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TYCO International, LTD (NYSE:TYC)

F4Q11 & Year End 2011 Earnings Call

November 16, 2011 8:00 am ET

Executives

Antonella Franzen – Vice President Investor Relations

Edward D. Breen – Chairman of the Board & Chief Executive Officer

Frank S. Sklarsky – Chief Financial Officer & Executive Vice President

Analysts

John G. Inch – Bank of America Merrill Lynch

Jeff Sprague – Vertical Research

Steven E. Winoker – Sanford Bernstein

Deane Dray – Citi Investment Research

Ajay Kejriwal – FBR Capital Markets & Co.

Gautam Khanna – Cowen & Company

Operator

Welcome to the TYCO fourth quarter earnings conference call. At this time all participants have been placed on a listen only mode. (Operator Instructions) This 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.

Antonella Franzen

Thank you for joining our conference call to discuss TYCO’s fourth quarter results for fiscal year 2011 and the press release issued earlier this morning. With me today are TYCO’s Chairman and Chief Executive Officer Ed Breen, and our Chief Financial officer Frank Sklarsky. I would to remind you that during the course of the 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 information 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, can be found on the investor relation’s portion website at www.TYCO.com.

Please also note that we will be filing our annual SEC Form 10K later today. Certain items to be discussed during today’s call, including those related to the company’s proposed separation will be addressed in a proxy statement to be filed with the Securities & Exchange Commission. Before making any voting decisions, investors are urged to read the proxy statement regarding the proposed separation and any other relevant documents carefully in their entirety as they become available because they will contain certain important information about the proposed separation. Free copies of the proxy statement, when available, and other documents filed with the SEC by TYCO can be obtained through the SEC’s website as well as through TYCO’s website.

In discussing our segment operations, when we refer to changes in average revenue per user, backlog, and order activity, these figures excludes the impact of foreign currency. Additionally, references to our earnings per share and operating margins during the call excludes special items and these metrics are non-GAAP measures. Again, these non-GAAP measures are reconciled in the schedules attached to our press release.

For 2011, our full year and fourth quarter include an extra week of results compared to the prior year. In order to reflect the true underlying organic growth of the businesses, we have adjusted down both organic revenue growth and orders growth to exclude the estimated impact of this additional week. All references to organic revenue and order’s growth discussed in today’s call exclude the estimated impact of the extra week.

Now, let me quickly recap this quarter’s results. Revenue in the quarter of $4.7 billion was up 14% year-over-year excluding the contribution from the electrical and metal products business in the prior year quarter. Organic revenue grew 6% in the quarter and again, this number excludes the estimated impact of the extra week. Earnings per share from continuing operations attributable to TYCO common shareholders was $0.83 and included charges of $0.09 related to special items.

Earnings per share from continuing operations before special items was $0.92 compared to our previous guidance of about $0.85 led by strong operating results across all businesses as well as a lower than expected tax rate. Now, let me turn the call over to Ed for some opening comments.

Edward D. Breen

Overall this was a very good year for TYCO both operationally and strategically. We had nice top line growth, strong operating margin expansion, a 25% increase in operating income and a 21% increase in earnings per share. Continued growth in our large and stable base of service and recurring revenue, momentum in our late cycle businesses and the sustained benefits of productivity and restructuring initiatives all contributed to the strong operational performance this year.

Additionally, the strength of our market leading businesses has positioned TYCO well for our recently announcement to separate into three independent publically traded companies. This marks a key strategic milestone for our North America residential, commercial fire and security, and flow control businesses. Before I get into our results for the quarter, I want to spend a few minutes reviewing the progress we have made on the key areas of focus we laid out at the beginning of the year: growth opportunities; productivity improvements; and third, capital allocation.

Starting with growth opportunities, we continue to invest in our businesses both organically and inorganically to drive top line growth. Let me share with you a few highlights. Capital spending grew 12% year-over-year to $1.4 billion. A high percentage of our capital goes towards growth in our larger recurring revenue base which grew 4.5% organically in 2011, and along with service represented 45% of our total revenue.

From a technology and innovation standpoint, we increased our R&D investment by an additional 12% during the year. We have 16 R&D centers around the globe focused on providing innovative products and services to meet our customer’s needs. For example, we are now developing Scott Connect in our life safety business which will, in addition to other benefits, allow fire fighters wearing our Scott fireproof protection gear to be remotely monitored for critical indicators such as location and air supply, thereby allowing quicker response in a hazardous situation.

Additionally, we increased our sales and marketing spend by 5% year-over-year as we continue to expand our efforts in emerging markets, align our businesses along key verticals and create awareness around our new ADT Pulse offering which was launched with our internal sales force about one year ago. We have also completed several key bolt on acquisitions across our three core platforms. These acquisitions have increased our presence in emerging markets, broadened our technology portfolio and strengthened our competitive position.

Security solutions acquired Signature Security in April. Signature expanded our sales, installation and service capabilities to residential and small business customers in Australia and New Zealand and solidified our leading market position in that region. Next, our fire protection business acquired Chemguard, a leading provider of fire suppression products, services and specialty chemicals. Chemguard broadened our global fire suppression products portfolio and increased our R&D capabilities in firefighting foam applications. It also augments our presence in high growth areas such as the Middle East and Latin America.

