Tyco International Ltd. F2Q08 (Qtr. End 03/31/08) Earnings Call Transcript

Tyco International (TYC)

Q2 FY08 Earnings Call

May 01, 2008, 8:30 AM ET

Executives

Edward C. Arditte - Sr. VP Strategy and IR

Edward D. Breen - Chairman and CEO

Naren K. Gursahaney - President ADT Worldwide

Christopher J. Coughlin - EVP and CFO

Analysts

John Inch - Merrill Lynch

Steve Tusa - JP Morgan

Jeff Sprague - City Investment Research

Shannon O'Callaghan - Lehman Brothers

Nicole Parent - Credit Suisse

Nigel Coe - Deutsche Bank Securities

Deane Dray - Goldman Sachs

Jeffrey Kessler - JPT Management

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Tyco second quarter results conference call. For the conference, all the participant lines will be in a listen-only mode. However there will be an opportunity for your questions and instructions will be given at that time. If you should require any assistance, please press star then zero. And as a reminder, today's call is being recorded. With that being said, I would like to turn the conference now to your host, Mr. Ed Arditte, Please go ahead sir.

Edward C. Arditte - Senior Vice President Strategy and Investor Relations

Thank you John and good morning everyone, thanks for joining our conference call to discuss Tyco's second quarter results for fiscal year 2008 and the press release that we issued earlier this morning. With me today on our call are Tyco's Chairman and Chief Executive Officer, Ed Breen, our Chief Financial Officer, Chris Coughlin, as well as Naren Gursahaney who is the President ADT Worldwide. As mentioned last quarter, we will periodically be putting our business segment presidents on the earnings calls to provide you with additional detail on their businesses and we are pleased to have Naren join us for the call today.

Let me, of course, remind you that during the course of the call, we will be providing certain forward looking information. We ask that you look at today's press release and read through the forward-looking cautionary informational statements that we’ve included in the press release. In addition, we will use certain non-GAAP measures in our discussions and we ask you to read through the sections of the press release that address the use of these items. The press release that we issued, as well as related tables can be found on the Investor Relations portion of our web site, at Tyco.com.

Now, let me quickly recap our results for the quarter. On a GAAP basis, we had diluted earnings per share from continuing operations of $0.56 per share, and this included a net charge of $0.11 per share for special items. Diluted earnings per share from continuing operations before the special items was $0.67. From a total Tyco perspective, our overall revenue growth was 8.4%, with organic revenue growth of 3.6%, and our operating margin before special items was 10.1%, which was higher than the 9.5% that we had guided to.

Now, let me turn the call over to Ed Breen for some opening comments. Ed will be followed by Naren who will discuss our ADT business and then Chris will review the results from the other businesses before we wrap up and we take your questions.

Edward D. Breen – Chairman and Chief Executive Officer

Thanks Ed and good morning, everyone. Overall, we had a good quarter, and made solid progress in executing our key initiatives. We continue to be focused on improving our operations, refining our portfolio and appropriately using our capital. On the operational front, we continue to grow our revenue and make improvements in our operating margin across all of our businesses over last year, as we are operating more efficiently and investing for growth. Making additional operational improvements is a critical focus area for us.

From a business portfolio perspective, we made progress in divesting our divesting businesses that don't fit within our portfolio and from a capital perspective, we invested more to strengthen our businesses and returned excess cash to our shareholders through additional share repurchase. Let me make a quick comment or two about each of our business segments. First in ADT, our organic revenue growth was a little lighter than expected, but operationally, we performed better compared to last year. From a revenue perspective, we had good recurring revenue growth of 5% in the quarter, and this continues the positive trend we have been seeing in this metric.

Our North America residential business continued to grow nicely and for the first time in some years, we had positive recurring revenue growth in our Europe, Middle East and Africa region. As most of you know, strengthening our recurring revenue has been one of our top priorities and continuation of this progress is encouraging. The recurring revenue growth in ADT was important to us in this quarter as we did see a decline in systems installation revenue in North America and in Europe due to the continued softness with our retailer customers, as we have previously mentioned, as well as a slower commercial market in the UK.

That said, we feel good about the recurring revenue growth outlook, given our leading indicators and our growth prospects in Asia and Latin America provide us with some cushion in a tougher economic environment. On the operations side, ADT made good improvements across the major regions and Naren will expand on this in a few moments.

Turning to Flow Control, we had a good quarter with improved productivity and a better operating margin versus last year. Our growth was very good in our Valves and Thermal Controls business but was negatively impacted by a tougher comparison in our water business where our order and delivery activity in the Australian market was good, but not as strong as in 2007, when organic revenue growth was 37%. With our strong order activity and record backlog levels Flow Controls should have solid revenue growth and good margin improvement for the full-year 2008.

I was also pleased with the margin progress we made in the quarter in our Fire business. We made progress in both North America and in our international businesses where our better execution, productivity, and our plan to be more selective in the jobs we bid and take is proving to be successful. In Safety Products, our growth rate has picked up, and our operating margins were better due to improved productivity. In addition, as part of our key initiatives, we increased our R&D spending and our sales and marketing activity.

Next, our results in Electrical and Metal products were strong. We have been in a better pricing environment for a few months, and this combined with better operating efficiency allowed us to deliver stronger results. We have also been very active in refining our portfolio. We announced and closed on the sale of a number of businesses that did not fit within Tyco and expect to receive more than $1 billion of proceeds from these divestitures. We closed on the sale of Nippon Dry-Chemical in Japan. We reached a definitive agreement to sell Ancon, a metal building products business, which closed yesterday and we anticipate closing on sale of Earth Tech later in the year, with proceeds from the sale of the Brazilian operation expected shortly.

