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Ingersoll-Rand, Plc. (NYSE:IR)

Q4 2009 Earnings Call

February 12, 2010 10:00 am ET

Executives

Bruce Fisher – Vice President Investor Relations

Herbert L. Henkel – Chairman of the Board

Michael W. Lamach – President, Chief Executive Officer & Director

Steven R. Shawley – Chief Financial Officer & Senior Vice President

Joe Fimbianti – Director of Investor Relations

Analysts

Terry Darling – Goldman Sachs

Robert Wertheimer – Morgan Stanley

Nigel Coe – Deutsche Bank

Jeffrey Hammond – Keybanc Capital Markets

Stephen Tusa – JP Morgan

Jeffrey Sprague – Citi

Mark Koznarek – Cleveland Research Company

David Raso – ISI Group

Mark Koznarek – Cleveland Research Company

Daniel Dowd – Sanford C. Bernstein

Andrew Casey – Wells Fargo Securities, LLC.

Robert McCarthy – Robert W. Baird & Co., Inc.

Shannon O’Callaghan – Barclays Capital

Ted Wheeler – Buckingham Research

Operator

Welcome to the Ingersoll-Rand fourth quarter 2009 earnings conference call. Today’s conference is being recorded. At this time I would to turn the conference over to Mr. Bruce Fisher, Vice President Investor Relations.

Bruce Fisher

We released earnings this morning at 7 am. Our website was down temporarily because of the storm in Dallas however, it’s now back up and running and you can find our earnings and the slides that go along with our conference call posted there. Just go to www.IngersollRand.com and click on the yellow icon on the home page and you will see all the materials there. They will be archived on our website and be available tomorrow morning at 10 am including a transcript of this call.

Now, 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 federal securities law. Actual results may differ, please see our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results.

In addition if you would, please refer to Slide 25 which covers the use of non-GAAP measures to describe company performance. Now, if I could I would like to introduce the participants on this morning’s call. We have Herb Henkel, our Chairman; Mike Lamach, our newly appointed CEO; Steve Shawley, our Senior VP and Chief Financial Officer and Joe Fimbianti, our Director of Investor Relations.

Herb will open with a few remarks and then Mike and Steve will review our business results and our outlook for 2010. Then we’ll open the lines for your questions. Now, if you would please go to Slide Three and I’ll turn it over to Herb.

Herbert L. Henkel

Thanks to all of you for dialing in to this morning’s call. For the last 10 years I’ve had the opportunity and the privilege to report to you on our progress and transitioning Ingersoll-Rand from a deep cyclical machinery company to a global diversified industrial company. I think we’ve made some significant progress. We now have great businesses with great people and we have a very strong leadership team. I’m very confident about our company’s future and now I’d like to turn it over to our CEO Mike Lamach who will go over the rest of the call with you.

Michael W. Lamach

I’ll start by saying you set a very high bar as CEO and on behalf of all Ingersoll-Rand employees around the world we want to thank you for your leadership over these past 10 years. You’ve transferred the company in to what it is today and built a strong foundation for us all to build on and personally I’m very honored to have the opportunity to lead the company going forward and truly excited about our collective future. So I’ll turn now to today’s call and I’ll start by getting you some perspective on our 2009 full year performance.

Last year at this time, I know many of you remember, that we expected turbulent markets for 2009 and forecasted full year revenue declines in the upper single digit range. As it turned out the markets were far more difficult than expected and our full year revenues were down about 19% or $3.2 billion from pro forma 2008 results. We offset this sharp market contraction largely by over delivering on productivity and cash flow and full year earnings per share excluding restructuring costs were $1.65 per share.

Total productivity increased by 5.3% for the full year and averaged about 5.6% for the second half delivering $681 million of savings for the year. We raised our Tran acquisition cumulative synergy benefits projection from $300 million to $500 million for 2010 and we completed the first phase of an ambitious restructuring program which will reduce our manufacturing footprint, improve our cost base and greatly improve our capacity utilization and operating margins.

We reorganized our climate and residential businesses which delivers immediate cost savings and makes it easier for us to leverage our capabilities and markets to deliver more value to our customers. We also significantly exceeded our original full year cash flow target of $920 million by over $670 million. We delivered this performance despite the much lower than expected operating earnings through effective cost control and strong working capital management.

This strong cash flow helped to greatly improve our balance sheet. We reduced total financing by $1.1 billion and met our commitment to reduce the Trane acquisition debt by $2 billion by the end of 2009 despite coming up short on our original projections for EBITDA. Additionally, we continued to focus to fund product development and introduced many significant new products during the year. Overall, I’m confident we’re building a strong culture of innovation and continuous improvement and we’re demonstrating that we can execute well regardless of market conditions.

Full credit goes to the many dedicated Ingersoll-Rand employees around the world that made our cash, productivity and share gain initiatives a great success in 2009 while always ensuring that we continue to deliver outstanding value to our customers. We know that there will be bumps in the road in 2010 in some of our key markets and we’re well positioned to generate continued productivity and growth as our markets begin to stabilize and then recover.

Now, let’s talk about the quarter and please go to Slide Four. In the fourth quarter we continued to drive our cash productivity and innovation performance achieving better than expected results in all three areas. While some market challenges continue, we did start to see year-over-year improvements and what looks to be bottoming in others. For the quarter revenues were $3.3 billion, down 10% versus prior year and down 13% excluding currency. Fourth quarter revenues were at the midpoint of our October guidance which anticipated a revenue range of $3.2 to $3.4 billion.

Fourth quarter reported earnings from continuing operations were $0.37 per share and $0.48 per share excluding $50 million of restructuring. There are some puts and takes that I’ll review on a later slide which included a negative $0.40 associated with discrete items. All of our segments except security technologies improved operating margins compared with the fourth quarter of 2008 and total segment margins were up 1.4 points. The decline in security margins was essentially due to an increase in restructuring expenses year-over-year and in geographic mix.

We delivered 5.9% growth productivity exceeding our 5% goal through a combination of tight cost controls, restructuring savings, Trane synergies and operational improvements. We also held or gained share in most of our businesses and continued to develop, introduce new products which will help revenue growth in 2010. We generated $412 million of available cash flow in the quarter and $1.6 billion for the year.

Please now go to Slide Five; before we talk about our business today I wanted to remind everyone that we realigned our business reporting structure in the fourth quarter. This was a major action to complete the integration of the Trane businesses which in the near term will give us improved channel access, help us better leverage our capabilities and markets and reduce costs by about $90 million.

Please go to Slide Six; this is a new slide that shows the year-over-year changes in our monthly order rates. As you can see, order rates started to turn down in the back half of 2008 and plunged downward by 20% to 30% in the first half of 2009. We started to see some moderation beginning in September. November and December were the first year-over-year positive readings we’ve seen since August 2008, some 18 months ago.

Overall, fourth quarter orders were flat although still slightly negative excluding foreign exchange. We see improvements in all segments except security which continues to be more negatively impacted by the decline of commercial construction. Excluding foreign exchange, the positive trend we began seeing in December has continued in to January.

Let’s go to Slide Seven; this slide gives a summary of revenue and operating margins for the quarter. Our fourth quarter 2009 operating margin was 6.7% on a reported basis and was 8.2% excluding restructuring costs. On an apples-to-apples basis, adjusted operated margin improved by 140 basis points despite a $360 million drop in revenues highlight the success of our productivity actions. I’ll go back to the topic of margins and operating leverage in greater detail on a later slide.

Let’s go to Slide Eight; this slide provides a look at the trends in our revenues by segment. We think revenues excluding currency shown on the bottom of the chart give a better view of our organic sales performance and our comments will focus on this measure. As you can see on this chart, it appears that we hit bottom in mid 2009 with some modest improvement in the rate of decline in the third and fourth quarters.

Our residential business which now includes both HVAC and security saw positive growth in both of those components in the fourth quarter. On a geographic basis revenues declined by about 14% in the US and about 11% in our international markets excluding the impact of currency. Equipment revenues declined about 12% on a comparable basis from last year. Worldwide recurring revenues held up better and were off about 4%. Part sales like many of the diversified industrial companies declined in the fourth quarter at a decelerating pace and we are seeing early signs of positive growth.

Please go to Slide Nine; This slide shows how our fourth quarter operating margin improved year-over-year. Fourth quarter segment operating margins were 6.7% which is up about 1.8 percentage points compared with pro forma adjusted 2008 as our productivity programs and lower material costs more than offset lower volumes. By reducing our fixed and variable cost structure and focus on productivity we’re positioning ourselves for continued margin improvements when our markets do begin to recover.

