Executives
Edward C. Arditte - Sr. VP Strategy and IR
Edward D. Breen - Chairman and CEO
George R. Oliver - President Safety Products and Electrical & Metal Products
Christopher J. Coughlin - EVP and CFO
Analysts
John Inch - Merrill Lynch
Shannon O'Callaghan - Lehman Brothers
Stephen Tusa - JPMorgan
Nigel Coe - Deutsche Bank
Jeffrey Sprague - Citi Investment Research
Scott Davis - Morgan Stanley
Deane Dray - Goldman Sachs
Tyco International Ltd. (TYC) Q3 FY08 Earnings Call July 31, 2008 8:30 AM ET
Operator
Welcome and thank you for joining the Tyco International Report Third Quarter Results Conference Call. At this time all participants are in a listen-only mode. After the presentation we will conduct a question-and-answer session. [Operator Instructions]. Today’s conference is being recorded. If you have any objections, you may wish to disconnect at this time.
Now, I will turn the meeting over to Mr. Ed Arditte, Senior Vice President Strategy and Investor Relations. You may begin, sir.
Edward C. Arditte - Senior Vice President Strategy and Investor Relations
Thank you. Good morning and thanks for joining our conference call to discuss Tyco's third quarter results for fiscal year 2008 and the press release that we issued earlier this morning. With me today are Tyco's Chairman and Chief Executive Officer, Ed Breen; our Chief Financial Officer, Chris Coughlin; as well as George Oliver, who has responsibility for the Safety Products and Electrical and Metal Products businesses.
Now, let me remind you that during the course of the call we will be providing certain forward-looking information. We ask you to look at today's press release and read through the forward-looking cautionary informational statements that we have included there.
In addition, we will use certain non-GAAP measures in our discussions and we ask you to 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 can be found on the Investor Relations portion of our website 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 $0.41 per share and this included a net charge of $0.47 cents per share for special items. Diluted earnings per share from continuing operations before special items was $0.88.
From a total Tyco perspective, our overall revenue growth was 11% with organic revenue growth of 6.2%, which was ahead of our expectations. Our operating margin before special items was 12.1%, which was higher than our operating margin guidance of approximately 10%.
Now, let me turn the call over to Ed Breen for some opening comments. Ed will then be followed by George for a review of Safety Products and Electrical and Metal Products. Chris will then review the results from our other businesses before we wrap up and take your questions.
Edward D. Breen - Chairman and Chief Executive Officer
Thanks, Ed and good morning, everyone. Overall, this was clearly a good quarter and we continued to make solid progress in improving our operations, refining our portfolio and carefully allocating our capital. Our results were strong in almost every area, which is satisfying.
On a total Tyco basis, our revenue growth rate picked up from the previous quarter even excluding the additional revenue contribution from Electrical and Metal Products.
As Ed mentioned, our operating margin adjusted for special items came in at 12.1%. Over a third of the improvement relative to guidance came from our fire, security, safety and flow control businesses with the remainder from electrical and metal and lower corporate expense. The higher revenue growth combined with the better margins and better below the line performance resulted in very strong EPS growth before special items which was up 73% year-over-year.
Let me make a quick comment or two about each of our business segments and then George and Chris will provide you with more detail in a few minutes. First, at ADT, recurring revenue continued to perform well growing 5% in the quarter, although this was partially offset by continued softness in our systems installation and service revenue primarily in our retailer end market.
Overall, revenue growth finished the quarter modestly better than we expected and our operating income was also a bit above our expectations and our operating margin was 13.5%.
Turning to Flow Control, we had strong revenue growth in two of our businesses and overall improved productivity resulted in a better operating margin versus last year. Double-digit organic revenue growth in our valves and thermal controls business was partially offset by our water business, which had a 7% organic revenue decline.
Our total Flow Control organic revenue growth was below our guidance, mostly due to lower than expected water revenue. However, Flow Control market demand continues to be strong resulting in increased order rates and a record backlog in this business. We continue to track towards solid year-over-year improvement in our operating margin in Flow Control.
Next our fire business had a very good quarter. Organic revenue growth was stronger at 4.2%, which was our best quarter of the year. From a margin perspective, we again made progress in both North America and in our international business.
Safety products also had a solid quarter with good revenue and income growth. We are seeing good progress in our growth efforts as we continue to invest in technology and emerging market expansion. We continue to add capability to our access control and video business and earlier this month we announced the purchase of IntelliVid, a leading developer of video analytics.
Finally, Electrical and Metal Products has been in a better pricing environment for the past two quarters and this combined with better operating efficiency allowed us to deliver very strong results.
And looking at our business performance in the quarter from a regional perspective, our revenue in North America grew 9% organically. Excluding the strong results in Electrical and Metal Products, our other North America businesses had 6% organic revenue growth. In addition, Asia and Latin America continue to grow nicely with mid teen organic revenue growth rates while the European region was essentially flat due to the softness in ADT.
Emerging markets represents 13% of our total revenue and revenue grew 20% organically in the quarter in these emerging markets. Based on our strength of our operating results and our outlook for the fourth quarter, we are raising our full-year guidance to a range of $2.97 to $2.99.
Turning next to our business portfolio activities, we have already received $1 billion in cash proceeds from our divestitures. Some of our cash will be used to selectively acquire modest size bolt-on business in security, fire and Flow Control. We recently closed our acquisition of FirstService Security, which adds additional systems integration capabilities to our North America commercial security business.
Also since our last conference call, we have acquired our two largest sensormatic franchises, which provides us with direct access to our customer base in certain territories while reducing our operating expenses.
Internal investments to fund growth and productivity projects in our business remain the first priority of using cash. However, we continue to expect to have excess cash and plan to return a portion of this cash to our shareholders. We recently completed a $1 billion share repurchase program and also announced a new $1 billion follow-on program. Our activities to date have resulted in the repurchase of nearly 5% of our outstanding shares.
