特靈科技 (TT) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ingersoll Rand second-quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session, and instructions will follow at that time. (Operator Instructions). As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Ms. Janet Pfeffer. Ma'am, you may begin.

Thank you, Mary. Good morning, everyone. Welcome to Ingersoll Rand's second-quarter 2012 conference call. We released earnings at 7 a.m. this morning, and the release is posted on our website. We will be broadcasting, in addition to this call, through our website at ingersollrand.com, where you will find the slide presentation that we will be using this morning.

If you would please go to slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements, and are pursuant to the Safe Harbor provisions of Federal Securities law. Please see our SEC filings for a description of some of the factors that may cause actual results to vary from anticipated.

This release also contains non-GAAP measures, which are explained in the financial tables attached to our news release.

Now I would like to introduce the participant's on this morning's call -- we have Mike Lamach, Chairman and CEO; Steve Shawley, Senior Vice President and CFO; and Joe Fimbianti, Director of Investor Relations.

Please go to slide 3, and I will turn it over to Mike.

Thanks, Janet. Good morning, and thank you all for joining us today. Adjusted earnings per share from continuing operations for the second quarter were $1.15. That's $0.27 above the midpoint of our guidance range of $0.85 to $0.90. I'll break down the op performance in the next slide, but it was about $0.12 from operations with the remainder related to the discrete tax items.

Given the uneven market environment during the quarter, we were very pleased with our ability to navigate the situation and to deliver above our commitments, based on solid operation operational performance in all of the businesses. Markets were generally in line with our outlook in the slow growth environment, although we saw deterioration in several overseas markets, and somewhat better-than-expected growth in North America. US revenues, excluding Hussmann, were up 4% in the quarter.

The revenues from international operations were up 1%, when excluding foreign exchange. Foreign exchange negatively impacted international revenues by 6%.

Focusing in on a couple of reasons that I'm sure are of interest to you, revenues in Western Europe were down high teens. Revenues in China were down, on a reported basis, with increases in Industrial, offset by lower revenues in Climate and Security. The lower revenues in Security are dependent on the timing of large projects.

In aggregate, for the second quarter, we saw flat revenues, excluding Hussmann refrigeration business from the 2011 comparison. Revenues, excluding foreign exchange, were up 3%, excluding FX; we experienced moderate growth in revenues and Industrial and low growth in Climate and Security. Residential revenues were up 3% year-over-year.

Excluding Hussmann, orders were up 1%, and up 3% excluding currency. Operating margin for the quarter was 12.4%, about 20 basis points versus prior year. If we exclude Hussmann and the property sale gain from last year, margins in the second quarter were up 70 basis points from second quarter 2011. Margins improved for pricing and productivity, partially offset by a favorable mix; currency; and higher restructuring and investment spending year-over-year, as we discussed in the April earnings call.

We are particularly encouraged by the results of Residential, which were right on forecast, and showed 150 basis points of margin improvement. Industrial posted a new record margin level, at 17%, with margin increases in all regions. Climate increased margins 100 basis points on a comparable basis, even in the face of challenging mix between HVAC and Thermo King. Finally, Security delivered margins of 20%, despite some heavy restructuring spend in the quarter and continuing soft markets.

All of our businesses continued to realize positive pricing. And in the second quarter, our pricing outpaced material inflation for the fifth consecutive quarter. Our focus on operational excellence -- which includes pricing, lean, sourcing, functional support and innovation -- delivered excellent results in the quarter, and enabled us to effectively navigate increasingly volatile global market conditions.

Let's go to slide 4. We exceeded the midpoint of our guidance of $0.88 by $0.27. $0.12 of that feat was from operations; with $0.01 negative from the combination of price, which was slightly positive; and headwinds from volume, mix and foreign exchange. Given the volatility in the markets and currency in the quarter, we were pleased with the performance. Productivity and inflation were $0.08 better than expectations, as the pipelines delivered productivity and we saw moderation in material and other inflation.

Other items, such as interest expense end share count, netted together, came in $0.02 positive. Our underlying tax rate was a couple points lower in the quarter. And you'll see that we are carrying that lower rate into the outlook for the balance of the year. That gives you a $0.03 benefit in Q2. That brings the operational EPS to an even $1.00.

We had discrete tax items that totaled $0.15 positive in the quarter. It was primarily due to a recent tax law change in Spain that enabled us to recognize some loss carryforwards. Interestingly, we were in a position to benefit from that, because of some entity restructuring and integration we had done a couple of years ago. That brings us to $1.15 of earnings.

Again, I'm very encouraged by our operational outperformance in the face of market currency challenges, which we expect to continue to present challenges in the second half of the year.

Now, Steve will take you through the quarterly results in more detail.

Thanks, Mike. Please go to slide number 5. Orders for the second quarter of 2012 were up 1% overall; and 3% excluding currency. Excluding currency, we saw positive year-over-year bookings in all sectors except Security, which continues to face challenging markets. Global commercial HVAC bookings were up low-single-digits. Transport demand was high-single-digits, with a slight increase in North America, more than offset by soft European truck trailer orders and lower marine demand.

Industrial orders were up 2%, with order growth in all regions partially offset by currency. Residential HVAC and Security bookings were up low-teens. Commercial Security orders in the quarter were down 10%, impacted by the timing of large project orders in Asia, as well as slower activity in currency in Europe, while North America was down only slightly.

Please go to slide 6. Here's a look at the revenue trends by segment. Note that the climate and the total data, beginning in the fourth quarter of last year, excludes Hussmann from the comparisons. Second-quarter revenues were flat versus last year, and were up 3%, excluding currency. Revenues, excluding currency, shown on the bottom of the chart, give a better view of our organic growth.

