Trane Technologies plc (TT) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ingersoll-Rand Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Janet Pfeffer, Vice President, Business Development and Investor Relations. Ma'am, you may begin.

Thank you, Mary. Good morning, everyone. We released earnings at 7 a.m. this morning, and the release is posted on our website. We'll be broadcasting, in addition to this phone call, through our website at ingersollrand.com, where you will find the slide presentation that we'll be using. This call will be recorded and archived on our website. If you'd please go to Slide 2, our forward-looking statements. 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 laws. Please see our SEC filings for a description of some of the factors that may cause actual results to vary from anticipated results. This release also contains non-GAAP measures, which are explained in financial tables attached to this morning's release. Now I'd like to introduce the participants in today's call. We have Mike Lamach, Chairman and CEO; Steve Shawley, Senior Vice President and CFO; and Joe Fimbianti, Director of Investor Relations. With that, please go to Slide 3, and I'll turn it over to Mike.

Thanks, Janet. Good morning and thanks for joining us on today's call. Today, we'll cover 3 broad areas. First, we'll take a look back on the full year 2012. Second, we'll look at, of course, fourth quarter 2012 results. And then finally, we'll conclude by looking at 2013's outlook and guidance. Given the impending security spin, we'll be delaying the analyst meeting that we traditionally have hosted in March until later in the year, closer to the effective date of the spin. The analyst meeting is usually where we would step back a little from quarterly results and look at our progress over time and plans for the future. And since that won't occur for several months, I'll spend a few extra minutes this morning recapping our full year 2012 and our progress on the transformation that we began in the company a few years ago. Steve will then take you through fourth quarter results, and I'll end with our outlook for 2013. So again, we'll spend just a few more minutes this morning than we normally do. I don't want anybody to get nervous. We'll obviously have a lot of time for questions toward the end. Let me start with full year 2012. In a macro environment of low revenue growth, our revenues for the year were up 1%. We increased adjusted earnings per share 23% and grew operating margins 30 basis points. In the face of some very challenging mix, our pricing excellence program delivered price realization, significantly over direct material inflation. Our Lean focus continued to show significant results in the implemented value streams, and we continue to invest in the future of the business, funding significant new product development and building our services footprint further. Revenues from products launched in the last 3 years were about 1/4 of our total revenue. We also invested in common systems, and we will have the first go lives this year. As you'll recall, the program will continue through 2016. Our capital allocation strategy has been consistent and shareholder-focused. We continued to increase our dividend with the announcement of additional $0.31 -- I'm sorry, 31% of an increase in December. The 2013 dividend will exceed now the 2008 peak by 17%. In 2011 and '12, we repurchased 55 million shares for $2 billion. In 2012, we repurchased $840 million in shares. And in December, announced a new $2 billion repurchase authorization that will be used by the first quarter of 2014. Finally, we concluded a significant strategic review with our board and in December, announced the planned spin-off of our security business, which will occur late this year. Please go to Slide 4. As I've talked about before, we started on a journey in 2010 to increase the operating capability of the company. We focused these efforts in 2 broad areas: innovation and operational excellence. In the area of innovation, we've almost doubled the proportion of our revenues from new products, which we measure as the percentage of total revenues delivered by new products introduced in the last 3 years. The new offerings have been in every sector of the business, from air compressors to unitary HVAC, to electronics locks to new service offerings. Through new processes, talents and investments, we have increased our capability and results in areas like intellectual property development and protection, speed to market, margin improvement and market share growth. In 2012, intellectual property disclosures were up 270%, and patent filings were up 75% over the prior year. We are, by no means, done. We'll continue to invest in innovation and are focusing on multiple key growth platforms identified during our planning process. To highlight a couple of examples of recent market introductions, on the lower left of the chart you'll see the Trane IntelliPak I. IntelliPak I systems are part of the Trane line of unitary rooftop systems designed to be the most efficient and cost-effective air conditioning units on the market. Available from 20 tons to 130 tons of cooling, IntelliPak systems deliver the highest energy efficiency rating in the industry for a standard product and are up to 20% more efficient than traditional forward-curved fans. Utilizing variable-speed compressor technology, IntelliPak I systems provide a simple turnkey solution for system setup and configuration, with lower life cycle costs. And through efficient operation and reduced maintenance demand, the new systems provide superior reliability. They're ideal for large office buildings, restaurants, retail centers, industrial facilities, institutional buildings used for health care and education. In addition to reduced energy consumption and lower life cycle cost, it provides very quiet operation in critical environments. Lower right corner, you see the ThermoKing Precedent. The Precedent features a completely new platform for the trailer market. It's designed to be fully compliant with the new EPA Tier 4 final regulations. The Precedent platform features a new Diesel Direct Electric architecture to deliver optimum efficiencies. Testing demonstrates that the electronic throttling valves saves 30% in fuel, reaches cooling set point up to 50% faster, translating to significant operational and environmental savings for fleets throughout the life of the unit. Please go to Slide 5. Another area of intense focus for us and for me personally has been improving our level of operational execution, which we call operational excellence. We categorize it into 4 main elements: strategic sourcing, implementing Lean through our value streams and in our functional processes and finally, with pricing. We centralized sourcing during 2012 and organized around common commodities in order to increase our strategic sourcing capability through targeted training, standard work and the addition of external talent when needed. We also strengthened capability in emerging markets to better support supplier qualifications, supplier development and strategic sourcing in those regions. In one example, our maintenance and repair operations, or MRO commodity team, implemented the new standard sourcing process for North America, which represents an annual spend, in this case, of about $70 million. They achieved 7% productivity and also developed a road map to maintain productivity at 5% for the next 2 years. They improved days payable by 5 days. They reduced North American suppliers from over 3,000 to a select few and increased their internal customer satisfaction score to 4 on a 5-point scale. We have 24 value streams under transformation, which happens to also represent 24% of our cost base. The value streams continue to deliver superior results and show separation in performance versus the remainder of the company. In 2012, the value streams reduced past due days by 66%; reduced cycle time by over 40%; increased cost leverage, which are the plants version of operating leverage and is based on cost throughput, by over 6 points; and had a 5-point increase in employee engagement scores while they were doing all of this. We will continue to roll out more value streams, with a plan to add 8 additional streams in 2013, which would then bring the cost base coverage to 40%. On functional costs, we have a target to reduce our costs by 2 points of revenue over the next 3 years. Implementation of common systems is a key enabler to that reduction. We'll have our first go lives in the first half of 2013 and the implementation to continue in 6 phases through 2016. As you can see on the bottom of the chart, these initiatives, along with innovation, has increased our margins almost 400 basis points over the last 3 years on very little revenue growth while still making significant incremental investments in the business. Operating leverage has been 38%, 31% and 73%, respectively, for the last 3 years. We started on pricing in early 2010 and have reaped benefit from better price realization and price management for the past 2 years. We looked back several years in history and couldn't find a year when we had done this, so it was a testament to the results we can produce when we focus on building a long-term, sustainable capability. This isn't just managing price lists. They're actually a fairly small component of what we've built. It's centered on capabilities like pricing elasticity analysis, value pricing of offerings and discount management. So I'll discuss more when I come back to give the guidance. We see a continuation of challenging markets in 2013. We plan to proactively address that backdrop, as well as prepare ourselves for our new cost structure post-spin by taking restructuring actions during 2013, beginning in the first quarter. I'm proud of the progress we've made, and I'm certainly encouraged by the opportunities that lie ahead. And with that, Steve will now take you through the fourth quarter results.

