Tyco International's (TYC) CEO George Oliver on Q1 2016 Results - Earnings Call Transcript

| About: Tyco International (TYC)

Tyco International Ltd. (NYSE:TYC)

Q1 2016 Earnings Conference Call

January 29, 2015 8:00 AM ET

Executives

Antonella Franzen - Head-Investor Relations

George Oliver - Chief Executive Officer and Director

Robert Olson - Executive Vice President and Chief Financial Officer

Analysts

Steven Winoker - Sanford C. Bernstein & Co. LLC

Stephen Tusa - J.P. Morgan Chase & Co. .

Jeffrey Sprague - Vertical Research Partners LLC

Nigel Coe - Morgan Stanley & Co. LLC

Deane Dray - RBC Capital Markets LLC

Shannon O'Callaghan - UBS Securities LLC

Scott Reed Davis - Barclays Capital, Inc.

Operator

Welcome to Tyco's First Quarter 2016 Earnings Call. Your lines have been placed on listen only until the question-and-answer session. [Operator Instructions] This conference is being recorded. If you have any objections please disconnect at this time.

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

Antonella Franzen

Good morning and thank you for joining our conference call to discuss Tyco's first quarter 2016 results and the press release issued earlier this morning. With me today, our Tyco's Chief Executive Officer, George Oliver; and our Chief Financial Officer, Robert Olson.

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

In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items. Today’s call is not intended and does not constitute an offer to sell or the solicitation of an offer to subscribe or buy securities of Tyco or Johnson Controls. So let’s subject matter discussed on today’s call will be addressed in a joint proxy statement and prospectus that will be filed with the SEC.

We urge investors to read it and its entirety when it becomes available. Information regarding the participants in the proxy solicitation is contained in each companies annual proxy materials filed with the SEC. The press release issued this morning and all related tables as well as the conference call slides which George and Robert will refer to can be found on the investor relations portion of our website at tyco.com.

In discussing our segment operations, when we refer to changes in backlog and order activity, these figures exclude the impact of foreign currency and divestitures. Additionally, references to operating margins during the call excludes special items, and this metric is a non-GAAP measure and is reconciled in the schedules attached to our press release.

Also, I would like to remind everyone that beginning this quarter, restructuring and repositioning charges are included within our reported earnings per share before special items. These charges are shown as a separate line item below the segment operating income. The prior year results have been recast to confirm to the current year presentation. The quarters of fiscal 2015 including restructuring and repositioning charges as well as the related tax impact are included in the appendix to the slides.

Now, let me quickly recap this quarter's results. Revenue of $2.4 billion in the quarter declined 4% year-over-year on a reported basis, driven by a 6% headwind from changes in foreign currency. Organic revenue growth in the quarter was flat and net acquisition and divestiture activity contributed 2 points of growth.

Earnings per share from continuing operations attributable to Tyco ordinary shareholders was $0.17 and included net charges of $0.25 related to special items. These special items primarily related to charges for the early retirement of debt as well as divestures, partially offset by a gain related to an equity investment. Earnings per share from continuing operations before special items was $0.42, compared to our guidance of approximately $0.40 per share.

Now, let me turn the call over to George.

George Oliver

Thanks Antonella, and good morning, everyone. Before we get into the details of the quarter, let me spend a few minutes on our announcement earlier this week regarding the powerful combination created by the proposed merger of Johnson Controls and Tyco as shown on Slide 5.

As a combined company we will have the number one position in commercial HVAC, the number one position in building-controls, and the number one position in fire and security. Creating the global leader and building solutions including products, technology and services.

Growing upon the strength of each company this combination represents a unique opportunity to truly address the total customer problem. As the world transforms into a more connected future, the combined company will be uniquely positioned to leverage the Internet of Things and connectivity for smarter customer offerings in a more integrated and data-rich future.

It will allow us to better capture opportunities created by increasing connectivity and integration in homes, buildings and cities. This combination is not only about serving our customers’ needs today, but just as importantly about being able to anticipate and deliver on the customers’ needs of tomorrow. I am very excited about this combination and the opportunities it creates for customers, employees and shareholders of both companies.

Lastly, the merger of the two companies creates compelling value for shareholders. In the new combined company Tyco shareholders will benefit from their share of at least $650 million in incremental, operational and tax synergies over the next few years. This alone creates roughly 30% value creation for Tyco shareholders before any opportunities for enhanced revenue growth.

Additionally, we expect that over time the multiple will creep upwards and reflect the high quality of the portfolio. In short, Tyco shareholders will be able to participate in the upside of the combined company, a highly attractive industrial global leader with strong growth prospects and opportunities across the globe in various end markets.

Shifting gears to the quarter, let’s move to Slide 7. 2016 is off to a solid start for Tyco. I am pleased with our results this quarter and with the hard work of our teams around the globe whose efforts helped us achieve better than expected earnings, despite the sluggish macroeconomic environment.

Our results for the quarter were driven by our productivity initiatives as well as the strength of our defensive, service and recurring revenue base which represented 40% of our total revenue. In fact, we were able to hold both our topline and operating profit levels relatively flat on an organic basis despite the difficult year-over-year comparisons in several of our higher-margin businesses and deliver first quarter earnings per share before special items of $0.42.

