特靈科技 (TT) 2005 Q3 法說會逐字稿

Good day, and welcome to the Ingersoll-Rand third quarter 2005 earnings conference call. This call is being recorded. At this time, for opening remarks, I would like to turn the call over to the Director of Investor Relations, Mr. Joseph Fimbianti. Please go ahead, sir.

Thank you, Peter. Good morning.

This is Joseph Fimbianti, Director of Investor Relations for Ingersoll-Rand. Welcome to our third quarter 2005 conference call. We will be starting at 7:00 a.m. this morning, and the release is posted on our website.

I'd like to cover some of the usual housekeeping items before we begin. This morning, concurrent with our normal phone-in conference call, we will be broadcasting the call through our public website. There you will also find the slide presentation for this this morning's call. To participate by the web, go to www.irco.com; click on the yellow icon on the home page of the website. Both the call and the presentation will be archived on the website and will be available late this afternoon. Now, if you would please go to Slide 2.

Before we begin, I would like to remind everyone that there will be forward-looking discussions this morning, which is covered by our Safe Harbor Statement. Please refer to our June 30, 2005 Form 10-Q, for the details on factors that may influence results.

Now I'd like to introduce the participants on this morning's call. We have Herb Henkel, Chairman, President and CEO of Ingersoll-Rand; Tim McLevish, Senior Vice President and Chief Financial Officer; and Rich Randall, Vice President and Controller. We'll start with formal presentations by Herb Henkel and Tim McLevish, followed by a question-and-answer period. Herb Henkel will start with an overview.

If you would please go to Slide 3.

Herb?

Thank you, Joe, and good morning everyone. This morning we announced record third quarter earnings and continued to demonstrate strong year-over-year earnings growth. EPS from continuing operations was $0.75 per share, an increase of over 27% compared to last year. Total earnings per share were also $0.75, which was above our post-split EPS guidance range for $0.68 to $0.73.

Total revenue also demonstrated strong growth. Revenue increased by about 10% compared to last year. Compact vehicle, construction, industrial, and security technologies continued their upward trend and enjoy double-digit increases compared to last year.

Please go to Slide 4.

These gains are a direct result of our growth strategy, which continues to emphasize developing innovative products and solutions, growth of highly profitable recurring revenues, and low risk, high return bolt-on acquisitions. Our revenue growth during the quarter again was generated across diverse markets and geographies. This product and market diversity helped to drive our earnings growth in the third quarter and will continue to do so over the long-term, as we become more and more resistant to future North American economic cycles.

Now, please go to Slide 5.

We believe that there were modest short-term benefits from the gulf coast hurricanes during the quarter. Most of the increase was related to portable generators, light towers, and bobcat compact equipment and attachments. The overall impact of our revenue performance was not material.

The hurricane also had a decided negatively impact on our cost structure, as with most manufacturers, material prices and transportation expenses rose immediately after the storms. Notably, while the energy prices have receded somewhat from panic-driven prices after the storms, they remain at historically high levels. This will continue to impact our cost structure going forward.

Now, I would like to take a few minutes to update our progress in the third quarter.

Please go to Slide 6.

Our investments in new technologies and solutions have been a major reason for our continued revenue growth and market share gains over the past several years. We have introduced a number of new products this year, from which we expect to generate at least $250 million of revenues with significant new product offerings in each of our reporting segments. New products that provide innovative solutions to customer needs will continue to be a crucial aspect of IR's ongoing growth strategy, and we have new product offerings in all of our business sectors that will be introduced in our five-year planning horizon.

Now, please go to Slide 7.

During the third quarter, we also continued to deliver on our goal to grow recurring revenues. Our large install base and powerful market-leading brands provide significant opportunity to expand revenue and earnings going forward. Recurring revenues will also create a strong foundation for consistent financial performance throughout the economic cycle.

Recurring revenues for the third quarter totaled $554 million, an increase of 12% compared to 2004, and equal to about 21% of our total revenues for the quarter. Compact vehicle, construction, and industrial technologies all had double-digit year-over-year gains in recurring revenues, and climate control recurring revenues were up about 9% compared to last year.

Please go to Slide 8.

We also added to our growth through our ongoing program of bolt-on acquisitions. During the third quarter, we completed three bolt-ons that expanded our position in the worldwide security business. In the third quarter, we established a joint venture with Taiwan Fu Hsing Company Limited, a leading manufacturer of mechanical door locks based in Taiwan.

Fu Hsing, founded in 1957, is a global manufacturer and distributor of mechanical door locks, primarily for the North American and Asian market. The company has manufacturing locations in China, Malasia, and Taiwan. Annual revenues for 2004 were approximately $135 million, with about a third of their annual revenue going to IR security technologies.

On August 31, IR acquired Astrum Informatik based in Erlangen, Germany, that develops and provides personnel scheduling and work time management software and services. Astrum provides business consulting, installation, and maintenance services to a range of industries with more than 800 clients in 32 countries, and in 28 vertical markets.

On August 19, we acquired the assets of Dolphin Electromatic Technologies, a Mumbai, India based provider of electronic solutions for security management. Dolphin has six offices located throughout India and provides solutions to customers in the hospitality, financial services, and pharmaceutical markets, as well as airports, sea ports and retail centers.

Our bolt-on strategy continued to build out our solutions portfolio and provides new avenues to pursue growth. Year to date, we have made six bolt-on acquisitions in the security space in various geographies throughout the world. These acquisitions should add about $500 million to revenues on an annual basis. With a balance of 2005 and going forward, we will continue to make high value-added bolt-on acquisitions as part of our ongoing strategy to compliment organic growth.

Since 2000, we have made more than 50 acquisitions that have added over $3 billion in sales, expanded our product and service offerings, and extended our geographic reach. We believe that the security and industrial technologies businesses in particular have considerable opportunity to expand globally through acquisitions. As I have noted throughout the last several years, we believe that the major product line platforms we have in place will support substantial growth in earnings and ROIC. Therefore, we do not expect to make any large acquisitions that would add a new platform to our business.

