Tyco International's (TYC) CEO George Oliver on Q3 2016 Results - Earnings Call Transcript

| About: Tyco International (TYC)

Tyco International Ltd. (NYSE:TYC)

Q3 2016 Earnings Conference Call

July 29, 2016 08:00 ET

Executives

Antonella Franzen - Vice President, Investor Relations

George Oliver - Chief Executive Officer

Robert Olson - Chief Financial Officer

Analysts

Jeff Sprague - Vertical Research

Steve Tusa - JPMorgan

Nigel Coe - Morgan Stanley

Deane Dray - RBC

Steven Winoker - Bernstein

Gautam Khanna - Cowen and Company

Julian Mitchell - Credit Suisse

Robert McCarthy - Stifel

Robert Barry - Susquehanna

Jeremie Capron - CLSA

Operator

Welcome to Tyco’s Third Quarter 2016 Earnings Call. [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. Ma’am, you may begin.

Antonella Franzen

Good morning and thank you for joining our conference call to discuss Tyco’s third quarter fiscal 2016 results and the press release issued earlier this morning. With me today are 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 related to the proposed merger with Johnson Controls. We ask that you look at today’s press release and read through the forward-looking cautionary informational statements that we have 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 for or buy securities of Tyco or Johnson Controls. Select subject matter discussed on today’s call is addressed in a joint proxy statement and prospectus that has been filed with the SEC. We urge investors to read it in its entirety.

Information regarding the participants in the proxy solicitation is contained in each company’s 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 exclude special items and this metric is a non-GAAP measure and is reconciled in the schedules attached to our press release.

As we referenced on last quarter’s call, pursuant to Irish and European regulatory requirements related to our proposed merger with Johnson Controls, we would be required to withdraw our standalone profit guidance prior to the publication of our Irish prospectus. On July 8, we formally withdrew our guidance and I want to remind everyone that we are limited in what we can say and therefore will not be providing our typical forward-looking commentary on this call. As a result, we expect this call maybe shorter than usual.

Now, let me quickly recap this quarter’s results. Revenue of $2.45 billion declined a little less than 2% year-over-year on a reported basis. Organic revenue growth of 1.5% was more than offset by a 3% headwind from changes in foreign currency. A 3% benefit from acquisitions was fully offset by a 3% negative impact related to divestitures. Earnings per share from continuing operations attributable to Tyco ordinary shareholders were $0.56 and included a net gain of $0.02 related to special items. These special items were primarily composed of favorable tax adjustments related to the IRS settlement, mostly offset by a write-down of a business held for sale and merger-related costs. Earnings per share from continuing operations before special items, was $0.54 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 provide a brief update on our proposed merger with Johnson Controls. Starting with Slide 5, integration planning is in the final stages and the teams are preparing to transition into the execution phase on day 1. In addition to the late May announcement of the senior executive team, we have sent names the next layer of leadership and we will continue building out the structure over the next several weeks. The Form S-4 was declared effective by the SEC in early July and the Irish prospectus hasn’t published.

Additionally, we have received approval from all necessary antitrust authorities around the globe. With those boxes checked, we have scheduled our shareholder vote for August 17. Given the progress we made on both the regulatory and integration planning front, we now expect to close the transaction on September 2.

As I have stated many times, the more I learn about the complementary nature of these two organizations and the value we can provide to our customers and shareholders as well as our employees, the more excited I become. We are weeks away from becoming one combined company and we are ready to hit the ground running.

Moving on to results for the quarter, let’s turn to Slide 6. As expected, organic growth accelerated in the third quarter led by our Integrated Solutions & Services business in both North America and rest of world. Organic growth in our short-cycle product businesses held flat despite continued pressures from the high-hazard, heavy industrial end markets. The segment operating margin contracted 30 basis points year-over-year, including 20 basis points of purchase accounting headwind. Overall, volume leverage and productivity offset foreign exchange headwinds and mix pressures and when coupled with lower restructuring and repositioning charges year-over-year resulted in 17% earnings per share growth before special items.

Turning to Slide 7, let me spend a few minutes on what we saw in a few key regions during the third quarter. Starting with North America, although macroeconomic indicators were somewhat mixed in the third quarter, we saw continued momentum in the U.S. market, with stable growth in nonresidential construction verticals year-over-year. We had another solid quarter of install order activity, with growth in our commercial, government and institutional verticals. As expected, activity in Western Canada remained soft due to the high hazard heavy industrial end markets, but appears to have stabilized.

Moving to Europe, with macroeconomic indicators turning slightly more positive throughout the quarter, Europe has been a relative bright spot for Tyco. This quarter saw organic growth in the low single-digit range with continued momentum in the services, manufacturing and commercial verticals being partially offset by our exposure to the North Sea oil and gas market. As it relates to any impact from the recent vote for the UK to leave the European Union, apart from FX translation, it is too soon to speculate on or quantify what the potential commercial impact could be. Our teams on the ground are well positioned, and we are confident we have the right model in place. Recall that a majority of our revenue base in the UK is service, including a strong subscriber channel.

