特靈科技 (TT) 2004 Q2 法說會逐字稿

Good day, every one and welcome to the Ingersoll-Rand second quarter 2004 earnings conference call. Today's call is being recorded.

With us today from the company is the Chairman, President, and Chief Executive Officer, Mr. Herb Henkel; and the Director of Investor Relations, Mr. Joe Fimbianti.

And at this time for opening remarks and introductions, I would like to turn the call over to Mr. Fimbianti. Please go ahead, sir.

Good morning. This is Joe Fimbianti. Welcome to our second quarter 2004 conference call. We release earnings at about 7:00 am this morning. The release is also currently posted on our website.

I'd like to cover some housekeeping items before we begin. This morning, concurrent with our normal phone-in conference call, we will be broadcasting the call through our public website. There you will also find the slide presentation for the call. Participate via the web, go to www.irco.com click on the yellow link on the left-hand side of the screen. Both the call and the presentation will be archived on our website and will be available this afternoon. Now if you would please go to slide number 2.

Before we begin, let me remind everyone that there will forward-looking discussion this morning, which is covered by our safe harbor statement. Please refer to our March 31, 2004 Form 10-Q for the details and factors that may influence results.

I'd like to take a moment to introduce the participants on this morning's call. We have Herb Henkel, Chairman, President and CEO of Ingersoll-Rand; Tim McLevish, our Senior Vice President and Chief Financial Officer; and Rich Randall, Vice President and Controller. We'll start with formal presentations by Herb Henkel and Tim McLevish, followed by a question and answer period. Herb Henkel will start with an overview.

Herb? Now if you would please go to slide number 3.

Thank you, Joe, and good morning, everyone. Welcome to our second quarter 2004 conference call.

This morning, we reported net earnings of $1.63 per share, which includes earning from continuing operations of $1.43 per share, and discontinued operations of 20 cents per share, which also includes the gain on the sale of the Drilling Solutions business. Total earnings per share from operations, excluding the gain on the sale of the drilling business was $1.42, a 75% increase over the last second year quarter, and exceeding our original expectations for the quarter. Please go to slide number 4.

End market activity in our overall order level for the second quarter improved substantially compared to last year. Virtually all of our end markets have responded positively to the recent upward movements in the U.S. and European economies, and we've seen continued strength in Asia. During this period of market growth, our revenue has grown faster than the underlying construction and industrial markets that we serve. We have also enjoyed a strong continuing upward momentum in our recurring revenue stream.

Second-quarter revenue growth for total IR was negatively impacted by a planned revenue decline at Dresser-Rand of approximately $60 million. This revenue reduction reflects our strategy to improve operating margins by eliminating sales of buyout components which are passed with zero margins to the customer, as well as very low margin complete unit sales. However, the underlying market demand at Dresser-Rand remained very strong, and orders in the second quarter increased 48% compared to last year after 30% year-over-year increase in the first quarter.

Aside from the expected revenue decline at Dresser-Rand, our core businesses generated substantially higher revenues compared to last year. Excluding Dresser-Rand, our overall revenues for the quarter were up about 16%. This is similar to the 15% revenue growth we generated in the first quarter. Excluding Dresser-Rand, all of our business segments generated double-digit growth rates in the second quarter.

Climate Control revenues were up approximately 11 percent in the quarter due to strong worldwide growth in the transport refrigeration business and improving demand for display cases in Europe and Asia. Air and Productivity revenue was up about 11% compared to last year due to strong worldwide growth in the air solution complete and aftermarket business. Infrastructure revenues were up 24%, driven by 20-plus% increases at Bobcat, road development, utility products, and Club Car. And finally, Security and Safety continues to perform impressively with revenues up about 16% in the quarter. We grew strongly in both the commercial and residential markets, with our total mechanical security device business up approximately 15% compared to last year. Electronic access control and solution business also continued its rapid growth, increasing by 27% compared to last year. Now please go on to slide number 5.

Second-quarter operating margins also improved substantially during the quarter. Margins benefited from increased revenue growth and our ongoing efforts to drive down costs by adopting Lean Six Sigma and other continuous improvement processes. Price increases and surcharges also helped to offset the impact of material cost inflation. As a result of these actions, total operating margins improved to 12.3% of sales, compared to 8.6% last year, and 10.3% in the first quarter of 2004. We continue to make progress towards our goal of 15%.

During the quarter, we continue to execute our long-range plan to drive our top-line growth and improve our processes and cost structure. I'd like to update you on the progress we made in some important areas. Please go to Slide number 6.

First, focusing on our initiatives in the area of dramatic growth. Two key areas of concentration have been product innovation and recurring revenue. You may recall at last year we very successfully launched new product in all of our businesses, adding $200 million to revenues, or about 2%, to our organic growth. We had forecasted to add at least 200 million of revenue in 2004 from new product launches. Strong market acceptance of new products such as the Club Car Precedent had caused us to revise our forecast, and we now expect new product sales in 2004 to generate more than $300 million in revenues, thereby adding about 3% to our organic growth rate. Now I would like to update you on some of our major product lines and solution growth. Please go to slide number 7.

At Air Solutions, the combination of improving industrial markets and traction on new Solutions drove a 19% growth in bookings during the quarter. Almost 500 units of Nirvana oil-flooded products, worth about $15 million, shipped during the quarter. This is about a 50% increase from the first quarter as the market continues to expand for this energy-saving technology. Oil-free Nirvana began to ship in the quarter, and we sold approximately 30 units' worth, about $2.5 million, to some of our key customers. The new Unigy small compressor line which was introduced at the end of last year continues to exceed our expectations. We receive 2,000 orders since the product launch, and have gained nine points of market share in the U.S. market for 5 to 15 horsepower products. Now please go to slide number 8.

Bobcat has been a major success story for us in the area of innovation. Over the last 3 years, Bobcat has refreshed and expanded the traditional skid steer and mini-excavator product lines and added new platforms, such as the Track Loader and the Tool Cat. Last year, Bobcat new product innovations added more than $100 million to sales. The new products, combined with strong markets, propelled Bobcat's sales up close to 25% in the second quarter after 30% gains in 2004 first quarter and 30% gains in the 2003 fourth quarter. We expect to continue our flow of product innovations to the market in 2004. We currently intend to introduce 15 new and improved products to the market. Eight products we originally expected to introduce this year have been postponed to 2005 due to the strength of current markets. The momentum created by the new product launches will continue to drive Bobcat growth in the second half of the year at a 15% to 20% rate, compared to last year. Now please go to slide number 9.

