江森自控 (JCI) 2016 Q3 法說會逐字稿

Welcome to Tyco's third-quarter 2016 earnings call.

(Operator Instructions)

This 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.

Ma'am, you may begin.

Good morning, and thank you for joining our conference call to discuss Tyco's third-quarter FY16 results, and the press release issued earlier this morning.

With me today are Tyco's Chief Executive Officer, George Oliver, and our Chief Financial Officer, Robert Olson.

I would like to remind you that during the course of today's call, we will be providing certain forward-looking information related to the proposed merger with Johnson Controls.

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.

Today's call is not intended, and does not constitute an offer to sell, or the solicitation of an offer to subscribe for or buy securities of Tyco or Johnson Controls.

Select subject matter discussed on today's call is addressed in a joint proxy statement and prospectus that has been filed with the SEC.

We urge investors to read it in its entirety.

Information regarding the participants in the proxy solicitation is contained in each company's annual proxy materials filed with the SEC.

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

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, and is reconciled in the schedules attached to our press release.

As we referenced on last quarter's call, pursuant to Irish and European regulatory requirements related to our proposed merger with Johnson Controls, we would be required to withdraw our standalone profit guidance prior to the publication of our Irish prospectus.

On July 8, we formally withdrew our guidance, and I want to remind everyone that we are limited in what we can say and, therefore we'll not be providing our typical forward-looking commentary on this call.

As a result, we expect this call may be shorter than usual.

Now let me quickly recap this quarter's results.

Revenue of $2.45 billion declined a little less than 2% year-over-year on a reported basis.

Organic revenue growth of 1.5% was more than offset by a 3% headwind from changes in foreign currency.

A 3% benefit from acquisitions was fully offset by a 3% negative impact related to divestitures.

Earnings per share from continuing operations attributable to Tyco ordinary shareholders were $0.56, and included a net gain of $0.02 related to special items.

These special items were primarily composed of favorable tax adjustments related to the IRS settlement, mostly offset by a write-down of a business held-for-sale and merger-related costs.

Earnings per share from continuing operations before special items was $0.54 per share.

Now let me turn the call over to George.

Thanks, Antonella and good morning everyone.

Before we get into the details of the quarter, let me provide a brief update on our proposed merger with Johnson Controls.

Starting with slide 5, integration planning is in the final stages, and the teams are preparing to transition into the execution phase on day one.

In addition to the late May announcement of the senior executive team, we have since named the next layer of leadership, and we'll continue building out the structure over the next several weeks.

The Form S-4 was declared effective by the SEC in early July, and the Irish prospectus has been published.

Additionally, we have received approval from all necessary antitrust authorities around the globe.

With those boxes checked, we have scheduled our shareholder vote for August 17.

Given the progress we made on both the regulatory and integration planning front, we now expect to close the transaction on September 2. As I have stated many times, the more I learn about the complementary nature of these two organizations, and the value we can provide to our customers and shareholders as well as our employees, the more excited I become.

We are weeks away from becoming one combined company, and we are ready to hit the ground running.

Moving on to results for the quarter, let's turn to slide 6. As expected, organic growth accelerated in the third quarter, led by our Integrated Solutions & Services business in both North America and Rest of World.

Organic growth in our short cycle product businesses held flat, despite continued pressures from the high hazard heavy industrial end markets.

The segment operating margin contracted 30 basis points year-over-year, including 20 basis points of purchase accounting headwind.

Overall, volume leverage and productivity offset foreign exchange headwinds and mix pressures, and when coupled with lower restructuring and repositioning charges year-over-year resulted in 17% earnings per share growth before special items.

Turning to slide 7, let me spend a few minutes on what we saw in a few key regions during the third quarter.

Starting with North America, although macroeconomic indicators were somewhat mixed in the third quarter, we saw continued momentum in the US market, with stable growth in nonresidential construction verticals year-over-year.

We had another solid quarter of installed order activity, with growth in our commercial, government and institutional verticals.

As expected, activity in Western Canada remained soft, due to the high hazard heavy industrial end markets, but appears to have stabilized.

Moving to Europe, with macroeconomic indicators turning slightly more positive throughout the quarter, Europe has been a relative bright spot for Tyco.

This quarter saw organic growth in the low single-digit range, with continued momentum in the services, manufacturing and commercial verticals, being partially offset by our exposure to the North Sea oil and gas market.

As it relates to any impact from the recent vote for the UK to leave the European Union, apart from FX translation, it is too soon to speculate on, or quantify what the potential commercial impact could be.

Our teams on the ground are well-positioned, and we are confident we have the right model in place.

Recall that a majority of our revenue base in the UK is service, including a strong subscriber channel.

In Asia, although recent economic indicators out of China continued to show signs of stabilization, underlying business conditions across the broader region remain soft.