In Asia, although recent economic indicators out of China continued to show signs of stabilization, underlying business conditions across the broader region remain soft. Year-over-year, strength in China and Korea during the quarter was offset by continued pressure in the high hazard heavy industrial space as well as the hospitality vertical in Macau. Lastly, Latin America continued to be an area of strong execution in organic revenue growth driven by our subscriber business.

With that, I would like to turn the call over to Robert to walk through the details of our third quarter results.

Robert Olson

Thank you, George and good morning everyone. Let’s begin with an overview of the quarter starting on Slide 8. Revenue of $2.45 billion declined about 2% year-over-year on a reported basis, including a 3% headwind in foreign currency. Acquisitions contributed 3 percentage points of revenue growth, which was offset by a 3% decline from divestitures. As George mentioned, organic revenue growth of 1.5% was driven by our Integrated Solutions & Services businesses in both North America and rest of world.

Before special items, segment operating income was $355 million and the operating margin was 14.5%, which included a 20 basis point headwind related to non-cash purchase accounting. Excluding purchase accounting, the segment operating margin contracted 10 basis points year-over-year as volume leverage and productivity benefits were more than offset by negative mix. Overall, earnings per share before special items increased $0.08 year-over-year, primarily related to lower restructuring spend compared to the prior year period. Productivity savings helped to offset the impact of FX, incremental purchase price accounting and negative mix.

Turning to orders on Slide 9, total orders increased 4% year-over-year, with 5% growth in service and 8% increase in integrated solutions and a 3% decline in products. Total backlog of $4.79 billion increased 3% on a quarter sequential basis and 8% year-over-year, partly driven by acquisitions. Total backlog increased 4% organically on a year-over-year basis.

Now let’s get into the details of each of the segments, starting first with North America Integrated Solutions & Services on Slide 10. Revenue in the quarter of $1.0 billion increased 3% on a reported basis. Organic revenue growth of 2.5% in the quarter was driven by a 4% increase in integrated solutions and a 1% growth in service. 1% contribution from acquisitions was partially offset by the negative impact of the weaker Canadian dollar. Before special items, operating income in the quarter was $148 million, and the operating margin declined 150 basis points year-over-year to 14.7%, including a 30 basis point headwind related to non-cash purchase accounting. Underlying margin declined 120 basis points due to increased investments and a higher mix of installation revenue compared to the prior year. Total orders grew 3% year-over-year, representing another solid quarter of growth, led by 4% growth in integrated solutions and 3% growth in service. Total backlog of $2.67 billion increased 5% year-over-year and 3% on a quarter-sequential basis.

Turning to Slide 11, Rest of World Integrated Solutions & Services. Revenue of $794 million, decreased 6% year-over-year, including a 6% unfavorable impact from FX. Organic revenue grew 2% with balanced growth in service and the integrated solutions. Acquisitions contributed 7% to revenue growth, which was more than offset by a 9% headwind from divestitures. Before special items, operating income was $92 million. The segment operating margin expanded 60 basis points year-over-year to 11.6%, including a 30 basis point headwind related to non-cash purchase accounting. The underlying margin increase of 90 basis points was driven by volume leverage, improved execution and productivity benefits.

Turning to order activity in Rest of World, year-over-year orders increased 10%, with 8% growth in service and 12% growth in integrated solutions, driven primarily by acquisitions. On an organic basis, Rest of World orders increased 3% year-over-year with 2% growth in service and 4% growth in integrated solutions. Backlog of $1.94 billion grew 14% on a year-over-year basis. Although the consolidation of our joint venture in the Middle East contributed to the improvement. On an organic basis, backlog increased 6%. On a quarter-sequential basis, backlog increased 2%.

Turning to Global Products on Slide 12, revenue of $651 million declined 4% on a reported basis. 2% headwind from the divestiture was compounded with a 2% decline related to FX. Revenue was flat on an organic basis as continued softness in the high hazard heavy industrial end market was offset by growth in other verticals. Before special items, operating income was $115 million and the operating margin was 17.7%. Year-over-year, the operating margin improved 10 basis points as productivity benefits more than offset the continued mix headwinds. Product orders declined 3% year-over-year driven by the timing of orders last year.

Now let me touch on a few other items on Slide 13. First, corporate expense before special items was $44 million for the quarter, a bit better than we had expected, driven by cost containment and productivity. Next, our effective tax rate before the impact of special items was 17.3% for the quarter. Moving to restructuring and repositioning activities, we incurred charges of $15 million for the quarter, half of which was related to pure restructuring activities.

Turning to cash flow, we had another solid quarter converting our income to cash. We generated adjusted free cash flow of $214 million in the quarter, representing a 93% conversion rate. Year-to-date, we have generated $625 million in adjusted free cash flow, which represents 104% of net income from continuing operations before special items.

