Tyco International's (TYC) CEO George Oliver on Q3 2014 Results - Earnings Call Transcript

Jul.25.14 | About: Tyco International (TYC)

Tyco International Ltd. (NYSE:TYC)

Q3 2014 Results Earnings Conference Call

July 25, 2014 08:00 AM ET

Executives

Antonella Franzen - VP of Investor Relations

George Oliver- Chief Executive Officer

Arun Nayar- Chief Financial Officer

Analysts

Steven Winoker - Sanford Bernstein

Deane Dray - Citi Research

Scott Davis - Barclays

Steve Tusa - JPM

Julian Mitchell - Credit Suisse

Gautam Khanna - Cowen

Nigel Coe - Morgan Stanley

Ajay Kejriwal - FBR Capital Markets

Brian Denes - Imperial Capital

Operator

Welcome to the Tyco’s Third 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 third 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.

During the fiscal third quarter the company decided to sell certain businesses previously reported within the rest of world installation and services operating segments. These businesses generated $41 million of revenue in fiscal 2013 with an operating loss of $11 million. Current and historical results related to these businesses are now classified as discontinued operations.

To recap this financial information for the quarter of fiscal year 2013 as well as the first fiscal quarter and second quarters of 2014 are attached to today’s press release. In discussing our segment operations, when we refer to changes in backlog and order activity these figures excluded the impact of foreign exchange. Additionally references to operating margins during the call exclude 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 $2.7 billion increased 5% over the prior year. Organic revenue growth of 4% and a 2% benefit from acquisitions were partially offset by the impact of divestitures. Earnings per share from continuing operations attributable to Tyco common shareholders was $0.93 and included a net benefit of $0.39 related to special items. These special items related primarily to a gain on the sale of our remaining minority interest in Atkore International, partially offset by restructuring and repositioning charges. Earnings per share from continuing operations before special items was $0.54.

Now let me turn the call over to George.

George Oliver

Thanks, Antonella. And good morning, everyone. Overall, this was a very good quarter for Tyco. The uplift in revenue we started to see last quarter has continued resulting in 4% organic growth. This was driven by very strong performance in products coupled with continued growth in service and supplemented with increased installation revenue for the second consecutive quarter.

Additionally, the momentum in margin expansion continues with a record high segment operating margin before special items of 14.5%. This represents an 80 basis-point improvement year-over-year. The investments we have made to expand to our product capabilities combined with continued improvement in operational execution drove 17% increase in earnings per share before special items.

Before I give a brief overview of the performance from each of our segments, I wanted to spend a few minutes on the general economic environment and what we are seeing geographically in our larger regions.

Starting with North America, demand seemed to have picked up a bit from last quarter coding activity has clearly accelerated, particularly in fire. We are seeing the impact of that in our North America order rates.

Let me spend a little bit of time on conversion cycles. Within the fire and security industry fire is earlier cycle than security. We get involved in the very early stages of a new building with the architects and contractors and this is long before the actual construction of the building commences.

Not only is there a lead time to developing an order but on the fire side of the business, there is a long cycle time from when we receive an order to when the order is converted to revenue. As each project is different, the cycle time in converting orders to revenue does vary greatly, but average is 9 months to 12 months. On the security side, the timing and conversion of orders to revenue is very different. Typically we are dealing with the end customer, say the tenant in the building as the security features such as intrusion, access control and video will be based on the needs of the tenants.

So on the security side; we typically don’t start to see the orders until the construction of the new building is nearing completion. Unlike fire these orders tend to convert to revenue much quicker. Again, it does depend, vary project to project but I would say orders converts on average in a three to six months time frame.

Continuing on to Europe, I would say the environment has been somewhat mixed. In the UK, we are beginning to see a slight pick-up in activity. As part of our transformation to an operating company, we have streamlined our business in the UK and have put the fire and security teams together under one leader. I’ve recently spent time with our team in the UK and I can say they are executing very well. The work we have done over the last few years, coupled with the streamline structure we have in place had significantly improved the business performance. The UK consistently performed at or above the average of our other installation and services businesses and we are well positioned to be able to capitalize on the recovering economy in that region.

On the other hand, the environment in Continental Europe continues to be sluggish. Here too we have streamlined the organization under one leader. Additionally, we have recently made a number of key leadership changes and are continuing to execute on various other productivity initiatives. On a relative basis, we are performing pretty well, but at this point, I wouldn't expect Continental Europe to be a significant contributor to growth.

Moving on to Australia, the softness in mining over the last 12 months and 18 months had certainly had a big impact on the overall economy, including the commercial, industrial and institutional space. I'm somewhat optimistic that we are beginning to see some improvement, although we expect revenue to decline year-over-year for the remainder of fiscal 2014, the operating margin has stabilized, given the many actions taken by the team to maintain the fundamentals of the business. Given order activity in the quarter, which included three sizable wins within the healthcare, transportation and oil and gas verticals, I feel that we will be well positioned to deliver growth in this region in fiscal 2015.

