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Tyco International (NYSE:TYC)

Q3 2012 Earnings Call

July 31, 2012 8:00 am ET

Executives

Antonella Franzen

Edward D. Breen - Chairman, Chief Executive Officer and Member of Special Committee

George R. Oliver - President of Tyco Fire Protection

Naren K. Gursahaney - President of Tyco Security Solutions

Patrick Decker - President of Flow Control

Frank S. Sklarsky - Chief Financial Officer and Executive Vice President

Analysts

Steven E. Winoker - Sanford C. Bernstein & Co., LLC., Research Division

Jeffrey T. Sprague - Vertical Research Partners Inc.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Scott R. Davis - Barclays Capital, Research Division

Nigel Coe - Morgan Stanley, Research Division

Deane M. Dray - Citigroup Inc, Research Division

Gautam Khanna - Cowen and Company, LLC, Research Division

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

Operator

Welcome to the Tyco Third Quarter Earnings Conference Call. [Operator Instructions] This call is being recorded. If you have any objections, please disconnect at this time. I will now turn the call over to Antonella Franzen, Vice President of Investor Relations. You may begin.

Antonella Franzen

Good morning, and thank you for joining our conference call to discuss Tyco's third quarter results for fiscal year 2012 and the press release issued earlier this morning.

With me today are Tyco's Chairman and Chief Executive Officer, Ed Breen; and Tyco's Chief Financial Officer, Frank Sklarsky. Also joining us for today's conference call are the presidents of Fire & Security, ADT and Flow Control, George Oliver, Naren Gursahaney and Patrick Decker, who will provide updates on their businesses and also participate in the Q&A session following our remarks.

I would like to remind you that during the course of today's call, we will be providing certain forward-looking information. We ask that you look at today's press release and read through the forward-looking cautionary informational statements that we've included there. In addition, we will use certain non-GAAP measures in our discussions, and we ask that you read through the sections of our press release that address the use of these items.

The press release issued this morning and all related tables, as well as the conference call slides, can be found on the Investor Relations portion of our website at tyco.com. Please also note that we will be filing our quarterly SEC Form 10-Q later today.

Certain items to be discussed during today's call, including those related to the company's proposed separation, are addressed in a proxy statement which has been filed with the Securities and Exchange Commission. Before making any voting decision, investors are urged to read the proxy statement regarding the proposed separation and other -- any other relevant documents carefully in their entirety because they contain important information about the proposed separation. Free copies of the proxy statement and other documents filed with the SEC by Tyco can be obtained through the SEC's website, as well as through Tyco's website.

I would also like to remind you that we are in a registration period due to the various filings related to the proposed separation and the announced merger of our Flow Control business with Pentair. As a result, we will not be able to answer questions related to those items and ask that you keep this in mind during the Q&A session.

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

Now let me quickly recap this quarter's results. Revenue in the quarter of $4.5 billion increased 4% year-over-year, including a 4 percentage point decline related to foreign currency. Changes in foreign currency exchange rates were more of a headwind than we originally anticipated and cost us about 1 percentage point of revenue growth compared to our previous expectations. Organic revenue grew 5%. Earnings per share from continuing operations attributable to Tyco common shareholders was $0.54 and included charges of $0.47 related to special items. Earnings per share from continuing operations before special items was $1.01.

Now let me turn the call over to Ed for some opening comments.

Edward D. Breen

Thanks, Antonella, and good morning, everyone. Overall, this was a very good quarter for Tyco, reflecting solid operational performance across Fire & Security, ADT and Flow Control. We had good top line growth, a 20% increase in operating income and strong operating margin expansion. Continued recurring revenue growth in ADT, volume leverage in our manufacturing businesses at Flow Control and Fire & Security, along with productivity, cost containment and restructuring initiatives, all contributed to our 190 basis points of operating margin expansion in the quarter. We delivered $1.01 in earnings per share before special items, marking the first time since the 2007 separation that we surpassed the $1 mark in quarterly earnings. This represents a 19% increase year-over-year.

Now let me give you a quick overview of our results for each of our businesses. Fire & Security had another strong quarter. Operating income before special items grew 4x as fast as revenue, highlighting the value of a nice mix of service, installation and product revenue. In ADT, recurring revenue, which represents almost 90% of ADT's total revenue, grew about 6% in the quarter with an increase in both the account base and average revenue per user. In Flow Control, increased volume in Valves, execution of Water projects and increased volume, along with a beneficial mix in the Thermal business, were the key drivers of the third quarter operating margin expansion. We surpassed the 13% operating margin we had expected to approach in the quarter and continue to be on track to achieve a 14% operating margin in the fourth quarter.

Before I turn it over to each of the presidents to review their respective business results, let me give a quick update on the proposed separation. First, as many of you have probably seen, we have been periodically updating our filings with the SEC, and we expect to be in a position to mail the proxy to our shareholders within the next week. Second, we have received tax rulings from the IRS and other tax authorities confirming the tax-free treatment of the spinoffs. Third, we have substantially completed the refinancing required by the separation. Also, clearance from the U.S. and EU authorities regarding the merger have been granted. And lastly, the Tyco shareholder vote related to the separation and the Pentair shareholder vote related to the merger will both be held on September 14.

We will hold an Investor Day for both Fire & Security and ADT on September 18 in New York City. Details regarding the event will be announced in the upcoming weeks. In summary, we are on track with the timeline we had initially laid out for the separation and the merger of Flow Control with Pentair.

With that, let me turn it over to George.