Please go now to Slide 10; Slide 10 bridges the components of our EPS compared with our previous guidance range from October. At that time we indicated that we expected to be in the range of $0.44 to $0.54 per share from continuing operations before restructuring. Our revenue came in essentially on guidance but unfavorable product and regional mix hurt our earnings by $0.05 versus guidance. We achieved higher productivity which contributed an additional $0.03 and the shift towards more earnings in low tax countries outside the US reduced our tax rate [improving] our earnings by $0.05 versus guidance. In total these items contributed about $0.03 above our guidance midpoint.

We also have some discrete items in the quarter which are shown on the slide. We negotiated a favorable asbestos settlement in the quarter which added $0.50 to our results. We also recognized the impact of a January 2010 revaluation of the Venezuelan currency. That cost us $0.05 and we booked discrete tax items of -$0.04. Bottom line, we delivered $0.37 of EPS from continuing ops and $0.48 excluding restructuring. As you can see on the slide discrete items were a drag on earnings and were worth a -$0.04 in aggregate.

Steve will now take you through a review of each of our reporting segments.

Steven R. Shawley

Please go to Slide 11. This slide lists the highlights of the new climate solutions segment and represents the Trane commercial HVAC business and the Thermo King and Hussman refrigeration businesses. Total revenues were $1.8 billion and declined by 16% excluding currency. I’ll talk first about the global commercial HVAC markets and our Trane business performance.

Global non-residential HVAC and equipment markets declined in the range of 15% to 20% in the fourth quarter with significant reductions in the Americas, Europe and Middle East. Asian markets were up high single digits reflecting good growth in China. Our results were a bit better than that because of growth in our parts, service and contracting businesses. I will take you through our orders revenues and backlog.

In the fourth quarter our global commercial HVAC orders continued to decline in equipment. However, we saw increases in contracting and service. I’ll review commercial equipment orders first. In the Americas, our largest market, commercial equipment orders declined roughly 20% ex fx. Europe was also negative. We did see positive order growth in Asia which was up high single digits. In December and so far in 2010 we are seeing some positives.

In North America for example, total commercial equipment orders were flat in December and up 4% in January. We’ve seen particular strength in recent and applied orders which were up 16% in December and up 18% in January and in Unitary the rate of decline is slowing. December orders were down 20% and January orders were down 9%. It is perhaps too soon to say that the market is turning but certainly order performances improved.

Now, let me switch to contracting and service orders which was a good story in the fourth quarters. Orders for contracting and service in North America which is our largest service market by far were up strongly, almost 30% in the quarter. This performance gives us a great starting position heading in to 2010.

Switching to revenues, our global HVAC fourth quarter revenues were $1.2 billion down 10% versus prior year on a reported basis and down 12% excluding the effects of foreign exchange. Total global commercial equipment revenues were in line with global markets, down 19% excluding fx. Americas’ equipment sales were down about 20%. Europe and the Middle East were down mid 20s and Asia was up mid single digits, all excluding fx.

Global parts, services and solutions revenues increased by 2% in the quarter excluding fx. We are benefitting from an uptick in energy efficiency projects and we continue to upgrade our capabilities to sell directly to owners. We ended the quarter with a global back log of equipment contracts, service and parts of approximately $1.3 billion. Global backlog was up 3% on a reported basis. Equipment backlog declined high single digits, offset by growth in contracting.

Current contracting backlogs continued to build and we were up 40% over prior year in the US reflecting the strong increase we saw in orders in the quarter. Globally, contracting backlog increased by about 35%. In summary, we would say that commercial equipment revenues remain weak although we see some improvement in the rate of decline. Servicing contracting look like they are poised to recover in 2010. In addition to our productivity, new product launches and restructuring actions are producing good results and that will put us in excellent position when the markets improve.

For the global Thermo King transport business revenues decreased by 7% which is a significant trend improvement to the 30% year-over-year decline that we saw in the third quarter. Worldwide refrigerated truck and trailer volumes were down slightly compared with 2008 as increased sales from recovering markets in the Americas and Asia were offset by ongoing declines in Europe.

Global bus HVAC shipments and marine container sales both increased substantially due to the easy comps and improved end market activity. TriPac Auxiliary Power Unit volumes declined significantly compared with last year as lower diesel prices and declining fleet revenues have continued to limit conversions in 2009. On a positive note Thermo King orders increased significantly in the fourth quarter setting the stage for improved sales and operating earnings in 2010.

Looking at stationary refrigeration, global sales were down about 33%. This was driven by a decrease in display cases and a sharp decline in the installation business, due to lower supermarket capital expenditures and deferral of expected fourth quarter remodeling projects in 2010.

Climate solutions reported operating margin was 4.9% in the quarter. This compares with 3.1% in the fourth quarter of 2008. The margin improvement was driven mainly by productivity which more than offset the volume drop. Lower restructuring expenses versus prior year was also a positive factor.

Please go to Slide 12; industrial technologies fourth quarter revenues were $591 million down 12% versus the prior year quarter and down 15% excluding currency. Revenues for the air and productivity business decreased by 13% due to lower volumes in all geographic regions. Revenues were down 16% excluding currency benefits. Air and productivity revenues in the Americas declined about 20% during the quarter with a 23% drop in equipment volumes due to declines in major industrial process fluid handling end markets.

Recurring revenues were off about 14% from lower industrial production levels and deferral of maintenance by customers. Air and productivity revenues in overseas markets declined less significantly down by 6% primarily due to declines in industrial activity especially in Europe. Ex foreign exchange, revenues were down 13%. Reported European volumes were down 7% and about 19% in constant currency. Revenues in Asia Pacific were off about 5%.

Club Car revenues decreased slightly compared with last year due to weak economic fundamentals in key golf, hospitality and recreation markets. Year-over-year market share held steady in a historically difficult market. Soft golf market revenues were partially offset by improved sales of low speed electric vehicles.

Industrial’s operating margin of 12.4% is a 1.9 percentage point improvement from 2008. The volume declines and unfavorable currencies reduced margins by four points. Improvements in productivity more than offset the volume decline and in industrial’s case contributed six points.

Please go to Slide 13; the new residential solutions sector which includes Trane and American Standard HVAC product lines and the Schlage Security residential business had fourth quarter revenues of $457 million up 7% compared with last year. It appears that we have finally reached the inflection point of the long down cycle in the residential market and we expect to see improvements going forward driven by increasing residential construction and strengthening of the replacement market.

Revenues for security were up slightly as new products and share gains in the US more than offset a soft remodeling market and a fall off in South America. For the HVAC business we estimate that industry shipments to new residential construction markets were down in a range of 30% to 35% in the quarter and replacement unit shipments increased over 30% combing for an overall increase in motor bearing units in the range of 12%. We believe this growth includes extra industry shipments of R22 systems which are being phased out. Excluding these extra shipments, we believe the market was up high single digits.

Our residential HVAC sales were up 14% principally from higher volumes and mix as we did not participate in the R22 system load in. Operating margins of 7.5% improved significantly compared with 2008 helped by the increase in volume and by significant productivity and cost reduction efforts.

Please go to Slide 14; revenues for security technologies were $454 million down about 7% and down 11% excluding currency. America’s revenues in the commercial sector were down 22% reflecting soft commercial building markets. Security’s European business was up 11% on a reported basis and up about 1% excluding currency. Asia revenues were up significantly almost 50% on a constant currency basis.

Operating margin for the sector was $76 million or an operating margin of 16.8%. Excluding restructuring costs margins would have been approximately 20.7% or only slightly below last year on a comparable basis. Accelerated productivity and strong cost control discipline and prior period pricing actions added seven points to the quarter’s margins and offset the loss of several margin points from volume declines and negative currency.

Please go to Slide 15; let’s switch gears to talk about productivity which continues to be an area of relentless focus. This slide shows a summary of our cost reduction and productivity action for full years 2008 through 2010. As you know, we have challenged ourselves to achieve annual gross productivity improvements of 5% or better every year. This represents a step level improvement to our historic productivity performance so 2% to 3% a year.

In the fourth quarter we achieved $188 million of savings which equates to gross productivity of 5. 9%. For the full year of 2009, we achieved savings of $681 million or 5.3% gross productivity. You can see both the cost and the benefits of our productivity programs on this slide. We expect gross material and labor productivity to reduce our costs by 2.5% to 3% per year in 2010 and beyond.

