Oct 19, 2012
Executives
Michael W. Lamach - Chairman, CEO and President Steven R.
Shawley - CFO and SVP Janet Pfeffer - VP, Business Development & Investor Relations
Analysts
Nigel Coe - Morgan Stanley Michael Wherley - Janney Capital Markets Jeffrey Sprague - Vertical Research Partners Inc. Jeffrey Hammond - KeyBanc Capital Markets Inc.
Deane Dray - Citigroup Global Markets Inc. Steven Winoker - Sanford Bernstein Joshua Pokrzywinski - MKM Partners Andrew Obin - Bank of America-Merrill Lynch Julian Mitchell - Credit Suisse Jamie Sullivan - RBC Capital Markets
Operator
Good day, ladies and gentlemen, and welcome to the Ingersoll-Rand Third Quarter 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode.
Later, we will have a question-and-answer session and instructions will follow at that time. (Operator Instructions).
As a reminder, today’s conference is being recorded for replay purposes. I’d now like to turn the conference over to your host for today, Ms.
Janet Pfeffer, Vice President of Business Development and Investor Relations. Ma’am, you may begin.
Janet Pfeffer
Thank you, Mary. Good morning, everyone.
Welcome to Ingersoll-Rand third quarter 2012 conference call. We released earnings this morning at 7 a.m.
and the release is posted on our website. We will be broadcasting, in addition to this call, through our website at ingersollrand.com, and that is where you will also find the slide presentation that we will be using this morning.
If you would please go to slide two. Statements made in today’s call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of Securities Law.
Please see our SEC filings for a description of some of those factors that may cause actual results to vary materially from anticipated. This release also includes non-GAAP measures, which are explained in the financial tables attached to our news release.
Now I’d like to go ahead and introduce the participants on this morning’s call. Michael Lamach, Chairman and CEO; Steve Shawley, Senior Vice President and CFO; and Joe Fimbianti, Director of Investor Relations.
With that, all please go to slide three and I’ll turn it over to Mike.
Michael W. Lamach
Thanks, Janet. Good morning and thank you for joining us on today’s call.
Earnings per share from continuing operations for the third quarter were $1.07. That’s $0.09 better than the midpoint of our guidance range from July.
About half the beat came from operations and the remainder was from other income. Versus our prior guidance, revenues were slightly below the low end of our revenue guidance range.
We are pleased with our ability to navigate a challenging market environment and to deliver above our earnings commitment with solid operational execution in all the businesses. Margin increased to 110 basis points despite a slight year-over-year decline in revenues on a reported basis.
Versus last years third quarter, operating margins were up in each of the sectors. Markets were somewhat softer, somewhat lower our outlook, particularly in China, which continues to show slower than expected growth.
We also saw a slowing in international industrial markets. Foreign exchange negatively impacted revenues by 2%.
Revenues including foreign exchange were up 1%; excluding FX we saw a moderate growth in revenues in industrial and single-digit declines in Climate and Security. Residential revenues were up 11% year-over-year.
Excluding Hussmann, orders were down 1%, but up 2% excluding currency. Operating margin for the quarter was 12.5%, up 110 basis points versus prior-year.
Margins improved for pricing and productivity, partially offset by unfavorable mix, currency and investment spending year-over-year. Steve will give you more details in a few minutes, but to highlight a few areas residential delivered 430 basis points of margin improvement and gain share on the quarter.
Industrial improved margins are 140 basis points and 1% revenue growth. Climate increased margins a 100 basis points on a comparable basis in the face of a challenging mix between Trane and Thermo King.
And finally Security delivered 20 basis points of margin improvement despite continuing soft markets. All businesses continue to realize positive pricing, and in the third quarter our price realization outpaced direct material inflation for the sixth consecutive quarter.
Our focus on operational excellence and innovation delivered excellent results in the quarter, and enabled us to effectively navigate global market conditions. I’m very encouraged by execution performance in the face of generally slowing market conditions, which we expect to continue to present challenges in the last quarter of the year.
Now Steve will take you through the quarterly results in more detail.
Steven R. Shawley
Thanks, Mike. Please go to slide number 4.
Orders for the third quarter 2012 were down 1% overall and up 2% excluding currency. Global commercial HVAC bookings were up slightly.
Transport orders were flat with double-digit increase in North America offset by soft European truck and trailer orders and lower marine demand. Industrial orders excluding currency were up 2% with order growth in the Americas and Club Car, partially offset by weakness in euro.
Residential bookings were down 1%. Commercial Security orders in the quarter were down 3% excluding currency, mainly impacted by the timing of large project orders in Asia as well as slower activity in Europe.
Please go to slide 5. Here is a look at the revenue trends by segment and region.
Note that the Climate information on this slide excludes Hussmann from the comparisons. The top half of the chart shows the third quarter revenue change for each sector.
For the total company third quarter revenues excluding Hussmann were down 1% on a reported basis versus last year and were up 1% excluding currency. Focusing on organic revenues, which exclude the impact of foreign exchange, Climate revenues decreased 1% with an offset – with an increase in North American transport revenues, more than offset by declines in Europe and Asian transport revenues.
Global HVAC revenues were flat excluding currency. Industrial had moderating growth at 4%.
Residential was up 11% and Commercial Security revenues were down 4%. I will give you more color on each sector in the few slides.
As you can see on the bottom of the chart, on the geographic basis organic revenues were up 4% in the Americas while Europe and Asia were both down in the quarter, mid-single digits excluding currency. Please go to slide number 6.
This chart walks through the change in operating margin from third quarter 2011 of 11.4% to third quarter 2012, which was 12.5%. This data excludes Hussmann for comparison purposes.
