特靈科技 (TT) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Ingersoll-Rand second-quarter 2013 earnings conference call. At this time all lines are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your host, Janet Pfeffer, Vice President Strategy Business Development and Investor Relations. Please proceed.

Good morning. Thank you, Sean. Welcome to our second-quarter 2013 conference call.

We released earnings at 7.00 this morning and the release is posted on our website. We'll be broadcasting in addition to this call through our website at Ingersoll-Rand.com where you can find the slide presentation that we'll be referring to this morning. This call will be recorded and archived on our website.

If you'd please go to slide 2, statements made in today's call that are not historical facts are considered forward-looking and are made pursuant to the Safe Harbor provisions of Federal Securities Law. Please see our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated. This release also includes non-GAAP measures which are explained in the financial tables attached to our news release.

A couple of things to note before I turn it over to Mike, similar to last quarter, we will be talking to adjusted margins during our commentary which excludes restructuring and spin-related costs. Our news release and tables give you the reconciliation of GAAP to adjusted margins. And this is consistent with how we gave guidance in both February and in April.

And to remind everyone also earlier this year we transferred a business line from Security Technologies to Residential Security. That was about $20 million of revenue in the quarter and it's about $80 million for the full year 2013. There's no impact to the consolidated level. In the charts and comments, we'll focus on year-over-year change in revenue and orders for those businesses on a comparable basis, so as to best represent the underlying performance.

Now to introduce the participants on this morning's call, Mike Lamach, Chairman and CEO; Steve Shawley, Senior Vice President and CFO; and Joe Fimbianti, Director of Investor Relations. With that, please go to slide 3 and I'll turn it over to Mike.

Thanks, Janet. Good morning and thanks for joining us on today's call.

We delivered growth and profitability above our earnings commitment in the second quarter with solid operational execution across the Company. On top of this, we completed several key milestones related to the Securities spin as well as a successful debt offering. I'm proud of all the great people in our Company for these accomplishments and thank them for their personal and collective commitment to the success of Ingersoll-Rand and ultimately in the successful launch of the new security company, Allegion.

Our revenues for the second quarter were up 3% versus last year both on a reported basis and excluding foreign exchange, reflecting top-line performance just above the top of our guidance range. Revenues were up in Climate, Residential and Security Technologies, but we saw a decline in Industrial. Orders were up 2%.

Adjusted earnings per share for the second quarter were $1.14. That's $0.06 above the midpoint of our guidance range of $1.05 to $1.10. Better performance from operations essentially delivered all of the upside to guidance.

Adjusted margin increased 20 basis points. Operations before corporate unallocated costs increased adjusted margins by 80 basis points. Versus 2012 second quarter, adjusted operating margins were up in three of the sectors.

Residential delivered a 330 basis point improvement. Employment margin was up 90 basis points and Security margins were up 50 basis points. Lower revenues were a headwind for industrial. Corporate costs were higher in the quarter as expected, due to higher benefit costs and increased investments related to our IT transformation.

This marks our ninth consecutive quarter of a positive gap between pricing and direct material inflation. Our lean focus again showed significant results in the implemented value streams, and we continue to invest in the future of the business funding significant new product development, investing in the new IT platform and building our services footprint. Spin-off and restructure costs were $0.11 in the quarter.

We continued our share repurchase program, repurchasing approximately 9 million shares in the quarter. We still expect to spend the current $2 billion authorization by the end of the first quarter of next year.

We continue to be on track for the spin and have completed several key milestones. We filed the form 10 in mid-June right on schedule. Winning five excellent outside directors as well as the Chairman and CEO, Dave Petratis. We announced the name for the new company, Allegion.

In June we completed a successful debt offering for Ingersoll-Rand, securing $1.55 billion at attractive interest rates and maturity profiles. So it was a quarter with many accomplishments and milestones to take note of.

Now Steve will take you through the second-quarter results in more detail and I'll be back with an outlook for the third quarter and full year.

Thanks, Mike. Please go to slide number 4.

Orders for the second quarter of 2013 were up 2% on a reported basis and up 1% excluding currency. Climate orders were up 4%. Global commercial HVAC bookings were up low-single digits. Transport orders were up mid-teens.

Industrial orders were flat, with order growth in the Americas offset by lower bookings in Europe and Asia. Residential bookings were down 3% on a comparable basis. We believe the Residential bookings performance to be a result of the significant improvements made in the HVAC product delivery cycles over the past year. Improved lead times have allowed customers to place orders much closer to required delivery dates, which is creating a temporary shipping of orders to later dates compared to last year. Commercial Security orders in the quarter were up 3% on a comparable basis.

