Tyco International's CEO Discusses F2Q2014 Results - Earnings Call Transcript

Apr.25.14 | About: Tyco International (TYC)

Tyco International Ltd. (NYSE:TYC)

F2Q2014 Earnings Conference Call

April 25, 2014 8:00 AM ET

Executives

Antonella Franzen – Investor Relations

George R. Oliver – Chief Executive Officer

Arun Nayar – Executive Vice President and Chief Financial Officer

Analysts

Deane Michael Dray – Citigroup Global Markets Inc.

Jeffrey T. Sprague – Vertical Research Partners, LLC

Nigel Coe – Morgan Stanley & Co. LLC

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Scott R. Davis – Barclays Capital, Inc.

Stephen Tusa – JPMorgan Securities LLC

Julian C. H. Mitchell – Credit Suisse Securities LLC

Operator

Welcome to the Tyco’s Second Quarter Earnings Conference Call. All participants have been placed on a listen-only mode until the question-and-answer session (Operator Instructions). Today’s call is being recorded. If you have any objections, please disconnect at this time.

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

Antonella Franzen

Good morning, and thank you for joining our conference call to discuss Tyco’s second quarter results for fiscal year 2014 and the press release issued earlier this morning. With me today are Tyco’s Chief Executive Officer, George Oliver; and our Chief Financial Officer, Arun Nayar.

I would like to remind you that during the course of today’s call, we will be providing certain forward-looking information. We ask that you look at today’s press release and read through the forward-looking cautionary informational statements that we’ve included there.

In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items. The press release issued this morning and all related tables, as well as the conference call slides, which Arun will refer to, can be found on the Investor Relations portion of our Web site at tyco.com. Please also note that we will be filing our quarterly SEC Form 10-Q later today.

As a reminder on March 3 of this year we signed a definitive agreement to sell our South Korean security business ADT Korea. Accordingly the results of ADT Korea are now reported as a discontinued operations in all periods presented. Both current and historical results as well as the forward outlook discussed today refer to continuing operations which again excludes the results of ADT Korea, which were previously reported in the Rest of World Installation & Services sector.

We expect to complete the sale of ADT Korea in our fiscal third quarter. In discussing our segment operations when we refer to changes in backlog and order activity these figure exclude the impact of foreign currency. Additionally, references to operating margins during the call excludes special items. And this metric is a non-GAAP measure and is reconciled in the schedule attached to our press release.

Now let me quickly recap this quarter’s results. Revenue in the quarter of $2.5 billion, increased 0.5% over the prior year as 2% organic revenue growth and a 2% benefit from acquisitions was mostly offset by the impact of divestitures and changes in foreign currency exchange rates.

Earnings per share from continuing operations attributable to Tyco common shareholders was $0.39 and included charges of $0.06 related to special items. These special items related primarily to separation and restructuring activity.

Earnings per share from continuing operations before special items was $0.45, included in these results is a $0.04 insurance recovery related to the improper recording of revenue in China which we disclosed in the fourth quarter of 2012.

Now let me turn the call over to George.

George R. Oliver

Thanks, Antonella, and good morning, everyone. I’m pleased with our second quarter results and the momentum that is building across all three segments as we reach the half way mark in our three year growth strategy. We continue to make progress towards our 2015 goals each quarter. And this quarter is no exception.

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

Additionally, the segment operating margin continues to expand as we reaped the benefits of project selectivity and our productivity initiatives. Overall this resulted in another strong quarter of our earnings per share growth. In addition to strong operational execution this quarter, we announced the divestiture of ADT Korea and the sale of our remaining minority interest in Atkore International.

Let me spend a few minutes discussing these portfolio changes and our plan from the proceeds.

As I have previously mentioned we’re always looking at our portfolio to ensure we have the right mix of businesses to maximize long-term value for our shareholders. ADT Korea is a good business with nice margins. However, it required a high and growing capital intensity. The sale provided us with a unique opportunity to monetize the investments we have made building the number two security provider in that market.

Our strong position in this market allow us to command a very attractive multiple for the business. In addition, the sale of our remaining stake in Atkore, our former electrical and metal products business allowed us to remove the remaining volatility relayed into our equity investment.

Combined these two transaction generates over $2 billion in deployable cash. Our priority for deploying excess cash have not changed. M&A will continue to be our priority given the right opportunity at the right price. Although we do not expect any sizable transaction to come to a close in the near term, we continue to actively look at a number of opportunities of varying sizes.

I made a commitment at our Investor Day in 2012, there we’d not sit on cash and that we would deliver 15% earnings per share CAGR over the three year period. At that time, our 2012 normalized earnings per share before special items was $1.50. And I remain firm on that EPS growth commitment.

The net dilution of ADT Korea in Atkore is about $0.20 of annualized earnings per share. We expect to begin putting the proceeds to work immediately repurchasing shares to completely offset and turning dilution by 2015.

Now turning back to our second quarter results. Let me give you a quick overview of the performance of each of our segments. Then I’ll turn it over to Arun to provide you with more details.

