Trane Technologies plc (TT) — Q3 2015 Earnings Call Transcript

Thank you, Trisha. Good morning and welcome to Ingersoll Rand's Third Quarter 2015 Conference Call. We released earnings at 6:30 this morning and the release is posted on our website. We'll be broadcasting in addition to this call through our website at ingersollrand.com, where you will also find the slide presentation that we will be using. If you would please go to Slide 2, our safe harbor statement. Statements made on today's call that are not historical facts are considered forward-looking and are made pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause actual results to vary from anticipated. This release also includes non-GAAP measures, which are explained in the financial tables, which were attached to our news release this morning. With that, let me turn it over to Mike Lamach, Chairman and CEO; and Sue Carter, Senior Vice President and CFO. Mike?

Great. Thanks, Janet. Good morning, everyone, and thank you for joining us today. In the third quarter, we exceeded our EPS forecast, improved operating performance, and delivered profitable growth through solid execution that more than offset headwinds from the global economic environment. Our operating income and operating margin percent were both all-time records, particularly good performance in the face of a slowdown in the Industrial segment and in the Asian and Latin American regions. Our team responded well to the challenges. We were able to overdeliver on our commitments despite lower-than-forecasted revenues. Adjusted earnings per share were $1.21. That's up 10% versus the third quarter of 2014. That compares to our guidance range of $1.15 to $1.19. So adjusted EPS for the quarter was $0.04 better than our guidance midpoint. Revenues were approximately $50 million lower than the midpoint of our guidance forecast, about half of that from more unfavorable foreign exchange and about half from lower volume. And that translates to a couple of cents headwind versus our earnings guidance. The tax rate was also a little higher, and that was another $0.02 of headwind. These headwinds were more than compensated for by higher productivity and lower spending as well as a slightly lower share count driving the $0.04 earnings outperformance. Organic revenue growth was 6%, led by strength in the U.S. and European Transport and Commercial HVAC businesses as well as Residential HVAC. Europe and the Middle East, excluding currency, remains strong. Excluding currency, Latin America was down low single digits, as strong results in Mexico partially offset weakness in Brazil. Excluding currency, Asia revenues were down 3%, reflecting continued weakness in China and emerging markets. Climate organic growth was 8%. Industrial markets were weaker in the quarter. Organic revenue and Industrial was down 2%. As you'll see when I get to the forecast, we adjusted our fourth quarter down slightly to reflect slower Industrial markets and currency. Organic orders in the third quarter were up 1%, impacted by tough comparisons in Transport against record orders in 2014 as well as a slowdown in Industrial. Commercial HVAC bookings, excluding foreign exchange, were up low single digits, and were up mid-single digits in North America. Adjusted operating margins increased 1 full percentage point as stronger productivity and pricing, combined with deflation, more than offset negative currency, investments, and other inflation. We repurchased about 4 million shares in the quarter and have completed our announced $250 million of share repurchase in early October. And now I'll turn it over to Sue, and then I'll come back to you to take you through the fourth quarter outlook.