Please go to slide number 5. Here's a look at the revenue trends by segment and region. The top half of the chart shows revenue change for each sector for the total Company and the second quarter revenues were up 3% versus last year on both a reported basis and excluding currency.

Climate revenues increased 5% with HVAC revenues up low-single digits and transport revenues up high-single digits. Industrial revenues were down 3%, Residential was up 7% on a comparable basis. Commercial Security revenues were up 3% on a comparable basis. I'll give you more color on each sector in the next few slides. On the bottom of the chart, which shows revenue change on a geographic basis, revenues were up 4% in the Americas while Europe and Asia were each down 1% excluding foreign exchange.

Please go to slide number 6. This chart walks through the change in adjusted operating margin from second-quarter 2012 of 12.8% to second-quarter 2013, which was 13%. Negative mix and foreign exchange collectively created a 50 basis point headwind to margins.

Our pricing programs continued to outpace material inflation, adding 70 basis points to margin. Productivity offset by other inflation was 50 basis points accretive to margins. Year-over-year investments and other items were higher by 50 basis points.

In the gray box at the top of the page overall leverage was 21%. Leverage in the sectors was 40%, partially offset by higher corporate investment spend. The box in the middle of the page shows the revenue and adjusted operating margin by sector and in total. Operations excluding corporate increased adjusted margins by 80 basis points. Corporate costs were higher in the quarter due primarily to higher benefit costs and increased investments related to our IT transformation.

Please go to slide number 7. The Climate Solutions segment includes Trane commercial HVAC and Thermo King transport refrigeration. Total revenues for the second quarter were $2.1 billion. That is up 5% versus last year on a reported basis and up 5% excluding currency.

Global commercial HVAC orders were up low-single digits. Orders were down in the Americas but up in Europe and Asia. Trane's commercial HVAC second-quarter revenues were up low-single digits. HVAC revenues were up in the Americas, Europe, Middle East and Asia.

Commercial HVAC equipment revenues were up mid-single digits while HVAC parts, services, solutions revenues was down slightly versus prior year, impacted by lower contracting revenues which had a benefit of a large contract in last year's second quarter.

Thermo King orders were up mid-teens versus 2012 second quarter, with Americas trailer orders up over 40%. Thermo King revenues were up high-single digits. The adjusted operating margin for Climate Solutions was 13.4% in the quarter, 90 basis points higher than the second quarter of 2012 due to volume, productivity and pricing, partially offset by inflation and higher investment spending.

Please go to slide number 8. Industrial Technologies second-quarter revenues were $763 million, down 3% on a reported basis and 4% excluding currency. Air and Productivity revenues were down mid-single digits versus last year. Revenues in the Americas were down slightly while Europe and Asia are each down low-teens.

Air and Productivity orders were down low-single digits. Higher orders in the Americas and Asia were offset by lower orders in Europe. Club Car revenues in the quarter were up mid-single digits and orders were up mid-teens versus prior year. Industrial's adjusted operating margin of 16.3% was down 100 basis points compared with last year. Pricing and productivity were more than offset by lower volumes and inflation.

Please go to slide number 9. In the Residential business, second-quarter revenues of $713 million were up 9% compared with last year. Adjusting for the product line move, comparable revenues were up 7%. Residential HVAC revenues were up mid-single digits versus last year. Revenues for the Residential Security portion of the sector were up low-teens on a comparable basis, with increases in the new builder channel and South America partially offset by lower big box revenues.

Sector operating margin of 11.2% was up 330 basis points compared with 2012, as pricing, volume and productivity more than offset inflation and adverse mix. We continue to execute our deliberate strategy to improve product depth and channel performance while increasing margins. As the second quarter margins would indicate, we are pleased with the progress and the team's ability to balance those objectives.

Please go to slide number 10. Revenues for Security Technologies were $399 million, down 3% on a reported basis and up 3% when adjusted for the product line move. Americas revenues were up mid-single digits. Revenues were down mid-single digits in Europe and up double digits in Asia.

Bookings on a comparable basis were up low-single digits. Adjusted operating margin for the quarter was 21.6%, up 50 basis points from last year as productivity, price realization and favorable mix were partially offset by inflation and higher investment spending.

Please go to slide number 11. We finished the second quarter with working capital of 3.5% of revenues. Working capital and cash flow levels are consistent with our historical seasonal performance. Year-to-date available cash flow is $100 million higher than last year's first half.

With that, I'll turn it back to Mike to take you through the guidance.