Year-over-year, strength in China and Korea during the quarter was offset by continued pressure in the high hazard heavy industrial space, as well as the hospitality vertical in Macau.

Lastly, Latin America continued to be an area of strong execution in organic revenue growth, driven by our subscriber business.

With that, I'd like to turn the call over to Robert to walk through the details of our third quarter results.

Thank you, George, and good morning, everyone.

Let's begin with an overview of the quarter, starting on slide 8. Revenue of $2.45 billion declined about 2% year-over-year on a reported basis, including a 3% headwind from foreign currency.

Acquisitions contributed 3 percentage points of revenue growth, which was offset by a 3% decline from divestitures.

As George mentioned, organic revenue growth of 1.5% was driven by our Integrated Solutions & Services business in both North America and Rest of World.

Before special items, segment operating income was $355 million, and the operating margin was 14.5%, which included a 20 basis point headwind related to non-cash purchase accounting.

Excluding purchase accounting, the segment operating margin contracted 10 basis points year-over-year, as volume leverage and productivity benefits were more than offset by negative mix.

Overall, earnings per share before special items increased $0.08 year-over-year, primarily related to lower restructuring spend compared to the prior year period.

Productivity savings helped to offset the impact of FX, incremental purchase price accounting and negative mix.

Turning to orders on slide 9. Total orders increased 4% year-over-year, with 5% growth in service, an 8% increase in integrated solutions, and a 3% decline in products.

Total backlog of $4.79 billion increased 3% on a quarter sequential basis, and 8% year-over-year, partly driven by acquisitions.

Total backlog increased 4% organically on a year-over-year basis.

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

Starting first with North America Integrated Solutions & Services on slide 10, revenue in the quarter of $1.0 billion increased 3% on a reported basis.

Organic revenue growth of 2.5% in the quarter was driven by a 4% increase in integrated solutions and a 1% growth in service.

A 1% contribution from acquisitions was partially offset by the negative impact of the weaker Canadian dollar.

Before special items, operating income in the quarter was $148 million, and the operating margin declined 150 basis points year-over-year to 14.7%, including a 30 basis point headwind related to non-cash purchase accounting.

Underlying margin declined 120 basis points due to increased investment, and a higher mix of installation revenue compared to the prior year.

Total orders grew 3% year-over-year, representing another solid quarter of growth, led by 4% growth in integrated solutions, and 3% growth in service.

Total backlog of $2.67 billion increased 5% year-over-year, and 3% on a quarter sequential basis.

Turning to slide 11.

Rest of World Integrated Solutions & Services, revenue of $794 million decreased 6% year-over-year, including a 6% unfavorable impact from FX.

Organic revenue grew 2%, with balanced growth in service and integrated solutions.

Acquisitions contributed 7% to revenue growth, which was more than offset by a 9% headwind from divestitures.

Before special items, operating income was $92 million.

The segment operating margin expanded 60 basis points year-over-year to 11.6%, including a 30 basis point headwind related to non-cash purchase accounting.

The underlying margin increase of 90 basis points was driven by volume leverage, improved execution and productivity benefits.

Turning to order activity in Rest of World, year-over-year orders increased 10%, with 8% growth in service, and 12% growth in integrated solutions, driven primarily by acquisitions.

On an organic basis, Rest of World orders increased 3% year-over-year, with 2% growth in service and 4% growth in integrated solutions.

Backlog of $1.94 billion grew 14% on a year-over-year basis.

Although the consolidation of our joint venture in the Middle East contributed to the improvement, on an organic basis backlog increased 6%.

On a quarter sequential basis, backlog increased 2%.

Turning to Global Products on slide 12, revenue of $651 million declined 4% on a reported basis.

A 2% headwind from a divestiture was compounded with a 2% decline related to FX.

Revenue was flat on an organic basis, as continued softness in the high hazard heavy industrial end market was offset by growth in other verticals.

Before special items, operating income was $115 million, and the operating margin was 17.7%.

Year-over-year, the operating margin improved 10 basis points, as productivity benefits more than offset the continued mix headwinds.

Product orders declined 3% year-over-year, driven by the timing of orders last year.

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

First, corporate expense before special items was $44 million for the quarter, a bit better than we had expected, driven by cost containment and productivity.

Next, our effective tax rate before the impact of special items was 17.3% for the quarter.

Moving to restructuring and repositioning activities, we incurred charges of $15 million for the quarter, half of which was related to pure restructuring activities.

Turning to cash flow.

We had another solid quarter, converting our income to cash.

We generated adjusted free cash flow of $214 million in the quarter, representing a 93% conversion rate.

Year-to-date, we have generated $625 million in adjusted free cash flow, which represents 104% of net income from continuing operations before special items.