Now, let me turn things back over to George.

George Oliver

Thanks Robert. Before we open up the line for questions, I want to take a minute to personally thank the Tyco employees for their hard work and dedication, which for many spans more than a decade. Tyco has been through a significant transformation over the years. I am extremely proud of what we have accomplished in the 4 years post spin as the new Tyco. We have made significant strides in improving the fundamentals of the business while maintaining a laser like focus on driving innovation, commercial excellence and maintaining the appropriate organizational cost structure. Of course, none of this would have been possible not for our passionate employees, the invaluable leadership and counsel of our Board members and of course the support of our investors.

In summary, the stage is now set for a successful transition into the execution phase of our day one plan with Johnson Controls. Going forward, we will maintain a similar laser like focus throughout the integration process. I feel confident in our ability to achieve $1 billion in synergies and combined productivity, which we laid out for you at EPG in May. And I look forward to speaking with you about our progress on future calls.

Thank you 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. And now we will begin the question-and-answer session. [Operator Instructions] Our first question comes from Jeff Sprague from Vertical Research. Your line is now open.

Jeff Sprague

Thank you. Good morning everyone.

Antonella Franzen

Good morning Jeff.

George Oliver

Good morning Jeff.

Jeff Sprague

Good morning. Hi George, just picking up on your closing comments there, I am feeling a little nostalgic here this morning for the last Tyco quarter, but I want to say, really, congrats. You did a great job improving operational performance and I think you led the company into a very smart, strategic deal here, so best of luck.

George Oliver

I appreciate the feedback, Jeff. Thanks.

Jeff Sprague

Just a question on service and the service investments, could you elaborate a little bit more on what you were doing there in the quarter, does it cleanly dovetail with what you expect to be doing when you combine with JCI and would you describe this as some kind of running start into the merger or just any additional color there would be helpful, I thought?

George Oliver

Yes. Let me start Jeff, by – let’s talk about service within our business model, it is a very critical element with what we do and making sure that we are not only getting the – creating the installed base with our technology, but at the same time that we are now expecting the ability to be able to service that installed base over the life cycle. And we have made tremendous progress in how we are with our project productivity and making sure we are doing the projects, we are deploying our technology and we are positioned to get the service. At the same time, we have been increasing our sales force and our capabilities in the field to be able to not only to accelerate our installed base, but also be able to now extract the service opportunity. And as you have seen in our orders, across the board, we are seeing some nice progress, both in installed as well as service. We have projected to get our service business issue to get to about 2%, 2% plus and we are on track to do that. That is really a product of not only the sales force, but also being able to expand the service footprint that we have across the globe to be able to capitalize on the installed base. So as I think about the merger going forward, certainly that’s going to be a critical element of the new business model to be able to deploy technology in our installations and then being able to extract the service over the life cycle of being able to service and create potential services on that installed base going forward. I am pretty proud of the progress we have made. As you can see, in North America we are a little bit short of what we thought we would be in service this quarter, but with the work we have done in the front end as well as the footprint that we have been expanding, we are going to be well positioned to continue accelerate that. And then as you see in Rest of World, we have got some real nice orders in service and we are continuing to execute that with pretty balanced growth in both installation and service through the third quarter.

Jeff Sprague

And just a follow-up to that George, kind of dovetailing to that, certainly I have been a little confounded and perhaps you have too, in kind of the order to conversion cycle taking a little bit longer than expected, but we do have now organic growth positive here for the first time in about a year after – over a year of positive orders, I guess we are not going to have the same visibility or the same reporting going forward, but would it be logical to assume that kind of run rate organic growth in these businesses move up towards these order rates that we have seen in the last few quarters?

George Oliver

Yes. What I would say Jeff is if you look at our backlog both year-on-year, up 8%, sequentially improving, that is going to translate into continued improvement in our organic growth going forward. And so we have made a tremendous amount of progress with our commercial excellence initiatives and being able to build that backlog, continue to get strong orders in spite of some of the economic pressures that we are seeing in some areas across the globe. And what I see going forward is we are going to be able to take that backlog, you are going to see continued improvement in the organic growth, with a keen focus on being able to grow our services in line with our execution of installed revenues.

Jeff Sprague

Great. Thanks a lot. Best of luck.

George Oliver

Thanks Jeff.

Antonella Franzen

Thank you.

Operator

Our next question comes from Steve Tusa of JPMorgan. Your line is now open.

Steve Tusa

Hi guys. Good morning.

George Oliver

Hi Steve.

Antonella Franzen

Good morning.

Steve Tusa

Congrats as well, George, hopefully we are seeing lots of you over the next 18 months here as you guys transition into the new company, congratulations.

George Oliver

Thanks, I appreciate it, Steve.

Steve Tusa

So just on the North America margins, can you maybe just discuss a little bit more of those moving parts and those items? And I have one quick follow-up on that.