Volume, negative mix, and foreign exchange collectively created 120 basis point headwind to margins. Our pricing programs continued to outpace material inflation, adding 150 basis points to margin, productivity offset by other inflation was a 110 basis points accretive to margins.
Year-over-year investments and other items were higher by 30 basis points. And the grey box at the top of the page you will see that revenue leverage was excellent in the quarter with operating income increasing despite a decline in revenues.
As the box in the middle of the page details, we saw margin improvement at every sector even with revenue declines in climate and security. Please go to slide number 7.
The Climate Solutions segment includes Trane commercial HVAC and Thermo King transport refrigeration. Total revenues for the third quarter were $1.9 billion excluding Hussmann that is down 3% as reported and down 1% excluding foreign exchange.
Global Commercial HVAC orders were up 1% as reported and 2% excluding FX. Orders were down slightly in the Americas and up low teens in Europe, but were down in Asia.
Trane’s commercial HVAC third quarter revenues were down 2% and flat when excluding currency. HVAC revenues in North America and Latin America were down slightly on a reported basis and up slightly excluding foreign exchange.
Revenues in Europe and the Middle East were down mid teens on a reported basis and down low teens when excluding currency. Revenues in Asia were up slightly.
Commercial HVAC equipment revenues were down mid-single digits. HVAC parts, services and solutions revenues were up mid-single digits versus prior-year.
Thermo King orders were flat versus last years third quarter. Revenues were also down high-single digits, down low-single digits when excluding currency.
Worldwide refrigerated truck and trailer revenues were down low-single digits with an increase in North America more than offset by declining volume and currency in Europe. The Marine Container business was down significantly versus last year.
The operating margin for Climate Solutions was 12.7% in the quarter, a 100 basis point improvement versus third quarter 2011, excluding Hussmann, pricing and productivity more than offset inflation and higher restructuring and spending on investment initiatives. Please go to slide number 8.
Industrial Technologies third quarter revenues were $702 million, up 1% on a reported basis and up 4% excluding FX. Air and productivity revenues were down slightly versus last year on a reported basis and were up mid-single digits excluding currency.
Revenue in the U.S. was up high-single digits, international revenues were down mid-single digits on a reported basis and flat excluding currency.
Air and productivity orders were down mid-single digits on a reported basis and flat excluding currency. Club Car revenues in the quarter were up mid-single digits and orders were up low teens versus prior-year.
Industrial operating margin was 15.2%, was up 140 basis points compared with last year as higher revenues, pricing and productivity were offset by inflation and higher investment spending. Please go to slide number 9.
In the residential business third quarter revenues of $559 million, were up 11% compared with last year on both a reported basis and excluding foreign exchange. Our residential HVAC revenues were up low teens versus last year.
Our HVAC unit shipments in the third quarter were up mid teens, while market unit shipments were up mid-single digits. AHRI industry data show that market unit shipments in September were down nearly 10% versus last year.
For the first nine months of 2012, the 13, 14 SEER segment of the market was higher than prior year as mix continues to shift to the low end of the efficiency range. This further validates our strategy to add products to address the lower SEER range more effectively.
With the new products introduced in the past year, our market share in the 13, 14 SEER range has now recovered back to our share from 2010. We continue to see the market mix move towards 410A systems.
Although R-22 units remained a significant portion of the unitary market, we now believe the R-22 market unit shipments will be down about 20% for the year. Revenues for the residential security portion of the sector were up low teens with increases in the new builder channel, Big Box and South American customer volumes.
Sector operating margin of 8.1% was up 430 basis points compared with 2011 as pricing and productivity more than offset inflation and adverse mix. Please go to slide number 10.
Revenues for Security Technologies were $391 million, down 7% on a reported basis and down 4% excluding currency. Americas’ revenues were down low single digits.
Overseas revenues were down mid-single digits excluding currency. Global bookings were down 6%, 3% excluding FX impacted by slow activity in the U.S.
and Europe and the timing of large projects in Asia. Operating margin for the quarter was 21.5%, up 20 basis points from last year, as productivity and price realization offset unfavorable revenue mix, higher investment spending and inflation.
Please go to slide number 11. We continue to maintain our focus on working capital.
We finished the third quarter with working capital of 3.9% of revenues, similar to our levels in the third quarter of 2011. Slide number 12 please.
We resumed our share repurchase in June. We repurchased about 7.6 million shares in the third quarter and had purchased 10.8 million shares year-to-date through yesterday.
We still expect to spend approximately $840 million on share repurchases this year. With that, I will turn it back to Mike to take you through the forecast.
Michael W. Lamach
Okay. Thanks, Steve.
And please go to slide 13. Our revenue outlook for 2012 is $13.95 billion to $14.05 billion, about a $100 million lower at the midpoint versus our prior guidance due to softer markets in Asia and Europe, partially offset by somewhat stronger euro.
Asia, specifically China, has been softer than our prior forecast. Although we still expect Asia to be up for the year, we had trimmed our revenue growth expectations for the region by about 5 percentage points from the mid-single to low-single digits.
We believe China bottomed in Q3, but given the current customer request dates for many of our products there namely large chillers and air compressors; we won’t see a rebound in revenues until next year. Revenues in Europe were somewhat below our expectations, including some favorability from currency.
We continue to see good growth in the Middle East and Eastern Europe, which has been helping to offset the softness in Western Europe. Overall, we still expect revenues from Europe, the Middle East and Africa taken together to be down in the low teens for the year including currency impact.
Activity in the U.S. continues at moderate growth rates in commercial HVAC and industrial.
Refrigerated transport markets are expected to have moderate year-over-year growth in North America and to decline in Western Europe. We see continuing moderate uneven growth in residential markets.