Starting with our North America Installation & Services segment. Organic revenue growth turned positive a quarter ahead of plan as continued growth in service offset a moderating decline in installation revenue.

I have seen a lot of turnaround over my career. But there has been a change, I’ve seen in North America security business in second to none. Beginning in early 2012, we modified our strategy for this business to focus on profitable growth, which included putting in place a new leadership team, restructuring the business and most importantly reorganizing the sales force to be closer to our customers.

We are now more focused on going after the right end markets to play it to our strengths, so that we can utilize our depth and expertise to execute successfully and more profitably. As a result of these changes not only are we winning the right projects and executing on the better we are standardizing, simplifying and automating processes to drive speed within the business. This combined with strong performance in our Simplex Grinnel wire business is what has led to another strong operational quarter in North America.

Turning to the Rest of World Installation & Services segments, we continue to see strong growth in Asia, these are other growth markets. We are encouraged by the continued stabilization in Europe and we expect Europe to be a modest contributor to growth in the second half. In Australia the overall economy continues to be soft, which is pressuring our performance in the region.

The mining sector has been significantly impacted in the absence of large commercial and industrial projects, is also putting some pressure on our operating margin. I’ve been to Australia a few weeks ago and I am really pleased with all of the actions the team has taken to maintain the fundamentals of the business. The team is executing well despite the difficult environment and I am very confident that the business is well positioned when the economy recovers.

Moving onto global products, revenue exceeded our expectations and the operating performance was very strong. I’ve been a part of these businesses, since 2006 and I am very proud to see the positive results our incremental investments in R&D, in sales and marketing are having, across our fire protection, security in life safety businesses.

Lastly, I want to touch on the focus that we are placing on technology. A key part of our strategy to accelerate growth is driving innovation and technology to create differentiated solutions for our customers. Our goal is to continue developing technology that will enable us not only to maintain our position as a leader in the fire and security industry, but to leverage our capabilities to create value propositions and deliver growth and returns for our customers and our shareholders.

For example, we recently launched our PowerSeries Neo hybrid intrusion detection platform, which integrates Visonic’s leading edge, PowerG wireless technology into our existing DSC intrusion product line. This new platform redefines intrusion security, by providing a hybrid solution that combines the functionality of a hardware and system with the simplicity of a wide range of wireless devices. PowerSeries Neo caters to a wide spectrum of intrusion industry needs ranging from residential through commercial applications.

This platform has been designed to decrease installation cost and increase the functionality we deliver to our customers. In addition to numerous product launches, we recently expanded our global center of excellence in Birmingham, Alabama. This center developed standards, technical specifications and detailed work plans leveraging our technology for security systems in 14 different languages. This enables consistent security installations globally, which allows multi-national companies to streamline and standardize their security systems around the world while having a single point of contact for their global security needs.

Integrating systems in technologies to solve customer problems essential to our growth strategy. We are driving toward bringing not only security systems, but also buyer in other building system together on a common platform to provide customers with ease and efficiency in controlling their operations as well as providing analytical services on the data collected.

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

Arun Nayar

Thank you George, and good morning, everyone. You can follow my comments on our financial performance starting with Slide 4. Let me start with an overview of our results for the second quarter.

Revenue of $2.5 billion grew 0.5% year-over-year. Organic revenue grew 2%, which is the highest organic revenue growth quarter since separation with growth across all three segments. Products grew 2%, service grew 1.5% and installation revenue turned positive. Installation revenue grew 1% organically. As growth in Asia and our other growth markets was partially offset by softness in the Australian market and the anticipated decline in North America which was driven by projects and activity.

Acquisition growth of 2% was more than offset by the impact of divestitures and changes in foreign currency exchange rates. Before special items, segment operating income increased 15% to $335 million, and the operating margin improved 170 basis points year-over-year to 13.5%. As Antonella mentioned included in segment operating income is a $21 million insurance recovery. Adjusting for the insurance recovery, segment operating income increased 8%, with an 80 basis point improvement in operating margins.

Increased revenue improved installation performance and the benefits from sourcing, productivity and restructuring initiatives drove the operating margin improvement. Overall, earnings per share before special items increased $0.08 or 22% year-over-year. This increase consistent of a $0.05 contribution from operations, and $0.04 from the insurance recovery, partially offset by $0.01 headwind from changes in foreign currency exchange rates. Orders in the quarter grew 3% year-over-year with 9% growth in products and 3% growth in service.

Installation orders were flat year-over-year due to the lumpiness of larger orders, which impacted the year-over-year installed order growth rate by 4 percentage points. In April we’ve seen a nice pickup in orders and have a strong pipeline of bidding activity supporting increased order growth in the second half of the year. This coupled with backlog of $5 billion which increased 6% year-over-year and 3% on a quarter sequential basis sets us up very nicely second half of the year.

Now, let’s get into the details of each of the segments. Starting, first with North America Installation & Services on Slide 7. Revenue in the quarter, up $939 million, decreased 1% on our reported basis driven by the divestiture of our Canadian guarding business and unfavorable changes in foreign currency exchange rates. On an organic basis, revenue grew 1% year-over-year as 2% growth in service was partially offset by a 1% decline in installation revenue.