Thanks, Mike. Let's go to Slide 4, please. Orders for the third quarter of 2015 were down 2% on a reported basis and up 3% excluding currency. On an organic basis, which excludes both currency and acquisitions, orders were up 1%. Climate orders were up 3% excluding currency. Commercial HVAC bookings were up low single digits, and Residential HVAC bookings were up mid-teens. Transport orders were down, primarily due to difficult comparisons with record 2014 bookings in North American Transport and in Marine. Organic orders for Industrial were down 4%. Organic orders decreased by mid-single digits in Air and Industrial products and improved by low single digits in Club Car. Please go to Slide 5. Here's a look at the revenue trends by segment and region. The top half of the chart shows revenue change for each segment. For the total company, third quarter revenues were up 3% versus last year on a reported basis and up 6% on an organic basis, which excludes both foreign exchange and acquisitions. Climate revenues increased 8% on an organic basis. Industrial revenues were down 2% organically. I'll give more color on each segment in just a few slides. The bottom chart shows revenue change on a geographic basis, as reported and organic. Organic revenues were up 7% in the Americas, up 10% in Europe, Middle East and Africa, both led by strong HVAC and Transport performance, and Asia was down 3%. Let's go to Slide 6, please. This chart shows the change in operating margin from third quarter 2014, up 13%, to third quarter of 2015, which was 13.6% on a reported basis and 14% on an adjusted basis. Volume, mix, and foreign exchange collectively were a 20 basis point headwind to operating margin versus prior year. Within that, about 40 points negative was from currency and 20 points positive from volume mix. Price and direct material inflation contributed 60 basis points to margin with positive price and direct material deflation. This is consistent with the expectations we gave you in July, as the positive gap widens in the second half of the year from material deflation. Productivity versus other inflation was positive 90 basis points driven by strong productivity and cost containment. Year-over-year investments and other items were 70 basis points. This breaks into 3 pieces. This is the first year in which Cameron is included in our results and impacted margins by 20 basis points due to intangible amortization. In the box, you can see 20 basis points of headwind from investments and 30 basis points from higher restructuring costs. In the gray box at the top of the page, overall leverage on an adjusted basis was 45%. Backing out currency and acquisitions, organic leverage was 41%. That is better leverage than our July guidance, as lower revenues were more than offset by productivity and spend controls. Let's go to Slide 7, please. The Climate Segment includes Trane commercial and residential HVAC and Thermo King Transport refrigeration. Total revenues for the third quarter were $2.8 billion. That is up 4% versus last year on a reported basis and up 8% excluding currency. Third quarter organic Commercial HVAC revenues were up mid-single digits. Excluding currency, Commercial HVAC revenues in North America increased by mid-single digits compared with last year and increased by high-teens percentage in Europe and Middle East, and HVAC revenues in Asia were flat. The North American Residential HVAC market continued an orderly transition to the new regional SEER standards. Residential HVAC revenues were up low teens. Thermo King revenues were up low teens excluding currency with strong gains in North America. In Europe, organic revenues were up low teens. Climate's margin performance was strong. Adjusted operating margin for Climate was 15.8% in the quarter, 150 basis points higher than the third quarter of 2014 due to productivity and volume/mix, partially offset by other inflation, currency and higher investment spending. Please go to Slide 8. Third quarter revenues for the Industrial Segment were $729 million, down 2% on a reported basis and also down 2% organically as revenues from the Cameron acquisition offset the negative impact of currency. Air Systems and Services, Power Tools, Fluids Management and Material Management organic revenues were down mid-single digits versus last year. Organic revenues were down low single digits in the Americas, up low single digits in Europe, Middle East and Africa and down in Asia. Third quarter organic revenues from Parts and Service increased mid-single digits. Club Car revenues, excluding currency, were up high single digits. Industrial's adjusted operating margin performance was strong in the face of volume challenges. Adjusted operating margin was 14.4%, down 40 basis points when compared with 14.8% last year. However, the Cameron acquisition, including known purchase accounting impacts and negative currency, account for 190 basis points of downward pressure on Industrial margin. On lower volume, the team delivered pricing and strong productivity and cost savings initiatives to more than offset inflation and investments. Please go to Slide 9. For the third quarter, working capital as a percentage of revenue was 5.4%. The increase versus prior year is primarily inventory. This includes some incremental inventory to support Q4 air compressor shipments and some pre-build of inventories prior to ERP system go-live, which went live in October without event. Also the lower growth forecast puts pressure on inventory, which will probably end the year higher than our prior forecast. We had good collections in the quarter, and our days sales outstanding improved year-over-year. Our balance sheet remained very strong. We have no debt maturities this year. We expect adjusted free cash flow in 2015 to be in the range of $950 million, which excludes the IRS payments and restructuring. That would be within a couple of points of our 100% of net income target for cash generation. And with that, I'll turn it back to Mike.

