you don't sound quite as positive or constructive, or not -- don't quite seem to have the same visibility.

Is there something in particular going on in your business?

Do you see it in perhaps (inaudible) or something, it's not hitting orders?

But just your overall take where we're at on the non-res construction cycle, putting the oil and gas and energy verticals aside.

Sure, let me start, Jeff, by if you look at the key metric being the ABI, its been positive for the last 12 months.

There was a slight dip in January and February, but it's back up in March.

We've seen continuing positive activity in the US with the exception of oil and gas.

When we look at the overall North America market, if you segment the large order that Arum talked about that we had last year in Canada, the $30 million order, and you segment out the oil and gas decline that we felt pretty significantly in Western Canada, our US order rate continues to be very strong, kind of mid-single digits, which is in line with what we've seen over the last three quarters.

And so maybe we've tempered our position because of the impact that we've had in total North America driven by Canada.

But that hasn't changed our view relative to how we're positioning in the US to be able to capitalize on the non-resi recovery.

Are you seeing an institutional specifically, George?

We're hearing a lot of commentary on K-12 and hospital from folks.

The way I would break it down, Jeff, is number one, I would say I feel good about the work we're doing from a commercial standpoint, building a pipeline of orders, continuing to now execute on the backlog.

If I were to segment the market by security and fire, security right now looks to have strength in commercial, government, retail and banking.

On the fire side we're seeing, again, strength in commercial, institutional, hospitality, and infrastructure.

But with the work we've done, with the continued performance in our fire business, in the strong turnaround that we've had within our North America security business, gives me tremendous confidence that with the investments we're making we're going to be well-positioned to be able to capitalize on the North America non-resi recovery.

Okay thank you.

Thank you.

(Operator Instructions)

The next question is from Steve Tusa with JPMorgan.

Hey, good morning.

Good morning, Steve.

So just on this oil and gas, just so I understand.

So you basically you've seen the orders but you have yet to see the revenue impact?

Is that right?

No.

We've seen, Steve, we've seen a significant order on the install side, order decline over the last six weeks.

As well as in the quarter we saw approximately $25 million or $30 million of pressure on revenue, mainly driven by our service revenues in the UK, in Western Canada and within our fire protection products business globally where we provide high margin special hazard solutions.

Okay.

So I'm just trying to figure out that 15% decline.

I'm trying to figure out the run rate here.

So if we assume that your oil and gas business stabilizes and it kind of carries forward into next year, are we working with two quarters of tougher and then two quarters of easier comparisons?

Or are we working with one quarter of tougher and then three quarters of easier comparisons?

That 15% decline is not an annual rate because of your fiscal year.

So I'm just trying to work through that.

And then I have one quick follow-up.

Steve, the way to think about it, as in total is about $80 million of revenue.

And I'd break it down as about $25 million, $30 million of that in Q2 and the rest of it is all spread in Q3 and Q4.

Okay.

So one tough comp and then the kind of stabilizes for next year?

Yes.

If things go flat.

If you get it right on that kind of decline?

Correct.

That's the right way to think about it.

Okay.

And then just, you mentioned the restructuring, stepping up restructuring this year.

I'm having a little bit of trouble kind of making your back-half margins work.

You're kind of run rating year to date in North America install up, I don't know, $30 million and then $70 million.

But do you still have the year up $110 million to $150 million or whatever.

Rest of the world also looks a little bit punchy.

Maybe is that the restructuring really coming through in size?

And then any view on next year, on 2016 restructuring at this stage?

I'd say that when we look at the restructuring, we've spent about $100 million year to date and then expect to spend about another $50 million to $60 million in the back half of the year.

And Antonella mentioned earlier, 60% of that, what we have spent on the restructuring piece, which is roughly -- if you think about it, we spent $70 million in restructuring, $30 million in repositioning for a total of $100 million in the first half of the year.

(Multiple speakers)

Okay.

So it the restructuring coming through in a big way in the back half to get to those margins?

Right.

The other thing to remember, especially for the North America run rate, Q1 was impacted by a legal charge that we talked about that was included within our number.

So although from a print perspective it looked like 30 basis points, remember there was a $6 million, $7 million charge in there that was masking some of the underlying margin improvement.

Right, okay.

Thanks for that reminder And then next year's restructuring?

Well, we said that we expect a run rate going forward of $75 million-odd a year from 2016 onwards.

Okay.

Great.

Thanks a lot.

Thank you.

The next question is from Scott Davis with Barclays.

Hi.

Good morning, guys.

Good morning, Scott.

Trying to get a sense of reconciling earlier M&A comments.