Climate revenues increased 2%. Industrial had moderating growth at 6%. Residential was up 3%, and commercial Security revenues were up 1%. I'll give you more color on each sector in a few slides. On a geographic basis, revenues were up 4% in the US and down 5% in international markets; up 1% internationally, if you exclude foreign exchange.

Please go to slide number seven 7. This chart walks us through the change in operating margin margins from second-quarter 2011 of 12.3% to second-quarter 2012, which was 12.4%. This data excludes Hussmann for comparison purposes. The volume, negative mix, and foreign exchange, taken together, create a 100-basis-point headwind in margins. Our pricing programs continue to outpace material inflation, adding 160 basis points of margin.

Productivity, offset other inflation, was 110 basis points, accretive to the margins. Year-over-year investments and other items were higher by 160 basis points, including 60-basis-point impact from the absence of the gain we recognized last year when we sold a restructured facility in China. There was also a 30-basis-point impact from higher restructuring. Increased non-restructuring costs reduction and growth investments were 70 basis points -- had a 70-basis-point impact on the quarter.

In the gray box in the upper right corner, you can see that revenue leverage was [good] in the quarter at 29%. Leverage was 165% when you exclude last year's property sale gain.

Please go to slide number 8. The Climate Solutions segment includes Trane commercial HVAC and Thermo King transport refrigeration. Total revenues for the second quarter were almost $2 billion, and is down 1% when excluding Hussmann from last year. Revenue was up 2%, excluding foreign exchange. Global commercial HVAC orders were up 2%, with global equipment orders up slightly, and parts and services up mid-single-digits.

Quarters were up mid-single-digits in the Americas, but were down in both Europe and Asia. Trane's commercial HVAC second-quarter revenues were up 2%. HVAC revenues in North America and Latin America were up mid-single-digits. Revenues in Europe, Middle East, were down on a reported basis, and flat when excluding currency. Revenues in Asia were flat, up slightly when excluding currency. Commercial HVAC equipment revenues increased low-single-digits. HVAC parts, services, and solutions revenue was up mid-single-digits versus prior year.

Thermo King orders were down high-single-digits in the second quarter. Revenues were also down high-single-digits, with over half of the decline coming due to currency. Worldwide refrigerated truck and trailer revenues were down mid-single-digits, with an increase in North America more than offset by declining volume and currency in Europe. The marine container business was down over 20% versus last year.

The operating margin for Climate Solutions was 12.1% in the quarter, a 20-basis-point decrease versus second-quarter 2011, excluding Hussmann; but a 100-basis-point improvement, when excluding the property gain from the prior-year comparison. Price and productivity more than offset inflation, higher restructuring, and spending on investment initiatives.

Please go to slide number 9. Industrial Technologies' second-quarter revenues were $790 million; up 2% on a reported basis, and up 6% excluding FX. Air and productivity revenues increased 4% versus last year and were up 8% excluding currency. Revenue in the Americas was up high-single-digits. Although we saw organic growth in all regions, overseas revenues were down on a reported basis due to currency.

Air and productivity orders were up slightly on a reported basis, and up 6% excluding FX. Club Car revenues in the quarter were down slightly, and orders were up 6% versus prior year. Industrial's operating margin of 17% set a record for the sector for the quarter. Margins were up 140 basis points compared with last year; as higher revenues, pricing, and productivity were somewhat offset by inflation, higher investment spending, and currency.

Please go to slide number 10. In the Residential business, second-quarter revenues were of $653 million were up 3% compared with last year, on both a reported basis and excluding foreign exchange. Bookings were up 13%, with mid-teen increases in both HVAC and Security. Our residential HVAC revenues were up slightly versus last year. Unit shipments were up high-single-digits. 13, 14 SEER share of the market was higher than the prior year, as mix continues to shift to the low end of the range, validating our strategy to add products to grasp that SEER range more effectively.

We did see some encouraging movement in the past couple of months towards 410-A systems, although R-22 units remained a significant portion of the unitary market. We now believe that R-22 market units will be down about 5% for the year, which is good news for the industry. Our R-22 mix will, of course, be up, given our full participation in that part of the market for all of 2012.

Revenues for the residential security portion of the sector were up mid-teens, with increases in the new builder channel, big-box, and South American customer volumes. Sector operating margin of 7.9% was up 150 basis points compared with 2011. Improved pricing and productivity more than offset inflation and adverse mix.

Please go to slide 11. Revenues for Security Technologies were $411 million, down 3%, and up 1% excluding currency. Americas revenues were up slightly, as pricing exceeded lower volume. Overseas revenues were down 8%, mainly from currency. Global bookings were down 10%, primarily impacted by timing of large projects in Asia, and currency. The Americas were down slightly.

Operating margins for the quarter was 20%, down 180 basis points from last year, as productivity and price realization were offset by higher restructuring and investment spending, inflation, and unfavorable revenue mix.

Please go to 12. Our focus on working capital is unwavering. We finished the second quarter with working capital at 3.3% of revenues, an improvement of 1.1 percentage points versus the second quarter of 2011, and similar to our performance in the first quarter.

Please go to slide 13. Available cash flow in the second quarter was $228 million. As anticipated, we resumed our share repurchase in June. We repurchased about 900,000 shares in the second quarter, and had purchased 2.2 million shares through yesterday. We now expect to spend approximately $800 million on share repurchase this year. With that spend, we would complete our current $2 billion authorization. With the increased repurchases, we are updating our expected average diluted share count for the year, from 315 million to 311 million shares.