Great. Thanks, Sue, and please go to Slide 10. North American institutional markets continued the recovery in the third quarter. There's no change to our revenue forecast there. We also continue to see growth in Commercial and Industrial buildings and retrofit. We still expect mid- to high single-digit growth for 2015 in North America and Commercial HVAC markets. The regional standards change in Residential HVAC is going as planned. We expect motor-bearing unit shipments for the year to be flat, up low single digits in 2015, reflecting the pre-buy that occurred in the back part of 2014. To round up North American Climate Segment markets, we expect North American transport markets to be up double digits in 2015, reflecting good trends in trailer, truck, and APUs for most of the year. North American Industrial markets have remained fairly weak. Gulf markets are expected to be up low single digits. We expect Latin American, Asian, European, and Middle Eastern HVAC equipment markets in the aggregate to be up low to mid-single digits at constant currency, but flat to down after considering currency. Within those regions, Europe and the Middle East have been relatively strong for us, excluding currency. Asia had slowed since July, and we now expect Asian markets to be down for the year. We expect European transport markets to be down, including foreign exchange, but up at constant currency. Industrial markets in Europe and the Middle East, Latin American, and Asia are more challenging, and we expect these markets to be down for the full year. Aggregating those market backdrops, we expect our reported revenues for the full year 2015 to be up about 3% versus 2014. Our prior range was 4% to 5%. So in total, we're reducing the back half revenue forecast by about $140 million. As I said earlier, $50 million of that happened in the third quarter. Overall, foreign exchange will be a headwind of about 4 percentage points, which reflects the deterioration of several currencies since July, when the expected impact was 3% to 4% negative. We expect acquisitions to add about 3 points for the year. Organic growth, excluding currency and acquisitions, remains at the same 4% to 5% range we gave in July. We expect Climate revenues to be up about 3% on a reported basis and approximately 6% organically. There was very little change in the Climate revenue outlook, only about $25 million or $30 million. And it's mainly a reflection of softer FX rates than in July and reflects continued weakness in China. For the Industrial Segment, revenues are now forecast to be in the range of up approximately 3% on a reported basis, which compares to an anticipated growth of 6% to 7% in July. In dollar terms, the full year Industrial forecast was lower by about $120 million. It's almost all from lower volumes, as short-cycle markets have not recovered, as well as allowing for some shipment push-outs on larger machines. You might recall that our July forecast needed about 2% organic growth in Industrial in the second half. The new forecast reflects about 2% contraction in organic growth in the second half in Industrial. Within the Industrial Segment, organic revenues are now forecast to be down 1% for the full year compared to our July view of up 1% to 2%, reflecting the softness we saw in the third quarter and continued weakness in overseas markets. For operating margins, we still expect Climate margins to be in a range of 13%, identical to our prior guidance. We expect Industrial adjusted margins to be approximately 14%, also identical to our prior guidance, as higher productivity and continued spending controls are offsetting the impact of lower volumes. Please go to Slide 11. Our adjusted earnings per share guidance range has been tightened to $3.69 to $3.74, an increase of 11% to 12% versus 2014. That excludes acquisition step-up, restructuring, the Venezuelan currency devaluation and the IRS agreement. It slightly moves the midpoint for the year down by $0.02, which reflects lower revenue backdrop that we're entering the fourth quarter with, and is partially offset by the cost actions that are taken, and that will continue. The range for reported, or GAAP, continuing EPS is $2.57 to $2.62. Fourth quarter revenues are forecast to be up 2% to 3% on a reported basis and on an organic basis. Currency impact offsets the impact of acquisition. Adjusted fourth quarter earnings per share are forecast to be $0.90 to $0.95. We expect about $0.02 restructuring costs and a $0.01 related to taxes for Venezuela. Including these, the reported continuing EPS range is $0.87 to $0.92. We have provided an EPS bridge for the fourth quarter in the appendix to give you the walk from year-to-year. The fourth quarter forecast would put leverage, excluding currency and acquisition, so organic leverage, at about 75% and about 2.5 percentage points of growth. That higher-than-normal leverage is driven by strong productivity, material deflation in the quarter, and includes $15 million lower corporate expense than last year. Before we go to questions, you might have seen the announcement we made this morning naming Todd Wyman as the President of our Compressed Air Systems and Services business. Many of you have had the opportunity to meet Todd since he joined us 6 years ago. He's been instrumental in our value stream transformation and the development of the company's business operating system, which is the foundation for the company's growth and Operational Excellence strategies. Todd's global business experience and demonstrated success in strategy implementation make him highly qualified to serve as the Compressed Air Systems and Services business President. Keith Sultana was named to succeed Todd as Senior Vice President, Operations and Integrated Supply Chain for the company, including leading our Operational Excellence strategy. Keith joined Ingersoll Rand 7 years ago and most recently served as Vice President of Global Procurement. Before that, Keith led the Global Integrated Supply Chain for the company's commercial heating, ventilating and air conditioning business in North America, Europe, Middle East and Africa. Before that, he led the Climate Solutions and Industrial Technologies sectors. So our commitment to our business operating system remains as strong as ever. At one point or another, Keith has had direct manufacturing and supply chain responsibility for every IR business, which makes him an ideal successor to Todd. These changes reflect our commitment to premiere performance and aligning capabilities with business opportunities and market conditions, and they are consistent with our organizational leadership development plans. So in conclusion, our strategies for growth and Operational Excellence have delivered a 5-year trend of excellent operating leverage, margin, and earnings improvement, and they remain the right strategies for the future. This quarter's performance was a demonstration of our focus on meeting or exceeding our commitments to you. Our focus remains to grow earnings and cash flow through the further implementation of our strategies. We have already taken and will continue to take action to generate growth and earnings as needed to respond to market conditions. And so with that, Sue and I will be happy to take your questions.

I would like to begin by discussing the management change in the Industrial segment and congratulate Todd and Keith on their new roles. I'm curious if there will be any changes regarding the margin orders for Industrial tech. The reason I bring this up, Mike, is that the margins in that area attract considerable investor interest, and I wonder if there is an acknowledgment, given Todd's background, that there should be a stronger emphasis on productivity and cost containment.