George R. Oliver

Thanks, Ed. Good morning, everyone. Fire & Security's results for the quarter were highlighted by good revenue growth and strong operating margin expansion. Our results emphasize the fact that we continue to be disciplined around our cost and confident about our ability to drive efficiencies. These initiatives are benefiting our results and will help accelerate our investments in top line growth while positioning us well for continued operating margin expansion in the future.

Now let's review some of the details for the quarter. Overall, revenue for the quarter was $2.7 billion, an increase of 3% year-over-year, including a 4% decline related to foreign currency. Organic revenue grew 4% with net acquisition and divestiture activity adding an additional 3.5 percentage points of growth.

To give you a little more color across each of our regions, organic revenue growth was led by North America, as well as Asia Pacific and Latin America. Europe was essentially flat as growth in products was offset by weakness in systems installation.

Turning to the performance of each of our global platforms, service, installation and products, let me start with the largest and most stable portion of the portfolio, service. Service represented about 45% of our revenue, and grew 3% organically year-over-year. Service grew in all geographic regions, but was led by growth in Asia Pacific and Latin America.

Systems installation, which represented about 35% of our revenue, was up modestly on an organic basis as growth in North America, Asia Pacific and Latin America was partially offset by a decline in EMEA due to continued softness in the nonresidential construction market.

The remaining portion of Fire & Security's revenue comes from our global product businesses, which represented about 20% of our revenue. Organic revenue grew 10%, following an 11% increase in the prior year quarter, as we continued to experience good demand across Fire Protection products, Life Safety and Security products.

Total Fire & Security orders grew 9% year-over-year, with service up 4%, systems install up 6% and products higher by 25%. Backlog of $4.7 billion increased 1.5 percentage points on a quarter sequential basis. Both orders and backlog exclude the impact of foreign currency but include the impact of recent acquisitions.

From a profit perspective, operating income before special items was $356 million, and the operating margin improved 110 basis points to 13.4%. This improvement was led by increased volume leverage in the product businesses and continued growth of our higher-margin service revenue. In addition, improved execution in installation projects and the continued positive impact of restructuring and cost-containment initiatives contributed to the year-over-year increase. Our reported operating margin of 13.4% includes a 30 basis point headwind related to increased investments in R&D, sales and marketing.

As I highlighted on last quarter's call, we are a technology leader in the industry, and innovation and product development are critical to our future success. This, along with our global sales and services footprint, differentiates us from our competitors, and it is these strengths that we plan to continue to leverage as we move forward.

Looking ahead to the fourth quarter. We expect revenue of approximately $2.75 billion. Embedded in this guidance is year-over-year organic revenue growth of 3%, a $110 million or 4 percentage point negative impact on revenue due to foreign currency, which will be mostly offset by the positive impact of acquisitions.

Additionally, as we disclosed last year, the fourth quarter of fiscal 2011 included a 53rd week. This additional week increased revenue by approximately $100 million last year, which will not be repeated in revenue for the fiscal fourth quarter in 2012. From an operating income perspective, we expect the year-over-year operating margin, net of increased investments, to improve 50 basis points.

Finally, as I think about Fire & Security post separation, I think about our unique position as a market leader in our industry. Our diverse mix of quality product and service solutions, along with our global scale of operations, market-leading brands and innovative spirit, position us well for future growth. We have an impressive base of stable service revenue that supports attractive free cash flow generation. And most importantly, we have bright, engaged employees, who genuinely care about protecting people and the places that they live and work. I am very excited about how these businesses have come together and the strong foundation we have built as the new Tyco.

Now let me turn it over to Naren.

Naren K. Gursahaney

Thanks, George, and good morning, everyone. During the third quarter, we continued our trend of delivering profitable revenue growth with total revenue of $815 million, which is up 4% from last year. Recurring revenue for the quarter, which accounts for nearly 90% of total revenue, was up 5.6% versus prior year. Recurring revenue growth was fueled by continued solid performance in gross customer adds, which were up 4.7% year-over-year.

Net adds were up 1.4% during the quarter as we did see an increase in customer attrition, which grew 30 basis points on a quarter sequential basis to 13.5%. The primary drivers of this increase were the anticipated headwinds from the price escalations we implemented in the second and third quarters and an increase in disconnects due to relocations as a result of the pickup we are seeing in the housing market.

While these relocations create some short-term pressure, they also create a future opportunity as we look to re-establish relationships with existing customers as they move into their new homes and capture new customers who move into the homes that are already outfitted with ADT systems. We have a number of targeted programs in place to address both movers and resale opportunities and are investing to strengthen these initiatives.

Our price escalations helped fuel continued momentum in driving higher revenue per customer, which grew 3.6% year-over-year to $38.36. New revenue per customer in our direct new sales channel was up 5.5% to $45.12, driven by the continued strong performance of our Pulse platform. Our Pulse take rate in this channel climbed to 39% versus 19% in the prior year. We also saw continued momentum on Pulse in our small business sales channel, where the take rate improved to just over 19% versus 7% last year.

Nonrecurring revenue, which accounts for about 10% of total revenues, was down 4.3% during the quarter. This decline was the result of the initial implementation of our business model change moving towards more ADT-owned systems, which I discussed on our call last quarter. This change resulted in about $10 million of lower nonrecurring revenue for the quarter and a slight improvement in operating income. As I mentioned on last quarter's call, this change has virtually no impact on our cash flow or economic returns for these accounts.