Now let me turn things back over to George.

Thanks, Robert.

Before we open up the line for questions, I want to take a minute to personally thank the Tyco employees for their hard work and dedication, which for many spans more than a decade.

Tyco has been through a significant transformation over the years.

I am extremely proud of what we've accomplished in the four years post spin as the new Tyco.

We have made significant strides in improving the fundamentals of the business, while maintaining a laser-like focus on driving innovation, commercial excellence, and maintaining the appropriate organizational cost structure.

Of course, none of this would have been possible, were it not for our passionate employees, the invaluable leadership and counsel of our Board members, and of course, the support of our investors.

In summary, the stage is now set for a successful transition into the execution phase of our day one plan with Johnson Controls.

Going forward, we will maintain a similar laser-like focus throughout the integration process.

I feel confident in our ability to achieve $1 billion in synergies and combined productivity which we laid out for you at EPG in May.

And I look forward to speaking with you about our progress on future calls.

Thank you for joining us on the conference call this morning.

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

Thank you.

(Operator Instructions)

Our first question comes from Jeff Sprague from Vertical Research.

Your line is now open.

Thank you.

Good morning, everyone.

Good morning, Jeff.

Good morning, Jeff.

Morning.

Hey, George, just picking up on your closing comments there, I'm feeling a little nostalgic here this morning; it's the last Tyco quarter.

But I wanted to say really, congrats.

You did a great job improving the operational performance, and I think you led the Company into a very smart strategic deal here.

So best of luck.

I appreciate the feedback, Jeff.

Thanks.

Just a question on the service and the service investments, could you elaborate a little bit more on what you were doing there in the quarter?

Does it cleanly dovetail with what you expect to be doing, when you combine with JCI?

And would you describe this as some kind of running start into the merger?

Or just any additional color there, would be helpful, I think?

Yes, let me start, Jeff, by -- let's talk about service within our business our model, is a very critical element with what we do.

And making sure, that we're not only getting the -- creating the installed base with our technology, but at the same time, that we're now extracting the ability to be able to service that installed base over the life cycle.

And we've made tremendous progress in how we're -- with our project selectivity and making sure we're doing the right projects, we're deploying our technology, and we're positioned to get the service.

At the same time, we've been increasing our sales force, and our capabilities in the field to be able not only to accelerate our installed base, but to be able to now extract the service opportunity.

As you've seen in our orders, across the board, we're seeing some nice progress, both in installed as well as service.

We've projected to get to our service business this year to get about 2%, 2%-plus, and we're on track to do that.

That is really a product of not only the sales force, but also being able to expand the service footprint that we have across the globe, to be able to capitalize on the installed base.

So as I think about the merger going forward, certainly that's going to be a critical element of the new business model, to be able to deploy technology in our installations, and then being able to extract the service over the life cycle, being able to service and create additional services on that installed base going forward.

I'm pretty proud of the progress we've made.

As you can see, North America, we're a little bit short of where we thought we'd be in service this quarter.

But with the work we've done in the front end, as well as the footprint that we've been expanding, we're going to be well-positioned to continue to accelerate that.

And then as you see in the rest of world, we've got some real nice orders in service, and we're continuing to execute that, with pretty balanced growth in both installation and service through the third quarter.

And just a follow-up to that, George, kind of dovetail into that thought.

Certainly I've been a little confounded and perhaps you have too, in kind of the order to conversion cycle taking a little bit longer than expected.

But we do have now organic growth positive here, for the first time in about a year, after over a year of positive orders.

I guess, we're not going to have the same visibility or the same reporting going forward, but would it be logical to assume that kind of run rate, organic growth in these businesses, move up towards these order rates that we've seen in the last few quarters?

Yes, what I would say, Jeff, if you look at our backlog both year-on-year, up 8%, sequentially improving, that is going to translate into continued improvement in our organic growth going forward.

And so, we have made a tremendous amount of progress with our commercial excellence initiatives, in being able to build that backlog, continue to get strong orders, in spite of some of the economic pressures that we see in some areas across the globe.

And what I see going forward, is we're going to be able to take that backlog, you're going to see continued improvement in the organic growth, with a keen focus on being able to grow our services in line with our execution of installed revenues.

Great.

Thanks a lot.

Best of luck.

Thanks, Jeff.

Our next question comes from Steve Tusa of JPMorgan.

Your lines is now open.

Hello.

Good morning.

Good morning.

Hi, Steve.

Congratulations, as well, George.

Hopefully, we'll be seeing lots of you over the next 18 months here, as you transition into the new company.

Congratulations.

Thanks.

I appreciate it, Steve.

So just on the North America margins, could you discuss a little bit more, of those moving parts and those items?

And I have one quick follow-up on that.

Sure.