We have seen some positive movement in replacement systems. For commercial security, we expect to see a continuation of challenging conditions in the U.S.
non-residential new construction market for next year, particularly in our key institutional markets. Although euro has strengthened since our July forecast, foreign exchange will continue to be a headwind in 2012 adversely impacting the revenue growth by about two points.
In total, we expect the annual revenue to be flat to up 1%, compared with 2011 revenue of $14 billion, excluding Hussmann. Excluding foreign exchange, the expected organic growth rate is 2% to 3%.
Please go to slide 14. We are nearing our guidance for full-year EPS from continuing operations to a range of $3.17 to $3.23 per share.
It’s unchanged at the midpoint from our July guidance. Our forecast for the average share account for the year is also unchanged to 311 million shares and the full-year tax rate forecast remains at 19%.
We expect to generate available cash flow of about $1 billion. Fourth quarter revenues are forecast to be $3.4 billion to $3.5 billion.
Revenues on a comparable basis excluding Hussmann are forecasted to be down 2%, up 1% versus the fourth quarter of last year. That includes FX, which will be a headwind of about one point, and that means including foreign exchange, revenues will be down 1% to up 2%.
Fourth quarter earnings per share are forecast to be $0.64 to $0.70. We are assuming a share count of 306 million shares and a tax rate of 29%, both of which are the same as we guided in July for the fourth quarter.
Please go to slide 15. We are pleased to have delivered a solid third quarter.
We had strong overall operational leverage and margin gains in all sectors. For the balance of 2012, we see mixed demand patterns with slowing growth in North America, declining markets in Europe and slow growth in Asia.
Currency translation, adverse revenue mix and incremental investments will continue to impact our fourth quarter results. However, this will be more than compensated for by the ongoing benefits from price realization, productivity and lower inflation.
We’re focused on continued change and improvements to ensure that we’re managing our business optimally across the spectrum of economic conditions. Our focus is on positioning our company to continue to grow earnings and cash flow with very little help or possibly no help from markets.
We continue to feel good about our Company and our progress. We have a portfolio of outstanding market-leading brands.
The longer term attractiveness of the end markets in which we operate and our competitive positioning, will allow us to befit of those sectors if the economy improve. Our management team is committed and it’s actively managing the company to generate sustainable, profitable growth.
We had continued to invest in innovation and to introduce new products across the enterprise. For example, in August Thermo King launched the Precedent platform to address new Tier IV regulations for engine emissions.
Precedent which is available across a range of options to suit specific customer needs, set a new industry standard in both fuel efficiency and emissions control, by delivering double-digit fuel savings, best in class performance and lower life cycle cost. Initial customer reactions have been very favorable.
And overall we’re on track this year to achieve our goal of delivering 25% of revenue with products introduced in the past three years. Our operating philosophy has been to not wait for a macroeconomic lift to improve our businesses.
We’ve proactively work to reduce cost and improve productivity, while still making prudent investments for the future. With the start of the year, we expected flat and slow growth in our markets and we built our plans to that environment.
That’s proven to be the correct call for this year enabling us to deliver double-digit EPS growth with essentially flat revenue. I’m proud of the focus our team has maintained and results we’ve delivered, even in the midst of choppy markets and uncertain macroeconomic currents.
Now, Steve and I will be happy to take your questions.
Operator
(Operator Instructions) Our first question comes from Nigel Coe from Morgan Stanley. Your line is open.
Nigel Coe - Morgan Stanley
Thanks a lot. Good morning.
Michael W. Lamach
Hey Nigel.
Steven R. Shawley
Hi, Nigel.
Nigel Coe - Morgan Stanley
Just Mike you made an interesting comment that you’re confident that China bottomed last quarter, in 3Q. What give you that confidence?
Michael W. Lamach
Yeah Nigel, we actually saw a progression from Q1, Q2, and Q3 in bookings, high negative kind of teen bookings in Q1, negative mid teens Q2, slight low digit almost flat in Q3 and that’s just sort of orders in hand in Q4 would give us sort of a sense of fourth quarter bookings and total being up for the year. So we feel pretty good about that.
Now if you go beyond China, Asia, it’s actually been – it’s really healthy as well. So we’re about equally divided between China and Asia.
So in general I think we’re rounding the corner in China.
Nigel Coe - Morgan Stanley
Now that’s great color. And then if we could just switch to margins, obviously another great quarter year-over-year.
Price inflation it was a – was a big factor, how does price inflation look as we go from 3Q into 4Q and perhaps into 2013. And could you maybe comment on pricing by segments?
Michael W. Lamach
Yeah, inflation moderates Q3 to Q4 sequentially. Price moderates from Q3 to Q4 sequentially.
We think this will be the seventh quarter in a row that we will still see a positive spread between the two.
Nigel Coe - Morgan Stanley
Okay. And then just finally Thermo King the flat bookings surprised me a little bit.
Obviously, revenues were down high single digits, but how does that business look as we go into 4Q?
Michael W. Lamach
Nigel, one of the reasons why bookings were pretty flat is with – I mentioned in my remarks that the Marine business is down significantly. So if you take marine, which is – shows up in our European pile, it’s down quite a bit from prior-year.
So the – and when I say quite a bit, its double-digits plus type of a number. So if you look at truck and trailer bookings in Q3, the Americas were actually up double-digits.
We’re still seeing some pressure on bookings in truck trailer in Europe. But quite frankly the bookings in truck trailer Europe are not down as far as we kind of expected.
So what you got here is, we’re continuing to hold our own and what I’ll call the core of our business within TK truck and trailer globally. But the Marine Container piece is having a big impact on it.