Flow control required a majority ownership stake in Dubai based KEF Holdings at the beginning of our fiscal fourth quarter. This acquisition was a key strategic move in the Middle East for our valve business and flow control enhancing our presence in key emerging markets and industries. KEF’s products are highly complementary to our current valve offerings and provides us with one of the world’s leading steel casting facilities, while enhancing our local footprint and management team.

Thirdly, moving on to our productivity improvements, we continue to focus on restructuring and productivity programs as well as cost containment initiatives throughout the year. These actions coupled with organic revenue growth contributed to the strong year-over-year improvement in TYCO’s operating margin of 160 basis points. Lastly, we continued to return excess cash to shareholders. During fiscal 2011, we used $1.3 billion of cash to repurchase 6% of our outstanding shares, and since year end have repurchased an additional 5 million shares for $200 million.

Now, turning to our results for the fourth quarter, organic revenue grew 6%. Additionally, we expanded the operating margin in the quarter by a 100 basis points year-over-year excluding the benefit related to the contribution of the electrical metals product business.

Now let me give you a quick overview of our results in the quarter for each business and I’ll turn it over to Frank to give you more details in a few moments. Starting with security solutions, recurring revenue grew nicely in the quarter with continued momentum in ARPU and account growth. Non-recurring revenue grew at an even higher rate than recurring driven by strong growth in North America and the Asia Pacific and Latin America regions. Top line growth in security coupled with the benefits of restructuring actions and productivity initiatives contributed to the 100 basis point improvement in operating margin year-over-year.

Moving on to fire, positive order momentum continued in the fourth quarter. Increased volume in service and products as well as gains from productivity and cost containment initiatives resulted in strong operating margin performance in the quarter. In flow control, the 14% year-over-year increase in orders once again exceeded prior quarter levels and marks the seventh consecutive quarter of positive year-over-year order growth. Flow’s positive order trends over the last few quarters are now starting to drive top line growth.

Overall for TYCO we have seen a nice pick up in our organic revenue growth over the last few quarters. Growth in service revenue, momentum in order activity related to our late cycle businesses, and a continued solid performance in our recurring revenue, positions us well as we’ve entered fiscal 2012. With that, let me turn it over to Frank.

Frank S. Sklarsky

Before I get into the details of our business segment performance, I would like to give you an overall perspective on our financial performance in the quarter. Revenue in the quarter of $4.7 billion grew 14% with organic revenue growth of 6%. Strong revenue growth across all of our businesses was led by our late cycle flow control business. When combined with cost reduction activity across all of our business units and at corporate, operating income before special items increased 25% and earnings per share grew 24% year-over-year.

Now for our operating results by business; starting with security solutions revenue for the quarter increased 11% to $2.3 billion with 6% organic growth. Recurring revenue which represents 57% of security’s total revenue in the quarter continued to perform well with organic revenue growth in all geographic regions. Continued ARPU expansion and account additions drove the 5% organic revenue growth in this category. The remaining 43% of revenue which is non-recurring in nature grew 7% organically driven by growth in every region.

From a profit perspective, operating income before special items was $374 million and the operating margin improved 100 basis points year-over-year to 16.4%. Increased investments to sales and marketing and R&D were more than offset by growth in recurring revenue and the continued positive impact of restructuring and cost containment initiatives.

Now, let me walk you through the regional performance of security solutions for the quarter. Starting with North American residential and small business, nearly 90% of revenue is recurring and we had another strong quarter. Organic revenue grew 5% with higher average revenue per user and an increase in the number of accounts driving the positive year-over-year growth. The North American residential account base of 6 million customers increased 1% from the prior year.

Average revenue per user grew about 3% year-over-year as new accounts were added to the base at a higher monthly revenue rate per account partly driven by the increased penetration of Pulse. During the quarter we saw continued momentum in the Pulse take rate which increased to 23% of the new accounts added by our internal sales force. Additionally, new Pulse customers continued to migrate towards the higher end packages. Attrition remained relatively flat at 12.9% on both the quarter sequential and year-over-year basis.

In our North American commercial business, organic revenue growth was up 7% driven mainly by retrofit and upgrade work. In the EMEA region, organic revenue grew 4% with growth in both recurring and non-recurring revenue for the second consecutive quarter. We continued to see substantial improvement in the operating margin in this region as past restructuring actions drove a 330 basis point year-over-year improvement to 12.7%. The Asia Pacific and Latin America region had a strong fourth quarter with organic revenue growth of 11%.

Turning to some of our key metrics for the global recurring revenue business, our account base of over 9 million customers grew by more than 2% year-over-year, and global average revenue per user also grew by more than 2% on a constant currency basis to $45.35. Average revenue per user continues to benefit from our broader product offerings. Lastly, our worldwide attrition rate improved 10 basis points sequentially and 20 basis points year-over-year to 12.6%.

Let me make a quick comment on security products. Revenue in the quarter of $104 million grew 1% organically following a 24% increase in the prior year quarter and significantly improved its operating margin year-over-year while increasing its investment in R&D. Additionally, we recently announced the acquisition of Visonic, a leading global developer and manufacturer of wireless electronic security systems and components based in Israel.

Visonic will expand our technology platform in wireless encryption and remote diagnostics while complementing our market presence in the intrusion security market. We expect this transaction will close by the end of the calendar year.

