特靈科技 (TT) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to the Ingersoll Rand third-quarter 2011 earnings call. Today's conference is being recorded. At this time I would like to turn the conference over to Janet Pfeffer. Please go ahead.

Thank you, Robert. Good morning, welcome to our third-quarter 2011 conference call.

We released earnings at 7 a.m. this morning and the release is posted on our website. We will be broadcasting, in addition to this call, through our website at IngersollRand.com where you will find the slide presentation that we will be using this morning.

If you would, please go to slide two. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions 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 results to vary from anticipated.

In addition please refer -- but now I would like to introduce the participants on today'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 please go to slide three and I will turn it over to Mike.

Thanks, Janet. Good morning and thanks to all of you for joining us on today's call. During the call today I will discuss our third-quarter results, as well as discussed the recalibration of our guidance, as we continue to manage against the very real headwinds of this economy. Steve will dive deeper into some of the quarterly results as well.

In the third quarter we delivered revenue growth of 5% and 7%, excluding the Hussmann refrigeration business that we sold on September 30. Third-quarter earnings from continuing operations were $0.81 per share. That is the $0.04 above our revised mid-point guidance range.

The sectors were essentially on our revised forecast and the positive variance above the revised range was principally from lower corporate costs and positive foreign exchange gains.

End market activity was mixed across the business. During the quarter we continued to see strong bookings in industrial air and productivity. We had healthy bookings in commercial HVAC, although we did start to see equipment orders in Europe and North America temper toward the end of the quarter.

Transport demand moderated in the quarter. Global Security orders in the quarter were up 4% led by strong bookings in Asia. However, North American Security orders were flat as the commercial construction recovery, which was expected originally to be in the back half of 2011, has clearly pushed out, especially for our key institutional markets. Residential orders impacted by a stagnant US housing market and lack of consumer demand for our 410A replacement systems were down year over year.

For the Company orders were up 4% and 3%, excluding currency. Hussmann orders were down versus last year and depressed total order growth by almost 2 points.

Operating margin for the quarter was 11.3%, that is up 30 basis points. The improvement was significantly below the margin improvements we have achieved in the past several quarters and look to achieve in the future. Although margins improved from pricing and productivity, they were depressed by a year-over-year decline in revenues and residential HVAC, Club Car, and Hussmann, and further by a diverse mix in residential HVAC and commercial security.

We continue to realize price across all businesses. In the third quarter our pricing outpaced [direct to] inflation for the second consecutive quarter.

On September 30, as expected, we closed on sale of a majority stake in Hussmann to CD&R for gross proceeds of $370 million. The proceeds are being used towards our share repurchase program and available cash flow is expected to be about $1 billion for the year.

We continued our share repurchase program and have repurchased over 17 million shares(Sic-see presentation slides) as of September 30 and about 22 million shares as of yesterday. Revenue and profitability performance in residential HVAC had a significant impact on the quarter. I want to take a few minutes to update you on the market and our actions to address our market position and profitability.

The R-22 dry-shipped loophole continues to have a significant impact on the residential HVAC industry. As a result of the loophole, R-22 units made up 25% of the market's outdoor units shipped in the quarter. 410A demand softened significantly in the third quarter.

Industry motor-bearing unit 410A shipments were down over 15% in the quarter versus the prior year. Based on our discussions with the EPA, we believe the loophole will likely stay in place through 2012 and, therefore, we began producing R-22 units in mid-August. We were able to quickly bring production to the needed run rate. Given the timing of the season, however, R-22 shipments will have a minimal impact on our revenue until we are through next year's cooling season.

The impact on our business was further exacerbated by the continued downward mix shift by consumers to lower SEER, lower cost, less featured systems. The Trane business model has traditionally been built around providing premium products, customer support, and efficiency levels. We believe this is a medium- to long-term shift in consumer behavior and are making the necessary adjustments to adapt our products and business model to this trend.

Given lower 410A volumes, we made a conscious decision to bring down 410A inventory levels by more than 20 days by year-end through reducing build rates in the factories, which resulted in unabsorbed costs impacting margins in the third quarter, and this will continue in the fourth quarter. We have been executing to our operational plans on the new residential projects as outlined in July.

All production lines are able to run at rate. The material cost production plan is going as scheduled, which means we will be through about 80% of the parts by year-end.

Now let me turn it over to Steve for a discussion of each of the businesses.

Thanks, Mike. Please go to slide number four. This slide gives a summary of our quarterly order rates for the past seven quarters.

Orders for the third quarter 2011 were up 4% overall and 2% excluding currency. We had strong bookings growth in industrial at 16% and a solid increase of bookings in the commercial HVAC equipment and services.

Climate orders were up 3% on a reported basis and 6%, excluding Hussmann, as transport orders slowed in the latter part of the quarter, particularly in Marine. Residential orders declined 8% in the quarter and commercial security orders were up 4%.

Please go to slide number five. Here is a look at the revenue trends by segment.

We think revenues, excluding currency, shown on the bottom chart give a better view of our organic growth. As you can see on the bottom chart, third-quarter revenues were up 3% excluding currency. Industrial had a strong quarter of growth at 9%, Climate also had 8% growth when excluding Hussmann, Residential was down 12%, and commercial Security revenues were up 4%.

On a geographic basis, revenues were down 1% in the US and up 10% in the international markets.

Please go to slide number six. This bridge analyzes the change in third-quarter segment operating margin year over year. Third-quarter operating margins were 11.3%, an increase of 30 basis points compared with 2010. Volume mix and foreign exchange reduced margins by about 120 basis points.

Volumes were about flat in aggregate with growth in Climate and air and productivity offset by volume declines in Residential and Club Car. Almost half of our total revenue growth was from FX, which closed through at a lower margin and depresses leverage somewhat. The remainder of the margin impact is from an adverse mix in Residential and Security.