Thanks, Mike. Please go to Slide #6. Adjusted earnings per share from continuing operations for the fourth quarter, which exclude impairment, we're $0.76. It is $0.09 better than the midpoint of our guidance range. $0.03 came from better performance in operations. There was about $0.01 of costs incurred related to spin that was not in the guidance, and the remainder was from a lower tax rate. We were pleased with our ability to navigate challenging market environments and to deliver above our earnings commitment, with solid operational execution in all of our businesses. Margin increased 100 basis points despite flat revenues. Compared to the fourth quarter of 2011, operating margins were up in each of the sectors, with residential delivering an 800-basis-point improvement despite slightly lower revenues. Revenues were flat both on a reported basis and excluding foreign exchange. Excluding FX, we saw a slight decline in climate and low-single-digit growth in revenues at industrial. Residential revenues were down 5% year-over-year. Security Technologies revenues was up 7%, with Americas up high-single digits. Excluding Hussmann, orders were up 1% and up 2% excluding currency. Operating margin for the quarter was 10.6%, up 100 basis points versus prior year. Margins improved from pricing and productivity, partially offset by unfavorable mix and investment spending year-over-year. All of the businesses continue to realize positive pricing. In the fourth quarter, our price realization outpaced direct material inflation for the seventh consecutive quarter. We repurchased 10 million shares in the fourth quarter, bringing the total repurchase in the year to 18.4 million shares. To sum, our focus on operational excellence and innovation delivered excellent results in the quarter. Please go to Slide #7. Orders for the fourth quarter of 2012 were up 1% overall and up 2% excluding currency. Global commercial HVAC bookings were up mid-single digits. Transport orders were down low teens, with a double-digit decrease in truck trailer orders and significantly lower marine demand. Industrial orders, excluding currency, were up 3%, with order growth in all regions and at Club Car. Residential bookings were down 5%. Commercial security orders in the quarter were up 16%, mainly impacted by the timing of large project orders in Asia. Please go to Slide #8. Here's a look at the revenue trends by segment and region. Note that the information on this slide excludes Hussmann from the comparisons. The top half of the chart shows the revenue change for each sector. For the total company, fourth quarter revenues, excluding Hussman, were flat versus last year on a reported basis and excluding currency. Focusing on organic revenues, which excludes the impact of foreign exchange, climate revenues decreased 1%, with HVAC revenues flat and transport revenues down mid-single digits. Industrial had moderating growth of 4%. Residential was down 5%. Commercial security revenues were up 7%. I'll give more color on each sector in a few slides. As you can see on the bottom chart, on a geographic basis, organic revenues were up 1% in the Americas, while Europe was down mid-single digits, excluding currency. Asia was up 7%, led by double-digit increases in industrial and security. Please go to Slide #9. This chart walks through the change in operating margin from fourth quarter 2011 of 9.6% to fourth quarter 2012, which was 10.6%. This data excludes Hussmann for comparison purposes. Volume, negative mix and foreign exchange collectively created an 80-basis-point headwind to margins. Our pricing programs continued to outpace material inflation, adding 110 basis points of margin. Productivity offset by other inflation was 140 basis points accretive to margins. Year-over-year investments and other items were higher by 70 basis points. In the gray box at the top of the page, you can see that revenue leverage was excellent in the quarter, with operating income increasing despite flat revenues. As the box in the middle of that page details, we delivered margin improvement at every sector even with revenue declines in climate and residential. Please go to Slide #10. The Climate Solutions segment includes Trane, commercial HVAC and Thermo King transport refrigeration. Total revenues for the fourth quarter were $1.8 billion. Excluding Hussmann, that is down 2% as reported and down 1%, excluding foreign exchange. Global commercial HVAC orders were up mid-single digits. Orders were up low-single digits in the Americas. Orders were down slightly in Europe on a reported basis and up slightly, excluding foreign exchange. HVAC orders in Asia were up mid-teens, with China up over 20%. Trane's commercial HVAC fourth quarter revenues were flat. HVAC revenues in the Americas were up low-single digits on a reported basis and