Thanks, Steve and please go to slide 12. As a reminder, for purposes of giving guidance for 2013, it's on an as-is basis. It assumes the current Ingersoll-Rand with the current full operating sectors as in place for the full 12 months of 2013. As we announced in December, we expect Security spin to take place in the fourth quarter but to be clear, the guidance does not reflect the spin. Consistent with our April guidance, we've we broken out spin and restructure costs from the core EPS guidance in order to give you the best representation of the Company without the impact of the impending spin.

To give you an update on our market views, let's start with US Nonresidential. Construction starts and put-in-place trends have shifted a little since our prior guidance, with total put-in-place outlook was slightly lowered and the mix changed. Commercial and Industrial expected growth got a little stronger, more than offset over by lower Institutional outlook. Institutional markets are expected to be down for the year by 5% versus down 3% in the prior market forecast.

The 2013 outlook for Commercial and Industrial put-in-place was raised from 8% to 9%. Increases in bank and office buildings and retail support our view of a stronger second half versus first half in unitary HVAC. However the applied forecast was lower based on the lower Institutional outlook, so our overall Trane Commercial outlook is just slightly lower than it was last time.

We continue to expect low-single digit growth in North American commercial HVAC overall and flat to a low-single digit decline in North American commercial security. We expect North American truck-trailer markets to be fairly flat on a unit basis in 2013.

US residential new construction markets continue to show good growth. We expect industry motor-bearing unit shipments for the year to be up high-single digits for 2013, driven largely by new construction. We expect to see R-22 to be a lower percentage of the market, probably down over 20% versus last year.

Asian HVAC equipment markets are expected to be fairly flat in 2013. China HVAC is expected to be up low- to mid-single bits. We saw good HVAC bookings progression in the quarter, which as we said, was needed to underpin the balance of the year forecast in Asia and specifically China HVAC.

Industrial Technologies saw a softening in most markets in the quarter. In China in particular we had spoken about the need to see acceleration in Industrial bookings in quarter two, to support the prior forecast. That did not occur as the government has tightened credit and support to address global capacitized industry, so we adjusted our second-half outlook accordingly.

Our Asian security business, which is more influenced by the timing of large infrastructure projects, should be up high-single digits for the year. And overall the outlook for Europe, Middle East, and Africa taken together should be up slightly across the Company. Based on our results in the second quarter and our visibility for the remainder of the year, we are updating our revenue outlook and tightening our earnings guidance range for the year.

Our revenue outlook for 2013 is now $14.2 billion to $14.4 billion, which is a $100 million reduction to the midpoint our prior guidance, which equates to 1% to 3% growth versus 2012. Translating that to our outlook by sector, we expect Climate Solutions revenue to be up 1% to 3%, which is the same as the prior guidance. We're adjusting our outlook for Industrial Technologies. Industrial revenues are now forecasted to be in the range of up 1% to down 1%.

Residential is still expected to be up 8% to 10% on a reported basis and up 4% to 6% on a comparable basis. And for Security Technologies we're adjusting the top end of the revenue range down slightly to reflect the lower upside forecast in the second half. We expect Security to be down 3% to 4% on a reported basis and up 1% to 2% on a comparable basis.

Please go to slide 13. We are maintaining our full-year EPS midpoint but tightening the range of our guidance for full-year EPS from continuing operations to $3.50 to $3.60. The full-year tax rate forecast for 2013 is still expected to be 23%. This excludes one-time costs and restructuring of $0.65 to $0.75, updated to include $0.15 for the cost of early retiring the 2013 and 2014 debt, which was not in the prior forecast. And bringing up the bottom end of the range for spin-related costs and restructuring based on our latest estimates. We'll continue to update our estimates as the spin date gets closer and we finalize the remaining structuring plans.

To focus on the third-quarter guidance refer to the right-hand column on this chart. Third-quarter 2013 revenues are forecast to be $3.65 billion to $3.75 billion. That translates to a range of up 2% to 4% versus the third quarter of 2012.

Adjusted third-quarter earnings per share are forecast to be $1.07 to $1.12. We're assuming a share count of 295 million shares and an ongoing tax rate of 23%. One-time costs are expected to be about $0.25 in the quarter and that includes $0.15 for the cost of early retiring the 2013 and 2014 debt. For the full-year 2013 we still expect to generate available cash flow of about $1.1 billion, excluding one-time and restructuring costs.

In closing, we're pleased to have delivered a solid second quarter. We continue to feel good about our progress. Our focus is on positioning our Company to continue to grow earnings and cash flow with or without help from markets. We've implemented a consistent and shareholder-focused capital allocation program.

