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Ingersoll-Rand Company Limited (NYSE:IR)

Q4 2008 Earnings Call Transcript

February 11, 2009 10:03 am ET

Executives

Bruce Fisher – VP of Strategy & IR

Herb Henkel – Chairman & CEO

Steve Shawley – SVP & CFO

Analysts

David Raso – Isi Group

Jeff Sprague – Citi Investment Research

Alex Blanton – Ingalls & Snyder

Steve Tusa – J.P. Morgan

Terry Darling – Goldman Sachs

Andrew Obin – Banc of America

Jeff Hammond – KeyBanc Capital Markets

Rob Wertheimer – Morgan Stanley

Eli Lustgarten – Longbow Securities

Robert Mccarthy – Robert W. Baird

Nicole [ph] – Deutsche Bank

Brian Jacoby – Goldman Sachs

Operator

Good day, everyone, and welcome to Ingersoll-Rand fourth quarter 2008 earnings conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like the turn the call over to the Vice President of Strategy and Investor Relations, Mr. Bruce Fisher. Please go ahead, sir.

Bruce Fisher

Thank you, Sean. Good morning, everyone, and as Sean said, welcome to Ingersoll-Rand’s fourth quarter 2008 conference call.

We released earnings at 7:00 AM this morning and the release is posted on our website. I'd like to cover the usual housekeeping items before we begin. This morning, concurrent with our normal phone-in conference call, we are broadcasting the call through our public website. There you will also find a slide presentation for the call. To participate via the web, go to our ingersollrand.com, click on the yellow icon on our homepage. Both the call and the presentation will be archived on our website and will be available tomorrow morning at 10:00 AM.

I would also like to invite everyone to join us this Friday, February 13, for our Analyst and Investor Day. Our Chairman and CEO, Herb Henkel, our CFO, Steve Shawley, and our business leaders, including Mike Lamach, our new President and Chief Operating Officer, will be there to discuss our businesses, our key strategies and programs. The session will begin at 8:00 AM Eastern Standard Time and conclude at approximately 12:00 noon. You can access both the audio and the presentation charts through our website.

Now please go to slide two. Before we begin, I would like to remind everyone that there will be a forward-looking discussion this morning, which is covered by our Safe Harbor statement. Please refer to our December 31, 2007, Form 10-K and third quarter 10-Q for details on factors that may influence results.

Now, I would like to introduce the participants on this morning's call. We have Herb Henkel, our Chairman and CEO, Steve Shawley, our Senior Vice President and CFO, and Joe Fimbianti, our Director of Investor Relations. We will start with a review of our results by Herb and Steve, followed by a question-and-answer period. Herb will start with an overview.

Now, if you would, please go to slide number three.

Herb Henkel

Thank you, Bruce, and good morning, everyone, and thanks to everyone who dialed into this morning's call.

Fourth quarter reported earnings had a significant amount of noise from unusual items, including impairment costs, restructuring and one-time acquisition related costs. Stripping out the effects of these items, EPS from continuing operations was $0.53 per share, which was below our original forecasted range of $0.55 to $0.75. However, it significantly exceeded the revised EPS expectations we gave you in December at $0.20 to $0.30, primarily from better operating performance, lower currency losses, and a lower tax rate. Steve will give you some additional details in his presentation later this morning.

Revenues for the quarter were below our original forecast from October, both the historic Ingersoll-Rand businesses and both parts of Trane. Our margins are also negatively impacted by the lower volumes, unfavorable product mix and currency, which offset productivity and acquisition synergy savings. For the quarter, reported revenues increased by 58% and declined by 11.5% on a pro forma basis, including Trane. The rate of decline substantially exceeded our October forecast that called for flat year over year pro forma revenues. Order intake also slowed substantially and was off about 18% compared with last year on a pro forma basis.

When we saw the slowdown coming in the third quarter, we initiated a $110 million restructuring program that would benefit all of our businesses in 2009. During the second half of the year, we have begun realizing the available cost synergies from the Trane acquisition. We realized about $105 million of savings in calendar 2008, which is about 30 million ahead of our plan. We have significant additional opportunities available and we expect to add between $175 million to $185 million of synergy cost reduction benefits in 2009 and then add on top of that additional growth synergies.

And now, let me turn it over to Steve who will take you through the fourth quarter results in more detail.

Steve Shawley

Thanks Herb. This morning we're going to provide additional pro forma information to supplement the GAAP reporting data so that you can get a clearer view of our performance in the fourth quarter and understand our forecast guidance for 2009. But before we get started, I wanted to cover some of the major unusual items that were in the fourth quarter results. Please go to slide number four.

Three significant items impacted the $10.22 EPS loss from continuing operations that we reported for the quarter. The largest piece was an after-tax impairment charge of $3.4 billion in creating an EPS loss of $10.56 per share. Restructuring costs incurred were $71 million equal to about $0.16 of EPS and one-time acquisition related costs, primarily inventory step up and in process R&D of $25 million or $0.03 per share.

Excluding these items, fourth quarter EPS from continuing operations was $0.53 per share compared to our interim guidance of $0.30 per share. There are a number of schedules attached to the press release that give additional details about these unusual items impacting our operating margin for our four business segments.

Please go to slide number five. Before we review the P&L, I wanted to discuss the impairment charge that we reported in the fourth quarter in more detail. As we previously disclosed, the company performed its annual impairment test on good will and indefinite life intangible assets during the fourth quarter of 2008 as required by US GAAP. The tests were performed at the reporting unit levels to evaluate each unit’s carrying value compared with an estimate of its fair market value. As a result of significant declines in macroeconomic market conditions, there has been a substantial decline in global equity valuations in general and IR’s market capitalization in particular.

Based on the results of our current valuation, we recorded a $3.4 billion after-tax non-cash impairment charge in the fiscal year end results, which largely relates to the conditioning and services business segments. We also have charges for the European operations of security and climate control technology. This impairment charge is a non-cash adjustment, and does not impact our existing debt covenants, or our borrowing capacity under current liquidity agreements.

Please go to slide number six. With that out of the way, let us look at the fourth quarter performance. This slide gives a quick summary of revenue and operating margins for the fourth quarter. As you can see on the upper right, reported revenues were $3.7 billion, up 58%. If we include Trane on a pro forma basis, revenues actually declined by about 11.5% and down 8% excluding the impact of currency. Adjusted for the one-time Trane acquisition and restructuring costs incurred in the quarter, operating margins were 7.5%. These one-time costs, which totaled $94 million, are detailed in the box on the lower left. Please note that this analysis also excludes the impairment charge. I will come back to the topic of margins and operating leverage in greater detail later in my presentation.

Please go to slide number seven. This slide entitled year over year revenue growth provides a look at our segment growth rates, removing the impact of currency. After delivering consistent growth for 2007 and the first-half of 2008, the momentum we have seen in key end markets tailed off in the third quarter. In the fourth quarter, we had a sharp decline in revenues as a result of significant softening in a number of our key end markets. Pro forma fourth quarter revenues were down about 475 million compared with last year and including the negative impact of currency. On a geographic basis, revenues declined by about 14% in North America and about 7% in overseas markets excluding currency. Worldwide recurring revenues were off only by about 1%, while equipment revenues declined by about 15% on a comparable basis with last year.

Please go to slide number eight. This bridge represents the total segment operating margin on a pro forma basis and excludes the impact of impairment, restructuring and one-time acquisition costs. This look is given to better understand the true dynamics of our operating margins at the enterprise level. Fourth-quarter segment operating margins declined to 7.5%, which is off about 1.7 percentage points compared with pro forma 2007. Favorable price realization and productivity improvements, including the greater than expected Trane acquisition synergies, were offset by the unfavorable impact of lower volumes, lingering material inflation and foreign exchange.

Please go to slide number nine. This slide bridges the components of our fourth quarter adjusted EPS and continuing operations of $0.53 to our December 18 revised guidance of $0.20 to $0.30 per share. The results exclude the impact of impairment, restructuring and one-time acquisition costs. The biggest differences between the guidance midpoint of $0.25 and actuals were about $0.11 from operations, $0.11 from lower than projected tax rates, and $0.04 from currency. We also had slightly lower than expected interest expense; added together this comes to $0.53 per share.

Let's now moved to a review of our reporting segments, please go to slide number 10. In order to provide a more meaningful basis of comparison, all of this morning's discussion of sector operating margins will exclude the impact of the impairment charges. Slide 10 lists the highlights for air conditioning systems and services and represents the Trane business that was acquired on June 5, 2008. The results are on a pro forma basis compared with last year.

Fourth-quarter revenues were $1.65 billion, down 9% versus prior year, on a reported basis, and down 7% year over year, excluding the effects of foreign exchange. Our commercial air conditioning revenues, which are the combination of commercial equipment and parts, services and solutions, were down 5% reported and 2% excluding FX.