excluding foreign exchange. Revenues in Europe and the Middle East were down mid-single digits on both a reported basis and when excluding currency. Revenues in Asia were down low-single digits. China HVAC revenues were down mid-single digits in the quarter. Commercial HVAC equipment revenues were down low-single digit. HVAC parts, services and solutions revenue was up low-single digits versus prior year. Thermo King orders were down in low teens versus 2011's fourth quarter. Thermo King revenues were down mid-single digits growth on a reported basis and when excluding currency. Worldwide refrigerated truck and trailer revenues were up low-single digits. The operating margin for Climate Solutions was 10.3% in the quarter, a 10-basis-point improvement versus fourth quarter of 2011, excluding Hussmann. Pricing and productivity more than offset inflation and higher spending on investment initiatives. We saw a particularly strong operating leverage in North America HVAC for new products, and cost reduction efforts fueled margin expansion from very little volume growth. Please go to Slide #11. Industrial Technologies fourth quarter revenues were $765 million, up 3% on a reported basis and up 4%, excluding FX. Air and Productivity revenues were up low-single digits versus last year on a reported basis and excluding currency. Air compressor revenues were up mid-single digits. Revenues in the Americas were up mid-single digits. Growth in Asia was offset by declines in Europe. Air and Productivity orders were up mid-single digits on a reported basis and excluding FX. Orders were up in all regions. Club Car revenues in the quarter were up high-single digits, and orders were up low-single digits versus prior year. Industrial's operating margin of 16.1% was up 80 basis points compared with last year. This higher revenues, pricing and productivity were partially offset by inflation and higher investment spending. Air and Productivity margins exceeded 17%. Please go to Slide #12. The Residential business fourth quarter revenues of $422 million were down 5% compared with last year on a reported basis and excluding foreign exchange. Residential HVAC revenues were down low-single digits versus last year. Our HVAC equipment -- I'm sorry, our HVAC unit shipments in the fourth quarter were flat versus the prior year. Last year, in the fourth quarter, recall that we had significantly reduced our inventory levels. Adjusting last year's shipments for the impact of that inventory reduction, unit shipments were up high-single digits. We were also the only major competitor that did not have a significant price increase effected in the fourth quarter of 2012, which tends to pull in shipments as distributors are trying to stock in advance of the increase. Since we had implemented a mid-year increase in 2012, our latest increase was more targeted and went into effect during the first quarter of 2013 rather than the fourth quarter of 2012. Consistent with the trends of the first 3 quarters of the year for 2012, the 13 -- the 14 share of the market was higher than the prior year as mix shifted to the low end of the efficiency range. Revenues for the residential security portion of the sector were down low teens, with increases in the new builder channel. South American volume increases were more than offset by lower Big Box revenues. In the fourth quarter of 2011, we had a significant increase in Big Box from the load in of new security products. Sector operating margin of 6.9% was up 810 basis points compared with 2011, as pricing and productivity more than offset inflation and adverse mix. Please go to Slide #13. Revenues for Security Technologies were $445 million, up 7% on a reported basis and excluding currency. Americas revenues were up high-single digits. Overseas revenues were up mid-single digits as higher revenues from projects in Asia more than offset volume declines in Europe. Global bookings were up 16% on a reported basis and excluding currency. Buoyed by share gains in the U.S. and the timing of large projects in Asia, bookings, excluding currency in Europe, were down slightly. Operating margin for the quarter was 20.6%, up 150 basis points from last year as productivity and price realization offset inflation and higher investment spending. Please go to Slide #14. We continue to maintain our focus on working capital. We finished the fourth quarter with working capital of 2.8% of revenues, which is a 1-point improvement from the end of the third quarter. We ended the year a little more -- with a little more inventory than last year as we intentionally increased stocking levels in targeted areas. For example, we were stocking more engines for TK as they transition to the new Tier 4 engine standards. With that, I will turn it back to Mike to take you through the guidance for 2013.