Given our solid balance sheet and cash flow performance, we will probably go to the Board for another review of the dividend late this year, similar to last year. We will also look to re-up the share repurchase authorization at that time.

With that, I will turn it back to Mike to take you through the forecast.

Okay, thanks, Steve. Let's go to slide 14. Our revenue outlook for 2012 is $14 billion to $14.2 billion. That is $100 million lower, at the midpoint, versus our prior guidance, due to currency and softer markets in Europe and Asia. We had a very subdued view of Europe entering into the year; we expected it to be down even at constant currency for the year. It's gotten marginally worse in the past couple of months, which caused us to reduce our forecast for Western Europe.

We have seen improved results from the Middle East and Eastern Europe, which have been helping to offset that softness. We've seen increases there in Climate, Security and ITS. Overall, we now expect revenues from Europe, Middle East, India and Africa, taken together, to be down in the low- to mid-teens, including currency impact.

Asia, specifically China, has been somewhat softer than our prior forecast. Although we still expect to Asia to be up for the year, we have trimmed our revenue growth expectations by about five percentage points; from the mid-teens to the high-single-digits. Activity in the US has been a little stronger in commercial HVAC and Industrial. Refrigerated transport markets are expected to have moderate year-over-year growth in North American and to decline in Western Europe.

We see continuing slow growth in residential markets, where we have had some positive movement in replacement systems. As Steve said, we expect R-22 and low SEER units to remain a significant portion of the market in 2012. For commercial security, we expect to see a continuation of challenging conditions in the US non-residential new construction market for the next year, particularly in our key institutional markets. Additionally, foreign exchange will continue to be a headwind in 2012, adversely impacting our revenue growth by about 2 points.

In total, we expect annual revenues to be flat to up 2% compared with 2011 revenue of $14 billion, excluding Hussmann. Excluding FX, the organic growth rate is 2% to 4%.

Please go to slide 15. We are updating our full-year EPS from continuing operations guidance to a range of $3.15 to $3.25, an increase of $0.20 at the midpoint. $0.15 of that increase comes from the tax discretes we saw in the second quarter. We expect there to be another $0.02 positive of discrete tax benefit between the third quarter and fourth quarter -- it'll be positive $0.08 in the third quarter, and $0.06 negative in the fourth quarter. It'll net the $0.02 positive.

We are flowing those through for the year. The remaining $0.03 is the net impact of the lower share count, given our increased repurchases and the lower ongoing tax rate, partially offset by the impact from the lower revenue forecast. Based on our forecast, we continue to expect -- generate available cash flow about $1.1 billion.

Third-quarter revenues are forecast to be $3.6 billion and $3.7 billion. Revenues on a comparable basis, excluding Hussmann, are forecast to be flat, up 2%, versus the third quarter of 2011. That includes FX, which will be a headwind of about 3 points. And that means, excluding foreign exchange, revenues will be up 3% to 5%.

Third-quarter earnings per share are forecast to be $0.95 to $1.00. We're assuming a share count of 311 million shares and a tax rate of 17%. That rate reflects an ongoing rate of 23%, as well as the impact of the estimated positive discrete tax item of $26 million, which then brings the rate down to 17%.

Please go slide 16. We're pleased to have delivered a solid second quarter. We have strong overall operational leverage, and margin gains in commercial HVAC and in Residential and Industrial businesses. For the balance of 2012, we see mixed demand patterns; with steady, slow growth in North America, declining markets in Europe, and slowing growth in Asia. Currency translation will continue to impact our second-half results. And we will get ongoing benefit from price and lower inflation.

We're focused on continued change and improvement to ensure that we are managing our business optimally across the spectrum of economic conditions. Our focus is on positioning our Company to continue to grow consolidated earnings and cash flow with very little help, or possibly no help, from revenue growth. We continue to feel good about our progress. We have a portfolio of outstanding, market-leading brands. We continue to demonstrate our ability to generate high levels of cash flow, even in the face of a challenging backdrop.

The longer-term attractiveness of the end markets in which we operate, and our competitive positioning, will allow us the benefit of those sectors that economy improves. And our management team is committed and is actually managing to Company to generate sustainable, profitable growth. As I've said before, we're not waiting for macroeconomic lift to improve our businesses. Instead, we're practically working to reduce costs and invest in our growth markets.

Now, Steve and I will be happy to take your questions.

(Operator Instructions). Andy Casey, Wells Fargo.

Thanks. Good morning, everybody. Question on -- in the past you've given us margined by segment; could you help us with that? I'm just trying to see where the difference is in a modest second-half decrease? Most of it's probably what you described already. But if you could help with the margin, that would be nice.

Margin, Andy, by business for the balance of the year?

Yes, please.

Andy?

Yes?

Margin for the balance of the year?

Yes, please, Mike.

Yes, sure. We'll release our Climate again. We would look at X, FX. Let me do it all-in, reported flat to 2% growth in Climate for the full year. And I would expect flat to modest improvements in margin in Climate for the full year. I think they do a nice job of offsetting some of the TK declines with improvements in Trane business.

Industrial, I would think you would see 2% to 4% growth for the full year. And in here I think you'll see margin expansion similar to what you've seen in the first couple of quarters. So, good margin expansion there throughout the balance of the year; something in the, maybe, 120 to 150 basis point range for the full year.

Residential has really no change for me there; 1% to 3% growth. And we're looking for a couple hundred basis points of growth here. Last year, they did about 3.1%. This year, they should to do just a little bit better than 5%.