Before special items, operating income in the quarter was $117 million and the operating margin of 12.5% increased 160 basis points year-over-year. A greater contribution from higher margin service revenue improved installation margins particularly in security as well as productivity savings drove the operating margin improvement. Overall, orders were flat year-over-year in North America Installation & Services. As service growth of 3% was offset by a 3% decline in installation orders.

As we have said previously order rates can be lumpy particularly in the installation business and can fluctuate from quarter-to-quarter. From a dollar perspective installation orders were higher on a quarter sequential basis. That is why we often referred to backlog as a key indicator. In the second quarter, backlog in North America Installation & Services of $2.4 billion increased 2% on a quarter sequential basis.

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

Turning to Slide 8, Rest of World Installation & Services, revenue of $943 million was flat year-over-year. Service revenue grew 1% and installation revenue grew 3%, our total organic revenue growth of 2% in the quarter.

A 4% benefit from acquisitions was more than offset by the impact of divestitures and changes in foreign currency exchange rates. Before special items operating income was $109 million and the operating margin increased 190 basis points year-over-year to 11.6%. Softness in Australia which is a large and profitable region for us, as well as incremental investments we have made in our Growth Markets was more than offset by the $21 million insurance recovery.

In the second quarter, overall orders increased 3.5% year-over-year in Rest of World Installation & Services. Service orders increased 4% and Installation orders increased 3%. Backlog of $2.3 billion increased 11% year-over-year and 4% on a quarter sequential basis.

Turning to Global Products on Slide 9. Revenue grew 5% in the quarter to $605 million. Organic revenue grew 2% and acquisitions contributed 3 percentage points to growth.

Operating income before special items was $109 million and the operating margin expanded 120 basis points to 18%. Leverage from increased revenue coupled with a greater mix of higher margin products as well as productivity benefits drove the operating margin expansion. This was partially offset by a 30 basis point headwind from non-cash purchase accounting related to the acquisition of Exacq Technologies.

Product orders increased 9% year-over-year, with growth across all three platforms. As we discussed in last quarter’s earnings call, the National Fire Protection Association delay the implementation of new standards related to self-contained breathing apparatuses, including our new Scott Air-Pak X3 until early April. In late March, we did receive approval to begin shipping our new Air-Pak X3.

As we look ahead to the third quarter for Global Products, we expect to ship the X3s that were delayed from the first half of the year, which was expected to result in organic revenue growth of approximately 11% in the third quarter.

We expect the operating margin before specialize items to be approximately 20.5%, representing a 70 basis point improvement in operating margin year-over-year. Again, this includes a 30 basis point headwind related to non-cash purchase accounting for the acquisition of Exacq Technologies.

Now let me touch a few other items on Slide 10. First, corporate expense before special items was $54 million for the quarter. We expect corporate expense in the second half of the year to be at a slightly higher level, which is consistent with prior years. For the full year, we now expect corporate expense to be $225 million.

Given the proceeds from ADT Korea and Atkore, we now expect net interest expense for the full year to be approximately $85 million. Next, our effective tax rate for the quarter before the impact of special items was 16.9%. We expect the effective tax rate for the third quarter and full year to be approximately 18%.

As George mentioned, we expect to begin repurchasing shares in the near-term. Given that we are more than halfway through our fiscal year, share repurchases will have a minimal impact on fiscal 2014 earnings per share, but will set us up nicely in fiscal 2015 to cover the net earnings per share dilution related to the sale of ADT Korea and our remaining interest in Atkore.

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

Now let me turn things back over to George.

George R. Oliver

Thanks, Arun. Let’s turn now to our earnings guidance for the third quarter and our expectations for the full year. We expect revenue in the third quarter to increase 4% year-over-year to approximately $2.65 billion, with organic revenue growth in the range of 3% to 4%.

Additionally, the net benefit from acquisitions and divestitures is expected to contribute a point of revenue growth. This is expected to be partially offset by a $20 million year-over-year headwind related to changes in foreign currency given current exchange rates.

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

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

Now let me update you on our full year guidance. We now expect revenue for the full year to be approximately $10.35 billion, with organic revenue growth of 2% to 3%. Included in our revenue guidance is a net benefit of acquisitions and divestitures, which is expected to be fully offset by a $90 million headwind, related to changes in foreign currency exchange rates.

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

At the beginning of the year we indicated that we expected earnings per share before special items to be in the range of $2.05 to $2.15 for the full year. This included a net $0.20 of earnings per share from our ADT Korea business and remaining interest in Atkore.

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

Given our year-to-date performance and our expectations for a stronger second half of the year, we are tightening our guidance to the high end of the range and increasing it for the impact of share repurchase. We now expect earnings per share before special items for the full year to be in the range of $1.93 to $1.97. This represents earnings per share increase of 18% to 20% over fiscal 2013’s base of $1.64.

Thanks for joining us on the conference call this morning. And with that, operator, please open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question today is from Deane Dray with Citi.

Deane Michael Dray – Citigroup Global Markets Inc.

Thank you. Good morning, everyone.