Turning to Slide 8. Let me spend a few minutes on what we are seeing in each of the regions. Starting with North America, the U.S. market remains a relative bright spot with continued growth in non-residential construction year-over-year. In particular, we are seeing good momentum in the commercial and institutional verticals. The only weak spot was Western Canada due to the high hazard, heavy industrial end markets.

Overall, our North America Integrated Solutions and Services business performed very well in the quarter with 2% organic growth. Retail in North America had a solid start to the year with 3% organic growth. As many of you are aware, we have been increasing our investments in this vertical both organically and inorganically and we are seeing very nice traction in terms of order growth and customer interactions.

Just last week, I met with many of our key customers at the National Retail Federation show in New York. And they expressed their support in how we are building out our retail technology and solutions portfolio to help solve their biggest problems. I am very excited about the future opportunities in this vertical and I’ll touch on our most recent retail acquisition in a few minutes.

Moving to Europe, the macro environment remains sluggish and exchange rates are volatile. Overall, organic growth in our European businesses was relatively flat in the quarter. In Asia, the environment is clearly under pressure creating global uncertainty. This region represents about 8% of our annual revenue and declined mid-single digits organically year-over-year.

Although China saw a bitter growth, Southeast Asia was soft. While a relatively small market for us Latin America remains an area of strength despite the volatile economic and political conditions across the region and headwinds in resource based economies.

Organic revenue growth in the high single digits was primarily driven by the strength of our subscriber business. Sales in our Pacific region, which include the Australia fire business in the first quarter, declined high single digits organically.

Fiscal Q1 was an important quarter from a strategic perspective with several significant developments toward our continuous efforts to remix the portfolio and improve the growth profile, which are shown on Slide 9. In early December, we announced the divestiture of our fire installation and service business in Australia.

As many of you are well aware, this business is heavily tied to the mining industry, which has endured a downturn for the past three years with no meaningful recovery anticipated over the next few years. We remain committed to the Australia market with our largely subscriber-based security business and will continue to provide fire and life safety products to the region through our global products business.

On a pro forma basis following our divestiture, the Pacific will represent about 3% of sales. At the same time, we announced an increase investment in our existing joint venture in the Middle East, which we now effectively control and which solidifies our footprint in an important growth region for Tyco.

As we now consolidate the joint venture the Middle East accounts for roughly $200 million in annual revenue. By maintaining this strategic alliance and taking full control of the operations, we now have the installation and service capabilities necessary to target a rapidly growing commercial market with stringent codes and standards allowing us to gain share in the Middle East.

Within our retail solutions business, we completed the acquisition of ShopperTrak, a leading global provider of retail analytics and intelligence for a purchase price of $175 million. Combined with the late fiscal 2015 acquisition of FootFall, we have built a $1 billion world leading retail business with a full suite of solutions ranging from loss prevention to inventory management and visibility to shopper analytics all of which lead to better operational performance for retailers and a better shopping experience for customers.

In addition to the strategic fit within the portfolio the combination of ShopperTrak with FootFall in our existing retail solutions business, we have line of sight to an attractive pipeline of synergy opportunities. Also we expect this acquisition to accelerate our commercial capabilities as an integrated solutions provider and to open the door to C-Suite executives.

Data analytics and software are at the cornerstone of our growth strategy to solve broader customer problems. Preliminary traffic data is becoming increasingly more important to retailers as they capture and analyze data to provide actionable insights. These capabilities can now be translated to various other verticals to better control safety, make operations more efficient to provide better customer service.

Before I turn the call over to Robert to walk through the details of our first quarter performance, let me touch on a couple other items. First, we’re very pleased to reach an agreement with the IRS to tentatively resolve the decade-old intercompany debt issue. Robert will explain this specifics about agreement in a little more detail later in the call, but I would note that when finalized this should resolve the last significant legacy matter outstanding.

Second, I'd also like to update you on our progress relative to our planned internal investments for 2016. As you may recall from our discussion last quarter a significant part of the increase in our internal growth spend is related to the investment in our salesforce.com platform, which we refer to as E3. E3 allows our sales team and service technicians a complete 360 degree view of the customer, which in turn improves the customers experience with Tyco.

Phase I of our two-year rollout began in our UK business in early October and while we are still early in the process result so far have been very encouraging. That said we will maintain a very deliberate pace in our rollout of E3 and for all of our investments for that matter and if macro conditions deteriorate, we have the controls in place to throttle back R&D and sales and marketing investments as necessary.

As I mentioned earlier in my opening comments, we remain focused on delivering net savings through productivity and restructuring benefits as well as driving growth. We are confident, we have the right playbook and we are controlling the things we can control in spite of the continued difficult macro environment. Our first quarter results reflect this and we are reaffirming our full-year 2016 EPS before special items guidance of $2.05 to $2.20.

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

Robert Olson

Thank you George and good morning everyone. Let’s begin with an overview of the quarter starting on Slide 11. Revenue of $2.4 billion declined 4% year-over-year on a reported basis including a 6% headwind from foreign currency. Acquisitions contributed three percentage points of revenue growth, which was partially offset by 1% decline from divestitures.