(technical difficulty)

And Security -- we would look to see revenues flat, perhaps minus-3%; and margins to be essentially flat with last year.

Okay, and thanks for that. Just a couple of follow-ups -- in Residential, did you realize any pricing, as of July, for the HVAC side?

Did we realize pricing in July? We realized pricing in the quarter; we had good pricing in the quarter. And then, we had made some adjustments to price -- not across the board -- beginning in July for certain products, which we're pretty early in that process to see what will stick and what won't.

And, Mike, is that included in the new 1% to 3%?

Yes.

Okay. Thank you very much.

Jeff Hammond, KeyBanc Capital Markets.

Good morning, guys. On price cost, it seemed like a pretty big positive in the quarter. Can you give a little more granularity on where that was coming from; where you might be seeing relief; and how you see that playing out in the second half?

Yes, I think that -- Mike mentioned earlier that we were pretty pleased with what the Climate group was doing to offset some of the mix issues with TK. Climate was really the kind of a standout there, good price realization across the businesses in Climate. And Security is continuing to do well there. Security has done a great job of maintaining their margins throughout pretty tough markets for the past, coming up on four years. So they've been able to do it with price and productivity, and so they've been able to realize -- produced price as well. I would say it's kind of across the board.

My guess is, price levels have held in there. They are contributing to the positive delta over direct material inflation. And also, as Mike said there, we're starting to see some improvement in the Residential side. So I would say, if you boil it down, it's sort of Climate, Security, Industrial, and then Residential kind of doing better.

So it's more price traction than any kind of benefit from commodity deflation or --?

We're starting to see some benefit from commodity deflation. It's about on track with where we thought -- for the guidance for Q2. It's going to be get a little better in Q3, but most of the delta here is on the price side. It's really not coming from the -- inflation is abating, no question about that, but the delta margin is coming from just better price realization.

Okay, great. And then just, quickly, on Residential -- you had pretty good orders first quarter and now second quarter, and the revenue growth continues to be muted. Can you talk through the disparity there? And then can you also talk about mix within the bookings?

Sure, Jeff. First, I've got to tell you that we're really pleased with what we saw. The revenues were -- the margins, both were spot-on the forecast that they gave us for the quarter. And the new products went well. I think they have addressed the issues they were facing at this time last year very nicely. In fact, I would say as we were looking at this a couple of quarters ago, I had hoped to be in a position, in July, to tell you this. And I am in this position, here in July, to tell you that I think we've -- that they have done an outstanding job, and they are where I had hoped we'd be in terms of their progress.

What we're seeing here is that the launch of the new price point product, lower price point product, the brand -- and just the mix that we've had with R-22, it has caused unitary volumes to be up kind of higher-single-digits for us, driving a much, much lower mix. So when you look at us on a total MBU or on a volume basis, we are at line or maybe even above the market. We haven't seen the market yet through the much a month of June -- the actual data and reports, the third-party reports -- but I would expect we're at line or just above that. But on a revenue basis, of course, it puts pressure on the fact that we're really not selling, from a mix perspective, the higher-efficiency systems that we were two years ago.

The other thing about Ameristar, which I think is interesting, too -- we had a whole different approach to how we launched that product this year. We took it as a methodology of allocating the product in advance. We wanted to create pull from distribution as opposed to pushing another low price point product out in the marketplace. So what it allowed us to do is we were able to exactly forecast the demand we wanted to see for the product, build to that demand, and ensure that we sold exactly to that demand level. And so, as we had demand that exceeded that -- and in some cases we did -- we were sure to prioritize first with those that had taken the pre-allocation on the product. So that worked extremely well for us as a model entering the market.

Okay. Thanks a lot.

Mike Worley, Janney Capital.

Hi there. Good morning, guys. I was just wondering if you could give a little bit more color on Thermo King, and what you are seeing in the truck market, both in Europe and China?

Yes, Thermo King in general; maybe just talk a little about that. We saw, in the quarter, TK down, of course, high-single-digits; North America up mid-single digits. Europe, when you exclude marine, was down high-teens. And marine itself was down over 20%. And all those, of course, include currency. Excluding currency, TK revenue was down low-single-digits.

TK orders were down about 10%, including currency, in the second quarter; and North America was about flat. Europe, excluding marine, was down over 20%. And marine orders were down somewhere in the mid-teens. So our outlook for TK for the full year is down mid-single-digits in total; with North America up mid-single-teens, and Europe and marine down mid-teens.

When I add the latest ACT information that came out on refrigerated trailers market for North America, they called their forecast down by -- what was it? 2100 units, I believe, for the year, off their previous forecast. And our forecasts have been below ACT for some time. But you can kind of get what's happening here, in terms of the second half of the year.

Okay. And then, the other question I had was just on the residential security side of things. You said that it was, the revenue was up mid-teens, and that seems pretty strong. I'm wondering, do you think you are taking share there? Or has there been some promotional items there? Or what do you think is the reason for such strong residential security?

It's a combination of new product launches, a little more strength in the builder market, and then just more activity at retail in terms of sell-through. So, just across the board, the last couple of quarters for us have been pretty good. I think the first quarter a little stronger, high-teens; second quarter, mid-teens -- so -- low teens. Continued growth there; we've launched some new product into the marketplace that's done quite well, in addition.

Okay. Thanks a lot, guys.

Eli Lustgarten, Longbow Securities.

Thank you. Good morning, everyone. One clarification question -- you dropped the ongoing tax rate from 25% to 23% for this year. Can you give us any insight of what you think might happen in 2013? Do we stay at 23%, or go up with the strong US business? I'd just get some sense of how we should model this thing.