Operating income for the quarter was $208 million before special items, reflecting a 10 basis point improvement in operating margin year-over-year. Our productivity programs and the business model change helped to offset the cost of investments we are continuing to make to grow our customer base.

One of the primary growth investments is the continued expansion and strengthening of our direct sales coverage. On a year-over-year basis, we have increased our direct sales headcount by 8%. Marketing expenses increased by 2% during the quarter, as marketing and sales productivity largely offset the increase in lead-generation activities to support the additional sales reps and advertising cost increases in our key channels.

As we look forward to the fourth quarter, we expect recurring revenue to continue to grow at the rate we have seen over the past several quarters, approximately 5%, with the underlying recurring revenue growth drivers being consistent with what we saw in the third quarter. The fourth quarter will also have a full quarter's impact of the ownership model change that I mentioned earlier. Therefore, we expect nonrecurring revenue to decline between 15% and 20% year-over-year. As a result, total revenue growth is expected to be about 2.5%.

In terms of operating income. We expect to see about 125 to 150 basis points margin improvement in our operating margins versus last year. The change to more ADT-owned systems will give us a margin rate tailwind of approximately 100 basis points, and the balance of our margin expansion is driven by our ongoing focus on productivity programs, partially offset by the continued investments we are making to grow our residential and small business platforms.

Overall, I feel very good about the performance this quarter and our prospects for continued profitable growth as we look ahead to become an independent public company. Our 16,000 employees are passionate about helping customers protect and connect to what matters most, their families, homes and businesses. Building on our nearly 140-year legacy, the industry's most recognized brand and an innovative set of offerings, such as ADT Pulse, we are all very excited about the future of ADT.

Now I'll turn things over to Patrick.

Patrick Decker

Thank you, Naren, and good morning, everyone. This was a solid quarter for Flow Control. Revenue of $981 million in the quarter grew 6% year-over-year, including a 5.5 percentage point negative impact from foreign currency. Organic revenue continued to grow at a healthy rate, increasing 10% year-over-year. Operating income before special items was $130 million, a 23% increase year-over-year. The operating margin of 13.3% was strong and exceeded our expectations as increased volume leveraged nicely.

Now let me add a little color to the performance of each business. In Valves & Controls, revenue grew 7% organically, driven primarily from the oil and gas and process end markets. The leverage from the increased volume continue to lift the operating margin year-over-year. Orders growth in the quarter moderated to 5% due to rebalancing of inventories by some of our distributors. We saw a good order growth in July and expect orders growth approaching double digits in the fourth quarter.

In Thermal Controls, organic revenue grew 4%. Typically, the third quarter tends to be Thermal's seasonally weakest quarter. However, increased product sales benefited mix during the quarter, resulting in improved operating margin performance year-over-year. Orders in Thermal increased 26% versus the prior year.

In Water, revenue grew 26% organically, reflecting execution against backlog. As you would expect, the increased volume provided significant operating leverage, resulting in an operating margin of 12%. As you know, this is a project-based business, and therefore, orders tend to fluctuate from quarter-to-quarter. While Water orders declined 16% year-over-year, the current backlog in Water, coupled with projects we expect to be awarded over the next couple of quarters, this business is expected to support a continued solid operating margin.

Overall, total Flow Control orders in the quarter increased 5% year-over-year, and backlog of $1.8 billion was in line with the prior quarter. As we move into the final quarter of the year, we remain confident, based on our existing order backlog and improved conditions in Water, that we can further increase our operating margin to 14%.

Now I'll turn things over to Frank.

Frank S. Sklarsky

Thanks, Patrick, and good morning, everyone. Let me quickly touch on a few other important items. First, our cash position and overall balance sheet remain strong. We ended the quarter with $1.1 billion of cash. In the quarter, we generated free cash flow of $341 million, which included $91 million of cash paid for special items, primarily related to separation and restructuring activities. Adjusted free cash flow was $432 million. On a year-to-date basis, adjusted free cash flow of $846 million increased 14% year-over-year.

Over the past few quarters, we have continued to invest in the future growth of our businesses, increasing our capital expenditures and dealer spend. These investments are reflected in the free cash flow results.

Additionally, as you've seen in our quarterly results, management has embraced the opportunity to further rationalize both operational and administrative costs leading into separation. The lower corporate number in the third quarter is reflective of these efforts, and the result will be more streamlined corporate cost structures post separation. In fact, the initiatives we have taken to drive down the corporate cost line will benefit each of the separated companies, and it is expected that these savings will offset the additional costs the companies will incur in order to operate as independent public entities. As such, corporate expense before special items was $71 million in the third quarter. The favorable performance in corporate expense before special items compared to our original estimate was also impacted by the timing of certain project expenditures and annual actuarial valuations.

As discussed in detail in our third quarter 10-Q filing, which will be issued later today, we changed the methodology associated with the assessment of our asbestos accruals. As a result, we recorded a net charge in the amount of $114 million on a pretax basis as a special item to increase the reserve to reflect our best estimate of what will be needed to discharge these liabilities. Lastly, following the separation, we continue to believe that the corporate expense and tax rate guidance we previously provided in our filings for each of the 3 companies remains appropriate.

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

Edward D. Breen

Thanks, Frank. Before we open up the line for questions, let me briefly touch again on the fourth quarter. As George mentioned, last year's fourth quarter revenue benefited from a 53rd week, which, on a total Tyco basis, contributed an additional $145 million to the top line, which will not repeat in this year's fourth quarter. The revenue and operating margin guidance provided is reflective of segment results as they would have been reported as part of Tyco and not on a pro forma standalone-company basis. As consolidated Tyco earnings per share, including ADT and Flow Control, will not be reported due to the pending separation, we will not be providing total Tyco EPS guidance for the fourth quarter. But let me share some thoughts on our expected performance.