Now let me turn the call over to George Oliver.
George R. Oliver - President Safety Products and Electrical & Metal Products
Thanks, Ed and good morning to everyone on the call. I'm pleased to have the opportunity to discuss the details of the third quarter results for the Safety Products and Electrical and Metal Products segment.
Let me start with Safety Products and provide you a quick overview of the business. Safety Products operates 38 manufacturing facilities globally with 10,000 employees worldwide supporting our global customer base. We're organized around three business platforms, fire suppression, electronic security and life safety.
Safety Products overall performance in the third quarter was strong with revenue up 16% to $511 million and organic revenue growth of 11%. The operating margin before special items was 17.8%. Our revenue growth was driven by strong performance in our fire suppression and life safety platforms.
In fire suppression, where we recently integrated our water and chemical fire suppression business, we generated 13% organic revenue growth. The integration of the fire suppression business has positioned us in the industry as a total solutions provider and we are starting to see that translate into increased global sales.
In life safety we generated 18% organic revenue growth, which was a nice improvement for this business. As you may know, the challenge for our life safety business over the past few years has been the reduction in homeland security grants that were provided to municipalities for emergency responders.
We responded by increasing our investment in R&D to diversify our overall portfolio and develop new products. As a result, we are seeing good performance from these new products in both North America and around the world.
In electronic security, our growth is driven by continued focus on two key areas; access control and digital video. Our new products and services are designed to take advantage of the development of IP networks and provide our customers with the advanced analytics needed to make sense out of all of the data streaming through their electronic security hardware. To do this we have ramped up our R&D efforts while also making strategic bolt-on acquisitions such as IntelliVid.
Sustaining and growing our technology leadership is a core strategy across all of Safety Products. These and other growth investments are positioning the business to compete and win on a global basis. To enable these technology investments and offset rising material costs, we are continuing to drive operational excellence initiatives. We have teams working on both direct materials and indirect cross sales opportunities.
In addition, we are significantly enhancing our product pricing disciplines to protect our operating margins. To illustrate this, our growth investments including R&D and sales and marketing generated an 80 basis point margin headwind last quarter. We almost fully offset this as well as raw material headwinds with our operational excellence initiatives.
This was a solid third quarter for Safety Products and we are continuing to position the business for long-term growth. While we will not repeat the 11% organic revenue growth we had in the third quarter, we expect to achieve 5% to 6% organic growth in the fourth quarter, which will result in a full-year growth rate of approximately 7%.
Now let's turn to our results for Electrical and Metal Products. This was an extremely strong quarter as rapidly rising steel prices and our resulting pricing actions translated into revenue of $652 million. Due to the significant profit fall-through on the higher revenue, our operating income before special items was $146 million, which was nearly $100 million higher than last year's third quarter and about twice the operating income we achieved last quarter.
As you may know, we purchased and processed approximately 900,000 tons of steel each year and we produce nearly a billion feet of electrical cable each year. Our profitability in these product lines will fluctuate with raw material input costs. This was particularly true in the third quarter when steel prices increased by more than $300 per ton with a year-to-date increase of approximately $500 per ton.
Again, we managed our pricing discipline in step with these market increases, which drove the higher revenue and income growth in the quarter. As with our Safety Products business, operational excellence is a major area of focus in Electrical and Metal Products. Our lean manufacturing efforts are improving the speed and throughput of our manufacturing processes, which has resulted in a 10% year-over-year reduction in our conversion cost per ton. It adds significant improvement in our working capital turnover.
Looking ahead to the fourth quarter, steel prices are currently holding in the $1,200 per ton range. As we replenish inventory in a higher price environment and anticipate a typical seasonal volume decline, this will narrow our spreads and result in lower operating income sequentially.
Based on current market conditions, we are estimating our fourth quarter revenue to be approximately $620 million with operating income of approximately $90 million. Income at this level would represent a 73% increase over last year's fourth quarter and a $56 million decline from the operating income we achieved in this third quarter.
Now, let me turn the call over to Chris to update you on the other businesses.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Thanks, George and good morning, everyone. Let me start with the results for ADT. Overall, ADT worldwide revenue grew 4.8% to $2 billion with organic revenue growth of 1.8%. Recurring revenue, which represents half of ADT's total revenue grew 5% organically with year-over-year improvement in all geographic regions.
Our EMEA region had positive recurring revenue growth for the second quarter in a row. ADT systems installation and service revenue, which represents the other half of ADT's total revenue, declined 1% organically driven mostly by our retailer end market and to a lesser extent our European operations where we are seeing a softer economic environment. North America was modestly positive after declining 5% last quarter and the rest of the world continued to grow at low double-digit rates.
From a proper perspective, ADT's operating income and operating margin before special items were slightly above what we had expected. Operating income before special items was $270 million and the operating margin before special items was 13.5%.
Turning now to some of our key metrics, our total account base grew 1.6% year-over-year to 7.2 million accounts. In addition to our growing account base, our average revenue per user also increased to $46.88, which is a 3% increase over last year. The average revenue per user has been steadily increasing as a result of our broader product offerings and pricing initiatives.
During the quarter, we saw a modest pick up in our attrition rate, which increased 50 basis points to 12.7%. The increased attrition was entirely in the U.S. commercial business as we made a conscious decision to exit an unprofitable commercial contract, which represents about half the increase.
Additionally, some commercial customers switched from a contractual service agreement to a pay as you go arrangement, which also impacted our attrition rate. However, we do not expect it to have a negative impact on our revenue or profitability. Internationally, our attrition rate continues to improve.
Turning now to Flow Control, revenue grew 15% to $1.1 billion with organic revenue growth of 5.3%. The continued strength in our end markets resulted in another strong quarter for the valves and thermal control businesses.