You talked, George, about $200-million to $500-million-size deals and a robust pipeline and such, but [seemed] to downplay the impact.

I know there's -- in guidance.

And I know there's only a couple quarters left to get things done.

But is it something where you're seeing, you just doubt that you can announce or close stuff in the next quarter or so?

Sure, Steve.

Let me start with this and George may want to add something.

But I'd say that as we look at acquisitions, we claim we have a fairly strong pipeline of opportunities that we are pursuing at the moment, which add up to the $200 million to $500 million that George referred to in his comments.

Now, we do not know about the exact timing of these, when we close these transactions.

And with the purchase price accounting, the impact that it would have on our EPS numbers is going to be de minimus.

And it's definitely not baked into the numbers we have provided.

Okay.

But you do expect to be able to do transactions to help 2016, is that correct?

Absolutely, Scott.

Scott, if you look at the acquisitions that we've done this year and project those going forward, they're going to be a nice add to 2016 when you look at our earnings profile.

So we're very pleased with the acquisitions we've completed this year and how they are going to contribute to the overall earnings growth as we project our three-year plan.

Okay.

And then as a follow-up, the 9% orders, plus orders in products, and I know this can be a little volatile, but what does that tell you?

And when I look at that, I wonder is there a replacement cycle that's going on, that even though you haven't seen much of a non-res impact yet for install, that folks are actually ordering some products?

Is that real, or is it just too lumpy to read too much into it?

Scott, our orders in products have been very strong here, continuing to see the impact of the investments we're making as well as I think there are some other activities that's driving some of that growth.

Let me talk about life safety.

Life safety has been a business that we've been investing in, the Air-Pak, the new product that has been extremely well received in the market and by our customers.

We're seeing a nice pick-up there, as well as we're going to be going through a replacement cycle because all of the Air-Paks that were put into the market post 9/11 are now needing to be replaced.

So the opportunity that we have there has been significant.

We've positioned our business well with the technology and the new products we brought into market and we're capitalizing on that.

So that's helping our life safety business.

The acquisition we did in IST, which is the gas detection business, now that's part of the portfolio.

We're immediately beginning to see some synergies on our core business in how we leverage that with expanded distribution, as well as now working on the cost synergies.

So that would be what's driving life safety.

When you go into security products, we are the market leader in, whether it be intrusion, access technologies and a player within the video space.

There's a lot of new market that's being opened up that we're providing product to with our sensors and devises that are going into the home, that are going into new solutions.

We've been investing pretty significantly within this space, and we're beginning to see the traction now in the orders, and we see that continuing, that order growth continuing with our ability to be able to drive strong, in spite of our FPP, the fire protection products softness that we're seeing in oil and gas, continue to deliver very strong mid-single digit organic growth.

And then combined with the acquisitions we've made, very nice total growth within our product businesses this year and beyond.

I'll pass it on.

Thanks, guys.

Thank you.

The next question is from Gautam Khanna with Cowen and Company.

Yes, good morning.

Thank you.

Good morning, Gautam.

Last quarter I think you mentioned something about pricing and certain markets getting a little tougher.

And I was wondering with this macro situation, oil and gas or other verticals, are you seeing incremental price pressure?

And kind of how are you factoring that into your forecast, if at all?

Yes, Gautam.

What I would say is any time that a vertical, whether it be mining or oil and gas, goes through the downturn that they've gone through certainly pricing comes into play.

And as the industry leader with what we do, we stay very disciplined in how we price, not only our products but the service that we perform.

So there is some risk with some of the volume when we go through these cycles.

But if we look back, as we've gone through these cycles we've come out the other end much stronger.

Same discipline.

Investing in technology and then positioning to be able to continue to support the customers that we serve.

When you net the pressure that we have there in mining and oil and gas and some of the areas where we are having some challenges, we are still going to deliver price across the enterprise somewhere between 0.5 to 1 point over the enterprise.

And so we're staying very disciplined.

Pricing is one of our key levers across all of what we do that we're driving that we believe is going to continue to be some of the ability to be able to mitigate some of the pressures that we continue to experience.

Okay.

So when we look at the backlog number, which is flat year on year or sequentially, you're embedding kind of year-on-year better price within that backlog of 50 bps to 100 bps.

So when we look forward, there's not going to be a big erosion?

Correct.

Gautam, on our installation business we've been very disciplined in leveraging all of our best practices with how we develop new projects, not only from a design standpoint, but how we deploy those projects through the installation phase.

And then making sure that we're capitalizing on the technology that we embed to be able to get the recurring service revenue.