With the expected proceeds from these sales, as well as the cash flow that our businesses generate, our first priority continues to be reinvesting in our businesses. As we have been over the past few quarters we will continue to make investments in our businesses to grow our revenue organically and to improve our productivity, which includes our restructuring activities. We will also use our cash to selectively pursue modest-sized bolt-on acquisitions for either Security, Fire or Flow Control.

We recently announced the purchase of the FirstService Security, which will strengthen our ADT business by adding more advanced systems integration capability to our commercial security business. Finally, we expect to have excess cash and our plan continues to be return this cash to our shareholders. To date, we have used $676 million of our authorized $1 billion share repurchase, which has reduced our fully diluted shares by 3.25%.

I also want to comment on what we are currently seeing in our different markets around the world. Overall, North America grew 5% organically in the second quarter, driven by strength in our energy and infrastructure end markets, which was more than offset by a weaker retail environment in ADT Commercial. Asia and Latin America continue to grow nicely for us with double-digit organic revenue growth this quarter, while the European region was softer, and as I mentioned this was mostly due to the ADT Commercial business primarily in the UK.

From a business perspective, the ADT residential business continues to improve as our customer base continues to grow. Our other businesses continue to see good order growth and backlog improvement. To give you a feel for what we have seen, our North America Fire business had 12% order growth in the quarter and our orders and Flow Control grew 24% globally, or 14% excluding currency.

The strength of our order activity and our improved productivity give us confidence in the full-year 2008, and as a result, we are raising our full-year guidance to the range of $2.65 to $2.75. Overall, we continue to execute our long-term strategic objectives and have made significant progress during the first half of the year. As we look forward, we feel good about how we are strengthening our businesses for the long term.

Now, let me turn the call over to Naren for an additional update on ADT.

Naren K. Gursahaney – President ADT Worldwide

Thanks, Ed and good morning, everyone. I'm pleased to be here today to discuss ADT's results in more detail. While our operating profit and margins were about what we expected, our second quarter revenue performance reflects better results in recurring revenue and softer results in our systems installation revenue. On a worldwide basis, ADT's revenue grew 4%, including 1% organic growth to approximately $2 billion.

Let me first spend a minute on the recurring revenue part of our business as this represents about half of ADT's total revenue. Recurring revenue grew 5% in the quarter on a worldwide basis, which is the fastest growth rate in a number of years and represents continued improvement across all of our regions. North America continue to show improvement in this area, driven mostly by our strength in our residential business. While in the Middle East… Europe, Middle East and Africa region, recurring revenue growth crossed over and turned positive during the quarter.

Asian and Latin America also continued to see strong double-digit organic growth in the recurring revenue. When we look at the leading indicators of recurring revenue growth, we are also encouraged as they support our expectations for continued good growth throughout the remainder of the year. Our global account base grew by 1.9% year-over-year to almost 7.2 million customers, while attrition rates held steady at 12.2%, despite a negative 20 basis point impact due to the higher disconnect rates associated with the analogue to digital conversion in North America, which I will discuss in a little more detail in a couple of minutes.

Our average revenue per user increased to $46.87, which was a 3% increase over last year, excluding the impact of currency. Now, let me switch to the non-recurring systems installation and service revenue part of our business, which declined approximately 3% organically during the second quarter. Both North America and Europe saw declines primarily as a result of lower sales to our retail customers. We continue to see softness as these customers are opening fewer stores this year and delaying capital investments in existing systems upgrades, resulting in lower equipment installs overall.

We remain closely aligned with our key customers in this important segment and are confident we will capture this business when their investment levels ramp up again. In addition, we saw softer sales in Europe, particularly in the UK, with the market environment for the commercial business has weakened. Our systems installation service business in Asia and Latin America grew approximately 20% organically which provided some relief to the slowdown we are facing in North America and Europe.

From an operating income perspective, we increased our operating income before special items by 6% to $233 million, and improved operating margin by 20 basis points year-over-year to 11.9%. This year's second quarter operating income before special items included $27 million of expenses primarily for the analogue to digital conversion. This reduced our operating margin by 140 basis points.

Now let me give you a little more color on the analog to digital conversion project, which is largely been completed. We converted more than 90% of affected customers in the United States and Canada, which we're very pleased with, but there are approximately 16,000 customers that have not yet responded to our numerous attempts to complete the conversion. This has impacted our global attrition rate by 20 basis points. While some of these customers will be converted over the next quarter or so, we anticipate the financial impact on our results to be minimal.

When we look at our results on a geographic basis, each of our regions showed good profit improvement. In North America, our operating margin increased year-over-year, as we focused on improving our service delivery platform, which has increased our average gross margins across the business. We're also benefiting from faster growth in our higher margin residential business. Europe also improved its profitability as we saw the early benefits of our restructuring savings and in other parts of our international businesses we continue to share steady operational improvements.

From a strategic perspective, I'm very excited about our recent announcement to acquire FirstService Security. As Ed mentioned, this enhances our systems integration capabilities for our commercial customers and expands our presence in a number of key vertical markets. Looking ahead to the third quarter, the softer economic environment in North America and Europe will likely continue to impact our systems installation revenue, but this should be offset by continued strength in recurring revenue and certain international markets. Based on this, I believe revenue growth and operating income, when you exclude the analogue to digital conversion cost will be similar to what we saw in the second quarter.