Total global commercial equipment systems which represent about 55% of our commercial HVAC sales were off 10% in the quarter and 7% excluding FX. The global parts, services and solutions business continues to perform reasonably well, growing 4% in the quarter and 6% excluding FX. This part of our business continues to expand steadily and represents about 45% of our commercial sales. For all of 2008, the service and related category represented 33% of total Trane sales, including residential.

Let's turn to the residential part of our business which represented about 20% of the total Trane revenues in the quarter. We estimate that industry shipments to new residential construction were down in the range of 25% to 30% in the quarter and replacement unit shipments showed a modest decline. For the quarter, our residential product sales were down 26% year over year in line with the market. So to summarize, overall for the quarter, Trane commercial sales declined 5% reported and 2% excluding FX. The declines in all geographic regions for equipment, parts and services revenues were up about 6% excluding FX. Residential sales declined by 26% driven by continued weak housing market.

If you turn to orders and backlog for the fourth quarter, we will find total global commercial orders be off 6% excluding FX. In the Americas, equipment orders declined mid teens, while orders for contracting part service and controls were up slightly. We ended the quarter with global backlog in excess of 900 million, global backlog was down 5% reported and 3% excluding FX. Backlog in the Americas declined over 20%, while international backlog was up over 20%.

To show meaningful comparisons to last year, this number excludes 18 million in one-time acquisition related costs and 32 million of additional ongoing amortization cost and 16 million of restructuring costs. Excluding these items, operating margin was 4.5% compared with 8.4% in 2007. We realized price increases in commercial and we achieved improved growth material productivity in the quarter. However, these actions were not enough to offset inflation, lower volume, and the investments we're continuing to make to grow the business long term.

Please go to slide number 11. Moving to climate control on slide 11, revenues in the fourth quarter where 751 million, down 18% on a reported basis and off 13% excluding currency. The global Thermo King transport business, revenues decreased by about 25%,largely due to weak global truck and trailer markets. Currency translation had a full 5% negative impact on global Thermo King revenues in the fourth quarter.

Worldwide refrigerated truck and trailer volumes are down 29% compared with 2007. As you know, North America industry shipments for trailers have been decreasing for the last eight quarters due to the declining ton miles and significant economic uncertainty. Looking at the North American refrigerated trailer industry as a whole, fourth quarter net unit orders were down approximately 40% compared with already depressed volumes in 2007. Full-year 2008 industry shipments were 26,800 units, down about 17% compared with last year, after a 16% decline in 2007.

Thermo King’s North America fourth quarter trailer revenues were down 14% compared with last year, reflecting the market decline. Thermo King European trailer revenues declined over 40% compared with last year as the European market slowed substantially compared with the strong growth we have seen over the prior two years. Translation also had a strong negative impact on the year over year results. We expect the significantly weakened market condition to continue in Europe well into 2009.

Thermo King global refrigerated truck revenues were down 25% reflecting significant weakness in Europe and 9% decline in the US. Global bus HVAC shipments and marine container sales also declined substantially due to slow down in end market activity. Aftermarket parts were down about 8% reflecting lower fleet capacity utilization and inventory management actions through the entire channel.

Finally, we enjoyed a substantial growth in TriPac auxiliary power unit sales where fourth quarter sales more than doubled compared to last year. Unfortunately, we're not expecting this level of growth to continue in the APU market as lower diesel costs have extended the break even period for these products.

Looking at stationary refrigeration, global sales were down about 10%. This was driven by a decrease in display cases for regional supermarket chains and double-digit declines in the installation business. Climate’s operating margin for the quarter was 7.8% excluding restructuring costs. This compares with 13.3% in the fourth quarter of 2007. The margin contraction was driven by the decline in high margin truck and trailer revenues, lingering material inflation, and the impact of currency, which offset productivity improvements.

Please go to slide number 12. Let’s go now to slide 12, industrial technologies fourth-quarter revenues were $671 million, down 12% versus the prior year quarter, and down 8% excluding currency. Revenues for the air and productivity business decreased by 11% due to lower volumes in all geographic regions and negative currency. Air and productivity revenues in Americas declined about 5% during the quarter due to declines in major industrial process in fluid handling end markets.

Recurring revenues were off about 3% from slower industrial production levels and some deferral of maintenance by customers. Air and productivity revenues in overseas markets declined by 14% compared with 2007, primarily due to declines in industrial activity, and a nine point drag in currency translation. Reported European volumes were down 19% and about 17% in constant currency. Revenues in the Asia-Pacific were off about 4% as declines in machinery volumes were partially offset by growth in the aftermarket businesses.

Club Car revenues decreased by about 22% compared with last year with declines in all geographic areas due to weakening economic fundamentals in key gold, hospitality and refrigeration markets. Club Car continues to gain market share in the declining dollar and softening utility market vehicles.

ITS’ operating margin was 11.2%, excluding restructuring, down from 13% in 2007 on a comparable basis. Improvements in price and productivity were more than offset in the quarter by lower volumes, material inflation and unfavorable mix.

Please go to slide number 13. Let’s go to slide 13 and look at security technologies. Revenues were 586 million, down about 8%, 5% excluding currency compared with strong results last year. Commercial security revenues were down 7% resulting from slowing markets in the US and Europe. Currency accounted for three percentage points of commercials revenue decline in the quarter. America's revenues were down 5%, about a 10% decline in volume, partially offset by 5% of price improvement.

Securities European business was down 14% reported basis but only 2% excluding currency. Asia revenues improved compared with last year mainly due to strong sales of electronic solutions. Americas sales in the residential segment declined 18% in the quarter. Residential’s results were indicative of the continuing decline in domestic residential buildings and remodeling activity.

Volume gains in South America and revenue gains from prior period pricing increases help to partially offset the fall off in US residential activity. Excluding restructuring, margins improved by one half of a percentage point, to 19.8%. Accelerated productivity and prior period pricing actions more than offset lower volumes, unfavorable product and geographic mix and currency.

Please go to slide number 14. Let's go to the balance sheet. For this analysis, the numbers are on a comparable basis for the third and fourth quarters of 2008 and include Trane. As you can see, we had some deterioration in our fourth quarter working capital performance in our operations. The biggest issue was inventory turns which slowed as a result of the rapid fall off of our factory volumes. Total enterprise working capital was as a percentage of revenues improved slightly from the third quarter, but it did not reach the levels necessary to achieve the cash performance goals that we had set for ourselves in the quarter.

As a result of our restructuring, we look for inventories to come more into line with market demand by the end of the first quarter. Given our 2009 cash performance goals, we are strongly focused on driving working capital reduction and to make it a significant cash source for 2009.

Capital spending in the quarter was $110 million, about 3% of revenue, while the depreciation and amortization totaled 100 million. CapEx for all of 2008, including pro forma Trane, was 376 million, and we expect 2009 spending to be in the $320 million to $330 million range.

Please go to slide 15. Considerable interest in our balance sheet liquidity, I wanted to give you some additional details this morning. Available cash flow for the year was $612 million, which was below our average performance for the past five years. We finished the year below our goal of $1 billion due to the sharper than expected revenue declines in the fourth quarter that reduced operating earnings, and left us with higher than planned inventory levels.

Fourth-quarter cash flow was also negatively impacted by restructuring spending and losses on currency hedging transactions. For 2009, we are targeting to generate $1 billion of available cash flow from operations, earnings, and working capital productions.

Please go to slide 16. Our total debt balance at the end of the quarter was about $5.1 billion; about $3.4 billion is long-term with a $750 million bridge loan that comes due next – this June, and about $1 billion of commercial paper outstanding. During the fourth quarter, we maintained access to the commercial paper market and our rates have come down from their peak in October.

We paid about $428 million in acquisition debt during the quarter and our total post acquisition debt pay down is about $900 million compared to our initial target of $1 billion. We finished the year with $550 million of cash on the balance sheet, which is consistent with our liquidity plans. We continue to maintain significant financial flexibility and liquidity of $3 billion and available untapped credit facilities, giving us a liquidity cushion over our commercial paper outstanding of more than $2 billion.

We have adequate commercial paper capacity and even more flexibility through our receivables security program. Obviously, managing for cash remains a very high priority. Our bond maturity schedule is also well balanced with about $220 million coming due in 2009. Combined with the expiration of the bridge loan in June of 2009 and considering normal financing requirements, we would expect to pay down about $675 million of additional debt in 2009.

The majority of our current long-term debt will mature after 2012. Additionally, we are preparing to refinance the bridge loan with a medium-term bond offering in the first half of 2009.

Please go to slide 17. To sum up the quarter, we had significantly weaker end-markets than our original expectations, which anticipated fourth-quarter revenues to be relatively flat year-over-year. Revenues were actually down 8% in constant currency and off 11.5% with the impact of foreign exchange considered.

The lower volumes, unfavorable product mix, currency and lingering high commodity costs negatively impacted our margins. We exceeded our 2008 acquisition synergy targeted by $30 million by realizing $105 million of savings giving us confidence in our 2009 synergy projections.