The valve business grew 18%, just 10% organic, and the thermal controls business grew 23% or 15% organically in the third quarter. As we discussed in last year's… last quarter's conference call, we expected a revenue decline in the water business primarily due to timing of large-scale water projects in Australia. As a result, our water business had a 7% organic revenue decline in the quarter, which was a bit weaker than we had expected and the tough comparisons in this water business will continue to be with us for the next few quarters.
Before special items, operating income and Flow Control grew 23% to $155 million and the operating margin improved 90 basis points to 13.7%. Higher revenue and better productivity in the valves and thermal control businesses more than offset the decline I mentioned in water.
As Ed previously mentioned, our end markets remain strong. Our year-over-year order rates increased 27% globally or 18% excluding currency and our backlog increased 34% to a record level of $2.1 billion.
Looking ahead to the fourth quarter, the negative comparison for water will become bigger. Despite the continued revenue strength in valves and thermal control, we expect a negative comparison water will result in low single-digit organic revenue growth in the fourth quarter for the total Flow Control. From a profitability perspective, we continue to expect solid year-over-year improvement in our operating margin for fiscal 2008.
Now let me turn to our fire business, which had another strong quarter. Overall, fire revenue grew 8% to $919 million with organic revenue growth of 4.2%. Stronger organic growth in North America and Asia was partially offset by a year-over-year revenue decline in Europe and certain other international markets as we continued to exit non-core operations.
Revenue in our North American SimplexGrinnell business grew 8% organically with over 50% of the revenue generated from service. Our business is focused on certain vertical markets such as education and health care and a number of these markets are expected to remain strong over the next few years. This focus in part explains the order activity we saw in the third quarter.
On a global basis, order activity increased 15% and 10% excluding currency and we finished the quarter with a 13% increase in our backlog. This was also a very strong quarter from an operating income perspective with improvement in North America, EMEA and the rest of the world. Before special items, operating income for the total fire business increased 37% to $97 million and the operating margin before special items was 10.6%, a 220 basis-point improvement over the prior year.
Operating income improvement in SimplexGrinnell was primarily attributable to increased revenue as well as our continued focus on productivity. The operating income and margin improvement in our international fire business was mostly due to better operational execution and increased service mix. We continue to feel good about the performance of our fire business and our order activity and backlog position us for a solid fourth quarter.
Before I turn it back over to Ed, let me make a couple of other comments. Free cash flow in the quarter was $446 million after spending $81 million for restructuring activity and the settlement of certain legacy legal items. Our free cash flow for the quarter was well in excess of last year's free cash flow. For the full year of 2008, we continue to expect our free cash flow to approximate net income and as we discussed in last quarter's call, this free cash flow will be… then be reduced by approximately $200 million of cash spending to reorganize our tax structure.
Turning to corporate expense, we continue to expect our full-year corporate expenses to approximate $500 million, which would imply a $10 million to $15 million increase in the fourth quarter versus the third quarter reflecting the timing of a few expense items. We expect net interest expense to be in $65 million to $70 million range in the fourth quarter. This will be an increase of approximately $10 million over the third quarter partly due to incremental amortization related to the early extinguishment of debt. The fourth quarter net interest expense is a good estimate for our quarterly expense run rate in 2009.
Our GAAP tax rate for the quarter was 18.4% and was favorably impacted by 6.8 percentage points related to the tax impact of the special items. We are still guiding to an annual tax rate of approximately 25% for the full year, implying a 27% to 28% tax rate for the fourth quarter.
Now, let me turn the call back over to Ed Breen to wrap up this morning's call.
Edward D. Breen - Chairman and Chief Executive Officer
Thanks, Chris. With regards to business conditions and the economic environment, we are carefully monitoring order activity and are generally pleased with what we are seeing. As we noted in our comments, our order activity remains strong across our business except for ADT commercial where the retailer market is weaker.
For Tyco overall, the strength of our order activity and our improved productivity has allowed us to make good progress so far in 2008 and also gives us confidence in our fourth quarter outlook.
Before I wrap up, I also want to provide you with some additional guidance for the fourth quarter. First, we expect earnings per share before special items in the fourth quarter to be in the range of $0.71 to $0.73, which results in full-year earnings per share before special items of $2.97 to $2.99. For total Tyco, we expect revenue growth in the 6% to 7% range with organic revenue growth of around 3%. With lower growth rates in Electrical and Metal Products and Flow Control because of our water business and approximately 5% to 6% organic growth in TSP, which would be down sequentially, our guidance for the fourth quarter represents a year-over-year increase of about 26% in earnings per share before special items and an increase of just under 60% for the full year.
Thanks for joining us on the conference call this morning and with that, operator, you could open up the line for any questions.
Question and Answer
Operator
Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from John Inch from Merrill Lynch. Your line is open. Please ask your question.
John Inch - Merrill Lynch
Thank you. Good morning.
Edward D. Breen - Chairman and Chief Executive Officer
Good morning, John.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Good morning.
John Inch - Merrill Lynch
Good morning. So ADT, half is the installation business that I think, Chris, you said was down a point and I believe retailer was three points of that drag. Can you just remind us again how big the retailer business is, how much was retailer in isolation down? And I think, Ed, you've talked in the last couple of quarters of how you've called out retailers kind of a project deferral type of dynamic. Is that still what you're seeing or do you think it's kind of getting a little worse? Maybe a little more color there.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Yes. It's, John, the retailer, it doesn't appear to be getting worse, but it's down… last quarter and this quarter, it's down in the range of 10% to 15% and that's on a global basis. So we've seen the retailer softness pretty much everywhere. If you lump the whole business together, everything we do in the retailer market, it's a little over $1 billion of revenue in the fiscal year. Most of the… it's really two factors. One is there's less store openings and that's pretty easy to track. We can see that with our big customers. But the other thing we're seeing and it’s a pretty big piece of this is just deferral of upgrade projects which most of these we continue to talk to our retail customers about and we know at some point they are going to do those. It's a matter of when and when they budget for it, so they've clearly pulled back their budgets and they are not doing some of these refurbs and upgrades. That will get back. The store opening piece looks like that will stay down for quite some time.