It's sensitive to US income, sure. We've put longer-range guidance out there at 25%. We continue to, Eli, to do tax planning all over the world. In fact, some of these discrete actions, or discrete tax items, are showing up because we've been able to consolidate entities in foreign jurisdictions. So we can have one business that's making money, take advantage of accumulated losses from other businesses, and pass. That's exactly what happened in Spain. We would expect to continue to do those kind of planning things throughout perpetuity. So I think that, at this point in time, we -- looking at a rate of about 25%. I would say that, from a modeling perspective, I would keep it at 25% for the future years.

Okay.

But again --

Eli, to Steve's point -- we actually, just in the last couple of years, all the integration that we've been doing across the Company; we've reduced the number of entities across the Company by a net 80. And that has had statutory benefits to us in terms of the costs associated with that.

But the real value comes -- in particular, we're now able to value some of the NOLs that we couldn't before through the entity consolidation. So it's very difficult to project that on by country, by entity basis. 25% has been a -- is a good modeling number for you. As we get more visibility into tax plans for next year, we'll update that accordingly.

Just keep in mind, it is highly sensitive to US income. And, of course, your guess is as good as anybody's, as to what the US markets will look like in the next year. So if we don't see that type of growth year-over-year that maybe we've expected in the past, that would help the rate. But, given what we know at this point in time, the 25% is probably still a pretty good number.

During your commentary, you talked about, in Security, some large projects in Asia causing the decline. One, can you quantify the size of it? And, two, have you put any of those projects in the second half of this year? Or have they been postponed indeterminately? Or how should we look at that?

Yes, Eli, their business, they've done a great job with capturing most or all of the airport business there, the big airports. They've done a lot with the rail stations, and quite a bit with city traffic monitoring systems. And, of course, that's been pinched in the last few quarters with some of the infrastructure containment going on in China, but it does pick up in the back half of the year. And we do see it recovering, but every year we seem to get that lumpiness associated with whether a big order in Security books in Q2 or Q3.

It is one of the lower-margin contributors to the business for us in that regard, so timing isn't as critical. We're much more focused on how the Americas will do, and what sense we're getting for recovery in Europe. But I think bookings in Asia, particularly China, will recover in the back half of the year; probably the fourth quarter, as these infrastructure projects become real. Now, they are real already in terms of the quote in the proposals. We're really waiting for government approval to proceed with some of them.

What's the magnitude of these kind of things that didn't happen? Are they $20 million, $30 million or $100 million? Can you give us some idea of what --

Yes. We booked them as large as, say, $50 million. But $20 million or $30 million would be sort of a variety of what we're talking about right now.

You've had record profitability in the industrial businesses, even though as orders begin to slow a bit. Is there anything preventing you holding this record profitability, even if things get a little bit sloppier, particularly overseas?

Well, I think we continue to drive it, similar to what we did in North Carolina around putting all of our compression around the Company together, all of our machining operations. We're doing the same thing right now in Asia, in China specifically, and doing a similar body of work in our German facility. I think that this is great. We're able to take a slowdown in the HVAC large rotor business that would go into big rotary chillers -- same equipment, same machining used to be able to produce the rotors that go into our large Aeron.

So, actually, what we're seeing here is a nice balance between the two; we're able to keep that operating. So, I think we can. That's one big example. A compressor like that could be 10% to 30% of the cost of the system. And so, you can absorb that year around. And, regardless of any particular point in the cycle, there is an opportunity there to keep those margins going.

We do all that work, actually, in industrial plants. So Industrial gets the benefit of that absorption, as opposed to Climate.

And one final question in Climate -- at what point would weakness in Thermo King begin to affect the ability of the sector to show improved profitability? So there's some concern about -- we know overseas markets have been sloppy. Now we see a lot of the US markets being somewhat questionable in growth in the truck sector.

I think we've taken a conservative but, I think, realistic forecast for the year in what we've looked at taken down here. So I can tell you that we can move margins up slightly, based on the mix that we've seen in total Climate, minus one-to-one, that kind of -- I'm sorry, flat two for the full year. So if we work inside that range, with the outline we've given you for the forecast, we would be able to marginally improve profitability. But if you back out that China factory sale there, actually it's pretty impressive. It's a point of margin expansion when the mix has really went the wrong way on us.

All right, thank you very much.

Steven Winoker, Sanford Bernstein.

Thanks. Good morning. Seems like pretty impressive productivity in the quarter; can you maybe talk a little bit about what some of the biggest actions you are seeing coming through, Mike, that are continuing to give you this buffer to the volume?

Well the nice thing, Stephen -- it's just not one thing. I would be concerned if it was one thing or one big event. But it's the pipelines across the Company and the various ways that we track them; whether it's the centralized material organization, or it's the increased number of value streams that we put out; are all sort of stepping up to a higher level of productivity pipeline. And, thankfully, that's coming through in the actual results. We're resourcing those pipelines aggressively, to make sure that we're looking at productivity and ensuring that we've got resourcing to be able to get it done.

We are including the engineering and sourcing organizations into a lot of the VA/VE work that we're doing across the Company. And that's helping, because we're now making bigger changes across the Company that might go across different product lines. So we might look at electrical motors across both industrial and HVAC. We deal with, largely, the same suppliers, and so we're able to make modifications there on a system level across those businesses. Res operations is another big one for us. We are not seeing the negatives there. In fact, we're seeing very good productivity there. They hit all their rates, hit all of their operating metrics they had for the quarter, with the new relaunch of the products, so that's been a plus for us.