We've proactively worked to reduce costs and improve productivity while still making prudent investments for the future. We continue to invest in new products and service offerings in our IT infrastructure and further developing our people and our operating capabilities. The spin of Allegion is on track and I'm pleased to have Dave on board as of August 5 as its leader.

I'm proud of the progress we've made and results we've delivered and I'm optimistic about the opportunities that lie ahead for us. Now Steve and I would be happy to take your questions.

Thank you.

(Operator Instructions)

Julian Mitchell, Credit Suisse.

I was just looking at the EBIT bridge and if you look at the productivity net of other inflation, that was running at about a 50 BPS tailwind-to-margin in Q2. That's lower than the 90 BPS affecting Q1. What do you think the full year is there? Is there something on timing of products quarter-to-quarter and the run rate is more like a first-half blended number? Or how are you thinking about that for the second half?

I think so, Julian. We've said right along that we would expect to see about 50 BPS coming from the difference between -- you're talking about pricing versus direct material inflation, I assume, right?

Well, productivity.

Productivity in general?

Yes. The productivity net of other inflation line.

Okay, we'll address that.

Just that that was a 50-BPS contribution, I think in Q2, and it was more like 90 in Q1. Is that just lumpiness and the full year is going to be somewhere in between the two? 70 or so?

Actually, yes, if you look at second half, it's more of a blended rate for the second half compared to the -- if you look at the first two quarters and the blended rate, that's about what you get for the second half. You do see a little increase in productivity, gross productivity, in the back half of the year. You do have a little bit of that tame inflation environment, so you do get a little bit better in that productivity, other inflation, in that regard.

Steve was going down the path of also answering the pricing question which, it's been good to us, halfway through the year. And I think as you look at the back half of the year, to maybe bring up the question there, I think we'll see something on the order of 40 to 60 basis points in Q3 and Q4, that price to material inflation component as well. So I do think it supports Q3 forecast. The Q4 forecast would put our operating leverage between 40% and 50%, in the mid-40s. And that supports, I think what we've done in the past, and also supports the forecast that we have for both productivity and pricing.

The other thing about the other inflation, it includes all salary increases. We're on a pretty much of an April 1 salary merit increase schedule. So the first quarter is always going to look a little better than the rest of the year because of that factor, Julian.

Got it. Thanks. And then on mix was a big issue in Q1, that you highlighted in three of the four segments. You said it would get better in Q2. Clearly it's got a lot better. How do you think about mix for the second half?

I would think mix for the second half is going to be generally better than what we've seen in the first. A couple of reasons. One, the Residential mix down of SEERs seems to be leveling out. We're definitely seeing a bottoming of the average SEER rating there, which was a big, big factor in our mix issues up through the first quarter.

We're also seeing a good mix of Thermo King business through the middle part of the year here, which is going to help the mix certainly in the third quarter. And I would say that if we still have a mix problem, it's probably somewhat in the Industrial sector, because in addition to just general volume issues in the industrial sector, it's shifting away from tools to more complete air compressors, so we have a little bit of a negative mix there offsetting some positive developments in some of the other sectors.

Andrew Casey, Wells Fargo Securities.

First, on the EU commercial HVAC order commentary, that's consistent with what some other companies have said recently, but it's still kind of surprising what's going -- that order commentary against what seems to be going on over there. What do you think is driving that and is there any regional concentration that you're seeing?

We play across the entire region, including the Middle East as well, so I think we have low expeditions for Western Europe and they're better than what we had thought. We're continuing to see good growth and solid bookings coming out of Middle East as well, which is in those numbers. Our Unitary business in EMEA is really up nicely and that has to do, in some regards, with the new product and plant now producing those products for us in Eastern Europe, as well. and I think we're more competitive on that product. But, yes, Andy, so Western Europe is it a bit better than we would have thought coming off a real low. The Middle East is pretty strong in India, which is in that number as well, is about what we expected.

Thanks, Mike. And then on the Climate Solutions in general, the segment margin performance, specifically the strong 36% incremental contribution surprised me and it is very positive. Is that what we should expect from this segment with top-line benefit or was there some something special going on this quarter?

Well, I'll tell you, what's special for the last three or four years is Trane Commercial has made new and new leverage highs. In fact, if you go all the way back through the history of American Standard and Trane, back as far as we can really look back, we've probably added 10 to 12 points of the average operating leverage in that business. And I think that's got to do with a lot of hard work around plant consolidations, the co-location of some manufacturing with our industrial business, a lot of new product development, product at higher margins coming out of the business, focus on the service business and what we have been able to do there.