John Inch - Merrill Lynch
But it sounds like things are kind of holding steady at that down to 10% to 15% or versus deteriorating.
Edward D. Breen - Chairman and Chief Executive Officer
No, no, I would say it’s staying…. so far, now this is about two, two and a half quarters in a row that it's been down at this level and I'd say, yes, holding at that level. The thing I was pleased about this quarter is our actual systems installation business was slightly better sequentially, being down 1%, we were a little lower even the quarter before. So our other commercial systems installation businesses were actually up a little more and that will offset some of this additional…. this weakness we're seeing on retailer. So, sequentially second to third quarter we were actually a little better.
John Inch - Merrill Lynch
Okay. And then maybe a question for George. This quarter I think Johnson Controls and Honeywell both called out in their own fire security business some raw material headwinds that dragged results. Did you guys incur any of that and how was that able to be offset the pricing or what was the impact in the quarter?
George R. Oliver - President Safety Products and Electrical & Metal Products
Yes, we're beginning to see some of that headwind on the raw materials. We've been very aggressively targeting cost out. Every year we target 5% cost out and work with the teams to try to offset any headwinds and that also allows us to be able to reinvest in the businesses for growth. So, we are starting to see some of that but the combination of the cost out as well as our pricing disciplines has been able to offset that to maintain our margins.
Edward D. Breen - Chairman and Chief Executive Officer
Yes, John, I would also say at our fire business that, again, we're seeing the improved mix particularly internationally of our service business.
John Inch - Merrill Lynch
Okay. So there was no net drag from raw [ph] this quarter?
Edward D. Breen - Chairman and Chief Executive Officer
No, but John if you add up the whole… no, there was not but if you add up the whole year, the fiscal year, and we have taken this by every raw material, we approximate that about… we've had about $125 million of headwinds this year due to raw materials across the company. And by way for us a big piece of that is obviously fuel because of our big fleet of vehicles around the globe. So, when you take that into account, we have been able to offset, we think, just about all of that either through our other strategic sourcing initiatives or as George highlighted in his business, a lot of other cost out actions that we've taken. We expect actually some additional headwinds next year from raw materials because some of this just hit in the second half of this year and it hasn't had the full-year impact and obviously we're working on plans to continue to offset that also.
John Inch - Merrill Lynch
And just lastly for Chris, are there any kind of latent true-up P&L costs that are going to hit you guys associated with, maybe, some sort of profit sharing arrangement with Covidien and the electronics business?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
No, there's no real profit sharing agreement. We do have an agreement obviously on tax sharing but other than that, we are totally separated from them and there will not be any true-ups. Again, the only thing is we do share some of the legacy legal matters related to the class action suit and some of those get resolved here over the next few years we will share those expenses as well.
Edward C. Arditte - Senior Vice President Strategy and Investor Relations
And John, we had some of that interestingly this quarter where we did have the settlement of a legacy legal item and in fact what went through the Tyco P&L was our share and presumably you would see the share for Covidien and electronics in their numbers.
John Inch - Merrill Lynch
I am sorry, I meant cost sharing. There's no incredible cost sharing activity in the fourth quarter, is there?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
No it would only relate to settlements of those legacy legal matters when they happen.
John Inch - Merrill Lynch
Thanks very much.
Edward D. Breen - Chairman and Chief Executive Officer
Thanks, John.
Operator
Our next question comes from Shannon O'Callaghan from Lehman Brothers. You may ask your question.
Shannon O'Callaghan - Lehman Brothers
Good morning, guys.
Edward D. Breen - Chairman and Chief Executive Officer
Good morning, Shannon.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Good morning, Shannon.
Shannon O'Callaghan - Lehman Brothers
Just a couple of questions on fire. The margin there in the quarter, very strong. I mean, is that sustainable or are the things you're achieving there look like they weren't usually strong in the quarter or what do you think?
Edward D. Breen - Chairman and Chief Executive Officer
Shannon, it's a combination of a couple of things. The margins in SimplexGrinnell in North America improved and as Chris highlighted, every one of our international regions improved. It's a couple… it's a few things. One is as we have highlighted in the international businesses, we are… I'll just describe it as using the playbook of SimplexGrinnell in North America and making a lot of moves that are just making us more efficient in how we're running the business and we're clearly seeing that in the margins. The second thing internationally and Chris pointed this out, is we have exited some non-core fire businesses, a bigger piece of them lay in some Latin America areas which were just not profitable. So from a mix standpoint that's really helping us out there. But they would be the two biggest items. It's really execution in the business that's improving, because as you see the revenue grew 4.2%. It’s not… you don't get lift like you do through a factory here. It's us just running the business better.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
There are no unusual items in there in this quarter.
Shannon O'Callaghan - Lehman Brothers
Okay. And then how about these exits? I mean, how much of a drag is that at this point and when does that roll off or is there more stuff you want to exit?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
It probably averages over the last few quarters, maybe one to two points of growth headwind as we just wind down some of these things. For the most part, this has been just business that has wound down that wasn't particularly profitable as opposed to real businesses that we have exited through divestiture and so on. So, I would say we might have a little bit more of this in the fourth quarter, but I think for the most part we will have lapped it at that point.
Shannon O'Callaghan - Lehman Brothers
Okay. And ADT Europe, I mean, it sounds like recurring revenues still heading back in the right direction. How are you feeling about things over there and margins maybe still around where they were but when do you expect them to pick up?
