特靈科技 (TT) 2010 Q3 法說會逐字稿

Good day, everyone, and welcome to the Ingersoll-Rand third quarter 2010 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Ms. Janet Pfeffer, Vice President of Business Development and Investor Relations. Please go ahead.

Thank you, Ben. Good morning, everyone. Welcome to Ingersoll-Rand's third quarter 2010 conference call. We released earnings at 7 AM this morning and the release is posted on our website. We'll be broadcasting in addition to this phone call through our website at IngersollRand.com, where you will find the slide presentation that we will be using this morning. This call will be recorded and archived on our website and will be available tomorrow morning about 10 AM. If you would, please go to slide two.

I would like to remind you that the statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provision of the federal securities laws. Actual results may differ. Please see our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. In addition, please refer to slide 21, which will cover the use of non-GAAP measures to describe the Company's performance. Now I'd like to introduce the participants on this morning's call. We have Mike Lamach, Chairman, President and CEO; Steve Shawley, Senior Vice President and CFO; and Joe Fimbianti, Director of Investor Relations. With that if you would please go to slide number three and I will turn it over to Mike.

Thanks, Janet. Good morning and thank you for joining us on today's call. I would like to start by thanking our employees and customers for their continued dedication and support in the third quarter. We continued our focus on driving top tier operational performance and delivered strong revenue growth, with three of our four sectors achieving top-line increases. We expanded our margins, grew our earnings and generated strong free cash flow. We have generated significant productivity, averaging 5% over the past seven quarters. Third quarter earnings from continuing operations were $0.80 per share, at the top end of our third quarter earnings guidance range of $0.70 to $0.80. For the quarter revenues were $3.7 billion, up 8% versus prior year, 9% excluding currency and near the top end of our guidance range of 5% to 8%.

During the quarter we continued to see strong bookings, as a number of our businesses are showing solid growth. For the Company, overall, orders were up 8%, 10% excluding currency and improved in each of our segments except for commercial security, which continues to be hampered by the ongoing decline in North American commercial construction activity. Our backlog also increased by 17%. Operating margin for the quarter was 10.9%, driven by productivity and higher volumes. Three of our four segments improved operating margins year-over-year and total segment margins were up 150 basis points. Leverage on our year-over-year revenue gains was 31%. We achieved 4.7% gross productivity, as we continue to drive disciplined cost controls and operational improvements. Our innovation focus continued to result in the introduction of new products and services in key areas of the portfolio and in emerging markets. These actions will help to fuel our growth in both revenue and profit in the years ahead.

We also remain focused on cash flow management and retaining the benefits achieved through the operational intentionally paid to working capital improvements over the course of the past two years. As expected, we repaid $250 million of maturing debt in August, as well as making a pension contribution just shy of $250 million in September. We are on track to deliver $1 billion of available cash flow for 2010.

Please go to slide four. This slide gives a summary of our quarterly order rates from 2008 through the third quarter of 2010. As you can see, we hit the bottom for orders in the back half of last year and reported flat orders in the fourth quarter. Reported orders for the third quarter was slightly below the first two quarters of this year, up 8% to overall, 10% excluding currency. All sectors, except for commercial security, enjoyed year-over-year gains. We had especially strong gains in industrial air and productivity, stationary, and transport refrigeration, and Asia commercial HVAC equipment.

Please go to slide five. Please look at the revenue trends by segment. We think revenues, excluding currency shown in the bottom of the chart, gives a better view of our organic sales performance. As you can see on the bottom chart, the third quarter was up 9% excluding currency. We had improvements in all of our sectors except for security, which was down 4%, in the face of significant declines in the domestic commercial construction market. I will give you two other views of our third quarter results, a geographic split and a split between recurring revenue and equipment. On a geographic basis, revenues improved by about 5% in the US and were up by 16% in international markets, excluding the impact of currency. Equipment revenues were up 7% and worldwide parts and service were up by 11% compared with the last year.

Please go to slide six. This bridge analyzes the change in third quarter segment operating margin year-over-year. Third quarter operating margins were 10.9%, an increase of 1.5 percentage points compared with 2009. As you can see, volume, price, and mix on $270 million of additional revenue added 2 points to our operating margins. Productivity, netted against inflation, increased margins by 50 basis points, as commodity inflation increased in the quarter particularly related to metals. We continue to invest in new product development and those activities, coupled with restructuring investments, reduced margins by 1 point. Our focus on reducing our fixed comparable cost structure and our innovation initiatives remain core elements of our strategy, as we position ourselves for higher margins and faster than average growth as our markets fully recover.

Please go to slide seven. This slide explains how we compare versus the EPS guidance range we provided in July. At that time we indicated that we expected to be in the range of $0.70 to $0.80 per share from continuing operations, with a midpoint value of approximately $0.75. Revenue was about $30 million over our midpoint, all of that due to FX. Volume, mix, and currency were about $0.03 better. Productivity was about $0.01 short of target, but much improved over second quarter. The tax rate was about 1 point higher, which translates to $0.01 unfavorable to earnings. And net interest and other items were favorable $0.01. Timing of restructuring was a positive $0.03.

As discussed in our press release, this week we signed a letter of intent to sell our Energy Systems business. As a result Energy Systems has been reclassified to discontinued operations. Note that the move of Energy to discontinued operations had no impact on third quarter EPS from continuing operations. So overall, versus our guidance, we were near the top end of guidance on revenue due to some positive currency and delivered earnings with top of the range, mainly due to mix, currency and timing of investments. Steve will now take you through a review of our reporting segments.

Thanks, Mike. Please go to slide number eight. This slide covers the climate solutions segment, which includes the Trane commercial HVAC business and the Thermo King and Hussmann refrigeration businesses. Total revenues of $2.1 billion for the third quarter were up 9%, 10% excluding currency FX. I will talk first about the Trane commercial HVAC business. Globally nonresidential HVAC equipment markets were up low-single digits in the third quarter, following a decline of mid-single digits in the second quarter. We believe the Americas' market bottomed in the third quarter after two years of decline.