We're looking at the opportunities, Nigel, and we're committed to the 17% to 19% operating margins that we've communicated in the past. We want to accelerate that as quickly as possible. And for the segment to achieve that, we've got to achieve that in the Compressed Air business first and foremost. So the effort here would be certainly on all of the growth and Operational Excellence activities in the company. We see great opportunity in the value stream work in accelerating that, re-accelerating that. So it's really, I think, a tribute to Todd's leadership, but also to a commitment to being on-track and getting ourselves on track for that business.

Okay. Fair enough. And just a quick follow-on there, Mike. The 50 basis points of price cost benefit this quarter are consistent with commentary, but I think probably a little bit better than certainly what we expected. Does that continue to get better as the hedges start to roll off on the copper and aluminum? Or is this a pretty good run rate from here?

So Nigel, let's think about the cost, or the price and material from a longer-term perspective. So what we would have as a goal is we'd have a goal to have a spread between direct material inflation and price of about 20 to 30 basis points for the year. What we said when we talked in July was that in the second half of 2015 we would see wider spreads because the material deflation was really kicking in, which is exactly what we saw in that 60-bp spread. But in general, we're still targeting about 30 basis points of spread for the year. And then as we look at going forward, we'd hang onto that goal of having a positive spread of 20 to 30 basis points. So I don't think that as you look forward, at least in the near term, that 2016 commodities are going to increase. We've got about 50% of our copper for 2016 locked in. However, I think it's more realistic to think about the overall spread being 20 to 30 basis points rather than a 60 basis point spread being a new normal. I don't think that works.

We might have given more than we thought, really. But we kind of thought 50. It was 60, so it's pretty close to the number that we had thought.

Just quickly on Cameron and just the M&A impact. Just wanted to check my math. It sounds like you've actually held your Cameron forecast, if I'm assuming a 3% acquisition contribution, that would imply about $380 million in revenues in the back half with FRIGOBLOCK, so we end up with about $340 million for Cameron. It sounds like no change there, but then, Mike, you also made a comment about derisking Cameron a little bit. So can you just reconcile that? Or am I missing something in that math?

Jeff, that's a great question. Let me clarify that we have reduced our total forecast for the second half of the year by $140 million, with $50 million of that anticipated in Q3 and $90 million in Q4. The change attributed to Climate is approximately $30 million, which leaves $60 million related to our Industrial businesses. Specifically for the Cameron large machines, we are anticipating a risk of $20 million to $25 million due to known delays, often associated with customer acceptance and readiness at those sites. Therefore, we consider $20 million to $25 million to be linked to large machines. The remaining amount could be evenly divided between the short cycle replenishment in Industrial and foreign exchange impacts. Regarding the Cameron segment and the large machine risk, we are looking at that $20 million to $25 million exposure. Additionally, concerning short-cycle recovery, some factors involve plant air for both the Ingersoll Rand legacy and Cameron businesses, but we are not observing a rebound in order rates. Furthermore, we are noticing a slowdown in capital spending from Industrial customers in Q3 and Q4, which is also contributing to the overall situation.

Okay. And then just shifting gears, on TK, orders, down on tough comps, but the comps are going to stay tough, right, in North America, in particular, in trailer. How do you see things playing out? Should we still be thinking about double-digit-type declines or more in trailer in North America in 2016?

So Jeff, let me give that a shot. So you're right, as we look at the order rates for North America for trailer in the third quarter, they declined again. We expected that. We talked about some of those orders being roughly at peak in the second quarter, and it really is a tough compare to 2014. So when we look at the fourth quarter, first, I'll take fourth quarter, we expect the trailer orders again to show negative year-over-year comparisons, again, based on really strong 2014, actually, record order levels last year. And so what we're looking at is the tough comparisons on TK in total, orders for the third quarter in overseas markets were actually down, and ex currency, we're roughly flat. But you also asked a question about 2016. So if we look at what's out there in terms of ACT data, so we're not talking about our forecast, but we're looking at ACT data, we still are seeing forecasts for that to come down in the ranges of probably some of those double digits. But we're closely assessing the markets, especially in trailer, and looking at the record volumes. So not really a precise answer, but the tough comps are really the big part of the story, and in 2016, ACT doesn't see much change from their prior outlook.

Jeff, if you took that 10% or 15% kind of as sort of the market for North American trailer and recognize it's a little bit less than 25% of our business, we're probably going to see pretty good markets in Europe and the Middle East. We're seeing probably good markets for Marine, rail, bus, and for our air refrigeration businesses. So we talked about the scenario last time that a 10% to 15% decline in North American trailer is something where we think we could still grow margins in the TK business and potentially actually grow the top line, but that's not to be concluded until we finalize the plan.