Moving to fire protection, overall revenue in the quarter was $1.3 billion with organic revenue growth of 4%. Service revenue in the quarter of $500 million grew 6% organically as we continued to focus efforts on expanding our service base, especially recurring service. Systems installation revenue of $460 million was down 1% on an organic basis as growth in Asia Pacific was more than offset with declines in North America and EMEA due to project selectivity and the continued softness in the non-residential construction market.

The remaining portion of our fire protection business, fire products which encompasses the fire protection products and life safety businesses reported revenue of $375 million in the quarter with organic revenue of 8%. Operating income before special items was $183 million in the quarter and the operating margin increased 160 basis points to 13.7%. Increased leverage from higher volume in the product businesses, a higher mix of service revenues across all regions, and gains from productivity and cost containment initiatives drove the operating margin improvement year-over-year.

As most of you know, the fourth quarter is fire’s strongest revenue quarter as a significant amount of electronic upgrade work is performed while schools are on breaks during the summer months. Given this seasonality and as we expected, total fire backlog of $1.13 billion declined 9% on a quarter sequential basis excluding currency. Year-over-year orders grew 3% including 6% growth in service, 10% growth in fire products, and a 5% decline in systems installation.

Moving to flow control, revenue of $1.08 billion was driven by strong sales in valves, as well as the continued impact of customers accelerating the completion of installation work on some large projects in thermal. Operating income before special items was $124 million and the operating margin was 11.5%. Valves and controls which comprises about 60% of flow control’s annualized revenue grew 13% organically in the quarter. We also continued to see good sequential margin improvement in valves driven by the leverage on the incremental revenue.

Orders in valve controls remained strong during the quarter with 15% growth year-over-year. Order activity was positive in all end markets led by strong growth in oil and gas and power. We have spoken previously that there were a number of large projects awaiting final approval from our customers and we are now beginning to see larger orders from some greenfield projects including some recent project wins for a large natural gas pipeline and an aluminum refinement project in the Middle East.

Additionally, we recently announced that we will participate in a five year frame agreement with Shell to provide certain values and aftermarket service on a global basis. We expect this to begin resulting in order activity later this fiscal year.

In thermal controls organic revenue growth of 34% was driven by strong order activity over the last two quarters as thermal orders tend to translate into revenue within 60 to 90 days. In water, organic revenue declined 18% as a result of the completion of the Australian [inaudible] project earlier this year and soft order activity in water over the last few quarters. We have however, recently been awarded several midsized water projects and believe we’re in a very good position to win other large projects during the first half of this year. This gives us confidence that operating results in water, including margins, will improve in the second half of fiscal 2012.

Overall, flow orders in the quarter increased 14% year-over-year with a 15% increase in valves, a 41% increase in thermal, and a 14% decline in water. Backlog of $1.74 billion increased 4% on a quarter sequential basis.

Now, let me touch on a few other important items. First, our cash and overall balance sheet remains strong. For the year we generated operating cash flow of $2.4 billion and free cash flow of $1.1 billion which included $252 million of cash paid for special items. While working capital grew somewhat during the year as a result of our revenue growth, working capital days were in line with the prior year.

We’re also pleased with the continued improvement in the average duration of our accounts receivable. Next, corporate expense before special items was $107 million in the fourth quarter, bringing our full year corporate expense to $392 million. We expect corporate expense in 2012 to be similar to last year with first quarter expense in the range of $90 to $95 million. Our effective tax rate for the quarter and full year, before the impact of special items was 15.5%. the tax rate was favorably impacted by a number of one-time items during the year.

For fiscal 2012, we are expecting our full year effective tax rate before special items to be in the range of 19% to 20% with a tax rate in the first quarter of approximately 20%. With regard to fiscal 2012 guidance related to other below the line items, net interest expense is expected to increase to $225 million, primarily due to a lower average cash balance.

Lastly, let me quickly touch on restructuring. We ended 2011 with total restructuring and acquisition related charges of $126 million. In light of the separation announcement, we have identified several actions to further streamline our operations. We expect to incur restructuring charges in the range of $125 to $150 million in 2012. These charges are in addition to the $700 million of costs related to the separation, and both of these figures will be excluded when we provide our guidance for 2012.

Now, let me turn things back over to Ed to wrap up this morning’s call.

Edward D. Breen

Before I go to guidance I wanted to provide a quick update regarding the separation. The most complicated work is in our legal, tax, and financial reporting groups and we are making good progress in each of these areas. In addition, we are in the process of building out the management teams with public company capability and we have also begun the process of recruiting new independent board members for our companies. Overall, we are on track with the separation process.

Now let’s turn to our earnings guidance for the full year. As you know, exchange rates have been extremely volatile. So using current exchange rates we expect total revenue of $17.5 billion to $17.7 billion. Embedded in this guidance is year-over-year organic revenue growth of 4.5% to 5.5% which excludes the impact of foreign currency, acquisitions and divestitures, and the extra week in fiscal 2011.

Based on the actions we have taken to date to streamline our operations and the additional actions we are planning for fiscal 2012, we expect the revenue increase to leverage quite nicely resulting in year-over-year operating margin expansion of approximately 100 basis points. This represents an overall increase in operating income before special items of approximately 10% to 13%.