Price netted against direct material inflation was positive in the quarter at about 60 basis points as price increases continued to hold. Productivity negative against other inflation increased margins by 150 basis points. Margins were negatively impacted by the productivity shortfall in Residential.

Investment spending, focused mainly on new product development and growth of our service businesses, was higher than last year, impacting margins by 60 basis points.

Please go to slide number seven. The Climate Solutions segment includes the Trane commercial HVAC and Thermo King transport refrigeration businesses, and through September 30, included the Hussmann retail refrigeration business.

Total revenues for the third quarter of $2.3 billion were up 8% and 5% excluding currency. For the Trane and Thermo King businesses revenues were up 11%. Trane's global commercial HVAC third-quarter revenues were up 9% versus prior year. HVAC revenues in North America increased high-single digits. Revenues in other regions were up 13%.

Global commercial equipment revenues increased 15% with year-over-year improvements in all regions. Global parts, services, and solutions revenue increased by 2%. Global commercial HVAC orders were up 9% with 7% growth in global equipment and double-digit order growth in parts, services, and solutions.

For the global Thermo King transport business revenues increased almost 20%. Our worldwide refrigerated truck and trailer revenues were up over 20% with strength in North America and Europe. Global APU, marine container, and aftermarket revenue showed strong growth in the quarter. Thermo King orders were flat in the third quarter as increases in APU and truck trailer were offset by a significant decline in marine bookings.

The operating margin for Climate Solutions was 11.5% in the quarter, a 110 basis point improvement versus third quarter 2010, driven by pricing, volume gains, and productivity, partially offset by higher commodity costs. Excluding Hussmann, Climate's margins improved by 150 basis points in the quarter.

Please go to slide number eight. Industrial Technologies' third-quarter revenues were $697 million, up 12% on a reported basis and 9% excluding FX. Industrial markets continued to be strong in all regions. Air and Productivity revenues increased 17% versus last year. Air and Productivity orders were up 16% with strong improvements in all regions.

Club Car revenues were down more than 10% in the quarter from weak markets in both golf and utility vehicles. Industrial's operating margin of 13.8% was up 1.1 percentage points compared with last year from higher revenues, pricing, and productivity, partially offset by lower Club Car volume and inflation.

Please go to slide number nine. In the Residential Solutions sector, which includes Trane and American Standard HVAC product lines and the Schlage security residential business, third-quarter revenues of $507 million(Sic-see presentation slides) were down 12% compared with last year on both a reported basis and excluding foreign exchange. Bookings were down 8%.

Revenues for the Residential Security portion of the sector were flat with slight increases in the new builder channel offset by a decline in big box customer volumes. Our residential HVAC revenues were down 15% as the continued sluggish housing market resulted in very soft replacement and new builder markets, as Mike discussed earlier. Sector operating margins of 3.8% were down 6.2 percentage points compared with 2010 as improved pricing was more than offset by lower volume, adverse mix, and inflation.

Please go to slide number 10. Revenues for Security Technologies where $438 million, up 7%, and up 4% excluding currency. America's revenues are up slightly from price improvements. Revenues in our European Security business were up on a reported business basis, but flat excluding currency. Asia revenues increased over 50%.

Global bookings are up 4%. Americas and European orders were flat. Asia orders were particularly strong as several large projects were booked in the quarter. Operating margin for the quarter was 20.2%, down 1.9 percentage points from last year, as productivity and price realization was offset by geographic mix and material inflation.

Please go to slide number 11. We continued to advance our Operational Excellence initiative which is our long-term approach to a lean transformation in the Company. This is a multi-pronged effort to reduce costs and improve efficiency and customer satisfaction throughout the Company.

We continued to restructure and decrease the size of our manufacturing footprint in 2011. To date, we have restructured or divested 22 manufacturing facilities and reduced square footage by over 30%. Direct material makes up about 40% of our cost base and progress continues in our direct material cost reduction programs. We are centralizing management of spend and consolidating our vendor base to better leverage our strategic sourcing resources.

We are also reducing costs and improving quality through value engineering activities in all of our businesses. Climate Solutions war on copper is an example of the progress we are making. This effort represents over 100 individual projects that will reduce copper usage by almost 12%, a 7 million pound annual run rate savings.

Year-to-date we have held over 135 rapid improvement events or RIEs. The RIEs are focused on making meaningful improvements to processes and activities within our 19 selected value streams. Each RIE involves four weeks of planning effort, a 4.5-day event involving shop floor changes, and four weeks of follow-up to ensure process sustainment.

We have had some notable gains during the year. For example, in the value streams we have had a 25% reduction on average in cycle time and a 48% reduction in the cost of poor quality year-to-date. We are starting to see a clear separation between the results of the value streams and the average company performance. We are planning to stay focused around these initial 19 value streams to ensure that the improvements are sustainable before expanding our efforts.

But this doesn't all happen in the supply chain. We are embarking on a long-term program to reduce our functional costs in IT, finance, HR, and legal that currently total over 5% of our revenues. For the next three to four years we will be reducing our functional costs to move toward top quartile metrics of approximately 3% of revenues. These activities will be anchored by implementing common systems and processes across the enterprise, including a common ERP platform.

Please go to slide number 12. Let's move to the balance sheet. We finished the third quarter with working capital at 3.7% of revenues, down from 5% at the end of the first quarter. We expect to maintain working cap sales in the 3% to 4% percentage point range on a full-year basis.

Please go to slide number 13. Our balance sheet remains in good shape and in the quarter we continued buying shares under our share repurchase program. We ended the quarter with $1.4 billion of cash on the balance sheet and net debt of $2.2 billion. We purchased 16 million shares by the end of the quarter and anticipate purchasing in excess of 35 million shares by year-end.