Please go to Slide 9.

I would like to turn to operational excellence. During the quarter, we continued to benefit from cost reductions associated with our productivity investments. Operating income improved by 22%. Margins increased by 1.3 percentage points to 13.0 on the benefits of higher revenue and ongoing efforts to drive down costs. Year to date, we have increased operating income by 24% compared to last year and raised margins by a full percentage point, despite $140 million of increases in material costs. Year to date, margins have been penalized by about 1.8 percentage points due to material cost increases. Going forward, we expect to see continued high material costs and we're working to protect our margins by increasing productivity and adding surcharges.

Now, please go to Slide 10.

We will also continue to improve our business execution by implementing lean six sigma and other continuous improvement programs throughout our operations. These programs are targeted to significantly reduce operating costs going forward, as well as reducing working capital and CapEx requirements.

Mike Ryan, former president of Bobcat ,has been promoted to our vice president of operations, where he leads our operational excellence, supply chain, sourcing, and internal global consulting teams. We have also established seven work-stream teams across several business processes, including operations planning, engineering, supply chain, manufacturing, service, SG&A, and human resources. Our objective is to optimize these business processes, using lean methods across these seven work streams by reducing the cost of these processes, while improving the quality and reliability of our products and services.

There are a number of early successes from our team implementation. At Bobcat, volumes have expanded by approximately 75% in the last three years. We have been able to more than double the daily output of many excavators from the Bismark plant through better process balance, fixed model assembly techniques, and coordination with key suppliers.

In our Tecate, Mexico security plant, we have been able to consolidate lock component manufacturing from seven buildings into two. Productivity was increased by more than 30% since this transformation has taken place. Our ultimate goal is to unify our business activity into a common set of efficient processes across the entire company. This will be a long-term transformation project, which will create considerable sustainable value. We'll document our progress in this area going forward.

Now please go to Slide 11.

We maintained a strong balance sheet in the third quarter. Our debt balance for the quarter was $2.2 billion, or about 1.3 billion of net debt. Our debt to capital ratio is approximately 27.9%, which is comfortably below our long-term target of 30 to 35%.

Now please go to Slide 12.

During the quarter, we also continued to deploy our cash to create shareholder value. In early August, the Board of Directors increased the quarterly dividend by 28% to $0.16 per share on the post-split basis. Over the last two years, the Company's dividend has increased by approximately 68%. At the same time, the Board also authorized the expansion of the Company's share repurchase program to $2 billion. At the end of the third quarter of this year, the Company has repurchased shares worth approximately $630 million for year-to-date 2005.

In the third quarter, we acquired 3.9 million shares for approximately $150 million, and in October, we have purchased 2.1 million shares for approximately $80 million. We have about $1.1 billion available for repurchase, and we expect to complete the repurchase authorization over the next two years.

Now, please go to Slide 13.

We continue to believe that over the next five years, we have a strategy and organization structure that will give us substantial opportunities to expand revenue and earnings to create additional value going forward. We continue to believe that we can grow organic revenue 4 to 6% for the total company and that our cash generation will finance additional bolt-on acquisitions to reach 8 to 12% annual revenue growth. Our plan also indicates that we have substantial opportunities to lean out operations to reduce costs and to increase efficiency. We continue to target a 15% operating margin, which will be a key driver towards reaching our earnings growth, ROIC, and cash flow goals.

Now, please go to Slide 14.

In closing, we had an excellent quarter, and we're expecting record earnings for full year 2005. We are successfully executing sound, long-term growth strategy, which would generate considerable value going forward. We also believe our diversified portfolio of businesses and our evolving lean business model will dampen the impact of any future North American business cycle.

Tim McLevish will now cover IR business unit performance in more detail.

Tim?

Thank you, Herb, and good morning.

I would like to begin my discussion with the quarterly financial results.

Please turn to Slide 15.

Revenues for the third quarter were in excess of $2.6 billion, up 10% from the comparable period in 2004. The increase is attributable to growth from all of our segments with double-digit growth in compact vehicle, construction, industrial, and security technologies. Excluding acquisitions, total revenues increased by 8% compared to last year, and 7% after excluding the favorable impact of currency. The 1% currency impact on revenues was consistent across most of our reported segments.

Operating income for the third quarter was $340 million, up $62 million, or 22% from 2004. This reflects a margin of 13% of revenue, up from 11.7% last year. These continued strong operating results were driven by volume leverage, price increases, and productivity actions offsetting year-over-year raw material and component part cost increases.

Included in operating income was the negative impact of approximately $24 million in raw material and energy inflation. While the quarterly impact of these cost increases has declined from the first two quarters of 2005, material costs continue to remain high. For the quarter, our material inflation was offset by savings from our productivity programs and from price surcharges.

Moving down the income statement, interest expense was essentially flat compared to the prior year, at $35.5 million, due to slightly higher debt levels offset by a reduction in average interest rates. Other income for the quarter was $9.6 million compared to $5.1 million in the prior year. The increase is attributable to interest income on a cash investments and reduced minority interest expense in the quarter.

Our third quarter effective tax rate was 18.5% compared to 17% in the same period of 2004. The increase reflects our expected increase in 2005 earnings and a higher proportion of income derived from the higher U.S. tax jurisdiction. We project a full-year rate of 16.9%.

Earnings from continuing operations for the third quarter were $256.1 million, or $0.75 per share, which equalled the top end of our guidance range. Our favorable results were attributable to continued strong markets and improved operating margins.

Discontinued operations reflect cost net of tax of $1.9 million for the quarter. The ongoing discontinued operations cost totalled approximately $10 million, net of tax. These costs were largely offset by $8 million of gain resulting from the final resolution of some transaction issues on previously divested businesses.

Our net earnings for the quarter were $254.2 million, or $0.75 per share.

Please turn to Slide 16.

Our 8% organic revenue growth reflects increases in most of our major geographic regions. North American revenues were up 11% for the quarter and constituted approximately 65% of the total. European revenues were up 3%, while Latin America increased 28%. Asia-Pacific declined 5%, reflecting the Chinese government's curtailment of construction investment.