The fourth quarter is our seasonally strongest operational quarter of the year, and this year will be no different. In fact, given the segment guidance provided, we expect an additional $0.06 of earnings per share from segment operations on a quarter sequential basis and $0.09 per share year-over-year despite the benefit of the 53rd week last year. Given our year-to-date performance and our expectations for the fourth quarter, including our latest view of foreign currency exchange rates, we would expect the consolidated Tyco would be nicely ahead of the earnings per share guidance of $3.65 we provided last quarter.

As you know, it was just over 10 months ago that we announced our plan to separate Tyco into 3 companies. In making our announcement, we emphasized that this transaction was the next logical step for our company and our shareholders. I'm pleased to be able to say today that we have completed substantially all the heavy lifting related to this transaction, and we are now in the home stretch.

On a personal note, this represents my final quarterly earnings announcement as Tyco's Chairman and CEO. After 10 years of leading this great company, the time has come to pass the baton to new leadership. Having watched each of these businesses evolve through the years, I feel a great deal of pride in what we have accomplished together. Today, all 3 businesses have industry-leading positions with strong financials, leading technology, exceptional brands, exciting growth prospects and exceptionally talented employees. I see very -- a very bright future for these businesses and for all of our people around the world who will contribute to their future success.

I am very proud that our 3 business presidents will be stepping into new roles as public company CEOs, with George leading Fire & Security and Naren leading ADT. I'm very pleased to inform you that Patrick will become President and CEO of Harsco Corporation, a global industrial services company, effective September 10. Harsco made this announcement earlier today. Having worked closely with each of these leaders through the years, I feel a great deal of pride in what they have accomplished and look forward to seeing them achieve continued success in their new roles.

With that, operator, let's open it up for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Steven Winoker with Sanford Bernstein.

Steven E. Winoker - Sanford C. Bernstein & Co., LLC., Research Division

You know what? I think it deserve mention before my questions just to say, Ed, congratulations, your 10-year anniversary. You saved this company. I remember 10 years ago when I was at UTX and all of this news broke out and we really wondered about the future of the company, and I just think it's worth merit and mention to say congratulations. Let me ask a couple of questions, if I could, then transition to ADT. Naren, could you maybe give us a little bit more color on the pricing actions that you took in the quarter, the impact relative to last quarter, and how many more quarters of this can you sustain?

Naren K. Gursahaney

Well, Steve, as I mentioned in the last call, we're continuously trading off our 5 value drivers. We saw an opportunity in the business to be a little bit more aggressive on the pricing side, primarily because during the economic downturn 2009, '10 and '11, we had been very cautious there and actually held back that. So we made the decision to accelerate some of our escalations into Q2 and Q3. In total, it was about 900,000 accounts that we escalated during those 2 quarters. And I would say we're pretty much caught up at this time. There's a little bit of a tail there that will carry into the fourth quarter, but at this stage, we'll be moving back to our normal annual cycle around price escalation. So pricing will continue to be an important value driver for us as we look at ARPU. But I would say the acceleration that we did over the past couple of quarters will definitely slowdown as we look to the fourth quarter and beyond.

Steven E. Winoker - Sanford C. Bernstein & Co., LLC., Research Division

Okay. But you covered, what is it, around 30% of your account base? Or what percentage of your account base have you covered with the last 2 price increases?

Naren K. Gursahaney

In total, it was about -- a little less than 30%. But again, part of that would have been in our normal cycle. The rest of it, like I said, about half of that or little less than half of that would have been incremental to what we would've normally done.

Steven E. Winoker - Sanford C. Bernstein & Co., LLC., Research Division

Okay, all right. And then the other thing is -- I know I ask this all the time, but I just want to know every quarter. Any progress, from cable and telco perspectives, in terms of their pricing and share impact? Are they -- are you experiencing any kind of change in trajectory or impact from the increased investments from those guys?

Naren K. Gursahaney

Well, again, as we've mentioned in the past, we track our progress in those markets where we have the cable competition very closely, and we're looking at our performance every week. As I look at, specifically, the third quarter performance, again, I feel very good about how we're performing in those markets. There are some specific performance metrics, like our Pulse take rate and the upfront dollars that we're getting from our customer, that are better in those markets than what we're seeing in some of the other markets. And that, I think, is a reflection of the fact that there's more advertising around interactive services there, so there is a little bit of a lift in the water level. But overall, I still feel very good about our performance. There's nothing in there that surprises me or has me concerned. So I still feel very good. And more importantly, I feel good about both the products and services that we have to compete with those players in the marketplace.

Operator

Our next question is from Jeff Sprague with Vertical Research.

Jeffrey T. Sprague - Vertical Research Partners Inc.

Just back to Naren for a follow-up on ADT and Pulse. I think the $45.12 number you threw out is your dealer account ARPU, and I guess that's a blend of Pulse and non-Pulse. Can you just give us a little color on where your actual Pulse ARPU is running and kind of that, I forget if you call it, gold, silver or bronze, but those kind of price levels that kind of how people are breaking into those different buckets?

Naren K. Gursahaney

Jeff, just to clarify, the $45.12 number I gave you, that was new sales ARPU for our direct channel. So that was not a dealer number. The Pulse ARPU is consistent with what we've seen over the past several quarters, hovering right around that $50 range. And I would say the mix between the different Select, Advantage and Premier, again, is pretty consistent, about 70% in the Select and then kind of building up from that. But no significant changes either on the ARPU side or that mix between Select, Advantage and Premier.