Lastly the Asia market is very attractive for us. We've seen a nice pick up in the commercial, petrochemical, oil and gas and hospitality verticals. This region served as a nice platform for growth for us and it's important to keep in mind that in most of these countries we are starting off with a relatively small position.

Turning to the performance of our businesses for the quarter, our North America Installation and Services segment delivered another solid quarter. Both service and installation contributed to organic revenue growth in the quarter and our continued full focus ongoing after the right end markets that play to our strengths, coupled with our productivity initiatives drove the strong year-over-year operating margin improvement.

In the rest of world installation and services segment, despite some macro pressures we are seeing in particular regions which I spoke to earlier. The team has delivered 2% organic growth driven by Asia and our other growth markets.

Moving on to global products we had a very strong from both a topline and operational perspective. All three platforms contributed to the double-digit organic growth led by life safety. As you may recall, we received approval from the National Fire Protection Association for our new Scott Air-Pak X3in late March.

We have been building backlog in anticipation of the approval and we're able to convert that backlog to revenue in the third quarter. This coupled with a very strong performance in security products and fire protection products resulted in our highest revenue and operating margin quarter. Overall, I would summarize our third quarter performance as very strong. I am proud of our teams across the globe for not only delivering strong operational results but for all of their efforts in transitioning from a holding company to an operating company.

Over the last two years we have made numerous management changes realigned organizational structures and are in the process of transforming many functional areas. As we all know, change is not easy and despite this we’ve continued to deliver quarter after quarter and we’re well positioned to deliver on our three year EPS CAGR of 15% through fiscal 2015.

Turning to capital allocation, we completed the previously announced divestiture of ADT Korea and the sale of our remaining minority interest in Atkore International during the third quarter. As I outlined during the last quarterly earnings call the $2.2 billion in proceeds we received in these two transactions are being quickly put to work returning capital to shareholders via share repurchases.

Over the last three months we’ve repurchased 20 million shares for $876 million and we expect to continue repurchasing shares throughout the remainder of this fiscal year. In total we continue to target 30 million shares being repurchased in the second half of fiscal 2014. It is important to note that while the benefit of share repurchases is being utilized to offset the $0.20 dilution from the divestitures that does not prevent us from continuing to pursue acquisitions. Our ability to utilize our strong balance sheet in addition to our free cash flow generation gives us this flexibility.

During the quarter, we completed the acquisition of a commercial and residential security business in Belgium and reached a definitive agreement to purchase a residential security business in Brazil for a total of approximately $45 million.

On an annualized basis, these businesses are expected to generate revenue of approximately $35 million. These acquisitions are good, bolt-ons, can easily the integrated and are quickly accretive as a help to build scale within these regions. The strength of these businesses when combined with our existing platforms position us well to meet the security needs of our customers.

Additionally, technology and innovation are the future of our company and we pride ourselves on being a technology leader. In addition to incremental organic investments in R&D and technology acquisitions, we consistently look for opportunities where our technology and innovative solutions and services can provide near and long-term proven value for customers’ strategic objectives and growth initiatives.

This week, we announced our successful RFID inventory visibility project with Inditex, the largest apparel retailer in the world. At the start of the pilot Inditex was looking for a technology solution to optimize their inventory controls, improve in-store processes and increase loss prevention measures. As we partnered with Inditex to implement this solution Inditex has been able to leverage our products and RFID technology in 700 stores across 22 countries to deliver significant operational values.

Our RFID technology solutions enable real time accurate merchandise insights across all stores allowing Inditex to better accommodate their customer needs online and in store locations enhancing their customers’ shopping experience.

This is one of many example where we are committed to providing our customers with differentiated products and services focused on solving their most critical needs and equipping them with technology solutions and future service that can be leveraged to provide additional value as their business needs evolve and grow.

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

Arun Nayar

Thank you, George and good morning everyone you can follow my comments on our financial performance starting with slide four, let me start with an overview of our results for the third quarter. Revenue of $2.7 billion grew 5% year-over-year organic revenue grew 4% which is the highest organic revenue growth quarter since separation with all three segments contributing to this growth. Products grew 12%, service grew 1% and installation revenue growth accelerated to 2% from the 1% growth we saw last quarter.

Acquisitions contributed 2 percentage points of growth and were partially offset by a 1 percentage point headwind related to divestitures. The four special items, segment operating income increased 11% to $386 million and the operating margin improved 80 basis points year-over-year to 14.5%. Higher revenue, improved execution, 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 17% year-over-year with operations contributing $0.07 of the increase. Orders in the quarter grew 3% year-over-year with 3% growth in service, 4% growth in installation and 3% growth in products. As you know, the year-over-year percentage change in orders is impacted by the timing of large installation orders, which can skew the year-over-year comparisons.

A better indicator of future top-line performance is backlog, which increased 3% year-over-year to $5 billion. On a quarter sequential basis, backlog was flat, as we shipped a significant amount of X3 Air-Paks, which have been building in backlog over the last couple of quarters.