For the balance of 2010, we expect markets in Europe and the Middle East to decline slightly and growth in Asia to continue, led by strong growth in China. Trane's global commercial HVAC third quarter revenues were up 6% versus prior year on both a reported basis and excluding the effects of foreign exchange. Global commercial equipment revenues increased 2% excluding FX. This is the first time equipment revenue growth has been positive since the second quarter of 2008. Global parts, services, and solutions revenues increased by 11% excluding FX. This continues the momentum that we saw in the second quarter, which was up by about the same percentage.

Shifting to orders, our global commercial HVAC orders were essentially flat on both a reported basis and excluding foreign exchange, impacted by tougher comparables in service and contracting, as a result of several large performance contracts awarded in the third quarter of 2009. Global equipment orders were up mid-single digits. For the global Thermo King transport business revenues increased by 23%, which is consistent with significantly improving markets compared with last year. Our worldwide refrigerated truck and trailer revenues grew at about the same rate with strength in all key regions. Global bus HVAC shipments and marine container sales both increased substantially due to easy comps and improved end market activity. Thermo King orders increased by about 40% in the third quarter, setting the stage for continued improved sales and operating earnings for the balance of 2010.

Looking at stationary refrigeration, global revenues were up 7%. Overall bookings increased by 21% in the quarter. North American display cases revenues were up 13%, primarily driven by supermarket upgrades and remodeling projects being undertaken by several of our national and regional customers. Operating margins for climate solutions was 10.4% in the quarter compared with 9.3% last year. This 1.1 point margin improvement was driven by volume gains, productivity and better mix, partially offset by higher commodity prices.

Please go to slide number nine. Industrial technologies third quarter revenues were $624 million, up 22% on a reported basis and 24% excluding FX. Industrial markets are continuing to recover after stabilizing in the first quarter. Air and productivity revenues increased 24% versus last year, with increases in all regions. Hub car revenues grew by 18% compared with last year, with increases in both golf and utility vehicles. Total orders in the industrial segment were up 24%, with strong improvements in all geographies. Industrial's operating margin of 12.7% was up 3.9 percentage points, primarily from higher revenues, pricing, and productivity.

Please go to slide 10. In our residential solutions sector, which includes Trane and American Standard HVAC product lines and the Schlage Security residential business, third quarter revenues of $575 million were up 1% compared with last year. Excluding foreign exchange revenues were up 3%, the fourth consecutive quarter of positive growth in residential. Although the third quarter growth was not at the level that we experienced in the second quarter, as residential markets overall moderated during the quarter. Bookings were up 4% versus last year, 6% excluding currency. Revenues for the residential security portion of the sector were down about 11%, but flat excluding currency. North American revenues declined slightly. South America was down over 50%, primarily from significant negative currency translation related to the devaluation of the Venezuelan bolivar. For the HVAC business we estimate that the industry shipments of motor bearing units decreased by about 1% versus prior year.

Our residential HVAC sales were up 4%, principally from improvements in replacement sales and introduction of new products. We gained about 1 point of share and the residential HVAC portion of the sector expanded margins by a point in the quarter. Operating margins of 9.6% were down 60 basis points compared with 2009, driven primarily by inflation and negative currency.

Please go to slide number 11. Revenues for security technologies were $410 million, down about 6% and down 4% excluding currency. America's revenue in the commercial sector were down 5% in the face of significant year-over-year declines in commercial construction markets. Our European security business was down approximately 10% on a reported basis and 2% excluding currency. Asian revenues were down mid-single digits due to the timing of large projects. Operating margin for the quarter was a very strong 22.1%, up about 30 basis points despite the sales decline. Strong productivity and price realization drove improvement in margins.

Please go to slide number 12. As we have discussed on many occasions, our overall target is to increase operating margins at least 200 basis points per year. Year-to-date September margins are up by 240 basis points and we expect to end the year above our target as well. As part of our margin expansion focus we have set a long-term goal of delivering 5% annual gross productivity. Year-to-date we are at 4.8%. Productivity in the quarter was 4.7%, improved from the second quarter, as the supply chain inefficiencies discussed in July were addressed during the quarter. For the fourth quarter we expect productivity of 5% and we see ending the year at just under 5%. I remind you that the disposition of KOXKA and the Energy Systems business does have a slight negative effect on the overall productivity plan for the year. Our manufacturing overhead and footprint improvement programs continue.

Year-to-date we have announced 11 manufacturing plant closures, as well as reducing two plants with the KOXKA divestiture, bringing the total to 13 fewer manufacturing sites globally. We spent about $25 million of restructure and productivity investments in the quarter.

Please go to slide number 13. In addition to our productivity programs, we continue to focus on developing and launching new products and services. We expect about 18% or $2.5 billion of our 2010 revenues to be from new products and services introduced in the last three years, with a number of new offerings in each of our new businesses. This is up from approximately $1.8 billion or 14% of sales in 2009. We are increasing our 2010 spending on innovation related investments by the equivalent of $0.15 to $0.20 per share over 2009.

Pictured are five of the new products we launched in the third quarter. Just to highlight two of them, our industrial technologies business, Chinese industrial companies now has access to a lower cost industrial Ingersoll-Rand rotary screw air compressor. This new product, which we challenged our team in China to develop in record time, costs 17% less than similar products, is localized to meet market needs and generates less noise than higher cost compressors. It is marketed as a V-series under the Shanghai Ingersoll-Rand compressor brand. The China team was more than up to the task, as they developed and launched this product in just eight months. Residential Systems' new air handler platform, to be sold under the Trane brand as the Hyperion air handler and the American Standard brand as the forefront air handler, features a number of industry exclusives and is the industry's most advanced air handler.

It won the 2010 Comfort Tech Show product award as the most innovative product in the forced air category. Its air tight, double wall cabinet eliminates exposed insulation and helps prevent energy loss reducing its carbon footprint. Reinvesting in our businesses is critical to our future growth and we have a growing pipeline of product and service innovations that will continue to strengthen our market positions.

Please go to slide number 14. We continued to achieve our deleveraging goals during the third quarter. Total debt was reduced by $224 million in the quarter and $436 million year-to-date.