Nigel Coe - Morgan Stanley
But in your plan, do you have charge you have to thinking down mid to high single digits in 4Q?
Steven R. Shawley
Well our outlook for TK for the full-year is flat, slight down in total. So North America will be up mid-single digits, Europe excluding marine down in mid-teens and marine down over 20%.
So I think the math works out Nigel for it.
Nigel Coe - Morgan Stanley
Okay. That’s helpful.
Thanks.
Operator
Thank you. Our next question comes from Mike Wherley from Janney Capital Markets.
Your line is open.
Michael Wherley - Janney Capital Markets
Good morning and how are you guys doing?
Steven R. Shawley
Good morning and thank you.
Michael Wherley - Janney Capital Markets
Just looking at the climate, you said that the orders in Europe were up in the low-teens in the HVAC part of that business; so I was wondering if you could talk about that strength where it might be coming from geographically.
Steven R. Shawley
Yeah, it’s in the applied business and we’re seeing really strong bookings throughout the year and then fourth quarter in the Middle East that continues to board well. A combination of new product introductions I think helping to support that.
And we’re seeing actually a little bit better performance in Southern Europe than we would have thought coming end of the year. So, actually the weakest part relative to our own forecast would have been Northern Europe particularly Germany.
But the Middle East and India are really a strength for us.
Michael Wherley - Janney Capital Markets
Okay. And then on the residential business; I was just wondering if you’re getting a sense from the builder market or the big boxes; is this pretty controlled demand or do you think that there might be some inventories sort of stocking up going on?
Michael W. Lamach
Well I think from a retail perspective with big box you’ll see the typical fourth quarter destocking that goes on. So I think just in terms of their patterns for the last seven, eight years that I’ve been involved you’ll see some destocking there across the Board.
From a HVAC perspective, I think inventories are largely in check with where they should be. So, I don’t think we’d see any anomaly happening between inventory levels and the seasons there.
Michael Wherley - Janney Capital Markets
Okay, and then just following up on residential. When you’re looking at those 13 SEER and 14 SEER products; do you have any sense as to whether or not, now that you have them back into the market, whether or not you can't continue to gain share in that part of the market in 2013?
Michael W. Lamach
I feel good about it. If you look in the course it’s really just a season we’ve been able to not just get 2011 back, but really kind of gain on 2010 and I think that as next year we come into the season and we continue to sharpen our cost position on those entry level products and our distribution system across those products.
I feel pretty good about our odds what we’re still – if you think about sort of the Trane brand, in terms of the brand recognition it’s just roughly twice our share and I think that’s really the entitlement going forward for us is to continually eat into that entitlement in the years ahead. So I feel good about what we’ve done and I feel good about actually next year, and I wish it was summer at this point.
Michael Wherley - Janney Capital Markets
All right. Thanks a lot.
Michael W. Lamach
Thank you.
Operator
Thank you. Our next question comes from Jeff Sprague from Vertical Resources.
Your line is open.
Jeffrey Sprague - Vertical Research Partners Inc.
Thank you. Good morning, it’s Jeff Sprague.
Michael W. Lamach
Jeff, we know who you are.
Jeffrey Sprague - Vertical Research Partners Inc.
Yeah, I also wasn’t sure that was me and thank you, good morning. Could you just provide a little bit of color Mike on what you’re seeing kind of in energy retrofit markets.
We heard from someone today they’re actually seeing some slippage going on there in the commercial side. Are you seeing that at all and just a general kind of retrofit versus new activity in commercial?
Michael W. Lamach
Well specially Jeff, in performance contracting we had some larger bookings in Q3 there, which always went lends itself toward larger applied sales and again if you look at even the shift between unitary and applied Q3 and Q4, you’re seeing – that what we’re seeing the unitary down sort of mid-single digits, applied is up mid-single digits. So all that is really getting more toward large retrofits that are driven by energy savings, energy efficiency so, we’re actually I would say seeing more of a shift toward energy efficiency.
If you look at sort of the customer base whether it’s institutional or its commercial or manufacturing customers that buy applied cooling products from us that are applied air compressor products from us. They’re looking at the same sort of markets that we are which are largely flat markets and for a lot of these units that are coming out, particularly the newer units we’re putting out in the market place, we’re seeing two, three year paybacks and that’s sort of a sweet spot.
So, I would probably differ from the view you heard, say that we’re seeing probably more of a shift there. It’s also true that we shifted resources, feet in the street really from looking at some of the – I would say sort of the planned and spec market over to the retrofit market, toward energy conservation so you’ve also got more feet in the street for us pursuing owner direct negotiations that are energy efficiency motivated, so that could be part of it, it’s just the focus that we’ve had on trying to find some growth in pockets where we think growth can be had which isn’t in the planned and spec institutional construction market.
Jeffrey Sprague - Vertical Research Partners Inc.
And then additionally a different topic, very early days, but do you see or expect to see any kind of behavior change in the channel kind of with the Goodman Daikin deal and just any high level thoughts on the competitive landscape?
Michael W. Lamach
We have been living with Daikin McQuay for a while now. So we’ve seen that on the commercial side, and on the residential side it’s just way too soon to have seen anything or to comment on it; so nothing to this point.
Jeffrey Sprague - Vertical Research Partners Inc.
All right. Thank you very much.
Michael W. Lamach
Sure.
Operator
Thank you. Our next question comes from Jeff Hammond from KeyBanc Capital.
Your line is open.
Jeffrey Hammond - KeyBanc Capital Markets Inc.
Hey, good morning guys.
Michael W. Lamach
Hi, Jeff.
Jeffrey Hammond - KeyBanc Capital Markets Inc.