And I think that that will actually be even a bigger plus for us in Q3 or Q4. So we feel good about the fact that the Q3, Q4 leverages are fairly high, when you look at it for the balance of the year for us. But when you look at the source of that leverage, coming from what I've talked about, including residential, there is a clear path to it.

Okay. And so I know you put down a 1.1 percentage points difference versus other inflation. Give us, maybe, just a little bit more color. I know you keep those internal numbers; but, maybe, a little more color about just how large that productivity was, or how small the other inflation was?

Well, you think about the $0.08 beat to productivity inflation, only about $0.02 of that came from deflation; the balance of it came from better productivity.

Okay, and then restructuring expense, you guys have mentioned a few times. And maybe a little bit more color on what you're doing on that front? Are you accelerating it? How are you thinking about that?

We've been continuous, Steve. I think you've known us long enough that -- as long as I've been talking to you anyway, for nine, 10 quarters -- we've had a continuous stream of restructuring, starting with the big plant consolidations all the way through to some of the functional lean work we're doing in the Company now. We've been at that on a fairly consistent basis. And I think we'll stay at that on some consistent basis going forward, so I don't think we'd do anything dramatically differently. We've got plans for what we would like to see happen, but don't think we would be spiking out anything particularly unusual for you. Again, it's really embedded into what we've been doing every quarter for the last nine, 10 quarters.

Okay, and the $0.07 reduction in the back half of the year on both volume, FX's, everything, all-in operationally. So given all this productivity commentary and the restructuring commentary, how might I think about how much of that is pure volume versus the offset in some of those other areas? How are you thinking about the mix of that in the back half?

I think that, you have to remember, FX is an issue in the back half, which is also in that number. So we saw a weakening of FX between last guidance in this guidance, for sure.

Right. But I know it says volume FX, but there is obviously got to be a -- between the last midpoint in the new midpoint, are you just saying that you're holding your productivity assumptions and all your other assumptions constant? So there's no improvement in those other areas to offset the FX in the volume side here?

What you see, Steve, too, is a mix issue, too. If you start taking TK volumes down further, as an example, we are fighting that mix issue as well. So you are actually seeing productivity that's very similar to what we had forecast last quarter still flowing through; fighting a bit more of a mix issue with some of the higher-margin businesses.

Okay, all right. So, mostly consistent otherwise. All right, great. Thank you.

Deane Dray, Citigroup.

Thank you. Good morning, everyone. Questions on the HVAC side -- we understand that the business is fairly lumpy in terms of seeing surge in orders at the tail end of the first quarter and the second quarter. So I'd be interested in how that played out this quarter, because it just also happened to coincide with some really scorching heat. And so the expectation was that you may have benefited from that, right towards the tail end. But from a seasonal standpoint, how did that play out?

Talking about Res HVAC, Dean?

Yes.

We saw a strong March, a strong April; and then it subsided a bit in May, subsided a bit in June; picked up a little toward the back half of June. The feeling, it's more inventory related than it is heat related, at this point in time. I don't know if I can comment any deeper. Steve, maybe you've got some thoughts on that.

Well, if you look at just the bookings versus the revenue for the quarter, Dean, the bookings were up mid-teens for the res HVAC business, and that came as about pretty much as a result of that seasonality that you just described. We are entering third quarter with a pretty good backlog in the res business as a result of that. I don't know how it might have played out for some of the other guys in the industry, but we feel pretty good about the fact that the orders came in strong in June, and we're going into the third quarter in pretty good shape.

Yes, Dean, you've got to think, too, mid-teens or low-teens kind of revenue for us is still going imply kind of mid-, higher-teens volumes for us as it relates to the mix down to the lower SEER equipment.

Just want to make sure I'm hearing you correctly regarding some comments on July, because it's important for this business, we know. The pace in June carried into July, but how would you characterize it?

Actually, the bookings towards the end of July picked up, giving us a -- (multiple speakers) of -- June, I'm sorry, June -- giving us a backlog that we carried over into July. So, no commentary yet on July, but the back part of June provided increased bookings, which we are carrying forward into Q3.

Okay, that's helpful. Last question for me -- on the Security side, we know, seasonally, this is real important in terms of institutions like colleges that do the switchovers or upgrades on the block installations. What's the expectation this year? How do you expect that to play out?

Well I would say it's a lot more demand creation than it is around retrofits in the marketplace that are plan and spec. And so the activity process shifted toward an electronic locking retrofits with major universities and hospitals, as opposed to expectations of major innovations that they are going to be conducting. We're adapting our salesforce and adapting our go-to-market strategy for that reality, which kind of really gets you into this flat, minus-3 for the year -- and Q3, which is probably going to be down low-single-digits, year over year. So we're suffering from that institutional slowdown. We're doing what we can in terms of trying to create our own demand.

But you are seeing a mix, the take rate on the electronic blocks becoming a greater share of your business?

Is the fastest-growing part of our business. I wish it was larger. But yes, absolutely, you see it going up.

Thank you.

Stephen Volkmann, Jefferies Securities.

Thanks. Hi, guys. I may be beating a little bit of a dead horse here, but I just want to make sure that I understand -- the bookings, obviously impressive in residential; the forecast for revenues up very modestly only. The whole difference there is mix, or are you being a little bit conservative regarding bookings in the second half?