As anticipated, we paid the $250 million maturity in August. We also made a pension contribution of just under $250 million in September and expect to contribute additional pension funding of up to $200 million in the fourth quarter. These discretionary funding actions count heavily toward our efforts to deleverage the Company and they are also expected to offset any incremental pension expense that would otherwise be triggered in 2011 by the lower discount rates that we are anticipating. Cash balances ended at $811 million and we had no outstanding commercial paper at quarter end. We have reduced our total financing by roughly $2.3 billion since the completion of the Trane acquisition in June 2008.

Please go to slide number 15. We finished the third quarter with working capital at 3.3% of sales, down 60 basis points from last year. We expect to maintain working capital to sales in a range of 3% to 4% for the full year through improvements that we have been making in manufacturing systems, processes, footprint restructuring, and supply chain and logistics management.

Please go to slide number 16. We delivered available cash flow of $371 million in the third quarter bringing year-to-date cash generation to $557 million. Based on the year-to-date performance we fully expect to deliver our plan of $1 billion of available cash flow in 2010. With that I will turn it back to Mike for the forecast.

Thanks, Steve. Let's go to slide 17. Our forecast for the fourth quarter is based on mixed but improving markets. We continue to expect the slow recovery in the US and European economies, growth in Asia, and mixed activity levels in our major vertical end markets. We believe recent activity indicates that we are seeing stages of recovery in refrigeration, industrial, commercial HVAC parts, contracting and service, as well as signs of improvement in commercial and residential HVAC equipment. But we expect to see a continuation of the challenging conditions in the US nonresidential construction market for the balance of the year, which will continue to impact both the Trane and security commercial businesses. We're certainly encouraged by our orders and backlog, but remain cautious in our market outlooks. We continue to focus on achieving productivity and continued investment in our long-term growth through innovation.

Based on this mixed but improving view of the world, as well as a weaker dollar, we are raising our revenue range for the full year 2010 to up 6% to 7% compared with 2009. We expect industrial to show gains in the low teens. Climate solutions revenues are expected to be up mid-single digits, with low single-digit declines in HVAC equipment and gains in both refrigeration and contracting parts and service. Residential is expected to be up mid-single digits, with HVAC up mid to high-single digits, while security will be down mid-single digits due to currency. Security is expected to show year-over-year decline due to its exposure to nonresidential building, especially in North America. This results in a full year forecast of $13.85 billion to $13.95 billion, equal to a 6% to 7% full year growth for total Ingersoll-Rand. This compares to our previous revenue guidance of up 4% to 6%.

Please go to slide 18. I would like to take a moment to walk through the changes from our July guidance for fourth quarter and full year. You recall from the prior slide that our revenues are up about $100 million from the mid-point of prior guidance. Fourth quarter revenues are forecast to be in the range of $3.5 billion to $3.6 billion, which is up approximately 7% to 10% compared with the fourth quarter of 2009. Over half of the increase, versus our July view of 4% to 7%, is due to foreign exchange. For the fourth quarter EPS from continuing operations is expected to be in the range of $0.56 to $0.66, including $0.07 of restructuring and productivity investments. This EPS estimate also reflects a 20% tax rate and positive yet somewhat lower price and higher inflation in the fourth quarter versus our July view, based on end market conditions and commodity pricing trends. Translating that to EPS, the $100 million in higher revenues from volume and foreign exchange would add about $0.05 to earnings.

Higher commodity inflation and lower but still positive pricing is about $0.04 of headwind earnings versus our July view. Most of this movement has come from copper pricing, up 23% since July. Finally, the higher tax rate costs $0.01 and the divestiture of Energy Systems adds about $0.01 in the quarter. We are now projecting full year 2010 EPS from continuing operations, including restructuring and excluding $0.12 of onetime healthcare tax costs, to be $2.30 to $2.40 per share. This raises the mid-point of our range $0.07, $0.05 of that from the third quarter beat and the other $0.02 from the reclassification of Energy Systems to discontinued operations. Please go to slide 19.

With this outlook, at the mid-point of the range our leverage on incremental revenues versus the prior year is about 40% in the fourth quarter and over 40% for the year, resulting in significant earnings growth in both periods. Please go to slide 20.

For the third quarter we delivered earnings at the top of our range, improved margins and continued to improve the balance sheet. To sum up the forecast for 2010, we expect 2010 to demonstrate our focus on driving toward premier operational performance across each of our businesses, while steadily increasing delivery of customer focused innovation. We expect to see continued improvement in revenue growth and significant earnings growth, as we continue to deliver on these objectives. I am going to turn things over to Steve for a final comment before we open for questions.

Yes, thanks, Mike. I am going to vary from normal procedure for a second because -- might save some time because a number of questions have already come in from a number of you regarding some confusion around the guidance we have given for restructure impact for the year.

Let me try to explain it like this. Our original plan was to spend $100 million of restructuring. We thought that was going to equate to about $0.25 a share. Our current plan is to spend about $88 million of restructure for the year. And what's happening is a number of you have picked up on the comment that the impact that we gave last guidance was $0.25 per restructuring versus $0.18 this time around.

What's going on here is that as we reevaluate our restructuring programs and, quite frankly, the difference between the $100 million and the $88 million is associated with businesses that we have divested, don't need to spend the restructuring, has taken fairly significant noncash charges down in the discontinued ops line as we have divested those businesses. The earnings per share impact is due to the fact that most of the spending, or a big piece of the spending that we now see for the year, big piece of the $88 million, is coming in higher tax jurisdictions, so we got a bigger tax benefit associated with the spending now than we planned. Unfortunately if you look at the rest of the earnings, it's also skewing towards higher tax jurisdictions, so we lost that benefit net in the tax rate guidance we've just given.

I hope that helps explain the situation a little bit. If not, it makes it more confusing. I am sure we'll hear about it, but that's what's going on with the guidance associated with the restructuring. We in no way are pulling back on our restructuring commitments. It's just that we're getting a little closer to the end of the year. The projects are a little clearer at this point in time, and we have a much better idea or view of the mix of those projects by geographic region.. So with that we will open up to questions.

Open up for questions, Ben.

(Operator Instructions) We'll take our first question from Steve Tusa with JPMorgan.