Just to clarify that answer for Jeff. On the Cameron deal, you had originally promised $0.08 to $0.10 of gross accretion for 2015. So bottom line, what number do you expect to achieve this year on that?

So cash accretion is at about $0.08, maybe a little bit better, but about $0.08.

Okay, great. Can you share what you're observing regarding the restocking impact in the residential sector and the destocking trends in Industrial? What kind of effect do you believe this is having on the business?

Well, Residential is lumpy, Steve. So that's hard for a quarter-to-quarter compare with Altap and with the change in SEER regulations, but our global Residential business was up mid-teens but our North American Residential bookings were up high teens. I wouldn't put a lot of stock into the booking numbers and just some of the anomalies from quarter-to-quarter. The industrial restocking is just more of an indication of slowing industrial markets and the fact that companies like ours are probably pulling in a bit on CapEx, and we see our Service businesses growing. So one thing you see in a typically mild pullback in either Commercial or Industrial space is the Service business should grow, and our Service business grew mid-single digits in Industrial, which is pretty good performance.

Okay. And then just following up your point about 30 basis points ongoing price versus raws. And if I think about the same growth rate, maybe, next year as this year for the overall business, if that were to be the case, do you think you can hold these kinds of mid-40s organic incrementals?

I think, Steve, we'd look at really more along the lines of what we've said longer-term, which is we're more comfortable with looking at incrementals that are at our gross margin levels as opposed to trying to project what happens to all of those. And I understand the comment on deflation and the productivity that we've had, but I think there's going to be some other areas that are going to have tougher comps in 2016 going forward. So I think, the price spread of 20 to 30 basis points and our incremental leverage being at the gross margin levels are probably better longer-term ways of just thinking about the business.

I was hoping Sue could clarify the comment on expectations for inventory increasing in the fourth quarter and its impact on your free cash flow conversion.

I hope that our inventory does not increase in the fourth quarter. Currently, our inventory level is higher than it was a year ago. This is partly due to the buildup of air compressor inventory for fourth-quarter shipment, the pre-build for the ERP go-live, and some effects from a decrease in revenue. I expect the inventory to decrease in the fourth quarter, but I don't anticipate it returning to previous levels seen at the end of 2015. We will continue to manage this situation, but it is not an issue; it will just be slightly heavier than before. In terms of free cash flow, our original range was $950 million to $1 billion, and we currently project around $950 million. We are actively managing receivables and optimizing other elements of free cash flow to compensate for the increased inventory compared to last year. I don't see this as a problem; our free cash flow, being at 98% of projected net income, aligns well with our expectations, and we're simply seeing a little higher inventory than a year ago.

I appreciate that clarity. Mike, could you share your thoughts on the strong performance in Europe related to Climate? Were you surprised by it? How much does the mix play a role in that? It seems like you might be gaining some market share.

Well, it's been surprising us for a couple of years in terms of just the success that I think we've had with there. But as I've said in the past, we've got an excellent team leading the business and a lot of new products and services being launched into the marketplace. So a continued good performance there.

Just a question on Industrial. I think you're guiding for Q4 organically to be down about the same degree in revenues as Q3, so maybe down about 2% year-on-year. But the orders progression has got worse Q3 versus Q2, and the organic sales hurdle is higher in Q4. So maybe just confirm if that's really the case. And maybe talk a little bit about how you're seeing industrial demand trending kind of within the quarter and in the last couple of months, specifically.

The widest area we have is in China, which has a broad spectrum of potential outcomes, both best and worst case. We're currently adopting a more conservative outlook for China, which is uncertain. The rest of the situation largely pertains to the booking trends we are aware of and some cautious perspectives regarding restocking in certain stock businesses.

Yes, Julian, you are correct. When we spoke in July, we observed some recovery in short-cycle markets in June, although not uniformly. Unfortunately, the anticipated re-acceleration did not persist into the third quarter, prompting us to lower our Industrial organic growth outlook for the second half from plus 2% to minus 2%. You are absolutely right.

Got it. But I guess, you're not expecting the decline to get worse in Q4 even though you have a tougher comp in Industrial?

Yes, we experienced a somewhat unexpected favorability in bookings in Latin America for the compressor business. We believe we have taken a conservative stance, and the team in China has plans for some larger orders that may materialize. For the back half of the year, we anticipate $90 million for the company, with $60 million specifically for Industrial in the fourth quarter. We feel confident that we have this under control based on what we know today.