Well okay, if you look at Q3 expectations in the res business, we would look for revenue growth in that 3% to 7% range in the business. We know that our volume of units is going to be much higher than that because of the mix. It's become a relatively short-cycle business, so when we see Q2, late June bookings up 13%, it's good. I don't get wildly excited about that because we are able to execute that very quickly with the plant capacities today. So we're going to have to just go month-to-month here and see what happens in Q3. But our expectation would be, revenue growth of 3% to 7%; unit growth, higher than that.

Okay, great, that's helpful. And then just to switch gears here, with respect to use of cash -- obviously, more share repurchase here; and I guess Steve kind of intimating that we'll see some more dividend and maybe some more share repurchase going forward. Does this mean that you've abandoned the idea of paying down this pretty large tranches of debt I think you had due this year or next year, and kind of headed toward that A-rated credit? Is this kind of a secular change in your of how cash should be used?

Well, hopefully, we've been intimating for a long time that we want to get the dividend rate up (technical difficulty), so I would look to 2013 for us to take a meaningful step towards that. In other words, on the dividend payout, something closer to the 25% range, moving closer to 30% in 2014.

As it relates to your question about A ratings and debt, I think the bigger question really is, what do we believe the optimal capital structure of the Company should be? What should it look like? In that regard, we have studied it. We're going to continue to study the question, as the variables that go into that are very dynamic. So I will say that the one thing for sure, though, is we do believe that the important strong balance sheets is clear. We know that an investment grade is absolutely viewed favorably. We know our peer universe maintains that investment grade rating. So we also know it's important, in a downturn, to have a strong balance sheet.

So we're going to raise the dividend. We're going to talk to the Board about reauthorizing a share repurchase. We're going to continue to study and determine what the optimal structure of the Company should be going forward. And once we really have that nailed down and detailed, we're going to be back out to you and all shareholders at that point in time.

Just one clarifying comment -- want to be sure -- we have always said that our range of share buyback this year is going to be between 300 and 800. And we really are, at this point in time, saying we are going to be pretty much at the higher end of that range. I particularly want to clarify, though, is that our payout ratio today is about 20% of available cash on the dividend side. So we would be looking for an increase in that of somewhere around 25% in 2013; make sure that everybody got those numbers right.

That's very helpful. Thank you, guys.

Andrew Obin, Bank of America.

Yes, good morning. Just want to make sure that, in terms of your earnings outlook, did you make any negative adjustments for the slowdown in truck orders in North America and Europe?

Well, yes, Andrew, sure, if you look at -- when we look at, as we're dropping the second-half forecast by about $0.07, and what's causing that fundamentally is that we've had a different outlook, a more negative outlook, particularly in Europe and in Asia, along with the currency headwinds that we're seeing. We see weaker markets in Europe and China and FX; volume reductions were mainly in European transport, Asian HVAC equipment; and, to a lesser extent, in Industrial in both Europe and Asia. Now we're offsetting part of that with a slightly higher forecast in North America HVAC, Industrial and Residential. And, obviously, there is a negative mix impact from those volume changes when you take them together. You are essentially correct.

No, but I'm specifically referring to Thermo King, just because it's one of your high profit businesses. And truck OEMs, there has been a significant slowdown in order activity in the truck market in North America. And as we talked about your earnings adjustment, operating earnings adjustment for the second half, I'm trying to understand what are the major buckets, the key buckets, just more specifically. And within that, I'm wondering just how big all the negative drag was TK?

I think, Andy, if you look at it like this -- we factored in a slower TK second half. But when we started the year, we did not have as much optimism in our forecast for that market as you would have seen in some of the outside markets. I just said a few minutes ago, the ACT guys dropped their North American trailer market forecast but 2100 units here in mid-June. And it's still not down to the point where we would have planned the year for that market.

So we took it down a bit to reflect, primarily, weaker container activity in Europe, and the big impact of foreign exchange. So Europe is a factor, foreign exchange is a factor in TK. But we're looking at not having as big an impact on our numbers as what you would see in the outside world when you look at some of the market indicators that are coming through. I don't think it makes sense -- (multiple speakers)

No, that's exactly what I was asking. And the second question, could you just rank order the biggest negative drivers for the second half? What were the biggest headwinds? If you could just give us more clarity, quantify them, and rank order them, or just to give a little bit more color than the broad statements you guys have provided.

The headwinds is really second-half midpoint forecast from the outlook in April, reduces by about $0.09 just on the revenue side of this thing.

And that's climate control mostly, right?

Yes, I mean it's -- Climate is always a big part of this. But we would see a slowdown in Security as well, in the back half of the year.

I think Industrial will be okay. And we think res, we are ticking up a little bit. But yes, a big part would be Climate. And Security would be the other big part.

Okay, thank you very much. I'll take it off-line. Thank you.

Julian Mitchell, Credit Suisse.

Thanks a lot. I guess, firstly, just to focus on the Security business. You talked about margins being flattish for the year. I mean, Q1 was down about 50 bps; Q2, down 180. And I guess when you've talked in the past, you made it clear that any revenue drop-through would all be spent on product introductions and refreshing the overall business. So what's behind the confidence that Security can rebound on the margin side in the second-half?

The biggest thing, Julian, was the restructuring they did in Q1 and Q2. And they don't do that in Q3 and Q4. So I think they've got -- just restructuring alone answers the bulk of your question there.

And that restructuring was done primarily in Europe, Julian, which is pretty expensive. So, that's behind us here as we get through the first half.

Okay, got it. And if we think about the overall margin bridge that you guys have on page 7 in the slides-- when you think about the second half, for those four main items it sounds like price, material inflation, and productivity and other are fairly similar to what you had in Q2. Volume mix, FX, little bit worse, maybe. What's happening with that investment/other line, just for the overall Company? I mean is that sort of a -- I think in Q2 it was maybe a 80, 90 bps; maybe 80 bps headwind, ex the gain. What's the headwind expected from that portion in the second half, please?