In summary, I believe our second quarter results reinforce the value of the ADT business model. Our strong recurring revenue base and geographic and end market diversity help us deal with difficult economic environments. Our focus continues to be on delivering high quality services for our customers. Now, let me turn the call over to Chris to give an update on our other businesses.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Thanks, Naren, and good morning everyone. Now, let me start with discussing our Flow Control business. Overall, Flow Control had another quarter of good revenue and operating income growth. Revenue grew 17% to just over $1 billion, which was 7% organic growth. The Valves and Thermal Controls businesses continued to be very strong with combined organic revenue growth of 13% in the second quarter, as they continued to benefit from the strength in the energy markets. The Water business had a negative 5% organic growth in the quarter, which was below our expectation, as well as our growth rate in prior quarters. This business is project oriented in nature, particularly where we are involved in large-scale water infrastructure projects. We have been very active in building out water pipeline projects, particularly in Australia, where organic revenue growth was 37% last year. As we have previously discussed, we expect our Water business revenue to normalize over the course of this year, from the peak levels we saw in 2007, which will result in our overall Flow Control organic revenue growth moderating from prior year levels. Having said that, we expect Flow Control revenue growth to be in the high teens for the full year, as strong double-digit revenue growth in the Valves and Thermal Controls businesses should more than offset the tougher revenue comparisons in the Water business.

In addition, our order rate and backlog support solid growth for the remainder of the year. Our orders grew 24% and our backlog was up 28% year-over-year to $1.9 billion, which is our highest backlog to date. Before special items, operating income in Flow Control grew 28% to $143 million and the operating margin improved 120 basis points over last year to 14%. This was mostly due to better pricing and productivity in the Valves and Thermal Control businesses. For the full year, we still expect to see year-over-year operating margin improvement in each quarter, with a full-year improvement of about 100 basis points. Given the project nature of the business and product mix, the operating margin varies somewhat quarter to quarter. The revenue mix of business in the second half of the year will likely be lower margin than the first half of the year due to reduced revenue and profit contribution from the Water business.

Now, let me turn to our Fire business, which continued to make solid improvements in operating income and operating margin. Overall, Fire revenue grew 5% to $861 million with organic revenue growth of approximately 1%. Good organic revenue growth in North America and Asia was offset by revenue declines in Europe and other international markets, as we continue to exit non-core operations and to be more selective on the bidding of projects. In North America, the SimplexGrinnell business had organic revenue growth of 4%, and orders and backlog were strong as they both grew 12% year-over-year. Before special items, operating income for the total Fire business was $78 million and the operating margin improved 130 basis points to 9.1%. While SimplexGrinnell's margins improved in the second quarter, both year-over-year and sequentially, Europe and the other international businesses also saw improvements in their margins, mainly due to better execution and again being more selective on projects. We continue to feel good about the performance in our Fire business overall, as our order activity and backlog position us for a solid second half of the year.

Now, I’ll move to Safety Products where revenue grew 11% to $469 million and organic revenue growth of 5.4% was strong across all three lines of business; fire suppression, electronic security, and life safety. Before special items, operating income increased 13% to $80 million, as a result of higher revenue and the operating margin was 17.1%. Our margin increased, as reductions in G&A expense more than offset planned investments in sales, marketing, and R&D, which support our growth programs. During the second quarter, we also incurred $26 million of restructuring charges, as we began to execute plans to simplify operations and exit certain manufacturing facilities. While we started to incur charges this quarter, we expect the savings to begin in fiscal 2009.

And now, let me turn to Electrical and Metal Products where revenue grew 13% to $542 million, and the organic revenue growth was 11%. Revenue grew nicely with significantly higher metal pricing versus last year and strong volume gains in our core steel products. Before special items, our operating income was $75 million, and our operating margin of 13.8% was somewhat higher than we expected, as steel and copper spreads widened in the quarter. Operating income improved significantly versus last year's $26 million, and the $45 million we earned in the first quarter. While it is difficult to predict where metal pricing will go from here, we do think that steel pricing will continue to increase during the third quarter as a result of reduced imports and higher input costs. Therefore, we expect revenue to approximate $600 million in the third quarter, and the operating margin before special items to be similar to what we saw in the second quarter. For the full year, we have assumed revenue of approximately $2.2 billion and an operating margin before special items between 11.5% and 12.5%. This assumes metal prices flatten out after the third quarter and our operating margin contracts from the 13% to 14% level, as spreads narrow when lower cost inventory is replaced with higher cost inventory.

Before I turn it back over to Ed, let me make another couple of comments. Our GAAP tax rate for the quarter was 22.4% and was favorably impacted by 70 basis points related to the tax impact of special items. Our tax rate reflects [ph] continued progress in implementing our post-separation tax planning. The tax rate can still swing on a quarter-to-quarter basis and as such, we are still guiding to an annual tax rate of approximately 25% for the full year. I am very pleased with the progress we have made this year on the tax structure of new Tyco. As you know, the separation caused to us pull apart the structure that had been put in place to support what I’ll call old Tyco. We have moved quickly to put in place a revised structure to support our new company and these changes have had a favorable impact on our year-to-date tax rate. It is important to note that the reorganization of our structure is expected to cost us between $150 million and $200 million of cash this year.

In looking at our cash flow during the quarter, we had free cash flow outflow of $2.74 billion. This reflected the release of the $2.96 billion escrow account related to the settlement of the legacy class action litigation, which we had previously funded. In addition, we spent $82 million for restructuring activities and other items. Excluding these items, our cash flow would have been $306 million in the quarter, which compares to last year's $275 million. For the full-year 2008, we continue to expect our free cash flow, prior to the escrow release, to approximate net income. This free cash flow will then be reduced by the $150 million to $200 million I just mentioned.

As we have said before, we expect our full-year corporate expenses to approximate $500 million. Through the first half, our corporate expense totaled $252 million and included $18 million for separation, restructuring, and other special items. While our corporate office expenses are expected to remain relatively constant throughout the year, there are a number of items that flow through corporate that could impact our expense levels in each quarter. As such, we expect corporate expense to be $20 million to $25 million higher in the third quarter versus the second quarter, which reflects a few items that may hit us that are timing related.

Finally, as Ed mentioned, we closed on the sale of our Ancon business in the UK just yesterday. This business had revenue in 2007 of $107 million and operating profit of $23 million. We have now reported Ancon results for 2008 in discontinued operations for the full year and therefore it is not included in our second quarter results nor any previous quarter. Based upon the 2007 income, this would represent $0.03 to $0.04 of earnings per share.

