Tyco International Ltd. F3Q09 (Qtr End 06/26/09) Earnings Call Transcript

Tyco International Ltd. (TYC)

F3Q09 Earnings Call

July 30, 2009 8:30 am ET

Executives

Ed Breen - Chairman & Chief Executive Officer

Chris Coughlin - Chief Financial Officer

Ed Arditte - Senior Vice President of Strategy & Investor Relations

Analysts

John Inch - Merrill Lynch

Jeffrey Sprague - Citi Investment Research

Nigel Coe - Deutsche Bank

Scott Davis - Morgan Stanley

Shannon O’Callaghan - Barclays Capital

Steve Tusa - JPMorgan

Steve Winuker - Sanford Berstein

Ted Wheeler - Buckingham Research

[Dean Dray] - FBR

Presentation

Operator

Welcome and thank you all for standing by. At this time all participants are in a listen-only mode. (Operator Instructions)

Now, I would like to turn meeting over to Senior Vice President, Strategy and Investor Relations, Mr. Ed Arditte, sir, you may begin.

Ed Arditte

Thank you Jain and good morning everybody. Thanks for joining our conference call to discuss Tyco’s third quarter results for fiscal year 2009 and press release issued earlier this morning. With me on today’s call are Tyco’s Chairman and Chief Executive Officer Ed Breen and our Chief Financial Officer, Chris Coughlin.

Let me remind you that during the course of the call we will be providing certain forward-looking information. We ask you to 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 with you and we ask you to read through the sections of our press release that address the use of these items. The press release issued this morning and all related tables, as well as the conference call slides, can be found on the Investor Relations portion of our website at tyco.com.

Now, let me quickly recap our earnings this quarter. Revenue in second quarter was $4.2 billion compared to $5.2 billion last year. Organic revenue declined 12% with five percentage points of the decline attributable to Electrical and Metal Products. GAAP diluted earnings per share from continuing operations, was $0.51 and included $0.07 related to special items.

Diluted earnings per share from continuing operations, before special items was $0.58 and this compared to our guidance of $0.43 to$0.45 cents. Now compared to the street consensus of $0.45 cents, our operations were better by $0.05, led by strong performance in ADT as well as a lower than expected operating loss in Electrical and Metal Products. The remaining $0.08 difference was attributable to lower corporate expense and a lower tax rate.

Now with that let me turn the call over to Ed Breen for some opening comments.

Ed Breen

Thanks Ed and good morning everyone. Well it seems a bit strange to start a quarterly conference call by saying I’m please with our performance in the quarter with revenue and income both down year-over-year, but I’m actually very please with our efforts and results this quarter in a number of areas.

Our businesses remain focused on a number of important operational priorities, specifically cost reduction and restructuring, tight management of our working capital and continued investment in our growth initiatives, together these efforts have allowed us to achieve better than expected results this quarter, while positioning us for better performance, when our markets return to more normal conditions.

Our results for the quarter continue to be driven by our recurring revenue and service activities, which continue to grow on a combined basis, despite the economy. However, the economy is having a bigger impact on our product business and our systems installation activities in security and fire.

We are actively addressing our cost structure through both restructuring activities and tighter cost management and these efforts were reflected in our margins, which improved sequentially, due in large part to our strong performance in ADT and better than expected results in electrical and metal products.

Before I comment on each of the businesses, let me quickly update you on our key areas of operational focus. Chris will then provide more detailed review performance in the quarter on a segment-by-segment basis. First we remained active in our restructuring activities and incurred charges of $44 million during the quarter primarily in ADT and safety products.

For the year, we are on track toward our full year 2009 restructuring estimate of $200 million. We are starting to see some of the early benefits from these actions, but most of the benefits should impact our results in 2010, when we would expect to generate incremental savings of approximately $150 million. Next, we also made additional progress in the management of our working capital.

Despite the significant volume declines, working capital days remained relatively flat on a year-over-year basis and we reduced primary working capital by more than $100 million in the quarter and more than $200 million year-to-date. The decline in inventory levels and the tight management of our accounts receivable contributed to the strong cash flow generation in the quarter.

On the investment front, we have continued to fund our growth plan despite the economic slow down. Our capital expenditures, including our dealer spend, is slightly above last year’s level and we are continuing to get more impact from our R&D spending. At two of our new R&D centers in Shanghai and Bangalore, we are focused on developing products tailored to local needs and we have partnered with highly respected local universities in these regions to attract leading engineering talent.

For example we have increased the number of engineers in these two R&D centers by almost 100 this year alone. Now let me give you a quick overview of what we are seeing in each of our businesses. Starting with ADT, the resiliency of our recurring revenue business has helped considerably in this current environment. Recurring revenue, which represented more than half of ADT’s total revenue, grew organically for the 13 consecutive quarter.

In addition to growth in all regions, our key metrics, account growth, average revenue per user and the disconnect rate all improved, which continues to support the stability of our recurring revenue business. On the top line the strength of our recurring revenue was more than offset by the impact the economic downturn is having on our systems installation revenue. However, margins improved in the quarter due to the strong performance in our residential business and our cost reduction activities.

Turning to flow control, margins remained flat with last year, despite the revenue headwind. The margin performance in the quarter was due in large part to our cost containment efforts, as well as improved productivity. In Fire, service revenue declined modestly on an organic basis, while the systems installation portion of our Fire business continued to soften.

