特靈科技 (TT) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Ingersoll-Rand second quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode.

(Operator Instructions)

Please note today's conference is being recorded. I would now like to hand the conference over to Janet Pfeffer, Vice President Investor Relations and Treasury. Please go ahead.

Thank you, Karen. Good morning, everyone. Welcome to the call. We released earnings this mornings at 7:00 a.m. and the release is posted on our website. We'll be broadcasting, in addition to this phone call, through our website at www.ingersollrand.com where you will find the slide presentation that we'll be using 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 statements are made pursuant to the Safe Harbor provisions of federal securities law. Please see our SEC filings for a description of some of the factors that may cause actual results to vary from anticipated. This release also includes non-GAAP measures, which are explained in the financial tables to our news release.

Now let me introduce the participants in this morning's call. Mike Lamach, Chairman and CEO; Sue Carter, 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.

Great. Thanks, Janet, and good morning and thank you for joining us on today's call. In the second quarter we delivered earnings per share of $1.13. There was a small amount of restructuring in the quarter, less than $0.01. This quarter's reported and adjusted EPS are identical. That's at the top end of our adjusted earnings guidance range and a 22% increase versus the second quarter of 2013. Revenues were $3.5 billion, up 4.3% versus last year. Revenues were consistent with our guided revenue range of up 4% to 5% for the quarter. [Orders] were up 5% in the second quarter, the climate up 6% and industrial up 2%.

Adjusted operating margin, which excludes restructuring from the prior year, was up 150 basis points. Climate margins increased 150 basis points and industrial margins were up 30 basis points. Pricing exceeded direct material inflation as it has each quarter for more than three years. Operating leverage was about 50% with 43% leverage at the segment. We repurchased 4 million shares in the second quarter. Overall, a very good quarter with revenues about where we thought they would be and excellent operating leverage on the revenue growth, particularly in the HVAC businesses, both residential and commercial.

Now Sue will walk you through more details in the second quarter. I'll then take you through a third quarter and 2014 outlook.

Thanks, Mike. Starting at a high level, our bookings for the quarter were up 5%. Revenues were up 4% and our operating margins without restructuring were up 150 basis points year-over-year. Reported earnings per share were $1.13 versus midpoint guidance of $1.10. We were a little better on price and mix and $0.01 lower in restructuring.

Let's move to slide 4. Orders for the second quarter of 2014 were up 5% on a reported basis and, excluding currency, climate orders were up 6%. Global commercial HVAC bookings were up low single digits. Transport orders were up midteens. Orders in the industrial segment were up 2% on both a reported basis and excluding currency.

Let's go to slide 5. Here's a look at the revenue trends by segment and by region. The top half of the chart shows revenue change for each segment. For the total Company, second quarter revenues were up 4% versus last year on a reported basis and excluding currency. Climate revenues increased 4% with commercial HVAC revenues up low single digits and transport revenues up high single digits. Residential HVAC revenues were up high single digits. Industrial revenues were up 4% on a reported basis and excluding currency. I'll give more color on each segment in the next few slides.

On the bottom of the chart, which shows revenue change on a geographic basis, revenues were up 3% in the Americas, 16% in EMEA, and Asia was down 2% while excluding foreign exchange. The lower revenue in Asia was mainly driven by geographies outside of China. China was about flat excluding currency.

Now let's go to slide 6. This chart walks through the change in operating margin from second quarter 2013 of 11.4% to second quarter of 2014, which was 13.1%, an increase of 170 basis points. This chart is on a reported basis. We've clearly [striked] out the impact of restructuring costs for you, which was 20 basis points of tailwind year-over-year. Volume mix and foreign exchange collectively were 60 basis points positive versus prior year. Our pricing programs continued to outpace material inflation, adding 50 basis points to margins. As Mike said, we've been consistently positive on this measure for more than three years.

Productivity versus other inflation was a full margin point positive impact in the quarter. Productivity ramped up in the quarter as we got past all the weather-related impacts of the first quarter and saw benefit from the restructuring done in late 2013 and earlier this year. Year-over-year investments in restructuring were higher by 40 basis points in total. In the box you can see that that was comprised of 60 basis points of headwind from investments, mainly in IT, channel expansion and new product investments, and there was a 20 basis point benefit from lower restructuring costs. So if you prefer to look at this on an adjusted basis, adjusted margins increased a net of 150 basis points versus the 170 basis points on a reported basis. Leverage in the quarter was excellent at almost 50%, excluding restructuring from last year, and 43% in the segment. Climate leverage at 48% was led by the HVAC businesses, particularly in North America.