Now, let me turn the call back over to Ed Breen to wrap things up in this morning's call.

Edward D. Breen - Chairman and Chief Executive Officer

Before I open it up for questions, let me provide you with some closing comments and our outlook for the third quarter. Our second quarter operating performance was well ahead of last year, with improved operating margins in each of our businesses. Based on our first half performance and given what we are seeing today, we are comfortable raising our guidance for the full year, as I mentioned earlier. For the third quarter, we expect revenue growth to be approximately 8%, with organic revenue growth of around 4%. From a profit perspective, we anticipate our operating margin before special items to be approximately 10% in the third quarter.

Thanks for joining us on the call this morning and operator, we'd be glad to open it up for any questions.

Question and Answer

Operator

[Operator Instructions] First, we'll line up with John Inch with Merrill Lynch. Please go ahead.

John Inch – Merrill Lynch

Thank you. Good morning.

Edward D. Breen – Chairman and Chief Executive Officer

Good morning, John.

John Inch – Merrill Lynch

Can we start with ADT? If you were to exclude the retailer aspects of the installation business, what's happening in your other sort of non-res businesses? Are you seeing any kind of impact in I think you mentioned SimplexGrinnell continues to see backlog strength. Maybe a little bit more color around the non-res, non-retailer portion of that segment.

Edward D. Breen – Chairman and Chief Executive Officer

Yes, John, maybe I will have Naren jump in with a little color commentary on ADT. Generally speaking it's really been the retailer market as we highlighted that started to hit us last quarter and we did see a little bit more softness in other commercial in the UK, but really nowhere else. And as you just mentioned, our backlog is at a record level in our Fire business and we had an improvement across all regions on the fire side.

As you saw our backlog in a lot of our other businesses are at very good levels. So the weakness we have seen is pretty much been isolated to that part of the market. Now, remember also, lot of the verticals we sell into, you know, the university business, the K through 12 [ph] schools, all of those type of things, you know, it's a pretty good chunk of our business. I can't imagine that will change. That's a lot of code driven work that we do. And when you really bifurcate a little bit more, a lot of our business is repeatable and lot of service business, both in ADT and on the fire side which continues to be performing about where we thought it would. So, that's the retailer piece and a little more on the UK, where we are seeing pretty good order trends and that's continues through the month of April.

Naren K. Gursahaney – President ADT Worldwide

I think Ed hit the nail on the head. For us, it's really the retailer space plus the softening that we are seeing in the UK. I would say for the ADT business, it probably cost us a point or two points of organic growth during the quarter. So that kind of puts a box around it. You know, we expect continued softness in that space, and we're planning for it and taking actions appropriately.

John Inch – Merrill Lynch

I think Ed and Naren you also called out that residential was improving. That's probably going to be surprising to a lot of people, given the U.S. housing downturn. What exactly were you talking about? When you say the residential is improving, I mean how do you parse the disconnect rate in residential with signing up new accounts versus the ARPU? Maybe again if we could flesh that out a little bit more.

Edward D. Breen – Chairman and Chief Executive Officer

I think I mentioned kind of what the breakdown was in our recurring revenue and a big chunk of that is our residential business. We continue to see good growth on the unit side, with the total on our … on the recurring revenue up 1.9% year-over-year and continued improvement on the ARPU side, up about 3% year-over-year.

So we are seeing at least consistent trends out in the market place on the residential side of our business. And we continue to be optimistic about the opportunities there.

Edward D. Breen – Chairman and Chief Executive Officer

And, John, on attrition side as Naren highlighted we got hit with about 20 basis points due to the analogue to digital conversion and we still stayed flat on attrition. So kind of operationally, you know, taking away the transition we had to go through, you know, we kind of operationally made a little bit of improvement on the attrition side also.

John Inch – Merrill Lynch

Yeah. Ed, are we still tracking to have the called out restructuring end by the end of this year?

Edward D. Breen – Chairman and Chief Executive Officer

Absolutely.

John Inch – Merrill Lynch

And it looks like you made some progress in ADT margins in Europe. Is that a function of the restructuring or is it mix or is there something else going on there?

Edward D. Breen – Chairman and Chief Executive Officer

I think restructuring is the major contributor and, you know, the part that I feel good about is we made 100 basis point improvement year-over-year despite the softness we saw in the UK. Clearly we are seeing some traction from the restructuring. We will see more of that as we go forward. We completed about 90% of the actions related to our restructuring in continental Europe.

John Inch – Merrill Lynch

And Naren, you still think Europe can be a double-digit margin business overtime?

Naren K. Gursahaney – President ADT Worldwide

We are still driving for 10% by 2010.

John Inch – Merrill Lynch

Thanks very much

Edward D. Breen – Chairman and Chief Executive Officer

Thanks John.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Thanks John.

Operator

The next question is from the line of Steve Tusa with JP Morgan.

Steve Tusa – JP Morgan

Hey, good morning.

Edward D. Breen – Chairman and Chief Executive Officer

Good morning, Steve.

Steve Tusa – JP Morgan

Just a question on Flow. They missed the organic revenue guidance and, you know, you talked about the project timing but wasn't that something that, you know, that tough compare, wouldn't that have been factored into your guidance for the quarter?

Edward D. Breen - Chairman and Chief Executive Officer

Yeah, Steve, we thought we had that factored in and really that was the one number we missed on from what we thought we would do. And you are absolutely right. We had organic growth in this business last year, in the water business of 37%. If my memory serves me right, the year before that, it was up 30%. This business has really boomed very nicely for us and we have flattened out. As we highlighted I think the last couple of quarters we were expecting that to occur and give us a tough compare for the next few quarters, however, in the second half of this quarter that we just finished, we had real significant project delays in Australia. And totally weather related. I don't know if you are aware of this, but a lot of monsoons, significant rains over there. We are digging a lot of trenches, putting stuff in and it really slowed our project down significantly from what we planned on. So that's where we were off on the organic revenue piece.