Overall, our operating performance was similar to the second quarter. We continue to focus on growing our service business, which now represents about half of Fire’s total revenue. Safety products performed a bit weaker than expected, as the business continued to be pressured by lower demand across the end markets. The benefits of our cost reduction initiatives were more than offset by the volume decline.

Additionally, we made significant improvement in reducing inventory levels during the quarter. Finally, the operating performance of Electrical and Metal Products was slightly better than expected due to improved spreads, despite lower than expected volume. This business is on track for a return to profitability in the fourth quarter, due mostly to our improving steel cost position.

Before I turn it over to Chris, let me quickly comment on our orders. While orders in the quarter were down year-over-year across-the-board, we continue to see stabilization in our order activity on a quarter sequential basis, with slight improvement in Fire, safety products and flow control. At this stage, it’s much too early to draw any conclusions from these numbers and given the environment, we will continue to adjust our cost structure until we see sustained improvement in order rates.

With that, let me turn it over to Chris.

Chris Coughlin

Thanks Ed and good morning everyone. Let me start with ADT worldwide, where revenue was $1.7 billion in the quarter, with organic revenue decline of 5%. Recurring revenue, which represented over 55% of ADT’s total revenue in the quarter, grew 4% organically. This growth was more than offset by a 15% organic revenue decline in systems installation and service, mostly due to weakness in North America and Europe, resulting from softness in the commercial markets.

Despite the revenue headwind, the operating margin before special items improved 30 basis points over the prior year to 14.2%. Growth in our higher margin recurring revenue, coupled with restructuring savings and cost containment initiatives more than offset the volume pressure on operating income. From a regional perspective within ADT, our US residential business continued to perform well.

Recurring revenue, which represented more than 85% of our residential business, grew 5% in the quarter, and our operating margin before special items continued to improve. Additionally, our key metrics continued their positive momentum. Our account base and our average revenue per user each grew 3% on a year-over-year basis, and our US residential attrition rate remained flat with the prior quarter at 13.6%.

Turning to our US commercial business, about 40% of our revenue was recurring in nature, with the remaining 60% being systems installation and service. As we have seen over the last few quarters, the systems installation and service revenue portion of this business has been impacted by the softness in commercial markets. Capital budgets within our customer base continue to be tightly managed with capital being spent in small increments.

Overall organic revenue in the commercial business declined 13% in the quarter. The operating margin before special items improved on a quarter sequential basis result from our cost actions. Additionally, our US commercial attrition rate improved 110 basis points to 14. 1%.

Moving onto the Europe, Middle East and Africa region, our recurring revenue grew 3% on an organic basis. However, this was more than offset by a 16% organic revenue decline in systems installation and service where we saw continued softness in our commercial markets throughout the region.

Overall revenue in Europe, Middle East and Africa region declined 10% organically. Excluding special items, the operating margin in the quarter was 4.6%, which was an 80 basis point improvement from the prior quarter. In our other regions around the world, which are primarily commercial, organic revenue grew 3% in the operating margin was in the low teens.

From a global perspective, our worldwide account base grew 2% year-over-year to more than 7.3 million accounts with growth in all geographic reasons. We also saw an increase in our average revenue per user to $0.45 and $0.51 which increased 2% year-over-year excluding the impact of foreign currency. Our worldwide attrition rate improved 20 basis points in the quarter, to 13.4%, driven primarily by the reduced attrition in our US commercial business.

Next I’ll turning to flow control; we have revenue of $951 million, and an organic revenue decline of 5%. Organic revenue growth in valves moderated to the 2% level as we began to see some volume pressure in North America. However this growth was more than offset by continued weakness in water which declined 13% organically and the volume drop off in thermal controls, which declined 14% organically.

Operating income before special items was $131 million, and included $20 million of currency headwind. The operating margin before special items was 13.7% and was flat with the prior year, despite the revenue in currency headwind. We were able to achieve this due to our cost containment measures and benefits related to our restructuring actions.

Order rates, excluding currency, were down 30% year-over-year. However, orders grew 1% on a quarter sequential basis. The backlog of $1.6 billion declined $59 million or 4% in the quarter. Excluding foreign currency, backlog declined 9%. As we looked at the fourth quarter, we expect revenue to be similar to that with the third quarter with an organic revenue declined of 10% to 12%. We expect the operating margin to be approximately 13%, which is a modest decline on a quarter sequential basis due to product mix.

Now, turning to our Fire business, revenue in the quarter was $856 million in organic revenue declined 5%. Service revenue represented about half of Fire’s total revenue, and declined 2% organically in the quarter. Our systems installation activity, which comprised the remaining half of Fire’s revenue, declined 7% organically, due in large part to the continued softness in our end markets.

The backlog of $1.2 billion increased $16 million or 1% in the quarter and excluding foreign currency, backlog declined 2%, operating income before special items was $70 million with an operating margin before special items of 8.2%, which was inline with our expectations. We are focused on cost reduction activities globally, and continue to right size the business, given the volume decline.

Next, in our safety products business, revenue in the quarter was $380 million and organic revenue declined 19% as our business continued to be impacted by the soft competent. Fire suppression and electronic security were impacted by lower distributor inventory levels and continued weakness in end market demand, while the decline in municipal budget spend contributed to the weakness in our life safety business.

Organic revenue decline 24% in Fire suppression, 12% in electronic security, and 16% in life safety. Operating income before special items was $45 million, and the operating margin before special items was 11.8%. The favorable impact of cost containment efforts was more than offset by under absorption in our manufacturing facilities, and to a lesser extent, product mix.