We generated $360 million of cash flow in the third quarter. We are targeting available cash flow of $1 billion for the year. With that I will turn it back over to Mike.

Thanks, Steve. With that let's go to slide 14. I wanted to touch on our innovation performance before moving to the forecast.

We have steadily improved the flow of new products and services to the market. About 13% of our 2008 revenues were generated from new products and services introduced in the last three years. Our initial target for 2011 was 19% of revenues, which we are forecasting to exceed by a few points, ending the year at almost 22% of revenues.

Pictured are a few of the new products and services we launched in the third quarter; I will highlight just two of them. Thermo King launched the ColdCube, which is a new portable refrigeration unit designed for entry level for small business customers, such as caterers and florists, for whom it isn't practical to invest in a large, temperature-controlled delivery truck. Feedback has been extremely positive.

In Security Technologies we continue to realize strong gains in the healthcare market, particularly in the Europe and Middle East region. Leveraging solutions customized for the healthcare industry our Security Technologies team recently landed two significant wins valued at $7 million.

Please go to slide 15. Updated revenue forecast for 2011 is based on varied levels of activity in our key end-markets. We believe the activity levels indicate continued strength in industrial markets.

Commercial HVAC equipment has remained strong in emerging markets. The North American market, still driven mainly by replacement, is growing but at a slower pace than we have seen in the past few quarters. Transport markets, known for being very cautious, appear to be moderating and we expect to see low teens revenue growth in the fourth quarter.

We expect to see a continuation of challenging conditions in the US non-residential new construction market for the remainder of the year. We also see a continuation of depressed conditions in residential markets as single-family housing starts and consumer confidence remain at very low levels.

So based on this backdrop our revenue range for full-year 2011 is $14.85 billion to $14.95 billion, up 5% to 6% compared with 2010 reported revenues of $14.1 billion. Excluding Hussmann from the comparison in order to give a view on the outgoing businesses, revenues would be up 8% to 9% versus 2010. This compares to the preliminary revenue guidance range issued on September 30 of $14.85 billion to $15 billion.

Climate Solutions revenue are expected to be up 11% to 12%, excluding Hussmann. Based on continued strong bookings in industrial markets but a slowing golf market, we expect industrial to show gains of 14% to 15%.

We are lowering our residential revenue forecast based on the negative impact of the continued growth of R-22 units and continued downward mix shift to lower SEER products. Now expecting the sector's revenue to be down 3% to 4%. Commercial security is expected to show a 3% to 4% year-over-year improvement in revenue.

Let's go to slide 16, and now we will turn our attention to full-year guidance. You will notice this is a change from three weeks ago.

Our full-year EPS guidance range is now $2.70 to $2.76 based on what we learned over the last three weeks about our September and October bookings, which were light, particularly in the European and North American Climate Solutions businesses. We believe it's prudent to flag this as a risk and reflect its impact on our Q4 earnings guidance.

For instance, our preliminary guidance issued on September 30 of $2.70 to $2.80 -- this reflects the earnings impact of taking the top end of the range down by $50 million. This EPS guidance reflects an average share count of 340 million shares and a tax rate of 24%.

We expect to generate available cash flow of about $1 billion, which excludes proceeds from Hussmann. Fourth-quarter revenues are forecast to be $3.525 billion to $3.625 billion, down 2% to 5% on a reported basis. And recall that beginning in the fourth quarter the revenue from the divested Hussmann business goes to zero as its results will be reported in other income.

Revenues on a comparable basis, excluding Hussmann, are forecast up 2% to 5%. Reported EPS from continuing operations for the fourth quarter are projected to be approximately $0.64 to $0.70.

Let me take a moment now and share with you the way we are dealing with an economy that continues to produce strong headwinds and for some of our businesses has not yet resulted in the kinds of tailwinds we had hoped for. It's clear, given the economic backdrop coupled with the challenges we are facing in the residential business, it's time to recalibrate our long-term earnings targets. In particular, our targets that we have set for 2013 are out of reach in that timeframe.

We continue to believe in the fundamentals of our business. We have adjusted our expectations to account for the economy. Despite the adjustment in time frames, we will continue to execute on our strategic goals.

While looked at our assumptions for the initial targets and reflected on what has changed in those two years, it feels essential that we make these adjustments. To be more specific, we have not seen a residential or non-residential construction recovery in the US or Europe. Commodity inflation has been higher, refrigeration phase out in residential HVAC has essentially been reversed by loopholes in regulation, and these are just to name a few.

We have seen choppiness across several of our various end markets, and while we don't see a sustained across-the-board decline in activity, we do expect the variability in demand trends to continue for the short and medium term. Some businesses will have strong growth, while others may be more sluggish. Where we are seeing a downward shift in demand patterns, we are triggering those plans to react to the changing volumes.

It's disappointing not to reach targets on the original timeline. I knew when we established our framework that progress would be uneven given the starting point and the aggressive targets that we set, but I continue to believe that long term this company can meet those goals. I hold myself and our leadership team accountable for succeeding.

My confidence is based on the accomplishments and commitment of our employees over the past 2.5 years. We have had a number of quarters in which we achieved 200-plus basis points of margin improvement as an enterprise. Two sectors will achieve 200-plus basis points of improvement again this year.

We significantly advanced our pricing capability. New products and services continued to fill the innovation pipeline. We divested several non-core underperforming businesses. Productivity progress has been real, the cash story has been great, and we will enter year with a significantly reduced share count.

Our goals inside the Company are unchanged -- to increase margins, drive innovation, and pricing excellence, and generate significant cash flow for reinvestment in share buyback and dividends. What this means is that we will continue our lean transformation, engagement of people, and investment in innovation.