I would now like to take a few minutes to talk about the results of our businesses.

Please turn to Slide 17.

The climate control technology segment consisting of the market-leading brands Hussman and Thermo King reported third quarter revenues of $723 million. In total, revenues were up 4% compared to the prior year. Continued strong revenue growth in our transport business was offset by softness in our display case markets. Recurring revenue for the sector grew 9% versus prior year. Bookings for the quarter were up 12%, reflecting a strong reception to our new auxiliary power unit and our growing position with Wal-Mart.

Operating income for the segment was $82 million, representing an operating margin of 11.3%, which is consistent with prior year performance. Material cost increases were offset by pricing actions and productivity improvements.

Climate Control America's revenues were up 9% versus 2004. The growth was driven by continued strength in the transport business and modest growths in the retail business. Recurring revenues increased by 12% in the quarter. Climate Control International revenues for the quarter were down 3% year-over-year. In European markets, third quarter revenues were flat to prior year as gains in trucks and marine containers were offset by declines in trailers and supermarket display cases. Lower Asia-Pacific revenues were mainly attributable to a decline in transport revenues, partially offset by growth in display cases and stationary refrigeration service.

Please turn to Slide 18.

The compact vehicle technology segment generated third quarter revenues of $637 million, up 16% from 2004. Operating margins were 14.6% of revenues compared to 12.7% in the prior year. The increase in operating margin is attributable to volume leverage and improved price realization, partially offset by increased material costs and manufacturing inefficiencies associated with supply chain issues.

Bob cat revenues increased more than 20%. The increase was attributable to strong growth in the America's, new product introductions, and the continued strength of the attachments and aftermarket parts businesses. Bookings for Bobcat in the quarter were up 28% versus prior year.

Club Car third quarter revenues were flat compared with the prior year. Double-digit growth in Golf was offset by revenue loss from the end of our pathway program.

Please turn to Slide 19.

The construction technology segment reported revenues of $292 million, up 11% compared to 2004. Operating margins were 9.2% of revenues compared to 11.2% in the prior year. The reduction in operating margin was largely attributable to the commodity cost increases, unfavorable product and geographic mix, and supply disruptions causing manufacturing inefficiencies in the quarter. We are also experiencing a shortfall in our planned purchasing productivity as our productivity focus has been diverted to expediting activity over the first nine months of this year.

Road development revenues decreased 2%, as growth in the America's was offset by reductions in Europe and sharp declines in China. Revenues in the utility equipment business were up 31% compared to the prior year. The substantial revenue growth was fueled by new products, expanded distribution, increases in all geographic regions, and the impact of Katrina.

Please turn to Slide 20.

The industrial technology segment produced third quarter revenues of $437 million, a 10% increase over prior year. Air Solutions revenue grew 9%, driven by strength in the America's and new products. Recurring revenues were up 15% and constituted 48% of the total.

Productivity Solutions revenues were up 8% versus prior year, due to strength in all product categories and new product growth. Operating margin for the segment was 14% of revenue, up from 11.6% last year. The year-over-year increase was attributable to volume leverage, higher margin new product introductions, recurring revenue growth, and the benefits of our productivity improvement program.

Please turn to Slide 21.

Security technology segment revenues were $527 million, up 14% compared to 463 million in the prior year. Excluding the impact of acquisitions and divestitures for both periods, revenues were 3% higher than the comparable 2004. Bookings in the quarter increased 18%, 7% organically.

North American revenues were up 3% on a comparable basis, and bookings were up 8% in the quarter. The increase was attributable to continued solid residential and commercial markets, and modestly negative institutional markets. Additionally, we continued to see strong revenue growth in our electronic controls and integrated systems business at 19% for the quarter.

Operating margins for the quarter were 19.3% compared to 16.5% last year. Adjusting for one time items, the margin for third quarter of 2004 would have been 18.6%. The remaining margin improvements is largely attributable to leverage on our volume growth and from the benefits of our productivity program.

Please turn to Slide 22.

Let's move on to the balance sheet.

Maintaining customer service levels in a double-digit growth environment, while facing supply shortages, continues to pose a challenge for our working capital management program. We finished the quarter with our investments in operating working capital at 12% of revenue, which is above our target range of less than 10%, a relatively flat to the second quarter of this year. Our working capital performance was impacted by a deterioration in inventory turns versus the prior year.

During the period of raw material shortages, we maintained our safety stock levels to help alleviate supply disruptions. As these supply availability issues continue to subside, we will be bringing our inventory back to normal levels.

Day sales outstanding increased slightly over year-over-year, while our days payable outstanding remained consistent with the prior year. At the end of the third quarter, our total debt was $2.2 billion, an increase of approximately 200 million compared to the third quarter of 2004. This increase is attributable to $300 million of ten-year notes issued during the second quarter of this year to lock in attractive interest rates. This new debt will be -- will replace higher coupon borrowings, which mature in 2006.

Debt to capital ratio, at the end of the quarter, was approximately 28%, which is flat relative to the prior year. Capital expenditures for the quarter were $23 million or less than 1% of revenue, while depreciation and amortization expense for the quarter was $46 million.

Our solid balance sheet continues to provide a foundation to support the growth strategy of our company.

Herb will now conclude our formal remarks with the outlook.

Thank you, Tim.

Please go to Slide 23.

Over the last six weeks, the Gulf Coast hurricanes have added a level of uncertainty to the macro-economic environment. Even though energy prices have receded somewhat from earlier in September, they remain at historically high levels and will continue to impact our cost structure going forward. We continue to evaluate the aggregate affect of these events, but we do not anticipate a significant impact on our 2005 earnings, as modest revenue gains would be offset by higher material, energy, and transportation-related costs.