We initiated $110 million restructuring program in the quarter and expect to generate $135 million of gross savings or $100 million net improvement in 2009. We paid off $428 million of acquisition debt in the quarter for a total post acquisition debt pay down of almost $900 million, making good on our promises to deleveraging the company.

We expect 2009 to be a challenging year and we are focused on delivering unprecedented levels of productivity and cash flow in the face of this declining market environment.

Herb will now take us through the forecast for 2009. Herb.

Herb Henkel

Thanks Steve. Please go to slide number 18. The uncertainty related to the cost and availability of credit has caused a notable decline in the tone of business over the last 90 days. And our most recent quarter rate leads us to expect a sharp decline in business activity. We expect the rate of decline to continue into the first half of 2009. We also expect a less pronounced year-over-year deterioration in the second half with fourth-quarter 2009 revenues at levels similar to those accomplished in 2008.

This year our forecast has considerable added complexity compared to previous years due to the current deterioration in the world economy. Because our end-markets are slowing and uncertain we are actively reassessing what we believe the next few quarters are going to look like. We are operating with the conservative baseline plan for 2009, and we have developed additional contingency actions if markets perform worse than we expect.

So, let me start by reviewing the economic assumptions behind our 2009 forecast. Slide 18 summarizes the key economic and business metrics for 2009. For US construction, we assume residential building markets will show no upturn before 2010. Non-residential construction will see about a 12% year-over-year decline in square footage terms with institutional activity of about 5% to 6%.

The reefer trailer market shipments in North America declined about 16% in 2007 and decreased by an additional 17% in 2008. Recent order rates indicate that the market will be down again in 2009. The ACT [ph] forecast is looking for about 18,000 unit shipments for the year. European truck and trailer market had a sharp downturn in the fourth quarter after a strong first half of 2008.

Demand for 2009 is forecasted to decline by approximately 40%. Industrial production in capacity utilization had a major drop-off in the fourth quarter, and we expect an additional decline in 2009. Finally, our forecast is based on a euro to dollar rate of $1.30, which accounts for about a two percentage point decline in year-over-year revenue from currency translation.

Now, we will go to slide number 19. In summary, for 2009 we expect to see declining activity in most of our major end-markets. We assume the US and Western European economies will experience negative comparisons for all of 2009 with the slowest period in the first half of the year. We also expect slow growth in the Middle East and in Asia.

Based on this macroeconomic view, we expect pro forma revenues for full year 2009 to be down 6% to 7% compared with 2008 and down 8% to 9% including about 2 points drag from currency translation.

We expect climate control, industrial, and security to show declines in the high-single digits with somewhat lower declines at Trane. Additionally, our forecast is built on the following assumptions; we will benefit from lower commodity costs, especially nonferrous metals and from $180 million of additional Trane acquisition synergies and $100 million of net restructuring benefits. Also importantly, our productivity programs should lower costs for 2009.

Additionally, we expect to see a drag of about $125 million from additional pension costs. Finally, the forecast has pricing that is flat year-over-year for 2009 as carryover pricing for 2008 is offset by price erosion costs by lower commodity costs.

Now please go to slide number 20. I wanted to update you on our synergy action in the quarter. Integration planning began back in January of 2008. We formed 14 integration teams. We staffed this effort with dedicated full-time resources both internal and external to ensure execution with vice president level internal resources bolstered with outside expertise as necessary.

In the fourth quarter, we reached the sixth month mark for the combined Trane and Ingersoll-Rand Company. The prior planning and systemic changes we implemented showed strong momentum during the quarter. Fourth-quarter savings were $75 million and total $105 million for the full year, which exceeded our prior target for 2008. These savings came from reduced headcount and implementing the first wave of indirect and direct material saving programs. For 2009, we are targeting $175 million to $185 million of additional cost synergies, which would leave us at year-end with between $280 million to $290 million in cumulative savings.

We are in the early stages of making customer contacts through also realized growth synergies. We are focusing on cross selling, parts and service, controls and energy efficiency. We expect to generate incremental sales in 2009, which will yield at least $10 million to $15 million of operating income. In total, we are targeting to generate $300 million in benefits in 2009, which is about $100 million above our prior forecast.

As we get further along in this process, we're finding more opportunities and we are executing well on them.

Now please go to slide number 21. Slide number 21 bridges our pro forma 2008 performance with our 2009 forecast. Starting with 2008 at $3.34 per share from continuing operations, we expect to generate approximately $1.35 per share in benefits and cost savings from productivity, restructuring savings, and the synergies from combining IR with Trane. Lower volumes and unfavorable mix, currency, and higher pension costs are expected to put a drag on earnings.

We also expect about $0.64 of headwind from the combination of higher interest expense and the loss of interest income, along with the higher tax rate and share count. Total EPS for the continuing operations forecast excluding restructuring would be between $1.85 to $2.25 per share.

Now please go to slide number 22. Full year 2009 EPS forecast also includes about $0.07 of costs from discontinued operations. First-quarter results will be negatively influenced by the turbulent economic conditions and our focus on reducing working capital to generate cash. First-quarter revenues are forecasted to be in the range of $3.1 billion to $3.2 billion, which is flat on a reported basis and down approximately 17% on a pro forma basis compared with the first quarter of 2008. Reported EPS for the first quarter will be approximately breakeven to $0.15 loss.

Now please go to slide number 23. To sum up our forecast for 2009, we expect a difficult 2009 with a turbulent environment and declining end-markets. We are taking aggressive action to manage through this downturn. We are delivering cost synergies and expanding our growth synergies. We will realize savings from restructuring and we are stepping up productivity targets to the 5% level, while working to capture material cost savings from commodities.

We plan to solidify the balance sheet by refinancing our bridge loan and paying down additional debt with our focus on cash generation. We have contingency actions available to trigger if markets declined more than expected, and were continuing to fund high priority projects that will focus on growth for future years.

Thank you and I would now like to open the floor on to your questions.

Question-and-Answer Session

Operator

(Operator instructions)

Bruce Fisher

Shawn, hello.

Operator

Yes, sir.

Herb Henkel

Shawn.

Operator

Yes, are you able to hear me now?

Bruce Fisher

If you both will bear with us, I mean, I am sure we will be able to find our operator.

Operator

I'm not sure why they are not able to hear me. (Operator instructions)

Herb Henkel

Having done this for 10 years, it is always exciting to have something new happen.

Operator

All right. We will take our first question from David Raso of the Isi Group.

David Raso – Isi Group

Hi, this is David Raso. Can you hear me?

Bruce Fisher

(inaudible). Please bear with us while we try to find him.

Operator

Mr. Raso, I can hear you. It doesn't sound like the speakers can.

David Raso – Isi Group

Yes, maybe the audience can hear us, but not the company.

Operator

Yes, it sounds like that is what is occurring. All right everyone; please stand by while we try to resolve this issue. It'll be just a moment. And again ladies and gentlemen, we apologize for the temporary interruption in today's conference. We are looking into the issue. We apologize for the delay.

All right, ladies and gentlemen, the speakers have been reconnected. Again our first question comes from David Raso of the Isi Group.

David Raso – Isi Group

Thank you very much. Question on Trane and its profitability, I am looking at the fourth-quarter on a pro forma where you had decremental margins, even if I exclude the ongoing amortization costs, and of course include all the savings, the decremental margins are up 50% and if you exclude the cost savings it actually lost money. And then I look at the ‘09 guidance you gave for housing starts, non-resi, the fund together is not terribly different than we saw in the fourth-quarter for Trane revenue. How should we be thinking about the profitability for ‘09 in Trane relative to what we just saw in the fourth quarter?

Herb Henkel

David, I think that Trane, we have said this a few times before, the Trane, particularly the Trane commercial group, Trane Residential to some degree had the biggest impact of the lingering material inflation. If you look at the bridge on Trane commercial they are significantly upside down with regard to material inflation relative to direct material productivity. That is largely due to steel, due to the nonferrous metals. So in the fourth-quarter, we saw a significant amount of commodities still coming out of copper valued at $3.35 a pound. So the biggest single change that we will see between years is deflation in the commodities that the Trane uses.

David Raso – Isi Group

Thinking of pro forma Trane margins, excluding your ongoing amortization, I look at it about 9.5% to 9.7% or so. For the full year ‘09, pre the amortization cost, do you see the margins down materially from the 9.7%; how should I think about the core margins?

Herb Henkel

I think you're pretty close David. I would say it is 9 to 10 that is the kind of numbers that we would look at.

David Raso – Isi Group

Okay. And one last quick one, on the first quarter the medium-term, the term out the bridge loan, from our calculation the bridge loan is actually at a pretty attractive rate. I think it is still at LIBOR plus 53 bps. I mean, obviously, you need to term it out and I appreciate the benefit that is going to provide just for security of looking at the balance sheet, but how are we thinking about the rate, there ought to be a higher interest-rate involved with the medium-term, how should we model in that?