George R. Oliver

Good morning, Deane.

Antonella Franzen

Good morning.

Deane Michael Dray – Citigroup Global Markets Inc.

It was interesting unlike some of the companies that have reported so far this quarter, you heard the term weather interruptions and I can’t help, but think and some of your truck world’s installations had some interruptions. Any chance you can size for us what you think that was and what are the phases for next quarter about recouping that?

George R. Oliver

Sure, Deane. Let me start by saying, when you look at our Installation & Services into North America, it’s roughly about $4 billion, pretty significant business for us. Second quarter is typically our seasonal low quarter to begin with as there is normally weather-related issues that we experience. I’d say that this year was a little bit worse than what has been historically. And I think when we sum up, it’s hard to put an exact number on it, but there’s probably headwind of about $0.01 for us within the quarter.

Deane Michael Dray – Citigroup Global Markets Inc.

Great. And then for Arun, I don’t try to pin you down too specifically on this, but on the buybacks where you’ll be offsetting all of the dilution from South Korea and the joint venture, at what point do you think you hit that offset? You said 2015. Is that an exit run rate, is that a mid-year? Any chance you can be more precise at this stage?

Arun Nayar

Deane, we’ve gone to buy back shares as quickly as we can. And as I mentioned in my remarks, our expectation is to buy back about 30 million shares during fiscal 2014. We will continue that effort into 2015 and our expectation is for the full year of 2015 we would be able to offset the entire net $0.20 of dilution from the sale of ADT Korea and the remaining interest in Atkore.

Deane Michael Dray – Citigroup Global Markets Inc.

Great. Just lastly one clarification. When you commented on April and seeing the nice pickup, was that on installation orders or was that broadly for Tyco as a whole?

Arun Nayar

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

Deane Michael Dray – Citigroup Global Markets Inc.

Got it. Thank you.

Operator

Thank you. The next question is from Jeff Sprague with Vertical Research.

Jeffrey T. Sprague – Vertical Research Partners, LLC

Thank you. Good morning, everyone.

George R. Oliver

Hey, Jeff.

Jeffrey T. Sprague – Vertical Research Partners, LLC

Just a couple of things. First, George, your commitment to the 2015 plan was pretty clearly stated there in your opening comments and we see the composition of margins will look different with ADT tax out of Rest of World. Can you give us kind of a framework of what we should expect for margins in that business now going forward, how much room for recovery is left there?

George R. Oliver

Let me start, Jeff, by going back to the 2015 plan that we put into place. When you look at the macro environment that we had forecasted at that time, we have seen additional softness from that period of time, mainly in Europe and then more recently in Australia. But that all being said, we’ve been operating. From an operation standpoint, we’ve been delivering very strong operations being able to offset some of that macro pressure that we’ve seen over the last couple of years. On the margin rate, when you look at the Korean business, it certainly was a nice contributor to revenue. It’s been running roughly mid-single to upper single digits from a growth standpoint. When you look at the margin rates, I mean it has an impact on the rest of the world by about 140 basis points. So overall, it’s a very attractive business, and that being said the growth was slowing, it was requiring a higher level of capital to maintain that business, which has ultimately what led us to divest the business.

Now, when you look at the new reported segment, not the new reported segment the update on the segment, it would impact the segment by, like I said, 140 basis points, but for the whole company, we now have done 15% to 16% segment operating margin. We will be positioned to deliver 14.5% to 15.5%. So it’s roughly about a 50 basis point impact on the total company.

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

Jeffrey T. Sprague – Vertical Research Partners, LLC

Okay. And then our North American Install, did you see the revenue inflection there in the third quarter? Are we kind right at that inflection point at this juncture?

Arun Nayar

Yes, what I would say Jeff, when you look at orders – let’s look at orders, because when you look at, what’s most important is the backlog. So our backlog year-on-year in total for the company is up 6%, it’s up 3% on a sequential basis. These quarterly compares are tough because of the lumpiness that we see within our installed orders. I will get the, when you look at the dollar value of the orders that are being generated. They have been higher than the average that we’ve had here over the last period, last couple of years.

And so that’s what is building the backlog. And so, in the quarter we are actually – we delivered 1% organic growth in North America which was a little bit better than what we originally thought. The order range that we see coming through and the pipeline that we are looking at for the second half, we feel very good about. And that supports our ability to be able to originally in North America we said, we were going to be somewhat flat for the total year being down in the first half up in the second half flat.

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

Jeffrey T. Sprague – Vertical Research Partners, LLC

And then just finally, your comment on share purchases is pretty straight forward. It does appear that you’re not planning on deploying all of the caps on that core proceeds year before, year end, presumably saving some powder for deals. But it would seem that you have some powder just on the balance sheet to do deals. And am I correct that, at build are you holding back some cash for M&A? And maybe little color on what the pipeline looks like?