Let me start by -- if you assess the third quarter, we were down 150 basis points year-on-year, about 30 basis points was purchase accounting.

Now if you reflect over the last four years, we have significantly improved margins within our North America business by almost 500 basis points.

And what I would say, when you look at the type of work we do, that would be in the top quartile of performance.

Now as you know, over the last 18 months, we have been increasing our investments.

We've been building out our sales force.

We've been enabling the sales force, with the salesforce platform to be able to get leverage on that investment.

And what I would say is, we've been executing extremely well with those investments.

So that is some of the pressure on the margin rate.

When you look at the mix within the quarter, so as we look at the acceleration of our installed revenue continuing to accelerate, and I'd say we continue to execute well within our installed business.

And then on the service side, we were a little bit short of where we thought we'd be.

What we've been doing, is building out not only the sales force, but also making sure that we have the capacity in place in the field to be able to fulfill that increase in orders.

So we came in about 1%.

We were targeting roughly 2% to 3%.

So there was also now a mix impact.

What I would say is that, at the same time, we've been increasing costs in expanding our footprint.

So we've been adding service techs, making sure that we're -- as we're accelerating the installed base, as we're getting additional service orders, that we're going to have the capacity in place to be able to fulfill that growth going forward.

And so, we're a little bit short of where we thought we'd be in the quarter, but I can assure you that with the fundamentals that we put into place, we're going to be able to continue to improve going forward.

Okay.

And then, just one last question.

On these -- you reaffirmed the $1 billion of synergies, and you talk like you've dug in a little bit more here.

What's the potential for upside to those, given how conservative these look as a percentage of sales?

First, I'd like to stop by saying, I can't say enough about Alex and the team and Johnson Controls, with the work that we've done, the way the teams have come together, and the teamwork that's been displayed.

There's been tremendous integration planning that's been completed.

And at this stage, what I would say is that we're confident that with what we've laid out EPG, we laid it out in three key buckets.

So the first bucket was, when you look at the combined company, about $2 billion of G&A costs.

We're confident that we're going to be able to deliver about a 20% reduction on that cost base.

A lot of that is the duplication of the public company costs.

When you look at the next bucket, it was mainly, what we call enhanced.

It's taking the progress that both companies have made in our cost of goods related to our procurement.

And in addition to the progress that each of the businesses have made on a $12 billion buy, we see another $275 million of net savings, which is about another 2%.

And what I would say, the team is working in that space, again very confident that we've got the plans in place, to be able to start to hit on that, starting on day one.

And the last piece, is the one that we've been working here most recently as we think about the business unit structure coming together, there's about $8 billion of costs that's in the field.

And the teams are continuing to work through that, as we think about a more refined organization that will enable us, to not only get the cost synergies which we laid out to be about $225 million, or a 3% reduction on that cost base, but also at the same time, be positioned to accelerate revenue.

So at this stage, what I would say is the work that has been done gives us tremendous confidence, that we'll be able to deliver on the plan that we outlined at EPG.

I think Alex and I both feel very good about where we are today, and then being positioned here on day one to hit the ground running.

And what we plan to do is over time, is continue to give you an update on the progress we make.

And then certainly, looking to try to, as we go forward, trying to do more.

But at this stage, it's hard to say that that's where exactly we are with that.

Great.

Thanks a lot.

Thanks, Steve.

Thanks, Steve.

Our next question comes from Nigel Coe from Morgan Stanley.

Your line is now open.

Thanks, and good morning.

Good morning.

Good morning, Nigel.

Yes, I echo Steve's and Jeff's comments about the deal, congratulations.

Thanks, Nigel, it's a little hard to hear you.

Okay.

Oh, sorry, let me speak clearly.

Okay.

So I hate to pick up the baton on North America margins, but it's causing a few questions from investors.

One of your competitors has also referred to weakness in North American margins.

So I'm just wondering, I hear the investment spending and the mix on service, but has there been any deterioration in the broader price umbrella in North America?

When you look at the different end markets that we serve, what I would say is, like for instance in Western Canada, when you have a high mix of oil and gas and heavy industrial high hazard end markets, certainly the work that is available, there's a lot of competition for that work.

That being said, we've always stayed very disciplined within our business, to make sure that with the value that we create, with what we do, that we're getting the expected returns.

And so, you're always going to have some end markets, depending on how they're performing with some additional pressures.

What I would say, Nigel, is we're very disciplined, not only in how we book projects, but then with a plan to deploy, whether it be technology or techniques that enable us to be able to execute the margins better than what we book.

And when you look at our -- you're always going to have some variation, depending on the projects that are being completed.

But what I would say, is when you look at our trends and the way that we performed, we're positioned to be able to sustain that type of margin, in spite of the price pressures that we see in a couple of the end markets.

Okay, that sounds fine.