Jeffrey T. Sprague - Vertical Research Partners Inc.

Great. And just flipping over to George. George, can you share a little color on what drove the product strength in your business?

George R. Oliver

Sure. I mean, if you go back, Jeff, we've been investing pretty heavily into these businesses for a number of years now. And I think that investment really now is beginning to pay off. We're not only extending the portfolio, but making sure that we're positioned within the growth markets, both the emerging markets as well as vertical markets, to be able to capitalize on the growth opportunity. And so the organic piece, we've also done some nice strategic bolt-on acquisitions, which have really complemented our portfolio, enabling us to better serve the customer base that we serve with our current channels, as well as capitalize on the new channels that they have brought to the business. So it's a combination of the 2 that really is driving that strength.

Jeffrey T. Sprague - Vertical Research Partners Inc.

And then just on Europe. Have you been able to defend or even improve those margins despite the fact that you're now hitting some revenue headwinds there [indiscernible]...

George R. Oliver

If you look back in -- over the last few years, we've done tremendous amount of work restructuring these businesses and making sure that we're focused on how do we grow profitably within these markets. And I can say, across the board, when you look at our current performance, our products are up modestly relative to the growth. Service is relatively flat, with install just slightly down. So overall, given what's happening within Europe, I'd say we're performing pretty well. And I think the work that we've done in restructuring these businesses, the investments that we're making now focused on profitable growth is really paying off. And across the board now, we're operating with double-digit margins.

Antonella Franzen

Yes. And, Jeff, I would just add that if you kind of take a look back, remember, that those margins in the EMEA region were once at that mid-single-digit range, and now they're in the double digits, and all that progress happened during an economic environment when we weren't getting any growth in the Europe region.

George R. Oliver

All of our businesses, Jeff, in -- within the U.K., within Continental Europe, across Security, as well as Fire now, is operating with double-digit returns.

Jeffrey T. Sprague - Vertical Research Partners Inc.

That's great. I remember when there was a minus sign in front of the margins.

George R. Oliver

So do I, Jeff.

Unknown Executive

Me, too.

Operator

Our next question is from Ajay Kejriwal with FBR.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Great. And then, Naren, maybe just following up on that ARPU discussion. Is it possible to parse that growth between mix and price? I know you had a very nice price increase on accounts this quarter. But any color? How much was mix versus price?

Antonella Franzen

When you look at the increases that we gave in ARPU, that should kind of give an indication. I mean, it's not just price, but the ARPU growth of 3.7% would be reflective of the price escalation. As well as, as new customers come on board, they're coming on at a higher rate because they're taking additional services. And then you obviously have the account growth at about 1.4% adding to that.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Good. Where I was going towards, what kind of sustainable -- so you had very nice ARPU growth last few quarters and you're guiding to about mid-single next quarter as well. The end market's growing low single digits. Obviously, you're doing much better than end market, but you're a big piece of the market here. So I guess any thoughts on what's the sustainable ARPU growth rate would be helpful.

Naren K. Gursahaney

I think Pulse -- while escalations may have been a significant driver over the past couple quarters, in the long term, the Pulse take rate is going to continue to fuel that growth. So as we bring on new customers and as we upgrade our installed base to Pulse, I think there's a nice opportunity there. And I still think that there is a strong unit growth opportunity. You got to keep in mind, only 20% of U.S. households have a monitored security system today. So I think there's tremendous penetration opportunities. Again, with the benefit of some of the new players coming in, the advertising and the awareness that they bring, we hope and believe that there will be an increase in penetration, and also as we bring more new capabilities to those customers to make the value proposition more attractive.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Good. And then maybe, George, just one on the bolt-on acquisition. Sounds like you did a couple in the quarter. In terms of the opportunities, any thoughts on what are the opportunities you see, whether they are outside the U.S.? Anything you see in Asia Pacific or Latin America?

George R. Oliver

Sure. I mean, a big part of our strategy was continuing to look at bolt-on acquisitions. If you recall, when you look at our market, although there are a couple of large plays, it's very fragmented across the globe. And so we're constantly looking at -- with our strategy of being a technology leader, expanding our service capabilities, positioning ourselves in the emerging markets and strengthening some of our vertical solutions, those are the priorities that we're looking at with these bolt-on acquisitions. We've got a nice pipeline of opportunities that we continue to work on, similar to what you've seen over the last 12 or 18 months, and that's certainly going to be a big part of our strategy as we go forward.

Operator

Our next question is from Scott Davis with Barclays Capital.

Scott R. Davis - Barclays Capital, Research Division

I'm going to ask one question for each Naren and George, but let's start with you, Naren. When you think about these relocates, I mean, I think about the long-term history of kind of ADT wasn't necessarily all that great at capturing when somebody moved into a new home and capturing it as a customer. I mean, what are you doing differently now that allows you to capture? And do you have kind of any stats of what your capture -- recapture rate is and such?

Naren K. Gursahaney

Steve, I think it's a great question -- excuse me, Scott. What we're trying to do and what we've done is we're really building the relationship with that customer much earlier in the process. So we're actually partnering with companies like HGTV and building our reputation for the safe move and building a program around the safe move. So we interact with our customers very early in that process of the decision to move out of their existing home, and we partner with them throughout that whole process. So I think we've seen some good success there, and part of that success is reflected in the momentum that we're seeing in our gross adds, which are up strongly in the 5% range this quarter. But also, on a year-to-date, we're running significantly above that, in the high single-digits. So I think we are making some good momentum, seeing some good momentum there.