With that Steve and I will be happy to take your questions.

(Operator Instructions) Steve Winoker, Sanford Bernstein.

Good morning. Maybe I could just start then on the last point around that long-term guidance that you are describing. So what are you thinking then in terms of how much further you are pushing that out? What kind of adjustments have you made internally so that -- where our people headed? How are you thinking about the -- a little more specificity on that front?

Steve, we have made great progress in 2.5 years. It's just clear we had to reassess where we were and particularly taking guidance down for the quarter and for the year. And the fact that we are just not seeing that recovery take place as we had hoped in 2011 late and certainly no res recovery that it's out of any timeframe that we indicated with the framework.

What I am not going to do is issue any new framework. I think that what I would like to do is just sort of year-over-year tell you through guidance what we expect to do in terms of performance of the Company. I think that structurally and ultimately we will get to where we wanted to go.

I am not going to predict a timeline, because I just can't predict which way this economy is going to go or at what pace it's going to recover in the areas that we need it to recover. But you can expect that we are going to focus on significant improvement across the Company, give you good guidance, transparency around what we are telling you, and take it one year, one quarter at a time.

Okay, I can understand that. Let me move to then a little bit more in the quarter. The productivity number, productivity net of inflation, if you excluded Residential Solutions, instead of 150 basis points for the whole company, what might that have looked like? And is Hussmann in there also?

Yes, it's all in, Steve. Gosh, it would definitely have been higher.

Right. I am just trying to get a sense of -- it sounds like a lot of progress, at least in climate and industrial so (multiple speakers).

Steve, I tell you Climate continues to do very well and to increase. I think they were 150 basis points in the quarter when you pull Hussmann out. Industrial continues to do the same and gain significant leverage.

We hold the security team to a different set of goals and objectives. Here we are really looking to grow this business and really asking that team to maintain -- incrementally grow the margins based on volumes and depending where those volumes are. But a different expectation for the Security business.

In the Res business clearly that has eroded our ability to hold to the original guidance that we had for the year. But I will tell you in the last two, three months as you interact with that team, as you talk through the business and their approach to dealing with what they have got in front of them, I think they understand the issues very well. I think they have got a plan for what they need to do and how to execute, and I think they have got a management cadence to keep on top of performance.

So you got two sectors doing very well. You have got Security, which we are asking really to grow and kind of hang on to those excellent margins that they have. We have got all the known issues in Residential that we have talked about through the past quarter till now.

Can you describe that residential turnaround? Is that how you are positioning an internally, or is this -- are you saying this is more the market doing this to you or is it a set of actions that you have going on inside of Residential right now? What is the environment like? What is the set of initiatives or key two or three things that we should be think about as investors? Are you going to turn this ship around short of the residential market tailwinds coming back?

Steve, in quarter two, if you reflect back, I explained that I thought you could sort of break the performance down in two 50% chunks. The first was really market and mix and the second had to do with two issues pretty well evenly split -- one was R-22 not being in the market, second was issues with new product launches.

And we had two tests, if you will, in Q3, internal execution tests around the business. One was how quickly can we get into the R-22 business, increase production -- create production, and meet demand in the marketplace. We had set a very aggressive goal to do that very quickly. I will tell you that we exceeded that goal inside the Company and that is a testament to that team's tenacity around winning.

The second piece of that outline is saying that it's a monthly view toward actual purchase price reductions on each material component with the product launches that took place at the beginning of the year, and that each month we have got the capability of tracking that and understanding if we are on or off performance. We maintained ourselves to be on plan with performance that matched that plan through the quarter, and I have no reason to believe that anything is going to fall off track. We will get to the end-of-year plan in that business.

And that is going to leave us really with market and mix. Here the focus has been to aggressively look at the 13 and 14 SEER product and make sure that we have got a cost position in those products that is second to none. We know we will get a premium for those products, but to really make sure the cost position is exactly right.

So we are focused heavily on the reality that 75% of the business will be 13 SEER. And if you include 14 in that it's going to be 80%, 85% of the market will be at that low-end efficiency. I think that that is going to be here for a while and we have got to get competitive in that part of the market to make a difference.

So as we entered back into the market, if you will, for R-22 in the quarter we have got about three-quarters of our due share back in that segment pretty immediately. If you think about that that is remarkable when you have got to build it, fill the channel, and give the dealer base the opportunity to quote that. It was a pretty remarkable turnaround.

I would expect that as we enter into next year we are going to be armed -- not have one arm behind our back. We will have a complete complement of R-22 cost competitive products, a complete complement of effective R-410A product, and based on customer demand we are going to adapt demand plan as we see it evolve.

David Raso, ISI Group.

Good morning. I think it was Steve, you mentioned September and October the order weakness in Climate Solutions was the bigger driver of the delta from three weeks ago. Can you detail that a little bit more? Thermo King, HVAC, you mentioned geographically Europe in particular, but can you please breakout Thermo King from HVAC?

Yes, Dave, the big swing was we saw a remarkable -- in a very short period of time in late September, a big swing between what was going on in bookings in the first part of the quarter versus the second part. And it affected European Trane commercial to a degree.

I would say that the transport markets in North America flattened. It wasn't dropping off of a cliff but it certainly flattened relative to previous growth rates that we have seen. We still have seen pretty good bookings in the truck-trailer piece of it. The piece that probably went the furthest south was bookings in the marine business, and that was expectations of several large orders coming in that we just don't see coming in at this point in time.

Okay. I am just trying to get a feel for the interplay on Thermo King margins globally are higher than the HVAC, but it sounds like it's a little bit across currents of both. HVAC Europe, North America truck flattening out is obviously not positive for margins, but --

Dave, I think the big theme actually was Europe, just in general Western Europe. For a while there was a disparity, really almost a divergence, between order rates and customer sentiment. And I think what you have got really in Europe more is more convergence around those two.