Now we'll get that business back and we will get some of that back in the third quarter, however, we are going to continue now with this tough compare for the next few quarters due to Water, you know, as we go out. But having said that, I think you saw from the numbers that Chris highlighted, you know, our Thermal business and our Valve business were very strong in the quarter. Our backlog and Valves were up 20% organically in the quarter. Our backlog in Thermal was up 67% organically and then the Water was a negative six, which we were not planning on the negative, we were planning on kind of flat growth. So, you know, the core of the business is feeling good with those kind of backlogs.

Steve Tusa – JP Morgan

Okay. But you do have, you know, the visibility on these projects? You know, it's tough [inaudible] monsoon season over in Australia with a lot of other stuff going on. But you do have, you know, good visibility on those projects coming back in the second half. So we should have faith that the reacceleration in organic growth is there?

Edward D. Breen - Chairman and Chief Executive Officer

Well, we highlighted. We said, just to give you a data point, we said we have 7.5% organic growth this quarter and we are projecting a combined flow of about 10% in the third quarter, so you will see some pickup occur. And, you know, as we highlighted we expect this year to make real good margin improvement for the full year. We are thinking at least, you know, about 100 basis points on the year. As you can see from this quarter, our year-over-year, we had about 120 basis points improvement. We are getting good efficiency in the business.

Steve Tusa – JP Morgan

One more on this ADT. This analog to digital stuff going away, but you are holding margins flat in the next quarter. Is that just the... you know is that how profitable the retail stuff is? Because it seems like it's more of an incremental adjustment on retail, which would be more than made up for in the $27 million coming back. Is that business just extraordinarily profitable?

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

I think if you look at our profit margins quarter sequentially, again, I would say the base business consistent with what we saw in Q2 excluding the one-time costs that we took for the analogue to digital conversion.

Steve Tusa – JP Morgan

Oh, gotcha. Okay, great. Thanks a lot, appreciate it.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Thanks Steve.

Operator

Next we go to the line of Jeff Sprague with Citi Investment Research, please go ahead.

Edward D. Breen - Chairman and Chief Executive Officer

Good morning Jeff.

Jeff Sprague - City Investment Research

Good morning, everybody. A couple of things. Chris, what you mentioned about the Flow margin progression, I think would have suggested that Water margins and Flow are higher than the rest of the segment. Is that correct and just triangulate us on that?

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

With the growth we have seen Jeff over the last two years, those margins have been a little bit higher than the overall mix. We are seeing margins improvements, however, in the Valves and the Thermal business as that business is growing. The mix will impact us in the second half. We will still see, as I said, each quarter, we expect to see some margin improvement versus the corresponding quarter last year.

Jeff Sprague - City Investment Research

That's interesting because I would have guessed on the oil and gas and other stuff, would you have had more pricing power than the Water related stuff, but it is just a...

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Well, again, the large, large volumes that we've had in Australia in that particular market has been a very profitable market for us.

Jeff Sprague - City Investment Research

Right. And can you give us a little bit of an update, Chris, on what we should expect for restructuring benefits flowing through in '09, the benefits of what you are doing in '08, and what you are thinking about for the '09 tax rate as you work through this planning process?

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Yeah. Let me first take the second one in terms of tax rate. It's still little bit early for us to look at what the tax rate will be going through '09. As I mentioned, we have gone through a very significant restructuring of our internal tax structure post the separation this year and we are seeing those benefits. So we are still looking out and trying to give... we'll give you towards the end of the year some better feel, but we are positioning our, I think ourselves well for at least a steady tax rate going forward. On the restructuring, again, we're seeing the benefits starting this year as Naren and Ed mentioned in our ADT business, I will also mention that we are seeing it already show up in our international Fire business where we also had quite a number of projects. So as we talk about European restructuring, I also want to highlight, it's not just the European security business but it's in our international Fire business as well. So, again, we are seeing some of those benefits this year and I think in '09, we are probably looking at an additional 50 to $100 million of savings that we will get through. Some of that, again, will depend on timing of these certain projects outside of the U.S., how quickly we can get those completed. I did mention a large project that we just undertaken in Safety Products, that will take us sometime as we move production and as we get into '09, we will start seeing some benefits. So I put it in the $50 million to $100 million range.

Jeff Sprague - City Investment Research

I'm sorry, just to be clear on tax early to give guidance, but you said working on steady tax rate going forward. I thought you had... or thought you had line of sight on a couple hundred Bips here over a few years as you reposition the portfolio.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Again, we are working hard on it. We said over a period of years we would expect that, but we haven't given any specifics for 2009.

Jeff Sprague - City Investment Research

Just one quick follow-up for Naren. When you said... your comment about Europe margins, was that Europe margins up 100 basis points in the quarter year-over-year?

Naren K. Gursahaney - President, ADT Worldwide

Yes, second quarter year-over-year.

Edward D. Breen - Chairman and Chief Executive Officer

And Jeff they were up sequentially 70 basis points.

Jeff Sprague - City Investment Research

What are you thinking about the full year for Europe?

Edward D. Breen - Chairman and Chief Executive Officer

I think we'll continue to see some progression as we get more benefits from the restructuring savings.

Jeff Sprague - City Investment Research

Great. Thank you very much.

Edward D. Breen - Chairman and Chief Executive Officer

Thanks Jeff.

Operator

Our next question is from the line of Shannon O'Callahan with Lehman Brothers.

Shannon O’Callaghan - Lehman Brothers

Good morning.

Edward D. Breen - Chairman and Chief Executive Officer

Good morning, Shannon.