George Oliver

Sure. Let me start by if you assess the third quarter, we were down 150 basis points year-on-year, about 30 basis points was purchase accounting. Now, if you reflect over the last 4 years, we have significantly improved margins within our North America business by almost 500 basis points. And what I would say, when you look at the type of work we do, that would be in the top quartile of performance. Now as you know over the last 18 months, we have been increasing our investments. We have been building on our sales force. We have been enabling the sales force with the sales force platform to be able to get leverage on that investment. And what I would say is we have been executing extremely well with those investments. So that is some of the pressure on the margin rate. When you look at the mix within the quarter, so as we look at the acceleration of our installed revenue continuing to accelerate and I would say we continue to execute well within our installed business. And then on the service side, we were a little bit short of where we thought we would be, what we have been doing is building not only the sales force, but also making sure that we have the capacity in place in the field to be able to fulfill that increase in orders. So we came in about 1%, we were targeting roughly 2% to 3%. So there was also now a mix impact. And what I would say is that at the same time, we have been increasing cost and expanding our footprint. So we have been adding service techs, making sure that we are as we are accelerating the installed base, as we are getting additional service orders that we are going to have the capacity in place to be able to fulfill that growth going forward. And so we are a little bit short of where we thought we would be in the quarter, but I can assure you that with the fundamentals that we put into place, we are going to be able to continue to improve going forward.

Steve Tusa

Okay. And then just one last question, on these you reaffirmed kind of the $1 billion of synergies and you talked like you have dug in a little bit more here, what is the – what’s the potential for upside to those given how conservative these look as a percentage of sales?

George Oliver

First, I would like to start by saying I can’t say enough about Alex and the team in Johnson Controls with the work that we have done, the way the teams have come together and the team work that’s been displayed. There has been tremendous integration planning that’s been completed. And at this stage, what I would say is that we are confident that with what we have laid out at EPG, we laid it out in three key buckets. So, the first bucket was when you look at the combined company, about $2 billion of G&A cost, we are confident that we are going to be able to deliver about a 20% reduction on that cost base. A lot of that is the duplication of the public company cost. When you look at the next bucket, it was mainly what we call enhanced that it’s taking the progress that both companies have made in our cost of goods related to our procurement. And in addition to the progress that each of the businesses have made on a $12 billion buy, we see another $275 million of net savings, which is about another 2%. And what I would say the teams working in that space, again very confident that we have got the plans in place to be able to start to hit on that starting on day 1. And the last piece is the one that we have been working here most recently as we think about the business unit structure coming together, there is about $8 billion of cost that’s in the field and the teams are continuing to work through that as we think about a more refined organization that will enable us to not only get the cost synergies, which we laid out to be about $225 million or a 3% reduction on that cost base, but also at the same time, be positioned to accelerate revenue. So at this stage, what I would say is the work that’s been done gives us tremendous confidence that we will be able to deliver on the plan that we outlined at EPG. I think Alex and I both feel very good about where we are today and then being positioned here on day 1 to hit the ground running. And what we plan to do is over time continue to give you an update on the progress we make and then certainly looking to try to as we go forward, trying to do more, but at this stage, it’s hard to say that, that’s – we are exactly where we are with that.

Steve Tusa

Great, thanks a lot.

George Oliver

Thank you.

Antonella Franzen

Thank you.

Operator

Our next question comes from Nigel Coe from Morgan Stanley. Your line is now open.

Nigel Coe

Thanks and good morning.

Antonella Franzen

Good morning.

George Oliver

Good morning, Nigel.

Nigel Coe

Yes. I echo Steve’s and Jeff’s comments about the deal. Congratulations.

Antonella Franzen

Thanks. Nigel, it’s a little hard to hear you.

Nigel Coe

Okay, sorry. Let me speak clearly. Okay. So, I mean I hate to pickup about North America margins, but quoting of two questions from investors, one of your competitors has also referred to weakness in North American margins. So, I am just wondering, I hear the investment spending and the mix on service, but has there been any deterioration in the broader pricing umbrella in North America?

George Oliver

Well, we look at the different end markets that we serve. What I would say is like for instance, in Western Canada when you have a high mix of oil and gas and heavy industrial high hazard end markets, certainly the work that is available, there is a lot of competition for that work. That being said, we have always stayed very disciplined within our business to make sure that with the value that we create with what we do that we are getting the expected returns. And so you are always going to have some end markets depending on how they are performing with some additional pressures. What I would say Nigel is we are very disciplined not only in how we book, book projects, but then with the plan to deploy whether it be technology or techniques that enable us to be able to execute the margins better than what we book. And when you look at our – you are always going to have some variation depending on the projects that are being completed. But what I would say is when you look at our trends and the way that we performed, we are positioned to be able to sustain that type of margin in spite of some of the price pressures that we have seen in a couple of the end markets.