Herb Henkel

Yes, no question about that there is going to be a rate impact. I think if we were going to put ourselves on the market today, the medium-term rate per our company would be somewhere in the 7.25% range, but it has been changing so rapidly. Two weeks ago, it had been 8.25%. So we had it built in about I would say about 7.5% to 8% range in our planning.

David Raso – Isi Group

That's helpful. Thank you very much.

Operator

All right. Our next question comes from Jeff Sprague of Citi Investment Research.

Jeff Sprague – Citi Investment Research

Thank you. Good morning.

Steve Shawley

Good morning Jeff.

Jeff Sprague – Citi Investment Research

Just on the topic, first, it sounds like surely matter-of-factly you are assuming you will get term deal done, but could you discuss kind of what the backup plan is if the market is not amenable to that, you know, do you work on extending that ’09 piece of the credit facility that is expiring or is it something else you do at the bridge loan, just kind of what the fallback plan might be?

Steve Shawley

Yes, Jeff, initially we thought we were not going to fallback plan a lot longer than (inaudible), because where things were in October and November last year. There are really two things going on. We are expanding our receivables securitization program significantly. We are just finishing all of that with the various banks and the audit process we go through. So, we are expecting to pick up about $300 million of incremental financing through that. That will help quite a bit. The other backup is very straightforward. We have already gone through credit committee with two of our relationship banks and effectively can refinance the bridge loan out of 2009. We have term sheets in front of us; we just have to negotiate and sign them. So, we believe we have significant contingency at this point in time to handle that but again it was in the paper yesterday, we are highly encouraged by what is happening in the corporate bond markets and we think that if the bridge has to get out of here pretty quickly.

Herb Henkel

So, we are optimistic Jeff but we also have contingency plans in place ready to go at least another full year thereafter.

Jeff Sprague – Citi Investment Research

Then on the Trane backlog, you indicated that it was up internationally, I believe that was a year-over-year comment. Could you comment on the sequential international book of business and how that is playing out as you look into the first half of ‘09?

Steve Shawley

One second, we will look it up. I'm sorry, Jeff, I have to get back to you on the international piece. I have in total but not broken out.

Jeff Sprague – Citi Investment Research

And just on what happened in Q4, I certainly appreciate it is volatile and hard to predict but I mean with the quarter basically over, you guys came to the conclusion that, you know, the midpoint of your range needed to come down some 60% or so from where you were at, and I am just – it is unclear to me what would have changed, what would have driven such a change so late in the quarter and then in fact it coming in that much better than you thought?

Steve Shawley

I think there are probably really two areas. One was the fact that as we mentioned our achievement of the Trane synergies outperform. And I guess, it probably surprised just a little bit because we took a look at this and said volumes are decreasing. It is really the first time around and let me give you an example. The big piece of the savings is what we our indirect material. This will be things as mundane as rental costs. Okay? So, we negotiate a contract at the corporate level and people have to go use the new rates. And we have to see those savings coming back in expense reports. Okay. So when you take a look at how all those works, we just be honest with and confident that we would see all of it come back as we would have teed up. I know it sounds a little (inaudible) but we felt it would be better to stick with where we believe we could deliver the synergies absolutely as supposed to predicting the upside. Either way obviously, it as per the reconciliation I gave you as the tax rate.

Last year, I don’t know if – those of who remember last year we had a significant surprise in the tax rate in the fourth quarter. The various adjustments that had to be made actually increased the effective tax rate in the quarter. This year was exactly the opposite, all of the adjustments fell out pretty much in our favor, and those are the two big pieces.

Jeff Sprague – Citi Investment Research

Great, thanks a lot.

Operator

Our next question comes from Alex Blanton of Ingalls & Snyder.

Alex Blanton – Ingalls & Snyder

Hi, good morning.

Steve Shawley

Good morning.

Alex Blanton – Ingalls & Snyder

Herb, could you comment on the following observation about the cyclicality of the business, I know that you have made a lot of acquisitions and sold a lot of companies in an attempt to reduce it, but when you look at your current product line there seems to be a great deal of it that is going into buildings of some sort mainly commercial, air conditioning products and security being the primary ones. But that tends to be a lag, a lagging factor. So, are you sure that you have included enough of a downside in 2009 for that because people tend to finish their projects even after the economy has started to go down, which it has and then very often there is a dearth of new projects for quite a while. So, could you comment on that?

Herb Henkel

I think it is a very, very good question. When you look at our businesses, I think we have to go back, and go back into the pie chart that we talked about in the past as to how much of it comes from the recurring revenue stream versus how much comes from the new construction. And when you do the recurring revenue stream you are talking about really two elements of it, number one, is the fixing of the installed base that is there, and then currently there is the replacement cycle for the installed base that is there. We took into account all three elements then as we continued reduction and you saw the numbers I plugged in. We took our whole goods for commercial and said, “Yes, it is going into new starts.” There are going to be 12 months later on and down 12%, 5% to 6% institutional. We took the recurring base, then we took the parts activity. And collectively when we put that altogether we come up with a picture that we laid out.

The year itself is, I wish it was the other way but unfortunately we are turning out of a very, very low point. We found ourselves like many of our customers in the fourth quarter underestimating what the downside activity was going to be like, and we actually had inputs and therefore it produced inventories more than we needed to. That is what hurt our cash flow. Now, as we and many other companies are talking about cash is king and you're focusing on that, we are seeing activity level that is exacerbated. So the market may be off 12% but I'm seeing off 18% in the short term because we are making inventory adjustments whether at the distributors inventory levels or whether candidly in my pipeline that I need to go and bring it back down. So I look at the issue being slightly different. My view is that the first half of the year, we are going to see slowing numbers as we described compounded by the impact of this inventory, the one that is sitting out there in both channels as well as with manufacturers. As you know, several of our factories are shut down. Many of our customers’ factories are shut down. But we then see in turns [ph] it is getting back to where in the second half of the year, we actually expect that the current rate would be only 5% to 6% of off where we see the first 2008 numbers. By fourth quarter, we actually expect to see run rates similar to 2008. And remember 2008 was not exactly bad in the fourth quarter either. It was off 11.5%.

So, I don’t think we are overly up. Just ticking up. I think we have laid in all the activity. To be the biggest wild card is the credit availability and that is what you are describing, would it continue to further deteriorate people being able to get financing for their new projects they got coming on, and that is why we have also built contingency plans that would be able to be pulled if we started to see that happening on the drawing boards going forward.

Alex Blanton – Ingalls & Snyder

Okay. Second question, I was looking for your balance sheet, but then I noticed that you haven't been including your balance sheet in your quarterly reports of earnings, correct?

Herb Henkel

Yes, we typically provide the full balance sheet obviously when we file our Qs and Ks. We try to give selective information to help you think about the company though.

Alex Blanton – Ingalls & Snyder

Yes, I see that. But you don't have the – you haven't had the balance sheet, I don't know how long it has been going on but I was looking for the amount of equity after the goodwill write-downs?

Steve Shawley

Yes, it is right about $6.7 billion.

Alex Blanton – Ingalls & Snyder

Okay, so you wrote-off about a third of or less than a third of the equity?

Steve Shawley

Yes, somewhere near that. I think our debt-to-cap ratio ended up like 43% range.

Alex Blanton – Ingalls & Snyder

And so basically what – what it says is the Trane was worth book value because you wrote-off all of the goodwill?

Steve Shawley

No, it is not true. There is still remaining goodwill on Trane.

Alex Blanton – Ingalls & Snyder

There is.

Steve Shawley

Yes.

Alex Blanton – Ingalls & Snyder

Okay, so what percent was written off then? I thought it was the whole thing but I didn't know what it was.

Steve Shawley

It looks like about 40% based on what we can see here.

Alex Blanton – Ingalls & Snyder

Okay, only 40% all right. Thank you very much.

Steve Shawley

Thank you.

Operator

Our next question comes from Steve Tusa of J.P. Morgan.

Steve Tusa – J.P. Morgan

Hi, good morning.

Steve Shawley

Hi Steve.

Steve Tusa – J.P. Morgan

On the stockholders equity question, does that reflect any kind of adjustment for pension under-funding with regards to weakness in the pension plan.

Steve Shawley

Yes, it does Steve. There is about $500 million of adjustment in there for the pension underperformance.

Steve Tusa – J.P. Morgan

Okay, and when we think about the cash flow for next year, you said you were going to do about $1 billion in free cash flow, you did 600 in change this year. What are the big differences? I guess CapEx is one area that you benefited, I mean, how much working capital benefit do you expect to get given that earnings are going to be down, you know by 40%.

Steve Shawley

Yes, we will get a little bit benefit from CapEx in the – that is not what we longer had. We kind of approach this as a balance plan. We are not going to burn the furniture and sacrifice the future but we are prioritizing CapEx. I think that if you look at the numbers in my report, on a pro forma basis we will probably spending somewhere in the neighborhood of $40 million or less in CapEx the next year. But that is fully reflecting what we believe our needs are going to be. We are not starving the company. The biggest impact is going to be in the area of working capital management. We look at – where we ended the year, our inventories actually dropped from third quarter to fourth quarter but they didn't drop as much as we had hoped. Inventories were actually down close to 200 million between the quarters, but we were looking for at least another 200 million in that or so in that category.