Our target for Trane acquisitions synergy savings has been increased to a cumulative $500 million including growth synergies through 2010. Breaking this down further, ongoing cost reduction synergies will contribute almost $400 million through 2010 and our already announced organizational structures will add $90 million next year. Restructuring program savings should add another $350 million cumulatively as we complete activities begun in 2008 and initiate new ones associated with improving capacity utilization, consolidating core processes and to focus centers of excellence and accelerating our low cost country sourcing and regionalization programs.

We expect to now achieve an incremental restructuring benefit of $145 million in 2010. Cumulative benefits of $359 million in the restructuring category and the $90 million shown in the organizational restructuring portion of the synergy category which are starred on this slide will require about $280 million in spending to accomplish by the end of 2010. Our productivity focus is expanding to all aspects of our company and are simply becoming a way of life.

Please go to Slide 16; this slide shows our next big productivity opportunity and that is to significantly improve our manufacturing capacity utilization. As you know, in addition to Trane we did many small acquisitions over the last 10 years. The result of these acquisitions and the current economic downturn mean that in 2009 we had overall capacity utilization of about 30%. We also have experienced unacceptably high levels of unabsorbed overhead in the range of $50 to $60 million a month.

We completed a corporate wide study in 2009 and started to take actions in 2009. Over the next three years we plan to complete the process of optimizing our capacity footprint. These actions should raise our utilization rates to a level of 60% to 65%. A return to more normal economic activity will drive utilization rates even higher allowing us to achieve very attractive leverage rates as production volumes increase.

We see pretty significant benefits from this initiative. First, we will reduce our cost base at today’s volumes. Second, our profit on incremental volumes will be in 35% plus margin range and third, we can direct more new investments to innovation and new products rather than investing in brick and mortar.

Please go to Slide 17; in addition to our productivity programs, we continue to make significant investments in new products and services. Close to $2 billion of our 2009 revenues are from new products and services introduced in the last three years with a number of new offerings in each of our businesses. We invested over $500 million this year in R&D, engineering and cap ex not including marketing and promotional expenses which drives both innovation and value engineering programs.

This slide highlights four significant new product areas. Reinvesting in our business is critical to our future growth and we have a full pipeline of products and services, many of which are synergistic and combine capabilities across our businesses. Many of these offerings are unique to Ingersoll-Rand and will continue to strengthen our market positions.

Please go to Slide 18; as we have discussed on many occasions the need to deleverage the company in the face of a very difficult economic conditions has been and will continue to be our top financial priority. I am extremely pleased to report that due to the unprecedented $1.6 billion of available cash generated we have been able to reduce total financing by over $1 billion while maintaining cash balances of around $900 million.

The outstanding commercial paper balance has remained at zero since the end of the third quarter and are liquidity cushion is still at $2.25 billion. We ended the year with total financing of $4.1 billion which equates to a total reduction of almost $1.1 billion for the year, a number that is well above our $675 million deleverage goal that we had set at the beginning of the year for 2009. We also had reduced our total net financing by $2.1 billion since the completion of the Trane acquisition in June of 2008 which is slightly ahead of the rate of deleverage promised prior to the acquisition, in spite of the lower levels of EBITDA resulting from the severe economic downturn.

Please go to Slide 19; at the beginning of the year we were confident that working capital reductions could be achieved given the soft markets but we’re really not counting on creating a whole new standard of performance Ingersoll-Rand. The managements’ focus on cash management has been intense. The results allowed us to outperform our cash targets this year, but to also raise the bar for working capital performance in the future. We finished the fourth quarter with working capital of 2.2% of sales, less than one third the level a year ago.

The biggest performance improvements have come in inventory turns, receivables and payable days outstanding. Receivables DSOs improved significantly in the fourth quarter and [inaudible] continue to be a drag. Only about 35% of the total $847 million reduction in working capital was related to the decline in volumes. The lion’s share was due to better processes.

Underling improvements that have been made in manufacturing, systems and processes, footprint restructuring and supply chain and logistics management are paying off in the form of lower working capital as a percentage of sales. We believe that these improvements are sustainable and will help maintain future working capital to sales ratios in the low single digits even as volumes improve over the next few years.

Please go to Slide 20; this chart provides a lot of detail on the makeup of our available cash flow. We showed this analysis back in February at our analyst and investor’s meeting as a road map of how we were going to generate the $920 million of cash necessary to meet our deleverage goal of $675 million. Today, this analysis shows what has been done in the face of lower than planned earnings to drive the generation of cash. To date, working capital has been reduced by $847 million. This focus on working capital and the efforts to effectively manage our cash taxes produced the available cash of almost $1.6 billion and we expect approximately $1 billion in 2010.

With that, I will turn it back to Mike for the forecast.

Michael W. Lamach

Let’s go to Slide 21; one year ago we saw significant downward shifts in many of our major end markets. Many of those markets appear to have bottomed in the second half of 2009. Fourth quarter order rates were flat compared with last year and notable improvement compared with the double digit year-over-year declines in the first three quarters of 2009. Our forecast for 2010 continues to call for a slow recovery in the US and Europe and mixed activity levels in our major verticals and end markets.

We’re operating with what we believe is a conservative base line for 2010 consistent with our most recent readings on our end markets. Let me start by reviewing the updated economic assumptions behind our 2010 forecast. This slide is an updated summary of the key economic and business metrics for 2009 and forecasts for 2010. For US construction, residential building markets appear to be bottoming at very low levels compared with 2006’s peak.

Non-residential construction is expecting a single digit reduction in contract value and square footage. The outlook for non-residential building deteriorated through 2009 as a slower economy and tighter credit negative impacted starts. This ongoing soft non-residential construction will impact our commercial HVAC equipment and security businesses.

The Refri trailer market in North America and Europe appear to have reached their inflection points. Order rates have solidified over the past three months and recent order rates indicate that the North American market could reach 26,500 units in 2010. European Refri truck and trailer markets are expecting a weak uptick in 2010 as well.

Industrial production and capacity utilization had a major drop off at the end of 2008 and the first half of 2009. We expect these markets to gradually improve through 2010 and support low to mid single digit revenue growth. We would also expect moderate growth in Asia. Finally, our forecasts based on a dollar to Euro ratio of $1.41.

Please go to Slide 22; based on this macroeconomic view we expect revenues for full year 2010 to be up 2% to 5% compared with 2009. We expect industrial and residential to show gains in the mid single digit range as markets recover. Climate control revenues are expected to be up slightly with declines in HVAC equipment and gains in refrigeration, contracting, parts and service. Security is expected to show a year-over-year decline due to its exposure to non-residential building and this results in a 2% to 5% full year growth for all of Ingersoll-Rand.

Please go to Slide 23; this slide bridges our pro forma 2009 performance with our 2010 forecast. Starting with 2008 at $1.65 per share from continuing operations, we expect to generate approximately $1.65 to $1.70 per share in benefits from productivity actions, restructuring savings and the acquisition synergies. Total inflation of 3% will be a $1.00 to $1.10 drag on earnings and aggregate currency, investments, interest expense, a higher tax rate and a higher share count will cost us $0.35 to $0.40. Price volume and mix should contribute $0.40 to $0.60 more than offsetting these items.

Total EPS for the continuing operations forecast will be $1.95 to $2.35 including a $100 million of restructuring expense and $145 million of non-cash amortization charges. Excluding restructuring costs, EPS from continuing operations is projected to be $2.20 to $2.60 per share which is a $0.20 higher range than what was projected in our original 2010 earnings framework of $2.40 per share.

Please go now to Slide 24; in summary we’re forecasting 2010 revenues up 2% to 5% and total operations EPS up 50% at the midpoint. First quarter revenues are forecast up 2% to 5% as well as the economic recovery remains sluggish and the North America non-residential construction markets condition to decline. Reported EPS from continuing operations for the first quarter are projected to be approximately $0.10 to $0.15 on a reported basis, up substantially from last year when we incurred a loss of $0.06.

The first quarter results will include $25 million of restructuring and $36 million of amortization expenses. To sum up, we expect 2010 to demonstrate some modest revenue growth and significant earnings growth as we continue to deliver on productivity, introduce new products and strengthen our presence in major markets. We remain focused on programs which will make us a better performing company at all points in the economic cycle.

We’re delivering cost synergies and now expanding our growth synergies as well. We’re organizing our business to take better advantage of market opportunities while realizing savings from restructuring and our target productivity at the 5% level. We’ve solidified our balance sheet in 2009 and are working to further reduce our debt balances in 2010. We’re dedicated to generating over $1 billion of available cash flow and we’re planning to invest in innovation to fuel growth in to the future.