Given the seasonality of our business, backlog normally grow sequentially in the first, second and third quarter. We typically see a seasonal decline in backlog in the fourth quarter, as a significant amount of electronic fire upgrade work is performed in schools during the summer break. We expect this trend to continue in the fourth quarter of this year as well.

Now let’s get into the details of each of the segments, starting first with North America Installation and Services on slide seven. Revenue in the quarter of $968 million was flat on a reported basis as organic revenue growth and the benefit of the Westfire acquisition were offset by the divestiture of our Canadian guarding business and unfavorable changes in the Canadian dollar exchange rate.

Service revenue grew 1% and the installation revenue turned positive with 1% growth for total organic revenue growth of 1% in the quarter. Before special items, operating income in the quarter was $134 million and the operating margin of 13.8% increased 170 basis points year-over-year.

Improved execution and the benefits of restructuring and productivity initiatives drove the operating margin improvement year-over-year. Overall, orders grew 5% year-over-year in North America installation and services with service orders increasing 2% and installation orders increasing 9%.

As I mentioned earlier, order rates can be lumpy, particularly in the installation business and can fluctuate from quarter-to-quarter. For example, this quarter was favorably impacted by several large orders, both in fire and in security. Key verticals contributing to the installation order growth included retail, oil and gas, government and the general commercial space.

Backlog is the key indicator of future revenue growth. And the third quarter backlog in North America Installation and Services reached $2.5 billion. This represents a 1% increase on both a quarter sequential basis and year-over-year.

Turning to slide eight, Rest of World Installation and Services, revenue of $1 billion grew 3% year-over-year; service revenue grew 1% and installation revenue grew 4% for total organic revenue growth of 2% in the quarter. Increased revenue in Asia and our other growth markets was partially offset by a decline in Australia. Acquisitions contributed an additional three percentage points to growth and divestitures negatively impacted growth by two percentage points.

Before special items, operating income was a $112 million and the operating margin declined 30 basis points year-over-year to 11.2%. The benefits of ongoing productivity initiatives were more than offset by the mix of businesses contributing to growth as well as a lower percentage of higher margin service revenue.

In the third quarter, overall orders increased 1.5% year-over-year in Rest of World Installation and Services. A 4% increase in service orders was offset by a 1% decline in installation orders driven by a tough compare with the prior year. Backlog of $2.3 billion increased 8% year-over-year and was flat on a quarter-sequential basis.

Turning to Global Products on slide nine, revenue was 15.5% in the quarter including a 3% benefit from the acquisition of Exacq Technologies to $693 million. Organic revenue grew 12% with strong growth across life safety, security and fire protection products. About five percentage points of growth was related to the timing of shipments of the new Scott Air-Pak X3.

Operating income before special items was a $140 million and the operating margin expanded 40 basis points to 20.2%. Leverage from increased revenue as well as productivity benefits drove the operating margin expansion. This was partially offset by the timing of incremental investments in R&D and a headwind from non-cash purchase accounting related to the acquisition of exact technologies, which together impacted the operating margin by 150 basis points. The better than expected revenue growth stand from a somewhat different mix within the business platforms than we had anticipated, which resulted and an operating margin before special items being slightly below our guidance of 20.5%.

Now let me talk on a few other items on slide 10. Corporate expense before special items was $58 million for the quarter, and our effective tax rate for the quarter before the impact of special items was 16.9%. As George mentioned, we saw that repurchasing shares during the third fiscal quarter, resulting and weighted average diluted share count of 466 million shares. We expect to continue repurchasing shares for the rest of the fiscal year, resulting in weighted average diluted share count of approximately 450 million shares for the fourth quarter and 465 million shares for the full year. We expect to exit the year with a diluted share count of approximately 442 million shares.

Now let me turn things back over to George.

George Oliver

Thanks, Arun. Let's turn now to our earnings per share guidance for the fourth quarter and what that implies for the full year. We expect revenue in the fourth quarter of approximately $2.73 billion with organic revenue growth of approximately 3% and a modest tailwind from favorable changes in foreign currency exchange rates. We expect continued solid operational execution of a very strong fourth quarter of last year.

Year-over-year, operations are expected to contribute about $0.05 per share of incremental earnings. Below the line items are expected to contribute an additional $0.03 per share driven by lower share count. As a result we expect the earnings per share before special items in the fourth quarter to be in a range of $0.54 to $0.56. As Arun mentioned, this based on a weighted average diluted share count of 450 million shares. This represents a 15% to 19% increase in earnings per share year-over-year, compared to last year’s fourth quarter recasted earnings of $0.47 per share.

With that, we are tightening our full year guidance range to the high end of our previous estimate of $1.93 to $1.97 and adding a $0.01 benefit related to the discontinued operations reported this quarter. Our revised full year guidance range is now $1.96 to $1.98 per share which represents an 18% to 19% increase year-over-year of a recasted base of $1.66 per share in fiscal 2013.