Edward D. Breen - Chairman and Chief Executive Officer
Yes, margins were in the quarter, Shannon, about 6%, and by the way, the good news is the recurring piece has now turned for two quarters in a row. I won't declare total victory but the lines are obviously pointing in the right direction and usually when you get that moving, that continues there. The negative we're seeing is clearly on the ADT commercial side, which is, again, mostly retailer. Although I will highlight, I should have said this earlier, in the UK we have seen some softness in general commercial, which we also had seen in the quarter before. So, we're getting a little bit of a headwind on the revenue that's not helping us there, but more of our restructuring actions will kick in during 2009 in Europe and we continue to expect to make good progress and still hitting our target of 10% sometime in 2010.
Shannon O'Callaghan - Lehman Brothers
Okay. And just, last one on the portfolio, I mean, you've got the billion of proceeds from some of the divestitures and done some acquisitions as well. I mean, how should we think about is there more divestiture activity we should be expecting? And same thing… same kind of question on acquisitions, what kind of size or target areas do you think we should think about?
Edward D. Breen - Chairman and Chief Executive Officer
Yes. I… look, I continue to stress the word bolt-on acquisitions to our three global platforms. So, we're not looking… we don't need anything big. There's nothing transforming here. We like where we're at. There's just some neat areas where we think we can add on that will help us from a market share standpoint and I think George's example that we just did the video analytics piece is clearly an example of a type of thing we would do. So, I put it in the bolt-on kind… I ‘d also highlight, two of the three larger deals, but they're not large, but for us they were the larger ones, two of them were the sensormatic franchises and they were the last two remaining franchises of any size that were out there that we wanted to clean up. So, there is no more of those that you would see that would be in any price range like that. So, that's done. And there are some trading out of some… still some smaller, non-core assets that we want to do, but I wouldn't put it in anything significant but what we're really trying to do is trade out non-core and add some things that are in the core of those three global platforms.
Shannon O'Callaghan - Lehman Brothers
Okay. Great. Thanks a lot.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Thanks, Shannon.
Operator
Our next question comes from Steve Tusa, JPMorgan. You may ask your question.
Stephen Tusa - JPMorgan
Hi, good morning.
Edward D. Breen - Chairman and Chief Executive Officer
Good morning.
Stephen Tusa - JPMorgan
Just a question on the progress on some of the non-operating items, whether it's corporate, you've kind of given interest is going to be up next year. Any update on the timing of how we begin to move this tax rate down and also maybe a little bit of color on corporate?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Sure, Steve. First when it comes to tax, again, as you've seen, we have made great progress since the separation in reducing our tax rate this year from where we exited last year as a result of the separation. So, we have taken a very big chunk out of that tax rate this year. So, we're working on programs that, again, we believe will be successful over time. I think it's still too early as we're looking at the program and when things can be implemented in terms of the timing as to whether, say for example, that would reduce it in 2009 from a 25% rate. So, I think for now that's sort of the run rate that we're running at. On the corporate side, as I indicated in my comments, we thought we would get to the $500 million sort of run rate that was our target and, again, we're obviously looking at the inflationary costs of salaries and particularly things like our global travel and what not next year. So, again, I think it's too early to say. We're going to try to run at least at that level, not have an increase and over time we're obviously looking to reduce all of our overhead expenses over time and we're still working to, as you know, to resolve some of our legacy legal and tax matters. So, I wouldn't expect any kind of significant decrease in that corporate expense in the near term.
Stephen Tusa - JPMorgan
Okay. Great. And then Ed, just a question on… from a strategic perspective on the portfolio evaluation. You've had a lot of the segment guys on the calls and also presenting at several investor events. I'm just wondering, is that just kind of a first-year thing as a public company trying to give people more insight into the businesses or is this, you talked about electrical and metal a little bit today. I'm just curious as to the strategic implications around portfolio management of these guys getting a little more public exposure.
Edward D. Breen - Chairman and Chief Executive Officer
Yes. No, these aren't conscious plan. I think a lot of feedback from some of our key investors saying you're kind of a new company, you are coming out of the gate. We're focusing, obviously, more on these sets of businesses because of what you have in the portfolio than maybe we did before and we made a conscious effort to make sure we're rotating our presidents to speak at whether it's investor conferences or on these calls and I would plan on us continuing to do that every quarter and mix it up a little at the investor conferences.
Stephen Tusa - JPMorgan
Okay. Great. And one more question quickly just you said 10% in Europe by 2010. Is that… you mean that could be on a run rate basis perhaps in the back half of the year? That's not an annual target for 2010?
Edward D. Breen - Chairman and Chief Executive Officer
Yes. No, no, don't take it as an annual target. We'll hopefully hit it sometime during that year and clearly by the back half of the year but I can't tell you exactly when but we'll be tending there.
Stephen Tusa - JPMorgan
Okay. Thanks a lot.
Edward D. Breen - Chairman and Chief Executive Officer
Yes.
Operator
Our next question comes from Nigel Coe, Deutsche Bank. Please ask your question.
Nigel Coe - Deutsche Bank
Thanks. Good morning.
Edward D. Breen - Chairman and Chief Executive Officer
Good morning, Nigel.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Good morning, Nigel.
Nigel Coe - Deutsche Bank
Yes, just a couple of quick clarifications. So Flow Control, organic growth in 4Q, if I could back away the water business, the valves and controls, they still grow in double-digits?
Edward D. Breen - Chairman and Chief Executive Officer
Yes, the valve business, the revenue grew 18% and the thermal business in the quarter grew 22%. So you can see they are very hot. By the way, the orders, if you take those other sets of business, the valve orders third quarter year-over-year grew 31% and the thermal orders grew 34% year-over-year and then total, as Chris had mentioned when you add everything together including water we grew at about 27%. So, as we keep piling, the valves and thermal business very hot, record backlog levels and by the way, water is… although down, we grew 70% in the last two years in that business, approximately 70%. So we're running at high levels although on an organic calculation down and it will be with us for two or three more quarters and we lack that issue in water and that turns positive.