Hi, good morning.

Hi, Steve.

Just a question on price cost. It was a little bit more of a negative than we would have expected this quarter. I understand the dynamics of raw materials costs. How do we think about that going into next year? Is the price now loaded in there? Are you going to get more price towards year end? What's the risk around that 3% kind of place holder for inflation next year?

Steve, this is Mike. Let me tackle that first. I would say if we go back into the third quarter, we had anticipated price realization of about 40 basis points. We got about 50 basis points in actuality for the third quarter. At that time we talked about the fourth quarter outlook to be a point of net price realization. We still see that happening, which would give us a slight positive for the full year 2010. Our focus in 2010 was really around eliminating price leakage in the portfolio, which clear to us is going into 2011 is that it is going to actually take price increases to offset what we're seeing in terms of commodity costs. Now this is a general industry issue and I know from our point of view we would be tending to want to push inside that envelope as far as we can within the industry, particularly in the areas of res HVAC and the unitary commercial HVAC where the impact is greatest. So we're on, in-tune with what we're seeing here is going to take more than just price leakage management. It will take price increases to offset and that's across the industry.

Can you talk about what your, what the revenue growth was at your Company-owned distributions. So basically what your sell-through was in the quarter to consumers or to contractors?

I don't have that in front of me, Steve. We can get you an answer on that. Typically we're looking primarily at sell-through. Our own Company distribution is the most realtime indication across the business. We're up 4% in total and I didn't hear throughout the month and quarter any anomalies or differences to sort of historical trends. I would tell you that for sure. Don't know the breakout between the two.

Yes, because, I mean, carrier was just down so big and that's mostly factories, so I am just curious if there was any kind of differences there. And one last question for you. Just on commercial HVAC was there any difference between unitary and applied in the quarter? Is unitary picking up a little bit better than the applied business?

Well, I would tell you that on a global basis last time we spoke about equipment in general and we talked about the North American markets in general that we were hitting an inflection point. I wasn't going to call it out, but was going to say, listen, we have seen it stabilize and I would continue to say that that trend really is continuing. When we look at bookings in the quarter and bookings trends year-to-date, last two quarters, second and third, we have toggled around the zero point, slightly positive, slightly negative, but flat. I think the trend around stabilizing continues. Would not call it uptick yet. We did acknowledge, as I am sure you all picked up on, finally seeing an improvement in the architectural billing index. That has a strong correlation on our businesses, but out anywhere from six to twelve months, depending on the business.

And one last quick one. When you guys give 2011 guidance, you will -- we will be keeping the longer term target that you set in mind with 2011 as kind of a building block there or is there anything out there that you see that is unusual about 2011 that you need to kind of highlight in order to avoid confusion around that point?

Steve, I understand your question right are we going to change our long-term guidance annually? The answer is no, okay, in terms of the framework for what we're going to do to grow the Company and make it more profitable.

Okay, great. Thank you very much.

We'll go next to Nigel Coe with Deutsche Bank.

Thanks, guys. I just want to dig in a bit deeper to the impact of inflation on the margins. We saw it grow from 2Q to 3Q, no big surprise given copper inflation, but obviously copper prices continued to increase in 3Q. I am just wondering what the kind of the headwind on margin is within that $0.04 pinch you have got for 4Q?

Well, when we say ramping, Nigel, is it inflation between second quarter and third quarter, and we talked about this last time, was up about 1.5%. In other words, if you look at where we are for third quarter, we picked up a full 1.5%, maybe a little bit more, of inflation quarter to quarter and we're expecting to pick up another 0.5% on top of that in the fourth quarter. Now, we had also picked up some speed on the price side, so that increment, that 0.5% increment is being offset in our pricing moves that we see in the fourth quarter. We still have that gap pretty much that we had seen in the third quarter rolling into the fourth. So, again, it is one of the reasons why our guidance is on margin is a little bit conservative in the fourth quarter.

Okay. So a stable gap in 4Q versus 3Q. And on the pricing --

We're stemming the increment at this point in time, but there is still a gap that opened up in the third quarter that we don't see closing this year.

Okay. And then into the first half nic I know you don't want to get into 2011 guidance, but do you see that gap narrowing as we go through the first half?

Nigel, it would be too premature to say. I could tell you that the earlier comment I am convinced that it, from an industry perspective, will take a price increase to offset that, so I think that we've got to play a role in pushing the envelope and we intend to do that. I don't think it will be maintained just through managing leakage on our end. This is primarily in the res, HVAC, and commercial unitary HVAC business where the material costs are highest per unit.

Okay. And in terms of the, just want to dig into it a little bit into the climate solutions business and I know you don't disclose the margins by sub-segment, but I am just, to that point you have made, Mike, the both of the inflation is coming through on commercial HVAC and residential HVAC, you got a lot of leverage in the transportation refrigeration businesses, so I am seeing that those margins are up quite solidly. Is the commercial HVAC business margins being pinched by the (inaudible) inflation, i.e., are they down year-over-year?

Hold on a second, Nigel. We don't want to give you an answer off the top of our head here.

Nigel, while we're looking, I can tell you that the mix has moved, if you look toward the service growth and the contribution on service growth, I would tell you that the answer is no, it's increased. When you peel down beneath that I will tell you that I would believe on the equipment side it's decreased slightly and I would tell you that mainly as a result of, that's where price is toughest and where we have seen commodity come through probably the strongest. But back to the Trane commercial business, it would be up carried by service contracts and parts, down a little bit at equipment and equipment really being a function of input costs and the inability to drive as much price. Interestingly, climate solutions actually got pricing in Q3. They got about 40 basis points of price in Q3, so they are trying to push on that fact. I would even comment and tell you that in the commercial unitary business we have given up a little bit share to kind of make that point heard in the marketplace. So that is the place where I think it would be the toughest for us.

Okay. So we need to see volumes start to accelerate before we see the margin improvement on the equipment side?

Absolutely.

Okay. Thanks, Mike.

We'll go next to David Raso with ISI.

Good morning.

Hi, David.