As the restructuring efforts begin in the next six to nine months, we expect increased activity in the effected region, which will help offset the impact of cost increases. Despite the macro-economic uncertainty, activity in most of our major end markets continued at strong levels of demand during the third quarter. Orders, excluding acquisitions, were up about 15% compared to 2004, with double-digit growth rates in all of our business sectors. Based on our recent order trends, we expect year-over-year total revenue growth of approximately 10% for the fourth quarter of 2005. We expect to continue to see material and energy cost pressure in the fourth quarter, and we are focused on minimizing the impact of cost increases by making permanent reductions in our operating cost structure, through productivity gains, and by adjusting prices. Operating margins will improve from the higher volumes and cost reductions.

Now, please go to Slide 24.

Earnings from continuing operations for the fourth quarter are forecast to be $0.75 to $0.79 per share, 17% to 23% improvement compared to last year. Discontinued operations in the fourth quarter are expected to be 2% per share of costs for total company EPS of $0.73 to $0.77.

Please go to Slide 25.

We are increasing our forecast for full-year EPS from continuing operations to $3.02 to $3.06. Full-year discontinued operations are expected to be about $0.08 of cost for total company EPS of $2.94, $2.98. Full-year available cash flow, which is cash flow from operations less capital expenditures, is expected to be approximately $775 million.

Our balance and diversified portfolio of businesses positions us to enjoy continuing earnings growth next year. Our preliminary look at 2006 shows another year of double-digit earnings growth. We will provide a full-year 2006 forecast during our fourth quarter earnings conference call in January.

Now, please go to Slide 26.

This ends our formal remarks and I would like to open the floor to your questions.

Thank you.

[OPERATOR INSTRUCTIONS]

We'll go first to Barry Bannister at Legg Mason.

Hi, guys, how are you?

Hi, Barry.

Of the 10% sales growth for the total company in the third quarter, could you delineate what was currency, what was price, and what was units, and what was acquisitions as a derivative?

Yes, there's about 2% -- 2% of it was acquisitions. Overall, about 1% was currency, so you have 7% organic over the quarter. Pricing increases and surcharges was 1, 1-1/2% from prior year.

So you're talking 6% really unit-driven, Barry.

Yes, that's what I wanted to know. Thanks.

Then the other question was -- you mentioned the orders without acquisitions were up 15%. I believe last quarter, without acquisitions, orders were up 10%. So you said there was macro-economic weakness, but then you said orders accelerated. Did I hear you correctly?

You did. It was very, very strange. We had relatively weak July, relatively, compared to fine lumber, weaker July and August, followed by a terrific September. And it was very strange because when we added up the dollar that went into the effected area as they were only in the area of our compact equipment, and so we saw strength across the entire enterprise.

-- Q3 a year ago that made the comps easier?

Yes, I would say if you look, you're absolutely right there. There were lower numbers as a result of that. It's also why we're also not forecasting a 15% increase in the fourth quarter, saying that we're now at about, you know, 15% dropped down to 10%. Our backlog, as you know, really only runs for about 28 to 30 days worth of revenues for the following quarter.

Our backlogs are basically built back up. They had depleted a little bit over the second quarter, and they are built back up to normalized levels of about 30, 32 days.

Okay. Thanks a lot.

We'll go next to David Raso, Citigroup.

Hi, good morning.

Good morning.

I wanted to delve into the '06 guidance a little bit. If we look at the fourth quarter sales guidance in the midpoint of the EPS with all the other puts and takes, and look like the full-year sales up about 12% incremental margin's about 20. The leverage this year has been understandably, with the cost issues, continuing. The leverage has really been the SG&A line. You've grown sales nicely, and SG&A really not up much at all. When we think about '06, and I'm not sure if you're prepared to give more detail, but how much are we thinking on the top line, and are we looking for some leverage to come from the gross margin line next year, or do you see still that much opportunity on growing sales without SG&A growing?

Let me speak to it this way, Dave. Again, this is a prelim, we're in the process obviously as we speak during our full detailed forecast. We look at next year. We see in terms of the organic growth of the 4 to 6% objective we had set as something we could certainly realize. You add on to that the full year impact of the bolt-on acquisitions we made this year. As you know, we said we had full-year annualized revenues from those of about 600 million for what we've done so far. That's if you take sub-year out and replace it with the full year going forward, you've got over 300 million right there so far year-to-date.

Then I would also tell you that based on what we see now with our operational excellence program, our goal continues to be to try to increase margins anywhere between 1 to 1-1/2% going forward. So when you add those collectively up for next year, you come up with a double-digit number. I'm not going say to you what the specific number is, but that's why I want to really point out with the prelim view, that we see an ongoing ability to continue to deliver the organic growth. We certainly have a good backlog, if you will, of acquisition candidates to look at. I feel very confident about the programs we have in place on operational excellence. So unless we really have a strange slow down and other things are going on, innovation continues to be one where we're thinking of over $200 million for next year, so I feel just feel very confident that we are in line to have another double-digit earnings ratio for next year.

When you speak to the 100 to 150 bits on a margin improvement, that's operating margin, correct?

That's correct.

I'm trying to break that out of here, but the question I'm trying to get to is -- looking at the leverage next year for the margin improvement, given the cost issues kind of are what they are, is it gross profit margins we get some leverage on the COGS, or it is still -- you see the SG&A doesn't have to increase at all on that roughly 10, 9% top line?

I think you try to do both. Obviously, we're looking at the trade-off always of -- on the SG&A side, our focus is on the SP's. As we continue to try to build our presence in developing countries, whether China, India, or the old Russian parts of the world. So I see some S, if you will, increase in there and try to do a better job of leveraging the G&A. I think the biggest improvement you're going to see is going to be on the gross margin line as we continue to improve global sourcing, as well as our overall effectiveness that's there.

So, more directly my question was -- are you assuming some, either be cost relief or productivity improvements, supply chain, purchase, whatever it may be, we should see a little better leverage in the COGS next year?

I agree.

We already know target savings, and we're $125 to $150 million on a reduced comparable year-to-comparable year purchases of raw materials. So that will certainly be a contribution. Then as we continue to lean out our factories, that should generate additional savings.