That concludes our formal comments and we would now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Terry Darling – Goldman Sachs.

Terry Darling – Goldman Sachs

Mike, I was wondering if you might be able to help us with margin expectations by segment for the first quarter and then for the full year. Obviously the first quarter guidance relative to consensus, the revenues aren’t too far off but I think people are trying to understand a little bit better the sequential margin performance there. And while you’re at, maybe we can talk about that on the full year basis too?

Michael W. Lamach

I think I’ll start with climate solutions and take a look at Q1 there and all this is going to include restructuring and purchase price accounting so I’m giving you a net number here. We should see OI in the 3% to 5% range. When you move over to industrial I would look for that to be closer to the 8% to 10% range again for quarter one. Residential probably looks a lot like climate solutions probably in that 3% to 5% range. Security technologies, typical of that business, it will be a lower first quarter and somewhere in that 15% range there.

On the full year, of course volumes come back, particularly in the climate business pretty dramatically in Q2 and Q3 so as you look at full year you’re looking at climate probably in the 7% to 9% range. Industrial in the maybe 9% to 11% range. Residential probably 9% to 10% and security 17% to 19%. There’s an example, we’ve historically talked about that business being 18% to 20% but again remember it’s about a point of restructuring that we’ll see in security throughout the year and so that’s where we get the 17% to 19%.

Terry Darling – Goldman Sachs

Against, just thinking about the sequential drop in EPS overall excluding restructuring but including amortization, relative to kind of normal seasonality, I know the world is still kind of in this mix between thinking sequentially and year-over-year but particularly in the margin outlook, what is different from normal seasonality as you go through all those segments? It looks like maybe climate solutions a little bit but I’m not adjusting for the restructuring piece in there. I’m just trying to think about what’s abnormally down seasonally here to create that stiffer decline in EPS overall.

Steven R. Shawley

Let me try to take a shot, just put the whole enterprise in perspective before we dig in to the pieces. If you look at the enterprise and you triangulate the first quarter a couple of ways. The first thing you look at is quarter one ’09 versus quarter one of ’10 and where we are there is the roughly midpoint of our guidance for ’10 the revenues are up like $90 million. So if you look at what happens to OI even considering the fact that there’s more restructuring in the first quarter of 2010 than there was in 2009, that’s about 100% leverage.

The OI has to leverage at about 100% of that revenue delta to get to roughly midpoint of the guidance that we gave you. If you triangulate from the fourth quarter of $3.3 billion, the midpoint of revenues would be a little over $3. So the fourth quarter leverage down if you consider the fact that inflation is going to be a little higher, the fact that foreign exchange is a little bit worse in the first than it is in the fourth and we leverage down on that $300 million of revenue by about 35%.

Now, if I take you in to that 35%, that might be a little bit high compared to what we have been leveraging down in the past and what you find is we probably have a pretty serious impact of the security commercial business in that mix. But, it’s not unusual relative to the seasonal profile that we would typically see first quarter versus the rest of the year. For instance, if I can look at first quarter compared to where the second and third quarter would normally be to hit the guidance range of revenues we’ve given you, we would see a $600 to $700 million increase between first and second and maybe third quarter type ranges off of that $3 billion base.

When you look at what $600 million does at a 35% leverage, that’s somewhere around $0.55 a share. You can kind of see how you triangulate the first quarter at the enterprise and then how it builds back up because of the seasonality you would see in the second and third quarter. What would drive that would be the fact that our service businesses are much higher in the second and third. You see some of the businesses that are turning around.

Typically the second quarter is a strong quarter for Thermo King for instance and we’d expect some of the businesses that we are looking at on a leading edge here kicking in in the second and third quarter period. So that’s kind of the profile at the enterprise level. We do have a little bit of mix because some of this non-residential construction impact, particularly on our security business has a bit of a negative mix for us going in to the first quarter.

Terry Darling – Goldman Sachs

Just maybe tag on one last one and that’s just with the balance sheet strength here can you take us through an updated thinking on use of that strong balance sheet and free cash as you move through the year. It doesn’t seem like you’ve got anything built in to the full year forecast there but maybe you can true us up on that point too.

Steven R. Shawley

Really, the story has not changed. We’re committed to really putting back in to our BBB+ ratings. We have to get our debt to EBITDA in the 2.0 range okay. Again, the way we’re going to that is we’re going to pay off the maturities that are coming due in 2010. We’re going to be looking at what our plans would be for 2011 to see if we can get back to that 2.0 sometime in 2011. That’s absolutely the total focus that we have at this point in time.

I think once you get in to 2011 and take a look at the amount of available cash at that point in time then you kind of go back to all the things that you take a look at relative to capital allocation. Everything from reviewing our dividend policy to looking at some minimal share buybacks to control dilution, possibly bolt on acquisitions, etc. That story has not changed.

Operator

Your next question comes from Robert Wertheimer – Morgan Stanley.

Robert Wertheimer – Morgan Stanley

My question would be on the applied side, if I heard right I think the orders sounded like the were really strong in December and January. So, did I hear right? Is there some sort of comp issue that they were just extraordinarily bad off the comp? Then I guess I would have expected applied to be one of the areas of weakness.

Michael W. Lamach

It’s interesting because one of the surprises that we had in the fourth quarter is we really got to the total equipment number. We thought we would get there with applied being stronger than unitary and interestingly it slipped, it slipped the other way and typically the mix works better for us when it’s a little higher applied in terms of leverage on that. So that was a bit of a surprise for us.

I guess the flip side of the order rate you’re correct it was higher and it’s going to be higher in January. The outlook we have because those are typically longer lead products in terms of loading in our plants looks really good for the quarter. We feel like it supports the forecast that we got out there. Unitary, I think it’s going to continue to be relatively weak for us. Applied I think is going to be a good story.

But actually Rob, the way it’s kind of working is some of these larger institutional projects, some of these projects that involved chilled water planets in particular are starting to move again for us a bit. So that was a pleasant surprise for us in December and January.

Robert Wertheimer – Morgan Stanley

Can you sort of describe on those orders, the pricing environment and whether you think you gained share or whether you think it’s that end of the market is just that much healthier on stimulus?

Michael W. Lamach

We launched the new [inaudible] product in August. We’ve seen share gain in HVAC business and we’ve turned that around after kind of a six, seven year decline. That’s been great. We’ve talked about that, we expected that to happen, the team has come through on that. We also localized for Asia and product. The applied chiller business is now in China for the Asian market and so we’re manufacturing screw chillers there now. We’re moving some [tripicals] there as we speak so we’ll really be in the region of use. That’s providing sort of 12 to 15 point margin bumps for us by putting that in the market that it’s serving so that has been positive.

It’s also helped us gain some share there as well. We had great activity in China. We’d say we picked up share there as well as a result of that screw chiller product going in which is really the number one product going in to that market.

Robert Wertheimer – Morgan Stanley

I’m sorry if I’m still on this but just the pricing on that applied side, is it still okay?

Michael W. Lamach

Yes, it’s good in applied. As you get towards the light unit series side it gets a little bit tougher but I think it’s behaving well. Commodity costs they were down, copper was down I think a nickel today, I think two days ago it was up $0.10. Those are big swings for us. When you look at sort of the uncertainty kind of coming in to that I think the behavior from companies like us is to expect a little more inflation and price accordingly. You’re not seeing any real bad behavior out there on that side of things.

Operator

Your next question comes from Nigel Coe – Deutsche Bank.

Nigel Coe – Deutsche Bank

I just want to dig in to the 1Q and the full year phasing. Steve, going back to the math you put out there, let’s say $0.20 for the first quarter and let’s say $0.50 pick up from 1Q to 2Q, it seems to imply the 4Q has to be at a level in line or greater than 3Q and 2Q which doesn’t feel right so is that how you think about the year or am I missing something?

Steven R. Shawley

If you look at how it will play out Nigel, the two big quarters are going to be the second and the third quarter. Again, you get the benefit of the volume there because you look at second quarter being up $600 to $700 million from first and third quarter is roughly the same, maybe slightly more, maybe $700 to $800 million up from the first. So you get not only the leverage on the volume there but also those are our two biggest quarters from a service perspective. Some of this contracting backlog is going to fall through during those periods of time so we expect the peak of our earnings cycle to be in the second and third quarter. Fourth quarter I think would be up incrementally from fourth quarter this year simply because of the fact that we’d expect our revenues to be up slightly from year-to-year.