I was a little surprised by the industrial resilience given what we’re hearing from some other just kind of industrial manufacturing companies. Can you just talk about the trend through the quarter what you saw into September and where there is may be more resiliency versus weakening?
Steven R. Shawley
Jeff, the starting point would be to say that, the new product launches that we’ve had last couple of years they continue to bear fruit. We’ve got an excellent oil free product out in the marketplace gaining share.
We’ve gone through systematically and had gone through all, but a couple of the larger frame centrifugal machines that are out there. Lead times have continued to be cut half through the lean work going on inside the Company.
I’ve used as an example on a couple of previous quarterly calls where it’s an example where the lean work starts with working capital improvement, it goes into margin improvement, it goes into share gain and I think all that really is coming to bear. The other thing is the largest investment that we’ve made this year in that business has been really a move towards the service side of the house and in putting in place incremental resources that to move towards similar to the HVAC story of service retrofit based on efficiency fare and so that’s been successful to-date is just growing the service business at a higher rate than the equipment business actually in both HVAC and in the air side of the business.
Jeffrey Hammond - KeyBanc Capital Markets Inc.
Okay. So you think the resiliency is more a function of maybe share gains in what you’re doing?
Steven R. Shawley
I’d say share gain and shift to sort of the service businesses and shift to the markets that are growing frankly, shift to focusing on the pockets of growth for us.
Jeffrey Hammond - KeyBanc Capital Markets Inc.
Okay. And then on buyback you said you’re going to wrap up your buyback program by the end of the year.
Just how should we think about buyback going forward beyond that and just capital allocation focus going forward?
Steven R. Shawley
Yeah we intend to talk to the Board in December and really lay that out for you for 2013 Jeff, but as we said last time we’re trying to go back and take a meaningful step in the dividend and to go back and reauthorize the share repurchase going forward; so we’ll be able to size that up for you in December.
Jeffrey Hammond - KeyBanc Capital Markets Inc.
Okay, great. Thanks.
Steven R. Shawley
Welcome.
Operator
Thank you. Our next question comes from Deane Dray from Citi.
Your line is open.
Deane Dray - Citigroup Global Markets Inc.
Thank you. Good morning everyone.
Just over on the residential HVAC side any updates on the rollout of the Ameristar brand?
Steven R. Shawley
It was a success. The season is largely over if you think about it from a cooling standpoint moving into the heating season here.
I think we’re in great shape really with regard to the furnace platform the work we’ve been doing there to get all price points including highest efficiency, 95% efficiency, furnace is ready for the market. So it was a success and I think we’ll build on it next year.
We’ll expand our capacity there and expand distribution and continue to make sure that we’ve gotten a best product at that point in a product range.
Deane Dray - Citigroup Global Markets Inc.
And then with respect to the differences we’re seeing in the applied versus unitary, my experience has been that on the unitary side that you tend to see a bit more price competition. On the applied these are bigger systems more engineering content and you often get a bit more pricing power.
Is that playing out now?
Steven R. Shawley
Yeah generally Deane I’d say it even splits a little finer than that. Applied yes and unitary, I was just talking about larger unitary so particularly on 25 tons and maybe even 50 tons and larger.
It starts to really almost look like an engineered system itself with controls packages that go along with that. So I think with that regard it’s much more of a applied sale than it would be for the smaller unitary up through 25 tons maybe up through 50 tons.
And what you saw on the first couple of quarters of the year was that like unitary and smaller unitary markets really growing, there was a bit of a commercial surge with commercial office buildings at that point in time and especially we participated in that with a very high share.
Deane Dray - Citigroup Global Markets Inc.
Okay, that color is helpful. And then on, I might have missed this but I know you called out some help from the other income lines, sometimes you have hedging in there, is there anything that you would call out?
Steven R. Shawley
Nothing abnormal Deane, there was a onetime issue relative to an old legal suit – legal claim.
Deane Dray - Citigroup Global Markets Inc.
Great. Thank you.
Operator
Thank you. Our next question comes from Steven Winoker from Sanford Bernstein.
Your line is open.
Steven Winoker - Sanford Bernstein
Great. Thanks and good morning.
Mike maybe you could start off a little bit on the productivity side and cost reduction in terms of how that’s playing along. I mean obviously we can see the good results, but how is it playing along against the implementation plan that you’ve got particularly with timing and rollout across the portfolio and are you looking – and are you seeing additional cost reduction opportunities that are increasing rather than decelerating in the portfolio particularly as you look out against headwinds in 2013?
Michael W. Lamach
Especially with the answer that we have to look at all the leverage that we have to full there because we manage them really independently, and if you think about the lean work going on we’re on track there with what we set out to do with the number of value streams. More importantly since those value streams are widening we’re looking at this more as a percentage of the cost under transformation, particularly the conversion cost of labor and overhead.
So that continues as planned and we’re still seeing the nice separation between results, but now over a little bit bigger base than we had last year. We’re also applying it to the SG&A side of the business, a project we internally refer to as AGILE where we’re redefining the SG&A structure really the G&A structure of the Company and we’ve been working through that as well.
So that have productivity force in Q3 and I think we’re still in the early innings there. I think that, that still as a 2013 major opportunity for us.
It really begins to be an opportunity in 2014 and 2015 as the systems implementation takes hold. We’re generating net productivity on the G&A side in spite of the fact that we’re investing heavily in the systems component there; so that’s a good story going forward.
The sourcing team has been in place now for a few quarters. That’s gaining traction, we have gotten material productivity which was greater than last year’s total productivity and we’ve invested in supplier quality and supplier development resources coming into the organization, just a whole new talent based around that.
That’s largely a 2013 – a 2014 opportunity around cost for quality for us which is an area that we haven’t really attacked to the same degree as we have in other areas of the business. So that I think is a positive for us as well.