And then just a quick follow-up on train in Asia. I think that, obviously, the trends even back in July were pretty unsteady in China. Maybe just talk a little bit about how you've seen the order intake and the backlog moving there.

Let's discuss China overall. Economic growth rates are significantly below historic levels as the government works to rebalance the economy, which has led to some uneven progress. This volatility makes quarter-to-quarter comparisons a bit unstable. However, HVAC bookings in China for the quarter increased by low single digits compared to last year. For the fourth quarter, HVAC revenues in China are expected to decline by low single digits, mainly due to applied systems growth being offset by lower unitary revenues and currency fluctuations. There are many factors at play here. Looking at non-residential construction market starts from the fourth quarter of last year, some trends have persisted into the latter half of 2015. Areas showing strength include data centers, healthcare, and mixed development opportunities.

The good news there, Julian, was the fourth quarter positive bookings in HVAC in China.

Mike or Sue, to clarify the leverage point for the fourth quarter, I believe you mentioned corporate decreasing by $15 million to $60 million. Is there any offset in other income or something we should be aware of? It seems like my estimate ends up a bit high if corporate drops by $15 million.

When considering the leverage for the fourth quarter and its various components, it's important to note that our organic growth is expected to be in the range of 2% to 3%, which translates to approximately $75 million to $80 million in revenue. If we also factor in productivity improvements and direct material inflation while continuing to achieve pricing increases, these will be key drivers of productivity in the fourth quarter. Additionally, if corporate expenses decrease, the calculations align to suggest that we could see leverage in the 75% to 80% range for that period.

And, Shannon, another way to look at it, it's $75 million of revenue at the midpoint. $40 million in operating income on that. Take $15 million off for corporate. Now you're talking about really $25 million on $75 million. You've got a 33% leverage. And look at the price deflation spread, look at the productivity of other inflation spread, and it's really a doable number.

Okay. I know your other line fluctuates, but there is nothing unusual or different happening there. It has been inconsistent, making it difficult to model. It primarily relates to currency, but do you have anything significantly declining in the other line?

No, so the fourth quarter should be relatively flat. So not really a lot of movement there that we're looking at.

Just on the Commercial HVAC bookings, up mid-single digits in the Americas. Do you have the, sort of, North America split of that, I think you used to give? And is there any parts of North America that you see getting better or worse?

Applied is showing a mid-single-digit trend. The institutional aspect of the larger unitary is performing well. The backlog aligns with booking trends, suggesting that if you consider the backlog predating bookings by 3 to 6 months, the rate remains relatively stable as we move into 2016. This indicates that we are likely experiencing the mid-single-digit institutional recovery we anticipated, which should continue for several years. According to Dodge data, the prospects appear more optimistic, with institutional activity expected to rise by 14% in 2016 compared to 2015, and starts projected to increase by 10%. However, it's important to note that historically these numbers tend to be high and may decline throughout the year.

Could you provide an approximate margin breakdown for the segments in the fourth quarter? I'm having some difficulty understanding the numbers due to some rounding dynamics and the variations next to the figures annually. A rough estimate would be helpful.

So if we're looking at the total year for Industrial being in the range of 13%, or roughly 14%, so you're right, we've got a little bit of a squiggle in there. What would that imply for the fourth quarter on Industrial is margins in sort of the 15.5-ish type of range. And part of that gets driven by the compressor shipments in the fourth quarter, as well as continued productivity and a lower inflationary-type environment.

Okay. And then for Climate, I think we're backing into something of around 13.5%. Is that about right?

So Climate, with the sort of 13% that we're looking at for the full year, would be just slightly below the 13% range for the fourth quarter.

Okay. That makes more sense. And just last question, just on the Resi dynamics, what will mix contribute this year? I don't think you guys had great mix in the second quarter like maybe some others did. So there's maybe different timing dynamics around how much 14 SEER you're now selling, how much of that 14 SEER transition is booked this year? And then how much is kind of still yet to come for next year?

We've experienced some challenges with our product mix this year, particularly with the 14 SEER models, but we expect it to balance out as the year progresses. Overall, we believe that 2014 will yield better results compared to 2013, and we are seeing strong margin growth in the Residential sector. Despite the mix issues, 2014 should provide good absorption and expansion, and we anticipate positive developments continuing into 2015.

And then for '16, is there still some benefit to come there?

I don't believe we'll encounter the issue of mix in 2016. There may be a quarter or a few months affected, but considering the changes in stocking dynamics this year with 13 SEER, I think we should have a fairly stable year next year regarding mix.

I guess, the first question I would have is just, taking into account some of your comments around the state of the U.S. non-residential and the limited visibility on the Industrial side, I mean, how do you think about, just directionally, about '16 in terms of EPS growth? And what can you provide, or what can you provide in addition, maybe for CapEx, or you have provided something I think on the margin side, what can you provide about '16, how we should be thinking about it?