Michael W. Lamach

Nigel, I’d probably add to that I think we’d see our strongest productivity quarter in the fourth quarter so I think that’s a bit of a pickup. In the last 60 days we’ve announced closure of six of our plant facilities, three in North America, two in Europe and one in South America so we’re moving on that and we’ll be through a lot of that transition as you get in to Q3 and in particular Q4.

Nigel Coe – Deutsche Bank

So just to clarify the pick up from 1Q to 2Q should be greater than $0.50?

Steven R. Shawley

It should be around that midpoint to midpoint.

Nigel Coe – Deutsche Bank

Then, the chart on the capacity utilization is interesting. What is your bottom growth assumption to get to the 60% range by 2012? Do you think it’s possible to maybe accelerate restructuring and get that quicker? What is the volume assumption to get to that 60% range by 2012? I mean is that on flat volumes or is there a volume assumption built in there?

Michael W. Lamach

Utilization? Yes, it’s on flat volumes. What we’ve said is that if we just size it for the volume today we know we can roughly double capacity. The reason it’s 60% to 65% is we’re leaving room for growth and so I think as most people know once you get in the high 70s and 80s on a five day a week two shift, kind of even a 20 hour day relative to doing maintenance it gets pretty tight so 65% to 66% would double kind of utilization leaving room for growth. That growth is consistent with our long range plan over the next three years.

Operator

Your next question comes from Jeffrey Hammond – Keybanc Capital Markets.

Jeffrey Hammond – Keybanc Capital Markets

I applaud you guys for moving away from the ex restructuring but just so we can see kind of apples-to-apples and you mentioned I think security Mike but can you run through where you think the margins get impacted by restructuring by business? I think you said for instance a point of restructuring in security?

Michael W. Lamach

Jeff, let’s take a look and see if we can do some of that for you. The point security is probably sort of the most notable and it was the most notable in the fourth quarter. It was again about four points. It’s relatively across the board. Steve, I don’t know if you’d have any other comments on that?

Jeffrey Hammond – Keybanc Capital Markets

Maybe if you want to dig in on that I can ask a quick follow on? As you look at the bridge you’ve got this $1.00 to $1.10 of inflation, how much of that is really commodity inflation? Then, within kind of price/cost mix, how much price do you have built in?

Steven R. Shawley

We look at sort of the non-ferrous and steel commodity portion probably to be up about $80 million year-over-year. Again, as I said on the call it really moves. It can move $20 million in a week right now with what we’ve seen on copper. As it relates to sort of all insulation you’re looking at labor and other inflation on other direct material, you kind of get in to that sort of $180 million range for material and probably about the same for other inflation. So with inflation we’re still thinking close to 3%. It kind of fits the 3% inflation model that we gave you earlier.

In terms of price, in the fourth quarter we put in place and did a lot of analytics and diagnostics around pricing. Interesting around price is again, as many people know, raising price doesn’t always mean increasing price it means you’ve got to take a look between your price and your net, sort of where do you leak it out. We’ve done that across each of the businesses by region, by business and have put a plan in place to really address that for the year. We’re going to attack that like we did productivity and cash.

So through that were looking at basically covering about one point of price. Now, ideally we would like to cover all of direct material inflation so we’ve put a challenge out there to the teams to kind of look at that and maybe even do a little bit better.

Operator

Your next question comes from Stephen Tusa – JP Morgan.

Stephen Tusa – JP Morgan

Did you say a point of price? I’m sorry I missed that.

Steven R. Shawley

About a point of price.

Stephen Tusa – JP Morgan

Positive price for the year?

Steven R. Shawley

Correct.

Stephen Tusa – JP Morgan

Then on that slide, just following up on Nigel’s question, the slide about the capacity utilization, what was that in 2008 or whatever the peak was, 2007?

Michael W. Lamach

The portfolio was so different back then as you can remember for us that it really wouldn’t make any sense. I would tell you that I would think at that point in time the best we can tell we would have been in maybe the high 40s range as near as we can go back and tell or the time we want to do that, we’ve really kind of zeroed in on that. Now, as we brought in Todd Wyman and we’re focused on the restructuring projects on uniform metrics across the businesses and in really getting out to see sort of the major facilities, we’re probably finding more capacity still so we would have thought probably four to six months ago we were in the 35% range. We’ve found more. We’re absolutely sure that we’ve found more and that’s a good thing on one hand but clearly we’re probably closer to the 30 as we stand.

Stephen Tusa – JP Morgan

Mike, obviously you’re coming in to this position, clearly if you’re running at 40% capacity utilization at the peak of the cycle, how do you make these changes with the kind of the same management teams in place? I mean it just seems like that is gross mismanagement and it’s kind of hard for one guy to drive that much change throughout an organization. Do you think we can do this with the standing personnel or are there the more significant changes you have to make going forward? The last question would be are we now dialing in this restructuring in to the consensus number? You know $50 to $60 million over the next few years so that’s now going to be part that we’re not going to be doing adjusted EPS anymore? Is that correct?

Michael W. Lamach

Yes, you’re correct on that point. I would also tell you you’re going to get a heavy dose of this in May when we get together and we’ll talk in more details around the utilization plans. First, I’m going to tell you I’ve been here six years and I’ve worked with a lot of people in the organization and we’ve got great people, it’s not an issue around people. We had such despaired businesses it was very, very difficult, the [movies] process is in a common location, we do not have despaired businesses for the most part at this point. We can move precision machining, we can move assembly operations, we can move mending bending and we’re doing that across these businesses.

There’s a plan. We have put some leadership in place across sort of the top of the company and within the sectors sort of leading the sector charge. It’s more aligned than it’s ever been before. I think people are relieved that we’re taking action with it so that’s where we are and that’s the opportunity.

Steven R. Shawley

Steve, just to add one thing to Mike’s comments about where we find ourselves. We’ve done over 60 acquisitions in the last 10 years and they were all bolt on small places. If I were to show you the chart of how those factories line up, we have very, very few factories are what I’d call operating in the optimal zone. In other words they’re just all too small, they all have a plant manager, they all have back office functions, etc. So that’s a product of how we’ve built this company not so much a product I think of any individual management style. So now as we have solidified the footprint with the Trane acquisitions, we’re in a much, much better position to take on this as an optimization opportunity and get that fixed as we go forward.

Michael W. Lamach

Hey Steve last point and I think it’s a good point to raise for others as well, when you look at the data that is put out from the government regarding cap utilization, at companies reporting that data, when we look at that it’s really a five day a week 20 hour a day two shifts and maintenance. So again, as you go from company-to-company and compare that metric for us is five days a week, 20 hours a day.

Operator

Your next question comes from Jeffrey Sprague – Citi.

Jeffrey Sprague – Citi

Just a couple of things to follow up on the whole restructuring idea, you’ve spent I guess about $450 million on various restructuring actions in ’08 including what you’re doing in 2010 to accomplish what you’ve done so far but now you’re talking just $50 to $60 million annually to get at the rest of all this capacity. Am I comparing those numbers right? Is that kind of a comparative thought and why would the dollar amount to get at the rest of this be so much lower?

Steven R. Shawley

Let’s get the numbers right, I think the total spend the last three years on restructuring projected to through the end of 2010 Jeff is like $280 million. If you look at Slide 15, it’s $280 and it’s driving roughly $450 million worth of benefits. So I think that helps you with your thinking a little bit. We think the way we’ve been doing these are very much high priority projects that have very quick turnarounds. If you take a look at doing these in the face of increasing volumes in our factories, we think the turnaround or pay off is going to be even quicker. We’ve had some pretty good experience with the restructuring programs so far. We’re projecting similar kind of experience and performance going forward.

Michael W. Lamach

Jeff, we front loaded those projects. As Steve said in 2009 they were projects that would pay back in a year. As you look at 2010, 2011 we’ve got now a little bit of momentum and carry forward. We’re getting in to projects that are 18 months and two years and some of them might even be longer that need to be done. So one of the nice things about giving you net guidance now is we’ve got more stability and understanding what the carryover is, what the spend is and feel more comfortable being able to give you that net guidance.

The other thing too is, and I think Nigel asked a question could you be more faster, the reality is we’re really trying to protect customers, protect share, we’re trying to manage within ourselves here in terms of the change. This three year plan is pretty linear in terms of what we need to do and how we’re thinking about it and we’ve put in place a program management office under Todd to help us execute and support these businesses where there might be a stretch with some of the change as well. So we’re comfortable with what we’ve got here over three years.