Okay. Thanks, Steve, and let's go to Slide 15. For purposes of setting guidance for 2013, it's on an as-is basis. It assumes that the current Ingersoll-Rand with the 4 current operating sectors is in place for the full 12 months of 2013. As we announced in December, we expect the security spin to take place in the fourth quarter. But to be clear, the guidance does not reflect the spin, given we do not yet have carve-out financials and specific data to spin. It won't be known for several more months. Also, we announced the spin in December, we indicated one-time deal costs and restructuring of $150 million to $250 million. We've broken out that amount from the EPS guidance in order to give the best representation of the company without the impact of the impending spin. And hopefully, that's all clear. And to save you all questions, there is no change or update to the information we gave you in December on the spin. It's proceeding according to our time line. We won't have pro forma financials for a few more months when we file the Form-10s. Finally, contrasting to 2012 when we had significant currency headwind for most of the year, based on current exchange rates, there's not much impact expected in 2013. The numbers I'll reference as revenue growth are the same with or without currency. With all that out of the way, our revenue outlook for 2013 is $14.2 billion to $14.6 billion, which equates to 1% to 4% growth versus 2012. I'm going to talk through what we're seeing by geography, and then we'll sum it up again by sector. Our outlook reflects activity in North American commercial HVAC continuing at moderate growth rates. Industrial markets are growing but at a slower pace than what we've seen over the past couple of years. We see continuing moderate growth in residential markets, albeit with choppy month-to-month trends continuing. We have seen some positive movements in replacement systems and in new home construction. For commercial security, we expect to see a continuation of challenging conditions in the U.S. non-residential new construction market for the next year, particularly in our key institutional markets. Given that the non-residential construction market impacts both our commercial HVAC and security businesses, I thought I'd spend some time giving some more color on the outlook there and how it impacts those businesses. We typically look at a group of indicators, the main one being Put in Place and starts data, which we get quarterly from Dodge. Put in Place is measured in dollars, and starts data is measured in square footage. To understand the impact on our business, you need to look at the trends by key vertical markets. Although total Put in Place is forecasted to be flat for 2013, institutional, which is over half of the Put in Place dollars, is forecasted to be down 5%, while commercial industrial activity is forecasted to be up 8%. Within institutional, our key end markets of education and medical are forecasted to be down high-single digits. And while commercial industrial overall is expected to be up, the largest growth sectors are warehouses and parking garages, neither of which will use much security or HVAC. Starts data is similar in trend to the Put in Place data. The Architectural Billing Index, or the ABI, can be a general leading indicator for us, and that's continued to be choppy, although the trend over the last several months is generally somewhat positive. A couple of other points to set the context. Recall that HVAC has a higher element of replacement than the security business. Security also tends to lag the trends more, given the timing of when it goes into the building construction, which is near the end of building fit outs. For example, HVAC generally lags ABI by about 6 months, while security lags it by about 12 months. The mix of all that leads us to a market outlook for low single-digit growth in North American commercial HVAC and flat to a low-single-digit decline in North American commercial security. Transitioning to refrigerated transport, we expect North American truck trailer markets to be fairly flat in 2013. Asian HVAC equipment markets are expected to be flat in 2013. China, though, is expected to be up low-single digits overall. Industrial Technologies also expects low-single-digit growth in Asia in 2013, and our security business there in Asia, which is more influenced by the timing of large infrastructure projects, should be up mid- to high-single digits for the year. Revenues in Europe are expected to show some recovery in the majority of our markets, albeit from very low levels in 2013. The exception for that is Thermo King. We expect truck, trailer and marine to climb low-single digits in 2013. Overall, we expect revenues from Europe, Middle East and Africa, when taken together, to be up slightly. So in summary, we see fairly slow growth for most of the end markets. So translating that to our outlook by sector, we expect Climate Solutions revenues to be up 1% to 3%, Industrial forecast to show more moderate growth than in the past couple of years, but growth there will be about 2% to 4%. And Residential is expected to be up 4% to 6%. Finally, Security Technologies should be up about -- in the range of 2% to 4%. Let's go to Slide 16. On the basis I discussed earlier, our guidance for full year EPS from continuing operations is $3.45 to $3.65. This excludes one-time deal costs and restructuring of $0.40 to $0.60, and this bridge reconciles that guidance for 2012. Operations drive the majority of the earnings growth of $0.35 to $0.55 and includes a headwind in pension and benefit costs. We benefit from a lower share count in 2013 given our capital deployment and share repurchase. Our forecast for the average share count for the year is 300 million shares, which reflects a buyback in the range of 900 million in the back half of 2013. The full year tax rate forecast for 2013 is expected to be 23% versus an 18% rate in 2012, which causes a $0.22 drag on earnings. Incremental investments are $0.20 for the full year. The largest 2 investments are for product development, the majority of which is in climate and for the implementation of common systems. And finally, to get it back to an apples-to-apples basis for treatment of restructure and one-time costs, you'd add back $0.11 for restructure that we had in 2012, and that would bring you to the range of $3.45 to $3.65. Please go to Slide 17. I've already taken you through the full year, so to focus on first quarter guidance, refer to the right-hand column of this chart. First quarter 2013 revenues are forecast to be $3.1 billion to $3.2 billion. That translates to a range of down 2% to up 2% versus the first quarter of last year. This reflects our view that, based on our backlog and order outlook, growth will start out sluggish and improve throughout the year. That's particularly the case in Europe and in Thermo King, which both start the year down year-over-year. Adjusted first quarter earnings per share are forecast to be $0.35 to $0.40. Security spin-off and restructure costs and potential non-U.S. discrete tax charges are expected to be about $0.20 in the quarter. We're assuming a share count of 302 million shares and an ongoing tax rate of 25%, which excludes the potential discrete that I just mentioned. There's a first quarter EPS bridge in the appendix to help you for reference. For the full year 2013, we expect to generate available cash flow of about $1.1 billion, excluding one-time and restructuring costs. Please go to Slide 18. We're pleased to have delivered a solid fourth quarter. We had tremendous, in fact, infinite operational leverage in the quarter and margin gains in all sectors. We continue to feel good about our company. Our focus is on positioning the company to continue to grow earnings and cash flow with very little help from markets. We have a multi-year record of delivering high operating leverage and margin improvement, and we've implemented a consistent, shareholder-focused capital allocation program. We proactively work to reduce costs and improve productivity while still making prudent investments for the future. Our investments are yielding a strong pipeline of new product and service offerings, as was evident at this week's AHR Expo, with several of you attended. We are accelerating restructuring activity to prepare the cost structure for 2 strong stand-alone companies. 2013 will represent another step forward in the progression of the company's innovation and operating capabilities as we improve margins, execute the security spin and continue to advance our core growth initiatives. And I want to assure you that we're up for all of those challenges. I am proud of the progress we've made, the results we've delivered and the opportunities that lie ahead for us. And with that, Steve and I would be happy to take your questions.