Flat organic revenue growth was better than the 1% to 3% decline anticipated with stronger revenue across all three segments. This coupled with strong productivity in the quarter resulted in a segment operating margin before special items of 12.9%. The segment operating margin include a 40 basis point headwind related to non-cash purchase accounting. Excluding purchase accounting, the segment operating margin was slightly ahead of the prior year as net productivity benefits will partially offset by negative mix.

Overall, earnings per share before special items increased 11% over the prior year as difficult year-over-year comparisons in several of our higher-margin businesses and the negative impact of FX was more than offset by lower restructuring and repositioning charges as well as net savings.

Turning to quarterly orders on Slide 12, total orders increased 3% year-over-year with 5% growth in products, 3% growth in service, and a 1% increase in Integrated Solutions. As we have discussed before, order growth particularly in our North America and rest of world Integrated Solutions & Services businesses is lumpy and can be impacted by timing of large projects.

Total backlog of $4.56 billion increased 4% on both the year-over-year and on a quarter sequential basis, partly driven by the consolidation of our joint venture in the Middle East. Excluding the joint venture backlog increased 1% year-over-year was relatively flat on a quarter sequential basis.

Now, let's get into the details of each of the segments, starting first with North America Integrated Solutions & Services on Slide 13. Revenue in the quarter of $953 million was relatively flat on a reported basis. Organic revenue growth of 2% was fully offset by the negative impact of the weaker Canadian dollar. We saw continued momentum in our service business, which increased 1% organically in the quarter with positive service growth and both fire and security. Additionally, Integrated Solutions grew 2% organically.

Before special items, operating income in the quarter was $132 million and the operating margin improved 10 basis points to 13.9%. Normalized for a $6 million charge in the prior year related to a legal matter, the operating margin contracted 50 basis points year-over-year, as the benefits of productivity were offset by incremental investments.

Moving to order activity, despite the tough compare with last year's total orders grew 3% year-over-year. Service orders increased 2% and Integrated Solutions orders increased 5% off of a 13% increased last year. Included in this quarter orders growth is a very large order and institutional vertical which contribute seven points of order growth and Integrated Solutions. Total backlog of $2.51 billion increased 2% year-over-year, and 1% on a quarter sequential basis.

Turning to Slide 14, Rest of World Integrated Solutions & Services revenue of $812 million increased 11% year-over-year driven by a 11% unfavorable impact from FX. Organic revenue decline 1%, as 1% growth and service as more than offset by a 4% decline in Integrated Solutions. Acquisitions contributed 3% to revenue growth which was partially offset by 2% headwind from divestitures.

Before special items operating income was $77 million. The segment operating margin declined 40 basis points year-over-year and 9.5% fully driven by non-cash purchase accounting. Excluding purchase accounting the segment operating margin was slightly ahead of last year at 10%. As productivity benefits more than offset the revenue decline.

Turning to order activity in Rest of World year-over-year orders are relatively flat as 3% growth and service was offset by a 3% decline in the Integrated Solutions driven by decline in high hazard heavy industrial space. Backlog of $1.87 billion grew 9% on both a year-over-year and quarter sequential basis. The majority of the improvement in both periods was driven by the consolidation of our joint venture in the Middle East. Excluding the joint venture backlog increased 1% year-over-year and was relatively flat on a quarter sequential basis.

Turning to global products on Slide 15, revenue of $611 million was flat on a reported basis. 6% benefit to revenue from acquisitions was offset by a 6% decreased revenue from FX. Revenue declined 1% organically, primarily due to a difficult comparison of 10% growth in the prior year period. We call the prior year period benefited from the timing impact of the Scott Air-Pak X3 shipment in the life safety business.

Before special items operating income was $97 million and the operating margin declined 130 basis points to 15.9%, including a 70 basis points headwind related to non-cash purchase accounting. The underlying margin declined of 60 basis points was primarily driven by product mix. Product orders increased 5% year-over-year entirely driven by acquisitions.

Now, let me touch on a few other items on Slide 16. First, corporate expense before special items was $52 million for the quarter and we expect corporate expense to be similar in the second quarter. For the full-year, we continue to expect corporate expense before special items to be in the range of $205 million to $215 million. To be clear this excludes expenses related to the JCI merger.

Next, our effective tax rate before the impact of special items was 17.2% for the quarter. We expect the tax rate to be approximately 17% in the second quarter. For the full-year, we continue to expect the tax rate to be in the range of 17% to 18%.

Moving to cash flow. We continue to make progress in converting our income to cash. We had adjusted free cash flow of $169 million in the quarter representing a 95% conversion rate. We continue to expect our full-year adjusted free cash flow conversion rate to be in the 90% to 100% range.

Moving to restructuring and repositioning activities, we incurred charges of $22 million for the quarter of which $14 million related to restructuring actions. We expect restructuring and repositioning charges in the second quarter to be approximately $20 million. For the full-year, we continue to expect restructuring and repositioning charges to be in the range of $75 million to $100 million.