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

Question-and-Answer Session

Operator

(Operator Instructions). The first question today is from Steven Winoker with Sanford Bernstein.

Steven Winoker - Sanford Bernstein

Thanks and good morning.

George Oliver

Good morning, Steve.

Antonella Franzen

Good morning Steve.

Steven Winoker - Sanford Bernstein

Hi, just on Australia, would you like clarifying how much is that was the impact on the quarter? And then how does it play into that fourth quarter guidance of $0.54 to $0.56 that you just gave up?

Arun Nayar

Well, Australia Steve as you know is about 20% of our rest of the world revenues. And in the quarter the Australian revenues dropped just in the high single-digits year-on-year. And our expectation is that as we go into Q4, the drop, it will decline. So it's a declining drop. And with the order intake that George referred to you in the quarter, we expect that when we go into 2015, we will start to see the pickup in our revenue.

Steven Winoker - Sanford Bernstein

Okay. So, I mean when you go into fiscal 2015 and that pick up, is it as early as Q1 or you thinking more like later in the year for that?

George Oliver

Yes, I think Steve it's going to be flat in the first half and start growing in the second half of fiscal 2015.

Steven Winoker - Sanford Bernstein

Okay, great. As George….

George Oliver

I will comment on that Steve, we are very optimistic given the type of projects that we're now in the process of developing and with the most recent wins that we've had, gives us confidence that we are going to be position to be able to deliver growth in 2015.

Steven Winoker - Sanford Bernstein

Okay, great. And then on the M&A front, George you talked about that the buyback would not hinder your ability to move forward on that strategically you mentioned Belgium and Brazil deal. But how should we think about that in terms of the kinds and size the deals from here, your willingness to leverage the company for short-term basis to drive some opportunistically what you are seeing on that front may be some help.

George Oliver

Yes, Steve. We stay very focused on our priorities, the four priorities that we laid out when we launched the new company. So those priorities are technology, number one; continuing to expand our product portfolio, looking to expand our footprint within the high growth markets and then being positioned to be able to accelerate service growth.

What I would say is that when you look at our capital that we have today, our confidence in our earnings being able to continue increase and then the cash flow conversion gives us lot of confidence to be able to continue the buybacks while we're continuing to support the M&A.

The deals that we're looking at today -- we have currently I would say six that are very active, they range from small technology deals that compliment the R&D that we're developing in-house. And then they go up to roughly about $200 million that could be potential product acquisitions indoor bolt ons within our installation and service space.

Certainly the focus is making sure that we've got acquisitions that compliment what we're doing and have strategic value of focusing on the converging market dynamics, technology is a big deal and then making sure that we're going to be positioned to be able to solve our customer problems while we're positioning to grow.

So we are -- we have had to walk away from a couple of deals because of the price as well as, as you get into diligence sometimes things aren't just right. But I think today we still feel pretty good about our ability to be able to execute M&A.

Steven Winoker - Sanford Bernstein

Okay, great. I'll pass it on. Thanks.

Arun Nayar

Thanks Steve.

George Oliver

Thanks Steve.

Operator

Thank you. The next question is from Nigel Coe with Morgan Stanley. Mr. Coe please check your mute button. Move on to the next question, the next question is from Deane Dray with Citi Research.

Deane Dray - Citi Research

Thank you. Good morning everyone.

George Oliver

Good morning Deane.

Arun Nayar

Good morning Deane.

Deane Dray - Citi Research

Hey first clarification on the products business 12% organic revenue was that skewed at all by the shipping of all those backlogs Scott Air-Paks?

Arun Nayar

Yes. I mean we talked about the 12% growth, we had very strong performance across all three of our platforms in the quarter. Now about 5% of that growth was recovery of the backlog that we built up within our Scott safety business with the X3. But overall even without that we had strong performance across all three platforms.

Deane Dray - Citi Research

And then similarly was the margin improvement the 170 basis points how much of that might have been because you’ve built the Air-Paks back in the second quarter and took cost, did you take cost against those, so was there a bump in margin because of that shipment as well as that impact margins?

Arun Nayar

No as you look at our three platforms we have very strong margins across all three, certainly there is a little bit of a higher mix there. But overall when you look at the increased revenue that we achieved was driven by safety. What I would say is that even with that we’re able to offset about 150 basis points of increased investment as well as the non-cash purchase accounting that was tied to our Exacq acquisition.

And so overall we continue to perform very well and we’re confident with the investments that we’re making, we’ll be able to continue this type of performance going forward.

Deane Dray - Citi Research

Great. And just last question for me related to two deals the Belgium and Brazil businesses and these are a bit very different from the bolt-on technology assets that you’ve gone after. So back into some of that more traditional installation and services. How do they stack up in terms of the traditional deal metrics that we would look at ARPU, multiples of monthly revenue and so forth?

George Oliver

Deane, first of all, we have been looking at these kind of transactions. So if you look at five or six transactions we've closed over the last 12 to 18 months, they’ve been a mix of technology as well as in our I&S businesses across the rest of world. So it's consistent with what we've done in the past. And in terms of multiples, as you can see that in imperatively valued acquisitions.