[Operator Instructions] Our first question comes from Jeff Sprague from Vertical Research Partners.

Could you give a little more color on the cash side? You said available cash, $1.1 billion. Do you have an early idea of what the cash requirements are on the restructuring spin cost in 2013? And any other one-offs that may actually tap into available cash?

Yes, Jeff. We -- when we talked about this in December, we talked about a refinancing we're planning in the middle of the year. We're planning on refinancing the debt tranche. It's due -- I think it's in August, and probably another $300 million on top of that to take care of the cash associated with the spin costs, restructuring, et cetera. So what that will do is that will free up most of the $1.1 billion to go towards the share repurchase throughout the year.

Right. And just totally shifting gears, on Europe, the notion that it gets better over the course of 2013, if only modestly, is that predicated on some early indication on orders somewhere? Is it more just kind of the low operating level that you're seeing across Europe and kind of some expectation that there's just some underlying bounce to that auto curve?

Yes. For us, Jeff, you've got to look at Western Europe, Eastern Europe and the Middle East. And so when we look back collectively, we're really seeing the Middle East will be up again mid-single digits, maybe a little bit better. Eastern Europe, up maybe a little bit less than that. And still, a fairly weak Western Europe. So net net, we're not expecting great things out of Europe, but do think, coming off the lows that we saw, we should see just a little bit of latter year growth. And that's supported with what we're hearing from customers, long-term customers.

Our next question comes from Shannon O'Callaghan from Nomura.

Can you just talk about corporate costs a little bit? One, in terms of just the 13 costs for the ongoing entity? And then in terms of this accelerated restructuring you're doing, are you going to be able to keep it at that level post-spin? Is that some of the aim here instead of absorbing kind of incremental public company costs for the 2 companies?

Let me just address the numbers question first, Shannon. In 2013, we expect the corporate unallocated cost to be somewhere in the $180 million range, about $45 million in the quarter. And don't forget, we're making heavy investments in common systems throughout all of this. And we really ramped that up this year. In fact, some of the story about corporate costs in Q4 was common systems-related. So that's a big piece of the increase in 2013. We also are seeing an uptick in pension and benefit costs, and we have some technology costs falling out, associated with the technology centers that are managed by the Paul Camuti here in the corporate center. That's what really tees up the increase in 2013. And like Mike said, we've pulled all the deal costs out of 2013, so that increase is not really deal cost related. I think if you look at the glide path of corporate costs going into the future, some of the restructuring obviously is going to have to impact corporate overheads. Also, when you look at the common systems spend sort of tapering down through 2015 and '16, I would say we hit the peak of spend for systems in late '14, early '15. So you'll see that start to come down with the abatement of the systems projects, Shannon.

Okay. So I guess with that kind of peaking out and some of the restructuring savings, I mean, you think the combined corporate costs of the 2 future entities can equate to this 180 you're talking about for '13? Or you think it goes higher because of additional public company costs for 2 companies?

Well, we're working on the stranded costs here, which is part of what we're doing with the restructuring that we're talking about for quarter 1 and going forward. So we're dealing with that now. But clearly, there's going to be additional public company costs for new security out in the marketplace. So -- I mean, just -- for right now, the placeholder is 180 for the year, and we'll update you going forward as to how much of the stranded cost will be addressed and what the stand-alone costs with security once we file the Form-10s.

Longer term, Shannon, we would target 180 to be the summation of the 2 stand-alone companies. But that's going to go through a little bit of a peaking here in '14 and '15 because of the systems projects and then probably ramp back down to that normalized level after we get through that.

Our next question comes from Jamie Sullivan from RBC Capital Markets.

I wondered if you could talk about -- you mentioned that the end markets within non-res construction that were important, I was hopeful -- I wonder if you could talk about kind of the exposure in Climate and Security by those key commercial, industrial and institutional end markets, if you have those figures.