Before I turn it back over to George, let me provide you a quick update on our recent announcement regarding the Stipulations of Settled Issues filed last week with the IRS. We reached the tentative resolution with the IRS to resolve the intercompany debt dispute currently before the U.S. Tax Court with a 1997 to 2000 tax years. The tentative resolution is contingent applying a similar approach for the 2001 through 2007 period referred to as the roll forward period.

Assuming the Appeals Division of the IRS applies the same terms for the roll forward period that we agreed to with the IRS litigation division. The total cash payment to be made by the parties to the 2007 and 2012 Tax Sharing Agreement would be $475 million to $525 million inclusive of all interest and penalties. As we have detailed in an 8-K filing Tyco would be responsible for 27% of the total, which equates to a cash payment of approximately $135 million at the midpoint.

We do not expect to recognize any additional charges related to this issue. Any change to the reserve will be a special item and excluded from our earnings per share guidance. We expect final resolution of this matter in the next six months.

Now, let me turn things back over to George.

George Oliver

Thank Robert. Let’s turn now to Slide 17 for our earnings guidance for the fiscal second quarter starting with the topline. We expect revenue in the second quarter to decline approximately 4% year-over-year on a reported basis with relatively flat organic revenue growth.

Additionally, the net impact of recent acquisition and divestiture activity is expected to add approximately one point of revenue growth. Given current exchange rates, we expect the year-over-year FX headwind of $120 million or 5%. In total, we expect revenue of approximately $2.3 billion. We expect the segment operating margin before special items to be in the range of 13.7% to 13.9% including a purchase accounting headwind of 40 basis points. Excluding purchase accounting this represents year-over-year margin expansion of 50 to 70 basis points.

Taking all of these assumptions into account as well as the expectations for corporate expense and restructuring and repositioning that Robert provided, we expect earnings per share before special items in the second quarter to be in the range of $0.44 to $0.46 based on a weighted average share account of 428 million shares.

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

Question-and-Answer Session

Operator

Thank you. At this time we’ll begin the question-and-answer session. [Operator Instructions] First question is from Steven Winoker of Bernstein. Sir, your line is open.

Steven Winoker

I just wanted to start with the JCI combination George and get a little more clarity on first of all the synergy side, in the cost side you talk about at least $650 million and I guess what you are thinking there I would have expected a slightly larger number.

And then secondly, on the topline, this has been an elusive opportunity for many building systems companies for years trying to get the real synergies across building systems that are kind of bought by different people, installed by different people et cetera. So is it on the control side, on the field side where might you see this heading or that could be more tangible for investors given the lack of kind of historical progress here?

George Oliver

Sure. Let me start with the strategy and because this is a very compelling combination that ultimately is going to change the game in the building. So I would start by looking at what we've been doing over the last of couple years relevant to our innovation. We have a unique position in the building with all of our sensors and devices and products that are installed.

We’ve been developing our Internet of Things platform, which is our Tycoon, which has given us the ability to be able to extract data, apply analytics and then be able to create smart operations and that can apply to smart homes, smart buildings, smart cities with the strongest position that we have been in buildings.

And also the recognition that the value creation is ultimately then put to work in the controls within the building that ultimately delivers energy savings or optimization of use of the overall facility. So as we’ve been [invasing] our strategy recognized that the control piece is a very important piece that ultimately takes the intelligence that we create and it puts that to work in new business models that allows us to be able to enhance the value creation that we can provide to our customers.

Now, I know this one or two others would say that it’s really just about bundling and what I would say is that with a combination of the Johnson Controls number one position in commercial HVAC, combined with the number one position in building controls, combined with the number one position that we have in fire and security changes the game and that will accelerate the amount of value that we can create and capitalizing on the market will accelerate our growth longer-term, while we’re delivering on the $650 million of synergies that we can extract with the combination.

Now getting into the combination, when you look at the $650 million of synergies, it starts by breaking down by a $150 million of tax synergies and those are pretty straight forward. When you look at the $500 million of operational synergies, it breaks down into about a $150 million of public company costs that are overlapped that we can immediately begin to address. We get about a $100 million of sourcing savings on the combined buy and that’s through the leverage of the buy as well as being able to utilize our combined portfolio of products.

And then the rest is the $250 million that derived throughout our operations. Now the way that you want to look at that is when you look at our combined SG&A structure it’s about - it’s almost $5 billion and the ability to be able to now synergize these cost positions and be able to deliver the $250 million.

I’m extremely confident of. I will be personally responsible and then we’ll be able to do again what we’ve done, what we’ve done in the last three years with the fire and security combination again with a combination of Johnson Controls and Tyco. And I’m very excited about being able to have the accountability to be able to do that and then ultimately be able to lead the combined entity.

Steven Winoker

Okay, George and the $75 million to $100 million of restructuring this year and all those programs that are in place. Is there not a more and optimized new structure with Johnson that would may be sort of - are you adding an extra step here that frankly when you put the whole thing together you’d have a different plan should any of that be put on hold or no these are totally complementary programs?

George Oliver

Steve, we’re looking at all of that we have a lot of things in motion ourselves and as we begin the detail planning over the next few months we are going to make sure that we - anything we do in addition to what we are already doing that we complement the synergies that we’re going to drive within the two. So what I would say is that I think there will be acceleration of what we’re doing combined with what they've been doing in transforming their business to ultimately deliver on these incredible benefits.