And if you look, David, as we said that right now I forecast that we'll probably be spending between $170 and $175 million of incremental on our building materials compared to what we did last year as a result of the inflation on those materials. We do not see those continuing to increase. We see the only question that we're really looking at now is, hopefully, how flat is the graph or how does it decrease during the next 12 months.

What was the number? I think back in July, obviously, the cost caught us all by surprise in September onward. What was the 175 -- say in July?

Well, we started the year saying there was going be between 125 and 140. By July, we wound up saying it was between 140 to 150.

25 to 30 incremental from July?

Yes, from the time we finished the second quarter and I looked at what we thought, that's the delta between what we've seen, especially in steel and hydraulic and so on, other kinds of other secondary components.

Great. Thank you very much.

Sure.

We'll go next to Alex Blanton, Ingalls & Snyder.

Hi, good morning.

Good morning, Alex.

I am concerned about the continuing supply shortages you're experiencing. Some companies have seen recent increases in production of their suppliers and are catching up a bit, and others don't have any problems at all, such as Parker Hannifan in that regard. So is this problem getting worse for you or better? And what are you doing about it to migrate to lean technology to your suppliers in order to get them to be able to increase their output? Could you comment on that, please?

I think there are two pieces to it. The -- your example, I think, is a very good one because they are the problem to us. It is companies that are in the hydraulics, tires, and those. Our focus, I would tell you right now, is singular when it gets to our construction technologies group. That is where we are finding, and obviously that also would impact, to some degree then, Bobcat. So really, narrowing it down at this time for what's going on the in the road development side, that has more than 50% of the total negative impact that we're seeing on a year-over-year type basis. What we see there is the strength that was experienced in the first half of the year, we were up over 20-some odd percent.

Caterpillar was having numbers, as you know, that were even higher than that. I think it caught both us, as well as our supply base, totally unprepared to respond to that. So that is why we have kicked in the safety stock to try to go through that, but even with safety stock, we're still experiencing product outages as we go forward.

One of the issues we were dealing with is that we have many sole-source contracts as part of our process. We're trying to lean out a supply base. We wound up going with single sources, and when we wound up doing that, when they wind up not delivering on a timely basis, we started having problems. We've now gone to secondary backup's to try to go on to help deal with unforecasted-type increases.

As we see the fourth quarter coming to what I would call more normalized rates, we no longer forecast Bobcat up 28%. We're forecasting them to be more in the 10 to 12% type range. I think our supply base will be able to catch up to that backlog that we have created. The good news is there was tremendous backlog. The bad news is neither one of us did a good job in forecasting it timely. So I look at this as being an aberration that really I'm making significant progress during the fourth quarter as we improve in both how we work with our supply base, plus getting closer to our forecasting accuracy is going to be like.

Okay.

The second question is, again, related to lean manufacturing, but you reported a CapEx of 1% of sales, which historically is quite low for Ingersoll-Rand. And I don't know what you're forecasting for the year, but could you comment on that, and also, why -- why is the CapEx as a percent of sales so low? I mean another company recently reported a similar thing and many people were concerned about it, saying, well, that shows that your managers are not very confident about the future because they are not investing.

Well --

And the company said, no, that's not the case. So could you comment on that?

Yeah, what I included in my comments, let me use a good example. At Bobcat, we've been able to more than double the capacity through the exact same square footage of plant that we have in Bismark, and we did that by adding about $1 million of tooling on the inside and equipment line. So what we continue to see is that we're able to go and increase.

Our throughput on the same square footage basis is up over 80% because of the leaning out, mixed model flow, and the things I was describing to you beforehand, so we really, at this point in time, as we see. Now, I have a couple plants that we're getting to be bottlenecks. We just announced we've spent some money out in Bismark putting in a new distribution center, but in general, our plant utilization still runs between 40 and 45% of the capacity levels. So as long as we have that, what you're seeing is a not too much brick and mortar going in.

Our full-year forecast, when we started out the year, we thought we were going be somewhere between 150 and $175 million worth of CapEx. As we now forecast the full year, we're looking closer probably between 110 and 125 million because, again, folks, it's got nothing to do with them reducing the forecast going forward, the good news is they have been able to lean out the existing capacity and been able to increase the throughput. As I said, at Tecate, we've had 30% increase in over six months. Bobcat, we've been running double in the last 18 months. So I think that's what you're seeing.

We're now looking, as we said, at continuing strong 2006 and our CapEx investment for next year, and our initial preliminary look, shows again, it to be somewhere not more than 1-1/2%. That includes a new operation in the Czech Republic, it includes a new operation in China, and it includes some restructuring activity we're doing, again, moving around for productivity, plants that we have in Mexico, as well as throughout the U.S. So this is not a try to save it. The good news is is that it really reflects our ability to go and increase our throughput.

So it has a very positive impact on cash flow and liquidity and growth, right?

That's what I want, and the whole thing behind it is we're still, on average, running at between 40 and 45% of plant capacity throughout our manufacturing system.

Okay, great. Thanks.

Well go next to Joel Tiss, Lehman Brothers.

Hi, guys. How are you doing?

Good morning, Joel.

Could you give us a little more color on how you got to 19% operating margins and security and safety, and it also sounded like you had a $10 million cost in there? Is that recurring? What's the nature of that?

No, what we're saying is we tried to give you the delta. Last year, if you remember, we had several instances of single events. We had a $10 million, third quarter 2004 event called kryptonite, when we had to go and do a recall on locks out there -- bicycle locks. This year what you're seeing is the more traditional ongoing operating income level. We had always said this was a 17 to 18% type business, and it turned out that with some of the productivity improvements we had, it bumped a little higher to the 19-type percent. So I would tell you it's a bit more normal than what we saw last year. Last year's 16 was because of a $10 million aberration. This year, the 19 is slightly higher than what we forecasted to be traditionally in the 17 to 18% level, and that's what I expect -- 17 to 18 to 19 in that bandwidth is what you'll see at security going forward.