Based on these items and the specific guidance Frank provided for corporate expense and below the line items, including a higher tax rate, we expect earnings per share from continuing operations before special items for the full year to be in the range of $3.50 to $3.60. As in prior years, we expect our earnings per share to be stronger in the second half of the year due to the normal seasonality of our businesses.

Now, let’s shift to our guidance for the first quarter. Starting with security solutions, we expect continued growth in both recurring and non-recurring revenue, with overall organic revenue growth of approximately 4% year-over-year. The operating margin for the first quarter is expected to be similar to last year’s first quarter. Turning to fire, growth in service and product revenue is expected to be partially offset by a continued modest decline in system installation. We expect total revenue of approximately $1.1 billion with an operating margin of approximately 12%.

In our flow control business, we expect to see year-over-year organic revenue growth of approximately 8% driven by the continued momentum in valve order activity. In total, we expect flow controls revenue to approximate $915 million, with an operating margin of 11%. We expect sequential operating margin expansion each quarter in fiscal 2012 and anticipate reaching a 14% margin in flow sometime during the second half of the year as we continue to leverage the increased volume in valves and begin executing on water projects.

Overall for TYCO, we expect revenue in the first quarter to approximate $4.2 billion with an operating margin of approximately 12%. This coupled with our expectations for corporate expense and below the line items, we expect earnings per share from continuing operations before special items in the first quarter to be about $0.77.

Thanks for joining us on the call and operator if you could please open the lines up for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John G. Inch – Bank of America Merrill Lynch.

John G. Inch – Bank of America Merrill Lynch

Can we start with Europe and maybe – I know you report your results on EMEA basis, but I’m not sure if there’s a way to isolate continental Europe, but what exactly are you seeing there? And maybe you could give us a little margin color for security in Europe?

Edward D. Breen

We’re not seeing any real change. Let me just give you the context here. Our revenues in Europe for the company, and this is a yearly comment, are about $3.5 billion of the $17.5 billion or so. For the company, our organic growth in the quarter was 3%. Now, Europe by the way, has been our lowest region all along and that was actually slightly above, like half a point above last quarter. So, I’m not seeing any change.

By the way, in our guidance for this new year, I am being a little cautious as you see on organic revenue of 4.5% to 5.5% because we are concerned we could see some softening in Europe, but I would say nothing at this point that we’ve seen. I’d also point out, and I think Frank just mentioned this, we had very nice margin movement in the security business, to your question about security. In EMEA this quarter, we now have the margins up to 12.7% so very nice move there during the last year.

Antonella Franzen

Which compared to a margin of slightly below 12% in the third quarter.

Edward D. Breen

And mid-single digits a year ago. We’re just not seeing anything yet. Again, it is our lowest growth region anyway, but nothing new relative to what’s going on in the world.

Frank S. Sklarsky

And of course, the exchange rate is the other piece of it that affects the translated earnings because that’s been very volatile obviously.

John G. Inch – Bank of America Merrill Lynch

Why isn’t corporate expense Frank, trending lower next year? I thought even ex the separation there had been initiatives to drive corporate expense down? Are you just being conservative or does the separation have some sort of a guarding impact if you will, on your initiatives to drive it lower? Like in some respects you just kind of push out your corporate expense lower initiatives because of separation?

Frank S. Sklarsky

I think the last point you made John, the fact that we’ve got a lot of folks in the legal, tax, and financial areas doing a lot of work associated with the separation, those folks are on roll, they’re still classified as ongoing corporate expense category. So excluding that, we continue to find efficiencies on a structural basis, but for the time being this year, it’s really prudent to maintain those resources to ensure a very successful separation. That’s really what’s driving it at this point.

Edward D. Breen

And John, I think our point on the last earnings call is still accurate. We expect when we separate the companies, therefore, because of efficiency moves we can make during the year, offset by some public company stuff, that we’ll be able to keep corporate flat if you re aggregate everything again.

John G. Inch – Bank of America Merrill Lynch

So in other words, corporate expense hasn’t hit a wall you’ve just got to keep the resources for now.

Edward D. Breen

There’s some water coming in and there’s some water going out, if I could say it that way.

Frank S. Sklarsky

And we’ve modified some of our transformational activities, but those will continue, and yes you’ll see over time post separation, you’ll continue to see structural improvements.

John G. Inch – Bank of America Merrill Lynch

And I see you’re stepping down from the Comcast board. People can I suppose speculate but what’s sort of the official reason for this?

Edward D. Breen

I think there was an 8K filed and I think I’m pretty precise on it. A couple of things I would say, the separation of ADT residential into its own standalone company, which I by the way, I plan on being a consultant with that board and being on the board of the other two companies, and I have been in personally, in conversations with cable operators, with telco operators, with other players and industries that are somewhat associated around this, and I just don’t want any appearance of any conflict as we move forward with the standalone security company. That along with the busyness of doing the separation anyway, was really the decision behind that.

Operator

Your next question comes from Jeff Sprague – Vertical Research.

Jeff Sprague – Vertical Research

Two big question areas, first just on capital allocation, Ed from here to the finish line on the breakup it looks like you pulled back the share repurchase in the quarter and then restarted it. What should we expect between now and breakup? Is there a little M&A still in the pipeline too or is it still kind of leaning towards share repurchase?