Nigel Coe - Deutsche Bank
Okay.
Edward D. Breen - Chairman and Chief Executive Officer
But the order rates are feeling very good.
Nigel Coe - Deutsche Bank
Okay. And then secondly on the attrition obviously had a bit of a bump-up this quarter. As customers move from CSA to pay as you go, is there any meaningful difference in what they pay for that? Obviously, CSA you've got more certainty on the revenues. Do they have to pay more on a pay as you go basis? Is that a richer margin for you guys?
Edward D. Breen - Chairman and Chief Executive Officer
Ye, I think, as we said in my comments, I don't think, again, it's large enough yet to think that there's going to be any significant impact on our revenue or on our profitability. Again, on some of the time and materials the margins might be pretty reasonable in doing that. So, again, we've seen a few customers start to switch and with the size of that recurring revenue base, it's not going to impact us in any kind of significant way.
Nigel Coe - Deutsche Bank
Okay. And a similar question on the buy end of the --?
Edward D. Breen - Chairman and Chief Executive Officer
By the way, a big chunk of that was also the retailer customer base and I think what they are doing, their budgets were squeezed and they're thinking they will piecemeal their way on their expenses versus making the commitment and usually they end up doing a big chunk of the work anyway.
Nigel Coe - Deutsche Bank
Okay. That's helpful. And then as you buy in these franchisees [inaudible], does that have a meaningful impact on the ADT margin, because obviously you're internalizing their margin?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Again, for the… it's not going to have a significant impact on our margins going forward. So, again, the acquisitions make sense for us on an economic basis but it's not going to impact in total in any kind of meaningful way.
Nigel Coe - Deutsche Bank
Okay. And then just a final one on E&M, as you have given… you've given us $0.14, $0.15 margin guidance for 4Q. It looks like the spread is… we have a more normal spread in 4Q i.e. the import cost has caught up with what you're charging now. Is that a fair comment?
George R. Oliver - President Safety Products and Electrical & Metal Products
Yes, the two dynamics there. The pricing, as I mentioned, in the quarter accelerated by over $300 on the spot market prices and so we increased pricing… our pricing in line with that. With the… for the remainder of the year we're assuming that the pricing of the commodity is slowing or flattening which would result in lower spreads as we replace the lower cost inventory with higher cost inventory going forward. But, in line with the commodity we're managing the price and the conversion cost, the speed of how we process the material to react to the change in market conditions right now and that's kind of the position we're in as we enter the fourth quarter.
Nigel Coe - Deutsche Bank
So if prices flatten out here into 2009, there might be a little bit more spread compression into 1Q '09, but nothing material.
Edward D. Breen - Chairman and Chief Executive Officer
It is timed to what happens with the commodity. So, as the commodity has been increasing we have been aggressively pricing in line with that.
Nigel Coe - Deutsche Bank
Right.
Edward D. Breen - Chairman and Chief Executive Officer
Now, if that were to soften certainly now replacing the lower cost inventory with higher cost inventor y puts pressure on the spread.
Nigel Coe - Deutsche Bank
Right. Great help. Thanks.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
And what, Nigel, just as you know, what we have been doing each and every quarter for the last four is being as transparent and specific with you as we can in terms of what our expectations are for the next quarter but to have numbers much beyond that is extremely difficult with something that's as volatile as this commodity is.
Nigel Coe - Deutsche Bank
Sure. Thanks.
Edward D. Breen - Chairman and Chief Executive Officer
Thanks, Nigel.
Operator
Our next question comes from Jeff Sprague, Citi Investment Research. You may ask your question.
Jeffrey Sprague - Citi Investment Research
Thanks. Good morning. Maybe just I'll stay with George Oliver for a quick second or two. George, you got the pass-through. I'm wondering what kind of response you're seeing in the market, though. Is there finally some evidence that there is some demand destruction as all this price and cost kind of comes through the pipeline?
George R. Oliver - President Safety Products and Electrical & Metal Products
Interesting, the demand is actually holding pretty steady. This business over time has… the pure demand has been within about 10%. We're watching that closely, certainly as we increase prices as the commodity has increased, but there's still a pretty significant backlog on non-resi [ph], which I think drives that demand in many of our segments, but that's something we watch closely. And certainly, as we look at this business historically we're about in the same where we kind of have been in the past as far as the demand.
Jeffrey Sprague - Citi Investment Research
Is there a way you can frame that? We got the organic revenues but a lot of that's price. Can you give us a color of the tonnage shipped or some metric that you use that’s kind of a unit metric?
George R. Oliver - President Safety Products and Electrical & Metal Products
Well, the unit metrics, I mean, we typically in the fourth quarter, we typically seasonally it goes down about 10%. We're seeing that typically this year, which is normal from previous years. So, the unit volume is holding up as where you saw that the additional pricing that we had in the quarter in the third quarter all came through pretty much in profit. And so right now we haven't seen a deterioration of the physical demand of any significance.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
And, George, correct me if I'm wrong, but our units or tonnage in the third quarter was up a couple of percentage points or so?
George R. Oliver - President Safety Products and Electrical & Metal Products
Yes it was, in the third quarter when you looked over year-over-year, it was still holding, it's roughly flat, maybe up 1% or 2% but it's relatively flat.
Edward D. Breen - Chairman and Chief Executive Officer
2% and the rest of it was price.
George R. Oliver - President Safety Products and Electrical & Metal Products
Correct.
Jeffrey Sprague - Citi Investment Research
Great. Thank you. Just shifting gears to fire a little bit. Ed, the numbers look really encouragingly strong. You called out kind of the educational government institutional type markets. Can you give us a little more granularity on kind of how much of that kind of those verticals make up your mix?