Jeffrey Sprague – Citi

Is that $50 to $60 million you think kind of steady state ongoing for the company or would it throttle back a little bit more once you’ve got all this accomplished?

Steven R. Shawley

To be honest with you if we had our druthers we’d spend more earlier and Mike addressed that point I think very well. We think that $60 million is going to be ongoing through the foreseeable future Jeff and it’s the main reason we wanted to incorporate the restructuring spend inside of our guidance going forward.

Jeffrey Sprague – Citi

Just one other question, could you just elaborate a little bit more on the pickup in service orders? Do you think it’s stimulus related, is it energy efficiency related? Does it tie to any particular vertical markets? Whatever color you could give there would be helpful.

Michael W. Lamach

Jeff, it definitely does not tie to stimulus, I would tell you that. We’re just seeing – I think even McGraw-Hill said $120 billion that was originally forecast, they may see $1 billion out there across the whole pipeline from concept all the way to complete so that’s not the case. We’re seeing it in energy efficiency, we’re seeing it in the contracting business. Typically they’re going to be turnkey contracts where we’ll go in and replace chillers and ancillary equipment as the turnkey contractor so that the equipment flows through the contracting sort of project management aspects of that.

The controls element, that’s the business that Steve in his comments mentioned is booming and backlogs are up say 40%. It’s exciting, people want to know sort of - the questions last quarter and the quarter before when we told you it was building was when does that start to spend and we’re starting to see that in the first quarter where we start to get these high single digit, maybe even double digit boosts coming out of that revenue stream and it will build through the year. So these contracts will go from it could be on the short end four to five months long to it could be 18 months.

Jeffrey Sprague – Citi

Booming isn’t a word we have heard too frequently so it sounds like people were sitting on this stuff trying to get to a certain level of economic comfort and then just started pulling the trigger?

Michael W. Lamach

These are complex jobs to put together. You’ve got to prove sort of engineering and analysis, you’ve got to go through the building modeling, you’re typically selling it at an executive level on a return on invested capital type equation and so it might take you six months to put together a project like that and I would say it started at the sort of summer time in the worst of what we were seeing in the economy and now you’re seeing the benefit of that come through in terms of orders and execution and I think it will continue.

Operator

Your next question comes from David Raso – ISI Group.

David Raso – ISI Group

I’m trying to look out to ’11 a little bit in some of these utilization initiatives, the productivity numbers you’ve used in the past about 5% was the goal. With these utilization activities are we thinking of that’s a number that will be going up especially looking out to ’11? Because, if you take the ’10 revenue guidance, every 1% incremental productivity gain in ’11 adds $0.30 a share or am I missing the point the point that some of the synergies that we’ve had from the Trane acquisitions and other activities begin to slowdown by the time you get to ’11?

Steven R. Shawley

I think that’s the way to think about it Dave because what we want to do is really kind of a three pronged approach here. First of all that ongoing rate of productivity is coming from material productivity, VAVE, that base range of 2.5% to 3% has got to go up and as we’re building the capability and the personnel and the resources to do that, that’s a piece that we’ve got to see increase in the longer term. There’s no question that the synergy savings will fall off. I think it will start dissipating in to gross synergies.

The main reason we formed climate solutions and residential solutions was to now shall we say institutionalize the ongoing synergies. So, that piece is going to be much more of a growth synergistic opportunity as opposed to cost by the time we get to 2011. But, what starts ramping in to offset some of that is the footprint management so we would expect to see 5% gross productivity in to the foreseeable future because of those dynamics.

David Raso – ISI Group

Just to be fair though I think this is still an industrial company capacity utilization rates are pretty powerful on earnings. Yes, you’re losing some synergies but if your capacity utilization can improve that much, not just from the typical volume improvement but truly structural change, wouldn’t you think there was an upward bias to it? I assume you’ll go through this in a lot more detail at the spring meeting but can you at least articulate a little bit at this stage how you’re thinking about the restructuring benefits when it comes to capacity utilization?

Michael W. Lamach

We’ve always said that we believe we’re going to get to 15% operating margins for the business. You start looking at the pieces of that over time and we’ve said if we can get utilization to where we need it to be it could be three to five points of margin. If you look at this sort of whole top line margin expansion initiative we’re kicking off that could be a couple of points as well. If you start putting the pieces together we need these things to happen. Probably as important as anything and maybe more importantly is you’ve seen a pickup in innovation spending actually even in Q1, this $0.04 of incremental investment spending in Q1 around product and service innovation and that’s the other piece of this thing that we’ve got to get working as well.

David Raso – ISI Group

To your point about 15%, I know it’s a kind of big picture goal but if you just take on ’11 some improvement in the economy, non-res is less of a drag and let’s say we can look at a year following with a little bit of volume, you get revenues up 10%. As you get your margins up to 10% you’re over $3 of earnings. But to talk 15% and not even be up to 10% by ’11 would seem to be a little inconsistent. Am I miss reading how we should be thinking about margins in ’11 getting to double digit already?

Michael W. Lamach

I mean we’re grinding out a couple of points here in 2010 and sort of the hard work you’ve got to do on a capacity utilization side is in productivity really grinding out another net margin points in 2011 and that’s sort of the pace and the mach that we’re on.

Steven R. Shawley

I think kind of the way to look at it is what we’ve said this year on the guidance is that we believe that 5% is doable. What the wild cards are is obviously the volumes but the inflation as well. We’ve built in a healthy dose of inflation in to our guidance for 2010 so you’d expect going forward that net increase in margins should be in I’d say 1.5% to 3% range with a 5% type of a gross productivity and it’s all based on what we think the commodity inflations are going to do.

David Raso – ISI Group

Could you just clarify again the price versus cost gap again to just make sure I heard it correct?

Michael W. Lamach

If you look at sort of the price side, we want to get a point out of 2010 and if you look at sort of how that matches up against direct material inflation, we’re not quite covering that. Direct material inflation is going to be about 140 basis points, price is about a point so we’ve got a little work to do there even to cover direct material inflation.

David Raso – ISI Group

But I don’t want to look at price as only having to cover my material cost, I need price to cover all my costs. Your cost pre-tax is like 4%.

Michael W. Lamach

David, we’re on the same page but with the over capacity right now in the industry if we can get sort of the market to behave with positive pricing, that’s going to be a step in the right direction. We’re in now way settling for not covering direct material inflation or even covering all of inflation. But, as we go back over five years we haven’t done that so this is going to be a very problematic approach that we’re going to take across the business. This is going to be a major focus for us in 2010.

Operator

Your next question comes from Mark Koznarek – Cleveland Research Company.

Mark Koznarek – Cleveland Research Company

I had a follow up question on the HVAC contracting business. You spoke about that a minute ago. I imagine that that stuff eventually when you say it comes to fruition anywhere from four to five months to 18 months, that pulls in a lot of equipment sales I imagine and what I’m wondering is what kind of visibility in terms of proportion of the overall HVAC business can you view via this contracting activity?

Michael W. Lamach

Mark, when you take out the resell revenue that we get typically when we do customer contracts you get a service business in the America’s that is probably about 40% of the total. Contracting, the way we measure it is just the contracting portion of that and typically contracting for us has been a third of that but it’s growing quite rapidly so it’s very, very quickly moving up the mix. We pull the equipment through at great rates. We measure that in the equipment number so when we’re giving you a contracting number it’s really sort of the non-equipment portion of what we’re doing.

We only do it when it pulls through equipment. We really don’t do contracting and turnkey and performance contract work where there isn’t our own equipment going on contract or a healthy portion of our equipment. That’s really the value that we’ve got.

Mark Koznarek – Cleveland Research Company

I understand that Mike, the question I guess maybe to state it more clearly is your contracting business pulls through OEM equipment and your OEM equipment on the commercial side accounts for roughly 40% of your HVAC business. How much of that is pulled through via contracting?

Michael W. Lamach

So it varies wildly. The smaller the contract the higher the equipment pull through, the larger the contract the more subcontracts or managing more project management. So Mark, number one it’s going to be a pretty while number. If you looked at it probably in aggregate again, it’s going to depend on the mix and size of the contract, you probably get 30% to 40% pull through equipment coming off of contract. So every dollar, you’re pulling through $0.30 to $0.40 of equipment through that.

It’s a wide variety Mark, these $40 million contracts we’ve booked, they’re going to have maybe pull throughs of 8% to 12%. You get a $150,000 to $200,000 contract you can be pulling through 80%.