Shannon O’Callaghan - Lehman Brothers

I guess for Naren and maybe Ed too. In terms of the progress on kind of the core ADT monitoring side of things. I mean, getting the recurring revenue into the 5% range, we were sort of flat and in the low single digits and, Ed, you used to talk about getting the 5 or 6. It seems you got there a little faster than you might have thought. Is that true and what would you attribute that to?

And also in Europe, things look ahead of planned versus the initial plans to get recurring revenue just to bottom there, you know, by sort of mid late this year. So, do you feel like you are tracking ahead of plan and what -- if so, what's going better than you thought?

Naren K. Gursahaney - President, ADT Worldwide

I would say on the recurring revenue piece, you know, we are seeing good sales production really across the direct channel primarily in North America and, you know, good progress there. We've got some programs that we launched out there to drive the better close rates, as well as better lead generation, as well as, you know, what we are driving on the ARPU side. We are seeing take rates on some of the new products kick in well and we have continued to escalate prices in segments of the mark that the we believe will hold it. On the European side, I would say we are on track with what we thought... where we will thought we would be this year, not necessarily ahead of schedule. You know, again, looking at where we are, versus where we need to get to by 2010, we still got lot of work ahead of us. Part of that will be the better mix of business and as we mentioned, you know, we did see the turn in recurring revenue in the quarter. I want to make sure that that's sustainable. We think we've got all the right programs in place there, but we have to continue to drive it. Like I said, generally speaking, Shannon, I think we are on track with where we thought we would be in Europe.

Shannon O’Callaghan - Lehman Brothers

And what was the... in Europe, what was the factor driving the improvement of recurring revenue in terms of, you know attrition versus better sales force productivity?

Naren K. Gursahaney - President, ADT Worldwide

It's a combination of both; attrition continues to come down nicely. In fact, our European attrition rates are now consistent with what we see in North America. So we made some very nice progress there. At the same time, we are doing a very good job on driving new recurring revenue in the business. So it's really balanced between the two.

Shannon O’Callaghan - Lehman Brothers

Okay. And just on Fire, you know, some nice margin improvement there in the quarter. How are you thinking about the benefits or, I guess, you get some benefit from getting out of some, you know, non-core areas maybe, but how do you think about the margins of that going forward and do you feel a lot more opportunity to improve them or they kind of hold here?

Naren K. Gursahaney - President, ADT Worldwide

No, Shannon, there's definitely opportunity over time here. I would say, there's two big things really... maybe three things really helping us on it. One is what Chris had mentioned, that, we are exiting and not taking certain projects. We put a much more disciplined process in place in the business and that's going to help us over time. But we are just executing better in the business. Simplex for now, if you have been watching, has been very nicely improving over about a three-year period here. And we've taken a lot of what I will just call the playbook that we had in SimplexGrinnell in North America. We spread that around to the rest of the world, and so there's what I call the rest of the world is starting to execute better along the lines of what Simplex started doing a few years ago. And I would also point out the area that I'm very focused on and our team in the Fire business is focused on, really it's our number one strategic objective is to increase the service part of our Fire business. In North America, service is about 50% of that business, and we have a plan to get that to a higher mix and also in our international markets. So if we can execute against the service part, that's obviously somewhat recurring which we like and it is also good margin business. And that's what can help our margins even more over the coming years. And I think all of you know what to point out, where we are starting to get these margins in this business, it's very attractive, because this business hardly takes any capital. So, the returns in this business are pretty darn nice.

Shannon O’Callaghan - Lehman Brothers

Okay. Thanks. Just last one, on the corporate expense Chris, you know, you mentioned sort of the timing things and staying at kind of $500 million, but as you think about that out into '09, are you still thinking kind of you could... the range will be $450 to 500, what are the things still left to do?

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Yeah, Shannon. Again, as you know, we implemented a program earlier this year, right at the time of the separation that significantly reduced our corporate office costs, and those savings we have been realizing and, in fact, are ahead of the plan. And so, those will remain relatively constant. There are some items that hit corporate that are timing. So, again, we haven't given any specific guidance on corporate yet for next year, but we're also impacted by some of the legacy items or legal costs and whatnot and so we will be filling in more as we move forward as to what we expect. But we are not expecting any... again, we have achieved most of the corporate office reductions that we expected post the separation.

Shannon O’Callaghan - Lehman Brothers

Okay. Thanks a lot.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Thanks.

Operator

Our next question is from the line of Nicole Parent with Credit Suisse, please go ahead.

Nicole Parent - Credit Suisse

Good morning.

Edward D. Breen - Chairman and Chief Executive Officer

Good morning.

Nicole Parent - Credit Suisse

Ed you referenced ADT North American leading indicator is still strong. Could you give us a sense of what they are. And then I guess, just also remind us kind of how long or short cycle the business is and with respect to visibility how much do you really have as you look at the second half and into 2009?

Edward D. Breen - Chairman and Chief Executive Officer

Well, you have to kind of take it by business, but let me just give you overall. As I think we mentioned, our North America organic growth rate in the quarter was 5.3%. So, that's all our business total Tyco, so that's pretty good to us. Again, Asia was up 15%, Latin America was up around 13%. The softness we saw was the decline in the EMEA region. Generally speaking, it looks good to us. You know, the part, Nicole.... a good part of our business, as you know, is recurring or repeatable business. As I said, that's 50% of our Fire business. the Naren's business, the residential piece, which is recurring, with some other is 50% of the Naren's global ADT business. Think I we have very good line of sight there. And then the rest kind of the other 50%, you have to break into pieces, some of it is long project cycle stuff, and some of it is a little bit shorter cycle. So, it's a mix in that part of the business but, a lot of it again is repeatable. I think we have good line of sight. And I think the backlog we have teed up going into the second half of the year gives us pretty good comfort as to kind of what our revenues are going to look like. What we have booked now in the Fire business is kind of what is going to ship over in the next six months and what we will be booking kind of the second half of this quarter and fourth quarters, really, going to be '09 shipments. So, lot of that seems to be in place. Naren are you going to comment on the ADT?