I can. I mean, I've got the data here for the Put in Place. It's used [ph] of course for Industrial. You're asking specifically how do we factor and play into those things, and this gets a little bit back into my comment about being selective around growth markets and platforms and going where the business is growing as opposed to sort of maybe what the historical mix has been. So the investments that we have made in the unitary product have been really targeted towards the growth we'll see in the commercial and office space as an example. So we got on that faster -- looking at this data from a longer-term perspective, understanding there would be an opportunity in that market as opposed to sort of addressing markets that just weren't going to grow. And so these pockets of growth are a lot more important to us than where the exposure has been historically. We see still great growth in data centers, which is another market that we're looking to address with more and more content as we approach those markets specifically. So not to evade your question, we've historically been a bit more institutional-tipped than commercially-tipped, but we are working that really to where the markets are growing. And security is a great example of that. They put in place a very, very effective program to get after a particular market niche where we weren't really penetrating, put a very specific set of programs together to address a channel need and drove tremendous success in North American security business in the fourth quarter. And so it is possible, over a 2, 3 quarter period of time, to move ourselves into these pockets and address them a little bit differently.

That's helpful color. And then just maybe on the margin front, if you could sort of walk us through by segment how you're viewing some of the trends in '13 versus '12 by segment?

Yes. And I think, to do that, to have it be apples-and-apples, we would pull restructuring out of both sides. Right? So we pull restructuring out of 2013, we pull it out of 2012. So I'd kind of give you those numbers, x restructuring, both just to help you apples-to-apples. But Climate, in spite of the TK softness, will probably see 40 to 60 basis points of margin improvement there. Industrial may see 50 to 70 there -- res, we're looking for more like 1 25 to 1 75. We think there's still opportunity -- great opportunity there to do something more dramatic. In Security, they're just going to be to do a great job executing where they're at. They're going to be fairly flattish, depending on the mix, which could go more toward Asian markets or a slight recovery in Europe. You might see it down as much as 40 basis points, but it'll continue to be just an exceptional margin earner for the company.

Our next question comes from Stephen Volkmann from Jefferies.

Mike, since you mentioned the AHR show, something like the tone down there was quite a bit more positive than the numbers you're giving us. And granted, sales guys on an expense account are always positive, but I'm just wondering if you're being somewhat more conservative there? If you see maybe some other mix we should think about or pricing issues or anything that would add to that?

No. You actually hit it on the head, you put 1,000 sales people together in an event and now it's pretty exuberant. So it's not going to be a horrible market, no doubt about that. But we just go back to the data, look at the Put in Place numbers, look at it by segment of the institutional, by segment of commercial/industrial and then compare that to where we've got specification activity, whether we have quote's outstanding, what the ABI is saying and then lag that. And you just end up where we're at. So I think we were pretty close this past year. I think we've got a good methodology in that business for doing fairly accurate forecasts there. So I just see it overall as being sort of a low moderate growth market for us. Service will probably grow twice as fast, as such been -- history, and we'll continue to grow service and invest in that footprint to help offset some of that cyclicality.

Great. That's helpful. And any color you want to give in January in that or any of the other businesses? I mean, the thesis that it's safe now that the fiscal cliff is gone. Are you seeing any of those types of trends?.

Yes. I have to say, I want to give no guidance by January. Okay? So to answer your question, no, I don't want to just talk about the month. So glad we're through the fiscal cliff, and we'll see what happens with round 2 in Congress. And I think our forecast reflects a bit more than status quo.

Our next question comes from Josh Pokrzywinski from MKM Partners.

Just to dig in here on resi, I know you said you had the inventory liquidation last year, but it still seems like the comp was fairly easy, underperformed the market in 4Q '11 by, call it, 600 basis points. Do you feel like, going into next year, that you're on pace to kind of meet or exceed where the market falls out and that -- maybe some of those mixed issues are well and surely behind you versus peers?

Yes, Josh. We had a very good 2012 collectively. So quarter-to-quarter, you get these aberrations with 2012 res, shares, volumes, margin improvement, just health of the product portfolio, talent in the business. It's been a very good year for us. Let me talk to you about the quarter specifically because there's a lot of nuance here that went out in the quarter. So on the call I mentioned we were down low-single digits versus last year. Now shipments would have been flat, obviously, because the mix changed for us. When you -- and you add back sort of the change in inventory levels and the fact that we were really pushing 90 million of inventory out through last year, in mostly fourth, then hey, you end up with a high-single-digit market for us. We -- I think Steve mentioned we were the only guys that didn't have a fourth quarter price increase in pulling shipments in. And we know of one large OEM that had that effect, that you had to -- extra ship before November over concerns of a factory closure, one of the larger factories closed. And so there was a lot there. But between pricing competitively, pulling it into the year and then our own reconciliation you have to do between '11 and '12. What I will tell you, and probably the way to keep sanity in this, is that we're about 50-50 owned versus independent distribution because our shipments and revenue reflects final sell-through on the owned side versus a couple of other OEMs who are 100% independent going through wholesale. When you compare that to the Hardy data, the sell-through for quarter 4 by month was up 11.6% in October. It moderated to 6% in November. It's actually down. It was negative 1.8% in December. And all that gave you a 5.7% sell-through for the quarter. All right? So if I look at the 5.7% sell-through through the quarter and look at us apples-to-apples being up single digits and the fact that Hardy's indicator level of inventory was up, okay, in the quarter, I feel pretty good about that. I think we are really well positioned coming into 2013. So Josh, I feel good about it. Unfortunately, I got to give you a little bit of bridge to explain it, but I think it's something that, clearly, you can piece together on your own.