Deane Dray - Citi Research

Okay. Thank you.

George Oliver

You're welcome.

Antonella Franzen

Thanks Deane.

Arun Nayar

Thanks Deane.

Operator

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

Scott Davis - Barclays

Hi, good morning everybody.

Antonella Franzen

Good morning.

George Oliver

Good morning, Scott.

Arun Nayar

Good morning, Scott.

Scott Davis - Barclays

This might be tough to answer, but I'm trying to get a sense of, in North America now your install orders up 9% is a great number. And that -- and what I'm trying to a sense of is kind of post the selectivity initiative, should we assume that these orders are at a price or a margin that's higher than what you historically had? I mean how do you think about that, because that's considering that you are still being relatively selective even though anniversaried that, I would assume that these orders would be fairly attractive. Is that one way to think about it?

George Oliver

Absolutely Scott, we’ve stayed very disciplined, focused on our fundamentals. So that as we're pursuing business that we'll going to be able to not only grow, but grow profitably. So it’s right in line with what our expectations are from a margin standpoint. We've done a lot of work. When you think about the work that’s been done in TIS over the last two years is been phenomenal, we've been able to separate all of our offices with ADT, we collocated half of those offices with our SimplexGrinnell business, we have been able to reprogram almost 0.5 million panels to our monitoring centers. So it’s been a tremendous amount of work positioning that business for the future. We have been investing in technology to make sure that we are going to be differentiated with the type of solutions that we can bring to the market. So what I would say is we are right on track with that plan and the order rate that you have seen over the last couple of quarters is beginning to show the pick-up in the ability to be able to grow the business. And that combined with continued strong performance in fire is really what’s resulting in that strong order rate.

Scott Davis - Barclays

Right. And do you get scale off of this? I mean I know this is labor intensive, can be a labor intensive part of the business but can you get scale off of orders at that level?

George Oliver

Well we have always said when you look at the fundamentals of the businesses, on average now when we grow our product businesses we get good leverage and so we get incremental margins somewhere around 25% to 30%. In the installation and service space with the mix of install we typically get incremental margin somewhere around 15% to 20%. And so when you say off of those orders as those orders come through, we begin to then get the leverage of that volume within the infrastructure that we have across the businesses.

Antonella Franzen

And Scott, the one thing I would add is it does add a nice base going forward for future service growth as well.

Scott Davis - Barclays

Yes. Now for sure I was just trying to get a sense if that there is scale above kind of standard G&A and I think you answered that. Lastly just it’s been a while since we have mark to market the cost out. I mean what inning if you had to put it in baseball terms, I mean what innings you think you are in and the rooftops and the procurement initiatives and all this other stuff that you’ve been working on the last couple of years?

George Oliver

Yes Scott, what I would say there is when we laid out the new company, we knew we had a tremendous capacity to be able to deliver savings with the merger of two very large segments within the old Tyco. What I would say is that in the early stages, we have been delivering significant operational performance on relatively low volume. And the plan is to as we begin to accelerate that volume; we get more of a contribution from the volume that we generate versus the cost up.

What I would tell you is that even with that the pressure on the volume in the first couple of years, we’ve been able to really execute above the plan on the Costo and that's around sourcing, the benefits we're getting out of sourcing, the work that we are doing to simplify our field structure, and then the transformation that's happening across all of our functions.

So, in many cases some of that is further along than others, but I'd say we're in the middle innings. There is still a lot of capacity to be able to continue to improve, drive the company to an operating company structure that's built on functional excellence that allows us to put the resource to work on the front end, solving customer problems and being able to grow the company while we are freeing up the resources on the backside of the company.

Scott Davis - Barclays

Okay. Great, answers. Thanks, congrats on a good quarter guys. And I'll pass it on.

George Oliver

Thanks Scott.

Arun Nayar

Thank you Scott.

Operator

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

Steve Tusa - JPM

Hey, good morning.

George Oliver

Good morning, Steve.

Antonella Franzen

Good morning, Steve.

Steve Tusa - JPM

Can you just say maybe comment little more deeply on the verticals that you are seeing, the most, the greatest inflection in on the kind of the leading indicator side on the fire side?

George Oliver

Sure. Let me start with North America. What I'd say is that we’re continuing to see some strength in the mid-sized commercial. We saw some positive results in the first half that's continuing in the second half. Our government business where we've had pressure in previous years, we actually started to come back and see some nice growth in the first half of this year with some nice growth in service, that's continuing in the second half.

One of the strength for us in the fire business is the institutional space and that's where we're seeing under our real nice pick up in the fire business and will continue to be an area of nice growth. The retail vertical in North America has been very strong for us, has went up nicely. I would say Steve, in North America the one soft spot is in the financial space in banking where it's been a pull back on capital but the indications that we're getting from our customers is that, that might pick up here in the second half.