Scott R. Davis - Barclays Capital, Research Division

Well, so just to follow up on that. I mean, any sense of, when somebody moves and they're an existing ADT customer, what the percentage chance you are to pick them up again?

Naren K. Gursahaney

I would say that one is they do have that predisposition to use a security system, and we're making sure that they've got the financial incentives as well to stay with us. I don't have a specific percentage capture rate there, but I think we're making very good progress there, and we see that as a continuing opportunity for us.

Scott R. Davis - Barclays Capital, Research Division

Okay, fair enough.

Naren K. Gursahaney

The assets that are sitting in the home, we want to make sure that we capture the people who are -- the new people who are moving in to our resale program.

Scott R. Davis - Barclays Capital, Research Division

Sure. Sure, makes sense. Okay. And one for George. George, can you give us just a sense -- I mean, you said all regions grew, but can you give us a sense, by geography, where the differences in growth rates were around the world?

George R. Oliver

Sure. When you look at the geographic footprint that we have, North America, we actually grew very nicely across both of our Fire & Security businesses. As I said, in EMEA, overall, when you look at just pure Europe, we're relatively flat. EMEA was up just modestly, and that included South Africa performance. So overall, just up slightly in EMEA, and that was driven, as I said, continued strong product growth in spite of the soft economy there. Relatively flat services, and install just modestly down. But then when you look at Asia Pacific we're up, in total. Obviously, strength in Asia, in China and then across the board, overall, good performance across the region, and that's how we measure it. So overall -- and then Latin America, when we segment Latin America, we continue to see nice growth across both of our Fire & Security businesses there in Latin America. So overall, we think the work that we're doing with our strategy, the investments we've made with the bolt-on acquisitions, I think are positioning us well to be able to differentiate and to be able to serve the customer base and continue to grow in spite of some of the economic challenges.

Operator

Our next question is from Nigel Coe with Morgan Stanley.

Nigel Coe - Morgan Stanley, Research Division

Ed, I'm glad you managed to break the dollar mark before you -- before separation. So just wanted to come back to the Pulse growth. 10% is pretty impressive. The gap between products and installs, I mean, I would expect those at some point to recouple. The differential, is that more geographic? Is there some pricing in there as well, inventories? I mean, what is -- explain that gap between products growth and installations.

George R. Oliver

Nigel, when you think of our portfolio, there's -- in our direct channel, we have about $8.5 billion of revenue and then on the product side, we distribute through an external channel, about $2.5 billion. And then at the end of the day, it's really making sure that we've got good coverage across all of the markets regionally. So we utilize where we have our focus with our direct channel, making sure we're differentiating the offerings that we have, and then we utilize parties [ph] and distributors to bring our technology to the rest of the market through our external channel. There's also -- when we look at our external channel, we serve a lot of the higher hazard end markets, and therefore, initially, there's not a lot of service. And so in the direct channel, we're constantly focusing on our project activity where it leads to recurring service revenue within our direct channel, because that, ultimately, is what drives our overall performance. So we're constantly looking at the mix and making sure that we've got the right channels to be able to get the product placed and then being positioned to be able to gain the service revenue over the life cycle of that installation.

Antonella Franzen

And, Nigel, the one thing I would add to that is that we have been and continue to be selective on the installation side, and we will continue to do that as we move forward. So as you could see, we were definitely getting the pull-through on the product side. And as George mentioned, we are trying to capture then the service side once the install is done.

Nigel Coe - Morgan Stanley, Research Division

Okay. No, that's clear. And then switching to Flow. Patrick, it looks like Valves softened a little bit in the 3Q, but then seemed to perk up again in July. Is there any reason why that would be the case? Why you saw some softness but then a re-acceleration in July?

Patrick Decker

Yes. Sure, Nigel. I think it was just a general tepidness in the distribution channel around what was going on in the general macro environment. People were looking at inventory levels, et cetera, on the distribution side, but I think now we've seen very strong order pickup in July. So it seems to have abated, and we have a pretty robust outlook for the next quarter. [indiscernible]...

Nigel Coe - Morgan Stanley, Research Division

And any intelligence on where...

Patrick Decker

No change in outlook on project activity. It's still a pretty robust market out there.

Nigel Coe - Morgan Stanley, Research Division

And how do you feel about channel inventory levels within Valves?

Patrick Decker

Feel good. Feel fine. It was not an issue in terms of being too much out there. I think it was just a general tepidness in terms of the economy and financials.

Nigel Coe - Morgan Stanley, Research Division

Okay, great. And, Patrick, congratulations on your new role.

Patrick Decker

Thank you. I appreciate it.

Operator

Our next question is from Deane Dray with Citi Research.

Deane M. Dray - Citigroup Inc, Research Division

I wanted to follow up with Patrick on Flow. Just -- I might have missed this. The double-digit orders expectation for the fourth quarter, how does that break out between the 3 businesses or maybe directionally?

Patrick Decker

Yes. So it's really a Valve commentary. That's the business that really is much more of a backlog business. The Water and Thermal businesses are choppy by definition because of lumpy projects that fall in and out of a quarter. So we feel good about the outlook from both of those businesses. And Valves, Valves is the business that we're really referring to when we say it would be approaching double digit.