Interestingly, when you look at the operating leverage between Trane and TK in the quarter, both businesses were over 30%. So, I would actually expect Trane to continue a good run. I think that we're wanting obviously that to be the new normal at Trane and in three years they've proven they can do that. And then we would expect a little bit better operating leverage actually coming out of TK in the back half of the year, again supporting more that fourth-quarter stretch that we have.

Nigel Coe, Morgan Stanley.

Wanted to dig into your Climate outlook for the full year, Mike. You gave some good current terms of expectations by Applied and Unitary, et cetera. But the 1% to 3% that's a decel from what you did in 2Q. Comps get a little bit easier, always improve sequentially. So I'm trying to understand why you wouldn't be at high end of that range or even a little bit better. Maybe just add a bit more currents into the second-half outlook versus what we saw in 2Q.

First talk about where there's strength and where we needed to see it. We were placing a bet on China and that was rewarded. Unlike the Industrial businesses where it's really more of a government policy reaction, the Commercial and businesses that we're playing in, healthcare, hotels, the nonover-capacitized industries in China. We saw the nice bookings growth there, and the nice revenue relationship there. That was good for us and we've talked about Europe and we've seen strength there.

Really it's all about the Applied market now in North America taking another notch down, and a lot of the readings that we are getting. Although we're seeing great performance coming out of the Unitary business and bookings and growth in share, it's just not enough, the mix, to overcome that institutional base.

So Nigel, it only really drops a little bit. When we think about the $100 million drop from the midpoint to the midpoint, revenue guidance, the bulk of that comes out of the Industrial business. A small piece comes out of Trane, largely the Applied business in North America. And a small piece comes out of our Security business, largely in Europe. But for Climate Solutions, we need to have second-half growth 3% versus first-half growth of 1.2%. So it really is an acceleration, back half to first half.

Okay. That's helpful. And then the sentence you just referenced in China and Asia HVAC stands in contrast to what we saw in Security. I'm just wondering, do you view the bulk strength in HVAC in Asia as a good lead for Security or are there different mixes that we should take into consideration there?

The biggest businesses that we have in China are very infrastructure-related. They're going to be airports, rail stations and so forth. The fastest-growing business that we have is the hardware and more traditional mechanical and electronic security business. When we talk about order growth in China, and that being lumpy, it's always associated with the timing of large infrastructure projects.

But we're happy with the progression of growth in, I would say, our Core Mechanical, Electronic Security Hardware business there. That's grown nicely and we're still relatively optimistic around the book of business yet to close for the balance of the year that would support our larger Integration business there.

Steve Tusa, JPMorgan.

Can you talk about the absolute price that you got and then price cost by the segments?

Yes. So price was just about a point for the Company, 90 basis points. From there we would have lost, say, 20 basis points to inflation so that was the net 70 there.

It was across the board. We actually have a positive relationship across the board in each of the businesses. Steve, probably, let's start with Residential, typically that's -- I know you're very focused on that. We would have seen price there in the 1.5-point range. Material inflation there, that actually would have been very sedate, so we got good pricing happening in Residential.

Security probably lowest price increase, we still have a margin impact of 30 basis points and a slightly positive spread there in material inflation. Climate was right on the average, about 1 point with 20 points negative material inflation. That leaves Industrial, in Industrial we had about 70 points of price, a little more inflation there, 50, 60 basis points there. So all businesses were positive across the board.

Thanks.

Andrew Obin, Bank of America Merrill Lynch.

Yes, just a question on Climate Solutions margin outlook. A little bit more color, given how strong TK orders are and that's very good for the mix. I'm just wondering, are you being overly conservative here? Or how conservative are you being for the second half?

A comment about TK first, Andy, the first half is really being influenced by this Tier IV engine conversion. So if you look at the ACT trailer market forecast for North America for the year, ACT is saying that the market's going to be up about 8%, if I remember correctly. So the market would suggest that the trailer activity is going to slow down in the second half, and that's what we've got reflected in our forecast, our North American trailer forecast is that we would maintain historical market shares and we would see upper single-digit type growth there for the year. So it's definitely skewed forward because of the Tier IV engine conversion.

I think if you look at TK outside of North America, we were surprisingly strong in the Trailer, Truck Trailer in Europe in the quarter. We're expecting that to moderate a bit in the second half. And everything else, Bus and Container for Q2 was fairly flat, if you look at the second half. Based on everything that's going on with worldwide shipping, Container for sure is expected to be actually negative comps in the second half. So there's a moderation of the TK revenue growth in the second half built into our forecast.