First of all, remember we'll discuss this in February, so I can only provide a general perspective on where things are heading. It's important to note that 75% of the company falls under the Climate Segment. Within that, about 60% pertains to HVAC, with more than 60% of that occurring in North America. Therefore, we have around 40% of the company experiencing strong growth dynamics as we enter 2016. I believe HVAC in Europe, Eastern Europe, and potentially the Middle East will see organic growth, although likely not at the same pace as North America. Overall, a significant portion of the business is growing for us. Regarding the Industrial sector, I foresee that Asia and Latin America may continue to face challenges, along with possible currency headwinds, but even with modest growth next year, we expect to improve margins significantly. While I won't provide an EPS number at this time, we feel confident about the growth opportunities we’ve identified in 2015, which could contribute to the company's expansion.

Okay. And then just one follow-up. In terms of just capital allocation and then just reinvestment in the business, given the prevailing environment, is there change or nuance at the margin in terms of M&A or other forms of capital redeployment or internal reinvestment?

No, Robert. When we look at it, we expect to continue the balanced capital allocation that we've got with investment in our businesses. We can expect to continue having a strong dividend payout, so in the 30% to 35% range. We'll continue to, at a minimum, offset dilution with share repurchase activities. And then the remainder of it, we'll basically continue to toggle between value-accretive M&A and additional share repurchase and just evaluate what makes the most sense at any given point in time. Now you had also asked about CapEx. And so, generally speaking, our CapEx is usually in a range of about $250 million, which is roughly equal to depreciation, and we don't expect that to change going forward either.

Both the CapEx and investments are a number that, Robert, we can work with during the year depending on what we see in terms of the environment. So there is some flexibility for us to spend less if we need to, to help bridge some of the EPS commitments that we'll make.

Just a couple of questions. First, on Cameron, obviously, backlog is typically weighted to the fourth quarter, but can you give us maybe an indication how order trends and visibility or coverage in the next year looks, maybe versus what normal seasonality should look like? There obviously, don't have a known end of the year yet, but just kind of any color on orders would be helpful.

Sure, Josh. One interesting aspect of the history of the engineered compressor business is that our shipments are currently back half-loaded, and generally, orders for large engineered compressors are also back half-loaded. This allows us to see real-time developments in various market segments. To provide some insight into what we're observing and its implications for 2016, the space is facing negative impacts primarily because oil and gas majors are cutting capital expenditures by 20% to 30%. Additionally, there is industry consolidation and a slowdown in EPC activity. This means there are generally fewer projects available while the number of competitors remains the same, so it's essential to be sharp, focused, and diligent about securing orders. Breaking down the different sectors, in processed gas, which comprises approximately a quarter of our business, we still see some growth from natural gas and LNG, although there have been project delays in the Middle East. The petrochemical sector is performing reasonably well, and there are opportunities in power generation, particularly in Europe, where there are ongoing projects. Regarding processed gas and the chemical side, the lower gas prices might influence feedstock prices and alter dynamics, but it's still a challenging environment with fewer projects. In engineered air, which makes up another quarter of our business, air separation in China remains relatively stable, although I do not anticipate significant changes soon. Activity levels are expected to be lower, with analysis showing reduced activity in the first half of the year compared to 2014 and 2015. The industry is facing overcapacity and reduced steel demand. For plant air, which is a book-and-turn segment, performance is roughly on par with 2014. There are still promising markets like the automotive and food and beverage sectors, although Europe is experiencing a slowdown, and Asia is down. The aftermarket represents areas of opportunity. Overall, we are navigating softer markets with some projects still in progress, and we are closely monitoring developments for 2016 across all sectors.

Synergy-wise, too, Josh, we're really on track there with, as an example, just sort of the plant air, the revenue synergies, the cost synergies. And if anything, over the last few months, we've gotten more conviction around the opportunity for the engineering, supply chain and manufacturing synergies that could exist in the business. So I think that we'll continue to make the business accretive. And in 2016, we'll make sure that if we've got the weakness that Sue's talking about, now that we've got a response to keep the margins at or better than where they were this year. We have a roadmap to do that.

Yes, and I think the bottom line of all of that is it's still a great business and it's still great products for us. And like I say, in spite of all of the things that I said about the market, it's accretive in 2015, and we're getting the synergies. So there's more to come on this one.

That's great detail. And if I could just ask a follow-up on TK. I've heard that some of the trailer guys have opened up the order books maybe a month or so earlier than they normally would, for the following year. Is that something you guys have seen? And is any of the strength in North America this quarter maybe a month or so pull-ahead from what you might normally have seasonally?