Despite the softer revenue, we continued to fund our growth plans and have maintained our research and development in sales and marketing spend levels. Additionally, we continue to work our cost structure during the quarter, resulting in charges related to restructuring activities of $11 million.

Next, Electrical and Metal Products, revenue was $320 million, which was slightly below our expectations, with an organic revenue decline of 47%. Lower demand related to the continued weakness in the non-residential construction market was the primary contributor to the revenue decline. Steel volume remained at historically low levels decline in 40% year-over-year while copper volume was down nearly 30%.

Despite the significant decline in volume, the operating loss before special items of $7 million was better than the $20 million loss we expected. Selling prices stabilized while a drop in the cost of steel declined at a faster than anticipated rate, resulting in a better than expected spread in the quarter. The volume decline was also partially offset by our cost reduction initiatives.

Additionally, we continued to improve working capital through inventory reductions, and we generated good cash flow in the quarter. Based on current market dynamics we anticipate historically low volume and low sales prices to persist in the fourth quarter. This should result in fourth quarter revenue in the $320 million range and an operating profit of approximately $5 million.

Before I turn it back over to Ed, let me touch on a few other important items. First, our corporate expense, excluding special items, was $98 million, which was well below our expectation of $125 million due to cost containment activity as well as a timing of certain expenses. As you have seen over the last few quarters, our corporate expense has been running, on average, about $20 million less per quarter than the prior year.

We expect that trend to continue, as our fourth quarter is typically the highest expense quarter of the year, due to the timing of certain tax and legal expenses and as such, we expect that corporate expense of approximately $130 million in the fourth quarter. Next, our tax rate, excluding special items for the quarter, was 13.4% reflecting a continued positive impact of our tax planning activities.

In addition, we adjust our year-to-date tax rate to the 16% level, which reduced our third quarter tax rate by approximately 2.5 percentage points. We now expect the full year tax rate to be at the low end of our previous guidance of 16% to 18%.

Now let me turn it over to Ed Breen to wrap up this morning’s call.

Ed Breen

Thanks, Chris. Before we open up the lines for our questions let me provide you with our outlook for the fourth quarter. We expect revenue and operating income in ADT fire and safety products to look quite similar to the third quarter, with continued growth in our recurring revenue base being offset by softer results in our product and installation businesses.

When combined with our previous comments on flow control and Electrical and Metal Products, we expect revenue to be similar to the third quarter on an overall basis. However, as Chris mentioned, there are few moving pieces, which will have a quarter sequential impact on our earnings and let me quickly review those.

First, the expected increase in our corporate expense to $130 million in the fourth quarter, compared to the $98 million in the third quarter will cost of $0.06 per share sequentially. Second, we are forecasting a 16% tax rate, adjusted for special items for the full year. Given the lower tax rate we had in the third quarter, this will result in a headwind of $0.02 per share.

Lastly, the expected improvement in Electrical and Metal Products will result in a net pickup of $0.02 per share. When combined, these three items result in net headwind earnings of $0.06 per share on a quarter sequential basis. Therefore we expect earnings per share from continuing operations before special items in the fourth quarter to be in the range of $0.50 cents to $0.53. This increases our full year earnings guidance to a range of $2.25 to $2.28, compared to our previous guidance of $2.15 to $2.25 per share.

Thanks for joining us on the conference call this morning and operator, if you please open up the lines for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from John Inch - Merrill Lynch.

John Inch - Merrill Lynch

Just to the fourth quarter guidance, remind us historically the profitability in the fourth quarter. It sounds like all else equal you are suggesting profit margins hold, but don’t fourth quarter margins typically expand? Or is there some other dynamic that’s occurring?

Ed Breen

John I think typically if you look back at our last few years you typically do see and expansion of margins in the fourth quarter, but I think in the economic environment that we’re in, the economy has removed a lot of that lift.

So, as we indicated in our remarks, we see a fourth quarter that from a numbers point of view from revenue and a margin point of view, looks an awful lot like the third quarter. In other words, the lift that we typically get, I think given the economic environment is just nowhere near as meaningful as we’ve seen historically.

Chris Coughlin

John, I would just again highlight as I said in my remarks if you looked at the safety products business higher fixed costs business we are doing our restructuring activities, but again the order rates have remained low. That would be similar with our flow control so that coupled with some product mix we don’t expect the lift we would get on higher volume that we’ve seen in the past.

John Inch - Merrill Lynch

Let me ask it this way. Did the quarter progress such that your mix issues became kind of worse at the end and through July? Or are you just being conservative?

Ed Breen

No, I don’t think there was anything from a mix point of view that is his at all different and there’s nothing to indicate that the fourth quarter would be any different, but again the headwind on the revenue side, as Chris spoke about, that’s impact on our product businesses is meaningful and based on where we sit today, we see a revenue outlook for the fourth quarter and a margin outlook for the fourth quarter that is very, very similar to the third quarter.

As Ed pointed out in his remarks there are a number of items including corporate expense, tax rate and the performance of Electrical and Mental Products that are adjustments to those numbers.

Chris Coughlin

So on a year-over-year basis we are still going up against high growth that we had last year in both the third and fourth quarters.

John Inch - Merrill Lynch

That is fine, one other thing on this point. What about currency? Currency strikes me as going to actually be a little bit more of a tail wind in the fourth quarter? Or is it not that impact you think?

Ed Breen

It is not tremendously impact. It is a little better right now again it is not going to impact our margins significantly.