And so we're -- when you look at margin and backlog, we continue to improve the margin we put in backlog.

And we continue to improve the execution of the projects to actually do better than the margin that we put in backlog.

Okay.

If you could just expand on your earlier comments regarding Australia.

I think you'd mentioned some of the general commercial business was starting to grow.

Oil and gas obviously was weak, with service down.

Could you parse that within Australia?

How much relates to oil and gas, and how long that you've been down in that business so we can get a sense for when the comps actually get easier within that business.

Thanks.

Sure.

Australia is the second-largest region in our rest of world segment.

It represents about 17% of the revenues, about 6% total Tyco.

The split of the business is roughly two-thirds service, one-third installation.

What we do see improving is the commercial and institutional space is improving, as well as when we look at our securities business there we're beginning to see nice growth.

When you look at the mining, the mining vertical is down about 50% from the peak in 2012.

It was at one time 15% of our revenues.

Today it's about 10% of our total revenues.

The Australian service, which has mainly been driven by mining, is creating a 2% point drag on the rest of world service.

And it's about a 1% drag on total Tyco service.

And the total-year impact that we're seeing is about $0.03 on our earnings.

That being said, I'd say the team is executing extremely well.

And then as we now lap, what we see we're pretty much right on where we thought we would be last quarter.

It's playing out as we expected.

And that as we get into 2016 we'll begin to show better comps year on year.

Okay.

So oil and gas was not an incremental leg down for your Australia view in the quarter?

(Multiple speakers)

No.

No, we don't have a significant position in oil and gas in Australia.

It's mainly mining.

And there's been no significant change to what we had originally forecasted within that vertical.

Okay.

Thank you very much, guys.

Thank you.

Our final question today is from Julian Mitchell with Credit Suisse.

Hi, thank you.

I just wanted to circle back to the implied sort of Q4 run rate, because I guess in terms of operations, contribution to year-on-year EPS it was about $0.09 in the first half, $0.05 in Q3.

So the jump up to $0.10 from operations in Q4, just because that's solely restructuring savings coming through, or is there something else that's going on in terms of mix that's also pushing out the operations contribution?

First, we would have to start with Q3.

We had -- last year we had the huge recovery of the Air-Paks in Q3.

So that was contributing to a tougher compare this year.

When you look at the sequential improvement from Q3 to Q4, we normally have a seasonal lift of about $0.06.

When you look at the acquisitions that have been completed, the acquisitions will add about $0.01.

And then with all of the accelerated restructuring and additional cost-out actions that we've been taking earlier in the year, those benefits are beginning to come through.

And as I said earlier, we'll start to see nice benefits later in the third quarter, but especially in the fourth quarter.

And that will contribute $0.02.

So the overall -- when you look at the sequential pick-up from Q3 to Q4, that would be the $0.09 of operational improvement that you see there.

Very helpful, thanks.

And my last question, just on the rest of world as service business.

I think that was up around, on revenues, up around 3% ex-currency and stripping out Australia.

Any color you can give within that on sort of emerging markets versus developed markets, how the service revenues are trending right now?

Sure.

I would start by looking at the mature markets.

We were seeing nice performance in the UK prior to this downturn in oil and gas.

So the rest of the year is going to be a little bit tough.

But if you go to Continental Europe, in spite of what the economy has been doing there, we've been seeing nice growth there.

It's been 2% to 3%, we're projecting maybe even more service growth within our Continental Europe business.

So we're seeing nice pick-up.

And a lot of that has been the deployment of our technology strategy, embedding technology in installations that we're performing.

And then with that, that's enabling us to be able to get the recurring revenue in the services with those installations.

In the growth markets, where we're seeing a nice pick-up is in Latin America.

We're seeing it somewhat across some of the businesses there.

We've been putting additional resources in.

We've been deploying new technologies.

And we're starting to see a nice pick-up with the service performance there.

That would be what's driving the overall growth market service revenue.

Great, thank you.

Before we end the call, I'd like to turn it over to George for some closing comments.

So what I would end with in saying, in spite of the current macro headwinds, I've never felt better about how we positioned the Company.

And more important now, how our leaders are executing on the fundamentals of this business that's going to position us to be able to execute on our next three-year plan.

We're making strong investments in technology.

We're making strong investments in our commercial capabilities.

And the combination is what gives me a lot of confidence that's ultimately to be able to deliver on the plan that we laid out last November with all of you.

So thanks for joining us today on the conference call.

Look forward to seeing many of you over the quarter.

Operator, that concludes our call.

Thank you.

This concludes today's call.

Thank you for joining.

You may disconnect at this time.