Edward D. Breen

There is M&A and part of our share repurchase is a little bit Jeff, of timing here. Remember, we had to be out of the market when we were going into separation so that’s why we took our foot off the throttle there for a few months. Then you saw us just recently repurchase about $200 million worth, about 5 million shares during the last 45 days or so, something like that. So I would expect we’d repurchase some more shares here as we move forward, but we do have a couple of timing issues.

One, because of separation we really have to do our acquisitions in the first half of this year because we have to kind of freeze our books, if I could say it, going into the second half of the year with all our filings. We have three or four acquisitions we expect are going to total about $250 million. We’re very excited about them, they’re strategic for the businesses, but they will be in the first half of the year. Remember, our cash is lower in the first half of the year than it is in the second half of the year.

I would add a third thing, we’re talking to the rating agencies. Our ratings are very important to us as we talked about on the last earnings call, so we will potentially look at how we throttle different pieces of this including share repurchase by quarter through the year, but we do expect to be repurchasing shares.

Jeff Sprague – Vertical Research

Just to be clear on the guide, the guide assumes what, the Q4 share countless this $200 million you just did as kind of the share base for 2012?

Edward D. Breen

Yes, because Jeff when you really look at the share repurchase in the second half of the year, it doesn’t have much impact on that average. So we’ll probably buy back more shares this quarter than we have been but the second half just doesn’t have any impact. We kind of have the impact of what we just bought back in there and give or take you’re in the ballpark.

Antonella Franzen

Jeff, the only thing I would add to that for Q1 is keep in mind we did do the $200 million of share buyback but that’s also when we do our annual grant of shares so there is some offset related to that.

Jeff Sprague – Vertical Research

Then I was just wondering if you could draw the distinction or if there’s anything to glean from the systems install business and fire being kind of a -1 organic but not recurring in security being positive 7? Maybe just step back and give us a little color on what you’re seeing kind of in commercial activity in general and why the distinction in those two pieces.

Edward D. Breen

Well, there’s a couple distinctions there. In security, the technology turns over quicker Jeff so we kind of look at it, when you go back and really study it, it’s kind of a four to five year turnover, a lot of new software products, so the electronics tend to turn over softer so as the markets have come back some, and frank made this point, 90% of the orders were getting a retrofit and upgrade work because there’s not a lot of new non-resi construction out there. So we’re seeing that more.

And in fire, the products clearly last longer, more in the nine to 10 year, double that range so that’s a key part of it right there. However, when you look at kind of the macro picture and then our picture, us being down a little bit on systems install, we are also impacting that by the selectivity of projects. As I mentioned the last few quarters we’ve really made a concerted efforts not to go after certain verticals on install and go after more, I call it core verticals, which I’d say hospitals, universities, those types of things we want and we want to get the recurring tail on those. So we’re clearly impacting that by a few points on our own.

I do think Jeff, if you do some study around this, I think that if you look at our results both security and fire on the commercial side, I think it’s very clear this year we’ve gained some share in the marketplace. Even on fire where we’re a little negative on system install we’re less than half as negative as the overall market is so I actually feel really good on our overall position. I do think system install will continue to impact us on fire through this year. We’re kind of expecting it to kind of be flat. Some quarters down a little, maybe up a little but generally no growth there. Again, we’re not expecting the market to come back until later this year to see some lift and secondly the selectivity continuing.

Frank S. Sklarsky

As you can see, selectivity is really helped the margin percentage and we’ve also been accretive in margin dollars. The other thing I would say about non-recurring too, on both sides, is non-recurring tends to be very nice ROI business so we’ve got our eye on that too.

Jeff Sprague – Vertical Research

Maybe just a really quick follow on and I’ll pass it on, is there more embedded margin improvement in the backlog in fire on the selectivity? In other words, are we seeing the full benefit of the selectivity come through on the revenue line?

Edward D. Breen

No, no as you saw from our guidance Jeff, you’ll continue to see margin improvement in the business. Part of it is selectivity, part of it is our restructuring cost containment, and clearly this mix is helping us going more towards driving it towards service. By the way, we’re seeing it on a global basis so I feel good about their momentum. By the way, let’s all keep in mind, we’re seeing that on a few points of organic growth because we’re not living off any new construction yet.

As I’ve said for the last year Jeff, I think we were very conservative over the last couple of years and said we didn’t expect non-resi to start lifting until the second half of this fiscal year. I still think that’s accurate. It might actually be out another quarter or two before you see some lift up. But without that, I think we have nice margin expansion continuing through fiscal ’12.

Operator

Your next question comes from Steven E. Winoker – Sanford Bernstein.

Steven E. Winoker – Sanford Bernstein

Just a quick question first on the guide, can you walk us through on the tax rate increase for the year what’s behind that?

Frank S. Sklarsky

In the recent past we’ve benefitted from some onetime items. I think we’re at the point now where we’re guiding basically back to a structural rate. When we talked about the separation too, about two of the businesses being in kind of the 20% range and one of them being a little higher, really where we’re focused on for the guidance for 2012 pre separation is in that 19% to 20%, so that is about the structural. We continue our planning activities and it tends to be a little bit lumpy by quarters but that’s really where we are right now. So no particular science to that other than the fact that it’s our structural rate versus what you’ve seen in the past we had a number of legacy and onetime items that benefitted us.