Deane M. Dray - Citigroup Inc, Research Division

And what were the Water projects that you said you had increased visibility on?

Patrick Decker

Yes. There's still a fair amount of infrastructure being built in Australia on the large diameter water transmission needs that are out there. These are long-cycle projects. We track them over many years. We've had visibility to these for quite some time, and we feel very well positioned to see a number of them coming down the pipe here.

Deane M. Dray - Citigroup Inc, Research Division

Great. And then for Frank, on the change in the asbestos reserve. Just remind us what the time frame was on the previous reserve, and the -- how far this new reserve takes you?

Frank S. Sklarsky

Yes. No, that's good question. And by the way, there'll be some more extensive disclosure you'll see in the 10-Q today. But basically, the consistency in the data and the confidence in the trends have allowed us to look at the look-back and look-forward periods. So went from 5 years look-back to 3 years look-back, because we see more consistent data over that period of time, and now we've gone looking forward from 7 years to 15 years. So the new one is 3 back, 15 forward, and we think that the accrual that we have now on the books is adequate to discharge our liabilities at this point.

Deane M. Dray - Citigroup Inc, Research Division

Has there been any change in your insurance assets?

Frank S. Sklarsky

Well, what we've done is we've taken a look at the whole ball of wax here in terms of the liabilities, as well as assets, and we have identified significant amounts of insurance. So what you'll see in the -- in totality is a liability, gross liability of about $436 million and a net liability, net of insurance, of $154 million. And so when you look at -- look at it in totality, that $154 million, you're looking at 15 years. You're not going to see any exposure in any given year that's really material to Tyco in total. But yes, we have -- we've taken a good hard look at all the insurance assets, and that's all part of the analysis.

Deane M. Dray - Citigroup Inc, Research Division

Yes. And from our perspective, any time we see a company take the reserve out 15 years, it's usually a good sign in terms of reduced claims and better visibility on the claims outstanding. Is that fair?

Frank S. Sklarsky

Yes, I think that's a fair point.

Deane M. Dray - Citigroup Inc, Research Division

Good. And I know I should know this, but where is the asbestos liability? Even though it now looks fully reserved, where does that go in the separation?

Frank S. Sklarsky

Yes. The vast majority, that's going to be over in Fire & Security.

Operator

Our next question is from Gautam Khanna with Cowen and Company.

Gautam Khanna - Cowen and Company, LLC, Research Division

I just wanted to follow up on the Fire & Security product orders again, just a little more context. Because I think -- I recall in the March quarter, the number was up huge as well, 33%. And could you characterize what the year-ago compares were that might explain it and perhaps, if there was inorganic contribution to that number?

George R. Oliver

Yes. The -- this is George, again. Going back through the orders, we're seeing about -- when you look at the order rates that we talked about, which is driven by products, up 25%, there's about half of that, that's attributed to the acquisitions that were made over the last year. And so when you look at the -- it would be roughly -- would be up about 5.5% organically on orders. And when we look at the base of that, that's achieved because if I go back and when we look at the kind of the growth that we're seeing, it's really organically based on the investments we've made and our ability to expand distribution and make sure that we're positioned to capitalize on all growth markets. And then it's complemented by the acquisitions that have been made that not only strengthen our portfolio, but also open up additional channels to be able to bring our current product to the market to be able to capitalize on that growth. And so it's really a combination of the 2 that's positioning us well to not only grow organically but to be able to supplement that with the acquisitive growth that has been achieved. And as you've seen, the revenues, about $100 million per quarter on revenue that we're seeing with the bolt-on acquisitions, has really come together nicely with the base businesses that we have.

Antonella Franzen

And, Gautam, the one thing I would add, the growth that we're seeing this quarter in orders, up 25%, is on top of the 10% accelerated orders growth we saw third quarter of last year.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay, that's helpful. And switching to ADT. You mentioned the attrition up 30 bps in part due to the relocations. And I wonder if that's a trend you anticipate will continue for some extended period. And if so, kind of -- could you quantify what the impact was of that 30 bps in the quarter?

Naren K. Gursahaney

Well, based on how the housing market has bounced around, I'd hesitate to speculate on what it might look like going forward. I think if we continue to see a strong housing market out there, that will drive incremental relocations, again, because of the way we track attrition. We follow the asset. We follow the home versus the customer. So when we lose that customer in their current home, that's an -- that hurts our attrition number. When we capture them in the new home, that helps our gross add number. But I think we're all going to be watching the housing market very closely. June was good, but not as good as May, and we'll watch to see what happens in July and August.

Gautam Khanna - Cowen and Company, LLC, Research Division

And could you characterize how much of that 30 bps came from relocations in the quarter?

Naren K. Gursahaney

Yes. It's about half.

Gautam Khanna - Cowen and Company, LLC, Research Division

And just stepping back a bit, higher level at Fire & Security. I mean, where do you think we are in the cycle? I mean, do you think we're kind of in the third or fourth inning? Are we in the fifth or sixth? Where do you see this -- where do you see where we are relative to the cycle?

George R. Oliver

Well, it's 2 big metrics that we follow. So the first is what is actually happening in the market. So that's measured by the Dodge Reports and McGraw-Hill reports that show that the actual level of activity is, actually, this year, down about 5%. And so that's actually what's happening in the market. Now the indicator of what's going to happen going forward is the ABI Index, which, at 50% or above, suggests that there's going to be future growth over the next 12 -- 9 to 12 months. And that index was coming up nicely up to about 2 quarters ago. And then what's happened here, it's now softened here in the next -- in the last quarter or 2 to roughly about 47%. So it suggests that it's -- although it's holding on, there's not a projection that there's going to be a lot of growth within the non-resi construction market going forward. And recognize that it is 35% of our revenue base within Fire & Security. What we've done nicely is we're very selective in the projects that we've been taking on and, with that, making sure that it's positioning us to be able to accelerate service growth, which, as we discussed, we were able to achieve 4% growth this quarter. And it's a critical piece of our making sure that we get the right projects and, ultimately, drive service is what's most important.