Just trying to think through the longer term goals for the Company and trying to list the framework 2011. If we did give 10% revenue growth off your 2010 base to 2011 and, Steve, your comment about the 200 bps of margin improvement, the goal each year, and that tacks on about $0.70, $0.75 of earnings and then we probably $0.05 next year from lower interest expense, please correct me if that's not a reasonable framework. And secondarily, if it is a reasonable framework, where do you see the margin improvement most notably next year? I know you're not going to give exact quantification, but at least kind of a ranking of where do you see the margin improvement next year?

Also, please, David, there is also going to be an impact on our tax rate, which we talked about in our meeting here back in May. We expect our rates to go up. I am not going to sit here and give you back and forth on bits and pieces for 2011, but if you take a look at where we hope to drive the improvements kind of across the board. I think it is going to be easier in businesses like climate, industrial, maybe even in residential where we have some top-line. I think we're still concerned about security going into the year, because there is still downward momentum on the commercial construction markets. Now security is also coming in at 20% plus margins to start with, so I think you take a look at sort of the wild card for next year, when do the commercial construction markets turn around and when can we leverage that security commercial business more effectively.

The way I am trying to think about it is that climate solutions business, obviously it has not been growing the last few years, so trying to think about the leverage to this business. I am just trying to think through copper is going to be up too, a bit of a wild card. But are we ready -- do we already have price increases kind of in the works to try to get ahead of it to start next year, assuming copper is going to continue to be a bit of a headwind? Like how quickly will those be implemented to start the year?

Dave, recognizing as bulk of the way that the business works in the HVAC commercial area is not on sort of a list plus or a discounting to a list. It is a per project basis with margins that happen one project at a time and you sequentially try to move pricing up through how you price into the market on an individual contracts and proposals, so that's been going on for some time. Again, it is why we were able in climate solutions in Q3 to get positive pricing pushing harder on that across the board and in fact we think that that rate would double in Q4. We're looking for something closer to 80 basis points to 1 point of price increase in Q4, so there is upward momentum there. It does take longer to move in that business and again recognizing that on all applied and large unitary that pricing is often set six months in advance of when you actually ship and build the product, so there is a lag in effect there as well.

Well, the reason I ask is just given the seasonality to that business, it sets up a first quarter that could be maybe a bit challenging for that business on margins. I was just to think through that lag lead. And the one follow-up, Thermo King margins, at least can you framework where are they today on a run rate versus the prior peak?

Versus the prior peak, Dave?

Correct.

Going back to like the '06 level?

Yes.

I would say based on where we are, it is slightly higher.

So already above that 13%, 14% kind if level already?

Yes.

Okay, great. I appreciate it. Thank you.

We'll go next to Rob Wertheimer with Morgan Stanley.

Hi, good morning, everybody. We talk less about air and productivity and you had nice revenues in bookings, so I just wanted to ask your view on what's driving that, whether it is just a pure rebound, because I know the comp is easy, whether it is new product, market share and how you feel about the health of your competitive balance in that business in general?

That's just been a great story for us across the Company around really innovation and launching products that not only are more innovative, but the whole cost position and the reduction of complexity in the SKUs in the portfolio is enormously reduced. It is also the place we invested most heavily in the re-footprinting of business in late '09 and early 2010, so it is really a combination of a number of factors. Exciting this quarter launching the new air compressor in China. I want to say that they had a goal in units for the year and they were able to achieve bookings on that goal in the first quarter, so I think it speaks to the spirit of innovation, localization, reduction of complexity, and I think that they will continue that into 2011 and they have got a nice pipeline of projects for innovation and for VAVE that's on the books for them.

Do you have a sense if you're gaining share in that business as a result of all of this or is it too early to tell?

It is pretty obvious, I think, when you look at the CAGI data and we look at sort of what's happening internationally, so, yes, I think we know that we've been picking up shares the last couple three quarters.

Great. Then my second question, if I may, is just in the resi HVAC side you mentioned share gain from the AC and furnace. Can you mention where that share gain is? Is it on lower end product? Is the mix positive or negative on the share gain and what's driving that as well? Thanks.

The mix is moving, I would say, towards 15 [sear] and that's my sweet spot for us, 15 sear and above. It is also as a result of some product launches that we had. If you look at the new air handler launch that Steve mentioned for you, I mean, here again (inaudible) alone we are up say 10% and so in no small part would it have been through the launch of the new platforms. But I would tell you that it is really going back and we have been systematically refreshing up from starting with 13 sear up through the 14, the new air unit, the new furnace platforms, new control systems, and so we have been on a steady pace there for a couple of years now of putting capital and expense into that business to refresh those portfolios, so it is what we expected to happen based on the business cases that is we invested in.

Thanks.

We'll go next to Steven Winoker with Stanford Bernstein.

Good morning.

Good morning.

Just first question. Can you just break out that, on page six, the inflation number between, the 3.7 point between material and labor or is that -- how much inflation do you see in each of the two contributing?

I think we got it here somewhere.

We're trying to get to page six here backwards. (multiple speakers)

I am more focused on net productivity than gross productivity at the end of the day. So I j ust want to -- .

Yes, actually, when you look at the numbers for Q3, it was pretty evenly split between direct material, inflation, and other, which is labor. It would be within $5 million of each other, so call it 50/50.

Okay, great. And then on the productivity number, the 4.7% or the 4.2 points here as opposed to the operating leverage, if you look at Hussmann, TK, Trane, can you give us some idea of how much you were getting sort of above or below the average in those businesses?

Yes. I can tell you that their gross productivity in the quarter was 4%. Now, the thing I would tell you about that business is that's the largest service business that we have, as well, and so they're a little bit handicapped in the way that that business works. We're looking more at gross margin for technician or gross margin for selling head, so if you look at it as a percentage of complete, they do much better, closer to 5%. But as you do the math based on the service base, it is closer to 4%.

All right. And then I guess I would ask sort of where did you get your most productivity across the portfolio this quarter?

Yes. So you talking about Q3?

Just gross productivity by type of business unit.

Security technologies would have been a leader again, I think, in that for Q3. Security technologies would have been a solid productivity 5% plus.