Steve?
Steven R. Shawley
No I’d just reiterate the comment about SG&A. I think the opportunity we have in ’13 is to really focus there, pull up the targets we have for reducing the G&A piece or cost structure.
Michael W. Lamach
Yeah, Steve I would say the restructuring that we’ve done is the last piece, we’ve done a lot of that. We’ve got a little bit more to do there, but that’s played well.
I’ll give you an example for Trane commercial in North America, they were able this past year year-to-date in forecast to achieve 45% operating leverage in the business and we got a little bit of volume coming into the unitary and applied business there against really what's been a very effectively restructured cost base and an integrated cost base in several factories now that we have merged with industrial. So this is very positive for us in terms of just what we’re seeing with volume and leverage the Trane commercial business.
So I would tell you that I’m still very optimistic about it. It’s been a long haul.
We had to add a tremendous amount of resources and talent into the company. And when it all works like it has and quarter two and quarter three we get the numbers that we’re entitled to get.
Steven Winoker - Sanford Bernstein
Great. And a quick question; could you call out compressor bookings specifically because I might have missed those, industrial?
Steven R. Shawley
When you say compressor, you’re talking about air compressor bookings?
Steven Winoker - Sanford Bernstein
Yeah, yeah.
Steven R. Shawley
Yeah. If you look at North America, we got to blend it with service here.
My guess would be its relatively flat and you’re seeing exactly what you think you’d see in Asia Pacific which is more or less a down for us there. Europe about as expected a little bit less than expected.
Steven Winoker - Sanford Bernstein
Okay. And then just a different topic, but I know you mentioned obviously the Board is going through all the review now and we’ll hear about that in December as you mentioned.
But, as you look at the industry and I’ve just been – as you look at the broader industry, do you believe that in general that there is still room for additional consolidation in HVAC and obviously the Daikin move with Goodman was sort of continuing to get people thinking about that, but just broadly speaking.
Steven R. Shawley
Well on the res side I think there, there probably is. On the commercial side you’re really dealing now with two or three major players that have got large shares in the market place, so it’s more difficult there.
Our chiller shares are up with 40%, so as an example and if you go to number two it’s probably 30%, number three is probably 20%. So there’s not a lot there to be split and if you see consolidation there it’s going to be fairly small players and frankly I would say the competitive base doesn’t need distribution on the commercial side generally speaking, and so anything you’d see there would be a small distribution network perhaps.
But on the res, yes there’s a lot of fragmentation of small suppliers out there where it has been really a cost play, it really wouldn’t be a distribution play. It would be a cost play.
Steven Winoker - Sanford Bernstein
And when you say res you include light commercial, like rooftops in there?
Steven R. Shawley
Well the danger there is because that goes through, in our case multiple channels and so it’s really effective for us because we manufacture all the light commercial in our commercial factories and we actually have equal share between our res channel and our commercial channel which is – we double up on that and we get something north of 30% share in light commercial because of that. So there’s some anomalies there when you think about the channels to market which, you’re really are able to manage those two channels with not a high degree of tension and overlap in the marketplace I would say a fair amount of but appropriate channel tension.
So you have to be careful that you consider that as well.
Steven Winoker - Sanford Bernstein
I mean separating RLC versus applied, that’s all.
Steven R. Shawley
Yeah. And I am saying, yeah you probably could see some more of that but it really runs through the same channel that you sell applied for half of the share.
Steven Winoker - Sanford Bernstein
All right, got it. Okay, thank you guys.
Steven R. Shawley
Bye, Steve.
Operator
Thank you. Our next question comes from Josh Pokrzywinski from MKM Partners.
Your line is open.
Michael W. Lamach
Hi Josh, we know who you are.
Operator
Please check your mute button.
Joshua Pokrzywinski - MKM Partners
Hello.
Michael W. Lamach
Hey Josh.
Steven R. Shawley
Josh.
Joshua Pokrzywinski - MKM Partners
Hey, good morning guys.
Michael W. Lamach
Hey.
Joshua Pokrzywinski - MKM Partners
Just looking to dig in here a little bit more on residential. I understand that, I mean given the order cycle there I mean the orders that you called out in the slide deck might not be the best way to look at it.
So if you could just give us a sense, how do we read on the furnace season, what are you guys seeing obviously -- I am sorry in easy comp last year with some of the warmer weather? And then maybe a sense around the profitability of residential into this year, so – I am sorry into the fourth quarter, so do you expect whether you can make money this year, just some detail on that into the fourth quarter.
Steven R. Shawley
Yeah Josh I mean we’re still holding to, we’ll see a couple of 100 points of margin expansion in the res business this year, so that kind of holds just the way it did before. And you’re correct on the bookings, that’s probably the one bookings number I don’t pay a lot of attention to because it fundamentally comes down to, it’s sort of like a week’s worth of bookings versus a week’s worth of bookings the prior quarter and so you don’t really get a sense for anything there particularly with cycle times being much, much shorter than they were.
Generally when we think about the full-year in the res HVAC business for the industry, it’s probably going to be relatively flat, that’s what the industry data really shows and we’re thinking we’re going to be kind of mid-single digits of course based on share gains that we talked about. Now going into the fourth quarter we would have a similar view there.
In fact you have seen almost every month of every quarter work in a pretty severe saw tooth. A great example was third quarter you saw a great July, ho hum August and a pretty poor September for the industry and that’s been the pattern we have seen all year long.
I would think the pattern would persist going into the heating season. The difference we have, the thinking we have put into the sort of heating season here, is we have taken on more inventory, more component inventory than we normally would and what would be sort of be on their forecast that we’re giving you.