Yes. If you look at it color-wise, you look at what we got left to do for the back half of the year, clearly industrial here, we are looking see what's going to happen bookings here in the next couple of quarters, particularly the Book and Turn business. So it's a place where we would assign more risk to that, the Industrial, and if you look at a place you'd see that we assigned perhaps more net opportunity it would be Residential, maybe climate just because they are executing so well. Security should come in right about on the numbers. I don't see much risk in what we're reporting there. I think in aggregate, it nets out to the forecast we've got with probably a bit more concern around Industrial, momentum and a bit more optimism around Res and Climate.

I got you. I understand you're highlighted that operational feat in the quarter and congratulations on that. But can you put it into buckets for us, was it better than expected pricing versus productivity versus you guys controlling investment? What went well in the quarter relative to your expectations?

Well, we had more volume than we expected and we converted on it. So nothing that would drive you the more crazy than actually seeing volume and not getting leverage on the volume because you weren't prepared to execute against that. If you look at the incremental leverage on the positive gap between actual and the midpoint of guidance, we had very nice operating leverage on the incremental.

That, really to me, is encouraging about our ability to deal with the additional volume should it present itself here by the end of the year. I would tell you, look, really nice job around price, real nice job around productivity, investments are launching, generally we're getting all we wanted out of that in terms of on-time and impact to the marketplace. More to come, Q3, Q4, there's been no curtailment of investments. In fact, Climate continues year over year to be a net investor, incremental investor year over year, also do all the businesses, but Climate in particular. They are really firing on all cylinders here.

Yes, and I just want to reiterate investment side. If you look at the corporate spend, it was up in the quarter versus prior year. Primarily due to the fact of investments going on with the IT technology transformation we're going through, so we did not skimp on investments in the quarter. I'll just add to Mike's commentary, the thing that's probably going a little better than we expected, and it's very pleasant to have it going this way, would be the leverage we're seeing on the Trane Commercial business. That, I think is a truly remarkable achievement that we've seen now, starting late last year and, really showing up here in Q2. With any kind of volume we would expect to see that type of leverage to continue.

Stephen Volkmann, Jefferies.

I think most of the core questions have probably been answered. I'm curious, I guess, as you look out post the spin, you've had a chance to get a lot of that together now. Have you changed or evolved your expectations for the segment margins for the remaining Companies in the two- to three-year time frame, assuming we have some kind of reasonable recovery?

Well, certainly not for Industrial. In fact, I've commented multiple times now that I think Industrial would tell you that margin potential is greater than what we originally thought. I think they're executing well against that. With our Climate business as it's organized today, TK and Trane, no, I think we get there as well.

The issue we've had, and we're clearly addressing it, is from the Res business and we are showing great, great progress there. But we've got a long way to go to get that target. And so we're going to try to update you more on what we think the potential is based on outcome ranges for growth when we're together late this fall. And perhaps be more specific about where we see it. But certainly not on Climate, not on Industrial, in fact it's up. Res, we're working on and great, great progress there. We'll see that continue.

Okay, great. That's helpful. And then can you remind me of the elevated investment spending IT et cetera, what's the timeframe on that? When does that normalize again or does it?

It's got a bit of a pattern throughout the year. If you look at what happened this quarter, in April we went live with the first phase of the transformation to the common systems across the Company. So the whole team, the whole cost structure we have employed to make this transformation work, really fell into an expense category because they were in an implementation mode in Q2.

What goes on because of the accounting rules, we have to expense all that money when they're in an implementation mode. As we move into the third quarter, we shift back into design phase for the Phase II. So some of the expense in Q3 will be capitalized and then amortized later once the systems come up and running. So you're going to see this spiking throughout the year depending on when we go live in the various phases. I would say that if you look at 2014, we expect the spend to peak out in '15, some slight incremental increases in '14 and '15 from this point, but certainly start to abate in 2016.

And you've got depreciation from the first systems going live in 2013, all the way through the last systems going live in 2016. So then we're going to be looking at some higher depreciation and amortization. But not by the time you get past 2016 and into '17 and '18, we ought to see a pretty remarkable decline in what we are spending in IT. But more importantly, as it relates to the G&A across the Company and the value of information that we're putting across the Company, the speed by which we're acting on it, I think would be remarkably different.

Josh Pokrzywinski, MKM partners.

Wanted to dig in a little bit on the Residential business. Clearly some great operating leverage there and Steve, I think you talked a little bit about mix in your prepared results. And then Mike, I think you followed on with the price cost commentary. I want to understand more. How much of this is mix? And then how should we think about the margins potential in that business as we shift more towards those higher SEER units? I think both yourselves and some of the other guys in the business out there have been talking about some of this mean reversion away from '13 SEER, away from R-22 into some of that more premium product, which obviously is more of your wheelhouse.