John Inch - Merrill Lynch

Can we talk about the flow business for a second? Did the spreads meaning the price you charge versus your cost inputs of the product, did that get better or worse? Really what is the outlook there?

Ed Breen

No change, John. We haven’t seen anything on the pricing side that would indicate any change and that is true in the orders we are putting into our backlog during the quarter and just kind of a side note to that on the orders in flow. Although down 30%, I don’t read much into this but they certainly stabilize during the quarter, because the actual orders were up 1% sequentially.

I think we are seeing stabilization there looking at our July results and kind seeing on the order side I would say the same thing is kind of stabilized at that level. I would also point out in the flow area, we have seen some of our other partners in the industry report their results which have big pump businesses and the pumps usually get ordered five to six months ahead of the valves.

I was actually surprised to see a fair amount of resiliency this quarter in the order rates on the pump side those orders a quarter or two ago were also down in the 30% range like the valve business.

I noticed some of the reported result just came out actually had about zero organic growth to 1% organic growth somewhat in that range, so I don’t know that’s an indicator, but that looked pleasantly surprising to me that we were seeing that on some broad based partners of ours and competitors. That hopefully is an indicator maybe the first half of 2010 is our tough compare and flow but maybe not the second half. I think it’s too early to say that.

John Inch - Merrill Lynch

You are working on a lot of little projects, are you not, Ed, in the water business overseas?

Ed Breen

Yes, we are expecting specifically some businesses to pickup in Australia and by the way, part of that is the stimulus package in Australia. There is other water projects in the lopper yet but we haven’t booked yet but we are working hard.

John Inch - Merrill Lynch

Lastly then $0.25 to $0.30 it looks like restructuring benefit incrementally that you called out for 2010. What are your thoughts maybe presuming you still are going to do some restructuring next year but you thoughts about presenting your earnings given these tail winds on an inclusive basis on restructuring costs.

Ed Breen

John we have made no decision on that. I understand where you are coming from on it. We will look at it hard. We are right now as we are already in our fourth quarter of our fiscal year; we are rack and stacking what we think our restructuring opportunities are for next year. Once we get our arms around that we’ll present that to you in November.

Chris Coughlin

John, we’ll try to continue to be as transparent as we can in giving you what those numbers are, before or after, et cetera. All the different kinds of special items like restructuring.

Operator

Your next question comes from Jeffrey Sprague - Citi Investment Research.

Jeffrey Sprague - Citi Investment Research

Just a little more on ADT, you called out the bulk of the restructuring actions were in ADT in the quarter. Are you starting to get a little more heavily after some of this European fragmentation you have been talking about? Maybe some color on what’s going on there?

Chris Coughlin

Yes, Jeff, we are the chunk of it was in Europe by the way there was actually some of it in the US which you see helped the margins besides mix. We were helping on our restructuring axe on the US side. A chunk of it was in I certainly don’t say this with any bragging in our voice but our margins did improve 80 basis points sequentially in Europe. You are seeing some of that come through I would expect you’ll see some margin improvement in the fourth quarter in the EMEA region also.

Again because of the actions we are taking and as I highlighted on the call, last quarter, what we are really taking a lack at now is exiting some regions and areas where we don’t feel we are going to have critical mass. I think that will have a good pay back for us, even with the down reference that we are seeing. So that is the actions you are starting to it see kind of kick in and will pick in as we go in ‘10.

Ed Breen

Jeff obviously we get a much quicker return on that restructuring investment in the US Where we can turn it pretty quick. It is still a challenge keeping up in Europe with the reduced volume in terms of the restructuring activities.

Jeffrey Sprague - Citi Investment Research

So have you kind of borne some of the costs of this closing of maybe regions or cities in ADT that are going to go, but the operations have not actually shut down yet? Or will that all happen?

Ed Breen

It’s happening as we speak and will continue to happen and Jeff, to Chris’s point, it takes a few months to really get the cost out of the system. It’s not as quick over there, because of the process you go through. So the different areas are in different stages and that’s why I think you’ll see another improvement from us next quarter on the margin side.

Chris Coughlin

Yes, this is going to be an ongoing process that we’re going to be going through right through 2010. So we may have been reserved some of the restructuring activities, but the actual work in dealing with the regulatory environment over there will continue to take some time.

Ed Breen

Jeff, just to highlight, I wouldn’t doubt if you’ll see from us an announcement or two that we might actually exit a couple of areas through a sale of the business or something like that versus the restructuring.

Jeffrey Sprague - Citi Investment Research

Just one other question, just kind of on Capital allocation with a little sidebar thought. Just anything opening up a little bit more on the M&A front that you have had an interest in maybe some small deals and just as a side little twist 3M’s not going to cover off the ball on respirators and stuff on swine flu. Is there any little play to more some of your safety products capacity into that type of area?

Ed Breen

I don’t know about that one, Jeff. I hadn’t thought about that it, but just that it’s a good thought. Just on the acquisition side in general, we are looking at a couple of things right now, I don’t know if they will happen. I promise you, we will be very disciplined about how we go after this and we certainly are not going to stress our balance sheet in doing any deal, but we are looking at a few things right now and as Chris mentioned on the last quarter, we will keep the balance sheet a little more conservative.

So if we do an acquisition or two, most likely cash would be involved in that and that’s why we’ll also be in a little bit more cautious right now on our share repurchase activity. We will pick that up at some point here.

We’ve been wanting to be cautious because of the economy and where the order rates are still at, but we’re also taking into account the fact that we could do an acquisition or two here. Again, don’t know if they’ll happen because we’re going to be very disciplined on pricing.