And just one last one on price. You walked through it a little bit in the prepared comments, but clearly you guys have done a great job on the pricing side in excess of inflation. How should we think about that in the 2013 kind of -- versus any thoughts you have on the material inflation side? And then obviously, some of these commercial markets start the pickup, I would imagine your pricing power moves with that. What kind of tailwind are you thinking for 2013 in -- at least in guidance?

Yes. The material inflation environment has been fairly sedate, and we've lapped most of our large price increases. So we think pricing this year will be under 1%. Probably a good number, something more like 75, 80 basis points for '13. And we'll still have a positive gap to material inflation, but I think it'd closer to probably 30 or 40 basis points for the year.

Our next question comes from Jeff Hammond from KeyBanc Capital Markets.

Just on the -- within your 1% to 4% growth, I think you said Thermo King down low-single digits. Can you parse out how you're thinking about growth in commercial applied versus commercial unitary versus parts and service?

Yes, some of that...

Or at least directionally.

Yes. Applied and unitary -- there is a shift going on with applied and unitary in the marketplace. We're seeing, in some cases, more unitary being used in some of the data center applications, which is a good thing for us because it's large unitary and that's very profitable for us. So we generally see applied be a little bit weaker in 2013. I would say slightly negative because it would still lean more towards institutional larger customers. And I would see unitary still more following the commercial/industrial Dodge data being more positive. So with slight shifts going on within vertical markets, you are seeing more unit -- I'm sorry, more unitary than applied. And then specifically, in the HVAC business in North America, we're dealing with low equipment growth. You'd probably see service growth 5% to 1%, 5% to 1%, kind of pulling the mix up there. And that's something that has been a function of putting feet on the street, putting technicians out, doing training and really working the whole part service agreement and retrofit market. And we were able to do that last year even in spite of the flatter market. So I hope that's helpful.

Okay. And then just on security, I think we've seen 14, 15 quarters of flat to down. So it was a surprise to see it inflect up. And I'm just -- I know you mentioned some of the large orders in Asia, but any kind of aberrations in that growth number? Or any kind of inflections you're seeing that would suggest some growth there?

Well, the one that we had talked to you about for probably a couple of quarters was larger infrastructure projects that we were waiting on in Asia kind of getting through the political changing of the guard in China and then finally, the awards with those projects. And what we saw clearly in China in the quarter was very, very positive in that regard. I think revenue is up nearly 40% in China for the quarter. So that was helpful. But the other positive story for us was just what happened with the security business in the Americas, and it got back to the earlier question of teams doing a good job, finding pockets of growth and growth platforms in flat markets. And we needed to do more of that, but that's a great example and one I'm proud to tell you about.

Our next question comes from Julian Mitchell from Crédit Suisse.

Just on the productivity, other inflation line in your EBIT margin bridge. That's been running now for 3 quarters in a row at sort of 100 bps plus in terms of the year-on-year margin effect. Is that a run rate you think that you can continue through '13 as you bring on these extra value streams?

Yes, Julian. Look, yes. Clearly, we set the targets out there. We think that we're going to see mild material inflation. We're going to see other inflation continue to rise at sort of an unhealthy rate. So you're looking at overall inflation running somewhere in the mid-3s, and you're looking at our productivity plans somewhere in the mid-4s. And I told you the 4 levers that we're pulling here around sourcing, functional lean and -- lean the value streams and all of that really kind of coming together is a plan to address it. So we continue to just sort of chip away, build a pipeline and work the pipelines here. So I would have no reason to believe we couldn't continue to see productivity at the same level. As long as you see sort of inflation staying where it's at, I think we're going to be fine. If we see higher inflation, that's going to test our pricing capability and see how agile we are there. So net net, no reason to believe we shouldn't be able to do that.

Yes, Julian. The '13 guidance includes a positive gap between productivity and other inflation. It's not quite as big as what we had achieved in 2012 simply because inflation is a little heavier. It seems like employee benefit costs, health care costs affecting that line. So a little bit of a contraction but still a very positive gap.

And then on this resi HVAC issue, so it sounds -- I mean, you're effectively saying that in Q1, you'll be able to deliver positive growth year-on-year in resi HVAC.

Yes. Yes.

Our next question comes from Deane Dray from Citi Research.

Just a quick question, clarification on the guidance. On the -- just the idea where might there be some discretionary spending where, if you needed to, you could pull back or if you added to it. So maybe on the investment side? And is there anything that you could throttle either way?

Dean, in the quarter, we were locked and loaded with the exception of the nailing down in communicating all the specifics around the restructuring activity. But in terms of investments and plans for the quarter, we're in good shape. For the year, it's running at about the same rate of increase as it was last year for us, and those programs have been paired to the point where these are the critical, essential programs going forward. So I don't see that we will be pulling back on investments per se. I think if we were to run into additional headwinds, we would take a second or third look at the restructuring work we're doing and go further there. But no pullback really that I see as being good long term on the investment line.

Great. And then a follow-up question for Steve on tax in the quarter, came in lighter than what we were looking for. Just kind of -- what are the dynamics there? And are there any other dynamics on the 2013 tax guide?