Steven E. Winoker – Sanford Bernstein

Any more insight about how you’re thinking about capital structure across the businesses as they separate?

Frank S. Sklarsky

I think to Ed’s point, we really are sensitive to making sure that each of the companies go out with an investment grade credit rating and with the commercial and fire security business having a rating similar to where they are today so that’s a focus area. We want these businesses to be going out there with healthy balance sheets so they can fund their organic and bolt on growth as well as determining their own respective degree to which they return cash to shareholders and so on.

So when we look at the capital structures and format that, obviously we’ll communicate more about that in the future. It really is about strong balance sheets with giving these companies financial flexibility for their own growth strategies. That’s really where we’re focused on. We’re getting into discussions with the rating agencies over the next couple of quarters and we’ve got our eye on that too so that’s really where we’re focused.

Steven E. Winoker – Sanford Bernstein

Ed, one of the things we’ve talked about before as being a barrier to entry for ADT relative to cable and other players, has been the installation workforce, the service workforce. A lot of the beta tests that I’m looking at now have product systems that are sort of trainable in a handful of hours, six hours, 10 hours of training for some of these guys. I’m just wondering what you’re seeing on that front in terms of level of competitiveness from these other folks. Pricing, as I understand it, also coming in around maybe $10 below your low end. Are you starting to see impacts in the markets where the beta tests are happening?

Edward D. Breen

No, not at all. In fact, we track every market where there’s entrance in the market. There is no change to any of our metrics and we track them all [inaudible] rates, ARPU rates, the whole thing in those markets. By the way, I think you can tell from other company’s comments there is very little momentum. But, you have to remember – first of all Steve, you have to look at it apples-to-apples. Let me give you one for instance, we have one competitor in a couple of markets that to your point is $8 to $10 below us but on an apples-to-apples basis because we include in ours our service maintenance package, we’re really almost right on top of each other.

I don’t see pricing – and by the way there are people that are launching a couple of systems that are actually a couple of bucks above us. I think when you neutralize everything and really look at it apples-to-apples which we do in every market, everyone’s pricing is pretty similar and that does not surprise me with the costs and the structure you have to have to run the business.

Secondly, by the way, you’ll always see people do promotional deals. I always use the example with all of you, watch cable and satellite guys, so sometimes you have to ferret through what’s promotional and what’s the real run rate after six or eight months in the business. We track all that stuff very carefully. But no, we’ve seen no change whatsoever in growth rates or anything in those markets.

By the way Steve, it’s not just the install people, remember 90% of what we see in security, we have a sales person go in the home, talk about where all the products should be in the home, especially with the interactive service with cameras, energy management control what do you want controlled what do you don’t? It’s a pretty in depth sales process and that’s the reason we have between our dealer network and internal network 9,000 sales people in every town and city around the country. It’s not just the install, there’s a lot more to it and I think we’ll continue to see nice momentum in fiscal ’12.

Steven E. Winoker – Sanford Bernstein

Last question for me, we keep talking about project selectivity as being a key driver for the organic revenue declines on the fire side, but part of my question is well, okay a year ago you were selective than as well so are you just seeing a broad market decline in pricing, or increase in competitiveness and therefore making more projects unattractive?

Edward D. Breen

No Steve. In fact, the projects we’re getting are better margin on the install side. So we’re being a little more selective, we’re getting better projects. Finally, I’m shuffling a little bit because it’s about probably by the end of this quarter, you’re absolutely right this will be about a year after this quarter where we’ve really started focusing on the verticals with the project selectivity. So I don’t think that comment keeps lapping itself as we go through the rest of this year, to your point.

But remember, the market, I looked at some data the last couple of days again, the actuals because I don’t really care about the forecasts, the actuals on construction numbers, the dodge reports and all that, and the industry year-over-year is probably down 7% to 8%, maybe almost to 9% when you look at the data and we’re down way, way less than that. I also think if you look at some third party reports you’ll see that we did gain share. I think we have a couple of competitors that are consolidating businesses together, they’re maybe not as focused right now and I think that probably plays in to it also. The selectivity piece, I think by the time we wrap up this quarter, I would say that’s really the one year lap on it.

Operator

Your next question comes from Deane Dray – Citi Investment Research.

Deane Dray – Citi Investment Research

I was hoping you could comment on the additional restructuring actions that you’re taking, the $125 to $150 million? If I’m not mistaken the $700 million original target for the separation did include some restructuring so what are these additional projects?

Edward D. Breen

I’m feeling good about this. We did have some restructuring in the initial $700 and what we were doing with that is we had already identified here’s what it’s going to cost us to separate the businesses apart and oh by the way, there’s some restructuring benefits we can get when we do that. Now that we have – and by the way I would lean more towards the new restructuring we talked about the $125 to $150 is the whole company by the way, but I’ll give you one of the big examples of it is now that we have the two commercial teams starting to talk about integration, which by the way we will probably most likely report next quarter under the new format so we’ll have the two commercial businesses together.

When you start putting two major global platforms together, and the teams are now meeting with each other, I think we have 23 different streams of teams meeting. It’s marketing, it’s IT, it’s sales, it’s the whole thing, you go down the list. We’re identifying other great projects as the teams start talking to each other so that’s really where it comes from. We just said to the team, “We’ve got to get the separation right, we’ve got to get all the management teams right. And, we’re very far along on all that, but boy let’s take advantage of this and do as much restructuring as we can during the year.”