And then just finally back to the pricing question again, in RLC, particularly just on the resi side, resi HVAC side, your price realization relative to the actual list discounts and all that you achieved, have been achieving, what's been the rough ratio there? Where are you, where it actually matters where you can do it on sort of a retail level, et cetera?

I would tell you that mathematically to answer you questions, it was about an 80 basis point drop in pricing and we're doing some things there again. I pushed that envelope now and in Q4 and we think we can mitigate that probably to maybe a 20 basis point decline for the fourth quarter, but 80 basis points maybe growing to 20 basis points and again looking ahead, this is an industry that really is needing a price increase. I mean, it is something I think that's going to have to happen.

So there has been a lot of distributor turnover across industry participants, I will put it that way. Are you seeing any fallout from that?

Well, some of it is planned. If you go back to what Steve Hochhauser and the team talked about in May, it is we have changed dramatically the expectations that we have for distributors and dealers and what that means and so I think that you can say there has been and pretty obvious with the share gains, that there has been a net benefit. But it is absolutely been dealers and distributors that are going to come and go and frankly none of that should be a surprise, it certainly isn't to us as we're trying to change the game in terms of margins and what the commitment mutually means between our Company and a dealer or distributor. I am not unhappy with the churn in the portfolio and would say that so long as share and margins are increasing, I would say the strategy seems to work.

And are you picking up any service acquisitions along the way?

No, no interest in that at all.

Okay. All right, thanks, Mike. Thank you.

We'll go next to Jeff Sprague with Vertical Research Partners.

Thank you, good morning, guys. Hi, Jeff. Steve, could you give us a sense on pension for '11 if you just kind of snap the line today on current discount rates and rate of return, where we'd shake out on headwind for '11?

The commentary I made kind, of an interesting position here having the unfunded pension that we do. As I said we made a pretty sizable contribution in the quarter and plan on making another one in the fourth quarter. Due to our pension fund there are some dynamics, okay. About half of our DB funds are in fixed income instruments, okay? We had a little bit of a leg up on the world because we started some time ago to change the mix between equities and fixed income and have made good progress on that. In fact the funding that we're putting into the funds currently is going into primarily fixed income instruments. So that will help us long-term to be much more of a liability manager as opposed to a investor in a type of a fund.

If you look at the impact on discount rates across our various funds, we have some funds that the discount rate is going to be decreased by 1% and some of about 0.75%, some at 0.5%, so somewhere between, let's just say, 0.75% is what we're expecting it to go down. That creates a pretty big pension obligation liability, but the fact that we're funding this thing this year based on the calculations we've made, we can spend that time of a discount and not see any headwinds in incremental pension expense in 2011, over and above sort where we are in 2010. So the game plan gives us kind of a double benefit. We continue to deleverage in the eyes of the rating agencies with that contribution and we also are controlling our destiny in '11 with pension expense.

That's sure a real outlining performance to the good relative to most people. Could we come back -- I hate to beat this price thing to death, Mike, but I think some of the kind of feedback from the field and everything here just in Q3 and the like is that resi volumes maybe weren't what they could have been relative to the weather and other factors because of the sticker shock relative to 410 A and the like and so if we've already got kind of a sticker shock dynamic out there, in resi in particular, I just really wonder about the ability of the market to actually take price here, which then conjures up the margin squeeze question. So just really a two-part question. First your thoughts on that, on the resi side in particular, but where do your material substitution offerings or actions play into this whole dynamic as we look into next year, whether it is aluminum, compressors, other things that you're trying to do?

Jeff, it is a great question with lots of parts in terms of being able to answer, but when you look at A Q3 and sort of industry number of shipments, unit shipments were down about 10% or so. We were actually positive, we were actually up. And, again, I go back to there is some good exciting new products in the marketplace and I think that that share shift is real and I think it is sustainable for us. As we have done that we have really attacked the whole cost position of these products as well and so, again I think we can expect some margin benefit through what we have done on just material costs and some of the costs of units we're putting together. That's the second piece of this thing. The third part of it is it is a handful of industry players, all faced with the same sorts of pressures in the marketplace. Really with the exception of one, I think everyone is talking about the need to drive price and I would just say that I think that if what we see in terms of commodity headwinds really materializes, and I believe that they will, you're going to see price late this year, first quarter of next year, begin to creep into the discussions. At least that's my guess.

And is there a needle moving impact on the raw map side next year on material substitution? Do we see it? Does it show up in the productivity number or is it (multiple speakers).

No, it is just a big platform in productivity. It is one of the larger projects against the 5% productivity goal that's moving to aluminum coils. Unfortunately, aluminum has made a hell of a move as well and so if you look at the increase in aluminum these days, sort of that gap, that advantage has shrunk relative to converting copper to aluminum. But as an absolutely a good trade off still today and one that's probably one of the larger projects we have towards the 5% number. And actually every program, every project, every unit is laid out in terms of the schedule to introduce and launch that. So I think we will be done in 2011 around that conversion.

Terrific. Thanks.

We'll go next to [Bob Carno] with Barclays Capital.

Yes, a couple of questions. I didn't hear anyone address Hussmann, yet, specifically and the bookings are up 21%, I guess it is certainly an easy comp, but maybe you can just give us color about how the whole Hussmann business model is evolving, how the whole push to resuscitate that business is going?

It is really no different from May, Bob, when we said it has got our full attention to get the climate businesses to 14% to 16%, that business is a business that has to improve most dramatically. We put a full court press on it with both external and internal resources. We made a number of decisions around discontinuation of product lines or lines of business that were not profitable to us. It is starting to show up in the margins that we're seeing in the business and I would say that relative to the early action plans that have been put in place we're getting the benefit of that early in this process.

I just add to that one of the things that was an issue in our what we call our service and contracting end of Hussmann, don't forget that's a $400 million business in that space. The contracting piece was the most impacted by the downturn because was a lot of entrants into the market. People who were contractors, construction contractors, felt that they could move into the contracting installation business, not the service business but the installation business, so one of the areas where we've gained a lot is just prudently moving away from very, very low price installation work and it used to be a big part of the base.

Thanks.