Operator

Your next question comes from Nigel Coe - Deutsche Bank.

Nigel Coe - Deutsche Bank

I thought the decline in North American commercial attrition was interesting. Can you just maybe comment a bit more on that sense? Is this something that we can sort of extrapolate? What does this tell us about, it is this a pretty toad maybe increasing refurbishment spent?

Ed Breen

Nigel, let me answer that this way, the benefit in large part is a benefit from a tougher period last year. So while we did see some improvement, I don’t think we’re at a point where we’re prepared to say that attrition rate we achieved in the quarter is fully sustainable and we’ve seen the worst of environment. It’s still a difficult environment. We continue to be closely managing this part of the business, but it’s too early to indicate that we’ve kind of hit a peak here.

Chris Coughlin

Yes, Nigel, the other thing I would. When you’re in the commercial business, obviously you’ve got some more significant individual customers within that customer base and if a significant market or significant customer in end market, it can move that attrition rate up and down in a more significant way than it would say on the residential side. As Ed said, we’re hopeful but I wouldn’t say that we couldn’t have a swing the other way as well.

Nigel Coe - Deutsche Bank

Can you just maybe comment on where you think you are on the distributor industry headwinds? Maybe the levels of inventories in both E&Ms safety products, and if you could tie into that typically when steel prices start to move upwards, we start to see restocking with the steel distributors. Do you think that happens this cycle?

Ed Breen

Yes, I do think so. It hasn’t happened yet. I think the inventories, by and large, I’ll give you that. I think the two big ones here our safety products business. I think we still did see, believe it or not, some destocking this quarter, because order rates were down even a little more than people anticipated. Our orders were down give or take 21% in that business.

So I think there was still a destocking going on during the quarter. Maybe a little bit more this quarter, but probably near the end of that. I do think the destocking on the electrical and metal side has now happened. People are run it really lean and mean. As you see from our results, we now are buying steel with significantly lower prices than we were before.

We’ve bled-off now the high price on the inventory. So the cycle at your point is starting to swing here a little bit and it will be interesting to see, do we get a little rebuild on the distributor side? I think at some point we do, but having said that, non-resi volumes are down so significantly and I think for at least some period of time, your people are going to be very cautious on restocking.

Chris Coughlin

Yes, as I said in my remarks, I don’t think we would expect any kind of significant move on volume in the fourth quarter. I think we’re going to see it down where were it is, so maybe as we move into 2010.

Nigel Coe - Deutsche Bank

One quick one on cash, typically 4Q is your, by far and away your strongest cash quarter relative to the rest of the year. Is there any reason to expect that not to be the case this year?

Chris Coughlin

Well, there is a couple of things there. The fourth quarter we expect another good cash quarter as we’ve had all year. We’ve worked hard in trying to be a little less dependent on the fourth quarter and moving some things on a sequential basis up in the year. So for example, on a year-to-date basis, we are ahead of last year’s cash position, even though our earnings are way down.

So I do expect there will be some impact, for example, on Electrical and Metal Products business, where we’ve had the significant decline during this year. So we won’t have the big fourth quarter there, but overall we should have a strong fourth quarter in cash performance as we’ve had in the past.

Ed Breen

Well and just maybe to punctuate that, we would still expect our cash to approximate net income for the year when it’s all said and done.

Operator

Your next question comes from Scott Davis - Morgan Stanley.

Scott Davis - Morgan Stanley

I want to go back to Jeff’s cash reinvestment question a little bit. You had stepped up buying your accounts and I’m hearing that your account pricing pretty good and you got a few competitors are kind of shutout of that market. Has this become really the best place I guess to reinvest your cash right now as far as returns?

Ed Breen

Certainly, Scott we are seeing that our internal programs that are driving some of the dealer activity or advertising programs and what not as well as the competitive landscape have made that a quite a good business for us. We continue to be able to generate a nice account growth and it has a very nice return. Again, it’s a return that we know we can get. It’s right in the sweet spot of our business. So we think that is a continued good allocation of capital.

We’re working hard and we have grown our internally generated accounts as well, but again, as cash flow has come in and the opportunities present itself we’ll continue to look at that. We have had the opportunity this year as we have in the past as well to get some bulk accounts where these are other venues that have monitored accounts that whoever reason want to sell those off, we’ve been able to buy those again at a good price where we would get a solid return.

I would say, there is not a lot of risk to that, because we’ve been very disciplined and how we look at the creditworthiness of each of those. So, again we haven’t seen any kind of increase in attrition or other things. So again, this is a core part of what we do and fits right in with our business strategy.

Scott Davis - Morgan Stanley

I’ve got two more questions on ADT. I know you don’t breakout specifically centramatic, but retail is one of the earliest businesses to get ahead if you seen any sequential improvement retail…?

Ed Breen

No.

Chris Coughlin

I wish I could say, yes.

Ed Breen

Scott, I think your question, is the business that’s down the most. The orders were down in the high-20s in that business. We’re not seeing probably it’s like everything else, whereas it’s not declining more, but we’re not seeing any improvement yet.

Scott Davis - Morgan Stanley

Moving into the Europe, I mean when you start to think about you know you used to talk about some of the structural issues of why you can get up to U.S. margins in Europe, but when you think about some of the country exit that you’ve done in the restructuring that you’ve done. I mean, what do you think the realistic run rate or margins are in kind of a normalized demand environment now?