You see it in the buildings business where both the Security European business and the TCS business, we are actually down in bookings on the quarter slightly negative, but it's a trend. And you had transport dip a bit as well negative. I think what you will see in Q4 will be more of a continuation of the trend around the buildings theme and more of a moderation around the TK business, as opposed to any kind of negative year-over-year, quarter-over-quarter results.

I think, Dave, to be clear, the US order rates have flattened. Truck-trailer is still -- it has definitely slowed but truck-trailer was still slightly positive in the quarter.

The issue for Europe, because we count the marine business of Thermo King in Europe, the down orders we saw in Europe for TK were really driven by Marine. As you know, marine doesn't leverage as well within Thermo King as truck and trailer for us so that is kind of the thumbnail sketch there.

Yes, that is what I am looking for. Just given that ex-currency total company orders were up only 2% for the quarter and your revenue guidance for the fourth quarter for the Company implied revenues year over year are down slightly to up 2.5%.

I am just trying to get a feel for if we did see a little more slippage in the revenue for the quarter is it coming from those businesses that particularly that have high downside leverage so to speak? And it sounds like it's a little bit of a mix [really it is not].

I would say that if you look at what we took off the top of the range it would be -- some stuff would be producing a little higher margin.

Okay. And lastly, for the long-term targets, obviously Residential the target of 15% to 17% on the margin, given we are mid-single digit and lower right now, it's probably one of the numbers that came down the most. But when I think about the adverse mix, and maybe correct me on that, but I am assuming the incremental R-22 shift and away from the 410A is a negative for your margins. I think that is a safe assumption, correct me if I am wrong.

How should I think about margins in residential next year and kind of in the context of that 2013 15% to 17% number? Is that where you would kind of cut that margin in half? The mix can't be a positive, I would think.

David, actually for the industry the change between R-22 and 410A is fairly dramatic I think in the industry in terms of the margins. 410A just had more of a systems component. Well, it's completely a systems sale and so in terms of driving revenue and absorption in effect within plants, it's certainly a more profitable proposition for the entire industry.

We saw 13 SEER itself, so I am talking about the most minimum 13 SEER efficiency. Not saying 13 or 14, but 13 alone went from about 65% of the market in the first quarter; grew about 10 points to about 75%, 76% in the third quarter. So again you see this shift down to 13 SEER.

Then within that you could make that in 410A or you could make that in R-22, and you really saw a doubling of the R-22 mix over that same Q1 and Q3 period. I think that what will happen here, and I don't think it will happen in 2012, is ultimately two things will happen. One is you will see minimum SEER requirements increase; you will see that at the end of 2012 . 2013 will be -- parts of the country will be up to a 14 SEER unit.

I think you will also see the EPA at some point in time working to close all or part of that loophole, and that will be an impetus for us and for the industry at large. So short of that it's going to be really self-made help in terms of being able to drive down the cost structure of the 13 or 14 SEER product and just really assess how it is we can become more competitive in that new reality.

Julian Mitchell, Credit Suisse.

Thanks a lot. I had a question I guess on the -- when you were talking about re-evaluating sort of targets and costs and stuff. Until recently it sounded like your manufacturing footprint efforts you felt were sort of drawing to a close -- you took down square footage 32% -- and the focus is switching a lot to the functional cost program where you talked about 200 points plus of margin benefit over time from that.

I guess, given what is going on in order intake given the moderating outlook on volumes, how do you feel about the footprint today? When you talk about measures have been triggered by the softer sales environment, does that mean a renewed emphasis on attacking manufacturing footprint simultaneously with the functional cost approach?

Well, you kind of gave two thoughts here around how we are attacking. There is really three. One has been the structural cost, the footprint of the business and I think you are right to say that that has largely run its course. We will continue to always look at capacity and move that and adapt that as we need to, but that is not really the story going forward.

You mentioned the functional cost area, that is something that we kicked off earlier in the year and we will be working aggressively on that over the next few years. But in the middle of that there is the real opportunity around what we are doing with the whole sourcing team, separating materials planning from sourcing and centralizing that sourcing with commodity teams. Where we have done that we have got great benefit; we want to do that faster and build capability in that area.

Then second from that on the labor component, on the value-stream work we are doing around the lean transformation, it's probably the most exciting long-term thing that we could be doing because it really affects the customer in a positive way. It's an opportunity not only to reduce costs, if you will, but really ultimately it's to provide better operating leverage and, hopefully, take some share through better operating performance.

And so to me it's that middle part that I think has got the longest legs to it. It's one of the hardest things to do because it's a long-term evolution of how we want to run the operational part of the Company and that takes a bit of time.

Thanks. Then I guess if you think about sort of the different businesses, the leverage, the incremental, the decremental, obviously they decremental that you had had was a lot bigger, I guess, than the incrementals in Climate and Industrials. So how are you -- when you are thinking about sort of going forwards, how are you -- aside from, I guess, the value stream, how are you thinking about closing that gap?

Is your view that in the decremental margins it's really a mix affect that will normalize by itself and then you have some self-help on your own side? What are you doing to make sure that that sort of steep decremental that you had in Q3 doesn't replicate itself? Because you had a residential decremental of 50% or something.

How do you make sure that if in the other businesses you get a softer top line the detrimental is nowhere near that bad?

Two things. First of all, Climate and Industrial incrementals were pretty good for us. Then if you look at security it's much, much more of a geographic mix. It's driving up really the growth in the Asian business. Here you saw us at 55% type growth rates in Asia for the quarter, and that is what we want to be doing there so that really is still solid performance within the Security team.