Nigel Coe

Okay, that sounds fine. And then on the backlog acceleration, that’s obviously the highlight from the quarter in my opinion. Is this a function of the absence or maybe the civilization of order trends and backlog trends within the resource industry say things hard to have those products or is this a broad acceleration and the pressures remain? So, I am just wondering is there sort of an underlying acceleration in commercial institution, etcetera or was this the absence of headwind from resources?

George Oliver

And Nigel, I will start by saying that the first, when you look at the last 4 years, first couple of years was truly focused on fixing our fundamentals and getting our margin structure in place so that we could begin to reinvest, begin to accelerate our growth and that’s what happened, right. So, we did a lot of work to get our margins addressed. And then in the last couple of years, we have been reinvesting in expanding our sales force and then enabling our sales force with E3. So, I think what you are seeing, for instance, in North America, with the expansion in the commercial and institutional space, we are now getting more than our fair share with the resources that we have deployed to be able to not only accelerate the orders, but also increase the backlog. And so I think some of that is there is market expansion, but also better execution with the work that we have done from a commercial standpoint. The same holds true within rest of world. When you look at rest of world, we have significantly upgraded that portfolio over the last 4 years with the moves that we have made making sure that the investments we are making are going to be in markets that are attractive that are going to represent growth and then where we have fundamentals that we can leverage very nicely to be able to create returns.

And so when you look at our performance in rest of world this past quarter, we saw broad-based performance. We saw our gross margins up couple of 100 basis points. We saw growth in the installed, the conversion of our backlog of installed, the installed growth, we saw nice service orders, with execution of service up 2%. And so what I would say in spite of some of the pressures that we have in maybe the UK market with the North Sea pressure and some of the high-hazard heavy industrial end markets in Asia, in spite of that, you are seeing fundamentals grow. And as a result of that, the resources we put on the commercial side, we are now beginning to see the pickup as we expected in the backlog and now more important the conversion of the backlog to revenue. And so I see that continuing.

Nigel Coe

And just to clarify on the backlog, are you seeing more large projects in the backlog or is it broader than that?

George Oliver

Well, we have had a number of nice wins with large projects, right? We are beginning to leverage our full portfolio, so that when we put together a proposal, we are leveraging all of our technology, all of our capabilities to differentiate the value that we create with our proposals. We have been able to win some very nice large projects. Year-on-year, it’s not that significant. You will get some fluctuation quarter-to-quarter and sometimes year-on-year, but nothing out of line with what historically you would have expected. And so a key for us is continuing to not only build the longer term backlog, but also get the short-term backlog. And then from a service standpoint make sure that we are positioned to capitalize on the service that generated with the backlog that we do create.

Nigel Coe

Okay, I will leave there, George. Thanks and good luck.

George Oliver

Thanks, Nigel.

Antonella Franzen

Thanks.

Operator

Our next question comes from Deane Dray from RBC. Your line is now open.

Deane Dray

Thank you. Good morning, everyone.

Antonella Franzen

Good morning, Deane.

George Oliver

Good morning, Deane.

Deane Dray

Just add my congrats and best of luck getting to that September 2 finish line, but that’s also a starting point, so best of luck there.

George Oliver

Thanks.

Deane Dray

And just on a forward-looking basis, wanted to hear your thoughts about the M&A outlook. And in particular, does the merger change in anyway the capital allocation towards deals both in your discretion, the timing of deals, any changes there? And broadly, how does that funnel look?

Robert Olson

Yes, Deane, this is Robert. I think the way to look at this is, is it’s going to be pretty similar to the recent history that both Tyco and JCI have had. We have talked about the couple of big deals that we have closed recently, couple of hundred million dollars each. We don’t have any big deals imminent, but I think we have also talked about how this is the go-forward company, is a very attractive company to look at value enhancing acquisitions.

Deane Dray

Great. And then just to clarify, look like both corporate spending and restructuring came in a touch lighter and was there – you have some additional color there?

Robert Olson

Yes. I think that we are very cognizant of the upcoming JCI merger and we are trying to drive productivity everywhere we can in advance. So, with regard to restructuring specifically, we think that there is some really good opportunities once we merge to get efficiencies and we will take full advantage of that. And so rather than do something twice, we will just do it once and do it very quickly.

Deane Dray

Got it. Thank you.

Operator

Our next question comes from Steven Winoker from Bernstein. Your line is now open.

Steven Winoker

Thanks. Good morning and obviously echoing everybody’s congratulations. It’s very exciting.

Antonella Franzen

Thanks, Steve.

George Oliver

Thanks, Steve.

Steven Winoker

So just once again sorry to dig into the North American margin, ISS margin point, but based on what you have talked about so far, I think you have got somewhere around it sounds like 40 basis points or so for service investments or the additional investments. You have got something like 20 basis points to 30 basis points from the installed growth faster than services growth this quarter. But that leaves I guess still about 50 basis points of other things, could you maybe just talk about how we should think about that and what kind of happened – was this a question of focus, a lot of things going on, or just help us understand that kind of gap?