Ed Breen

Well, Scott if the volumes would pick up back to where we were, we would be north of 8% now approaching 10% with the actions we’ve taken. Well, I hopefully will be over 5% in this next quarter just to give you a primer, so we are off 300 basis points to 400 basis points from where we could be. If we continue on the actions we’re taking, on the restructuring and exit some of these areas, I’m still convinced that we can get up to the 10% range.

Now, having said that, as you know our margins in the other parts of the world where the mix of business is similar are more or like 12%, give or take. I don’t think we easily get there, because we have more union issues and different labor issues in some of the European countries that we don’t have for instance in the Asia market. So, I think you’re always a little bit down on a relative basis, but you can get kind of that 10% range.

Operator

Your next question comes from Shannon O’Callaghan - Barclays Capital.

Shannon O’Callaghan - Barclays Capital

One question on safety products, also I mean you talked about distributors de-stocking, but I think you said you’re also took your own inventories down a fair amount. When do you think you have your production operating back to normal and have inventory levels where you want them?

Ed Breen

I think our inventory levels internally are in a pretty good shape, right now. Again, we are continuing to monitor those against the demand we are seeing. So, I think we’re there.

Shannon O’Callaghan - Barclays Capital

Then in terms of the sequential stabilization or slight up-tick in some of these order trends, I know you don’t want to make too much of them, but do you have any sort of other color across the segments of the pieces of it of things you are hearing of why things might be getting a little bit better?

Ed Breen

Well, the only thing, Shannon I’d maybe add to that and let me just specifically. When you look at overall Tyco, you’ve got two-thirds of ADT, which is recurring or service and you have half of Fire, which is service. So, I kind of put them aside because they are not backlog businesses, but that’s a big chunk of Tyco and its still growing.

So, kind of sit that off and then when you take the pieces that aren’t there, what felt a little better. Again, I think is reading maybe too much into it, but safety products orders did improved 2% sequentially, flow improved 1% sequentially, fire improved 3.5% sequentially, maybe that’s a little bit more and ADT commercial was down another 1.5%. So, that was the one down we had, but again not significant.

So, that clearly feels like stabilization. I would also add, that looking at our July orders, I would say we are seeing about the same thing. We are seeing no additional drop-off anywhere, but I wouldn’t say I’m seeing any lift in the activity yet. Then the only other point I would make that I did make earlier and I would add to that is in the flow area as I mentioned last quarter.

We are seeing a lot of activity that we are bidding on. As much as we’ve ever seen, but we are just not booking the orders at this point in time, but the actual inflow in our sales funnel is very significant and maybe that pretends to (a) when its rough and maybe it doesn’t last too long, because of what we just saw on the results that the pump guys are announcing and those orders clearly have always tracked that they are booked five to six months before the valve business.

So, again if there happens to be a trend developing there, maybe we’ll see something, a couple of quarters down the road that we pick up off this bottom.

Shannon O’Callaghan - Barclays Capital

Which of the end markets in flow is all of those bidding activity happening in?

Chris Coughlin

We are seeing some increased activity in water and again water had the most significant decline. So, for example in our Australian business, we are seeing water activity and we are also seeing a little bit in the oil and gas area.

Shannon O’Callaghan - Barclays Capital

Last one, just so fourth quarter, I guess you have electrical and metal going on like1% or 2% margin. The high cost inventory is gone, so, what needs to happen from there to get this back to be 5% or 10% or better than that in terms of margins? Do you need a volume recovery? Is there other lower cost inventory coming through, cost savings?

Chris Coughlin

I think it’s going to be a combination of both of those. I think as we continue to deplete inventory, our average cost will continue to go down, because we’ve been acquiring at lower cost. As we have said, these volumes are at absolute historic lows and so, for us to get back into some more reasonable level of profitability, I think we’re going to see some need some volume pickup here as we get into 2010.

Ed Breen

There’s also some signs in the marketplace of prices moving up a little bit. So, to Chris’s point, it’s a combination of volume and price. I think in the near term, it’s more likely we’ll see price than we’ll see volume.

Shannon O’Callaghan - Barclays Capital

But it seems like they should be tracking up from the 4Q level beyond that?

Chris Coughlin

Yes and we clearly think, again I won’t put a number on it, because I don’t think any of us have a clue yet, but I think that’s obviously a nice tailwind for us in the next fiscal year, obviously relative to zero profit for this fiscal year.

Operator

Your next question comes from Steve Tusa - JPMorgan.

Steve Tusa - JPMorgan

I’m not sure I heard this correctly, but you said flow was it ADT fire and safety flat and then did you throw flow in there as well for the next quarter on revenue basis?

Chris Coughlin

Flow would be flattish on the revenue basis Q4 over Q3.

Steve Tusa - JPMorgan

Everything is pretty consistent on the revenues Q4 to Q3?

Ed Breen

Just about across-the-board, we are looking at fairly consistent.

Chris Coughlin

Yes, we are looking at a fourth quarter revenue line at this stage. That’s a lot like the third quarter with no real deviation, no meaningful deviation in any of the businesses.

Steve Tusa - JPMorgan

So, that would mean an organic revenue comp, I guess ex electrical and metal of about around 9% to 10%, is that right?

Chris Coughlin

That sounds in the neighborhood.

Steve Tusa - JPMorgan

Then on that revenue decline, which I guess gets increasingly, it’s a little more of a decline in flow, I guess down 10% to 15% it looks like --

Chris Coughlin

That would be 12%.