Bob, I just Hussmann margins are up 5% from where they were and so we are, this attention we're putting on it, this focus we're placing on it is paying some dividends in terms of what we have seen today. There is a lot more heavy lifting to do.

Yes, I understand. Well, that was an easy question. Here is a tough question. You guys are targeting the 5% productivity gains and someone would say that early in the process you got the low hanging fruit, you ought to be running well north of 5% with the decay rate going forward as things get tougher. How would you address that observation, because it seems like you're, here you are getting close to 5 for the year, but it looks like it is just difficult to get there.

Well, it is five for the last seven quarters, Bob, and I guess, what in Q1 it was 5.9%. I guess there wasn't anybody patting us on the back then either at 5.9.

We'll pat on you the back if you get 5.9 a year.

So I am not going to apologize for 4.7, I guess. Look, I mean, these things you don't manage to a number. You manage a pipeline of projects, you manage making the right decisions around supply base, around plant footprint, around what business model you're going to pursue and this is all part of what we're doing around productivity. Steve and I have said and sticking to it, as far as we can see out in the pipeline, and we get about 18 months visibility into that pipeline, 5% is a good number. (multiple speakers)

The other way to look at this is that it is difficult to get a whole bunch of processes going. Todd is working on a whole bunch of things. What's the prospect of the whole process to accelerate to north of 5 as you go out, as you get the whole Company rolling?

I mean, Bob, we certainly set a target higher than 5 across the Company, right. Right. Five's a good number. It is a number we can manage with the footprint changes we've had this year alone. And I can tell you shutting down and closing that many plants really begins to be both a catching and receiving exercise, right, not just shutting down a plant. You're moving production to another plant, so multiply times two. Putting a quarter of your portfolio roughly into play in terms of your manufacturing portfolio at one point in time is prudent. Putting more than that at play and risking delivery and schedule and cycle to customers, that's not prudent. So today we're managing that. e want to do better. I will be happy with 5% and that's what we're going to continue to target.

Got it, thanks. Thanks, Mike.

Go next to Julian Mitchell with Credit Suisse.

Yes, thanks. My first question I guess was on the balance sheet. You're obviously making good progress there in terms of cash generation, pension contributions, the debt paydowns and so on. So perhaps you can give an update on what kind of leverage metrics you think about sort of longer term and what happens to your capital relative to those metrics.

Well, I think that to start off with, Julian, one of the reasons we're trying to drive our margins to the degree that we are is that we're fixated on return on invested capital and we have done a good job of getting our working capital down and keeping it down, so when you look at the turn side of that equation, we think we have done a pretty good job. There is always more you can do. 3% is still 3%. It could be zero. But we have improved our inventory turns.

We have improved our daily sales outstanding. So the basic blocking and tackling on the balance sheet is working and has been working now for close to coming up on two years. The piece that we have to drive to try the ROIC is the earnings, operating earnings side, and if you look at where we really want to go and if you take away all the discussion around productivity and the 2 points of margin improvement, we have got to get our return on invested capital up approaching equal to and greater than our weighted average cost of capital. That's the point where we think that this whole thing comes together. That is the point where we think that, in essence, we get a hunting license to grow this business. And so you want to get into the pure financials of our motivation here, it is to drive that ROIC up to a respectable level and create a whole new concept of what Ingersoll-Rand is.

Okay, but in terms of the, let's say, the capital returns to shareholders and that sort of stuff, your balance sheet has improved quite a lot the last eighteen months or so.

Yes and we have been focused on the leverage piece. If you look at where we started this thing from with the post acquisition debt, it is rather significant. And we still have a significant amount of debt on the balance sheet. We think we clearly will be able to fit into our triple B plus rating here by the end of the year when we take a look at where our EBITDAs in 2011 have going, Standard & Poor's has already taken away the negative outlook on triple B plus, so we're expecting to continue to chip away at that as we improve our cash flows and earnings. But the point I am making, the secret to the balance sheet and secret to our deleveraging is the earnings at this point in time. That's where the cash is going to come from. That's where the available cash flow that we need to continue to deleverage and then ultimately start investing in growth at a greater degree is going to come from.

Great. Okay. Thanks. And then finally, just on the, you mentioned before the, you have got around 20%, 25% maximum of the factories is where you want to be sort of adjusting the manufacturing process. I mean, how far overall are you on the factory adjustment process? Do you see a lot less therefore in 2011 as well? Thanks.

Julian, we have really talked about this. This is really a three-phase program. We talked about really the pace for us to be a couple points or better of margin expansion a year. Of course the 5% productivity, earlier question, is the driver. One sixth of typically what we would expect to get in terms of benefit comes from the footprint work that we're doing and we would see that we are on track with Phase I, loading up the plans for Phase II and expect to be off and running late fourth quarter, early first quarter around the next look at restructuring opportunities across the Company.

Okay.

I can't give you any more details right now, obviously, in that area.

Sure. Thanks.

We'll go next to Andy Casey with Wells Fargo Securities.

Good morning. On the HVAC markets, kind of tying a bunch of earlier questions together, with the potential pricing actions and the discussion timing kind of later this year, early next year, do you expect any distribution stocking initiatives, specifically talking about the seasonal discounting next year. Earlier this year you talked about avoiding that. More question on industry as opposed to what you would do.

Yes, Andy, I suppose it could happen. I can tell you if the cycle times in the business continue to get lower, not higher, from distribution to order to ship, so that cycle time is at an all time low and getting lower. I think that from a distribution point of view, particularly with independent distribution, working capital there is still tight. So I think any type of an early buy in anticipation of price increase would be fairly minimal and I certainly wouldn't expect much to happen in that regard.

Okay, thanks. And then, again, on the market, flipping over to commercial, the perennial question about any incremental benefit you're seeing from the government energy efficiency initiatives? Are they still kind of elusive?

I would say in general the whole energy efficiency world, so forget about for the government, think about applied business, the institutional markets. We have seen double-digit booking growth in every -- year-to-date we have seen double-digit bookings in that applied business and, frankly, the place we're seeing probably the most strength has been outside the US. It has been in Asia, where it has been just nothing short of exceptional. I would say that that story around energy efficiency is alive and well. It is driving our applied business and we're seeing double-digit bookings growth and we have every quarter.