Edward D. Breen

I think, Gautam, just to add to George's comment, the team has been posting these results, both orders and growth rate, without, in the last 4 years, non-resi helping us at all, as all of you know. It's down 50% to 60% from peak levels before the recession, and it has not picked up yet. So we're feeling good about the performance, but the key driver, commercial construction, is not helping us yet at all.

George R. Oliver

Go back to the downturn, since the downturn, it's actually down. There's been no recovery net through this period since 2008, and down -- we thought this year was going to be the beginning of the recovery. I believe it's going to be down somewhere around 5% or 6%, the non-resi construction activity.

Frank S. Sklarsky

And so all the work that's gone on, on rationalizing the cost structures is going to bode well for operating -- big operating leverage uplift on -- in an effort we've recovered [ph] at some point.

Operator

Our next question is from Steve Tusa with JPMorgan.

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

On the fourth quarter Flow revenues, you guys -- I don't think you guys gave a number on that. You gave numbers on everything else.

Antonella Franzen

No, we didn't provide a specific revenue number for Flow Control. We just really put out, at this point, an operating margins guidance number.

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

Any reason why that's the only one that's not -- is that because it's going to be a Pentair?

Antonella Franzen

Yes. As you know, the results of Flow will be included as part of Pentair. We did want to conclude on the margin target we had previously put out regarding the operating margin and approaching the 14% by the end of the year. So we just wanted to confirm that we are still on track to achieve that.

Edward D. Breen

But, Steve, there's no anomaly there. Our backlog is near an all-time high in Flow. Our orders were decent. Our July orders were better. So there's nothing going on there. [indiscernible] that will get the margins up another -- up to 14%.

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

And then I guess there's some news coming across saying that you're departing as CEO, Chairman. I mean, there's no change to you sitting on the -- any of the boards of any of these new companies you talked about prior, right?

Edward D. Breen

Yes, Steve, no change whatsoever.

Operator

Our final question today is from Shannon O'Callaghan with Nomura.

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

So the CapEx was up pretty decently in the quarter. I mean, can you maybe break that out by the segments? I mean, was it mostly ADT, or are you doing some things in the other pieces?

Antonella Franzen

I mean, it would be broken out between ADT and in the Fire & Security piece of the business that we have. The bulk of it would relate to ADT because, as you know, the majority of all the dealer goes into the ADT residential business. And then on the regular CapEx side, a piece of it would be within ADT and a piece of it would be in Fire & Security. When you do see the updated Form-10 filing for ADT, you'll see the exact amount that's allocated to resi, and you'll know exactly how much was Fire & Security.

George R. Oliver

And just a commentary on that. On the dealer side, we're continuing to invest there as we see opportunities. It's driving both our unit growth but also ARPU. As we get higher ARPU there, we have a higher funding level. Similarly, on the direct side, I'd say the only anomaly there is that business model change does put more dollars into the CapEx or some cyber CapEx number. Again, it doesn't change the cash flow overall. It just moves it from one bucket to another.

Frank S. Sklarsky

I think the message you're hearing that it's -- the vast majority of the CapEx is going toward growth.

George R. Oliver

Yes. And in Fire & Security, most of our -- all of our capital expenditure is in line with our growth. We're continuing to reinvest in the business.

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

And, Naren, do you know how much that -- the accounting change impacted the -- sort of the internal CapEx for ADT in the quarter?

Naren K. Gursahaney

It was between $5 million and $10 million. Again, it was a $10 million revenue impact. A piece of that is the sale and cost side of that. So it would've gone on the balance sheet.

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

Okay. And then can we -- just maybe a little bit more color on the Valves piece, maybe by some of the verticals and how -- maybe how much visibility do you have into those distribution channels, just to give us a little better feel. And it seemed like a decent slowdown in the quarter and then a snapback, yet the macro hasn't really felt like it's gotten a lot better. So kind of interesting why it's picking back up, I guess why it came in so much and why you think it's picking back up so much into 4Q.

Patrick Decker

Yes. I think the -- I think first of all as we've said in the past, this is a fairly choppy project environment in the markets that we serve. So I wouldn't read too much into any one quarter. I realize that it appeared to be a little bit of a pullback from what we've seen in terms of growth rate. But I wou-ld also remind everyone that we are lapping some pretty impressive growth numbers last year. But two, I think there was just a general tepid response in June to what's going on in Europe and other things, but we saw that bounce back in July. If I look at it by industry, oil and gas continues to be very impressive growth. I would say we had a little bit of volatility in mining, which is bouncing back in terms of growth there. But again, that's a watch and see. I think the power markets have obviously been toggling back and forth with what happened in Japan, but again, we feel good about the long-term aspect there. And then process, which is really driven by chemical, is obviously tied to GDP and what's going on generally in the overall economy right now. So that, I think, is where we really saw more of the pullback in June and a bounceback in July.

Antonella Franzen

Operator, that concludes our call.

Operator

This does conclude today's conference. Thank you very much for joining. You may disconnect at this time.

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