Receivables behaved pretty well. We saw a slight degradation in receivables quarter to quarter, a day or so but again, we are focused on driving thinks the old-fashioned way. The biggest issue they are facing right now is adjusting our production levels in the first quarter to capture back much of the inventory as we can.

So, to sum it actually if you looked at the EBITDA between the years and quite in everything, putting all the one-time costs and all the things that are going on EBITDA is fairly flat year-to-year. It might pick up maybe $18 million, when you look at not having all the one-time costs associated with the acquisition last year, but the big change is going to be in working capital. So that is going to be our focus.

Steve Tusa – J.P. Morgan

Okay, and then on this, very helpful, earnings but did you guys have given us, what is the inflation numbers in there. What is the – I guess I'm just trying to get a picture of, you know, price costs. I guess you said price is going to be flat, does that mean inflation is flat to down as well?

Steve Shawley

We have looked at the – our material inflation is kind of flat or it is just going to be a great relief because we've been getting (inaudible) like ever, but if you look at total inflation that is in there, obviously we accounted for wage inflation and other inflation. So we still have inflation in the plan that is probably running about 1% that is the inflation run rate in this plan. So, we still show slightly over $200 million of inflation as we go year-to-year.

Steve Tusa – J.P. Morgan

Okay, and then one more question just on Trane, I guess two parts to it. When you think about the early ‘90s and Trane’s margin that was kind of in the mid-single digits, is that kind of ruled out with the regards to the other restructuring and integration you're doing here, you know, is that a reason to think about it just at a higher base level of profitability even in a worse than expected downturn, and then secondly, as you are getting all this cost out and making these big moves, have you seen any attrition with regards to, you know, sales people or key operating people given this is a pretty significant cut that you're taking to the cost structure.

Steve Shawley

Let me just address the numbers, okay. Then maybe Herb, you can make a comment on the organizational effect. As I said earlier the biggest – maybe look at this if you look at Trane’s performance, Trane has fallen back on lot of the margins and it is performing certainly above high-single digits, at high margins recently. If you take a look at what happened in the third and fourth quarters, and really I think these have happened in the third quarter versus material inflation caught up with the group. I think that if you take a look at the material productivity, I mean there are a lot of new product lines actively going on. So not being able to drive material productivity on the old product lines. So, we are caught kind of in this crunch period of higher commodity costs, not really being able to reduce our cost base on the old product line. You are going to be coming up with almost a completely new product line in 2010. So we've got this a little bit of time phase going on without the ability to drive material productivity versus deflation. The biggest single thing as I said earlier is the swing in numbers on Trane is material inflation or the lack thereof. And we will see that picking in, I guess that will start to show up in late first quarter, second-quarter for sure. And that is sort of how we have the thing right now.

Steve Tusa – J.P. Morgan

Right, so you expect a positive price cost through 2009?

Steve Shawley

It is starting in probably the second quarter of 2009.

Steve Tusa – J.P. Morgan

Great.

Herb Henkel

And I think answering your question Steve on the people side of it, it is a tough economic environment in which we operate. Mechanically saying there is not a lot going on at Trane, and I think it is very, very exhilarating and exciting for people that they are working on. We're changing out over 50% of the product in the next 12 months. I think you're going to see a lot of new things coming on board and I think both the sales organization and the operating people, the engineers working on that are doing their darnedest to go through it, and we are not seeing any kind of what I would call disproportionate amount of people leaving. As a matter of fact, in terms of what I find this is one heck of a great group of people that have Trane in their blood.

Steve Tusa – J.P. Morgan

Great, thanks a lot. Thanks for all the details.

Operator

Our next question comes from Terry Darling, Goldman Sachs.

Terry Darling – Goldman Sachs

Thanks. Herb or Steve, I was wondering if you can take us through kind of longer list of items building a bridge between 4Q and 1Q, you know, it clears a lot of seasonality and the tax rate is going to go up, you have got maybe some – your restructuring costs were higher than your savings. Just wondering if you could take us through more detail there?

Herb Henkel

Yes, I can Terry. So, I will give you the macro part of it. As I described in our fourth quarter, our order rates were up about 18%. And that is the kind of numbers we are looking translating into revenues during the first quarter on a year-over-year type basis. So, we are expecting a continued very, very, very soft market on the revenue side. The second piece which compounds this problem is the fact that as Steve was alluding to beforehand, because we did not turn off manufacturing at the same level at which orders dropping in the fourth quarter we are also looking at how we get $200 million out of inventory out of our pipe, which means we are obviously going to have a significant reduction in absorption in our plants for the first 3 to 4 months.

Then you add to that, now that I have this inventory sitting there on the gross margin side, I'm going to get the whammy of the fact, they have a lot of 2008 type commodity cost in the product that I'm selling off. So I'm going to be seeing a gross margin number that is going to be not better than we saw in the 2008 that is there. You add on to that then obviously this whole issue with pensions that Steve was talking about, then you get – I'm going to try to get the positive stuff to it, okay. I said then you get down with those things. Then you get into the fact that we continue to see what it was for us, Steve described a pleasant positive surprise for us, but the rate at which we are able to get productivity as well as on the synergy said. So those on the other side of the ledger going forward.

Our expectations is that we are going to start saying pricing that will wind up eating into some of the carryover that we had from 2008. So, I'm zeroing that already in my entire thinking as I look at first half of 2009. So, it is a positive and in addition to that obviously, is really what we do wind up seeing as continued increase in productivity. We think, we can now step it up to 4% to 5% and that is going to continue to improve as we go forward.

Terry Darling – Goldman Sachs

Okay, so you're essentially assuming organic is down 18% in the first quarter or is that including currency?

Herb Henkel

No that is – because we frankly, we don't see the currency moving that much between Q4 and Q1.

Terry Darling – Goldman Sachs

Okay, and Steve, I'm wondering if you may be help us with the –

Herb Henkel

A quick correction, the 18% is including our expectations on currency.

Terry Darling – Goldman Sachs

Okay, and then Steve I'm wondering if you could help us a little bit with what our expectations should be on the kind of quarterly run rate balancing act between the restructuring, savings and sort of focusing just on this 130 million or 135 million gross number relative to the benefits, which I think you called out at $100 million. And just sort of how that flow works as we move through the quarters?

Steve Shawley

We – it is actually going to be further off-balance because if you go back to the (inaudible) when we talked about, when we saw this downturn coming, it was definitely the first quarter. You know, the benefit of having this business called Thermo King is sort of a leading-edge business gives us an overall indication of what is happening in both the US and European markets. Our restructuring program really started in earnest from a planning perspective in the third quarter. So, if you look at the work that has been going on, we have already announced and booked a significant piece in the $100 million or so. I think $77 million of the cost has already been taken in 2008, $71 million of that in the fourth quarter. So that is well under way. So I think that we will probably see a rough guesstimate of 40% of the savings in the first half, 60% in the second half, (inaudible).

Terry Darling – Goldman Sachs

Okay, and in terms of the segments where you are more aggressive or less aggressive, is it sort of mapped back to the schedule in the back of the page in terms of how the fourth quarter ratings looked, or will that shift around on us?

Steve Shawley

Might shift a little bit, but where the bulk of the money is going is climate control, and Trane commercial, quite frankly.

Terry Darling – Goldman Sachs

Okay.

Steve Shawley

In fact, some of the other questions about – maybe I was a little or you missed it. Some of the questions about how I was going to turn Trane margins, and a lot of restructuring is part of that.

Terry Darling – Goldman Sachs

Okay. And I can say as I get a little bit confused between various commentaries on raw material expectations versus inflation, I'm wondering if you could just focus on what your expectations are on a year-over-year going forward basis for just the raw material piece of the inflation. It seems to me that ought to be a benefit for you but I just got confused with all the commentary.

Steve Shawley

When you get done with it Terry, is that when you add up between steel in the copper pieces of it, we are looking at we believe that we will capture about $150 million worth in our 2009 numbers. We think that there is another upside of about $40 million beyond that but candidly we think that upside would probably be negated by potentially some price pressures. So, we don't count that extra 40. We sort of clean that up with what we think will be price erosion. So think along the lines of about $150 million of actual [ph] commodity improvements.

Terry Darling – Goldman Sachs

Okay, and last question Herb, just going back to your pricing comment there, it may be a little bit of history lesson for me on this, you know, as we think about the pricing dynamic rolling into 2010, you know, given an assumption that the economy is typically recovering at that point, would you expect to be back under water from a price raw material balance perspective at least in the first half of the year as capacity utilizations remain pretty weak at that point. Obviously, raw material headwinds I'm sorry, tail winds will probably have been realized with lot of – lot of things in between, but I'm trying to understand about whether pricing as we move into the first part of 2010 anyway, even if we have the early signs of recovery, you know, is a significant headwind at that point.