It really puts the focus back on the residential business and why the large decrementals in the quarter and what does that mean for quarter four. In my comments earlier, I talked about taking 20 days of inventory and out of that business, and really talked about taking 20 days of the R-410A product out of the business. And when you do that, it is worth something like $80 million, $85 million in inventory and probably something like $20 million, $25 million of lost absorption that we would see in the fourth quarter.

So what we're trying to really do here is make sure that -- and you're seeing these decrementals as we really take down both demand rates and inventory levels in that product line and, if you will, getting the organization in shape for the next season, which is really the next I would say litmus test around our capability and how that has changed from year to year. It will be next July as we are talking to you about how quarter two went for us.

So you will continue to see those large decrementals of residential as we adjust mainly at the inventory level going forward. Now in industrial, in climate, we are going to moderate somewhat in industrial over time. On climate, we flagged some weakness in Europe and in North America here. And this has been the most active team that we have had around setting up scenarios and setting up a play book around reducing over time, and they have been doing that for the last couple of quarters, parts of their cost structure to adapt to that.

So I feel good about the playbook and climate to adapt. I feel good about the playbook in industrial to adapt as well. And with res, we are just going to have to get through this quarter two, quarter three and next quarter in getting ourselves kind of back into fighting shape.

Okay. Thanks a lot.

Nigel Coe, Morgan Stanley.

Thanks, good morning. I don't want to hop on too much about (inaudible) targets, but if you go back to March 2010, I think you put out a $4 number with zero volume growth. Do you still think that is achievable? Assuming we get no volume help in the next two years, is $4 still a good number?

That goes back to the original framework. And if you look at that framework, it wasn't just the growth but it was where that growth was going to occur. And if it occurred in places where we were typically laden with business in North America, Western Europe, that had a different effect on the ability to grow the markets of the Company than it would be in emerging markets or developing markets for us. So it's not just the growth rate but it is also that aspect of it.

You are also seeing that I think in more businesses than res a tendency for the consumer or the customer to move more toward value offerings. And we are seeing that in our industrial business as we have watched our value brand for air compressors grow dramatically over this period of time, and that will continue as well.

So I really can't talk about that framework and kind of relate that back to what the margin potential would be in sort of a zero growth rate. We are working on right now a plan and a set of scenarios for 2012, and the intent would be next quarter lay that out for you in a way that I think looks at the reality of what we have got in the marketplace. And that is the intention going forward.

Okay. So you are not yet at a stage where you can give some feel for the benefit from just pure manufacturing and functional rationalization?

That is the point where we want to begin to talk about that, that is right.

Okay. And then on the resi margins is there any way you could, perhaps, give a walk, similar to what you did for the overall company, in terms of impact volume, price, and productivity? Because -- I guess my key question here is did you cut price or did you still get price as you struggled to maintain market share given the R-22 headwinds?

We actually realized price of nearly 6% in the quarter in res, so it was 5.9% to be exact, against a material number which was kind of in the 4% range. The biggest driver there is 7.5 points of degradation in margin with volume and mix.

Okay. And then just finally, I might have missed it, but what is the impact of margin in resi as you book through those inventory, the excess inventory?

I think we said about $20 million to $25 million and the bulk of that is going to be in the fourth quarter, Nigel.

Okay. And that is the margin impact?

Yes, of the inventory reduction impacting absorption.

Okay, thanks.

Nigel, clearly the industry itself is forecasting something in the neighborhood of down 7% for the industry. I think we are going to do a bit worse than that in the fourth quarter; a couple of reasons. One is just getting our cost structure in line for the 13, 14 SEER products that are being sold into the marketplace, so I don't expect to be a share taker in that process in the fourth quarter.

And so you really run into a fourth quarter that between the volume drop, sort of the industry drop, the mix that we are seeing you are looking at something that could be in the 1% operating margin range for the quarter. Although that is going to be an awfully low number, it would not alarm us relative to what we see and the plans that we are trying to do to improve the business.

Steve Tusa, JPMorgan.

I just wanted to ask a little bit more of a theoretical question, because clearly with your stock performance there is kind of a credibility issue that has developed air. Which for a new CEO who has a lot of promise and has been doing a lot of good things internally, I think is a very frustrating for investors.

Kind of starts with what happened in August when you guys are selling Hussmann and you had the conference call. I just am curious as to through this last couple of months of events, whether it's the Hussmann conference call, what happened on the second-quarter call following up with the Hussmann call where there was comments around some softening in key end markets, and then obviously the preannouncement on the last day of the third quarter.

What was your mindset? I am just curious as to whether it's a communication issue. Do you understand investors' frustration with kind of the way this has all happened? I hope that you are viewing this as kind of a potential kitchen sink event where you can kind of bottom out on a credibility basis and move forward.

I just want to kind of get your take on how you see this playing out from an investors' perspective.

Well, a couple things, Steve. One is if you look at sort of the operating performance of the Company over the last couple of years it has been really a good story around -- if you take the stock price out for a second, you can clearly see that there has been a lot of improvement around the areas that we have been focusing on around margin expansion and the degree of innovation coming into the business. At the end of the day, we feel good about that.

We have tried to be very transparent in what we are doing. I even go back to thinking about I guess the June or July timeframe, indicating at one of the conferences that I am picking up vibes that even the long-haul truckers are feeling that there is anxiety in terms of what they see going forward. That there is a nervousness in that group as well and how that might portend for something that we are seeing now, which is really a flattening of and a moderating of that business. So we are trying to communicate that.

I think that what we are trying to do here is really sort of shed this framework, if you will, because there has been very little to that framework that has materialized economically. Frankly, what has happened to me in the last couple of weeks, really three weeks even, is just sort of watching what is transpiring in Europe for us and then trying to communicate through to you now that I think I need to take the top of that range away.