Steven Winoker

Okay and just if I could speak a quick quarterly question and on that oil and gas headwinds you guys had expected I think 25% down in the quarter and maybe 10% for the year. What is your current thinking and what happened?

George Oliver

Well, I mean the way we look at its playing out as we thought we we’re at a tough run rate at the end of last year with what happened in the third and fourth quarter that has continued, it mainly hits our fire protection products business with our high hazard heavy industrial products as well as our life safety business with the breathing apparatus and some of the products that we put into that space including gap detection and then we have high density of our services across the globe mainly in the North Sea, Western Canada and throughout Asia.

What I would say it’s playing out as we expected. We continue to make sure that we’re working other opportunities to be able to offset any additional pressure that we see through the course of the year, but I feel very good with the plan that have in place to be able to deliver on what we ultimately expected to happen through the year.

Steven Winoker

Certainly outperformed. Okay thanks guys.

Operator

Thank you. Next question is from Steve Tusa of JPMC. Sir, your line is open.

Stephen Tusa

Yes, hey guys good morning.

Antonella Franzen

Good morning, Steve.

George Oliver

Hi, Steve.

Robert Olson

Good morning.

Stephen Tusa

Can you maybe talk about the - you guided to negative organic you came in flat can you maybe talk about the kind of visibility you guys have on this, revenue acceleration in the second half I mean a lot of companies that are a bit more short cycle have what looks like back end loaded accelerations in there. But I think that there are some specific you guys have mentioned some specific things related to your service business and how the backlog plays out. What’s your confidence level in that and how much visibility do you think you have there?

George Oliver

Yes, Steve it’s important to look at what we see happening not only with activity in the markets that we serve but also the ability to be able to generate orders. We are seeing nice progress with the investments that we’ve been making not only in our three capabilities stating in Europe, but also just the overall progress we are making with our commercial excellence initiatives that combined with the investments we are making in new products as well as our enterprise software that’s enabling new solutions we are beginning to see some real nice traction.

So when you look at our order rate in the first quarter was up about 3% we see the activity continuing to improve our conversation to orders, continuing to improve and that is going to be the foundation that enabled us to be able to continue accelerate revenue for the rest of the year and being able to deliver on the total year performance.

Stephen Tusa

But I guess is there a dynamic around the way the backlog plays out I think you guys have mentioned warranty and fire and some of the headwind from the roll-off of security a couple of years ago, the project selectivity is that now already in the run rate or is that still up to help the second half of the year?

George Oliver

Yes, the - what’s in the run rate I mean we look at let’s start with the segments. So when you look at install we are seeing - we are going to see continued nice progress granted there is a longer cycle of conversion, but we’ve been increasing our backlog sequentially over the last few quarters, which is going to be the base of business that comes through in the second half. Our service orders actually picked up in the quarter. So our service orders were up even though we generated 1% service revenue growth, our orders were up 2% in the first quarter and as we looked going forward we see that continuing to improve in the second quarter.

That they will continue to go from 2%, 2% plus, 2% to 3% and that is ultimately when we say that for the year we are going to get to service growth of 2, 2 plus that will get to a run rate that when we look towards 2017 that will get service back to being 3% to 4% in that range. And that as you know certainly with the quality of the base that we create with the selection of projects and then with the service that’s in embedded within those projects over the lifecycle as where we get the accelerated returns.

Stephen Tusa

Okay and then one last question just on the productivity versus investments, any update on what's the update there I know that you have $0.05 of incremental foreign exchange, but you’re reaffirming the guidance and you talked about some of these investments being perhaps you could slower them a little bit more discretionary timing wise, what’s kind of the update on that front because you got to offset this for XML obviously?

Robert Olson

Yes, I would start by saying that obviously as we provided guidance, we originally said we are going to spend in our reinvestment $70 million to $90 million that was going to be broken down into supporting our E3 initiative on the commercial front end of about $15 billion sales and marketing investments in line with our continued progress with our growth about $30 million to $35 million and then R&D was going to be up around $20 million to $25 million.

And so when we look at that we certainly had been in line with what's happening in the economies that we serve, taking that into account and then making sure that we are governing the reinvestment in line with that. So the way that I would look at it right now given where we are, given the macro conditions we believe that we are at the lower end of the reinvestment which ultimately as we look at the total year it gives us confidence that we are still going to be able to deliver on the total year commitment in spite of some of these other headwinds.

Stephen Tusa

Great. Good execution. Thank you very much.

Antonella Franzen

Thanks.

Operator

Thank you. Next question is from Jeffrey Sprague with Vertical Research Partners. Sir, your line is open.

Jeffrey Sprague

Thank you. Good morning everyone.

George Oliver

Good morning, Jeff.

Antonella Franzen

Good morning, Jeff.

Jeffrey Sprague

Good morning. Hey, a little bit to the earlier question about the possibility of duplicating record on restructuring. I was thinking about the flipside of the coin. I don't believe there is going to be a lot of antitrust scrutiny of this deal perhaps there will be, but could you speak to your ability to kind of share forward plans with JCI pending close in terms of investing product integration, the system integration and the like that you’ll be looking to achieve in this merger. And I guess really the essence in that question is will you have an opportunity to kind of commercially get a running start into the close?