17 to 18%, as we said, is kind of the annual expectation with that business with, all of the mix of the very strong margins, North America business, degraded a little bit in the mix to the international and also to some of our new product businesses, the integration and the electronics business. Seasonally, the third and fourth quarter tend to be a little bit better margin than the first half of the year.

So you're seeing more business as normal rather than an aberration.

Okay.

Can you also talk a little bit more about the outlook for the road paving business as we go through the cycle, '06, '07 focus, and give us a little more specifics on what's going on in China? Thank you.

Yeah. In China what we're finding is that our -- the product that we sell in China is mostly manufactured for the design that comes out of our German operation, ABG. The product is used on federally funded road construction where they use the German-European type standards. Those are the ones that the Chinese government has this year significantly reduced the activity of and not provided financing for the contractories to buy extra equipment. So we see that as really being off sharply. We're talking about significant double-digit type decreases year-over-year. We expect that will continue till probably into next year, and then we'll see that gradually building up and candidly, in the meantime, we have seen now how vulnerable we are to only participating in the major highway construction. We're busily working on localized manufacturing to go after mechanical-type stuff, which will wind up getting us to have a broader base.

Overall, the negative impact for the China part, put on top of something that we see stronger double-digit-type growth in the U.S. is what is resulting in the overall performance as being relatively flat to down a couple percentage points. We think that as we go forward into 2006, China improves. Russia, we see for us as being something that really starts picking up next year, and we see the T bill, approved now in the U.S., continuing to provide a strong base going forward. So I think that the cycle is going to be extended and actually improve in 2006 and into 2007 with the downturn in China this year being the biggest problem we have on revenue, and the operational issues we talked about beforehand being the ones that impact the margin the most.

And is there any concern over the longer term that you can't get this business up to the 15% operating margins that you're targeting?

No. As a matter of fact, we're saying that the normalized operating margins for this business has historically been the 17 to 18% type range, and that's what we're going to get back to very quickly.

Our expectation, 2006, we should see double-digit revenue growth and the supply disruptions, raw material cost, et cetera that have severely impacted us certainly in the third quarter, but have plagued us all year long, we would expect to subside. As Herb mentioned, we should return back to the 15-plus percent margins in 2006. 17 to 18 is very reasonable.

All right. Thank you very much.

We'll go next to Gary McManus, JPMorgan.

Hey, Herb. Good quarter. You know that, 15% order growth, if I look in the slides, the security had 7% growth organically. Can you give me what the order growth was in the other four segments?

They were actually -- they were more than double-digit in every single one of them.

Okay, but, but -- okay.

One more thing. I don't have those memorized. I actually have to look at a sheet of paper for that. Bear with me one second.

Okay.

If I look at the third -- hold on a second. That's the wrong sheet. Tim, could you look at that?

Yeah.

Climate control we're seeing up double-digits, low double-digits. Industrial technologies, mid-teens. Compact vehicle in the 20's, and construction also in the 20's.

Okay.

I'm struck on those last two being 20% order growth. I mean is that-- I know it was talked earlier that -- was it an easy comp a year ago? Are you seeing acceleration there? What do you think is going on because that doesn't --

We saw acceleration picking up again, Gary, at the back end. July and August was -- I was finally going to be right on my 10 to 12% level, and then along came September, and it wound up going very, very strong again.

Bobcat, as I mentioned in my comments, was up about 28% in orders. We think there's some hurricane effect in there.

Right, and I'm struck with the decline. I know you just talked about construction margins going up back to 15% or so next year, but I'm struck on why you had two percentage point margin erosion there on double-digit growth, and the other two segments, industrial and compact vehicle, had two percentage point margin improvement on double-digit growth. They all, I assume, have to do with raw material costs and supplier issues. What's going on specifically in construction that's causing this erosion that you're not seeing in the other two areas? I mean how much is it with the adverse product mix or geographic mix or inefficiencies? Just give us a little bit more detail there.

Let me give part of it. As we look at the mix, China being off sharply, that cost us about one point negative. I mean it was that big of a mix. Our product-- when you look at the total profitability, we have businesses there that have margins of 50%, so that cost us actually one margin point. The raw material costs and the availability, that's the suppliers to the large machinery companies, the expediting and so on, that cost us the 1% negative. So if you look, to go up in the revenue like we did, we saw, as I said to you, over half of our material inflation showing up in this business alone.

Okay, all right.

And I might point out on my comments, I mentioned that we aren't getting the purchase price, the purchase price of raw material productivity that we would normally expect in that business simply as I mentioned, because our purchasing agents and other folks are out there insuring the availability and expediting orders, et cetera, rather than working on their productivity.

So it's the same process, the same skilled people, just having a problem with. That's how extreme the supply problems are in that particular business, and that's how sharp the decrease is in the China market.

Okay, got it. Thank you.

We'll go next to Jeff Hammond, KeyBanc Capital Markets.

Hi, good morning.

Hi, Jeff.

Hi, Jeff.

If you could go at the orders a little bit different way, can you give us a sense of what the orders look like in Europe and Asia-Pacific?

Give us one second here.

Sure. One quick question while you're looking as well on the supply chain issues, are you contemplating any changes to any of your suppliers in light of these issues?

That's obviously an ongoing work in progress that you wind up looking at, and I would say to you that -- I said before, where we had some singular suppliers, we've had to, at this point in time, go and get ourselves a backup secondary supply base, and that's where we're focusing on more than anything else.

Yeah, Jeff, I'll go back to the -- we're talking kind of low single single digits or mid-single digits in our Eastern region. Strength in the 20's in Latin America. Asia-Pacific, again, is off modestly, and North America we're seeing the 8 to 10% increase range.

Okay, and then finally, can you kind of prioritize your acquisition appetite outside of the security business?

We feel that what we have is the opportunity to really look at -- number two on my list would be the industrial technology side. We see a lot of opportunities to provide solutions that augment what we're currently doing between our productivity and energy side things. I think that will be the second biggest area, and there's a lot of different global opportunities for that. The third area that goes beyond that, we continue to look to see how we can improve our recurring revenue, and if I look at into the compact equipment side, that would mean things such as more attachments to be putting along with our equipment, that would be, I think, the third priority target for us. And that now, what I'm describing to cut product. We continue to look at obviously, what do we continue to do to increase our footprint specifically in the growing regions of the world. So you'll continue to see us doing things in China as well as I think in parts of Eastern Central Europe.