Unfortunately, mathematically it means that the median goes -- if the middle goes down the average goes down, but what I am really trying to communicate to you is I think that the problems in Europe are a bit more serious and I think it's beginning to show in that convergence between sentiment and the order rate. And so again I hope you will take what we are trying to do here around producing the fourth quarter as an understanding that we are trying to tell you what we are seeing and lay out guidance that we are seeing at that point in time.

But I guess you are -- back to Nigel's point on the guidance for no growth and no share count reduction, which is kind of -- the share count reduction has happened. I just hear you blaming it on the economy and there doesn't seem to be any kind of mea culpa here at all. Again, I don't mean to kind of rake you through the coals, but I think it is a -- for a new CEO, who is trying to do big things, I think it's something that needs to be addressed over time.

And I think you need to be a somewhat aware of the investor frustration around that, because everybody is dealing with a tough economy. The R-22 thing was -- quite frankly, it looks like it was just missed and it's just mis-execution on that front. So I am just struggling with drawing a straight line from the economy to what is going on here. That is all.

Steve, appreciate the comments. I can tell you I am talking to our shareholders directly on a constant basis. I will continue to do that and taking that feedback and trying to adapt any communication issues going forward here.

Clearly, we don't want that to be your feeling and we will look to go forward and try to improve on that. The flip side of that, Steve, I don't think that the organization can apologize for great performance over the last couple of years. What I got to tell you here is I just don't see the moon and the stars lining up for us to be able to hit that original framework.

And what I am trying to tell you today is -- if the mea culpa is anywhere it's, look, we are not going to be able to achieve that framework in the timeframe that I outlined and I am telling you that today.

Right. Well, good luck. Thanks.

Josh Pokrzywinski, MKM Partners.

Good morning, guys. Just want to dig in, not to belabor the point on Residential, but shifting into the fourth quarter, obviously air conditioning and R-22 kind of moves to the sidelines as a driver. Are we just looking at tough furnace comps piling on top of the manufacturing variance to take down inventory?

I guess I am just struggling with your comment that the industry expects to be down 7% and you expect to underperform that. It seems like kind of the areas of logical underperformance with the share in R-22 kind of moved to the sidelines. I just want to make sure I am not missing anything.

I think Josh perhaps maybe it won't be as bad as that. We have really committed though. We have got a lot of momentum here in the pricing area and so I think that our price realization has been relatively high in the industry, and perhaps that has got something to do with that. I don't want to be a leader in and take the prices down across the industry. But, no, we are not forecasting anything horribly bad in terms of the furnace season at all.

Okay. And then just shifting over to TK, I would imagine that is one of the tidier businesses in the portfolio at this point; maybe less room for restructuring should things soften further. How should we think of decrementals there should that business turn negative in 2012?

Read into that -- we are not talking about it turning negative in 2012.

Right, I just want to be kind of prepared for the what-if should things soften further, just so there isn't a missed expectation on maybe the margin potential.

Josh, let me deal with that in terms of guidance we give you next quarter. What we will certainly try to do is as we look at the scenarios like that we will be clear about how that would maybe look toward more the bottom of the range or the range we give you. And maybe give you some sensitivity around what would move our guidance up to the top of the range or down to the bottom of the range, but give you some sensitivity around those sorts of things.

Got you. Maybe just remind us -- sorry to sneak one last one in here -- when should we start seeing copper with a [$3] handle or kind of a [mid-$3] handle flow-through the P&L? Should that be kind of a first-quarter dynamic? Because I know there is -- obviously you don't hedge, you kind of hedge through the supply base. How should we think of the timing of lower copper realization?

You are exactly right, it starts in the fourth quarter. Third quarter was a little bit above [$4] and the fourth will be a little bit below [$4].

Josh, I just want to make sure we are clear here. We do hedge copper through our supply base and we have --

Right, that is what I am saying. You hedge it through your supply base not directly.

Right. We have extended that a bit into first and second quarter of next year to try to take advantage of the current spots.

Terry Darling, Goldman Sachs.

Thanks. Mike, Steve, wondering if you might provide a little color on the 4Q margin expectations for the other businesses. I think you have talked about resi around 1% already; talk about some of the others.

That climate I think will continue to perform well. I think you could probably look at that as being somewhere in the 9.5% range, and you could probably vary off that 20, 30 basis points either way. Industrial probably in the 15% to 15.5% area in the quarter for us.

Security, actually relative to last year it will do fairly well. I don't think anything here is going to take that business down, say, below 19% on the low end. Maybe 19.5% on the top, which would be an improvement over last year. We were just a little bit under 18% in the fourth quarter there.

In Resi, I am thinking if we execute fully on the inventory reduction piece of this thing it's likely to be in the 1% range.

Helpful. Then the corporate number, what are you thinking for that? It was substantially below run rate here this quarter. Any one-timers in there and what are you thinking about for 4Q?

I am going to defer to Steve here on that, Terry, but there really weren't any one-timers per se in there. But Steve, I don't know if you have any comments on --

We will see the enterprise somewhere around 10% on the quarter, Terry.

10% of sales you mean?

Yes, 10% of revenue, ex Hussmann.

At the corporate line you are saying or you are saying the total company margin around 10%?

Right, that is the total company performance, right.

Okay. I can follow-up on that. Then, Mike, I am wondering if it's possible to quantify -- if you were to assume that the resi market is flat in 2012 from a units perspective, but you are picking up your fair share, what would that revenue delta, or revenue opportunity if we want to think about it that way, be?