It varies significantly among our customers regarding when they open their order books. If you look at the top ten customers, their ordering times differ. In the third quarter, some customers did open their order books, similar to past occurrences where we notice inconsistencies in who is ordering. We are aware of both the customers who have placed orders and those who have not, and we don't see any major shifts in that pattern. However, you will observe variations in book rates and revenue rates based on when the orders are placed. Some customers order between 1,000 to 3,000 units, which impacts our monthly totals when considering ranges of 6,000 to 9,000 units, as we've seen in recent months.

Just a question. There was some debate inside the company about how to look at the value stream process, and at the Analyst Day, you had indicated that you are reassessing your approach because you've sort of touched a lot of low-hanging fruit. And then we seem to have had a pause in execution last quarter, and this quarter, operating leverage just seemed to have come through very nicely. Can you describe to us what internal operating changes you've been implementing over the past 6 months to address this next level of operating improvement?

Yes. A lot, Andrew. I'm not sure I'll cover it here. It would be a great discussion that we could have when we're together for our review this spring, in general. But we've used these product growth teams as a basis to expand the effort across the company. We've continued to now touch really all of the business with their value streams. Sourcing has become, I think, mature across the company. We have got really good productivity the last 3 quarters, really, in general. If you look past Q2 and kind of look at the last 3 quarters, we're seeing productivity accelerate. It's never really that linear. I know we'd all like for it to be, but it's not. We'll have projects and ideas that at a certain point in time, pit in a quarter, and those make a difference. Higher volumes would make even a more positive difference, of course. So we're doing this all with actually quite sort of low volumes in some of our businesses. So we're excited that if volumes do return, we'd see even better productivity on the changes that we've made. And so, look, I think that we haven't really changed the operating system in 5 years. We've just really looked across as product growth teams that now have touched most or all of the company in one way, shape, or form.

And just a follow-up question, I apologize if you've answered it already, but can you comment on the cadence of industrial orders throughout this quarter?

The cadence throughout the quarter was consistent. There weren't any significant peaks to indicate volatility; it was pretty steady overall. We experienced notable growth in our Fluids Management business, which was a highlight for us as it grew by double digits. However, our Material Handling segment, which is our only business tied to oil, saw a significant decline, with bookings dropping by 50% compared to the previous year. Within the Industrial sector, excluding the compressed air business, there were both high and low points among the smaller businesses, but they are generally understandable, as seen in the example of Material Handling.

So a quick clarification, Mike, you mentioned earlier the Dodge data on the institutional side and the expectations for next year, but there's been a lot of noise in the data, especially on the Commercial side. I'm just curious, what, if anything, you're seeing, and what you're making of that noise line on the unitary side of your business?

I believe that the large unitary business continues to perform well, particularly in the institutional sector. The commercial activity has also been quite robust. When we differentiate between Commercial and Industrial, Industrial has shown slightly weaker performance in North America, but overall, the market conditions are still favorable for us. We remain optimistic about the North American market for both Institutional and Commercial and Industrial sectors. Looking ahead, we see Institutional leading in strength, followed by Commercial, with Industrial HVAC following that trend.

Okay, that's helpful. And maybe following up on that, how do you think about mix then as you head into next year? Clearly, we've talked a little bit about some North America headwinds on TK, but some of the mix headwinds on resi should subside. How are you guys thinking about mix, particularly in light of the Climate margin target of 13% to 14% for '16?

Well, I mean, on track, in a nutshell, Joe. I mean, TK still gives us really good volumes from a profitability perspective, we're working with pretty high volumes across-the-board. Even though the year-over-year decrease in the market will be there, we've got plenty of gas left there in growth parts of the business that we didn't have last time around. So we feel pretty good about being able to hold our head up on the TK business. As you look at Climate, great expansion in margins in the Residential business. I've said before, I'll say it again, mid-teens, mid-teens plus EBITDA. The Commercial business, particularly in Europe, is doing well, and we're hitting some critical mass there that I think will begin to contribute more to the op margins across the business. And then in general, North America just does a really good in terms of share and consistent margin expansion there, and so I feel pretty good about that. The wild cards are really Latin America and Asia for us as it relates to the HVAC businesses. And here, we talk about pricing in China, but it's not sort of an environment that's impossible. It's just more difficult for us. So we're persevering in China. And again, I feel good at least about the quarter, bookings going in the right direction. Would love to see the next couple of quarters look the same way before I'd feel more constructive about China, about Asia, in general.

Thank you. Thank you, everyone. Joe and I will be around if you have any follow-up questions, and have a good day.