Herb Henkel

Actually what I see usually happening is that pricing on the raw material side is the lagging thing when it shows up into my gross margin by about six months. Until it really shows up, it is impacting and it was actually out there because I've got to place the order, the guy has got to supply it to me, I've got to consume it, and so I look at things that raw material improvement that I just described to you in 2009 actually make me feel very good about at least the first half of 2010, because I think they will be all the way through that but at what point do you have the courage to lock it in longer term. If copper is you know, $1.40, do you think it is going to go to a $1, do you think it is going to go too and so for us, I think what we are going to be looking at doing this time, which we had done the last time around is that if let us say by the middle of the year, we start seeing that these things are pretty well stabilized, we will probably go longer on our hedge positions and wind up trying to go and secure it. So, right now my answer would be, I would feel very good about continued low-cost in my COGS for at least the first half of 2010. And if I can go and lock it up for 12 to 18 months on some of these items, we could probably make it all the way through all of 2010. So that is actually a real upside for us. That is what I saw coming out and that is where my old COG went. This is what I saw coming out going back to 2002 in the same way.

Terry Darling – Goldman Sachs

And that favorable raw mats compares in the first half is going to offset any continuing negative price picture?

Herb Henkel

That is my thinking right now.

Terry Darling – Goldman Sachs

Okay, thanks very much.

Herb Henkel

Sure.

Operator

All right. Our next question comes from Andrew Obin, Banc of America.

Andrew Obin – Banc of America

Hi, yes, hi. It is Banc of America, Merrill Lynch. Just a question in terms of your forecast for ‘09, you noted flat revenues in the fourth quarter. So should I assume that earnings will start showing positive comps sometime in the third quarter? Are we going to see positive comps in the second quarter already?

Steve Shawley

I think it must be part of the comps in the third quarter.

Andrew Obin – Banc of America

Okay, and that is just driven by the savings from the – on the Trane side, right.

Steve Shawley

Yes, the timing of all that, it is a combination of the restructuring synergies, the pickup in the volume.

Andrew Obin – Banc of America

And just more of a sort of a philosophical question, when you do accounting I assume that you did the discount to cash flow test when you impair the Trane assets, is that fair?

Steve Shawley

Yes, we could spend two hours on this topic, but we actually employed an outside firm to help us value the goodwill and long life intangibles. They use various techniques to do the valuation including outside multiples on sales, EBITDA, and other things to really hone this thing in.

Andrew Obin – Banc of America

Well, the question I have, how do you internally separate the fact that we have significantly reduced our expectations for earnings from Trane. I assume because economic conditions have worsened. I mean do you really have a methodology internally to from an accounting standpoint to separate savings just from the impact of declining revenues or do you back into the savings number?

Steve Shawley

Yes, we can separate it out. In fact, we put together a very detailed five-year look at all of our business segments in order to speed up the valuation work, and there was a significant amount of effort going into that. When you look at earnings cash flows based on where our current economic conditions put us, we also use that with our outside valuation help firms to take a look at various aspects of our basis on a competitive apples-to-apples multiply. We break this town by reporting segment. The outside firms takes a look at none of our cash flows discounted back for some present value. They take a look at what the competitive multipliers look like in the various industry segments that we play in. If you take a look at the multiples of sales, you come up with kind of a view to one of each of the pieces of the businesses at work.

Andrew Obin – Banc of America

Okay.

Herb Henkel

And then the only interesting piece behind Andrew that you report the ones that are negative. So that is the fact that the security Americas business was $3 billion above book. You don't record that anywhere. So, just remembered this is a one-way adjustment only, and if things got better somewhere again, six months from now, whatever it is, you wouldn't go back and reduce it. So it is a one-way valve that this thing operates on and we do it at one level below, which we report it. So that is why you saw when we secured it, we wind up doing the analysis in the Americas. We did the Americas, and we did Europe, and we also did Asia-Pacific, and that is how we run the company. And then the wind up looking at each of those and so what are now seeing is the report out as to any of those at that level have any kind of impairment based on the approach that Steve was describing to you.

Andrew Obin – Banc of America

Thank you. And just a follow up question, in terms of your statement that you think you can raise money, 7% in the market, is that based on the conversations you had with banks? It is just one of my companies that is AA- rated just raised money at 7%, you guys have ratings significantly below that, so the 7%, is that your estimate, or is that based on the conversation you have with banks?

Steve Shawley

We talk to our banks everyday, Andrew, about that topic. It is an indicative pricing every time which is anybody who goes to the markets and we updated liquidity daily.

Andrew Obin – Banc of America

And you guys don’t – you guys don't foresee a downgrade right, based on the conversations you had with the rating agencies, right?

Steve Shawley

No, we do not.

Andrew Obin – Banc of America

Thank you very much. I appreciate it.

Operator

All right. Our next question comes from Jeff Hammond, KeyBanc Capital Markets.

Jeff Hammond – KeyBanc Capital Markets

Hi guys.

Herb Henkel

Hello, Jeff.

Jeff Hammond – KeyBanc Capital Markets

Just wanted to get a little more granular on the business units, you comment for a 6% to 7% core decline overall, can you just give us a sense, either by business, how you're thinking about revenue or just order of magnitude, what businesses you think are more or less resilient within that?

Steve Shawley

I think it's a little bit kind of across the board. And if you look at climate control, there is two big pieces to climate control, is that the stationary refrigeration again, which we see, in our current look, it's probably going to be off– I'm talking about all of 2009, these are end market discussions, and not – which we have then translated into our plans. As you look at – we think that the stationary business is going to be better off than the transport piece, okay, so they would be off maybe mid single digits, maybe a little bit less. And the Thermo King piece, when you add up all of the comments we just made about global truck trailers, what we think is going to happen with bus, looking at the aftermarket being relatively flat, you are going to be looking at mid teens, mid to high teens in Thermo King. So, total climate, that's where we come up with the…

Herb Henkel

High single digit…

Steve Shawley

… kind of the high single digit numbers being off organically, okay.

Jeff Hammond – KeyBanc Capital Markets

Okay. Then in terms of the other businesses?

Steve Shawley

If you look at the other businesses, security is going to go pretty much the rate we see in terms of non residential construction. The res piece is going to be reflecting the residential – I would say that we would adjust a little bit was in the commercial business, but 60% of our security markets is institutions. Their rates of reduction are going to be less, we believe, than overall non-res construction. So that is why we come up with the security piece. If you look at industrial technologies, the industrial markets being off significantly with respect to our air and productivity businesses, we would be in roughly the 10% range. If you look at Trane, everybody focuses on the equipment side. You have got to remember our part service solution business. We actually believe it’s going to be up about 5% based on not only what we see in the marketplaces, but performance in the fourth quarter, and also kind of what we saw on the downturn between 2001 and 2002. That business actually grew about 5%, 6% maybe even 7% in the downturn.

Herb Henkel

So, that's on the parts and services business.

Steve Shawley

On the parts and services business. So when you take a look at overall, Trane commercial, we would expect them organically will be down about 3%.

Bruce Fisher

Well actually go through this in some depth on Friday, so…

Jeff Hammond – KeyBanc Capital Markets

So, yes, because if I look at your key economic indicators, and just some of this discussion, it seems like you get to an organic revenue decline greater than 6% to 7%?

Herb Henkel

Well let me if I can just sort of summarize. What we said is that, if you look at climate being off in the upper single digits and you also take – you do the same thing with security and industrial, then you have the biggest swing really is with Trane commercial being off a couple of percent, residential being off high single, so you come up with total ACSS being off less than 5%. And so when you that those pieces altogether, you wind up coming up with an overall look that comes somewhere between minus six and minus seven.

Steve Shawley

And also those indicators, they are primarily US domestic indicators. We have substantial portions of business outside of the US. It doesn’t take into account things like the model and the aftermarket like we do. We would expect…

Jeff Hammond – KeyBanc Capital Markets

Yes. I think your broad commentary was a little more favorable in Asia and South America and Eastern Europe. What are you seeing within your businesses in those markets? Are those proving more resilient or weakening kind of in line with everything else?

Steve Shawley

As I look at the Asian markets for instance, products coming across the board, we are looking at about 5% growth in those markets, obviously a lot less than we have seen in the past, it is still positive growth.

Herb Henkel

Yes, so we use to see 20, we are now seeing single digits.

Jeff Hammond – KeyBanc Capital Markets

And you saw that in the fourth quarter and near term in order rates?

Herb Henkel

Yes I think it's – probably closer to flat at the first quarter of this year, then picking back up a little bit, again we will talk about going forward. There is an unbelievable amount of inventory. I’ve heard all sorts of numbers that were substantiated, but there is an awful lot of inventory in many, many businesses that people are going through in terms of the first quarter. So I think you are just going to see – that's why this first quarter looks like I think an aberration and I would be surprised when people that I talk to and many of our customers and suppliers, that you wouldn't see that on a very, very broad basis.

Jeff Hammond – KeyBanc Capital Markets

Okay, thanks guys.