Steve Tusa - JPM

Yes weakness in financials definitely makes some sense unfortunately for our loss. I guess does this -- can this booking number go into -- that this specific booking number that’s kind of running at the high singles, can that giving that has a potential to kind of move into the solidly into double-digits for an extended period of time I mean is that the kind of wave of biddings you are seeing out there in your pipeline?

George Oliver

What I would say we look at a lot of different indicators and try to correlate what is really happening, so we are encouraged by the ABI that's continuing to be positive which suggest the activity will continue like I said in my remarks. I am feeling confident that the pipeline of projects that we're currently working, are going to translate to some nice orders going forward.

I wouldn't say though we're in a major acceleration of recovery. What I would say is that we feel confident what the type of work that we're working on and how that's going to be able to convert to orders here in the next quarter and position us for continued organic growth in 2015.

Steve Tusa - JPM

Okay. And then how were orders in the, last question I know you mentioned last call the April orders were kind of in the mid single-digits it seems like that was consistent throughout the quarter, correct me if I am wrong. And then how is maybe just little bit update on July on that front?

George Oliver

Yes I would say that the orders profile was consistent during the quarter when you look at our overall activity, install orders can be lumpy and so recognize that there is a little bit of that playing out both in North America on the positive side as well as the rest of world. But on average, we feel very good about the activity and that through the quarter and that’s continuing as we now get into the fourth quarter.

Steve Tusa - JPM

Great. Thanks a lot.

Antonella Franzen

Thanks Steve.

George Oliver

Thanks Steve.

Operator

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

Julian Mitchell - Credit Suisse

Hi. I just had a couple of questions around the M&A in Asia you talked about a very, very good cyclical growth outlook but your exposure there is very small and neither of the deals you announced were in Asia. So just one how the M&A pipeline is there? And then sort of related to that the Brazilian business you bought I think was residential. So I just wondered how you felt about the sort of desirability of M&A residential versus commercial and in fact differs by region?

George Oliver

Yes. I’ll cover on that, on the M&A we’re looking at our pipeline it’s really across the board. So, on the four priorities that we’ve outlined technology expanding our global products portfolio continuing to position our capabilities within the growth market and then looking at bolt-on service acquisitions that will complement the work that we’re doing in service. And so what I would say is really across all those priorities as well as across all of the regions. For instance just to reflect on last year the JVs that we did in China that positioned us to be able to accelerate the depth and expertise that we have in that market which combined with what we’re adapting in organically has positioned us now to grow very nicely within China. So we’ll continue to look at those type of opportunities as we position our capabilities to be able to seize the growth markets.

When you look at the overall M&A activity. We're not going to do acquisitions for the sake of acquisitions and we think very disciplined especially with the current valuations and how we're executing our acquisitions and they've got to be strategic and they've got to be able to deliver the financials that are expected to be able to be positioned to deliver increase shareholder value.

Arun Nayar

And Julian on the Brazilian piece of your question it's really building on an existing business that we have and the monitoring of residential security and this gives us biggest camp. So it's a very good synergies there.

Julian Mitchell - Credit Suisse

Thanks. And then just secondly you talk about how the UK, you've made very good progress on the restructuring that now seems if kind of Continental Europe, you are trying to do a similar thing, maybe just give us a sense of, I don't know 20 or 50 leaders in Europe let's say how much of that has changed in the last 12 months. Just to give some sense of how kind of radical the change in Europe is?

George Oliver

Yeah, I would start by saying is we have launched the new company, when we look at our top 300 leaders across the new Tyco. And who is in position today and who is in position when we launched the company. It's been over 50% change in either having a new leader or leaders in new positions across the company. And so as we have transform the company from a holding company to an operating company that has required significant leadership change. And so what we're doing in Europe is right in line with that as we work to make sure we've got the right fundamentals, we've got the right structure, we've got the right leadership it’s all part of that to make sure that we're position to be able to invest and then be able to deliver increase returns for those investments.

Julian Mitchell - Credit Suisse

Great. Thank you.

George Oliver

Thank you.

Operator

Thank you. The next question is from Gautam Khanna with Cowen.

Gautam Khanna - Cowen

Good morning thanks.

George Oliver

Good morning Gautam.

Antonella Franzen

Good morning, Gautam.

Gautam Khanna - Cowen

I wanted to follow up on the comment you made about the differences between fire and security in the backlog to sales conversions just how do you look at the overall North American backlog, today has the average duration of that extended and if so how does that compare to maybe 6 or 12 months, is it a six months conversion or average or is it a nine month?

George Oliver

We recognize that over the last year or 18 months that it has been driven fire and fire tends to be a longer cycle, so it’s 9 to 12 months but some projects going out as much as two to three years. And so recognize that we are beginning now to see a pickup in our security side, but the bulk of that increase has been driven by fire. And so that conversion will be on average over the next 9 to 12 months, it will position us as we think about 2015 to be able to continue to accelerate the organic growth that we have been able to achieve here in North America in 2014.