It's about the same. We have about $100 million of incremental investments in the year. And it's pretty well divided by quarter, Julian. What's going to change is the restructuring fees. This investment fees is -- proactive spending that we're doing on productivity initiatives such as -- and we talked about this before -- the common systems initiative we have; the centralization of our procurement; supply chain folks worldwide; and some very, very key product development programs that are going on. So that spending is pretty well spread through the year. So we expect the same, roughly, 70 bps type of a number for both Q3 and Q4.

Got it, thanks. And then, lastly, can you just remind me, the oil free compressor upgrade in Industrial -- when do you expect that product to really start having a commercial impact?

Julian, it has been. It's been a share gain for us in growth. So I think you're talking about, when does the capacity come online? Is that what you're asking?

Yes, so when do you see your ability to take market share and new capacity start to affect your revenues -- (multiple speakers)

Yes, we've been able to increase capacity in Germany already. And we've got the capacity for Asia coming on later this year. So we will be in good shape at the end of this year, beginning of next year.

Great. Thank you.

Terry Darling, Goldman Sachs.

Thanks. I just had a couple cleanup items. First, on the share count assumption, Steve, presumably there's a bunch of share issuance related to stock compensation in the back half of the year. Can you help us with that number?

The 315 million was our original estimate of the average share count for the year. So to drop it to 311 million means that there is a significant share buyback going on in the second half of the year. We think it's going to be a little bit of pressure, but not enough to even talk about on stock options issuances in the second-half.

Okay, so 800 million or so; 750 million still to go; even if you assume a stock price much higher from here, you're looking at 17 million down from 314 million. That gets you sub-300 million by a significant amount. Obviously timing can influence all of this, but there's not a significant share issuance to offset that?

Yes, we would have to take you through the math of when the buybacks occur, relative to the average count here. You are right, by the end of the year it's going to be down below probably 300 million. But the average then catches up with you, because you can't buy them back fast enough in the second half to move the average much.

Okay. And then, just trying to get a little perspective as we try to think about Industrial margins for 2013. Mike, maybe this is a question for you. Just looking at the strong year-over-year improvement implied in the forecast, I want to remember that there was heavy restructuring going on, at least in 3Q last year that impacts that comparison. But I think you called out 120 or 150 basis points year-over-year margin improvement, gets you close to 16. Is 2013 -- thought process, on a preliminary basis, more in the traditional 25% or 35% incremental range? Or is there more structural things going on that can carry sharper leverage in 2013, off of whatever kind of growth; mid-singles, or whatever you might want to assume?

Terry, I appreciate the question. I can't give you a good answer now. We're going to be sitting down here -- gosh, before we know it -- the next 10 weeks with these guys, working through for that month-long period in October, as to what the plan will be for the year, depending on how much investment do they want to do; how much restructuring; and then we will net it all out. But they're doing a great job. They're hitting records. No reason to believe they wouldn't hit a new record next year. But I don't have the details yet. We're putting those plans together in another month or so.

Okay, and then just lastly, can you update us with regards to conversations with Trian to any extent? Implicit in the capital allocation guidance in the second half, perhaps there is something there, but just to clear the air on that -- anything else you can add for us?

The conversations with Trian have continued. The 13D that you are seeing really outlines the ideas that Trian has. And so we're really in the process of taking these higher-level ideas that have been expressed in 13D and then, and the conversations that we've had with Trian, and working through the detailed analysis required in order to run these ideas to grand, actually, and evaluate the impact on what that would mean for shareholder value. So when we are in that process now. It's been a lot of good work by a lot of people inside and outside the Company to put that back together. So considerable progress, but it's a very comprehensive analysis to run that stuff down, and we're nowhere near completing that.

That capital allocation fees -- just talking to shareholders over the last year, have told me, hey listen, can you guys go re-visit this? What are you doing on the dividend? What are you doing about share buyback? And how do you think about the capital structure? So we've been thinking about the capital structure. And we've been modeling what an optimal structure would look like, and that work also continues. And of course that's something that is in Trian's ideas as well.

So we're working through that. But what we've communicated in the past is an aggressive but balanced capital allocation program. And we've always said we're going to get the dividend up to 30% of payout. We think we got another couple years to do that, coming up on that. We've really hit this buyback last year hard. We're hitting it hard this year. We're really consuming all that $2 billion.

We've communicated we're going to go out and talk to the Board about authorizing a new repurchase there. So we know that we want to return as much as we can to shareholders. That's always been the plan; and, basically, to focus on the organic growth of the Company; the product development of the Company; and integrating the Company together to raise margins, as opposed to thinking we're going to acquire growth and take on more acquisitions. That's never been in the cards for me, as to where we are in our strategy.

That's great color. Just one follow-up, on the piece that you referenced there, in terms of the analysis that's not nearly close to being done, what is the timetable for that piece of the analysis?

Well, it's when the work is done and complete, Terry. I can't tell you that we've got a definitive date. We intend to keep working through the ideas, making sure that the data and the analysis is complete and expansive. And when we feel like we're in a position to understand it, and communicate and talk to our Board about it, we will get a better feeling; as well as what questions to Board might have, and how they might want to proceed. So it's hard to put a timeline on something like this.

Understood. Thanks very much.

Thank you, everyone. Joe and I will be available for any follow-up questions for today. Thank you.

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.