Steve Tusa - JPMorgan

The margin there held up well this quarter, but when I look at your restructuring, it’s been about 20 bips of sales it have a lot of the focus. I don’t think the focus is been in flow; correct me if I’m wrong. So, what are you doing differently there to mitigate these declines? Is this kind of positive decremental performance something you can sustain even when these year-over-year declines get to the double digit range?

Chris Coughlin

Steve you are absolutely right. Most of the restructuring was not on the flow side as we mentioned. It was on safety products and ADT this past quarter. We’ve had very good cost containment in the business and we’ve had very good purchasing procurement containment efforts in the business that have paid off for us and that’s really what allowed us to hold where we were.

Steve Tusa - JPMorgan

So is that not considered part of your kind of raw materials? When you talk about price cost is that considered something other than productivity or something?

Chris Coughlin

Definitely we’ve got across the company. Steve, we’ve got a major effort going on in the procurement side across-the-board on everything. By the way that’s benefited us in safety products besides our restructuring also and it clearly helped us in the flow side.

Operator

Your next question comes from Steve Winuker - Sanford Berstein.

Steve Winuker - Sanford Berstein

I just want to come back to again the capital deployment question that keeps coming up. So, you are up to $1.8 billion from $1.5 billion and you are sounding notes of cautious optimism for the rest of the year raising your guidance.

What are the kinds of trigger points that we should be thinking about that you are thinking about, when it comes to taking a more assertive stands, considering your rating and everything else for certainly at least repurchases if not other deployment?

Chris Coughlin

Again, our priorities have remained the same in terms of capital allocation. The first, we’re looking at all our restructuring activities and making sure that we have those funded. Our capital programs again, some of which is part of the restructuring, but also maintaining our investments in the dealer program.

We want to be flexible in terms of acquisitions and again our priorities there are in Flow, Fire and Security. Then clearly, the return to shareholders in terms of dividends and share repurchases. So, given the environment, we want to remain conservative in managing our cash and balance sheet.

We want to give ourselves maximum flexibility in what is still at somewhat constrained environment. So, as Ed mentioned earlier, as we look at acquisitions, we want to be more conservative on stretching the balance sheet to do so, and therefore we may hand onto a little bit more cash than we have in the past, but we continued treasures.

We continually reassess the buyback alternative as well. So, again we’ll be a little more conservative when we had to pass. I would say, as we get through this year and finalize our plans for 2010, I think be a little more definitive on the allocation of capital.

Steve Winuker - Sanford Berstein

Are you comfortable with where your credit rating stands? Are you looking? How are you thinking about that particularly?

Chris Coughlin

I think we are very pleased that we got the upgrade back in September. I think again, we certainly don’t want it to decline from where it is. So, we want to stay in that range which gives us, a lot of access to the capital markets. So, we are in a BBB plus now. Many of our ratios are more at the A level as it is. So, we want to stay in that range.

Steve Winuker - Sanford Berstein

Then moving onto a couple of operational questions, on all of the restructuring dollars that are being spend, not just in the quarter, how much capacity, in terms of the equipment, the productive capacity are you really taking out in a more permanent basis, particularly in electrical and elsewhere?

I’m trying to get a sense for in the way back out, whether or not you’ve impacted your ability to respond in a better world?

Chris Coughlin

Yes, Steve, actually I feel good about that and that’s something we’ve really been thinking through also. It’s really only obviously on our manufacturing company. So, the big moves, we’ve made on the Safety Products side is actually closing up multiple facilities and we’ve moved into one.

By the way I’ll give you our biggest restructure, we closed multiple facilities and we’ve moved into one larger more efficient low cost facility in Mexico. We’ve plenty of capacity upside, if we are going to need it, but we are also right now seeing the benefit of that move very significantly from the brick and mortar infrastructure standpoint going out and then the labor flow through going through that facility.

So, I think on the Safety Products side, we are in very good shape for a pickup and even if the pickup is quick, which I’m not expecting, but if it did come back on a V-shape, we’ve been in good shape. We have more flow to a little more, I wouldn’t say permanently, but a little bit more on the electrical and metal side, some of our secondary facility, but what I feel good about there is, we’ve added capacity and expansion into our one major core facility in Harvey, Illinois.

So, we have opportunity there if we some pick up, but there having the things came back and to be much quicker we probably have a little bit more of an issue. Again, I don’t expect that to happen.

Ed Breen

Additionally, in more service related businesses, we’ve taken out for example, some installation capabilities in certain places around the world, but we also believe there was a pickup, we could ramp that up fairly quickly.

Steve Winuker - Sanford Berstein

On the E&MP, since you’ve done that that would suggest to me that you’d have more operating leverage on the way back up?

Ed Breen

Yes, again that’s going to be driven as we said much more by price than anything else.

Chris Coughlin

Yes.

Ed Breen

It’s not the big mover.

Steve Winuker - Sanford Berstein

Can you roughly quantify, where your capacity utilization is for just say again on the manufacturer side flow control, safety electrical?

Ed Breen

Steve, why don’t we talk that offline, because there is a lot of different numbers there I think we could probably help with.

Steve Winuker - Sanford Berstein

Finally, just again you have touched on this, but net pricing across flow, fire and safety. Can you just expand on what you are seeing? Is it mostly from backlog pricing certainly on the flow side? Are the order rates you are seeing pickup, are you now seeing pricing pressure in that bidding activity?