George Oliver

Yes, Jeff we’re looking at that and I think you’re probably right, we can push some of that before the close and you done this kind of stuff before we kind of know what stuff we are hoping front. We are going really country by country to get regulatory approval. I think you hit the nail of the head that although we complement JCI's portfolio really well, we don't overlap so we don't expect major issues. And as I noticed its’ sort of a country by country approach that there may be opportunities in certain countries to accelerate things.

Jeffrey Sprague

And I was wondering on the retail side you said 3% growth in the quarter. Could you just speak to obviously on the back of our mind that we are all kind of worried about retail right, looking at the headlines and pressure on traditional retailers, but they obviously are responding pretty aggressively with their own omnichannel strategies and the like.

Just wondering if you could kind of tie all that together kind of the bricks and mortar pressure versus what you're offering brings as they try to change their business models and thinking about kind of the growth in the new aspects of the business model versus maybe the traditional, is that a prevention side of the business?

George Oliver

Sure. So let me start by just laying out that the retail vertical and where we’ve been and where we’re going and what we see happening especially with some of the new technologies and solutions that were developing. So historically, we have been in a position to prevent that and protect the merchandise and certainly that business continues to be very strong because there was a high value proposition and reducing shrink for our retailers, but more important is the infrastructure that was utilized to be able to create those benefits.

We've been using that now to create intelligent solutions whether it would be store performance solutions, inventory management now with the combination of FootFall in sharper track, the ability to be able to now create sharper analytics and traffic in the like. And these are high value propositions to the retailers that significantly enhances their operations so they are getting a high return on the services that we are providing to them.

And so the engagements that I had last week at the National Retail Federation up in New York, very strategic, we become very strategic to the retailers and how they improve their operational performance, how they drive uplift in sales, how they make sure they have the right inventory to be able to support that and then ultimately drive significant value for their shareholders.

And so what I see happening although there is some concern in retail just in general that we’ve been capitalizing on the current trends and in spite of that have been growing. And with that we’ve been remixing our sales capabilities, our capabilities to be able to sell up into the C-Suite real strategic solutions and in spite of I think the pressure there that we see a runway here that we’re going to be able to continue to accelerate.

Jeffrey Sprague

Great, thank you.

Operator

Thank you. Next question is from Nigel Coe of Morgan Stanley. Sir, your line is open.

Nigel Coe

Thanks for the information on retail. I think that’s a very important point. But I wanted to switch back to the synergies and specifically the $4 million target, you [caught out 150 corporate, 350] above that. And I think there’s some concern out there that’s to the extent of the actual branch field office synergies between JCI and Tyco.

So I’m just wondering of that $350 million remainder, is the field consolidation - the disproportionate amount of that synergy. Maybe just characterize the progress you’ve made on consolidating your fire and security networks.

George Oliver

Sure. As we always said when we started the fire and security the combination that we would yield a footprint reduction of roughly 25%, 30% that we would make sure that we have the right resources in the field that our customer facing to be able to support the customer and grow, while we are creating shared services regionally that we can leverage the volume, deliver very strong productivity and ultimately put that resource back to work and grow.

We are still kind of mid innings relative to that transformation because of the timing it takes to get out of existing real estate and then to get into a more optimized footprint with what I discussed and having the right footprint in the region and then having the right shared services in place to be able to leverage the scale. Why I’m very confident being able to deliver on the savings, when you look at the - the benefit comes through G&A.

And so the G&A that’s still is there relative to the support of our businesses as well as what we see within the Johnson Controls businesses together is significant. And then you could look at just G&A or even the sales costs that we incur and the potential overlap there especially as it relates to the back office support of sales.

And so when we layout these incremental synergies, we definitely have line of sight to being able to deliver on these incrementals. Now as we get into the planning, the question is how much more could you do as we get into the planning pace. But Nigel when you look at the total cost base of the two businesses with what we’ve been able to accomplish and still be in the middle innings and then being able to look at what could be done with the combination, it's pretty compelling.

Nigel Coe

I agree with that. And then just a quick follow-on the obviously good news on the IRS, I know there is another stage to go before we can actually sign up on that, but how important was the IRS settlements and getting the JCI deal done. Was that continuously a barrier to forming some form of merger with the JCI or anyone else? Was that an important hurdle to cross?

Robert Olson

Well, Nigel, this is Robert. I think as you know we’ve been working that with the IRS for a long time now. So I think it was just in general are important to Tyco to get that resolved. We thought we had a really good case and credit to the IRS, they worked hard to support their side; both sides had to ultimately comprise a little bit, but as I said we thought we had a really good case.

The importance of this announcement is stipulation settlement issues is that both parties went in front of the Judge and basically signed, they agreed with the common set of facts. So it really puts both sides sort of limits any change from those common set of facts that we agreed to. So I think it’s been a real positive development. And the JCI opportunity not coming around, it would have created other opportunities that would have been exciting to, but we are obviously really excited about JCI merger.

Nigel Coe

So what you are saying, there wasn’t a material hurdle for the merger.