Naren K. Gursahaney - President, ADT Worldwide

On the ADT side, the recurring revenue indicators are consistent with what we are seeing on a global basis. The unit growth is upward of 1% unit growth increase year-over-year and the ARPU growth is, again, is in that 3% range. So it is very consistent with what we are seeing, on a global basis, again, because North America drives a lot of the volume with the big recurring revenue base that they have.

Nicole Parent - Credit Suisse

Super that's very helpful.

Operator

Our next question is from the line of Nigel Coe with Deutsche Bank.

Nigel Coe - Deutsche Bank Securities

Thanks, good morning.

Edward D. Breen - Chairman and Chief Executive Officer

Good morning.

Nigel Coe - Deutsche Bank Securities

So, if I take out the costs in Q2, you know ADT margins up 160 Bips. Now, with European restructuring gathering momentum, the mix between recurring and installs probably getting more favorable, shouldn't that accelerate in the second half of the year?

Edward D. Breen - Chairman and Chief Executive Officer

As far as the margin rate?

Nigel Coe - Deutsche Bank Securities

Margin expansions, yeah.

Edward D. Breen - Chairman and Chief Executive Officer

Again, Nigel, I kind of expect to see Q3 similar to what we saw in Q2, excluding, the amps cost there. Again, mix of business will continue to work in our favor, but we've got to watch closely the softening on the retail side, as well as the softening in the UK and potentially other parts of Europe.

Nigel Coe - Deutsche Bank Securities

Okay. And to what extent is rising gas prices impacting both ADT and the Fire protection.

Edward D. Breen - Chairman and Chief Executive Officer

It definitely is a big head wind for us. As the fuel prices go up, we got a huge fleet out there. At this stage, we are trying offset that with other areas of our sourcing activities and where possible we are trying to get price on that, looking at least at our time and materials type of service-type of activities where we can make a fuel surcharge. It's a relatively small piece of our business so we don't have as much leverage there, versus the traditional service contract business, but we are clearly feeling the pressure from the price at the pumps.

Nigel Coe - Deutsche Bank Securities

Okay. I guess Fire Protection is probably the most levered non-res installs. How variable is the cost base in Fire Protection. It seems like it is very variable. How could that cost base be flexed to respond to [inaudible]?

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Well, again, I think most of all, in the installation piece, we do have a large variable of cost base. Again, we are not going to make large moves based on what we see in the short term and I think our orders are looking good for the second half of the year. We have a good line of sight into our business. So, again, we have seen the leverage on the up side, but, again, we do have a variable work force in that installation piece of business.

Edward D. Breen - Chairman and Chief Executive Officer

I would say just overall to that, our variable work force is really in Naren's commercial part of his business and as Chris mentioned the Fire business. That's the two weaken flex, depending on what we are seeing on the volume side.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

More flexibility that you would have in the U.S. than in other parts of the world, depending on labor laws.

Nigel Coe - Deutsche Bank Securities

Sure. And then just one final one from me. In the Electrical business, you provided guidance, I think 13% to 14% for 3Q. Given the amount of steel that seemed on the low side in the context of where you have been in the past. You have been in the high teens when we seen this sort of spread widening on steel and copper. Can you reference to some of them, maybe what has changed this time?

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

Well, I don't think we are seeing any real change here, Nigel. I think what we are seeing is, a lot of it depends on where our inventory levels are. We are seeing strong volume growth and we have seen nice pricing increases. So we would expect to see that similar kind of pattern that we saw in the second quarter in the third quarter, so that as our inventory costs go up, as well, I think that that margin will be about the same in the quarter. Again, it's difficult to predict. These prices have been moving so quickly to see how fast they are going to move here in the quarter. I think we got a pretty good idea in the third quarter, but we do anticipate that moderating somewhat in the fourth quarter and then again our inventory costs will be higher. So we're expecting that margin to contract somewhat in the fourth quarter.

Edward D. Breen - Chairman and Chief Executive Officer

Nigel, we will continue to give you what we have over the last few quarters. Our best thoughts on the next quarter, we're trying not to make a call on the profitability of this business beyond more than one quarter, and as Chris said, if the market was to continue to strengthen and prices would go up, you would see that from us and we would expect it to flow through. We are just not going to make a call beyond the next quarter because quite honestly, it's not an easy thing for us to do.

Nigel Coe - Deutsche Bank Securities

Yeah, sure. Thanks a lot.

Operator

And we have a question from the line of Deane Dray with Goldman Sachs, please go ahead.

Deane Dray - Goldman Sachs

Thank you, good morning.

Edward D. Breen - Chairman and Chief Executive Officer

Good morning.

Deane Dray - Goldman Sachs

The first question for Naren, just to go back to that ADT retail business, and I know that's not a new issue. I would be curious to know whether this is more putouts or you are actually seeing cancellations, and when do you begin to lap this sector weakness?

Naren K. Gursahaney - President, ADT Worldwide

Again, Deane, I would still characterize them as putouts because again, it's not orders that have been placed. It's orders that we are anticipating, and I would say we continue to be very close with those customers. They have projects that have good return on investment, and they are looking to do them, but I think that whole retail space right now is going to be very cautious on capital expenditures right now. So it's one that we are continuing to monitor on a regular basis. I would say probably even more than a daily basis. We have our sales guys, in many cases collocated with the customers and we're continuing to watch it.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

From a compare point of view, we had a pretty good 2007 in our retailer business. And we started to see, as we talked about in our previous calls over the last couple of quarters, we started to see some softening. I think it's fair to conclude that as we said during our remarks, the compare will be with us certainly for the next few quarters. And, we will see after that.