Edward D. Breen - Chairman and Chief Executive Officer
Yes. Probably it's one other thing, too, Jeff that's very important. 50% of the business, like SimplexGrinnell's business is service and that's very repeatable type business. So, I think I mentioned on the last call we have a very big focus. In fact we just have reorganized the business around this whole service initiative because we want to continue to get the growth rate up higher there and we think we can than the mix of the other end of the business would run at. So, if we can do that and by the way we've been doing very well against that service. We'll hopefully over time creep up above this 50% level we now have it at and continue to be a bigger piece and by the way the service is our more profitable piece of the business. So, mix helps us in the repeatable service business is clearly helping us. The other side of it where we have… we really track these core verticals in the business and the health care and the education, the education is K through 12 and also a very nice chunk of that is in the university market, there's about another 20% to 30% of our businesses there in those key verticals.
Jeffrey Sprague - Citi Investment Research
And then the remainder?
Edward D. Breen - Chairman and Chief Executive Officer
All other commercial and all that makes up the remainder of the business.
Jeffrey Sprague - Citi Investment Research
And what's driving the growth in service? Are you capturing more of your own installed base or are you displacing local contractors that might have been doing it? Is it codes? It's probably some of all of the above but maybe a little more color on that.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Yes, Jeff, I think it's really a part of all of those. I think the codes drive a significant piece of that. We're actually quite active in that. We're working internationally also to drive those codes, which is improving our service mix internationally, and also the SimplexGrinnell here in the United States has a tremendous installed base. So, we're focused primarily on that installed base but again it's a combination of all three. It's also getting some other accounts as well.
Edward D. Breen - Chairman and Chief Executive Officer
And, Jeff, a lot of this I think you can… it's kind of logic, but a sales team typically likes to go do the elephant hunting and they want the new project and the new installation. So what we've done and this is a little crisp, we're focusing in this area, we're having a separate organization go look at it. We actually… I don't know if we've announced yet. We just hired a leader to run actually the service for SimplexGrinnell reporting into the President, Jim Spicer of the business. So, it's a focus where you put people on it, you get disciplined and you have certain parts of your team that aren't focused on the elephant hunting part of the business and going and getting the service and we think we've been successful and can continue to be successful to get share in that area.
Jeffrey Sprague - Citi Investment Research
And the Europe weakness you mentioned in fire is that just the runoff that we were talking about or is there some inherent weakness in the European commercial business?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Yes, Jeff, I would categorize the European not so much as weakness as selectivity in terms of projects and we've been talking about that for the last few quarters. I think that's been true internationally in Asia and Latin America as well where we have made a conscious decision to manage better price, more complicated projects, stay away from the lower end stuff and I think that's shown up in our numbers over the last few quarters in terms of better margins out of our international businesses.
Jeffrey Sprague - Citi Investment Research
And just one last housecleaning. That raw math number you threw out, Ed, on the headwind, does that include what's going on in temp or is that kind of --?
Edward D. Breen - Chairman and Chief Executive Officer
No, no, and thanks for clarifying that. No.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Because clearly that would more than offset all of it, again, some so that excludes that.
Jeffrey Sprague - Citi Investment Research
All right. Thank you.
Edward D. Breen - Chairman and Chief Executive Officer
Jeff, when we add up all of our other initiatives on sourcing, direct and indirect, we add up our Six Sigma and lean and all that. We net out… and by the end, and obviously restructuring in there simplification. We have netted out these headwinds. We're very happy with that progress. By the way, we're not done because as I mentioned earlier, those headwinds are even… not… we don't think obviously that much more next year but we're going to have incremental headwinds next year and we're already working on programs to make sure we can offset that.
Jeffrey Sprague - Citi Investment Research
Great.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Let me make one last comment on fire, just to remind everybody that the… at a 10% margin, that is a very, very high return on capital, as there's no capital in that business.
Jeffrey Sprague - Citi Investment Research
Since you jumped in on fire one last one. I think your commercial ADT businesses are actually running 12, 13ish. Is there any reason fire shouldn't be able to get there? Is it somewhat analogous really at the end of the day?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Well, there are different parts of that fire business. So, again, I think the mechanical sprinkler business in the competitive arena that they're in is not quite as… the margins are not going to be quite as high as electronics sprinkler. So, on the electronics side they're much closer ADT versus the sprinkler and then again the service content that we have, again, it produces a nice margin in the fire business.
Edward D. Breen - Chairman and Chief Executive Officer
And the effort, Jeff, is to keep working obviously the margins everywhere but it's the international margins although they have made very nice progress and they are the ones that are below the average. Simplex on its own in North America is up at those rates now.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Correct.
Edward D. Breen - Chairman and Chief Executive Officer
So it's the international businesses that are lower and when you average it together, you can see this quarter we did it 10.6%.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
And our electronic component is less internationally than it is in the U.S.
Jeffrey Sprague - Citi Investment Research
Got it. Thank you.
Operator
Our next question comes from Scott Davis, Morgan Stanley. You may ask your questions.
Scott Davis - Morgan Stanley
Good morning.
Edward D. Breen - Chairman and Chief Executive Officer
Good morning, Scott.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Good morning, Scott.
Scott Davis - Morgan Stanley
Most of my questions have been answered, but excuse me if I ask something that was already answered, but have you addressed whether you're thinking in terms of maybe getting more aggressive with your capital structure now that I think you've shown each of your businesses to be stable, strong cash generators and you've had a chance to prove yourself out at a stand alone company? Is it time to maybe get a little bit more aggressive with capital structure or is that we are not quite there yet?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
No. We're actually quite happy right now, Scott, in terms of where we are in our capital structure and our debt level. I think, we're still in uncertain times with the financial market. So, our capital structure right now gives us the kind of flexibility we need and, again, as we generate free cash flow, we don't intend to hold and sit on a lot of excess cash. So as we have indicated, we completed our billion dollar repurchase program here just recently and we have just announced another program, but the overall capital structure, I think, will remain similar to what you see now. We have as we get toward the end of our fiscal year is when we will sort of review or dividend policy and where we are on that. So, I would say stay tuned on that.