The Precedent Product line launched by Club Car in January has been the key driver of revenue growth in 2004. Despite the sluggish golf market, the product has been a huge success with our customers. Club Car shipments were up more than 20% in the second quarter, and orders were up almost 35% following a 25% gain in the first quarter. Additionally, we began to ship the 4 by 4 Rough Terrain utility vehicle to customers in the second quarter. We have booked more than 1,000 orders for this product, offsetting the seasonal decline in golf fleet vehicles we usually experience during the second half of the year. Customers are ordering the product because it sets new standards for performance, ease of operation, and durability. Now please go to slide number 10.

Our Security and Safety sector continues to take important new strides in product development. The sector is both refreshing key platforms for traditional mechanical lock products, and filling the product pipeline for electronic access control markets with several new innovative technologies. We continue to see market acceptance for an upgraded version of the Schlage D-lock, which is targeted at high traffic commercial applications since its launch in the 2003 fourth quarter. This new lock has helped us to grow in spite of lackluster commercial construction markets.

In the third quarter, we are introducing 2 new products to the residential market. The first is a redesign of the standard commercial lock product, which has increased durability and a lock lever configuration that can be moved to the left or the right. With this product, channel partners carry less inventory to meet end user requirements. We will introduce an entirely new product line of decorative door hardware called Accents in the third quarter. Accents is targeted at the lower end of the premium-priced consumer lock market, which is at a higher price point than the traditional Schlage product. We believe that this is a market that's been largely untapped in the past, and should provide security and safety another avenue for profitable future growth.

In the electronic security business, we have launched the E-lock product platform, which features a complete range of network locking products for commercial markets. Network locking products combine our mechanical lock and access control technology to create a flexible and cost-effective security solution for our customers. For example, the new Campus Link version of the E-lock family provides a cost effective solution for university dormitory applications where students' ID badges are used to authorize entry to the residences, providing convenience for the student and increasing security on campus.

The Schlage King Cobra family of products was also introduced this quarter. The King Cobra provides entry-level electronic lock solution where pin numbers are used rather than keys. These solutions are typically used in public facilities. A version of the product designed for retail storefronts is a first-to-market innovation that has received very positive market response. Now please go to slide number 11.

In addition to revenue growth through innovation, we continue to deliver on our goal of growing our recurring revenue stream during the second quarter. Our large install base and powerful market-leading brands are competitive assets that we can exploit to expand revenues and profits. Recurring revenues totaled about $629 million for the quarter. This was 10% above 2003, 26% above 2002, and 44% above 2001. Leading the way, Air Solutions' recurring revenues increased by 14% during the first quarter. Recurring revenues account for 47% of total revenues for the Air Solutions business. Additionally, we are continuing to make roads into our competitors' aftermarket business with our nonIR parts business which was up 23% compared to last year. Additionally, this service business maintained its operating margin at more than 20% of sales while requiring minimal incremental investment. Now please go to slide number 12.

Turning to operational excellence. During the quarter, we remained focus on managing controllable costs, inventories, and working capital. We also concentrating on enhancing our customer service. These efforts helped us to improve operating margins in all of our businesses and increase our cash flow compared to last year. We were able to generate $126 million of incremental operating earnings on $280 million of sales, yielding a contribution margin of about 45 cents on each dollar of revenue. You may recall we also had a 45% contribution margin on sales during first quarter of 2004.

During the second quarter, we continue to experience cost increases for a number of raw materials, most notably steel, copper, and aluminum. Some of these increases were built into our original forecast for the quarter, and we were able to offset additional price pressure through our purchasing centers of excellence. We expect additional cost pressures from metal prices for the balance of the year. Our business has instituted material surcharges to customers to attempt to offset our vendors' price increases. We also expect to be able to offset costs with pricing and productivity during the balance of 2004. Our problems with availability have been minimal. We are monitoring the situation closely and are working with our vendors to ensure adequate supply of materials. We're continuing to work to reduce material and service costs throughout the Company through our productivity initiatives.

During the quarter, we realigned our portfolio business by selling the Drilling Solutions business for $225 million. Four years ago, when we began the process of thoroughly evaluating our business portfolio, we identified several businesses in markets that were unlikely to provide consistent growth opportunities, required to achieve a corporate performance standards. Since then, we have divested several businesses that did not meet our long-term strategy, including some that had been with the Company for decades. In the process, we've reconfigured our business from a principally construction and mining manufacturer to a highly diversified enterprise.

During the quarter, we continued to make progress in our Lean Branch initiatives, in technician productivity, branch optimization, and parts sourcing. We expect these results to continue to improve as these initiatives progress enabling us to reach our profit improvement target of more than $25 million of the year, and our target is to generate operating margins of 15% during the second half of 2004. Now please go to slide number 13.

We are encouraged by our operating performance in the second quarter. We delivered very strong growth in our core businesses, and we were able to leverage that growth to make substantial improvements to our earnings. We're on target to deliver improved earnings and increased cash flow in the future. Our ability to execute our core strategies in large part account for our consistent strong performance. These strategies have been focused on generating dramatic growth in global markets, investing in innovations that will provide the greatest value to our customers, and implementing processes to drive continuous improvement in the efficiency and production of our operations. We have also demonstrated our ability to grow recurring revenues, enhancing our operating margins, offsetting cyclicality, and differentiating IR still further as an adapt solution provider. Clearly, we're on the right course to achieve our profit growth and return on capital targets. Thank you.

Tim McLevish will now cover IR's business unit performance in more detail. Tim?

Thank you, Herb. And good morning.

I would like to begin my discussion with the quarterly financial results. Please note that due to the sale of our Drilling Solutions business, the results of that business have been reclassified to discontinued operations, net of tax for second quarter of 2004 and all prior periods. Please turn to slide 14.

Revenues for the second quarter were up 12% to $2.7 billion. Excluding Dresser-Rand, where we are executing our planned reduction of buyouts, revenues were up 16% compared to the prior year. The increase is attributable to double-digit growth in all of our other segments. Organic revenues you were were up 9%, excluding favorable impact of currency, and were up 14% when excluding Dresser-Rand. The overall currency impact on revenues was approximately 3%, which was consistent across most of our reported segments.