Robert Olson

Yes. Steve, this is Robert. What I would say is it’s just a lot of little small items that just happened to line up going the wrong way. So now you get maybe $5 million, $6 million in total, but normally those things kind of balance out in the quarter. And this quarter, they just went one way. So I would look at that as one-time. And I don’t think – I think we see a pretty strong future ahead.

Steven Winoker

Okay. And then just to put a finer point on one of your earlier answers, oil and gas high hazard, you have been giving us sort of how far down that’s been each quarter, I know you talked about it qualitatively, but how far down was it this quarter?

George Oliver

So Steve, the way I think about it is when you think about – let’s start with our product businesses. It’s about 25% of our revenues. When we look at high hazard heavy industrial in total, it’s kind of mid to – low to mid single-digit decline in the quarter. And so that’s where we have had the biggest impact. Certainly, that has had some impact on our services, mainly in Rest of World. But at the end of the day, the biggest impact has been in our product businesses. So that’s why – that’s what drove us to be at the lower end of what we originally thought in our product business within the quarter. But what I would say is that that’s certainly is being driven by oil and gas and that we believe is now somewhat at the trough and looking forward to would be assuming that the oil prices behave, they will start to see some increase there as we go forward, but that’s where the biggest impact has been.

Steven Winoker

Alright. And that number you guys mentioned earlier, I mean that 3% decline is up against what 16% comp, right, is it mostly just a comp issue that we should think about?

Robert Olson

It is. You are absolutely right.

Steven Winoker

Okay, alright. And I guess I will leave it there and we will follow-up offline. Thanks. Bye.

Antonella Franzen

Thanks.

George Oliver

Thanks Steve.

Operator

Our next question comes from Gautam Khanna from Cowen and Company. Your line is now open.

Gautam Khanna

Hey, good morning guys. And I echo all the sentiments expressed earlier, good luck with everything.

George Oliver

Thanks.

Gautam Khanna

A couple of questions, first I was wondering, you mentioned Europe doing a little better, when I look at the slide with the macro environment arrows, last quarter to this quarter, it didn’t look like any of the arrows changed and I was just wondering if you could elaborate on what specifically got better?

George Oliver

What I would say again is it’s a combination of the work that we have done with our commercial team in putting on additional resources, enabling them with our E3 and then making sure that we are focused on the segments of the market where we do see the growth. And so when you look at Continental Europe, we have had very strong order activity in growth and that has been mainly what I would categorize as services in the manufacturing space and the commercial space. And then we have also had a very strong quarter in retail in Continental Europe. UK has been a little bit more pressured because oil and gas is still weak, where the operators are maintaining minimum service activity. Certainly, there is some nervousness now with Brexit, as it relates to government development, some of the major projects there. But overall, with the work that we have done in positioning those businesses, with the fundamentals, we have very strong fundamentals now in Europe and with the order activity, the pipeline that we built and the way that we are converting that pipeline, gives me a lot of confidence that in spite of some of the economic pressures that we are going to be positioned to continue now to improve and be able to deliver sustained organic growth there.

Gautam Khanna

Okay, that’s encouraging. And George, I was wondering if you could opine of where you think we are in the product cycle at Global Products, I mean excluding the high hazard industrial stuff, which is a known headwind, what is kind of the long-term organic growth rate of that business. And maybe if you can also talk about whether you have any major product launches in the next 12 months to 18 months similar to the Air-Pak that could change that general cyclical growth rate?

George Oliver

Yes. Gautam, I would start by, if you look back since the last downturn, we were on a run with our product businesses delivering strong – it was high single-digit organic growth, and we complemented that with acquisitions. And so the last 18 months, 12 months to 18 months has been where we have gone into this cycle as a result of the downturn in the high hazard heavy industrial space mainly drawn by oil and gas and mining, which is as you know, was a significant percentage of our overall product revenues. And so that has, when you look at that space, oil and gas being down the way it is and then the impact in the heavy industrial, that has been a major headwind over the last 12 months, 18 months. And so that’s the first where we have actually had a change in the profile there. That all being said, we are getting significant growth with our new product launches in the electronic space, with our security products, with our access, intrusion, video products within our retail segment. So the overall performance, when you look at it compared to other companies that are weighted in the high hazard heavy industrial space, we have actually performed pretty well because of the mix we have. So what I would project, once we get – I think we are in kind of the trough now with some of these end markets going forward. With any type of recovery, with the investments and reinvestments we are making, we should be positioned to deliver what I would say up to the mid single-digit organic growth area like we have historically. We are reinvesting. We are gaining market share in the space that we compete in. That is being offset by some of these pressures.

Gautam Khanna

Thank you very much. One last one, George, if you could just talk about ShopperTrak and if you have had any incremental traction in the retail vertical with that acquisition now?