Ed Breen

Steve, where we have seen some pricing pressure is on the sprinkler side of our fire business and that by the way didn’t surprise me, because I remember the last softness that was where we saw. By and large across the Board, the business we’ve been putting into our backlog recently is very similar on a margin front from what we have been booking prior. So we do track that. So no, generally whether its flow, the bigger portion of fire except the sprinkler piece that I just mentioned. We’re seeing stability there.

Ed Arditte

Operator, we have time for two more questions.

Operator

Your next question comes from Ted Wheeler - Buckingham Research.

Ted Wheeler - Buckingham Research

I wonder if you could comment as you did with flow on year-to-year orders and on the bid pipeline for fire protection the installation part of that. Was orders year-to-year in fire protection?

Ed Breen

Fire orders on an organic basis are down about 20%. We’re actually up in the quarter about 3% on a sequential basis.

Chris Coughlin

Remember, Ted that was just the installation part of fire. That’s not the part of fire, which is the recurring piece.

Ted Wheeler - Buckingham Research

How would you characterize that pipeline of opportunity?

Ed Breen

Running right now about, zero organically.

Ted Wheeler - Buckingham Research

That’s, I presume, some improvement?

Ed Breen

No, that’s a couple points down from where it was. If you had or forget this, I’ll give you the sales. A quarter ago we were a couple points positively organically. Now we were a one or two points negative, it doesn’t appear like that’s dropping off more, but kind of the activity is running in that zero organic range right now and that is a global comment.

Ted Wheeler - Buckingham Research

On free cash flow looks like fourth quarter might be a little below just recent quarter. Is that true and is that kind of due to timing to just this recession? How you’ve been moving working capital?

Chris Coughlin

No, I don’t think we are seeing anything on that front that relates to the economy. Again some of it is just the mix of business, for example as I indicated earlier electrical metal products, which had a very big year last year. There was some timing issues flowing into the first three quarters of this year that we’ll slow down. We expect consistent performance in our cash through the fourth quarter.

Ed Arditte

I would add to that, Ted there’s nothing, I wouldn’t read too much into our comments on the fourth quarter doing the calculation. I think we’re going to have, as Chris a good fourth quarter from a cash point of view. I think as Ed said, we continued to expect it to be roughly equivalent to net income adjusting for the special items.

Operator

Your final question comes from [Dean Dray] – FBR.

Dean Dray – FBR

A couple of data points on ADT might be helpful. This is a follow-up to Jeff’s question, on the potential for exiting some underperforming businesses in Europe. I know you can’t quantify specifically, but just give us a sense of what we would call addition by subtraction? The margins well below the ADT Europe and what might the lift be?

Ed Arditte

I would say, look its part of our overall restructuring plan as Ed indicated earlier, we have a goal of trying to get up to that 10% range. We are looking in a very comprehensive way, everything that goes on within that business. Some shrinking, some moving and servicing from different areas and shutting down places. Others will certainly look at as their better home elsewhere. Someone, it is going to be a whole combination of things that will take is us hopefully from this 4.6% range will be saw this quarter up overtime as this volume increases.

Dean Dray – FBR

Up overtime to what kind of level do you think?

Chris Coughlin

As Ed indicated earlier, we think we can get that business to the 10% level. Again it’s primarily it’s a commercial business. It’s going to be a little bit less than what we see in Asia because of the cost structure in Europe. Again it’s going to take the combination of all these restructuring activities in a very broad sense as we discussed, as well as volume pickup for us to get there.

Dean Dray – FBR

Then also on ADT, it looks like you may have some competitive dynamics going on right now with a name change of one of your competitors. How are you looking at this as a potential market share opportunity? It looks like it might be increasing some advertising, but what is the opportunity here?

Chris Coughlin

I think there is a lot more advertising, in general going out there as they go through their change. So again, we’re not ramping up in a dramatic way. We think we’re well positioned in our advertising spend and our ability to generate new accounts as we’ve seen. There is just a lot more out there, which I don’t think necessarily will be bad for us. Ed, do you want to…?

Ed Arditte

No, Dean we’ve seen this before both our competitor and us do a lot of TV advertising. They’re going to do more peers from what they’ve announced because of the name change. We always seen, what we advertised more they advertise. More as Chris said, it doesn’t really make any difference on [Inaudible] advertising. If there’s more out there on security, it seems to give a little bit of lift for the industry. Hopefully we get a fair amount of calls from that.

We are bumping up our advertising slightly on the TV front from where we were. I would point out that even our competitor us and probably they have a good management team, we’re very impressed with what they do. We’re both getting more advertising bang right now because ad rates are so low.

What we normally would spend, we’re just getting way more hits on TV. So that’s probably a good thing right now. Again, they have started cranking up their name change and their ads. Our flow into us over the last 30 days as they started implementing their stuff has been no different. We’re still seeing that the same level of activity we’ve had.

Dean Dray – FBR

How meaningful is that name change to a potential new customer?

Ed Breen

I’m going to leave that up for all of you to decide. Let me just leave it at that. They have a major change going on, but they’re good at what they do and we’ll see.

Ed Arditte

Ladies and gentlemen, thanks for joining our third quarter conference call today. If you have any follow-up questions, our team is available to assist. We look forward to talking to you again to review our fourth quarter year end results and our outlook for 2010. In early to mid November and we’ll put out an announcement indicating, when that is. Thanks again for joining us today.

That does conclude today’s conference. Thank you for participating. As a reminder, we will have replay available, those numbers are 866-395-9163 or 203-369-0499. Again the replay number is 866-395-9163 or 203-369-0499. Again, thank you participating. You may disconnect at this time.

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