And then, on the backlog acceleration, that's obviously the hard act in the quarter, in my opinion.

Is this a function of the absence, or maybe the stabilization of order trends and backlog trends within the resource industry facing the harsh and hazardous products, or is this a broad acceleration and the pressures remain?

So I'm just wondering, is there an underlying acceleration in commercial institutional, et cetera, or is this the absence of a headwind from resource?

So, Nigel, I would start by saying that, the first, when you look at the last four years, the first couple years was truly focused on fixing our fundamentals and getting our margin structure in place, so that we could begin to reinvest and begin to accelerate our growth.

And that's what happened, right?

So we did a lot of work to get our margins addressed.

And then, in the last couple years, we've been reinvesting in expanding our sales force, and then enabling our sales force with E3.

So I think what you're seeing, for instance in North America, with the expansion in the commercial and institutional space, we're now getting more than our fair share, with the resources that we've deployed to be able to, not only accelerate the orders, but also increase the backlog.

And so, I think some of that is, there is market expansion, but also better execution with the work that we've done from a commercial standpoint.

The same holds true within Rest of World.

When you look at Rest of World, we have significantly upgraded that portfolio over the last four years with the moves that we've made, making sure that the investments we're making are going to be in markets that are attractive, that are going to represent growth.

And that where we have fundamentals, that we can leverage very nicely to be able to create returns.

And so, when you look at our performance in Rest of World this past quarter, we saw broad-based performance.

We saw our gross margins up, couple hundred basis points.

We saw growth in the installed, the conversion of our backlog of installed to installed growth.

We saw nice service orders, with execution of service up 2%.

And so, what I would say, in spite of some of the pressures that we have in maybe the UK market with the North Sea pressure, and some of the high hazard heavy industrial end markets in Asia, in spite of that you're seeing fundamentals grow.

And as a result of that, the resources we put on the commercial side, we're now beginning to see the pick up as we expected in the backlog, and now more important the conversion of the backlog to revenue.

And so, I see that continuing.

And just clarify the comment on the backlog, are you seeing more large projects in the backlog, or is it broader than that?

Well, we've had a number of nice wins with large projects, right.

We're beginning to leverage our full portfolio, so that when we put together a proposal, we're leveraging all of our technology, all of our capabilities to differentiate the value that we create with our proposals.

We've been able to win some very nice large projects.

Year-on-year, it's not that significant.

You will get some fluctuation quarter to quarter, and sometimes year-on-year, but nothing out of line with what historically you would have expected.

And so, a key for us is continuing to, not only build the longer term backlog, but also get the short-term backlog.

And then, from a service standpoint, make sure that we're positioned to capitalize on the service that's generated, with the backlog that we do create.

Okay.

I'll leave it there, George.

Thanks and good luck.

Thanks, Nigel.

Thanks.

Our next question comes from Deane Dray from RBC.

Your line is now open.

Thank you.

Good morning, everyone.

Good morning, Deane.

Good morning, Deane.

Just add my congratulations, and best of luck getting to that September 2 finish line.

But that's also a starting point, so best of luck there.

Thanks.

And just on a forward-looking basis, wanted to hear your thoughts about the M&A outlook?

And in particular, does the merger change in any way, the capital allocation towards deals, both in your discretion, the timing of deals?

Any changes there, and then broadly how does that funnel look?

Yes, Deane, this is Robert.

I think the way to look at this is, it's going to be pretty similar to recent history that both Tyco and JCI have had.

We've talked about the couple big deals that we've closed recently, a couple hundred million dollars each.

We don't have any big deals imminent.

But I think we've also talked about how this is -- the go-forward company is a very attractive company to look at value-enhancing acquisitions.

Great.

And then, just to clarify, it looked like both corporate spending and restructuring came in a touch lighter.

And was there a -- do have you some additional color there?

Yes.

I think that we're very cognizant of the upcoming JCI merger, and we're trying to drive productivity everywhere we can, in advance.

So, with regard to restructuring specifically, we think that there's some really good opportunities once we merge to get efficiencies, and we'll take full advantage of that.

And so, rather than do something twice, we'll just do it once, and do it very quickly.

Got it.

Thank you.

Our next question comes from Steven Winoker from Bernstein.

Your line is now open.

Thanks.

Good morning, and obviously, echoing everybody's congratulations.

Ut's very exciting

Thanks, Steve.

Thanks, Steve.

So just, once again, started to dig in the North American margin, ISS margin point, but based on what you've talked about so far, I think you've got somewhere around, it sounds like 40 basis points or so for service investments or the additional investments.

You've got something like 20 to 30 basis points from the installed growth, faster than services growth this quarter.

But that leaves still about 50 basis points of other things.

Could you maybe just talk about how we should think about that, and what happened?