Deane Dray - Goldman Sachs

Is there anything seasonal in the retail sector? Back to school, where you would have seen an outsized order in maybe a fiscal third quarter or is it pretty linear?

Edward D. Breen - Chairman and Chief Executive Officer

There's clearly seasonality in that business, a lot of it ties around their budgeting cycle, lot of them closed their fiscal year at the end of January, the budgets are in February. So quarter is traditionally slower but, again, there are projects and we will just have to continue to watch that. We look at the year-over-year comparisons to try to break out some of the seasonality.

Deane Dray - Goldman Sachs

Sure. And then over in North America residential for ADT, has there been any change noticeable in credit quality, delinquencies, age receivables. I know that AT&T talked about their being some of the customers stopped paying their bills and switching over from landlines to wireless. But are you seeing any change in credit quality?

Edward D. Breen - Chairman and Chief Executive Officer

No, we monitor this very closely on a month-to-month basis, week-to-week basis, and looking at the past dues, kind of over 90 days and I would say over the last six months we have not seen any noticeable change there.

Deane Dray - Goldman Sachs

Good. And then over at Flow, and just to give you an independent verification on the weather reports out of Australia They actually, it's ironic but they have been experiencing the worst drought in 100 years and that's what triggered all of this spending on multi billion dollars diesel systems, so that's the driver behind it. But in the middle of the construction, they had this monsoon, which was so ironic, and it was short lived but, yes, we heard other people complain about it.

Edward D. Breen - Chairman and Chief Executive Officer

That's one we couldn't forecast.

Deane Dray - Goldman Sachs

Absolutely. You are not the only one. But within in Flow, you said in flow, 75% of the business is international. Is that also the same for Water? And I'm just curious as to what you are seeing on the municipal side in the U.S. You've had some of your competitors talking about potential softening there.

Edward D. Breen - Chairman and Chief Executive Officer

I think, again the Water business is primarily outside the United States, as is the rest of our business. And, again, the Water business overall has been a little soft. The municipal build outs that we have seen is slowing up a little bit in Europe as well.

Deane Dray - Goldman Sachs

Good. And then just last question for Ed, how about just your comments on... as we see reports of the litigation being settled between the bondholders and now the shareholders and just, as you close the book on these expectations going forward, is anything... any of these long tail transactions is over now?

Edward D. Breen - Chairman and Chief Executive Officer

Well, look, the big part of it, obviously, Deane is over as you just mentioned and I have been at Tyco five and a half years now so it's about time we get some of those big legacy things finished off. But we're starting to get... I will call them the shoulder cases. There are a few splinter cases here, like the New Jersey one we just got settled. There's three or four others that come out of that original, I guess I will call it class action litigation. They are smaller, obviously, but we want to get them behind us as expeditiously as possible. One of the things that Chris had mentioned, as we get that stuff behind us and we stop doing depositions and all, that we can bring down our legacy costs that we carry at the corporate office, really in our legal department. So it might be a smaller case, but the build you spend on working it with all the lawyers is pretty significant. So as we continue to knock those off and we are very focused on those, I think as you can tell, you know, that will help us a little bit on the cost side.

Christopher J. Coughlin - Executive Vice President and Chief Financial Officer

And just to remind everybody, to the extend that we do settle out those legacy cases, that's a shared liability of the three companies, and our piece is 27% of that. Operator, I think we have time for one more question, do we have another question on the line?

Operator

We do. We will go to the line of Jeffrey Kessler with JPT Management, please go ahead.

Jeffrey Kessler - JPT Management

Thank you for taking my call. A question for Naren. In terms of Europe, you mentioned that the business over there seems to be improving on a recurring revenue basis. The companies that are... some of the manufacturers over there, as well as some of the system integrators over there have experienced softness and yet your business has turned in terms of recurring revenue. Is the percentage of recurring revenue relative to your total revenue over in Europe, is that kind of the driver that is going on right there? Are you getting a higher percentage of recurring revenue as part of your... as part of your total revenue package? And can you keep that up?

Naren K. Gursahaney - President, ADT Worldwide

Again, it's a relatively small percentage of our total revenue base over in Europe. I think we have showed the number last year. It's in the 20% to 30% range. So not nearly as significant as what we have in North America. So, again, we are building off of a smaller base there. Again, it's been a combination of improvements on growing the new recurring revenue, as well as continuing to drive down the attrition rate. Again I don't want to get too far ahead of myself there, we saw it turn this quarter. We have to sustain that and continue to drive it up. But again, the bulk of our business there, still the non-recurring contract business and it sounds like some of the other folks are saying the exact same things we are saying, particularly about the U K right now.

Jeffrey Kessler - JPT Management

Also the FirstService acquisition, brings you into a couple of new vertical markets. Can you make any comment as to particularly in the systems integration business over in the U.S. Are there any verticals that you are targeting or looking at that might be new for ADT?

Naren K. Gursahaney - President, ADT Worldwide

I wouldn't say they are necessarily new for ADT. I think it just gives us some better capabilities in some of the markets that we have been focused on over the past couple years.

Jeffrey Kessler - JPT Management

Okay. Thank you very much.

Edward D. Breen - Chairman and Chief Executive Officer

Okay. Ladies and gentlemen, thanks for joining our call. If you have any follow-up questions, please feel free to give us a call. I look forward to reporting to you on our third quarter results, which will be right around the 1st of August. Thank you very much for joining us.

Operator

Ladies and gentlemen, this conference is available for replay. It starts this morning at 10:30 a.m. Eastern, will last until May 8th at midnight. You may access the replay at any time by dialing 1-800-475-6701. International parties, please dial 320-365-3844. The access code is 918069. Those numbers again, 1-800-475-6701 or 320-365-3844 and the access code 918069. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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