Arun Nayar

Yes I would start by saying that, we are focused everyday in creating the long-term shareholder value. Now the priority is M&A and we continue to review a pipeline of potential deals at varying sizes. We are always going to be very disciplined in our approach into doing these deals. And with the timing Jeff, timing is the factor, we don’t see any sizable deals in the near-term, which has led us to, we are going to try to do as much of the buyback as we can in the second half. We’ll continue to have capacity to be able to support the deals that we have in the pipeline, which we believe is the best allocation of capital for the future. We are not going to sit on cash, which is ultimately what led to the estimate of about 30 million shares in the second half, but we certainly are confident that if we have a deal come up that we’re going to be positioned to be able to execute on.

George R. Oliver

Yes. And Jeff, just kind of building on that point fairly, we will have capacity as well. So our intention is to use as much of the cash, as fast as we can that’s profitable and smart way of doing the buyback, and then needing capacity on our balance sheet for transactions in addition to that.

Jeffrey T. Sprague – Vertical Research Partners, LLC

Perfect. Thank you very much.

Arun Nayar

Thanks Jeff.

Operator

Thank you. The next question is from Nigel Coe with Morgan Stanley.

Nigel Coe – Morgan Stanley & Co. LLC

Thanks good morning. Yes, so we just wanted to begin with that move into the April order pickup and it sounds like it’s meeting North America, correct if I’m wrong or is it more both on than that. And to what extent you think this is product shift from 2Q business deal like it is. And secondly, could you give us any color in sense of verticals where you are seeing that strength in pickup?

George R. Oliver

Yes. I would say Nigel, the pickup that we see is really across the board, its across North America, rest of world, as well as our product businesses continued to perform very well. I’ll spend a little bit time on each segment, if you look at North America. We’ve been seeing a pickup on the front-end of the business. The recovery is a non-residential construction and that’s mainly in our fire business and that continues.

If you look at the ABI, the ABI suggested it went down again, but the feedback that we get from the field is that the activity is strong, we’ve got a nice pipeline, we’re executing and we see that continuing in North America.

If you look at Europe, we continue to perform very well. There has been modest organic growth in the second quarter. That’s been service continuing to grow, products continuing to grow, install was relatively flat. But I think, we’ve got those businesses now repositioned to be successful with whatever recovery happens there, we’re going to be well positioned to be able to capitalize on that.

We’ve talked a little bit about Australia, it is a big market for us. It’s about 7% of our total revenues. Without Korea, now it’s about 20% of our rest of world. It’s a split up of both fire and security with about 70% service.

Now mining, the mining industry in Australia is down, down I think by about 30% to 35% and that’s one of the strongest verticals that we have in that market. Debt has positioned us to be down double-digit for the year. But as I said, I have been with the team there and we’re executing all of the initiatives to really be positioned to maintain the fundamentals, and then be able to capitalize in the recovery when it does happen.

And so, the last is in the growth markets, China we continue to execute well in China. We’re up by 20% organically in the second quarter. It’s a relatively small business for us, a nice pickup in install as well as products. We are continuing to make the investments that are needed to be able to capitalize on that market. And we think that, that growth rate will continue with the business that we have there.

And so overall, we’ve seen a lot except for the exception of Australia, we’ve seen a pretty good pickup in orders across all of the business, across the regions.

Nigel Coe – Morgan Stanley & Co. LLC

And then maybe George can you just talk about the, some of the counter measures you have taken in Australia to maintain the fundamentals of your product. And then, just taking the mining business is specifically 30% of that business, as you mentioned, is service. So it sounds like the big dip we saw this quarter is more temporary than structural. Can you maybe comment on that, please?

George R. Oliver

When I say that we drive the productivity initiatives, which deliver about, like we said from day one, $150 million plus of productivity on an annualized basis, all of the initiatives that we have in place, they’ve been executing well across every one of them, so optimizing the branch network, driving sourcing savings, driving functionalization locally so we can then be able to reduce the structure that we have there in line with the revenue decline that we’ve seen. So I would say across all of our initiatives they’re executing extremely well, maintaining the fundamentals in spite of the decline of the revenue that we’ve experienced.

Now that being said, we’ve got a tremendous business there. I mean, mining is a very attractive vertical. We’ve got suppression systems that not only get mounted to the heavy equipment, but then we get to service over the lifecycle and maintaining those systems. It’s a tremendous business for us.

Our mix in Australia is about 70% service. And so we have seen an impact on the service there, short-term. But once that starts to pick up again, that service will come back. And that service business has an impact of about – when you look at our service growth rate about 1% percent. It’s actually about 1% to 2% of our growth rate, I mean Rest of World on the service side. So we are – based on my business there, I feel very good about the business. The team is doing all of the right things and we’re going to be very well positioned to be able to capitalize in the recovery.

Nigel Coe – Morgan Stanley & Co. LLC

And, George, any visibility on when it might come back, could it be in second half of this year? We’re looking at 2015.

George R. Oliver

We’re not sure that we’ve seen the bottom yet, although it seems to be slowing. The decline seems to be slowing. We’ve put a lot of resources and making sure that we’re positioned to capitalize on other growth within the market. But I would say our feeling is that in the second half hopefully we get into more of a stabilization and that that will start coming back in 2015.

Nigel Coe – Morgan Stanley & Co. LLC

Great. Thanks.