Was this a question of focus on -- a lot of things going on, or just help us understand that kind of gap?

Yes, Steve, this is Robert.

What I would say is, it's just a lot of little, small items that just happen to line up going the wrong way.

So in aggregate, maybe $5 million, $6 million in total.

But normally those things balance out in a quarter, and this quarter, they just went one way.

So I would look at that as one-time.

And I don't think -- I think we see a pretty strong future ahead.

Okay.

And then, just to put a finer point on one of your earlier answers, oil and gas, high hazard.

You've been giving us how far down that's been each quarter.

I know you talked about it qualitatively, but how far down was it this quarter?

So Steve, the way I think about is, when you think about -- let's start with our product businesses, it's about 25% of our revenues.

When we look at high hazard, heavy industrial in total, it's kind of mid to -- low to mid single-digit decline in the quarter.

And so, that's where we've had the biggest impact.

Certainly, that has had some impact on our services, mainly in Rest of World.

But at the end of the day, the biggest impact has been in our product businesses.

So that's why -- that's what drove it to be at the lower end, of what we originally thought in our product business within the quarter.

But what I would say is, that's certainly is being driven by oil and gas, and that we believe is now somewhat at the trough.

And looking forward to with the -- assuming that the oil prices behave, then we'll start to see some increase there as we go forward.

But that's where the biggest impact has been.

Right.

And that product number you mentioned earlier, I mean, that's -- that 3% decline is up against, what a 16% comp, right?

Is that mostly just a comp issue that we should think about?

It is.

You're absolutely right.

Okay.

All right.

And well, I'll leave it there, and we'll follow up offline.

Thanks, bye.

Thanks.

Thanks, Steve.

Our next question comes from Gautam Khanna from Cowen and Company.

Your line is now open.

Hey, good morning.

Good morning.

And I echo all the sentiments expressed earlier.

Good luck with everything.

Thanks.

A couple questions.

First, I was wondering, you mentioned Europe doing a little better.

When I look at the slide with the macro environment arrows, last quarter to this quarter, didn't look like any of the arrows changed.

I was just wondering if you could elaborate on what specifically got better?

Yes, what I would say, again, it's a combination of the work that we've done with our commercial team, in putting on additional resources, enabling them with our E3.

And then making sure that we are focused on the segments of the market where we do see the growth.

And so, when you look at continental Europe, we've had very strong order activity in growth.

And that has been mainly what I would categorize as services in the manufacturing space, in the commercial space, and then we've also had a very strong quarter in retail in continental Europe.

UK has been a little bit more pressured because oil and gas is still weak, where the operators are maintaining minimum service activity.

Certainly, there's some nervousness now with Brexit, as it relates to government, development, some of the major projects there.

But overall, with the work that we've done in positioning those businesses, with the fundamentals, we have very strong fundamentals now in Europe.

And with the order activity, the pipeline that we've built, and the way that we're converting that pipeline gives me a lot of confidence, that in spite of some of the economic pressures that we're going to be positioned to continue now to improve, and be able to deliver sustained organic growth there.

Okay.

That's encouraging.

And George, I was wondering if you could opine on where you think we are in the product cycle at global products?

I mean, excluding the high hazard industrial stuff which is a known headwind, what is the long-term organic growth rate of that business?

And maybe if you could also talk about whether you have any major product launches in the next 12 to 18 months, similar to the Air-Pak that could change that general cyclical growth rate?

Yes, Gautam, I would start by, if you look back since the last downturn, we were on a run with our product businesses, to it delivering strong -- it was high single-digit organic growth, and we complemented that with acquisitions.

And so, the last 18 months, 12, 18 months has been where we've gone into this cycle, as a result of the downturn in the high hazard heavy industrial space, mainly driven by oil and gas and mining, which is, as you know is a significant percentage of our overall product revenues.

And so, that has -- when you look at that space, oil and gas being down the way it is, and then the impact in the heavy industrial, that has been a major headwind over the last 12, 18 months.

And so, that's the first, where we've actually had a change in the profile there.

That all being said, we're getting significant growth with our new product launches, in the electronics space, with our security products, with our access, intrusion, video products, within our retail segment.

So the overall performance, when you look at it, compared to other companies that are weighted in the high hazard heavy industrial space, we've actually performed pretty well because of the mix we have.

So what I would project, once we get -- I think we're in the trough now with some of these end markets.

Going forward, with any type of recovery with the investments and reinvestments we're making, we should be positioned to deliver what I would say up to the mid single-digit organic growth area like we have historically.

We are reinvesting.

We're gaining market share in the space that we compete in.

That is being offset by some of these pressures.

Thank you very much.

One last one, George.

If you could just talk about ShopperTrak, if you've had any incremental traction in the retail vertical with that acquisition now?