Terry, I tell you, and this is similar to what -- Steve's question, I really don't want to get drawn into that until I have got the facts and I communicate that to you. So I don't want to speculate on that without really going through the work we are doing right now and coming out and telling you what I think it will look like for us.

I think otherwise we would think -- assume the R-22 market continues at 25% of total and you have your normal share, which has been, what, 20% plus or minus there? Is that the parameters we might operate with?

Our share of kind of the 13 SEER market historically was around 10%, 11%. Then as you move up through the various efficiencies it goes up. But, no, we were 10%, 11% at that point in time. Is that your question, Terry?

I was just wondering if I could shift gears and ask you about your view of the Carrier strategic move here to combined Fire & Security with Carrier and what the implications for you might be.

Well, I think from sort of an overall management of the Company, it's a large company unwieldy company with a lot of disparate parts so it makes sense to put your building businesses together. Obviously, didn't put Otis in there, but it makes some sense to put those things together and probably gain more efficiencies in doing that than probably any sort of growth upside.

There really is more of a trend in the market. In fact, we survey constantly on this and we find 97%, 98% of building owners kind of look at what we do as best-in-breed. They will think that way about fire systems, they will think that way about security, around HVAC, control systems, and there is a lot less of a -- there is no momentum around changing that.

Frankly, that particular question has been around for 25 years in the intelligent building world and that mix hasn't changed much. So that is sort of how I feel about it. We keep an eye on that integration aspect of putting businesses together. We occasionally will go-to-market together with HVAC and Security when a customer wants to do that, but it's not as common as one might think.

Jason Feldman, UBS.

Good morning. So you, I think, commented earlier that easing commodity costs could start flowing through in the first quarter. You have had a lot of price increases this year; have you been getting any incremental pushback or risk that some of those get rolled back as commodities have come down?

Well, they are awfully tough to get as you can imagine. We are pretty pleased to see two quarters in a row and we had put a lot of work into, I would say, the systems, the processes, the methodology across the Company to do that. I think the level of sophistication around how we think about price is very different than it was a year, year-and-a-half ago and how we segment pricing for the various customers that we work with.

And so we are going to continue to do that sort of independent of what happens with falling commodity prices. I think that you will see us not leading in those efforts clearly. I think that there is probably a quarter or two where you look at the quote backlog purging through with, hopefully, a little lower commodity costs coming through as well.

And so I think there is an opportunity here, probably to further that the spread, but these things change pretty quickly. We particularly watch that with steel and how steel changes relatively quickly. For us, it's a lot more impactful as to what happens with steel pricing than it does with copper.

Okay, thanks. Also, it's early to talk about next year, I understand that, but two areas. Based on discount rates and asset returns recently, do you have any thoughts about tension headwinds from an earnings perspective and contribution that might be necessary next year? And kind of how you are thinking also, now that you are almost done with the repurchases for this year, how that might play out next year as well?

Yes, we would expect some headwind next year probably in the $35 million to $40 million range increment cost for pension versus this year. The funding will be about the same, somewhere in the $50 million range, which has been consistent with -- I mean we funded the pension significantly in late 2010, so we were able to thwart some of the headwinds that would have been expected this year. But we will be back on a laddering next year of about, like I said, $40 million of cost and about $50 million of funding.

So it's not overbearing. We have done a lot of work in the past few years to shift our investments away from equities and our big funds, and we are continuing to do that. So we are trying to manage that liability that way.

Okay, great. Thank you very much.

Robert McCarthy, Robert W. Baird.

Thanks for taking my question. Actually I am going to ask you two though.

When you talk about the slower order booking activity in the Climate Solutions business, one of the things that I see is the 2% revenue growth in the third quarter and the aftermarket business within commercial HVAC parts, services, and solutions. That was a business that you originally were targeting something like a high single-digit growth rate for the full year. Is this part of the slowdown that you are talking about or is the slowdown that you are talking about focused on the unitary business?

Actually, Robert, it really reverses itself nicely in bookings that we have seen where we will be up light double digits in the fourth quarter. We had a very large couple of contracts, performance contracts, that we executed last year at this time, and we get a little bit of lumpiness here just in comparability between a really good quarter last year and this quarter.

But I would expect that business to be high single-digit sort of overall rates for the end of the year. And I would tell you in the fourth quarter we are trending something north of 10% bookings growth, so I don't think there is anything going on in that business other than a pretty tough comp last year in Q3.

Okay. So to the extent that something has changed or is in the process of changing within Trane commercial, again it's primarily European unitary business that you are identifying?

Well, the European business is going to be applied for us more than unitary, by a long shot. So it's really the applied business there and it would be both unitary and applied in North America moderating.

Okay. The other question I wanted to ask you is a little bit of a technical question, but relates to table seven at the end of your press release where you provide Hussmann results for the first three quarters of this year.

Unless I am mistaken, these are numbers that also include this North American service operations which you had retained. I say that, of course, because the indication had been that restoring Hussmann to the first nine months' numbers would add about $600 million of revenue not the $781.7 million that is shown in this exhibit. Do I have that correct?

Yes, you have it correct, Robert. We had to do it this way because we had to put all of Hussmann back into continuing operations. We tried to give this to everybody so we could reconstruct the history correctly.

Does that mean that the service operations had been taken out previously? I thought they had not.

No, they had not. We just wanted to make sure that everyone understood what the Hussmann impact was in the overall numbers. We can give you an adjustment for the branches to correct that, but we just wanted to make sure everybody understood what the total Hussmann impact was in the numbers.

Okay, we will follow that up off-line. Thank you.

This concludes our Q&A session. I will turn the call back to our moderator for any closing remarks.

Thank you, Robert. Thank you, everyone, for joining today. Joe and I will be available for follow-up today. Thank you.

And this does conclude today's conference call. We thank you for your participation and have a wonderful day.