Arun Nayar

I was talking about the bidding activity, but we’re looking at in April and the pipeline over there. There are one or two large orders that we’re looking at in Australia that may not impact the revenue stream in 2014, but certainly will set us up nicely for 2015.

Nigel Coe – Morgan Stanley & Co. LLC

Great. Thanks a lot.

Arun Nayar

Thank you.

George R. Oliver

Thanks, Nigel.

Operator

The next question is from Steven Winoker with Sanford Bernstein.

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Thanks and good morning. George, congrats on the sale of ADT Korea, great timing.

George R. Oliver

Thanks, Steve.

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Hey, listen. So on the service growth rate, you guys have talked for a while strategically about moving that growth rate up from 3% to 4% to 5%. Just this one quarter I guess we’re looking at 3% to 4% orders rate growth rate. But could you maybe give us some color on the progress you’re making? In conviction you have about being able to move that up and the kind of timing of that?

George R. Oliver

Sure. When you look at – when you take out Korea from the Rest of World and out of the company, that revenue was full service revenue, right, within the company. So you take that out, the impact that that has on our – and it was growing at mid to upper single digits. And so the impact of that business has on our service growth rate is roughly about 1%, right.

So that would get us instead of getting to a 5% growth rate by 2015 and roughly being the 4% range. Now if you combine that with the impact that we’ve seen in Australia with our service business there, because of the decline, that also has had a pretty significant impact on our service. And that will come back over time by 2015, we see our service growth rate to be somewhere around 3.5% to 4%.

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Right. But the initiatives that you are taking within driving more out of the installed base, what kind of progress are you seeing there?

George R. Oliver

Well, I mean when you look at all of our strategies starts with we’re making sure that we’re focused on projects that play to our strengths that we embed technology where we then derive the service longer term over the lifecycle of that installation.

The second part is that we’ve been putting additional capacity in place across all of our markets. And that making sure that we fill gaps that we have with technicians, we’re adding sales peoples in areas that maybe we didn’t have good penetrations for all of the initiatives combined we’re getting a better installed base, expanding our footprint of service, is what ultimately read to get into that growth rate, and service to 3.5% to 4% by 2015.

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Okay, great and Arun, could you maybe remind us of your return on capital hurdles and metrics for the M&A, if you are going to do, I mean I know you guys have been very explicit by your desire to do that took advantage of the current environment to sell assets. But given that pricing levels maybe continuing to elevate. Could you help us understand what those are, that flow through again?

Arun Nayar

Sure Steve, as we’ve talked about in earlier calls we go through a string of financial metrics as we look at any transaction. And just as a matter of fact, just if we look at this past quarter there are couple of transactions that we would kind of clearly advanced stages in discussions, but we didn’t conclude. Because it did not meet our criteria, so we are deploying this financial discipline with rigor on a daily basis.

And there is a number of things we do, we talked about the ROIC being excess of that. We talked about the EPS accretion being there by the second year, but more important than anything else is the fact there has to be a strategic fit with our long-term strategy.

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Right, and by just to remind me when you do, do these deals that are out of plan you do change the plan incentives to adjust for the deal impact.

Arun Nayar

Yes, we do make the changes to the incentives for the year.

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Great and sorry one last thing, just given the surplus growth as we – on the installed site, can you as you sort of see that progressing and you talked a lot about focusing on the backlog etc, but should this North American recovery pickup speed to kind of a historical level where you’ve been through this before. Where might that instillation growth had? Is it mid-single, high single-digits and how do you think about that?

George R. Oliver

All the non-resi recovery comes about and the speed with which it would comes about, so it is difficult to say how it is going to do it. As we look at 2014, as George mentioned initially we were talking about being flattish in North America, now we are looking at about a percent organic growth from North America just based on where we are today at the backlog and the order activity. Going into 2015 it’s going to be more driven by the speed of the non-resi recovery.

Steven Eric Winoker – Sanford C. Bernstein & Co. LLC

Okay, great thank you.

George R. Oliver

You’re welcome.

Arun Nayar

Thanks Steve.

Operator

Thank you. The next question is from Scott Davis with Barclays.

George R. Oliver

Good morning Scott.

Scott R. Davis – Barclays Capital, Inc.

Hi, good morning guys.

Arun Nayar

Hi Scott.

Scott R. Davis – Barclays Capital, Inc.

Guys, we used to talk couple of years, we used to talked about trying to find some opportunities in corporate expense to have that be another levered upon, when you think about taking some assets off the books, like ADT Korea and such. Is there an opportunity to slim down a little bit on the corporate expense line, it still seems a little larger than some of your peers?

George R. Oliver

Yes, Scott let me take that one. When you look at our total cost structure that we laid-out back in our Investor Day, going from what we would have to describe as a holding company before to an operating company has changed, as we look at how we functionalize the company, mix of that headquarters cost.

And so we are in the middle of deploying what we call it the Tyco business system and really driving fictionalization that’s allowing us to be able to create shared services that we can leverage in a much bigger way across the scale that we perform. And so we are in a major transformation from a functional standpoint that being said, we are getting to a stage where we can then began to reduce that. As we’ve been enabling the segments to be more efficient with their functional cost going forward we’re going be able to do the same at the headquarters level going forward.