Yes, we're early in the integration execution here of ShopperTrak.

What I would say is, as we look at our retail portfolio, the position that we have across each one of the segments, there's no other company that is positioned as well as we are.

We've got a retail team now, that we've configured in such that from a go-to-market standpoint, we can leverage all of our touch points with the customer, recognizing that we have multiple touch points, which then leads us up to being much more strategic in how we engage the C-level within the retail community.

I personally have met with a number of retail CEOs, and positioning with the value position that we have within the new portfolio, and this gives me a lot of confidence that with the strategy that we've deployed, with the combination of capabilities, we're going to be well-positioned to be able to capitalize on the new space that we've opened up now with the ShopperTrak acquisition.

Thanks.

Congratulations, and look forward to the next phase.

Thanks, Gautam.

Our next question comes from Julian Mitchell from Credit Suisse.

Your line is now open.

Hi.

Thank you.

Just a question on the pro forma revenue base of the combined entity.

So in January, the number was $32 billion.

At EPG in May, it was $30 billion.

I just wondered if there had been any more reductions to that pro forma number in the last couple of months?

No.

I mean, that is your pro forma number.

And the way to think about it, Julian, keep in mind, that it was more at a budget rate type number, the $32 billion.

And keep in mind how currency has fluctuated throughout the year.

So when you just take that all at your current rate, to where you're at that, that is the biggest piece of what that was.

Thank you.

And then, just on the free cash flow, the headline number was down quite a bit.

One of the adjustments, I guess, is this satisfaction of the pension obligation.

I hadn't seen that before this year.

Could you just clarify what that was, and if that is a future cash liability that we should be aware of?

Yes, Julian, this is Robert.

No, that was an obligation that we had accrued for over about a 15-year period, and it was a one-time payment.

And that is not going to be ongoing, one-time.

Thanks.

And then just lastly, yes, you mentioned mix for four quarters now as a headwind in global products.

Is it solely just this sort of oil and gas hazardous-related stuff, or is there a broader mix price issue?

Yes, Julian, that pressure is being felt across our fire protection products business, as well as life safety.

And when you look at the mix of those platforms, we have a heavy mix of chemical suppression in the fire protection products, which has been significantly impact -- that's where we have the highest volume, as well as very high mix, serving all of the industrial space, oil and gas, mining, all of those end markets.

And then, in our life safety platform, we have the gas detection, which we also added additional capability with the IST acquisition that we completed last year.

It's great technology.

We have a great position, but we are seeing the impact, that with the downturn in each of those end markets.

So what I would say it's -- like I said in the quarter about that end market composition was down low to mid single-digits in the quarter, in the third quarter.

Now as I said, I believe that that's bottoming out, and that going forward with any type of recovery in these end markets that will position us well to leverage the margin structure that we have in place, and be able to deliver very nice returns.

Very helpful.

Thank you.

Thanks, Julian.

Our next question comes from Robert McCarthy from Stifel.

Your line is now open.

Good morning, everyone.

Again, I will echo the congratulations on the job well done.

My first question would be around just the state of -- maybe you could talk about the state of US nonresidential construction, and the health of that market from what you're seeing, in terms of your order rates and revenue rates, and give us some complexion around that, drilling into some of your comments on slide 7?

Sure.

So what I would say, is in the fire business, we're seeing strength in as I said in the commercial as well as institutional end markets.

And when you look at the AVI and just the overall activity in that space, it does play to our strengths.

We were positioned well to be able to capitalize on that market expansion.

And as I said earlier in the call, with the work that we've done to increase our sales force and capabilities to be able to capitalize on that market growth, what I'd say is we're getting more than our fair share with that expansion.

When you look at combined with security, what I would say is we're also seeing decent activity in the government space, in the public sector, as well as healthcare.

And as we look at our combined capabilities, what I would say in addition to the fire business, that's where we're seeing some nice pick up of activity.

So what I would say is, in North America making sure that we've got our resources positioned to where the growth is occurring, and that's what ultimately is driving our orders growth.

That is offsetting some pressure that we're seeing in Western Canada, where we have a strong presence within the oil and gas and heavy industrial end markets.

That all being said, our Canadian team have done a great job in reallocating their resources, to make sure that in spite of that, we're picking up growth in some of the other strength that we've seen, Canada, mainly in Eastern Canada.

So overall, we've been able to mitigate the risk and capitalize on where the expansion is occurring.

Would you say your oil and gas exposure came in worse than what you were expecting, in line with what you were expecting?

Do you think you got it right this quarter, versus your internal expectations?

Yes, overall, Robert, I'd say we've got it pretty much right.

I mean, it -- we weren't expecting any significant pick-up in the quarter.

Certainly, we were hoping that we might start to see some activity, especially in line with the increase in oil prices.