Fourth quarter's tax accounting is always an adventure, Deane. If you look at last year, kind of huge positive adjustments, or favorable adjustments for NOLs got valued in Q4, that goes on every year end. So if we -- if I look at the fourth quarter tax rate, we were a little bit favorable on the ongoing rate, and the distribution income was kind of in our favor. So if I look at the $0.06 or $0.07 delta there, it's -- about half is associated with the slightly favorable rate for the year, and the rest of it is the fact that we had the chance to value some NOLs around world. Much less of a pickup than we got last year when we did that, but it's just something that happens every quarter and it adds potentially a lot of volatility to the tax rate. All along, very pleased with how that fell out. It was definitely within our parameters or expectation of the ongoing rate, and we just got -- we just picked up a few favorable pennies from the NOL valuation.

Yes, Deane. I mean, the only thing that's a little bit of a wildcard, let me try to spike that out for you, is this non-discrete -- U.S. non-discrete tax charge in quarter 1. Whether or not we'll owe that or not, it's a bit of a legal debate. And then two, the timing of that's a bit of a timing debate be. So we just spike that out, not to surprise anybody, that the timing -- worst of all world, it could be in the first quarter, and that's how we planned it.

So if you look at the rate going from '12 to '13, Deane, it's really based on the earnings -- the increase of earnings in the U.S. Primarily, it's going to cause a pickup in the rate. So that's kind of the ins and outs of that.

Our next question comes from Steven Winoker from Sanford Bernstein.

Just trying to understand the bridge on Page 21 for 1Q and the sort of seasonality on them. You gave us margin expansion for the year by segment. What's the overall expectation for 1Q for margin expansion? And I guess the next follow-up on that is does it differ materially from your annuals by segment?

Well, look. First of all, Steve, what's underlying all of this is going to be the weaker Thermo King across the board, picking up by the back of the year, but that's going to be one issue we have just from a business standpoint in the first quarter. And then if you look at it sort of by geography, Europe happens to be very weak for us in the industrial segment, which creates a mixed issue there because actually, industrial is a profitable business for us in Europe. And so it's a combination of those 2 are putting some pressure on all that. Now with that being said, we still see margin expansion of probably 20 to, call it, 50 basis points in the quarter.

Okay. And then since we're not getting a March analyst meeting, just one sort of longer term question. On the value stream point -- so I guess you took it up by about 16%, recovering your cost base by 16% now from 2012 to 2013. So you're covering 40% of the cost base. And as you think about these value streams, I get a lot of investors asking, "Is it getting easier or getting harder as you pick up the new ones and as you look out into the ones to go from here?

Well, I'll tell you, easy and hard is an interesting thing. If you talk about it getting more exciting, getting more momentum in the company, getting more people pulling on it, it's phenomenal. Okay? So I'm not sure about hard or easy, none of this is easy, okay, particularly if you want it to stick around longer than just a flash in the pan. But the impact has been dramatic. And every time we run the data, we call it separation of results. We take the value stream work and then compare that to the average of the company, and we just get further and further apart. Thankfully, we're also increasing the amount of costs under sort of management through the system, so it's very exciting, Steve. It's something that, looking back over 3 years, has been a long haul, and anybody that's in the Lean world will tell you that, that's still the early innings. So it's something that -- if I'm doing this 10 years from now, it certainly will be something we're talking about.

Our last question comes from Steve Tusa from JPMorgan.

Just on the resi stuff, I'm not sure I quite understand. What's the adjustment you're making for the inventory reduction? I mean -- because your comp was still pretty negative from a sales perspective, whether that was just going through your wholesale, your own distribution or not. So I'm just down 5 on the down 20, I'm just -- I don't quite understand the kind of inventory adjustment you're making there.

The 90 million inventory, Steve, that we had last year in the fourth quarter of 11, when you think about sort of what we had to do there, we had to pull that back from distribution, in some cases, where there was a sale, rework the products and then try to push it back out in the marketplace through any channel we could, often through our wholly-owned channels. So we fundamentally pushed the $90 million of inventory out in the marketplace that wasn't, I believe, inventory the market wanted, if you will. So we look at it and say if you adjust for sort of $90 million in revenue, that probably was something we forced, meaning 2011 was probably worse than the revenue we reported. That's where the adjustment comes in.

Ah, okay. So -- I mean, it just looked like 2011 was -- I thought 2011 was more dynamic around -- you just basically shut your plants down because -- I mean, it was still a pretty weak so it even -- fundamentally, that quarter was even -- '11 was even weaker than that.

Absolutely, Stephen. If you look at -- just harking back to that, we were -- I think we ran our plants 21 days the entire quarter. Okay? So we took it really on the chin, from absorption and all that, but it was fundamentally pushed in this $90 million through. So absolutely, we were forcing product into the marketplace with very low pricing, getting into the market which affected -- actually lifted the revenue for 2011. However, it also had an adverse impact on absorption because we weren't making anything. For the productivity, productivity was a pretty easy beat too, right, this year.

Thank you. I'd like to turn the conference back to Ms. Janet Pfeffer for closing remarks.

Thank you, Mary. Thank you, everyone. And Joe and I will be available for any follow-ups today. Have a good day.

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.