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

Scott R. Davis – Barclays Capital, Inc.

Okay that’s fair. And then, I was just trying to get a sense of your mindset here and one could argue that if you knew you are going to sell these assets and there is going to be some dilution that you’ll get ahead of it, and start buying back stock, about the time that the deal was announced or maybe even before than anticipating. I mean, (indiscernible) is that I mean, did you think it all about that taking a chunk of that to get ahead of the curve on the buybacks just to offset the dilution?

Arun Nayar

Scott, keep in mind that we’ve been working on this ADT Korea transactions for a while now. And while we have been working on it, we’ve been kind of prevented from being in the market.

Scott R. Davis – Barclays Capital, Inc.

Okay.

Arun Nayar

That’s the big factor.

Scott R. Davis – Barclays Capital, Inc.

That’s a fair point. And just to be clear when I look at, just final quick one clean up here, if you look on Slide 7, install orders, I know you have talked about this, but are we going, we were down 3% this quarter, will fiscal 3Q those orders turn positive is that what we are seeing?

Arun Nayar

Yes, among…

Scott R. Davis – Barclays Capital, Inc.

Between talking orders…

Arun Nayar

If you look at our pipeline of orders and the activity that we currently see that’s going to continue to get positive. It will continue to be positive, what’s critical here Scott is, when you look at the pure dollar volume and not the delta year-on-year that continues to expand. And that’s what’s enabling us to be able to build the backlog. It’s up year-on-year. As we continue to deliver very nice orders, the pipeline that we currently have is a good, as I have seen over the last couple of years that we are currently working on.

Scott R. Davis – Barclays Capital, Inc.

Okay, that’s a great color, I’ll pass it on. Thank you.

Arun Nayar

All right thanks.

George R. Oliver

Thanks Scott.

Operator

Thank you. The next question is from Steve Tusa with JPMorgan.

Stephen Tusa – JPMorgan Securities LLC

Hi, good morning.

Arun Nayar

Good morning, Steve.

Antonella Franzen

Good morning.

Stephen Tusa – JPMorgan Securities LLC

So can you just help us there is a lot of moving parts here, so basically just walk us from the midpoint of the prior range to the midpoint of this range, and I guess, I’m just thinking about the $0.04 to be insurance settlements, the $0.02 of accretion, $0.01 from I think interest expense or corporate or something like that. Are those kind of all of the items that are contemplated? Is there any kind of change, some headwind obviously from the Atkore sale? So are those kind of all of the moving parts maybe just operationally? Do you guys change your guidance outside of those items?

Antonella Franzen

Steve, let me take that one. So when you take a look at our previous guidance that we had put out there, it was $2.05 to the $2.15. And like we said the net impact of Korea and Atkore is about $0.20 a dilution. And really what we’re doing, so that get you to the wide range of $1.85 to $1.95 when you add that $0.02 of share repurchase, it gets you to $1.87 to $1.97 and we tied ended up to $1.93 to the $1.97 range.

The other puts and takes that you mentioned, I mean keep in mind the insurance recovery was really a matter of timing that we had in the year and we got the recovery related to that policy in the second quarter. So that was kind of always part of the guidance that we had put out there.

And yes, interest expense did go down a bit because we now have the proceeds, but keep in mind FX is now a headwind to us from about $0.02 from where it was at the beginning of the year. So it’s really the below the line items really offset. So your two main drivers again it really the previous guidance, the current guidance and Korea and Atkore and then the share repurchase.

Stephen Tusa – JPMorgan Securities LLC

Okay. And then by – you’ve given us organics for North American install. And I think you’ve given us some visibility on the Rest Of World stuff, and the other kind of updates on the segment guidance for margins or revenue growth that you want to call out to get people kind of set into the final two quarters here.

Antonella Franzen

Right. So from the North America perspective, George and Arun both mentioned we were originally at flat for the year, we now expect to be up at about 1%, I would say the margin expansion we had put out there continue to hold. We expect to be up somewhere in the range of 100 to 130 basis points for North America. And our guidance for global product has not changed. As you know, we had some shift within the quarters with the delay of the new (indiscernible) add mid single-digits organic growth with an operating margin 0.5% or so and that we continue to stick with us well.

Stephen Tusa – JPMorgan Securities LLC

Great. And one last question, you mentioned, you feel good about the April order rates, what does feel good mean, maybe if you could give us a little bit more precision, I mean, just in the context of you did 4% against an easy comp last quarter you did, 3% against a little bit of a tougher comp that you highlighted this quarter. There is some noise around the lumpiness. Maybe how good is April and is that really kind of a clean number given all the noise around, I don’t know, Easter and whatever else is going on out there.

George R. Oliver

Yes, Steve. What I would say is again it goes back to when we look at the dollar value of the orders that we’re generating. And if you look at the month of April in line with what we saw in the first quarter, second quarter continues to improve. And so when you average that with the kind of in the mid to upper single digits related to the activity that we see, and then we have a very strong pipeline of projects that we’re currently working on that we feel confident that we’re going to get more than our fair share and that will bode well for setting up 2015.