Robert Olson

I think that we’re in great case. So I think that it’s just something it makes sense the timing worked out but we had a great case.

George Oliver

Yes, Nigel specifically for the merger that we’re pursuing, no I mean it wasn’t our hurdle per se certainly the timing was obviously very, very positive.

Nigel Coe

Okay, thanks a lot. I’ll leave you there. Thanks.

Operator

Thank you. Next question is from Deane Dray of RBC Capital Markets. Sir, your line is open.

Deane Dray

Thank you. Good morning, everyone.

George Oliver

Good morning, Deane.

Deane Dray

I want to go back to the merger plan and just the way we look at it one of the more unusual structures is the staged 18-month management succession. So George I was hoping you could share a bit more color as how you expect your role as COO during this interim period I know you’ll have a Board seat which is unusual for a COO. So that probably speaks loudly to your management role, but what that the timing, will it be at all disruptive is there a trade-off here are there advantages in having you serve in this 18-month interim?

George Oliver

Yes, let me give you my perspective. Number one we’ve had a great relationship with the JCI team with Alex and his team as this has developed working very closely with them in making sure that we’re going to position the combined company for a lot of success. And we see not only in the synergies that we’ve outlined. But more important strategically how these businesses come together and change the game and how we serve buildings.

And we felt it was important that we get the structure we get the integration done right - right out of the gate, which ultimately is going to be the foundation for just tremendous growth and be able to be deliver long-term returns for both of our shareholders.

And so the idea here is that with the work we’ve done I go into a role learning in-depth all of their businesses and what can be achieved I have been fundamental to the business models that we’ve been developing here within Tyco and this gives us an opportunity to be able to expand those business models that I truly believe is going to create a lot of value for our customers and a lot of returns for our shareholders.

I will be an active participant on the board. And we believe that through this transition looking on building an unbelievable company that’s going to have a lean structure, that’s going to be focused on customers, that’s going to differentiate with technology, that’s fundamentally going to change the game and be able to create accelerated growth and increased returns for our shareholders.

Deane Dray

That’s great to hear. And then just a question on the quarter you called out an order on the institutional vertical, yes, it will brace for some negative orders and maybe this was a swing factor here I know you can't name the customer name, but just some context of what significant was there anything significant about this order the scope of the products and services and anything that you think would be helpful to share?

Robert Olson

Yes, Deane this is Robert. No it’s a large order but its right in our sweet spot these are things that we've been doing for many, many years and we know exactly how to execute so we are really excited about it but we called out - because it was a large order, but nothing unusual beyond that.

George Oliver

Deane, comment on that. That’s in our sweet spot it’s in an institutional space, it’s absolutely reflective of how we are changing the game with our combined technologies and creating new solutions that ultimately create more value and for others that think that is bundling this is how we are ultimately come in together and creating new platform that now is enabling us to be able to take bigger pieces of the pie and create a lot more value for our shareholders.

Deane Dray

Just can you give a size of the order?

Antonella Franzen

Those around - it’s a little north of 30 million.

Deane Dray

Terrific, congratulations.

Operator

Thank you. Next question is from Shannon Callaghan of UBS. Ma’am your line is open.

Shannon O'Callaghan

Good morning guys. Hey, George you got a lot of traction in the retail business, I mean opportunity there makes a lot of sense given your position. Is there any other vertical where you can help us kind of or where you’ve seen kind of this smart building concept really being implemented but sensors and data analytics and anything that actually kind of leverages across what you’ll now have with JCI?

George Oliver

Sure. So as we’ve said in our prepared remarks a lot of the learning that we've had in retail that was certainly early most advanced there with taking our sensoring and our devices and creating smart operations and ultimately building new business models that allow us to be able to create new services.

And it is happening Shannon across all of our end markets. So oil and gas is a great example where in spite of the economic decline, it’s an area right to be able to take all of the intelligence that we gather from the devices and sensors that we deploy in that space. And then to create real-time services that can be provided that obviously enhances life safety but also improves operations.

And I’d tell you that across the board, whether you look at commercial buildings and institutional buildings or big space across some campuses is a great space where we deployed a lot of our new technologies and new enterprise software that allows us to differentiate solutions. It’s happening across the board and that's why the timing of this merger with JCI relative to the building with what’ve done the business models we are building, the work they’ve done, they’ve got an unbelievable platform within their controls business, the medicines platform that can scale at any level.

And so the combination of the intelligence that we create in our sensoring and devices and how that’s been deployed through their controls, which ultimately deliver the value to the customer whether it be energy or utilization space or utilization of facilities that’s where the value will be extracted. So as we develop more and more will become more specific relative to the capabilities but it’s accelerating rapidly.

Shannon O'Callaghan

Okay, thanks. And then just in terms of the comment about the 30% premium when you factor in the 44% the capitalized synergies. A portion of that 44%, it seems is coming from the $3.9 billion you put in. So I mean is that really a premium effectively that is coming to Tyco or maybe you can just help me think through how you get to the 30% your thought process around that?