Mark Koznarek – Cleveland Research Company

Then the second one you mentioned, just real briefly stimulus and it sounds like you’re underwhelmed with the progress on that and I know a quarter ago we were talking about $6 billion rolling out over three years and you were hoping to get a third of it. Can you just update us on where that stands specifically?

Michael W. Lamach

We took the $120 million and we used a usage factor of 5% and we got to the $6 billion. I remember when we talked about that, we never included any of that. We said we’re not going to include any of it in our 2009 forecast, we’re really not even thinking about including it in 2010. I’m kind of glad we didn’t do that because it really isn’t spending that way at all. It’s a fraction of what we’ve seen. We’ve probably done something in the neighborhood of $100 million that we can attribute to that. It will probably be a little bit better than that 2010 but it’s not really been a meaningful aspect of our business.

Mark Koznarek – Cleveland Research Company

So we’re not really expecting a big loaf to drop in out of the sky this year?

Michael W. Lamach

No. I mean if it does I think as you know, plenty of capacity to handle it but no I don’t see us counting on that.

Mark Koznarek – Cleveland Research Company

Then finally, is there a date for the spring meeting?

Michael W. Lamach

May 12th.

Operator

Your next question comes from Daniel Dowd – Sanford C. Bernstein.

Daniel Dowd – Sanford C. Bernstein

I wanted to follow up on the hidden factory excess and the capacity utilization that you’ve been talking about. One way to improve the results is actually to compress the square footage but there’s other implications as well. You could have a systematic effort to be moving things offshore, that has cost implications even at the same level of capacity utilization and also probably as tax implications. Do you have a sense of how much of this is all shall we say constant geography and how much of it is likely to move things across geographies?

Michael W. Lamach

Daniel, that’s exactly what we’re going to lay out for you in May and the answer is yes and we have that and that’s what we’re going to lay out for you in some detail as to how we see that. Square footage really isn’t the only way or even a great way of measuring utilization because it’s really around tax time and it’s around cycle times inside the facilities. We’ve got to handle both, we’ve got to reduce rough tops because we’ve got too many but there’s also around process excellence within that.

We put in place a program across the company called gap to excellence where we’re going and really doing a lot of these studies around theoretical and actual performance looking at gaps and kind of tackling it one product at a time. At the same time, the strategy around low cost country sourcing expense really to get to a region of use. What we make often times is fairly large and cumbersome. Think about a chiller or a big air compressor putting that in a region where you sell it is critically important plus you got the labor benefit of that as well.

As we develop suppliers in these locations there’s the added benefit of being able to develop a supplier and often times send a part back where we might be buying it locally and we’re looking at that as well. It’s a combination really of all those things that I would tell you are baked in to this plan.

Daniel Dowd – Sanford C. Bernstein

Let me turn to one other issue briefly, when you talk about reinvesting in the business, it says in the slides a targeting of $2.5 billion of revenues from innovation in 2010. Now, that’s something like 19% of your revenue in 2009. How much of this is actually incremental? Presumably some of the things are dropping out of your portfolio and are being replaced by this?

Michael W. Lamach

These are not. In other words, what we’re looking really is things that – actually three year innovations, of course they drop out after three years and so if it was a big innovation and we’ve had it happen before where the number actually may dip a point. But, what it is is a three year cumulative total. We only look at it in a very specific way, there’s a matrix we look at to define if it’s a A, B, C or D project. Whether it’s a new product to a new segment or an existing product to an existing segment, we have ways of categorizing that and rules in place.

So there is rigor around how we do that. We have every sector, every business reports on that and we have a definitive long range plan through 2012 about where we want that number to go. We’ve been pretty vocal about that, we want to see that up in the 25% range in the 2012 and frankly, that’s not world class. We’ve got lots of room beyond that but getting that moving in terms of those investments is critical for us.

Steven R. Shawley

In fact, it’s very important if you look at we’re trying to improve the ratio of what is not replacement revenues. In other words, how can we drive more incremental and that’s why we keep track of it the way Mike described it. To a large degree these new products are offsetting what’s in our base but we are focused and we have metrics in place to try and drive the incremental piece specifically.

Operator

Your next question comes from Andrew Casey – Wells Fargo Securities, LLC.

Andrew Casey – Wells Fargo Securities, LLC.

Most of the questions have been answered but I wanted to go back to the 2010 guidance. In the release you commented about contingency plans if markets are beneath what you are expecting. If you could use Slide 23 can you talk about what variables could improve to offset in the event of lower volume leverage?

Steven R. Shawley

I think the lever we have been able to push the hardest is cost control. Obviously if you take a look at the achievement of the productivity this year, we’re on a roll. We have already geared up for the restructuring program so we would just do more than that. That would be our first choice. I think if you were to take a look at the amount of opportunity we have here to not only reduce our cost but also to control inflation. It would primarily cost driven moves we would take to protect us on the downside.

Andrew Casey – Wells Fargo Securities, LLC.

Just to clarify and I think you said this but I may have missed it, on the $0.15 investment in utilization improvement, is that basically even by quarter or is that front loaded in any way?

Steven R. Shawley

The way it’s working out now it’s going to be a little heavier in the first half but as we said earlier, what’s kind of falling off the program was restructuring that we did for the synergy driven opportunities. A lot of the restructuring associated with the combination of the businesses in 2009 quite frankly so as we go in to the future that $60 million that we talk about will start to become more constant throughout the quarters but this year is a little heavier first half, slightly heavier first half than in the second half.

Michael W. Lamach

Andrew, remember too we took the big piece out of the fourth quarter of ’09 so we were roughly I want to say $50 million we took in, in Q4 of ’09. We did that very late sort of in the December time frame so at the ceased point, when you include really the last month of 2009 it is fairly front loaded and that’s why I think that fourth quarter productivity will be again our best performance.

Operator

Your next question comes from Robert McCarthy – Robert W. Baird & Co., Inc.

Robert McCarthy – Robert W. Baird & Co., Inc.

I just have a couple of small follow ups and I appreciate you sticking with us so you can ask all these questions. Not to be argumentative but with all this discussion about 60 bolt on acquisitions and the lack of integration work that’s been done if you will, it sort of begs the question of where you are on the process of adopting and integrating best practices from both organizations? So I guess my question is do you have a formal acquisition integration process and is it the same for the entire company or is that one of the things that still has to be worked on?

Michael W. Lamach

That is absolutely what we did through the acquisitions, through the integration. This whole review for the synergies, we still meet, Herb, Steve and I along with the other members of the teams and the project teams every two week on the integration. It was a very programmatic approach. We’ll use it again whenever we need to.

Then, as you look at sort of the operating standards for the business, the way we report, the way we use metrics, all that has gotten much, much better in the last 18 months probably driven because we began the operating system work several years ago and it’s come now to a point where we’re putting it and ingraining it in everyone’s goals and objectives and the way we conduct reviews both monthly and quarterly across each of the businesses. Of all the worries that are out there that’s not the one I’m worried about. I think that’s part of what we’re doing here every day.

Herbert L. Henkel

Rob, if you think about what has happened to the small acquisitions, it wasn’t like we didn’t integrate the businesses because what you’ve got is like in the financial world, we have integrated the financial support for all those businesses. But, in Europe in particular there was a lot of acquisitions that had a plant associated with a brand, okay. So the upfront piece of the business and the back office was integrated but the factor itself was still out there chunking out whatever product supported that brand. So it’s become the final frontier in terms of your right, integrating acquisitions to some degree but I won’t lead you to the impression that we didn’t integrate those acquisitions in to the fore business.

Robert McCarthy – Robert W. Baird & Co., Inc.

No and I didn’t intend to imply that. I was very interested in the idea that you were largely reading out of the same book at this point given that we’re well pass 12 months in to the Trane integration.

Michael W. Lamach

As far as the company too, you look back at the cash and productivity I can tell you that’s one of the highlights across the organization is people were on that same page and there was a drum beat and a cadence and a review process and a lot of excitement about that. I think there is something kind of built there that we want to build on going forward.

Robert McCarthy – Robert W. Baird & Co., Inc.

The other thing I wanted to ask about was Hussmann’s performance in the US refrigerated case market. If I understood correctly, you’re talking about a pretty substantial year-on-year decline in the fourth quarter. It does look at least for that one quarter to be somewhat weaker than market. I wonder if there actually is an ongoing issue there that you want to get at to try and stop the erosion of your number one position in the US market?