Stephen Tusa – JPMorgan Securities LLC

Okay. So April orders are mid to high single-digits is what you’re saying like-for-like relative to the 3 to 4.

George R. Oliver

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

Stephen Tusa – JPMorgan Securities LLC

Okay. Mid single digits. Okay. Great. Thanks for all the detail, I appreciate it.

George R. Oliver

Great, thanks.

Operator

Thank you. The next question is from Julian Mitchell with Credit Suisse.

Julian C. H. Mitchell – Credit Suisse Securities LLC

Hi, thanks. Yes, I just had a question on the rest of world clean kind of operating margin. I think it was down about 40 bps in Q2 of a flat sales number. And I guess your guidance for the second half implies a slight year-on-year growth in the second half in the margin. But the similar organic growth is what you had in Q2.

So I just wondered, how confident are you that margin can swing around. And is that something that we see in Q3 or it’s more towards the back end of the fiscal year.

George R. Oliver

Let me start, when you look at the growth, it actually was 2% organic growth in rest of world. And as we look at the business on the operating margin, there is always going to be puts and takes. Right so, we certainly got the $21 million in joint recovery but that’s been somewhat offset by the softness that we’ve seen in Australia, we’ve seen a double-digit decline, a strong double-digit decline in the second quarter, but the total year is going to be double-digit but I believe that we’re going to be well positioned be able to recover when that economy recovers.

Now at the same time when the revenue, the first line revenue, we’ve continued to make investments in our growth markets. And so we have not stopped investments, we’re making which is going to position us well to be able to capitalize in that growth opportunity going forward.

So there is really no concern as far as being able to get to the margin rates, longer-term that we committed for 2015. It’s really an output of all of the productivity initiatives that we are driving, sourcing, simplifying the branch network, being able to functionalize our functional cost and then with that leverage with the volume coming back will be well positioned to be able to do it on the margin targets.

Julian C. H. Mitchell – Credit Suisse Securities LLC

Thanks and then on the acquisition outlook, you sound fairly confident that’s European U.S. non-res markets were a trough and yet see – you can’t see the rationale behind doing a big acquisition. So I just want to know is that because, it’s an issue of valuation, it’s an issue of – you don’t want to risk upsetting the cost reduction with the disruption of a big deal or is it because you kind of still figuring out strategically where you want to put the majority of your M&A money.

George R. Oliver

Look it does go with the strategy. So the size of an acquisition isn’t really an issue, it’s really our focus on the strategic value and then making sure that we’re getting that for the right price. When we look at our industry, the rise in changing market dynamics, there is an increased focus on technology which we want to make sure we stay ahead of as well as the expanding demand of our customers and the type of solutions that they are asking for.

And so our focus is to stay ahead of these market trends making sure that we’re leveraging the debt and expertise that we have within product security, in turn we’ll be well positioned to be able to capitalize on the growth going forward. So like we said, if we’re going to continue to be very discipline with the deals that we do, with the approach that we take and it’s going to be regardless of the transaction size, that we pursue.

Julian C. H. Mitchell – Credit Suisse Securities LLC

Understood. And then just very quickly and lastly, the mix boost to the margin in global products that you talk about in Q2, was that related to the Air-Pak X3 or that was related to other products.

George R. Oliver

Our product businesses are performing extremely well across all three platforms by a product, security products in life safety. So the 2% organic growth originally we thought will be somewhat flat, that performance was driven by a strong performance across all three businesses. Now there was minimal shipment of the X3s late in March, but that was pretty insignificant. Now because of that, with the backlog that we had at the end of the quarter, we expect to have low double-digit organic growth in the third quarter as a result those Air-Paks.

Now when you look back, the Air-Paks had a 2% impact in the first quarter on our organic growth, it had 3% in the second quarter. Now we’ll be able to deliver let’s say about 11% organic growth in the third quarter, if the total year, now being on target to deliver the mid single-digit organic growth.

The margin, we are getting tremendous execution here not only in executing on new products within all three platforms, we’re executing on pricing and we are executing the productivity initiatives extremely well. That is what is contributing to the margin expansion and that’s along and to make the reinvestment while we’re continuing to expand the margins as you’ve seen and so we’re going to be well positioned to be able to deliver not only on the mid-single digit organic growth but margins that will be roughly about 18.5% for the year.

Julian C. H. Mitchell – Credit Suisse Securities LLC

Right, thank you.

Antonella Franzen

Operator, I think that’s going to conclude our Q&A. I do want to pass it over to George Oliver for a couple of closing comments.

George R. Oliver

Thanks, Antonella. And thanks again for joining our call this morning. I want to reiterate that I’m very pleased with our second quarter performance which caps up a strong first half of the year. This foundation puts us on a great path to achieving not only our full year guidance for 2014, but delivering on our promise of a three year 15% earnings per share to 2015. Operator that concludes our call.

Operator

Thank you. This concludes today’s conference. Thank you for participating. You may disconnect at this time.

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