Yes. Josh, I think this is why this is a good business going forward. Everything from the basics of pent-up demand at some point in time, working its way over multiple years through the system, through to regulations and regulatory requirements around efficiency and the fact that we sell more expensive systems moving into the market, all very positive competitively for us broadening the product range and really working on the consumer and the dealer experience, everything from the improvement we've had in our ability to order and ship and fulfill. I think these are really getting to be industry best in class at that level showing up across the board.

I think that when you think about the structural parts of the business, coupled with the improvement opportunity that we have playing across the full range of the product, new product development, and really taking the whole value stream to the dealer and eventually the consumer, is a lot of opportunity. So again, I think for us, getting to a double-digit op margin, getting to a 15% EBITDA margin, are in the cards for us in the next couple of years. From there we'll figure out where it goes. Look, we like this business structurally going forward in this part of the cycle.

I assume you mean that double-digit op margin ex-Resi Security?

Yes, absolutely. And what we also do, and this is a little bit of an important detail, but we penalized that residential HVAC, but it's a little bit. Because all our light units there, if you think about it, really is looking up through, the majority of that, through our Commercial HVAC business. Really nice margins on that. And all of our parts business fundamentally is booked out through the Climate business.

So what you're looking at really is the provision of residential HVAC without light commercial and without parts coming into that. So if you really start to do a benchmark and apples to apples against res competitors, these op margins are pretty much in line, and should get a lot better.

That's helpful. Actually, and one follow-up there, how much of your business is '13 SEER today?

Let me see if I can try to get that for you, Josh. If I have to come back, I will do that maybe in answer to another question, okay? So let me think about that and come back.

Jeff Sprague, Vertical Research.

Just a couple things, a lot of ground's been covered. I wonder if you could, on the HVAC Climate side, Commercial specifically, address a little more what's going on in parts and service? You talked about the comps, but how does energy retrofit and upgrade look into the back half? Do you have any visibility on that and any geographic color around that?

Really it's a great question, Jeff, because when we talk about the Service and Parts business, the Service business has lots of tentacles to it. If you think about service as being scheduled and unscheduled service and parts, that business is growing nicely.

If you think about the part of this which is lower, it's actually the performance contracting and the turnkey contracting business, which makes sense at a macro level. Because what you're finding is a lot more customers opting for more traditional approaches to procuring equipment, which we're seeing in the Unitary results for sure, as opposed to using financing or guarantees to purchase the equipment. And the performance contracting, and to some extent the Turnkey Contracting business, often runs inverse to sentiment. People get more negative around their ability to finance and need to do capital improvement, performance contracting goes up. People feel a bit better about it, you see it shift more toward traditional avenues to fulfill it.

Interesting. And on Industrial margins, Mike, you expressed confidence on the outlook, near-term obviously you've got some pressure. Can you give us a view on how Industrial margins actually play over the balance of the year? And do you have any restructuring or other actions aimed at addressing that?

We are actually bullish on what's going to happen here year over year. If you look at a full-year of Industrial compared to 2012, I would still be looking for margin improvement. Some 50 basis points would be, I think, really doable. In light of and including all the discussion we've had around slowing market, so we will get a great leverage. Your question about restructuring and so on and so forth, that is so much a part of what's going on here.

Just day-to-day lean productivity, constantly thinking about the cost structure of the business, thinking about pricing, new product development. So they're looking within the industrial business for ways to protect that 50 basis point margin expansion. We've evaluated those plans and we think it's a good plan. And think that as you look at protecting the Company in terms of BPS plan, we clearly have opportunity in Climate and Res to fulfill that risk potential.

Jamie Sullivan, RBC Capital Markets.

Just a quick follow-on on the performance contracting, is that still around one-third of the service business? I was curious how big that business is.

Probably have to come back and answer that one as well. But I can tell you, Josh, your question about '13 SEER, it's about 60% of our mix today. And if you put '13, '14 SEER in there, it's about 75% of our mix. If you think about the evolution of what we've been able to do and to be competitive at that low end where it's now 75% of our business, we are pleased with the team's opportunity to navigate that. Coming back to your Performance Contracting business, it would be down year over year as a mix percentage. We'll try to get you a number here.

Okay.

Janet just said one-third is about as good an estimate as we've got.

Sure. And then I think on Thermo King you mentioned margin expansion in the back half of the year, I think, but growth also slowing due to a number of factors there. Just wonder if you could speak to that dynamic a little bit, whether there's some mix benefit or how we should think about it.