Operating income for the second quarter was $334.5 million or 12.3% of revenues. Margins have increase by over 3 percentage points compared to prior year. These strong operating results were driven by revenue growth leverage, price realization, and operational improvements.

I would like to take a moment to discuss certain year-over-year items that are included in our reported results. The quarter included approximately $15 million in productivity investments, and $11 million in legal and environmental charges. Offset by $13.5 million gain in sale of real estate, and approximately $7 million in currency benefit. Prior year results included $7 million of productivity investments.

Raw material cost increases, mostly steel and non-ferrous metal were largely offset by savings from our sourcing productivity. The prices of our key commodities are forecasted to continue to increase, which will continue to challenge us through the remainder of the year.

Moving down the income statement, interest expense was $40 million, compared to $44 million in last year's second quarter. The year-over-year improvement is related to the overall reduction in debt levels. Other expense for the quarter was $1.2 million, compared to $2.5 million income in last year's second quarter, which included a one-time currency gain totaling approximately $4.6 million. Our second-quarter effective tax rate was 14.6%, compared to 12.7% in prior year, and 13.5% in the first quarter of this year. The higher rate is due to the increase in our full-year earnings outlook and for disproportionate growth in earnings occurring in the U.S. tax jurisdiction which carries a higher statutory rate. Overall, this rate reflects the benefits of our ongoing tax planning initiatives.

Net earnings from continuing operations for the second quarter were $250.4 million, or $1.43 per share, which exceeded our previous guidance. Earnings from total discontinued operations were 20 cents for the quarter, which was comprised of 21 cents from the gain of sale of Drilling Solutions, and a loss of 1 cent for ongoing operations. Ongoing operations consists of legacy cost of previously divested businesses, offset by profit from the Drilling Solution business. Our total net earnings for the quarter were $286.2 million, or $1.63, compared to $139.3 million, or 81 cents, in the prior year second quarter. Please turn to slide 15.

Our revenue growth of 16%, excluding Dresser-Rand, showed increases in all major geographic regions. North American revenues were up 17%, and constituted approximately 65% of the total. European-served area revenue growth was 16%, approximately half of which was from the impact of currency. Asia-Pacific experienced an increase of 15%, and Latin America grew 9%. I would now to take a few minutes to talk about the results of our businesses. Please turn to side 16.

The Climate Control segment, which consists of the market-leading brands Hussman and Thermo King, reported second quarter revenues of $727 million. This represents an increase of 11% compared to 2003. The growth reflects the strength in our truck, trailer, and bus markets. Operating income for the sector was $92 million, representing an operating margin of 12.6%, up more than 4 percentage points from the prior year. The operating margin improvement was driven by volume leverage, recurring revenue growth, favorable product mix, and continuing operational improvements.

Climate Control America's revenue was up 7% due to strong growth in our Thermo King truck, trailer, and bus businesses. The continued strength in end markets for transport refrigeration is producing strong revenue growth in this business. The benefit -- excuse me, the benefits from our Lean Branch initiative continued to enhance the profit margins for our branch service operations, which approach 10% in the month of June.

Climate Control International revenues for second quarter were up 18% year-over-year, 10% excluding the impact of currency. Both European transport and stationary refrigeration markets showed gains versus the prior year. Revenues in Asia Pacific improved as well, primarily driven by improved stationary refrigeration markets. Please turn to slide 17.

Air and Productivity Solutions reported second quarter revenues of $380 million, an 11% increase over prior year. Air Solutions reported a 17% growth in revenue, driven by new product sales and increased aftermarket business. Recurring revenues were up 14% and constituted 47% of the total. Productivity Solutions revenues were up 7% versus prior year, due largely to the strength in the precision assembly business and recurring revenue growth. Operating margins for the segment were 11.1% of revenue up from 5.4% last year. The year-over-year increase is attributable to significant revenue leverage, new product margins, and the benefits of our productivity improvement programs. Please turn to slide 18.

Dresser-Rand reported revenues for the quarter of $277 million, compared to $337 million in 2003. The planned decrease in revenue is related to the reduction in low margin business and buyout components, which are sold or passed through to customers at no charge. Recurring revenue increased by 14%. Dresser-Rand's markets remained strong in the second quarter. Bookings increased by 48% over the prior year, and the business mix showed improvement. Operating income was 6.1% of revenue versus prior year's 2.4%. This margin improvement is attributable to the results of our productivity program, strong aftermarket business, and favorable business mix. The second quarter of 2004 included $1.4 million of costs related to productivity investments. The results reflect the progress we are making to improve the profitability of this business. Please turn to slide 19.

The infrastructure segment reported second quarter revenues of $887 million, up 24% compared to 2003. Operating margins were 15.3% of revenues compared to 12.8% in the prior year. Bobcat revenues increased 24%. The increase was attributable to strong North American markets, new product revenues, and the strength of aftermarket sales. Road development revenues increased 21%, largely driven by strong North American markets. Club Car revenues were up 21% from prior year, largely due to strong demand for the new Precedent golf cart. Our utility equipment business grew 33% over prior year. Segment operating income improved to $135.7 million or 15.3% of revenues, compared to $92 million or 12.8% in 2003. Improvement was due to leverage from increased volume, new product margins, and the benefits of our restructuring programs. Please turn to slide 20.

Security and Safety continues to report strong results. Revenues of $443 million were up 16% from the prior year. The increase is largely attributable to continued strength in North American residential and commercial hardware markets. Additionally, our Electronic Access and Worldwide Solutions business grew 27% in the quarter. Operating margins were 14.1% compared to 17.7% last year. This margin decrease reflects the costs associated with continued investment in new product development and one-time charges. These one-time charge included approximately $11 million of legal fees and environmental clean-up costs, as well as the previously announced restructuring cost totaling $7 million. Please turn to slide 21.

The $7 million of restructuring cost impacted our operating margins in Security and Safety by approximately 1.6%, and the $11 million legal and environmental charges reduced them by an additional 2.5%. Absent these one-time charges, the Security and Safety margins would have been 18.2% which reflect a more normalized expectation for this business. Please turn to slide 22, and let's move on to the balance sheet.