Okay, thanks, Mike. And then lastly, the change in personnel on your legal staff, that -- I shouldn't read that to have any impact on the legal entity consolidation initiatives that you're pursuing.

No, it's -- if you guys know Pat Nachtigall, Pat's been at GC for about eighteen years, with the Company for more than 30. We have been asking Pat to hang on. She originally was going to retire when Herb retired, but helped us get through the selection of a new GC. So, no, it has completely got to do with Pat wanting to spend some time in retirement.

Okay. Thank you very much.

You're welcome.

We'll go next to Mark Koznarek with Cleveland Research.

Hi, good morning.

Good morning, Mark.

Question, I guess, a little bit related to one that just came up regarding the footprint. Can you remained us as to the overall program, what these 11 facilities consist of. Are we about one-third of the way through it or are you really front loading it. Are these some of the larger facilities or is it kind of more minor and you're just warming up. Kind of some directional comments with regard to that?

Mark, obviously -- I hope it is clear I can't breakdown what percentage is complete and what is in Phase II and what's in Phase III for reasons that are obvious, but I can tell you that we have always said that we want to see capacity utilization double inside the Company and the equivalent to that was reducing our fixed costs by $300 million. And our pace of costs reduction around this would be about $100 million a year. And in terms of how you should think about it, model it, that's the pace we're trying to achieve with the $100 million per year over multiple phases. And to date we're right on track for that. No issues to date through execution at this point in the process.

Okay, great. Yes, that's exactly what I was after. And then to beat up this raw material thing a little bit more, have you guys talked about or can you get a bit more volatile raw materials, like copper, aluminum, what percent of your cost of goods is that and then typically your raw material contracts, are they pretty coincident with spot or do they lag by a quarter or two quarters, meaning do we still have pent-up pressure out there?

Well, steel lags a quarter and probably in the case of steel in terms of fourth quarter, anyway, it's probably favorable. Copper and aluminum, typically what's on the rise here in short run, and typically we see that in the quarter, we see those increases in the quarter. Just remember that the methodology we have had is a laddering of our copper and our aluminum and our zinc purchases. So we've maintained that philosophy so that sort of in the quarter, certainly the quarter giving guidance, we have essentially locked the cost for that quarter, anyway. Okay? I can't give it to you on a percentage of cost of goods because it runs the gamut from the amount of copper in a door lock versus the amount of copper in an HVAC system as a percent of the product value.

Yes, just some gross numbers. We use about 70 million pounds of copper and aluminum a year, so that's kind of a gross look at it. Commodity costs are roughly 10% of our material spend. Now we get sort of caught up in the fact that our sub-suppliers have commodity cost inflation and that rolls through the process, but that's usually a quarter or two after the main shock of the commodity increase. But I would say if you take a look at the time lag, it is a quarter or so from the time you see the futures going up. Now we do do some hedging. We do not use any type of financial contracts for that, it is all through our supply base. So any point in time we're probably about 30% to 35% hedged, but again that's buying us about a quarter of time in the future.

Okay and that is the 10% of cost of goods is raw commodity and then there is some other embedded commodity in the components that you're buying?

Yes, right. We buy a lot of things, small castings and things like that that eventually the material cost catches up with us, but that's kind of the profile.

So overall maybe it is double that, maybe it is closer to 20 when it is all said and done perhaps?

Maybe even a little bit higher. But, again, we have different contracts with different sub-suppliers. Some index the cost to us directly. Others is a longer term pricing arrangement. So it is not one for one, but we do see an impact within about three to four months of when we see sharp increases in commodities.

Great. Okay. Thanks a lot, Steve.

Ben, this will be our last question. Okay?

Okay. Our final question will come from Shannon O'Callaghan with Nomura.

Good morning, guys. Thanks. Steve, thanks for the clarification on the restructuring productivity spending this year. I mean, as you look into next year, where does it look like that could go?

Again, we're hanging in there with the $100 million. That's what we've put in through the long-term look. We believe that the footprint initiatives and other productivity activities, that's about what the budget is going to be. And, again, it is going to be within a range. That's our long range plan., $100 million a year.

Yes.

We put that into every year through 2013.

That's on the expense, too, so basically you are saying carryover savings and expense kind of offset from here?

Roughly.

Okay. And then just sometimes you guys have given a little bit of color on the next quarter margins by segment. Can you give us a feel for how you expect fourth quarter to play out by segment margin?

I mean, I would expect continued strong growth in climate. I would say revenue growth low double digits range. Probably operating margins there low 7 to low 8, industrial technologies continued double digit growth, high-single double digit growth there, margins that kind of run probably low 13s to high 13s, res solutions you look at the total business here is security and HVAC combined of course, we're looking at growth probably in the mid to higher-single digits, 7% type range. Need a little bit bigger spread in margins here depending what happens, but somewhere between 10% and 11.5% margins in the quarter there. And then security I think continue a challenge. We said low kind of double, I am sorry, low-single digit revenue growth but would expect -- I am sorry, corrections here -- negative growth single digits in the quarter, but we'll see great operating performance there again, probably in the quarter at somewhere between 21%, maybe a little better than that on the quarter.

And just last one on security. Obviously in the residential security side you have seen a bunch of margin pressure, but commercial security continues to impress and was up sequentially on down sequential revenues. As you are mentioning continued pressure there from non-res, does that even impact the margin, given how you guys have been executing there or can you hold 21, 22 at security?

I think we can and we're seeing great progress with the new launches, the Schlage AD lock would be an example of a second lock we highlighted on this call that was launched as well today. So the electronic portfolio continues to grow with higher margins in the balance and the shift proactively has been around those product lines, including credential and reader type technologies. So that business very quietly has continued to evolve. It is product mix from mechanical to electronic and in doing that actually increased the margins on the new portfolio, so you are seeing growth in that area of the business at higher margins.

Okay. Great. Thanks, guys. Okay.

Well, thank you, everyone, and Joe and I will be around to take your calls if you have questions during the day. Thank you.

That concludes today's conference call. Thank you for your participation.