Michael W. Lamach

Cases were down your point mid 20% range for 2009 but when you look at sort of Q4 and the bounce back there, bookings in total we were down a couple of points year-over-year for the fourth quarter. It has really come back, we’ve had some major wins in the last quarter that have come back. In the fourth quarter we mixed a little heavier towards maybe contracting than we would have liked but that business is recovering. It was a little lumpy between Q4 and Q1 and we saw that typically in December when orders were good and we bounced back in the quarter to finish the quarter down a couple of points in terms of bookings.

Robert McCarthy – Robert W. Baird & Co., Inc.

But your read would be that you’re not losing anything there you’re basically holding your own?

Michael W. Lamach

In fact, I think if you go back and look at the full year we would have picked up share in the case market.

Robert McCarthy – Robert W. Baird & Co., Inc.

Is that your expectation for the coming year then?

Michael W. Lamach

The share there got fairly high so I think holding on to that share is one thing. Improving the profitability of that business is really the focus around the whole business model and kind of getting that up to where we want it to be.

Operator

Your next question comes from Shannon O’Callaghan – Barclays Capital.

Shannon O’Callaghan – Barclays Capital

You took up the revenue assumption versus your original framework. What areas would you point to as having gotten better?

Steven R. Shawley

I think it’s really the leading edge businesses that are out there. I think the big hitter is our residential business led by residential HVAC. Those markets are coming back, they showed great returns, positive performance in the fourth quarter so we’re sort of on a roll there. If you look at the bookings that came through from Thermal King again, those are the areas that typically lead the cycles, we’re seeing business pick up there.

Also there’s some smatterings within the other businesses that have some promise. Mike talked a lot about the service and contracting businesses of the commercial HVAC markets so those are the reasons why we took it up. I think the difference between the top end of the range and the bottom end of the range quite frankly though is still nervousness about the commercial or the non-residential construction markets and the impact that they have on some of our big businesses.

We talked about the impact on security as being a bit of a negative even in the first quarter of 2010 and I think the deal with Trane commercial is can we see enough improvement in our service businesses to offset what we know is going to continue to be a down market for the equipment side.

Michael W. Lamach

The other thing I would add too Shannon is the industrial business specifically, that order book we didn’t talk much about it but that really picked up in Q4. So we’re feeling like that is coming back healthier coming in to the year so that would have been one a quarter ago we probably would have felt weaker about. We feel better about the industrial business going forward.

Shannon O’Callaghan – Barclays Capital

As you look at 2010 and the ramp, aside from the normal seasonality you would see, which of those businesses do you see as having kind of a sequential ramp pattern that is more than typical seasonality? Is it Thermo King and maybe industrial? Anything else?

Michael W. Lamach

Industrial stays relatively flat. Climate is the big one, you end up with the big Q2, big Q3 that we talked about. Res is the same, res is a big Q2 and Q3 relative to one and four. Security has always got sort of the strongest fourth quarter and historically we’ve seen that all the way following through to margins as well.

Shannon O’Callaghan – Barclays Capital

So you don’t expect anything out of normal seasonality? Nothings is on kind of its own schedule for 2010?

Michael W. Lamach

No, we wouldn’t expect anything that different.

Shannon O’Callaghan – Barclays Capital

Then just one more follow up on the price question. Have you actually gone out there with that point of price yet and how is it going?

Michael W. Lamach

Again, it’s not a matter of going out with a price increase, although some businesses have done that. It’s really kind of looking at that whole price waterfall which gets in to discounts and rebates, warranty, concessions, freight, shipping, you walk all the way through this stuff and that’s where we see the opportunity. Although there’s going to be some opportunities around price in certain businesses this is not something where it’s done through pricelists, it’s really done through behavior in the market and through a lot of the slippage through the price waterfalls. That was the big eye opener I think for us, it’s been the opportunity of putting on those waterfalls.

Shannon O’Callaghan – Barclays Capital

You said of pulling back discounts that you gave in ’09? Is that what you’re saying?

Michael W. Lamach

No, we’re not going to do that but you might differentiate those discounts differently between your largest most profitable customers and those that aren’t let’s just say. That might be a great thing to do and I would tell you that we’ve had more ubiquitous policies around some of that in some of our businesses. With a discipline around that, that we can get after that is part of 2010’s plan.

Shannon O’Callaghan – Barclays Capital

The last one for me, can you just give us an updated on your updated thoughts on the tax position with the IRS given the developments there?

Steven R. Shawley

We’ve pretty much plastered the walls with public disclosures about that. We filed the 8K. In the short version what happened was the IRS withdrew their assertion questioning the categorization of the intercompany as debt and recatorgizing it as all equity creating the issue that has been disclosed since the middle part of 2007. What they did is they came back and asserted an alternate position that they’ve taken which was again described in our disclosures.

I will say this, the alternate position that they have asserted we feel is more defensible from a technical perspective and we still obviously feel very confident that we will prevail and will continue to fight the cause and I think that if you look at where we are, our position is defensible.

Operator

Your final question comes from Ted Wheeler – Buckingham Research.

Ted Wheeler – Buckingham Research

On the commercial equipment orders with respect to performance contracting, when you have a performance contract award, do you automatically have that order for the equipment in the system as well or does that equipment order have a different timing to it?

Steven R. Shawley

Performance contract is going to be a progress billing environment where you’re billing sort of across the project to a schedule of values. You’re typically going to bill that equipment when you’re shipping the product to the customer and certainly at the time of installation. So within a project there’s a curve about when the equipment actually hits and it becomes part of the scheduled billing and it’s no different there than it’s been in the past.

Ted Wheeler – Buckingham Research

When would it go in to your commercial equipment backlog? Or, doesn’t it go in to the backlog?

Steven R. Shawley

It doesn’t go in to the backlog until the order is placed from the project manager in to the plant.

Ted Wheeler – Buckingham Research

So from the time you sign the performance contract for service, it could take 18 months to execute?

Steven R. Shawley

That’s right unless they’ve put that order in to the plant immediately. So it’s when the order is actually placed in the plant. In this case we’re the customer.

Ted Wheeler – Buckingham Research

I guess my question is getting to how much of the uptick in applied orders has to do with that process? You mentioned you were up.

Michael W. Lamach

I follow your question now Ted, it’s too early for the largest projects that we’ve booked. Those don’t peak until the summer months or I would say early fall.

Ted Wheeler – Buckingham Research

Then just kind of on the same subject matter, my recollection was commercial unitary orders tended to move ahead of applied in time sequence and it seems that is not the case now right? The applied is picking up and unitary is still very weak. What’s the story there?

Michael W. Lamach

Well unitary, res and light unitary definitely I think follow the trends you’re talking about. As you get in to large unitary, and you have to remember we’ve got a little bit of a different business mix than a lot of our competitors. Sort of half our equipment is large commercial unitary. So when we say unitary we mean both res and commercial. Large unitary is very weak and this is really associated with retail and lodging as well as that sort of traditional three to six story office building that we may have 78% shares on in some cases relative to that product. So that’s where we get kind of hit a little harder on that piece of it.

Ted Wheeler – Buckingham Research

Didn’t that piece though decline earlier than the larger applied once we go back two years?

Michael W. Lamach

I am talking about the large applied there and light was worse, it followed res. Large came in later and large commercial down turn is lingering. That’s still out there. Light frankly has gotten a bit better.

Ted Wheeler – Buckingham Research

My last question was just on the aftermarket orders, you talked about January in a few markets, do you have a feel for January with respect to the industrial technology aftermarket?

Michael W. Lamach

Are you talking aftermarket services in particular?

Ted Wheeler – Buckingham Research

Yes, for compressor related products.

Ted Wheeler – Buckingham Research

I don’t have it in front of me Ted so I don’t want to guess at it. I can tell you it’s tracking much more favorably than it had been. At one point you had completes and aftermarket parts kind of tracking in parallel. It was say 50% better, the rates where say half the decline of equipment, of completes in the quarter and I would tell you from what I hear about activity levels it continues to get better so I would look at that being kind of up mid single digits in 2010. It seems to be recovering as that capacity goes back on line, it seems to follow that we’re seeing now deferrals being tendered to us.

Steven R. Shawley

Thanks everyone. We really appreciate you joining us today. We certainly thank Herb for all his leadership and terrific work over the last 10 years. We welcome Mike and Joe and I are available for calls and questions after this call.

Operator

Ladies and gentlemen that does conclude today’s teleconference. Thank you all once again for your participation.

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Source: Ingersoll-Rand, Plc. Q4 2009 Earnings Call Transcript
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