Our working capital management program continued to show positive results. We finished the quarter with our investment of working capital at 8.8% of revenue, which is more than a full percentage point below our enterprise target of 10%. The favorable working capital performance was largely attributable to an improvement in our inventory turns from 6.1 to 6.6 times. We also showed modest improvement in our days payable and days sales outstanding. At the end of the second quarter, our total debt was $2.1 billion, a reduction of $475 million compared to the second quarter of 2003. The improvement resulted from the use of our free cash flow to reduce debt levels. Our debt-to-capital ratio at the end of quarter was just under 30%, compared to the prior year ratio of 39%. Capital expenditures for the quarter were $23 million, or about 1% of revenue, compared to last year's of $25 million. Depreciation and amortization expense for the second quarter was $52 million versus $50 million in 2003. We are pleased with the progress made in improving our balance sheet as it provides a foundation to support the strategies of our company.

Herb will now conclude our formal remarks with the outlook for the third quarter and the full year. Herb?

Thank you, Tim. Please go to slide 23.

Activity in most of our major industrial and construction end markets continued to improve during the second quarter. Our order pattern was also quite strong. It was up 16% compared to last year. From this recent order pattern, we see a continuation of the recovery in most North American and European markets and ongoing growth in Asia. Based on these anticipated improvements, third quarter earnings from total operations are expected to be in the range of $1.10 to $1.15 per share. This reflects a 25% improvement in earnings compared to the third quarter of 2003. Our third quarter forecast includes a cost of 4 cent per share from discontinued operations. Third quarter earnings are consistent with the normal seasonal patterns in our businesses.

During the third quarter, we see strong double-digit revenue growth continuing at the Infrastructure and Security and Safety sectors. And we expect Climate Control and Air and Productivity revenues to increase in the range of 6% to 8%. Dresser-Rand will again show negative year-over-year revenue comparisons as the elimination of low-margin projects and buyout components is expected to cause a decline in year-over-year revenues of over $100 million. Therefore, we expect overall third quarter revenue growth of between 7% and 8%. Excluding the Dresser-Rand impact would result in a 9% to 10% revenue growth. The third quarter earnings forecast excludes the gain on the sale of the remaining Drilling Solution assets and reflects an expected tax rate of 16%, which will also be carried into the fourth quarter. Now please go to slide number 24.

We are increasing our full-year diluted EPS forecast from total operations to $4.75 to $4.85. This represents a 42% to 45% increase, compared to $3.34 from total operations achieved in 2003. The new forecast midpoint is 38 cents per share above our previous guidance for 2004 that we gave you in April. The full 2004 forecast also excludes the gain on the sale of the Drilling Solutions business.

Fourth-quarter revenue growth is expected to be closer to our longer-term target range at 5% to 6% as we run up against more difficult comparisons and a double-digit year-over-year decline in Dresser-Rand revenues. Additionally, year-over-year revenue gains from currency, which has been averaging 3 to 4% over the last six quarters, will diminish in the fourth quarter to about 1%. Free cash flow from operations is expected to approximate $600 million, which is $100 million higher than our forecast from the beginning of the year.

In summary, 2004 will demonstrate that we are executing our strategy, delivering enhanced shareholder value, and that we are prepared to deliver an even better 2005. Now please go to slide number 25.

This ends our formal remarks. And we now open the floor to your questions.

Thank you, Mr. Henkel. To ask a question press the star key followed by the digit 1 on your touch-tone telephone. In order to allow everybody the opportunity to ask question, please be sure to limit yourself to one question and a follow-up. If you do have additional questions, you may requeue by again pressing Star 1 and then we will take those questions if time permits. We'll take our first question from Gary McManus. Please go ahead.

Good morning, Herb.

Good morning, Gary.

Hey, I'm real impressed with the margin improvement in the second quarter, but along those lines, can you talk a little bit about the ability for Ingersoll to show further margin improvement. When I look at all five segments they're within a percentage point of the levels they did in 1999 when your margins peaked, so as you look out a couple of years, which areas do you think have the best ability to show further margin improvement?

I can tell you on all four sectors. Let me do it this way, and Gary -- if I start off with Climate Control, we are now at this point in time into the low teens, and we see that clearly going north of 15% as both our recurring revenue and our stationary refrigeration market continues to improve. Our offshore markets as they grow will increase our profitability. So I see significant upsides in Climate Control.

When I move over into Industrial Solutions, we continue to see the growth in recurring revenues and Air giving us a shot of taking that to numbers we like from the certain Swedish company that are up in the 18% to 20% range. In addition, our Productivity Solutions business now is positioned to also go to 15%. And remember in this sector, we continue to report the investments we are making in our energy systems. So as those also provide profits going forward, I see this sector clearly moving even faster than Climate Control north 15%.

If I move over into the infrastructure, we now see Bobcat about still 3 to 4 percentage points away from where it was at its peak. We're still at this point in time roughly 17%, and we see that growing to 20, Club Cars at 15 with an opportunity to go to 18. Our drilling businesses are 5% away from where we see them peaking out. Overall infrastructure continues to have some upside.

Security and Safety, we have always described as having what we think is a longer term operating margin in the 18% to 20% type range. I don't expect that one to grow. So really the growth is in the first three that I was describing to you.

And Dresser-Rand, in particular, I was going to ask you -- the fourth quarter, which is typically had been seasonably strong in terms of profitability. Do you expect that, and, again, longer term margin improvement there.

Yeah. I'm sorry. I left that out in my industrial story. I see -- as you see now, we're up at 6 and 1%. And as I look at the remainder of the year, we will be at our 10% full-year level as we get into the third and fourth quarter. The revenues and the profitability go up rather dramatically. Going from 6 to 10 is what we see in the second half of this year.

Okay. I mean, specificly I remember the fourth quarter in Dresser-Rand, has unusually strong profits as they book profits at the end of the year. Is that still the case now?

Yeah, Gary. That's why -- when I was giving you those numbers, I was talking about full year. So, if you imagine if we're at, at this point in time, running at roughly 4.5% through 6 months to get to 10% full year, we obviously have to be running north of 15-plus percent for the third and fourth quarters.

Right. Okay. Great, Thank you.

We'll take our next question from Alex Blanton with Ingalls & Snyder. Go ahead, please.

Good morning.

Hello, Alex.

On the Bobcat business, and on any of your other businesses as well in the equipment area, can you comment on any shortages you might have had because yesterday United Rental said that their spending in the first half for new equipment was virtually flat with the year before, up 4% because they couldn't get enough equipment. There were big equipment shortages in the machines that they were trying to buy and, as a result, their spending was going to be unusually strong in the third quarter to make up for that. What are you experiencing at Bobcat? Do you have shortages? Is that why you have postponed the introduction of new products of some kind into 2005?