Gautam Khanna - Cowen

Okay. And you also mentioned kind of being in the middle innings of the returcturing initiatives that you laid out a few years back obviously running ahead of those cost down plans what types of new initiatives on the restructuring side are you looking at and how should we think about the required spend and payback as we move into next year?

George Oliver

Gautam I would start by saying that we are implementing Tyco business system across the entire enterprise. And this is really focused on looking at all of our key work streams and processes and then in line with that really driving functionalization of what we do. And so you can imagine the amount of change that’s taken place, it’s being able to get to the end stage that we believe we can get to that will lean out the company, clean up resources to be able to reinvest and continue to grow. And so what I would say is that a lot of these, some are further along than others, but there is a lot of that's required a lot of change to get to that ultimate in state.

And so I would say that we're going to continue to be able to work the pipeline will continue to deliver significant savings that will allow us to be able to reinvest in the business, while we are continuing to expand margins.

Gautam Khanna - Cowen

And last one, how should we think about R&D as a percentage of sales as we move forward into ‘15 and beyond? Do we expect that to remain at the same level?

George Oliver

Well, R&D I mean when you look at R&D this year, we're up 10% year-on-year. And that’s supporting very nice product growth as well as positioning ourselves to be able to leverage all the success that we've had in each of our product domains. And really now work towards how do we differentiate our enterprise solutions that we put through our direct channel, to really address customers problems and be positioned to be able to create additional value as an enterprise.

And so when we’ve measured that it's really measured on the product revenue which today it's roughly about 10% of the product revenue. But recognize that some of those investments are enabling the differentiated solutions that we're putting into our direct channel to be able to grow installation services.

Gautam Khanna - Cowen

We should expect that to remain kind of at the 10% level?

Arun Nayar

Yes, we've been growing if you look back at products over the last few years, we had we more than doubled the reinvestment of the last five or six years. And then in the last couple of years, it's pretty much been in line with the product growth that we've achieved within the segment.

So, we're going to continue to expand R&D, it will be pretty much in-line with the product growth that we achieved.

Gautam Khanna - Cowen

Got it. Thank you very much guys.

George Oliver

Thank you.

Operator

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

Nigel Coe - Morgan Stanley

Thanks, good morning.

Arun Nayar

Good morning.

George Oliver

Nigel, you're back.

Nigel Coe - Morgan Stanley

I am back, I’m back and better than ever. So just a couple of quick questions, back in the old cycle we have trained to believe that North American margins were better than rest of world margins. And it feel like that's happening right now. I mean -- I guess intuitively it makes sense as well given the high density you have in North America versus the rest of the world. So do you think that structurally as you go forward that North American margins will be better than rest of the world?

George Oliver

Well when you look at the business, when you look at rest of world in the quarter, we're growing very nicely. The mix that is coming out of that is really coming from the growth markets; we're achieving strong teens’ growth year-on-year. And that has a lower service mix within that the revenue that's being achieved in the growth markets. Where we’ve had pressure here recently is out of our more mature markets, Continental Europe as well as Australia that has a much higher service mix. When you look at the fundamentals of the business that we're developing in the growth markets, they are very similar to what we're achieving in the mature markets. It's really just a mix of service that's putting a little bit of pressure on the margin rate.

When you look at our orders that are being generated, we have a high level of confidence that we'll be positioned to grow across most regions and you will see continued margin expansion as a result within the rest of world going forward.

Nigel Coe - Morgan Stanley

Okay, that's helpful. And then secondly, there is a little bit of noise about ADT's ability (inaudible) small commercial market towards the end of this year. And I’d like comment ADT specifically but can you just talk about the North American commercial security markets, your position in the lower and the small business side versus the large business side, maybe just characterize the market share versus catches to that market at the low end versus the high end?

George Oliver

When you look at the security market in North America, it’s very fragmented. And there is no one that’s got any significant share when you look at the amount of players that compete in that market. Certainly, we’re one of the bigger players given the scale and size that we are today. And as we have leaned out the organization and really positioned ourselves really looking to now make more investments in how we go to market to be able to capitalize on that market in a much broader way going forward. So, there is really no sitting players; it’s very fragmented but I think we like our position within North America and with the structure we have in place today, we believe we’re going to be very successful in being able to capitalize on that market and grow.

Nigel Coe - Morgan Stanley

Would you say the fragmentation is even great at the lower end than the largest one?

George Oliver

That is correct.

Nigel Coe - Morgan Stanley

Yes. Okay, thanks George.

George Oliver

Thanks Nigel.

Arun Nayar

Thank you.

Operator

Thank you. The next question is from [Grace Lee] with CLSA.

Unidentified Analyst

Hello?

Antonella Franzen

Hi Grace. Good morning.

George Oliver

Good morning.

Arun Nayar

Good morning.