George Oliver

We are early in the integration execution here of ShopperTrak. But what I would say is, as we look at our retail portfolio, the position that we have across each one of the segments, there is no other company that is positioned as well as we are. We have got a retail team now that we have configured such that from a go-to-market standpoint we can leverage all of our touch points with the customer, recognizing that we have multiple touch points, which then leads us up to being much more strategic in how we engage to C-level within the retail community. I personally have met with a number of retail CEOs and positioning with the value position that we have within the new portfolio and this gives me a lot of confidence that with the strategy that we deploy, with the combination of the capabilities, we are going to be well positioned to be able to capitalize on the new space that we have opened up now with the ShopperTrak acquisition.

Gautam Khanna

Thanks. Congratulations and look forward to the next phase.

George Oliver

Perfect. Thanks Gautam.

Antonella Franzen

Thanks Gautam.

Operator

Our next question comes from Julian Mitchell from Credit Suisse. Your line is now open.

Julian Mitchell

Hi, thank you. Just a question on the pro forma revenue base of the combined entity, so in January, the number was $32 billion, at EPG in May, it was $30 billion, I just wondered if there had been any more reduction to that pro forma number in the last couple of months?

Antonella Franzen

No. I mean that is your pro forma number. And the way to think about it Julian, keep in mind it was more at a budget rate type number, the 32. And keep in mind how currency has fluctuated throughout the year. So when you just take that all, kind of add your current rate to where you are at that that is the biggest piece of what that was.

Julian Mitchell

Thank you. And then just on the free cash flow, the headline number was down quite a bit, one of the adjustments I guess is the satisfaction of pension obligation, I hadn’t seen that before this year, can you just clarify sort of what that was and if that is sort of a future cash liability that we should be aware of?

Robert Olson

Yes. Julian, this is Robert. No, that was an obligation that we had accrued for over about a 15-year period and it was a one-time payment and that is not going to be ongoing, one-time.

Julian Mitchell

Thanks. And then just lastly, you have mentioned mix for four quarters now the headwind in Global Products, is it solely just the sort of oil and gas hazardous related stuff or is there a broader mix price issue?

George Oliver

Yes. Julian, that pressure is being felt across our fire protection products business as well as life safety. When you look at the mix of those platforms, we have a heavy mix of chemical suppression in the fire protection products, which has been significantly impacted that’s where we have the highest volume as well as very high mix serving all of the industrial space, oil and gas, mining, all of those end markets. And then in our Life Safety platform, we have the gas detection, which we also added additional capability with the IST acquisition that we completed last year. It’s great technology. We have a great position, but we are seeing the impact that with the downturn in each of those end markets. So, what I would say is it’s like I said in the quarter about that end market composition was down kind of low to mid single-digits in the quarter, in the third quarter. Now, as I said, I believe that, that’s bottoming out and that going forward with any type of recovery in these end markets that will position us well to leverage the margin structure that we have in place and be able to deliver very nice, nice returns.

Julian Mitchell

Very helpful. Thank you.

George Oliver

Thanks, Julian.

Operator

Our next question comes from Robert McCarthy from Stifel. Your line is now open.

Robert McCarthy

Good morning, everyone again. I would like to add the congratulations on the job well done. I guess my first question would be around just the state of – maybe you could talk about the state of U.S. nonresidential construction and the health of that market from what you are seeing in terms of your order rates and revenue rates and give us a complexion around that, just kind of drilling into some of your comments on Slide 7?

George Oliver

Sure. So, what I would say is in the fire business, we are seeing strength. And as I said in the commercial as well as institutional end markets and when you look at the ABI and just the overall activity in that space, it does play to our strengths, where we are positioned well to be able to capitalize on that market expansion. And as I said earlier in the call, with the work that we have done to increase our sales force and capability to be able to capitalize on that market growth, what I would say is we are getting more than our fair share with that expansion. When you look at, combined with security, what I would say is we are also seeing decent activity in the government space, in the public sector as well as healthcare. And as we look at our combined capabilities, what I would say, in addition to the fire business, that’s what we are seeing some nice pickup of activity. So, what I would say is in North America, making sure that we have got our resources positioned to where the growth is occurring and that’s what ultimately is driving our orders growth. That is offsetting some pressure that we are seeing in Western Canada, where we have a strong presence within the oil and gas and heavy industrial end markets. That all being said, our Canadian team have done a great job in reallocating their resources to make sure that in spite of that, we are picking up growth in some of the other strength that we see in Canada, mainly in Eastern Canada. So overall, we have been able to mitigate the risk and capitalize on where the expansion is occurring.

Robert McCarthy

Would you say your oil and gas exposure came in worse than what you are expecting in line with what you are expecting? Do you think you got it right this quarter versus your internal expectations?

George Oliver

Yes. Overall, Robert, I would say we have got it pretty much right. I mean, we weren’t expecting any significant pickup in the quarter. Certainly, we were hoping that we might start to see some activity, especially in line with the increase in oil prices. That hasn’t occurred, where in some cases, later cycles, we are hoping that we might see a pickup in services, which is a little bit shorter cycle. We have seen some of that, but we pretty much in line with what we expected.