Well, answer to that question are, yes. It is not that we have shortages. It's the fact that we are trying to really continue to deliver on a timely basis, and if we had to go in to set up the assembly lines -- we have a mixed model assembly lines -- if we had to go in QN [ph], 8 additional new products, we were afraid it would actually reduce our ability to through-put the existing products. We need as many hours as we now have available to be able to meet customer demands. We have been receiving orders from companies such as United in very, very large buckets. We see numbers from them that are up 50 to 60% that were totally unforecasted.

So we are at this point in time scheduling them into the production runs, but they are certainly not receiving them as they would like to tomorrow. We're actually delivering to them in more like a 30- to 60-, 90-day type window. Overall we are seeing at this point in time capacity issues starting to creep in into our North Dakota operations. We are running all out. We have been operating on a full six-day schedule now since probably about October, November of last year.

But on the raw material side, getting back to the first question that you had, Alex. What we have seen is that when we get into hydraulic, sub assemblies, components, those are tight. They are probably in some cases critical path for us. Some of the large steel products are starting to cause us constraint issues, but, again, overall, I think we've got things pretty well under control.

Sometimes these are problems that are nice to have.

It sure beats the 2001, 2002 horizon.

Looking -- looking out ahead, you know, there are people already saying, well, this -- this demand is so strong it can't possibly continue it this way, and, gee, the cycle must be peaking. And that's why the stocks aren't necessarily responding as much as you would might think to these earnings. What do you think of that proposition?

I think that 24 to 30% quarter over quarter growth rates are not sustainable long term. That would be a world I would like to live in, but I don't think I will find it.

Well, right.

I think what -- what we've seen though, is that we are starting to see a, quote "slow down" as we forecast the fourth quarter on the rate of growth.

Yes.

But we are still seeing a 5% to 6% real growth market available going forward and candidly see that going into 2005. And I think that's a long-term, Alex, sustainable rate.

Isn't it the case that you have a lot of new technology in your products?

Yeah, I would say to you, Alex, what we're seeing is that we're actually creating new customers, because we are now coming up with $30,000 solutions for them that replace a single-purpose piece of equipment that used to cost $250,000. So if you had your choice of going and buying a $30,000 piece of equipment to use 95% of the time, and renting a single-purpose $300,000 piece of equipment for a couple of days a month, I think capital-wise it's a very smart move and that's what we're seeing.

So the new technology, doesn't it make a large part of the existing equipment population obsolete from an efficiency point of view so customers that have that equipment really have to replace it if they want to be competitive. Isn't that what's really driving this a lot?

Yeah, I agree with you to the degree that if I look at the product mix, if I look specifically at Bobcat, what we're seeing is that the average size of the unit being sold continues to grow because people are trying to do more work with that product, and that to improve their productivity as you were describing. So we do see a contractor try to step up in size, but obviously at the same time then, that used piece of equipment that we're now turning very effectively becomes the entry point for a brand-new landscaper that hadn't been in the business beforehand, and that's what we're starting the see as the cycle [technical difficulties] as it continues to go. And clearly, the attachment numbers, Alex, we're now up over 150 units that we put out there to try to again let them be able to do the work 300 days a year rather than 200 he had before hand.

One final comment. So if a large part of the existing equipment is obsolete, you're not going to be able to replace all that in one year, correct?

That's true. I would -- if you look at golf cart business the same way. When we see we introduced the Precedent, we say our orders are up 25, 30%. There aren't that many new golf courses. What you're seeing is people selecting to change out their existing vehicles because they like the features and benefits and value proposition for the new one, and so we're accelerating the growth rate there as a result of replacements going earlier.

Thank you

Sure.

We'll now go to David Bleustein with UBS. Go ahead, please.

Just following up on Alex's questions. Can you specifically talk about the lead times at Bobcat today, versus what a normal lead team would be?

Yeah, I would say to you that our lead times at this point in time are moving out where we measure them in weeks, 2 to 3 weeks. If you were to look at it 18 months ago it was 2 or 3 days.

Got it. What were the buyout components in Dresser-Rand's second quarter of 2003? The pass-throughs.

I think it was 38 million.

Million, okay. And can you w --

[Inaudible] I misspoke. It was 78 million. And as I said, in the third quarter it was actually up -- I think the exact number we're forecasting about 124, so it's over a hundred million and then.

In Q3 of last year it was $120?

No, sir. I said third quarter of this year it was going to be $120 some-odd million. It was $78 million compared to last year down. 2003-2004.

All right. And then -- hold on. The -- what we're talking about is the pass-throughs on which you were taking very little margin that you're not including in revenues this year?

Correct.

I was looking for the number in the second quarter of last year. That was represented by those pass-throughs.

Well, -- I am sorry. The absolute number itself?

Uh-huh.

No, actually -- we took out the total amount of $78 million.

All right, we will hit that one offline. Can you walk through the legacy costs again and why there were only 1 cent in the quarter?

It's actually a more normalized. We had a couple of -- a couple of things that affected the quarter. Clearly the -- the drill operations. We reclassed that into discontinued operation and it affected about 3 cents. The normal you would expect to see in the discontinued operations -- what we call the legacy, was still about 4 cents. You had about 3 cents' worth of benefit from the drill operations, and then you recall last quarter we mentioned on the call that there was this FISK benefit, tax benefit that we would be receiving, part of which showed up in the tax line and a piece of which fell into the discontinued operations line. So we got about a penny benefit down there.

Thanks a lot.

Hey, David? Can just I try to go back on that math once again?

Sure.

Because my memory -- I am getting old. In the second quarter of 2003, we sold roughly $79 million of past-through buyouts at zero profit. In the second quarter of 2004, we still had $33 million, but they now had a profitability of approximately 5%. That's where the difference comes in. So we're still doing some, but we are now charging 10% for those orders. So it's a mixed bag of really for what we're doing this year.

Okay. Congratulations

We have a question from Joel Tiss with Lehman Brothers. Go ahead, please.

How are you doing, guys.

Hi, Joel.

Can you give us a sense in your unallocated corporate expense is down. Can you give us a sense of what's in there?

Yeah, biggest piece of what you are seeing with reduction there is -- remember we talked about the real estate gain of $13.5 million, we had about 5 cents' worth of benefit there.