Frank S. Sklarsky

The only thing I would add to that is at this point in time there’s not an exact bright line necessarily between the specific restructuring bucket and the separation bucket. We’ll clearly get the accounting right once these things are executed so you might see a little squeezing the balloon between them a little bit but it’s as I had said, all rationalization activity and it’s all value creating.

Deane Dray – Citi Investment Research

Just on that point Frank, the idea that if it’s a separation cost versus a restructuring, restructuring should have some embedded savings so out of that $125 to $150, what type of payback do you think you’ll get?

Frank S. Sklarsky

On the strict restructuring we look at the two year payback or better so that tends to be very value creating. But even the separation costs are things that set up the businesses to operate very, very efficiently and pursue their growth strategies going forward so we think it’s all value creating. But the restructuring has very nice payback.

Deane Dray – Citi Investment Research

The over on ADT and Pulse, that 23% of new accounts taking the product, can you comment on what the expectation is, the take rate? And I remember when you first started rolling this out you said you were going to take a measured pace so it just raises the question, how is the roll out going? Are you moving fast enough and are you pricing it at the type of premium that you think this product can command?

Edward D. Breen

I think the pricing is about where it should be. You know, you always test it and tweak it so there’s always changes, but back to the prior conversation, I think we sit very nice competitively with our pricing on the interactive platform, from everything we’ve seen out there. So I kind of feel we’re in the sweet spot of where we should be on that. The take rate did hit 23%. We said all along that we expect to get the take rate to 25% or 30% so I’d take the 25% off and I’d say 30% was always our initial goal. I would say, I think you can see from these results, we’re just tracking very nicely there.

If you go back since we launched, we started with a 14%, went to a 15%, went to a 20%, now to a 23% it’s pretty nice progress. The other thing I’m happy about is let me just read you the top package, the premier package because Frank had mentioned this in his comments. The premier package if you go back to the first quarter of the year started at 10% take rate. So out of those that take it, now I’m giving you the percent that take the top package, 10%. The second quarter was 17%, the third quarter was 23% of those that take it and the fourth quarter was 25% so off the one fourth.

So not only are we seeing the take rate overall for interactive go up but our people are getting better, and better, which is the way it always works at moving people up with the packages. We’re also seeing that momentum. I think as we get later in the year we’ll talk about what the targets are for this type of business. Obviously, I think we’re nicely on track and remember, we’re going to launch the dealers as we exit this year. We’re in market trials with them right now and remember, these numbers are only from half the sales force which is the internal sales force.

Operator

Your next question comes from Ajay Kejriwal – FBR Capital Markets & Co.

Ajay Kejriwal – FBR Capital Markets & Co.

Just following up on that Pulse discussion, maybe any thoughts on the difference in cash flow and return dynamics on the new Pulse accounts versus migration of existing customers?

Edward D. Breen

That’s one of the exciting points here over the next couple of years. First of all, the IRRs on the interactive platform are higher. By the way, that’s with the install time being longer obviously because there’s a lot more here, more complications to it. Now, I will point out that one of the things we like is we will get better and better as kind of the next year goes along on our install time. We really spend a lot of time working on that because I think back to one of the prior questions, that’s very important that you continue to work that down.

Anyway, the IRRs are higher than the typical ADT account that comes on. By that IRR, is making an assumption that we stick with the current attrition rates that the company has, I think from all data points all of us have from these types of businesses, it’s going to be a stickier account over time and so hopefully there’s some movement on attrition, certainly to that part of the base.

I think the second part of your question is the one that’s exciting, we just have to get to the point where we can go back and do this, and that’s that the existing base, and I think I’ve given you these numbers before, but the existing base of ADT accounts, the heritage base what I would call it, is sitting in there at $36. The Broadview accounts that we brought on a year ago are sitting at $33 and Pulse is selling at $50 on average. So there’s one of the interesting opportunities that we have over the next few years.

Ajay Kejriwal – FBR Capital Markets & Co.

Just on the security solution margins in the quarter, how did that one extra week impact margins? Is there any dynamic between booking higher expenses –

Edward D. Breen

There’s really two points that probably held margins down a little in the business, one is as you saw, the non-recurring business is growing faster even than the recurring now. By the way, we’re accreting nice profit dollars, we’re very happy about that but because the margins are lower on commercial that’s probably about a 20 point headwind when you look at it on that basis. Then because a big piece of security is billed on a monthly basis, it’s the recurring part, the ADT part, we still are only billing on a monthly basis whatever it is the $40 or the $36 a month but we were actually expensing an extra week of people and overhead. That had about a 20 basis point negative impact so I was very pleased with where the margins came in at the 16.4 for the quarter, especially based on the one is actually a positive. It affects percent but we’re getting profit dollars in, the other is a onetime blip.

Ajay Kejriwal – FBR Capital Markets & Co.

That reverses in the first quarter, right?

Edward D. Breen

Yes, that’s right that’s not an issue. And by the way, our guidance for the first quarter remember we’ve got this one less week now because of the holiday. So for instance, in flow control we shut down that last week, we’re not shipping out of the factories. It’s just the way we run the business. But, that should help our second quarter, by the way so just be aware of that.