Operator

Our next question comes from Rob Wertheimer of Morgan Stanley.

Rob Wertheimer – Morgan Stanley

Hi. Good morning everybody. I guess two questions for you. The first one is just on the commercial orders, have you seen a slowdown yet in office buildings or more just the retail segment?

Herb Henkel

Well, it has been most pronounced in retail, but there has been a slowdown in orders across the board.

Rob Wertheimer – Morgan Stanley

Okay, fair enough. Second on copper, I have thought you guys bought around hundred million pounds of copper and I thought it was around 3.43 or 3.40 whatever average last year, did you lock in copper well below two bucks, and are you expecting steel to be up, or is there a little bit of room for upside to your positive on commodities?

Steve Shawley

I think if you look at what we have locked in, the early part of the year, when we had it right about two bucks. But in total across all of our commodities, we are only about 35% hedged out. And I use that word loosely because it is not a traditional financial hedge, we have got contracts out with suppliers. So if you take a look at what we have available to us, yes, there is upside. If you take a look at being able to take advantage of market conditions on another 50 to 60% of our buy, there’s definitely an upside.

Rob Wertheimer – Morgan Stanley

Perfect. And last question is, is there a cash contribution on pension in 2008 or 2009?

Herb Henkel

Yes, there is kind of back and forth and right now we are thinking that somewhere in the neighborhood of 80 million.

Rob Wertheimer – Morgan Stanley

In each year?

Herb Henkel

Yes, it kind of averages – it starts in 2009, and in the foreseeable future it will be about 80 million, 90 million.

Rob Wertheimer – Morgan Stanley

Okay. Thanks.

Operator

Our next question comes from Eli Lustgarten, Longbow Securities.

Eli Lustgarten – Longbow Securities

Good morning.

Herb Henkel

Hello, Eli.

Eli Lustgarten – Longbow Securities

Hi. Two cleanup questions, one, what is the tax rate percent we should use for 09 and the corporate overhead number? I guess we put – corporate and allocated dropped too. You reported 27 million, but it is 19 million adjusted, that half of where it's been, what should we use as an ongoing rate in that allocation?

Steve Shawley

I think we feel pretty comfortable at about 20% on the tax rate side (inaudible) on the corporate.

Eli Lustgarten – Longbow Securities

(inaudible) I am not sure what caused it to drop so much, more than cut in half from the prior quarters in the fourth quarter and what's an ongoing rate for that? Do you want to come back to me on that later?

Steve Shawley

Yes. I think we need to do that because there are lot of moving pieces in the fourth quarter in that. We don't want to give you a wrong answer.

Eli Lustgarten – Longbow Securities

Yes, just trying to figure out what you want to say. As far as the business goes, firstly on Trane, if you look at non-res construction profile, it is starts off stronger in 2009, gets weaker as you go to the end, weaker into 2010, and then part of what I'm concerned about is that on January 1, 2010, we have coolant conversion to R410A that takes place. Now can you talk about your – are you going to be ramping up production in the second half of the year on the old coolant to have an inventory into the New Year, or what are you going to be doing, are you going to convert to the new coolant, and how much of your product line has to be converted, there's a whole issue that takes place in the Trane business?

Herb Henkel

I'm going to invite you the next time we go over to Clarksville, you are absolutely right on it. We have at this point in time a number of new projects, I think it is over 50% if I add up in terms of total product value for the holders in the US, that are going to report a conversion. Now they are going to implemented throughout 2009. What we're doing at this point in time, it is interesting because some of these wind up actually costing the customer efficiency. So we are providing for them the alternative. This is like when the guys never changing over on the class a trucks, same thing.

So the question what we're trying to do is keep open as long as we can for the customer the option between using this system versus going switching over to the new one. I mean you have two groups of people. Some would say, gee, I don't want to be stuck with an old one, the other saying, well I don't want to be stuck with a new car. And so we're going to go through the year providing both products and so I don't expect to be building any kind of inventories. We're going to wind up obviously having to make a rational cutoff as we know we cannot be in production as of January 1, so that is mandatory.

So now we are going to make sure we don't get caught with a pipeline of stuff I have got to build which gets too close to that date. So as the year goes through, we will continue to monitor and see how far out we can make this flexible solution available to the customer versus when we have to go hard and say, okay, I just can't do it any more, because I don't want to be trapped with anything you are in. So this is no different than the class A track story that you and I talked about a couple of years ago.

Eli Lustgarten – Longbow Securities

But this still goes through the problem of the second half improvement that we are expecting for Trane and the problem of managing the business through all these changeovers, I guess it is…

Herb Henkel

Actually I wouldn't consider… I don't want to… it is very large test, but think of it along the lines of that, you have two SKUs to produce instead of one. The difference in terms of – candidly, one’s got 5% or 10% more copper than the other one, a little bit taller, a little bit wider, based on the number of a refrigerants you have to go run through the darn thing, but it is not rocket science in terms of you are producing something really dramatically different. It really is in terms of saying is that one modification versus the other.

Eli Lustgarten – Longbow Securities

All right. One final question, do you expect Thermo King to be profitable in the first quarter, first part of the year, at these levels of production?

Steve Shawley

Yes, marginally.

Herb Henkel

Yes, marginally, in the first quarter.

Eli Lustgarten – Longbow Securities

All right, thank you.

Steve Shawley

More profitable in the fourth quarter…

Operator

All right. Our next question comes from Robert McCarthy of Robert W. Baird.

Robert McCarthy – Robert W. Baird

Good morning guys.

Herb Henkel

Hi, Robert.

Robert McCarthy – Robert W. Baird

I appreciate you taking the question and extending the call the way you have. I have a couple of questions. First about your revenue outlook for 2009, as I understand, combination of the formal outlook and your answered earlier notionally at least you're looking at something like a 15%, 16% organic decline in the first quarter, averaging five to six in the second and third and then being about flat in the fourth, which would imply I believe that your second half expectations would be something like down 2% for the entire company. And if that's going to be the average, then you have got certain businesses that you expect to be up in the second half and I just wondered which one those would be or if you could generally talk about how we make this math work?

Herb Henkel

I think part of the math, Rob, works from what you're preparing into from this year. The reason I said that is, if you draw the graph, you're starting off with a – if I use 2007 as a base, I'm am wound up 11.5% off in the fourth quarter, so I'm saying is that I expect the fourth quarter of 2009 to be really not much different than what we had in the fourth quarter of 2008, that’s the way I would peg it out for you. The leading companies for us, we talked before about, where do we lag versus where do we lead, obviously in security and in Trane, that's of course pretty late on to a particular project.

When we get into companies however like in our industrial space, as soon as that first tick of activity level picks up, they wind up going and driving that, and the same is true with our Thermo King. They have been by far the best leading indicator. Remember we had the conversation about when I said back in May when we sort of what’s happening in Europe, and said, oh my gosh, this is an indicator of what’s going to happen in six months. But unfortunately it’s great directionally but not so good on the magnitude side, so we underestimated the drop off. We expect in terms of – if you look like IPI and some of these other sources of insight, I think you start seeing in terms of everyone sort of turning around somewhere in terms of it, whether it bottoms out in the first quarter, second quarter based on specific to what you're dealing with, but overall my understanding is that, it is less negative and a third and then getting better than that, so it's like almost being equal to 2008 in the fourth quarter.

Robert McCarthy – Robert W. Baird

So you are talking about tools, Thermo King and then almost all of your recurring revenue businesses?

Herb Henkel

Exactly.

Robert McCarthy – Robert W. Baird

Okay.

Herb Henkel

What we actually think – if I look at the residential side, obviously you would see in my forecast, we are just checking numbers that show that housing is off another couple of hundred – like hundred thousand, whatever it is, that is not the primary source. The real issue for us is look at the replacement of the existing units that are out there, that's the installed base, and when we look at what we think has been deferred into 2007 and 2008, there is a significant pent-up demand. We also know in terms of deferrals on service work with people spending the cash, so those are going to be the ones that come out right on the beginning part.

Robert McCarthy – Robert W. Baird

I am just curious. When does your industrial production forecast come from?

Herb Henkel

We use – I go by – I told about it, two sources that I like based on diversity of their background. We go by MAPI [ph]. If you look, you see they do it by region and by about 30 different industries. And as I said, I also like different agencies, it sounds like a commercial. I use the IPI and they do a pretty good job regionally, U.S., Japan, Europe, Asia Pacific and so on, and we sort of lay those altogether and see what do we come up with.

Robert McCarthy – Robert W. Baird

Okay. My other question is, I wonder if you could give us kind of pro forma basis, a geographic revenue split for 2008, the way you have traditionally North America, ESA, South America, Asia-Pacific?

Herb Henkel

I don't have that number, I have to get to the book. That's the way we probably see it. We're still at two thirds, 55 to 60% geographically North America, and 34% international. And then I have got – of the breakdown behind that thing, Europe reflects about 23%, 24%; Asia-Pacific then represents about almost (inaudible) the rest we have in the Americas.