That hasn't occurred.

We're in some cases later cycle.

We were hoping that we might see a pick up in services, which is a little bit shorter cycle.

We've seen some of that, but we, pretty much in line with what we expected.

I'll leave it there.

Thank you for your time.

Thanks.

Thank you.

Our next question comes from Robert Barry from Susquehanna.

Your line is open.

Hello.

Good morning.

Good morning.

A couple follow-ups here actually.

On that heavy industrial, I think you said in the past, that about a quarter of it's oil and gas, so was curious what's happening in the other three quarters of it?

So when you look at it overall, how George mentioned in the high hazard, heavy industrial piece, that is down in the low mid single-digits, but the oil and gas specifically is down closer -- in the mid-teens level, kind of similar to what we have seen, and very much in line with our expectations.

Got you.

So the other non oil heavy industrial is maybe flattish?

Up a couple -- maybe up 1 point or 2.

(multiple speakers) a little up slightly, yes.

Okay.

Good.

And then, just also wanted to follow up on a comment you made earlier about China.

It sounded like things were still weak, but maybe there were some signs of improvement.

So just wanted to get a little additional color there?

Thanks.

Yes, I think overall, again, I'd attribute some of our improvement to the work that we've done from a commercial standpoint, in making sure that our resources are positioned where the activity is, and that we've got the right fundamentals in place.

So some of that improvement that we're seeing, I think is purely operational.

I would say where we are seeing some strength is in the commercial space, and being able to capitalize on that, as well as some of the institutional.

Certainly, we're still seeing weakness in oil and gas.

It's mainly in the marine space in Korea.

The -- when you look at hospitality, we have a big presence and have been very successful in Macau.

There has been some weakness there, although recently we start to see some pick-up in activity, and I think that now is being recognized more broadly.

So what I would I say is that some of it is operationally, the ability to be able to capitalize on where the growth is occurring, and then maybe additional stabilization within the overall economic environment.

Operator, we have time for one more question.

Our last question comes from Jeremy Capron from CLSA.

Your line is now open.

Thanks, and good morning all.

Good morning.

Hi, Jeremy.

So George, you confirmed in May with Alex at EPG, that the cost synergy targets presented at the beginning of the year were on top of each company's internal operational efficiency improvement programs.

And obviously, at Tyco you've done a lot of work in the past few years, improving the cost structure in the US in particular.

So I'm wondering, where are you seeing further upside over the next three years at Tyco alone, excluding the cost synergies you can generate with JCI?

Sure.

When we laid out our three year plan -- or the second three year plan, it was over a year ago November, when we laid it out.

We said that we were still positioned with the productivity initiatives to generate about $35 million of net productivity on an annual basis.

And that was through all of our key productivity initiatives, continuing to drive savings on cost of goods, as we focused on the buy, a pretty significant buy, streamlining that, and getting leverage on the buy.

It was continuing to simplify our footprint, on not only North America, but also across Rest of World to be able to leverage our real estate footprint.

And then, more important, with consolidation of the services that support that footprint.

And we were, as we now enter this merger, we were about halfway through the progress that we're making, relative to really getting towards entitlement of that cost.

And so, we're continuing that activity, and in some cases accelerating that now with the planning that we've been doing with the integration with Johnson Controls.

And that's where you can get the additional savings above and beyond what was planned.

Okay.

And just a housekeeping question, here on your P&L, I noted $54 million in other income.

And I don't think you mentioned any of this on the call today.

So just looking for clarity here.

Thanks.

Sure.

This is Robert.

You might recall, the IRS settlement earlier this year, and as a result of that IRS settlement on the intercompany debt matter, we reviewed the status of all our reserves associated with both our 2007 and 2012 tax sharing agreements.

Based on this analysis, we reduced our total reserves by $71 million, of which $54 million went through the other income line, and $17 million represented a benefit to the income tax line.

And both of those are special items in the quarter.

Great.

Thanks very much, and congratulations again, on the merger and good luck.

Thanks, Jeremy.

I'd like to turn the call back over to George for some final comments.

So once again, I'd like to thank you for joining us for what was our last official earnings call as standalone Tyco.

As we head into the merger and closing, I'm looking forward to working with Alex and our new leadership team.

I have been continually impressed by the level of talent and depth of expertise demonstrated by the employees of Johnson Controls, and I have been extremely pleased by the way our teams have come together.

I would also like to thank Robert for his leadership and guidance over the last year.

He quickly learned the business, and has made significant contributions to the team.

He has been a strong partner to me on our journey, and I wish him the best in the future.

I look forward to speaking with you on future calls, and at our Analyst Day on December 5 in New York.

Thank you, operator.

That concludes our call.

And that concludes today's conference.

Thanks for your participation.

You may now all disconnect.