Okay.

You'll see that come out of the corporate unallocated. So if you added that back to the 14.5, you'd be at what we would consider a kind of a normalized $27 million quarterly number. When we think about the corporate unallocated, it's kind of $100, $105 million a year plus or minus maybe 5. And then, of course, this -- we've talked about the stock-based computation, the liability associated with previously issued stock. Depending upon where our stock price goes, that probably has the effect of each dollar of increase in our stock price affecting about $2 million of expense associated with that. That falls into corporate unallocated as well.

Okay. And can -- can you also give us a sense of pricing increases versus just surcharge pass-throughs? I know you mentioned pricing in some of your comments.

I would say to you, Joel, that what we saw is that our pricing is running between 1% and 2%, and our surcharges are also running in that relatively 1% to 2% type range and it is mixed. One business we would actually have -- Bobcat, we were actually at this point in time, had a price increase plus we had a surcharge.

Okay.

But at the magnitude. So, if I were to tell you that right now what we saw are surcharges plus the price increases, they basically have equaled and reduced -- eliminated the effect of raw material increases in the first half of the year, which just for magnitude-wise is in the $35 million to $40 million range, and I expect that magnitude to double in the second part of the year, again to be offset by what we had with material surcharges.

Okay. And lastly -- just a quick one. Can you give us a sense of the timing? What time frame you guys are expecting to give us a sense of what's going to happen to all the cash. You've obviously got, you know, a lot piling up. A lot of free cash flow generation and maybe $1 billion to distribute by the end of the year. Can you give us a sense of timing when we may hear something about that?

I guess you would say that the -- first of all, our activity in looking at bolt-on acquisitions is continuing at a very robust rate. And I say bolt-on acquisitions.

Secondly, we have a Board meeting coming up in August, at which time we clearly and the Board will review our dividend strategy, and to see what that reflects, and I gave you at the analyst meeting what I thought in terms of payout levels would be like, and that would reflect -- you probably need to look at that.

And then, thirdly, obviously, is we need to especially at 60 some-odd dollars a share based on what we have as our earning protection, a stock buyback is also a pretty good use of the cash that we have. All three. And you will be seeing that, I think, within the next few weeks.

Thank you very much.

Sure

We will take our next question from Jeff Hammond with Key/ McDonald. Go ahead please.

Hi, good morning.

Hi, Jeff

I wanted to touch on the contribution margin you said first quarter, second quarter, was running around 45%. I wanted to get a sense of what you're thinking about for the second half, or what you look at as a normalized contribution margin going forward.

Well, I'd say to you is that the normalized margins I look at is in the 35% to 40% range. That would be the contribution margin. And as I look at them going forward, I think you'll see us sort of going from 45 down to that level as we get to the fourth quarter.

Okay. And then compressed air, it looks like the equipment side was growing close to 20%. Can you give us a sense of what you're seeing in terms of market demand versus what was contributed from, you know, market share gains, new products?

Yeah, I think I would tell that you that's almost a 50/50 between the two. We're seeing that, as I mentioned, the addition of a the Nirvana and the other products that we're doing plus the strength we're seeing, I'm just giving you qualitative -- I don't have the number in front of me -- but feeling I get from looking at the numbers is it's almost half created by new product and half because of the market conditions that are out there. I think if I look at our primary competitor, that would sort of support those kind of numbers.

Okay. Perfect, thanks.

Sure.

Our next question comes from Andrew Obin with Merrill Lynch. Go ahead, please.

Yes, hi, good afternoon. Going into the Security and Safety business, over the past couple of quarters, the growth in the business has been really terrific, but at the same time, the margin was at the lower end of this 18% to 20% range. Given that you will continue to grow, you know, the electronics part of the business that doesn't have as good a margin as the poor lock business, why would the margin ever come back to 20%?

Well, actually it really has to do with where in the world it is. Number one or our European business so far is less profitable and we're in the process of fixing that. Secondly, if it's software on the electronic access control side, the probability -- frankly it's got Microsoft-type numbers attached to it. The hardware side is the one that's in the lower to mid teens.

So just as -- our forecast, when I look at the third and fourth quarter is that we'll be back in the 18% to 20% range because we don't expect to see any of these, quote, one-time fixes that we need to do again, but overall I'm saying is that between improving the profitability in Europe, we're making significant investment in our footprints over into China and other regions in Asia. I think that those will continue to produce results in the future, offsetting the up-front SG&A that we're loading in right now. But to me, this is 18% to 20% business with double-digit growth rate, with a continued growth of electronic access control being very, very, very strong. So, electronic access control by itself is not negative. It candidly has been that we've been staffing up with putting people -- you know feet on street and getting ourselves positioned into the marketplace. That's what's causing the money. It's not the long-term problem, it's the up-front leading with that kind of exposure.

Sure, so we should expect -- okay.

Third and fourth quarter I expect to be right back up in the 18% to 20% range for both of the quarters.

Fantastic business but -- the second question is just on Hussman and maybe I missed it. The note of the press release was I think we were a bit more optimistic about the orders coming back in North America in the first quarter, and at the analyst meeting, and the way the press release reads is that we're back to being a bit more conservative. Is that a fair statement?

I think that's fair. I think what we are seeing is that the -- I'm surprised nobody has asked it. The never-ever answered when is Wal-Mart going to sign this long-term contract. That's been dragging out, so frankly we thought -- I hope it's a multiyear deal as long as this one is taking. We thought that that was one that would already kicking in at this time, and obviously we're doing fill-ins at this time, not under contract, so that's slowed down some of the activity and we're also candidly seeing on a couple of the larger ones like at Kroger and Safeway where they, themselves, have not had fulfillment of what they first forecasted as to strengths. So overall, what we see is that the first half North American case business was relatively flat for us versus Europe and Asia being frankly quite strong.

That answers it. Thank you very much

We'll now go to Joanna Shatney with Goldman Sachs. Please go ahead.

Hi, it's Mercedes [ph] Garcia sitting in for Joanna. A couple of questions. You mentioned $18 million of cost in the Security and Safety business. 11of that is legal. How does the other 7 included in the 15 million of productivity investments?

Yeah, what we had is -- we have is two specific events. One is that we had a plumbing line which we exited, and that was about two and a half, and then we also shut down a door manufacturing operation outside the suburbs of Chicago which cost us the balance. That's where the total activity came out between the 8.