Robert Olson

Yes, this is Robert. Most of the sort of value growth to shareholders comes from the synergies and then next we’ve obviously got the exchange rate working in our favor. But we don't take any credit. So we’re entirely facing that on cost synergies both operational and tax. What we don’t take into consideration is any revenue synergies or any multiple uplifts. So those would just be upside from there.

With regard to that the way we structured the deal this is all part of the negotiations. And I think what we end up with through those negotiations was a really good outcome both for Tyco shareholders obviously but also for JCI shareholders. And remember we go to both sets of shareholders for approval, I look at this is win-win deal with great as George has alluded to great future.

Shannon O'Callaghan

Okay, thanks.

Operator

Thank you. Next question is from Scott Davis of Barclays. Sir, your line is open.

Scott Davis

Hey, good morning guys.

Robert Olson

Good morning, Scott.

Antonella Franzen

Good morning, Scott.

Scott Davis

I am not sure I ever asked this question to you guys or heard it asked. But do you guys when you think about non-res construction overall and I am just talking about North America not Rest of World. But do you have an explicit forecast you are using for 2016 I am kind of curious to hear your early view on 2017 and we’re getting some visibility but there's some early signs of 2017 might be a bit of an air pocket but I'd be curious you guys are closer to it. So be curious to hear what - what you're thinking and how you come up with a forecast assuming you use one?

Robert Olson

Well, we use a lot of different inputs, we use the architectural billings index as a lead indicator of the activity and that’s continued, it hasn’t been - it continued to be positive net - net-net up and down but overall net positive. We do track other inputs whether it be - we have pretty good visibility within our fire business on all new projects that are being developed and making sure that we’ve got visibility and then certainly deciding how we are going to compete to those new projects, we have a pretty good pipeline that we look at on a regular basis.

We certainly stay close to our customers with the direct channel, we have a pretty good view relative to what they're thinking with what might be occurring. So, Scott there isn’t any one answer I would tell you that as we do our forecast we take all of those different inputs and then try to base on what we think is going to happen. What I would say is that as you look at North America, we’ve done a phenomenal job and being able to turn the security business around and we’re getting growth now across the entire platform.

And with the addition of Girish Rishi, who came in roughly about nine or 10 months ago we are now bringing North America to the next level of integration because we had two very successful businesses in our Fire business and our Commercial Security business. There was still some structural overlap that this is now giving us a much better view of our combined customer base that will enable us to I think to become even more robust relative to how we plan. But we are watching that closely and we take a lot of different inputs and make sure that we are providing the contingency that we need to assure that we deliver on our commitments.

The other thing I would say is with the work we’ve done on the commercial excellence side and then now with the E3 initiative there's a tremendous opportunity for service growth on the existing installed base as well as now with these new service models that we are developing to be able to create a lot of value in a tough economic environment for our customers that ultimately enables us to be able to get accelerated growth. And that's a big focus now especially with the thought that that might slow here, the non-resi might slow here over the next few.

Scott Davis

Yes, got it. I’m curious on the technology side I mean when you go out and you talk to your customers you know there has been - this is an industry I think where we’ve - many of us have talked about a potential upgrade cycle for price eight or nine years and we just never - we haven't gotten it and you go to the tradeshows and you see new products and such, but it doesn't seem like there's anything that is really a catalyst to get people to upgrade.

But what's holding back some of these buildings I mean just thinking of the building I’m working with [indiscernible] there's been a big upgrade there, we've done a number of things in HVAC, we haven't done anything in fire and security I don't think in 15 years. I mean what's stopping these buildings from particularly in security and what are your customers tell you about that?

George Oliver

I’d start by saying when you look at the server market; the $120 billion served market in foreign security is viewed as being a low growth, low return market. And typically, what we have done historically as usually delegated down throughout the organization and it’s more viewed as a cost.

What I would tell you what’s changing, what’s going to change this trend is now there is tremendous value on creation with the ability to be able to create intelligence, being able to take that intelligence, create new business models and then have what I would call much higher ROI or return on the expenses that they incur that ultimately is going to support their business.

And so as we are deploying the new technology, the new platforms we are now getting up to the C-Suite and how we are strategically aligned now with the customer base and whether it’s working on - what we are doing in security driving presence and the work we are doing in retail driving item level intelligence. All of that is becoming much more strategic to the customer. And so the way that we’ve deployed our resources got to capitalize on that.

We over the last 18 months we’ve had a growth board where we start with the customer, what’s their biggest problem and then how do we put a big leader with the right resources leveraging all of our technologies in our products in our enterprise software to fundamentally change the game and how we solve that problem. And I would tell you today we have about 15 projects that are doing just that. I think as we get traction as the value proposition becomes clear and they recognize that with the returns that we generate it’s going to accelerate the trend.

Scott Davis

Interesting. Okay, well good luck with that guys and congrats on the deal, good luck on that.

George Oliver

Thanks.

Antonella Franzen

Operator, I would like to turn the call over to George for some closing comments.

George Oliver

So thanks again for joining our call this morning. I want to reiterate that we are off to a solid start in 2016 despite the macro concerns. I have never felt better about how we are positioned and how our leaders are executing on fundamentals. And I look forward to talking to many of you soon. So operator that concludes our call.

Operator

That concludes today’s conference. Thank you for you participation. You may now disconnect.

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