Okay, great. Thanks, guys.

Sure.

We'll go next to Rob McCarthy, Robert W. Baird.

Good morning, gentlemen.

Hi, Rob.

Herb, could you update us on the progress of the conversion of the main Hussman manufacturing facility in Bridgeton to lean the assembly line structure there, et cetera?

I'd say to you that I think the Bridgeston facility that is varies, but is earlier in the journey than some of those like Bismark, that are further down the journey. We are still, at this point in time, moving around the entire product flow, so that we're able to go and put through a mixed-model type approach rather than have dedicated lines for this brand display case and that brand. We moved to some unique product, stuff that's made one-of-a-kind, engineered type product. We move that into the facility out of our California facility over the last six months, and we're still in the process of setting that up. I would say to you that Bridgeton is one of those that at this point in time, is early in the process and I have not yet seen the benefits of the impact of the positive stuff coming out of there. That remains to be something I'm looking at for the improvement in 2006, not in the fourth quarter, 2005.

Are you in a position to make even a guesstimate at what kind of impact it could have on climate control margins next year?

Yeah, as I said, our goal when we look at this is they would single handedly impact by as much as 1 to 1-1/2%, just because of the cost associated with the labor component and the inefficiency on the productivity side from where we're at. So, you look at that, we're talking about something, which we're going to measure in the tens of millions of dollars.

Thank you, and that's helpful.

As a follow-up to the various questions you've been getting about the asphalt paver and related equipment business, is embedded in this discussion a growing resistance to price increases on the part of the customer base?

No, not at all, Rob. The biggest resistance is me trying to go and hold the line on raw material price increases. That's been the biggest issue that we've been trying to deal with in that business.

Okay.

If I could -- just for clarification on the '06 outlook -- your discontinued op's contribution to earnings per share this year is a little off of standard because of the gain in the quarter. Do we go back to a world where we're going to see something like 10 to $0.12 drag from discontinued op's next year?

That 8 to $0.10 is about normalized, and, yes, we -- this was a gain that there were, as you know, there's always a lag between the time you close a transaction and button out all of the last details, and this was just a residual affect from the drill sale last year that we had some residual adjustments, and that certainly benefited us in the quarter, but we should return to the dined of normalized level, 8 to $0.10.

Okay, great. Thank you.

Sure.

We'll go next to Andrew Casey, Prudential Equity Group.

Good morning.

Good morning, Andy.

If we could -- if I could ask a quick detailed question on the component of climate technologies piece of the 15% order growth, does the -- does the answer that you give spread across both transport refrigeration and stationery, or are we still seeing higher order growth rates in transport and lower order growth rates in stationary?

When we add in to the fourth quarter now, the APU, the auxiliary power unit that we're introducing at Thermo King, that winds up, again, then driving up the total transport business while we're continuing to be relatively flatter on the retail and the contracting side. The driver continues to be in the fourth quarter -- the transport piece.

Okay, and then could you comment on the stationary refrigeration service business? Has there been any reversal in the competitive trends you've talked about?

The service business in the third quarter was actually favorable from what we originally had forecasted, not so much favorable from the traditional fixes of refrigeration, but the fact that we had more HVAC-type activity, courtesy of the hot summer weather that was out there, and so we return now to more of what we were seeing at the end of the fourth quarter last year, profitability levels, which are in the upper single digits. So we see that improving. We still continue to struggle to be able to make our value proposition of being a nationwide supplier be something that we're able to provide through the traditional supermarket chains. They are still accepting it on a more local-type basis. We're finding nontraditional. We just signed a contract with Rite-Aid for a couple thousand of their stores. We would up going getting -- I couldn't believe it, my wife will probably love it. We now have the contract at Tiffany's, hopefully we get an employee discount now that we work there, but we're not doing their HVAC-type work at that location. So we continue to see a challenge in dealing with the traditional supermarket, but we're making much more end roads on what I call much more of the nontraditional type, or HVAC-type work.

Okay. Good luck on that discount, Herb.

You can always hope, buddy.

Yes. One last question on the security and safety margins. Did you pull back at all on the growth investment in the quarter?

Not a bit, not a bit. What you're seeing is strictly saying that no extraneous events that negatively impacted. We continue to make full bore investments, both in China, as we wind up going -- as you could imagine with those JV's we put in, we had to really increase our SG&A over there to be able to go from -- we were in China last $5 million. We'll be over $350 million at a run rate for next year. That means I have to make investments. Here in the US, on the electronics side, Tim was saying we had improvements of almost 20%, so we continue to go and make investments there as well.

And candidly, we're also continuing to make a lot of investments on the product side in the electrifying of slag. I want to make sure we do not fall behind in getting away from the key, to the keyless-type entry systems people are looking at more and more, both consumers as well as commercial applications. So, if anything, I would say we slightly stepped up our investment, both for vertical markets, geographic reach, and as well in some of the new technology that we want to focus on.

I think you guys have been challenging us for the last several quarters of when these recurring one-time charges would stop. I would say there were -- this is the quarter that that kind of happened, that we didn't have the unusual items that hit during the quarter so this is a much more normalized situation. Again, with the kind of the seasonality impact that I said, we're still targeting 17, 18% annual margin levels.

And so as you look next year, Andy, for this number, took the prelim 2006 together, I plug in the 17 to 18% type number, with the affect also applying to all the bolt-on acquisitions that we have made.

Great, thank you.

We'll go next to Ann Duignan, Bear, Stearns.

Thanks. Good morning, guys.

Hi, Ann.

Herb, let me know if you get that discount at Tiffany's.

I wasn't trying drive up their sales. I was just trying to figure on you how --

-- all Tiffany stores in the United States?

I wish it were three.