We got great bookings coming through production here. So in terms of the basics of factory absorption and the fact that we'll continue to tune the line for the new product line, we're optimistic that the best leverage days are ahead in 2013 and that business versus the first six months, which haven't which haven't been bad at all. In fact TK's overall op margins are going to be up year over year no matter what.

Great. Thank you.

Deane Dray, Citi Research.

Had some cleanup questions on the Residential HVAC business. And I know you guys have been praying for hot weather, but you just ought to be careful on what you wish for here. And on this topic, if you have any color on the sensitivity the business has to degree cooling days, because we've obviously had a huge spike there. And maybe some comments on inventory in the channel?

I'm the one that's looked back 25, 30 years on this and can tell you that it normalizes over a relatively short period of time quarter to quarter. I guess you can certainly see a spike at the end of a quarter, but pretty tough to recommend or trade stock on that. I'm sure some people pay attention to that, but in our business it's not going to move the needle all that much around really hot weather at a particular point in time. So I'm not the right guy to get on the track of telling you that this hot weather is going to create some huge upside to the Company in Quarter Three.

Inventory in the channel?

This is a good story. Inventory is down by design. We are surveying our dealers from order to seat 33% faster than we were last time of this year, at this time last year. That's by design. So the strategy has been, have our dealers need to inventory less. That's down. We think it makes it more competitive for our dealers, more competitive for us. We're purposely working that down and working on speed and fulfillment. I think all the good things lead to higher profitability and share when cycle times and fill rates are higher. And we're really doing a great job on both of those.

Chris Belfiore, Nomura Securities.

It's Shannon O'Callaghan, sorry. Guess I answered it wrong. How are you doing, guys? In terms of this restructuring and spin costs, what's the split between the spin costs and restructuring? I don't know if you can separate that, but I'm trying to get a sense of how much of that is restructuring that you feel like you're going to have to continue to do post spin?

Yes. Placeholder maybe $50 million would be the restructuring that we would need to do that would not be related to all the other fees involved and costs, breakage costs, to do this. And we're going to adjust that as we need to. We're really committed to getting go-forward cost structures right, and a placeholder now of $50 million seems like a decent placeholder to put out there.

Across the two entities essentially, right? Combined?

Well, no. This would be what we think we need to do from and IR go-forward basis.

For the remainco, okay. And how about Security, or would you speak to that or no?

What they're doing is you're designing something ultimately from scratch, right? You're designing a stand-up company, so you're creating an organizational model there that you think would work going forward. And when you think about a standalone company being set up, it's an incremental add to the structure and headcount there. So they're looking about how to do that in a lean way, but they're going to be adding people and necessary functional capabilities to run a standalone company. But, I don't think that's any more than the costs that are being allocated from the Company to them. We've managed to work that down now so that I think that will be fairly neutral, allocated costs to stand up costs.

Eli Lustgarten, Longbow Securities.

Just a couple of clarifications. One, with the refinancing of the debt you said it is a $30 million interest savings. When will we begin to start seeing that flow through the income statement? And two, you've updated little bit on margins for the year. You said you still expect 50-basis-point improvement in Industrial. Can you give us some guidance about the rest of the group? Are there any changes in what you're thinking?

Let me take the first part of the question. We actually paid off the 2013 and '14 securities this past week. So, we'll start to see the improvement in the interest expense through the second half here. Starting in late July through the end of the year. So, it will be a small impact in 2013.

Okay. And as far as operating profitability, I think you still indicated 50 basis points attractive improvement is still expected in Industrial, despite the volume change. Have you had any changes in the outlook for any of the three groups or you want to update us on what you're thinking at this point?

So we talked about 50 BPS. Security, I think the goal there is to grow the business and remain relatively flat, after we couldn't improve margins but that's not so much issue there as it is around growth. So look for flat margins there and investment around growth. I look at the Res business and see that they're on track and are expected to get two full points. I think we'll do that.

In Climate, no reason even with modifications we've made, with some of the mix between Industrial and Commercial, that we wouldn't see 50 basis points improvement there again. I think a steady improvement, sustainable improvement, I think done the right way with the right investments, and I feel good about 50 basis points there.

The 50 basis points, you're talking about Residential?

No, Climate and Industrial, 50. Residential, two. Security, flat.

Okay. Thank you very much.

I'm not showing any other questions at this time. I'd like to turn it back over for closing comments.

Thank you, Sean, and thank you, everyone. Joe and I will be available for follow-up later today. Have a nice day.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.