Unidentified Analyst

Good morning everyone. I guess I would like to dovetail one of the questions that has been asked previously about M&A. We understand that the non-compete agreement that you had with ADT is expiring later this year. And we’ve had a sense that one of the acquisitions you made in Brazil is about residential. So, we’re wondering to what extent Tyco is planning on entering sort of residential or small business space once this agreement expires?

George Oliver

Yes. Let me begin by when we -- just explaining the separation. When we separated the company, we maintained all the residential businesses outside of North America and they tend to be small businesses that are embedded within our commercial security operations across many of the countries.

These are businesses that when we look at our portfolio today, a very attractive, generating nice returns, we're getting good returns on the investments we're making and that's what really stimulated some of the activity in M&A in being able to really expand those businesses within some of those key growth markets.

When we look at North America, we've been very focused on being able to be positioned to lead commercial security. Those are reasons why we separated the company as we did for the residential business that became ADT as well as now with the commercial business being able to really leverage that capability with what we had within the fire protection platform.

And so we're very much focused on making sure that we're going to be positioned to take that combined position and accelerate our growth in North America, while we're continuing to make strategic investments in the other portfolio that we have across the globe.

Unidentified Analyst

Sure. Thank you.

George Oliver

Thanks.

Operator

Thank you. The next question is from Ajay Kejriwal with FBR Capital Markets.

Ajay Kejriwal - FBR Capital Markets

Thank you, good morning.

Antonella Franzen

Good morning.

George Oliver

Good morning, Ajay.

Ajay Kejriwal - FBR Capital Markets

So, on the fourth quarter and sorry if I missed this. But what's the organic growth expectation for global products and Rest of the World segments please?

Arun Nayar

We did not, Ajay we did not actually give any guidance to any of the segment organic growth. We do overall guidance for revenue growth to be around 3% range and a revenue number of 2.73 billion that as George mentioned in his comments.

Antonella Franzen

And Ajay, the only thing I would add is for Global Products, we’ve kind of had skewed organic growth quarter-by-quarter with the X3 shipments in life safety and I would just comment that the fourth quarter goes back to normal activity when typically we are growing in global products in that mid-single digit range.

Ajay Kejriwal - FBR Capital Markets

Got it, that’s helpful. And then rest of the world segment I know there was some comments on Australia you are expecting that decline to kind of moderate, so is there takeaway that organic growth improves a little bit in that segment or how should we think about that?

Antonella Franzen

I would say I would expect it do pretty similar to what you saw this quarter.

Ajay Kejriwal - FBR Capital Markets

Okay. And then maybe one more restructuring separation cost there we're $0.05 in the quarter a little bit higher than last quarter, was that inline with your expectation going in? And then maybe what’s baked into your estimate for the fourth quarter? Thank you.

Arun Nayar

Yes Ajay, the charge for restructuring was very much inline with what we expected we had guided to an annual charge of $75 million to $100 million we still expect to be in that range. In fact as we speak George and I looking at accelerating some actions that were initially planned for 2015 and to the fourth quarter. So we may actually be a little bit ahead of the initial guidance we had given in the $75 million to $100 million.

Ajay Kejriwal - FBR Capital Markets

So the fourth quarter charge should be more than $0.05 I guess that’s…

Arun Nayar

Yes.

Ajay Kejriwal - FBR Capital Markets

Got it, thanks.

Operator

Thank you the final question today is from Jeff Kessler with Imperial Capital.

Brian Denes - Imperial Capital

Hey, good morning guys.

Arun Nayar

Hey Jeff.

George Oliver

Good morning, Jeff.

Arun Nayar

Good morning, Jeff.

Brian Denes - Imperial Capital

It’s actually Brian Denes calling in for Jeff.

Antonella Franzen

Hi, Brian.

Brian Denes - Imperial Capital

Just a quick question, margin across all three segments were nice year-over-year particularly in North America what types of cost cutting measure we anticipate that deepen that level margin trajectory how was in the global product segment?

Antonella Franzen

When we look at I mean all the segments n a lot of the cost of productivity initiatives that we call them are really amongst all three segments. I mean clearly I would say the only one that doesn't impact global products really is our branch network optimization, because that's more on the INS side of the business. But our other productivity initiatives and sourcing initiatives are really across the board, so they help on the product segment as well.

Now clearly we had specifically said for the third quarter, that we would have a margin level in that 20% for Q3, which we did have. I would say the fourth quarter just again, it goes back to its more normal level, expectation where we would be for both the products which is in the high teens.

Brian Denes - Imperial Capital

Okay, alright, great. That's helpful for me. Thanks guys.

Antonella Franzen

Thanks.

George Oliver

Alright. Let me wrap up, again I want to thank everyone for joining us this morning. And I do want to take this opportunity to announce that we will be holding an Investor Day on Friday November 21st in New York City. During our Investor Day, we will provide an update on our strategic priorities and lay out our three year outlook post 2015.

The details and registration information related to the Investor Day will be announced in the upcoming months. I do look forward to seeing many of you soon. And operator, that concludes our call.

Operator

Thank you. This concludes today's conference. Thank you for joining. You may disconnect at this time.

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