So any event there was anomaly weather related or other, we’ll have the capability of building to that demand forecast for sure. But we’re really not just spanking on it based on what we’ve seen here today.
Joshua Pokrzywinski - MKM Partners
Got you. And I guess just the way the math works out that implies, we spend a margin in the fourth quarter kind of something maybe just shy of mid-single digits as well as is that a fair way to think about it?
Steven R. Shawley
Yes.
Joshua Pokrzywinski - MKM Partners
Then just to understand the fourth quarter guidance, you guys guided down about $50 million versus the last few and taking out about $40 million of EBIT. It sounds like price cost is relative neutral.
Is there anything going on at the corporate line or any other kind of one-timers or mix issues that we should be thinking about, you know, that maybe help to explain that sequential drop?
Steven R. Shawley
Actually Josh, it has really taken out $92 million at the mid-point of volume. Taking it out of the most profitable business we have which is actually Asia and China for both the Air and the Climate business, which are most profitable businesses.
We are also taking it out of the TK business in Europe, again which is a very profitable business for us. So, it's really mask that we've got the FX going one way, you know kind of a $50 million plus pickup on FX, volume coming down $92 million at the mid-point, but at very high margin sort of with those businesses coming down.
Michael W. Lamach
Our margin is also the capacity cost associated with it.
Joshua Pokrzywinski - MKM Partners
Got you. And it sounds like those are the precise areas where at least on near term more basis you guys are feeling a little bit between but maybe more of a ’13 term to see a new shipments?
Michael W. Lamach
Yes.
Joshua Pokrzywinski - MKM Partners
Okay. I appreciate the time you guys.
Thank you.
Michael W. Lamach
Thank you.
Operator
Thank you. Our next question comes from Andrew Obin from Bank of America.
Your line is open.
Andrew Obin - Bank of America-Merrill Lynch
Yes, good morning guys.
Michael W. Lamach
Hi Andrew.
Andrew Obin - Bank of America-Merrill Lynch
Just a short question on guidance just to make sure that I read it correctly. It seems that you have reduced outlook for the year by $50 million in terms of revenue, and if we apply sort of a reasonable decremental margin to that we would have gotten EPS hit maybe like $0.05 and that it looks like closer to $0.10.
A; am I calculating it correctly, and B; what's driving the substantial earnings hit relative to the guidance top line hit. Thank you.
Michael W. Lamach
Kind of the answer was in the previous question. There’s really two parts to the revenue change in Q4.
One is, a little over $90 million associated with volume that we’re taking out in China, Europe; it’s pretty high margins and also the capacity cost associated with that. But coming back the other way is a favorable change associated with foreign exchange because the euro primarily is kind of recovered here recently.
So that’s adding $50 million of revenue back with very, very little OI. So the leverage on the reduction in guidance looks pretty high as a result of that.
Steven R. Shawley
Yeah, Andrew but if you just think about EPS basis you add $0.04 back for outbox and drop to nearly $0.13 on the volume that we’re talking about and you get the $0.09 differential.
Andrew Obin - Bank of America-Merrill Lynch
That makes sense. And on free cash flow is it all related, you sort of $100 million hit there, is that just sort of net income reduction or what else is going on there?
Michael W. Lamach
Well there’s two components there frankly, one is just FX and the second is there’s been a several businesses where we’ve just decided, we made the decision to take on the incremental inventory here in the fourth quarter, a example I used was the res business around the furnace season again just to make sure that we got what we need. Even around coil production coming into the early part of next year, we’ll do some coil production even in the fourth quarter related to next year’s season, just to smooth and linearize capacity that we have available to use we think is a better way to do that in the next year.
And also in the TK business, you’ve got the changeover happening and so it’s a good time for us at least to have just in excess diesel engines on hand and you put that all together and $100 million was mostly designed and that’s being the other part of it. And to kind of clarify a little bit on the TK Andy the [agg] folks have reduced their estimate of the number of trailing units in the market again recently.
And it was mainly because they took out the assumption that there was going to be a free buy of refrigerated units because of this changeover to the Tier 4 classification. So it’s shifting a little bit of the demand into 2013 that we would expect it to see in the fourth quarter of ’12 but that’s why we picked up a little bit of inventory there.
Andrew Obin - Bank of America-Merrill Lynch
And now that Trane is, I don’t know if you can share anything there but have you thought about changing the pace of restructuring, how you allocate R&D, marketing expense. How much strategic discussion have you had with Trane and the Board given the involvement about how you’re going to run the business just very broadly over the next 12 to 24 months, if you can share anything?
Steven R. Shawley
Yeah Andy we have had I would say a very aggressive capability building program in place for two and a half years in terms of what we have done with bringing the talent into the company and development talent within the company to really do what we’re doing. So transformation to become a top performing diversified industrial don’t happen overnight clearly and we have been at it for 2.5 years.
Most that get into the business would argue that that there’s a lot of change going on and frankly how do you guys manage all the change going on inside the business between systems implementation, organizational changes, implementation of lean across the company while maintaining a very high level of investment in innovation around the product portfolio. So I feel good about the pace of change.
I feel good about the fact that year-over-year, over year we’ve had margin expansion with relatively, in this case flat market. So, and we have been able to really consume so the restructuring is embedded in what we’re giving you.
So this is not some sort of a zero restructuring story here, this is embedded in what we’re doing and embedded in the margin. So we feel good about that.
Now with regard to Nelson being on the Board, Nelson is on the Board now and Nelson is part of the discussions around the Company and so there is no update as to where we are other than to say that the release we had on August was heading toward sort of a December information with regard to what decisions we would make around the Company and those are progressing on plan and on track, no new news there.