Robert McCarthy – Robert W. Baird

Yes, okay. All right, thank you.

Operator

Our next question comes from Nicole [ph] of Deutsche Bank.

Nicole – Deutsche Bank

Yes. Hi, guys. Good morning.

Herb Henkel

Good morning Nicole.

Nicole – Deutsche Bank

Just a couple of quick ones for you, the rate arms hasn't changed, does that imply that long-term Trane margins will turn lower you’re your expectations? And also does that lower ongoing amortization within the treatment?

Herb Henkel

No. First of all, let me answer backwards okay. This was – we wrote off goodwill predominantly, which was not being amortized. If you take a look at the forward impact on P&L, it is really zero impact. In terms of indications of margins, if you take a look at not so much margin assumptions, but basically volumes, the biggest driver from an operations perspective, but also a good half of the adjustments due to the fact that our market valuations are just significantly over lower than they were back when needed we did the acquisition. I mean global market valuations. So the way they do this, is they take a look at theoretically what the outside market value is of each of your pieces, and it hasn't – quite frankly very little to do with your margins and projections of cash, although it is a lot to do with what people would pay for the business theoretically. And that is the discussion we had earlier is that that's why we engaged the outside arm to help us to aim very through job in getting that outside valuation view such that we do this correctly.

Herb Henkel

So this relates more to the IR stock price than it does Trane margins.

Nicole – Deutsche Bank

Okay, got it. And then lastly, a lot of companies have been moving their domicile away from Bermuda, are you guys assessing that?

Herb Henkel

Well, obviously we continue to look at what is the appropriate corporate structure for a company and we have been very interested to see why people where moving and we obviously evaluate and see whether saying in Bermuda or going somewhere else is the right thing to do for our shareholders. We will be very the active and continuing to look at that.

Nicole – Deutsche Bank

Okay, thank you.

Operator

We'll go next to Brian Jacoby of Goldman Sachs.

Brian Jacoby – Goldman Sachs

Hi guys. Thanks for taking my question. Just a couple quick ones on the pension side, if I heard it right, is that correct you're saying that the actual cash contribution will be roughly 80 million in 2009 and roughly 90 million in 2010, is that the right way to vary it?

Steve Shawley

Yes, that's what we are planning on.

Brian Jacoby – Goldman Sachs

Okay. And – what is the status of the pension plan at year-end, the funding status?

Steve Shawley

Well probably there's a big swing – there was probably a large swing. If you take a look at what the IR funds where at the end of 07, we were over funded by about 5%. And if you look at where we've wound up at the end of the year, combined IR and Trane plans, were underfunded by about 21%.

Brian Jacoby – Goldman Sachs

So what does that work out on roughly a dollar basis, is that –

Steve Shawley

635 million.

Brian Jacoby – Goldman Sachs

Okay. So there is no – it sounds like there is no real major cash contributions unless things really change further in 09, but it looks like there is no big cash contributions over the next…

Steve Shawley

No, we filed through that and I think the government’s ruling on giving companies in general break on the latter periods for funding is helped. So that is how we’ve based our planning.

Brian Jacoby – Goldman Sachs

Okay. And then other question was just around the funding strategy, you still have quite a bit of commercial paper outstanding. I guess the appetite is there for a bigger deal from the credit markets, would you consider terming out any of the commercial paper, just to bring it down. I realize you're balancing that goal of trying to repay 675 million in 09 and hence you want to CP outstanding I assume, but on the flip side, if things perhaps are worse, I mean not always bad to have a little excess liquidity, but is that at all something you guys are considering or should we just look at it as the bridge is all you really want to repay and your okay with the CP?

Steve Shawley

No. We include CP in our definition of debt. We want to pay down, no question about that. We expect CP levels to drop by the end of the year by almost 200 million. Again there is various pieces of. This piece that we are putting in place relative to the receivables securitization program of about 300 million is critical. During the term offering in early part of the year to take the bridge loan out, is critical. The other thing we have got into our plan here is the fact that our cash flow is definitely seasonal, it’s second half oriented. So when you look at rates at even seven plus percent, someone made the point earlier that this is going to be a big swing factor between the interest rates of the bank on the bridge loan versus the term loan, makes sense to go there. So the balancing act is we're going to be putting into term markets a reasonable number to keep the pressure off of CP, but picking and managing the fact that our cash flow is going to be predominantly in the second half to continue to pay down the CP level, so that's how we thought through this, and there is a delicate balancing act between the cost of capital and the liquidity flexibility you need.

Brian Jacoby – Goldman Sachs

Right. And the funding I assume is still going to be out of the Ingersoll-Rand Global Holdings as well, you're going to do it out of your immediate (inaudible)?

Steve Shawley

Yes, that would be the plan, that would be the same structure as last time.

Brian Jacoby – Goldman Sachs

Okay great. Thank you.

Operator

All right. Our next question comes from Andrew Obin, Banc of America.

Andrew Obin – Banc of America

Hi, guys. Just a follow up question. In terms of your outlook for revenue, and I apologize if I missed it, what’s North America versus international, and it will be super helpful if you could do it by region?

Steve Shawley

Well again these are the kinds of things we're going to talk in detail on Friday. We will take you through the businesses, we're going to take you through each regions. I think it may be more appropriate to do it there.

Andrew Obin – Banc of America

Okay. But just split, just rough split like how – let me ask you this question, are you forecasting that North America in 2009 is going to worse than international or is international going to be worse than North America, just that? In terms of revenue?

Herb Henkel

I think the US and Western Europe are going to be equally bad is the way I would describe it to you. And remember we say to you when we looked at it not improving and we said really is that we are going to have low single digit type growth and mid single digit type growth in the Asia-Pacific and developing world.

Andrew Obin – Banc of America

I appreciate it. Thank you very much.

Operator

And we have another follow up from Alex Blanton, Ingalls & Snyder.

Alex Blanton – Ingalls & Snyder

This is just on the impairment charge, it is of course a non-cash charge, doesn’t affect your covenants, but it does affect the borrowing power, I would think, since it reduces your equity in relation to your debt theoretically. But would you comment on I'm just curious as to what you think of the of the impairment charge as of proceeds because you don't get that back if the stock goes back up, do you?

Herb Henkel

That is correct, it is a one-way judgment. And again that’s why I think not too many people use it in any of the valuations when they determine your creditworthiness going forward.

Alex Blanton – Ingalls & Snyder

But how does it work in over time to your borrowing power, because a couple of years from now, are you going to still make an adjustment and say, well, remember we really have 3 billion more equity, we paid for this company, and then we had to write it down a few months later?

Herb Henkel

I think if you look at borrowing power, really for companies, it's really that – like us, our borrowing power is much more related to our future cash capability. And the rating agencies talk about capacities and how they give their rating, so we spent all day talking about cash, generation of cash, and the ability to keep a certain leverage of your company's reasonable. Even our debt covenants are very affected, when we mentioned of ratios in the debt covenants, debt covenants are relative debt to total cap type numbers. And so again back to the – that’s why we are focused on…

Alex Blanton – Ingalls & Snyder

That is what I was talking about, debt to total debt cap?

Steve Shawley

Again back to the – you asked about if its impinged (inaudible) that it is no, and it is based much more on our ability to drive cash flow.

Herb Henkel

I mean when I get into a rating agency conversation, what they ask me is, what’s your EBITDA. And I okay, look, it is 1.67 billion, last year was 1.6 billion, and then they look and say, what is the rest. I say, okay, working capital, this year is going to wind up being a source of cash. CapEx is minus 300, my interest is 300. Then you see the math really gets going, okay, but you have less at that point in time if I pay taxes of 100, you have got $1 billion of cash left. That is the coverage ratio that that is much more bundled than it is frankly – and I am not sure about that anyway, just hocus-pocus about writing things down in one piece because my organization chart has done at this level, nothing to do with cash generation capabilities.

Alex Blanton – Ingalls & Snyder

Absolutely not. That's why it's so strange procedure.

Herb Henkel

I think it is also why everybody says – I keep asking the question, who is going to do anything based on this number? I would really want to know because I have no clue about what the impact is.

Steve Shawley

The really settling end point here is that we will continue to generate a billion plus of cash over the next several – each year over the next several years. We are going to continue to pay down some more debt, and we are in a position here.

Alex Blanton – Ingalls & Snyder

Okay, thank you.

Operator

We have no further questions on the phone at this time.

Bruce Fisher

Yes, if you would, just let me close by saying thank you for joining us and what became something of a marathon session. There will be initial replay of the conference call if you would like to absorb it again starting at one o'clock today and will be available through February 18. If you have any other questions, you can call Joe Fimbianti or myself, and please don't forget to join us via the web cast this Friday, the 13th, beginning at 8 AM for our Analyst and Investor Day session, and that includes our call in again. Thanks so much for participating.

Operator

And again, ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may disconnect at this time.

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Source: Ingersoll-Rand Company Limited Q4 2008 Earnings Call Transcript
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