Okay. And that is included in the 15 million of the investment.

Yes, that's correct.

Was there any restructuring for Dresser-Rand for the quarter?

Dresser-Rand was running $1.5 million specifically in the quarter which is about the same level that we had in last year.

What are you expecting for the rest of the year?

I expect it to be running at the same kind of a level, somewhere around the 1 million per quarter. It's not a large number. We've made most of the changes we need to do there on the head count. Because as I mentioned, our order level is up 30% the first quarter, 48% in the second. We, therefore, actually are keeping employment where it is increasing productivity, we don't see head count reductions with that kind of an order file.

Herb, it's Joanna this time. Could we just walk through the progression on Dresser-Rand. We're still, I guess, targeting the double-digit operating margin number, and it's always been kind of fourth quarter loaded. But is there some chance that we see something unexpected in the third quarter, could we get double-digit in the the third quarter or at least high single-digit?

I will take the second of those two.

Okay. Thanks.

Are there any further questions?

I apologize, yes --

I don't think they didn't realized my answer was so complete that way.

All right. Well, our next question comes from Robert McCarthy with Baird. Go ahead, please.

Good morning, gentlemen.

Good morning.

Herb, can I trouble to you clarify a couple of things that you already said. In -- in response to questions about pass-through revenue at Dresser-Rand, you quoted $124 million third-quarter number.

Yeah.

Is that the level of pass-through revenue in last year's quarter?

That's going away in this quarter, that's correct.

The -- [ OVERLAPPING SPEAKERS ] -- out of a total of how much in last year's third quarter.

We had three -- you mean out of total revenues last year?

No, what was the total pass-through revenue in last year's third quarter?

That was the total pass through. We expect that to be almost completely gone this year. So we are expecting virtually zero on the pass-through side. It's down to 8 million.

Okay, in other words -- in the second quarter you did have --

Yes, we had some leftovers from last year's projects.

All right. And that --

What's happening, Rob, is that these have the large -- what they usually were were 20-plus-million dollar projects that we had buyouts attached to. They had cycle times of as long as 18 to 24 months. So when we instituted this changeover a year [inaudible] I still have this tail that's out there based on what the completion schedule is for these projects. So during the second quarter, as I said of this year, we completed about $33 million worth of stuff with pass-throughs in there. In the third quarter, the number is all the way down to 8 million. So you can see we're really sort of bleeding out that which is left over in the pipeline and that's why the net number goes from where it was like 124 million last year. We got about 8 some-odd million and that's why in our release I said we expect over 100 million of reduction on year-over-year on the pass-throughs.

Okay. I got it now.

We would expect there would continue to be some level of buyouts remaining as we go forward as customers realize the value we bring in integrating the buyout components, but then we should -- we should be receiving a fair margin for those at approximately 10% is what our target is.

Right, and we'll quit talking about what the level was. And, Herb, when you were talking about longer-term operating margin potential.

Yeah.

You went very fast. I had trouble keeping up. In the infrastructure segment, you talked about Bobcat being 3 to 4 points below peak.

Yeah.

What did you say about Club Car and road building?

I said Club Car which ran in the second quarter numbers that were in the 15%. That I thought that they had the ability to go up to 18, three more.

On a full-year basis?

On a -- yeah, right.

Okay. And road building?

Road building I said is also at this point in time where we're looking at where we're running on a year-to-date basis had another three points to go.

Okay. Then let me ask --

There was another one -- [ OVERLAPPING SPEAKERS ]

can you talk about what you saw in terms of tone of business, particularly booking activity as we moved through the quarter? I'm asking this in the context of, you know, pundit commentary there was a slowdown in the industrial sector in June.

I didn't participate in that. Our numbers we said to you in the first quarter, our-activity level was up like 15 some-odd percent. And second quarter, it turns out is that it actually started off strong in April. We had a somewhat -- well, you had to look for it -- reduction in May, but it increase right back up again in June. So when we wound up exiting June, we were running the same way we were getting into the quarter.

Very good, thanks.

Our final question in the queue comes from Andy Casey with Prudential Equity Group. Please go ahead.

Good morning.

Good morning, Andy.

Just a -- I guess a clarification. On the Lean Branch initiative, you mentioned it hit about 10% margins in June. Were those consistent during the quarter or did they accelerate?

It improved through the quarter to the 10% in June, but we're optimistic that we will we'll exceed that as we go through. We continue to add to that level, but, no, that wouldn't be a full-year or full quarter second-quarter level.

The rate we'd like to aspire to we will do for the full quarter going forward but it was like a turning point in the quarter.

Okay, great, thank you very much.

You're welcome.

Operator, anybody else in the queue?

We do actually have a couple more questions. The next comes from Ann Duignan with Bear Stearns. Go ahead, please.

Hi, good morning, guys. It's Ann Duignan. Just a couple of clarifications, for the outlook, do have you included a customs refund and can you give us some direction on timing and magnitude?

No we do not have a CDO payment included in our forecast. Timing-wise, you remember this is a submittal that's made somewhere around August, and then we sort of wait to see what comes back from the government. I mean right now there is still a payment, we just don't know whether it's going to happen in the fourth quarter or first quarter again next year like it did this year. And the magnitude of that number at this point in time is totally speculative, but if I were to forecast it's probably in the $40 million type range.

Okay, that's upside to the forecast --

That's correct. That's nowhere in our numbers because we learned for sure last year, Ann, that we don't know how they are cycling and processing this stuff.

Okay. I would appreciate that. Your CapEx spending. You're one of the few companies that have actually raised the CapEx spending year-over-year. What -- what do you think about, Herb, longer term, what what do you think your normalized spending should be, either in terms of percent of sales or as a ratio of depreciation?

The best way I think for us to look at it, Ann, is as a percent of sales and we're running somewhere in about the 1.3 to 1.5 percent of sales and that's as we wind up building capacity, tooling for new products, or as we -- we need to expand our footprint again in China and we need to expand our footprint in central Europe, so we'll see a couple of plants going up there, but all included, I expect if you plug us in at somewhere around 1.5% of sales that that would be a good number, probably even a little on the higher side. Our biggest expense, candidly, right now that I see running through more on the system side as we're going and doing, you know, upgrades into Oracle systems and other kinds of things we need for both customer interfacing as well as productivity improvement. When I go and I tie all of our plans together in procurement, I have to be able to communicate more effectively across the enterprise, so we need to spend systems money to be able to do that. That's where the money is going to be.