Antonella Franzen

Just to further clarify that, keep in mind that since we ended this year on September 30th, our Q1 compare will be same amount of weeks to Q1 last year but the holiday week does fall in our fiscal Q1 where typically that will fall in our fiscal Q2. So that does have a little bit of impact on our earnings in Q1. But again, as Ed mentioned, you see that benefit come back in the second quarter.

Edward D. Breen

Yes, it’s just the timing of when that week falls.

Ajay Kejriwal – FBR Capital Markets & Co.

Just maybe one last one for me, on the flow margin ramp – so 11% the first quarter going up to 14% sometime in the year, is that related to the water business costs get more absorbed?

Edward D. Breen

I would say it’s three things. The water is a very big piece of that because the margins improved nicely in the second half of the year and we’re living with that problem right now. And as Frank pointed out, we did win four midsized projects and we’re feeling good about a couple of these large ones we’re working on so I don’t have any different feeling than I told you last quarter that we ramp up.

Then we also continue to get – the second one I’d say which is a big one, is we continue to get leverage on the valve side as the valve business continues to pick up. The third one is we’re living with the purchase accounting from the KEF acquisition right now which starts drifting off. That would be the three things that are part of how you get the ramp going.

Operator

Your last question comes from Gautam Khanna – Cowen & Company.

Gautam Khanna – Cowen & Company

Ed, can you talk about what you’re doing to just insure that the segments don’t lose focus while preparing for the spin? I mean, it sounds like a pretty big ordeal, $700 million plus all the restructuring and what have you.

Edward D. Breen

The good news – let me tell you, what the businesses are involved in and we’re getting this finished very quickly is the selection of the management teams. But remember, 70% of it is in place so what we’re doing is filling out the public company functionalities. It’s not affecting whose running which division and all of that. So they have work to do there and a little bit of work to do, like the Presidents for instance we’re selecting new board members and that type of thing.

Again, we have a very high percentage of board members already identified because as I mentioned the last time, our board members all want to participate in these companies going forward. So that’s where they’re spending some time. Where they also spend time is on the restructuring actions and we do get, as we just mentioned, more restructuring opportunities by putting a couple of things together that weren’t together before, but that’s all part of running a business and I view that as very positive.

It’s interesting, what ends up happening and Gautam you’re absolutely right, there’s a ton of work here but 90% of it is done by the corporate team, it’s tax, it’s legal, it’s the controllers’ group. And as I think I mentioned on the last call, we did bring back I’d say pretty darn full time, Chris Coughlin who has been with us which has taken the big burden off of Frank and I. Chris is leading the separation process so really myself, Frank, the teams out there running the businesses, it’s a little bit business as usual besides a couple of those points I just mentioned. Then if you were here in Princeton and saw the corporate team you would see them all pulling their hair out.

Gautam Khanna – Cowen & Company

Just to expand on what you mentioned on the flow order pipeline with some of these larger projects, I mean how should we think about the order progression over the next several quarters? I mean you’re already up 14% year-on-year, is that number likely to kind of plateau head down or do you think there’s room to move up?

Edward D. Breen

I think we’re being a little bit cautious on flow, by the way on organic, you know, it’s going to grow very nicely year-over-year. Last year when you lump the whole year together it grew 1% and now we’re saying 6% or 7%. Although, we just had a nicer quarter than that. I’m just always watching this business, especially right to these big projects, they never seem to all happen exactly when you want them to. You can miss by a quarter or even two. You’ve got EPCs involved so if there’s one area I’d say we are probably just being a little cautious on what we are kind of flagging is that.

Now by the way, that has nothing against the momentum of this business. The orders are looking very nice. We’re having very solid years, we just highlighted to you with our guidance. I do think the second half of the year obviously is stronger than the first half because these new projects are just starting to kind of come in. As Frank highlighted, we just booked the initial parts of two of them. We haven’t booked anything on the Shell frame agreement, for instance, yet. We haven’t booked anything on the tar sands on some stuff we’re working on. I’m a big believer that fiscal ’12 the margins expand nicely, this business is growing nicely and I think we’re on a multiyear run here unless something happens in the global economy.

Gautam Khanna – Cowen & Company

Just two quick ones, on the acquisitions you mentioned [inaudible] you have $250 million across a number of properties, which segments are they likely to go into? Where are you going to see the biggest concentration?

Edward D. Breen

By the way, pretty much they will all eventually end up in the new commercial fire and security.

Gautam Khanna – Cowen & Company

Lastly, what are the latest plans with Temp, with the remaining interest there?

Edward D. Breen

I think over the next couple of years we’ll have an exit strategy but we’re really wanting the non-resi construction markets to pick up because that’s where you start getting that run, I mean we’re on a bottom that’s down 60% from the peak of four years ago. By the way, the business can still make money as you know, nicely one quarter, not as much the next, it’s very volatile but the volatility will always be there but the key is we want to see a pickup in non-resi and that’s the time when the business is worth more to us. Just remember, in our guidance through for electrical and metal, there’s really no meaningful impact. I would just punch that in as a neutral when you’re modeling things out.

Antonella Franzen

Operator, that does conclude our call.

Operator

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

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