Scott Davis - Morgan Stanley
Okay. My second to last question just relates to FIFO accounting. I think you're mostly on FIFO, if not all on FIFO. And we have seen some nice margin surprises this quarter out of FIFO reporters. Is there any way that you can equate and give us an indication of where margins would be had you were using LIFO instead of FIFO or what type of a headwind you might be running into once low cost inventory works its way off?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Again, I think with our businesses and particularly when you take our Electrical and Metal Products business sort of out of the equation, we talked so much today about the pricing impact and how that impacts our margins. A lot of our business is installation, service and what not and so, obviously, Flow Control and our manufacturing businesses, the Safety Products businesses that George talked about are clearly there. There are headwinds that have occurred this year that will occur going forward but are cost out. So, I wouldn't expect… obviously we're all facing headwinds, but again, I don't have the numbers of what it would have been in LIFO. But, I don’t think it would have a significant impact. Our margins have improved across the board this year and in this quarter as we have indicated for the full year this year we expect that margin improvement we have had. We have been aggressive in terms of our restructuring programs that we began last year. We are seeing benefits of that also improving our margin position. So, again, that’s how I would characterize it.
Scott Davis - Morgan Stanley
Okay. That's great. Thank you.
Edward D. Breen - Chairman and Chief Executive Officer
Thanks, Scott.
Operator
Our last question comes from Deane Dray, Goldman Sachs. Please ask your question.
Deane Dray - Goldman Sachs
Thank you. Good morning and while we have George here, I wanted to ask a couple of electrical questions if we could.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
He's ready for you Deane.
Deane Dray - Goldman Sachs
[inaudible]
George R. Oliver - President Safety Products and Electrical & Metal Products
Hi, Deane.
Deane Dray - Goldman Sachs
And, Ed, you didn't also add the benefit of having the presence coming through as it takes the burden off you and Chris and --
Edward D. Breen - Chairman and Chief Executive Officer
Deane, it's so true. We might add a couple more in these calls.
Deane Dray - Goldman Sachs
All right. So, George, I know I think we've vetted through what the price pass-through benefit in the quarter was, but could you take us through a little bit more about the reduced conversion costs and what's behind that or is this equipment and processes or is it more lean benefits and is there more to do here?
George R. Oliver - President Safety Products and Electrical & Metal Products
Yes, great. What we're doing here what we did last year, as we had as you know last year was a tougher year for us, we were really focused on what we could really control in this business to really become world-class and we did put a big, big focus on the conversion costs. Just to give you a brief explanation, we have coils of steels that comes in the back door, hot rolled, cold rolled steel. We put it through a series of processes on mills and we produce electrical conduits, sprinkler pipe and the like. And what we done there, that team has done extremely well, is focused on every element of the process right from the back door through the shipment to the customer and really have utilized lean manufacturing techniques, Six Sigma methodology and have really done a tremendous job in taking cost out. And what we do we don't look at just one element, we look at total cost. So it’s not only the cost of the mills in getting the products manufactured, but it is the total cost of the facilities that go into running these operations in the total cost that it take to convert a ton. And so I'm very pleased with what the teams have done and the targets they have set and the ability to be able to reach those targets with the efforts that have been underway. Now in addition to that, with our restructuring programs we are now consolidating a lot of our footprint to become even more efficient going forward. And there we get more leverage of our facilities, of the equipment, which ultimately will then translate into additional productivity going forward. So, we feel great about the progress we’ve made. It’s something that we can control, it does add incremental margin beyond the spreads that we manage within this business.
Deane Dray - Goldman Sachs
And is there more to do?
George R. Oliver - President Safety Products and Electrical & Metal Products
Oh, there's plenty. I can tell you, as you go through the facilities, there is plenty of opportunity that we're working on. Certainly that's what the team is focused on and it’s one of these things we have set the target every year. You work towards that target and you realize the amount of opportunities. That's what lean manufacturing does. It focuses on where the waste is within the process and as we continue to go forward, we continue to focus on those areas where we have made… today we have made a lot of progress taking the cost out.
Deane Dray - Goldman Sachs
I don’t know George, you're making this sound like a core business for Tyco. Any comment on that, Ed?
Edward D. Breen - Chairman and Chief Executive Officer
No. I think it is a nice business. Again it's volatile over a period of time. But, again we are focused on managing that business, it generates very nice and consistent cash flow over time and a very nice return on capital.
Deane Dray - Goldman Sachs
Okay. And just a last housekeeping question for Chris. It looks like your interests expense came in lower than what we were looking for. I guess, there was a separation item that was in there?
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Yes. There was... there were some separation items and again as we looked at interest income and expense during the year, it’s little noisy during the year because we had the big amount in our escrow. So, again I think when you look at it going forward it's going to be sort of a much more reasonable number.
Deane Dray - Goldman Sachs
Great. Thank you.
Christopher J. Coughlin - Executive Vice President and Chief Financial Officer
Thank you.
Edward D. Breen - Chairman and Chief Executive Officer
Thanks, Dean.
Edward C. Arditte - Senior Vice President Strategy and Investor Relations
Thanks for joining the conference call. We look forward to speaking with you again to report on our fourth-quarter results, which will be scheduled for some time in early November. Again thanks for joining us and operator I'll turn it back to you to provide the replay information.
Operator
Thank you, sir. Thank you for joining. This concludes today's conference. The call was recorded. If you'd like to listen to the replay, you may dial toll-free 1-800-570-8795 or you may dial the international toll number of 402-220-2264. Thank you for joining. You may disconnect at this time.
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