Okay. So more on software and hardware, back office stuff than physical plant.

Right.

Finally, on Power Works, is that business still a drag on profitability and when will it be a contributor?

Yes, it was a drag because what we have done in terms of it is we authorized -- I authorized monies to be spent on developing a 50 cycle 200 Kilo Watt-type unit specifically for China which is going in the next quarter and so we continue to see this as being a drag of about $5 million to $8 million a quarter and I expect a turn around and that drag will go away by the end of the year as we're starting to ship those units now. We made our first shipments to landfills that are doing very well. We've got some good thermal loads on the 70 KW units, but right now it's still turning out to be an investment rather than a generator of profitability.

Okay. And just real quick finally. On the revenue growth reported. Is there any significant acquisitions included in that number in any of the divisions?

None.

No.

Strictly organic.

Okay.

As you can see, even the currency stuff is going away as we go forward.

Okay. Thank you.

Sure.

Thank you, Ms. Duignan. We'll now go to Gene Barron with Capital International. Go ahead, please.

Just a couple of follow-ups. You targeted 200 to 300 basis points of additional margin improvement if I heard your kind of discussions by segment. And I was curious if that was something that could be achieved at current revenue levels or required more volume in order to absorb fixed cost and leverage that way.

The volume would obviously help, Gene, but what I am saying is that I am confident that the process procedures that we have in place will generate 2 to 3% in the next 18 to 24 months on their own. The volume would obviously just accelerate that process when we hit it.

Would accelerate it and not enhance it?

Well, yeah, then I'm saying then you get another 2 points probably behind it if the volume goes up.

And then just kind of drilling -- I mean -- there is a lot of one-time and discontinued stuff that I just wanted to make sure I clarified all of that, if you wouldn't mind going through a few of those things that you haven't already talked about. The tax benefit you mentioned in the press release of 8.75 million. Is that all in the tax line? Or you mention some of it in discontinued operation or is that an additional amount down there.

No, about 11 million total, 8.8 million that's reflected in the tax line and about $2 million that's reflected in discontinued operations.

Okay. And the -- the earnings from the drill solutions business, what was that in dollar terms in the quarter?

About $6 million.

So it would look -- based on what you're saying -- you know next quarter's forecast is 4 cents on ongoing legacy costs. $7 million? That's a little bit reduced from prior estimates which were kind of in the 9 million range. Is that correct?

We usually run 4 to 5 cents. Somewhere between $8 million to $10 million of legacy costs, barring other -- you know other things happening. So drill went away at the end of the second quarter. Obviously we won't get the benefit of that. We don't expect we'll get that tax benefit. 4 to 5 cents is what you should think about, $8 million to $10 million.

Okay. Is there any proceeds and whatever associated with the last remaining piece of drill?

Yes, there is. There is -- there are two -- there are two businesses, International businesses that we could not close along with the majority of it, that being in Korea and that being in India. We would expect to close those in the third quarter and there will be additional gains somewhere in the, say, $10 million to $15 million we would expect although a little bit reluctant to be too specific on that until we've got all the accounting completed. Generally in that range.

What type of proceeds after tax are you expecting from those?

Well, proceeds is about $30 million.

And 225 on the --

The 225 was really only proceeds of 195 in the second quarter. The remaining 30 to get to the 225 will come in the third quarter.

Okay. That's what I was trying to understand how much came in the second quarter versus the third quarter. And let's see if I had anything else on that list of miscellaneous stuff -- oh, all right. Just -- the back bookings increase in Dresser-Rand. How do you translate that into revenues given the of kind of 100 million a quarter that's coming off of pass-throughs?

When you look at the orders we took in the first quarter and the second quarter, the vast majority of those would be shippable as we get into 2005. We're really working off of backlog that was built, but now -- we're still running 6 to 12 months as a typical pass-through from when it shows up as a booking to when it shows up as a invoiced order. And so as we look at the fourth quarter going forward on Dresser-Rand, what I'm looking in terms of with them is the fact that they will continue -- they will overall still be down without buyouts like about 3% from last year's activity and then you expect a robust 2005 is the way I would describe it to you.

So if the revenue run rate we're looking at now would be increased substantially next year in that business, at the type of margins you've been talking about --

-- The margins we've been talking about, Gene, for that is the fact that we're supposed to be talking about 12% to 13% in 2005 after we hit the 10% level in 2004. And the orders that we took will deliver those kind of results.

Have you gotten any inquiries from interested buyers based on where you are at now?

You know that would be an inappropriate thing for me to respond to. Clearly people have my number and in case anybody is listening. Is that what your question was?

Yeah, maybe somebody is listening. Maybe wants to go on a date. You said you've got your number. Give you a call. [ LAUGHTER ]

You make -- I can't comment on that part, Gene. I would say obviously is that we continue to look at what we do with our portfolio both as bolt-on acquisitions as well as those that don't have long-term sustainable growth type issues, and we'll continue to work that as we did with drill and as we did with bearings and all the rest.

Okay, thanks for clarifying a lot of the moving pieces that kind of travel through there. You had an unusually high number this quarter.

Obviously that's what happens when you wind up getting into making, quote, moves like the sale of Drill. That sort of brings those kinds of things forefront and candidly, what also happened clearly is -- we had the building that we reside in here on market for the last 18 months. That finally is now closing in September, and that then causes other one-time type things to happen. So I think you'll find that the rest the year from what we are seeing on the real estate activity is significantly off, and I don't see the one-timers that we currently have been describing.

Kind of about balanced out in the quarter.

Yes, they did.

It really did.

Okay. Thank you.

Thanks, Gene

Gentlemen, there appear to be no further questions and I will turn the call back over to you for additional closing remarks.

Thank you very much. We're going to wrap up. Thank you for joining us. There'll be an instant replay of today's conference call available at approximately 3 p.m. It should be available until July the 28th. The call-in number is as follows: 888-203-1112. And the passcode is 302307. The international number is 719-457-0820. The audio and the slides from today's conference call will be archived on our website, and finally the transcript for the conference call should be available on the Ingersoll-Rand web site by late next week.

Please call me. Again, I'm Joe Fimbianti. If you have any additional questions at the following number: 201-573-3103. That concludes our call. Thank you very much.

Thank you, again, that does concludes to a conference call. We appreciate your participation and you may now disconnect.