I have a question, just a clarification on the joint venture S that consolidated in revenues, or does that show up on the equity line?

It will be consolidated, Ann [inaudible].

-- greater interest?

We will show the consolidation and the offsetting will show up in the minority interest, that's correct.

Okay, okay, just to clarify.

And then, Herb, just a question on the recurring revenues, I'm still struggling with your definition of recurring revenues. Correct me if I'm wrong, you include the sale of used equipment in recurring revenues?

That's correct.

And I guess I'm curious to understand why we should assume that used equipment sales would be considered recurring. I would consider those maybe performing in a different cycle in the sale of new equipment, but I would still expect used equipment to be cyclical. What -- I guess help me understand why you consider used equipment to be recurring revenue.

Ann, there's not a perfect definition. We've spent a fair amount of time internally trying to kind of figure out what made best sense.

You talked us out of the installation one, so we removed that part.

Thank you.

But we would view the -- the used equipment as having some offsetting effect when there is pressure -- when there's pressure in the markets because the economy and slowdown in markets and so forth, there is a tendency for people to downgrade and purchase used rather than new. So we see some offsetting benefits associated with that, which is ultimately one of the big, big drivers of our desire to expand our recurring revenue streams.

So maybe we're saying the same thing. You're defining that as having a different cycle.

A different --

That's exactly -- by the way, Ann, I mean we're -- we aspire to have that come a much bigger part of the portfolio, but it really is not providing any distortion. Now, the used equipment business is a nice business, we like, and we have growth aspirations as we said, but it is very small.

But the key part that you said, Ann, which we absolutely agree with, is the fact that we're trying come up with -- remember, were those type of events, those type of transactions that are counter-cyclical to maybe some of of the large type purchases you would have. So that's what we're really trying to measure is, if there were a downturn coming in a given marketplace, what are the kind of things you could look at to offset that downturn. Well, most people start buying less new portable air compressors, we find that the used ones wind up going up as an alternative for them to turn to. So that's really what we're trying gauge is how much are we strengthened at this time, in what I really call anti-cyclical, counter-cyclical type activities.

Okay. That's helpful.

Just a quick follow-up on the grocery display case business in Europe. You had mentioned last year that you had a lost a key account over there. When do the comps get easier for that business and then, Herb, could you just address what does the fundamental business look like for grocery display cases in Europe right now.

By the end of this year, we will -- because the contract carried all the way through last year in the fourth quarter, so the comps are, if you will, same-store type comps about by end of this year. As we look at for next year, our biggest question continues to be as to our success level at getting contracts in Car fore and TESCO, and that is something that we will, as we go through in the next month or two, we'll wind up getting a better feel for where that is going. But those two, because of the number of stores that they have in that region, will have a big impact. Outside of that, if you look at just the overall macros, we think that they are going to be up slightly this. This is one of these 1 to 2% type markets overall, but basically there are three, between Car For, as well as TESCO, and, to a lesser degree, getting into things like the metros and so on in Germany.

Okay. That's helpful.

Thank you.

Excuse me this. This Joe Fimbianti again. We'll take two more questions please.

We'll go next to Dana Richardson, Argus Research.

Good morning. My questions have been answered. Thank you.

One more question.

Okay. We'll go next to Nigel Coe, Deutsche Bank.

Good morning. [inaudible] I have a question on your margins. You sort of have the long-term target of 15%. When do you think you can actually get there, and how much of that comes from productivity and how much comes from a mixed shift towards higher-margin security businesses?

Well, I think what we go into is that, as I mentioned to you, we're looking at how we get somewhere between 1 to 1-1/2 improvement points each year. So that, if you looked at that as being the trend line, that would bring us to a run rate close to the end of next year and into 2007. That would be the time line I would look at, saying that we can actually say our plan would be up into that kind of a level. To the degree that we wind up making bolt-on acquisitions next year, that have lower margins, it will be potentially more of a drag to get there. If I look at this year, the businesses that we've picked up, we think they will be all at the 15% level as we wind up getting into 2006. So the only yes-but, to the 2007-type number would be if we wound up picking up $500 million worth of stuff at 10%. Then we would have to go ahead and bring that up.

You need to recognize that the purchase accounting in an acquisition, usually you would suffer for two to three quarters with fairly considerable degradation of margin as a result of the acquisition step-up of the inventory. Essentially you're selling -- until you sell through all of your inventory, you, for practical purposes, are selling that at virtually no margin.

Okay.

So if you look 1 to 1-1/2 points on to, which let's say it starts off at around 13, that's get you there and turned around in 2007 as your run rate.

Okay, great.

Just one quick follow-on -- the industrial license looks good, nice increase year-on-year. Could you just peel back that a little bit? You mentioned new products and aftermarket, but could you just give a bit more color there? And do you think that that level is sustainable and you can go on from there?

Well, I don't think it's sustainable. I think it's going to improve from there. When you look at is -- and we have the air, as a business, runs north of 15%. Productivity is running in the 13 to 14% type level -- I'm giving you full-year. Remember, we still have then, also baked in there, is the investment that we continue to make in our micro-turbine, which at this point in time, is talking about have having an OI, which is a couple million dollars negative. So when you put those pieces in there, and we look at that turning positive.

So I envision this will be a 15-plus percent business going forward for next year. The recurring revenue, which Tim mentioned before, is almost 50% of the business, has about a 20-plus percent operating margin.

Okay. Thank you very much.

Sure.

Okay. We're going to wrap up now. Thank you very much for joining us.

There will be an instant replay of today's conference call available at approximately 1:00 pm. It will be available until October 27. The call-in number is as follows 888-203-1112, the pass code is 3990481. International callers, it will be -- phone number will be 719-457-0820

The audio and the slides from today's conference will be archived on our website, and finally, the transcript for the conference call should be available on the Ingersoll-Rand website sometime next week. Again, please call me, Joe Fimbianti, if you have any additional questions, at my number, 201-573-3113, and this concludes our call,

Thank you very much. We'll see you in January. Thank you.

Again, this does conclude today's conference. Thank you for your participation.