Andrew Obin - Bank of America-Merrill Lynch
Thank you very much.
Steven R. Shawley
You’re welcome.
Operator
Thank you. Our next question comes from Julian Mitchell from Credit Suisse.
Your line is open.
Julian Mitchell - Credit Suisse
Hi, thanks. My first question is just on the investment spend, I think you've said before that the investment sort of in other line in terms of year-on-year margin effect for the full-year this year would be about 100 bps, I guess, headwind for ’12.
I just wanted to check that’s still the case and also when you are looking a bit further out, does that headwind start to shrink as you move into next year because it sounds like that new product introductions particularly in climate, industrial tech and resi, a lot of that work has been done. So you’re kind of investing, but the big kind of catch up ramp up is largely finishing.
Steven R. Shawley
Yeah, I will take the first part, Julian. The expenditures on the initiatives that we’ve been talking about, those are new product developments, those are common systems, those are things like centralizing our procurement organization are continuing and we hit that right on the head here in Q3.
We said about $25 million of incremental spend a quarter. It was exactly $25 million in Q3, and I’m [counting] on another exactly $25 million in Q4.
So the $100 million of headwinds associated with investment initiatives is still there, so maybe Mike, you can take the second half?
Michael W. Lamach
Yeah Julian, on the 2013 view, we’re in the process of putting our plans together. And similar to last year, we will do some scenario planning around different possibilities for the major lines of business and regions and so I don’t know the answer of that question at this point in time.
I can’t tell you that we will continue to invest in the applied HVAC portfolio. So most of what we’ve been doing has been in the unitary HVAC portfolio for commercial will go to the applied side.
And then on the industrial side, we will continue to invest there, but probably be able to hold that relatively flat going into next year. But we will have to come back and talk to you about that in another quarter and give you a full update on that at this point in time.
I think what we’re doing is working within that we can launch at higher margins, it’s contributing through the margin growth inside the Company. We have gained share wherever we’ve done that, so the formula seems to work for us.
And maybe a little bit to Andrew's question as well as what you’re asking, just really steady margin expansion over time, doing it in a sustainable way with product development and implementation of Lean across the Company, right. If there are faster ways to do that, I wouldn’t want to do that through cutting investments or to do something silly with regard to not really putting that permanent operational capability into the Company and that would just be a long-term mistake for us.
Julian Mitchell - Credit Suisse
Sure. Then on the security business, you never seems to get many questions, but you’ve obviously in this kind of transition of trying to move away from excessive reliance on mechanical more towards electronics access and so and I just wonder if you think that requires acquisitions to do that or you feel that internal R&D is sufficient, because I guess the rhetoric around M&A has been watered down a lot over the course of this year?
Michael W. Lamach
Well, I mean, I think you’ve got to hold the acquisition story up to the mirror of share repurchase. And I think the acid test is share repurchase and right now we just haven’t thought of better investment than our own Company.
You still see fairly pricey, very pricey electronics security sort of targets out there and that’s not on the cards for us. Now organically again it gets back into the investment question, a large part – I’d say all of the investment going on in security has been around electronic security platforms and they’ve got a very good capability sitting in that organization around the ability to develop product in that area.
So, I don’t feel like we’re compelled to do that and we certainly wouldn’t be compelled to do that favoring that over repurchasing our own shares here at the multiples we’re seeing for some of these opportunities.
Julian Mitchell - Credit Suisse
Great. Thank you.
Michael W. Lamach
Yep.
Operator
Thank you. And our last question comes from Jamie Sullivan from RBC Capital Markets.
Your line is open.
Jamie Sullivan - RBC Capital Markets
Thanks. Good morning.
Michael W. Lamach
Good morning.
Jamie Sullivan - RBC Capital Markets
Just wondering on the restructuring spending side, if you have a figure for the quarter and what you expect going into the fourth?
Steven R. Shawley
We talked about restructuring on the last call. We have restructuring front-end loaded, so we will spend somewhere in the neighborhood of $40 million in the first half of the year and that ramps down to about $10 million in the second half of the year.
So there is a – and that’s helping also – remember the conversation in last couple of quarters, we’re seeing the productivity show up in the second half associated with those spendings that went on in the first half. So, we’re kind of right on cue there with that program.
Michael W. Lamach
We spent about $20 million more in restructuring in 2012 and 2011 Jamie. So it’s been a pretty steady state restructuring program for the last 3, 3.5 years.
Jamie Sullivan - RBC Capital Markets
Okay. And probably kind of a similar focus on that as you go into next year, is that the way we should think about it?
Michael W. Lamach
For now, yes, we will come back and give you definitive guidance in the quarter. But for now I think it’s a good assumption.
Jamie Sullivan - RBC Capital Markets
Great. And then just one last one, on the industrial side, you talked about focus on the aftermarket side of the business.
What’s the mix of equipment versus service today and also maybe if you can touch on how the order patterns kind of trended in the quarter and if there are any surprises on that front?
Michael W. Lamach
About 40% today, Jamie. I think we will move that over next few years something closer to 50%, that’s our design in that business.
And there we’re looking at order rates for services that really kind of get into sort of the mid double-digit even at times high – I am sorry mid-single digits even high single digits order rates for service. So, we like the contribution margin service, we like the growth rates and obviously we’re trying to move the mix up closer to 50% in the industrial business.
Jamie Sullivan - RBC Capital Markets
Thank you.
Operator
Thank you. I’d like to turn the conference back to Ms.
Janet Pfeffer for closing remarks.
Janet Pfeffer
Thank you, Mary and thank you everyone. Joe and I will be around today if you have any follow-up questions.
Have a good day.
Operator
Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.