Robert McCarthy

I will leave it there. Thank you for your time.

Antonella Franzen

Thanks.

George Oliver

Thanks.

Operator

Our next question comes from Robert Barry from Susquehanna. Your line is now open.

Robert Barry

Hey, guys. Good morning.

George Oliver

Hi, Robert.

Antonella Franzen

Good morning.

Robert Barry

Just a couple of follow-ups here actually. On that heavy industrial I think you said in the past that about a quarter of it is oil and gas. So, I was curious what’s happening in the other three quarters of it?

Antonella Franzen

So, I mean when you look at it overall, how George mentioned in the high-hazard heavy industrial piece that is down in the low mid single-digits, but the oil and gas specifically is down closer to in the mid-teens level kind of similar to what we have seen and very much in line with our expectations.

Robert Barry

Got it. So, the other non-oil heavy industrial is maybe flattish?

Robert Olson

Maybe up a point or two?

Robert Barry

Up slightly, yes. Okay, good. And then just also wanted to follow-up on a comment you made earlier about China. It sounded like things were still weak, but maybe there were some signs of improvement. So, just wanted to get a little additional color there? Thanks.

George Oliver

Yes. I think overall, again, I would attribute some of our improvement to the work that we have done from a commercial standpoint in making sure that our resources are positioned where the activity is and that we have got the right fundamentals in place. So, some of that improvement that we are seeing, I think is purely operational. I would say where we are seeing some strength is in the commercial space and being able to capitalize on that as well as some of the institutional. Certainly, we are still seeing weakness in oil and gas. It’s mainly in the marine space in Korea. When you look at hospitality, we have a big presence and have been very successful in Macau. There has been some weakness there, although recently we have started to see some pickup in activity. And I think that now is being recognized more broadly. So, what I would say is that some of it is operationally the ability to be able to capitalize on where the growth is occurring and then maybe additional stabilization within the overall economic environment.

Antonella Franzen

And operator, we have time for one more question.

Operator

Our last question comes from Jeremie Capron from CLSA. Your line is now open.

Jeremie Capron

Thanks and good morning, all.

Antonella Franzen

Good morning.

George Oliver

Thanks, Jeremie.

Jeremie Capron

So George, you confirmed in May with Alex at EPG that the cost synergy targets presented at the beginning of the year were on top of each companies’ internal operational efficiency improvement programs. And obviously, at Tyco, you have done a lot of work in the past few years improving the cost structure in the U.S. in particular. So I am wondering where are you seeing further upside over the next 3 years at Tyco alone, excluding the cost synergies you can generate with JCI?

George Oliver

Sure. When we laid out our 3-year plan – the second 3-year plan, it was over a year ago in November when we laid it out. We said that we were still positioned with the productivity initiatives to generate about $35 million of net productivity on an annual basis. And that was through all of our key productivity initiatives continuing to drive savings on cost of goods as we focused on the buy sort of pretty significant buy, streamlining that and getting leverage on the buy it was continuing to simplify our footprint, not only in North America, but also across rest of world to be able to leverage our real estate footprint and then more important, with consolidation of the services that support that footprint. And we are – as we now enter this merger, we were about halfway through the progress that we are making relative to really getting towards the entitlement of that cost. And so we are continuing that activity and in some cases accelerating that now with the planning that we have been doing with the integration with Johnson Controls. And that’s where you can get the additional savings above and beyond what was planned.

Jeremie Capron

Okay. And just a housekeeping question here, on your P&L, I noted $54 million in other income and I don’t think you guys mentioned any of these on the call today, so just looking for clarity here? Thanks.

Robert Olson

Sure. This is Robert. You might recall the IRS settlement earlier this year and as a result of that IRS settlement on the intercompany debt matter, we reviewed the status of all our reserves associated with both our 2007 and 2012 tax sharing agreements. Based on this analysis, we reduced our total reserves by $71 million, of which $54 million went through the other income line and $17 million represented a benefit to the income tax line.

Antonella Franzen

And both of those are special items in the quarter.

Jeremie Capron

Great. Thanks very much and congrats again on the merger and good luck.

Antonella Franzen

Thanks, Jeremie. I would like to turn the call back over to George for some final comments.

George Oliver

So, once again, I would like to thank you for joining us for what was our last official earnings call as standalone Tyco. As we head into the merger closing, I am looking forward to working with Alex and our new leadership team. I have been continually impressed by the level of talent and depth of expertise demonstrated by the employees at Johnson Controls and I am extremely pleased by the way our teams have come together. I would also like to thank Robert for his leadership and guidance over the last year. He quickly learned the business and has made significant contributions to the team. He has been a strong partner for me on our journey, and I wish him the best in the future. I look forward to speaking with you on future calls and – at our Analyst Day on December 5 in New York.

Antonella Franzen

Thank you, operator. That concludes our call.

Operator

And that concludes today’s conference. Thank you for your participation. You may now all disconnect.

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