Go to slide 7. The climate segment includes Trane commercial and residential HVAC and Thermo King transport refrigeration. Total revenues for the second quarter were $2.7 billion. That is up 4% versus last year on a reported basis and excluding currency. Global commercial HVAC orders were up low single digits. Orders were up in the Americas, Europe and Asia. Commercial HVAC revenues were up low single digits. Revenues were up high single digits in Europe, up low single digits in the Americas, and down in Asia. Commercial HVAC new equipment revenues were down slightly while HVAC parts, services and solutions revenue were up mid single digits versus prior year. Growth in worldwide unitary equipment revenues was more than offset by lower applied revenues.

Thermo King orders were up midteens versus 2014 second quarter led by increases in truck trailer and bus. Container orders were slightly lower in the quarter. Thermo King revenues were up high single digits with truck trailer revenue up low single digits and marine container revenues up significantly. Residential HVAC revenues were up high single digits versus last year. Unit volumes were also up high single digits and mix was positive in the quarter. The adjusted operating margin for climate was 14.2% in the quarter, 150 basis points higher than the second quarter of 2013 due to volume and productivity partially offset by inflation.

Now let's go to slide 8. Second quarter revenues for the industrial segment were $794 million, up 4% from last year's second quarter. For the industrial segment excluding Club Car, revenues were up mid-single digits and orders were also up mid-single digits versus last year. Excluding Club Car, revenues in the Americas and Asia-Pacific were up while revenues in Europe, Middle East and Africa were up over 20%, part of which was positive currency impact. Revenues in the air compressor business were up mid-single digits with strong gains in oil free products and parts and services. Club Car revenues in the quarter were down low single digits while orders were down mid-single digits versus prior year as both markets were down in the quarter. Industrial's operating margin of 16.4% was up 30 basis points on higher volume, productivity and pricing, partially offset by inflation and investment spending.

Go to slide 9. Working capital as a percentage of revenue was 4% of revenue in the quarter. The increase versus prior year is from higher receivables and inventory, partially offset by higher payables balances. Days sales outstanding is up mainly due to mix of business, delinquency is unchanged from prior year. On inventory we have been intentionally increasing stock inventory levels of key assemblies in order to ensure supply, particularly in the higher selling season. [Year-to-date], June free cash flow was $98 million. Working capital will come down in the second half to a level closer to 3% of revenues based mainly on timing of revenues. May and June are our highest two months sales volume and, given our DSO, is about 60 days. That drove higher working capital balance at the end of the second quarter.

Let's go to slide 10. We repurchased 4 million shares for approximately $200 million in the second quarter. Year-to-date June, we have spent $1 billion in share repurchases and repurchased about 17 million shares. Our forecast for the year remains to spend between $1.375 billion and $1.475 billion on repurchase with $400 million to $500 million of that coming from free cash flow.

And with that, I'll turn it back to Mike.

Thank you, Sue, and please go to slide 11. Before we review the forecast, I want to take a few minutes to mention some very important new products that Trane commercial interest in Europe at the end of June. This was a milestone for Trane since we're 're introducing 5 new chiller products that same time. Products included centrifugal air cooled and [screw] chiller designs and cover a broad range of sizes and market applications including education, healthcare, lodging, large commercial buildings, and process cooling Europe. All these new systems are available with advance controls and were designed for cost effectiveness and optimal energy efficiency for both full load and part load performance.

The chiller in the upper right side of the slide, the Series E CenTraVac, is truly a breakthrough technology. These products are designed for cooling large commercial buildings and are up to 10% more energy efficient than the next best chiller available in this tonnage range. The true innovation is that the E Series is the first commercialized chiller to use and ultra low global warming potential HFO refrigerant. The new refrigerant allows the E Series chillers to continue to utilize Trane's highly reliable and efficient direct rise and low-pressure designs that have made Trane chillers the global leader in centrifugal chillers. I believe we are gaining momentum and the capabilities to introduce new products by in all of our businesses this will help to improve our growth rates as we see the slow recovery of our commercial construction and [markets begin].

Now let's move to the forecast and please go to slide 12. In the aggregate, markets were about where we thought they would be -- some a little better and some a little weaker. The second quarter revenues were in line with our guidance. [Dodge] put in place forecasts for 2014, did not change much in the latest update. In total the 2014 Dodge forecast is still up about 8%. To relate this to our North American business, commercial and industrial buildings tend to use more unitary equipment while the institutional markets use more applied equipment. The commercial and industrial forecast was unchanged at up 18% versus 2013, while the institutional forecast still is forecasted to be down 1% for the year. Within commercial and industrial, the vertical with the largest growth is still warehouse at over 30%. They have little HVAC content. Key verticals for Trane, our office and bank, retail and manufacturing, which are all up but at the more modest rate. With in institutional, government is expected to be down over 20% while education and healthcare are forecasted to be slightly down in 2014. The only vertical in institutional forecasted to be up 2014 was amusement, was not the key vertical for Trane.

We expect Europe, Middle East and Africa to be up mid-single digits for the year. Asian HVAC markets are expected to be up low single digits overall with China up low to mid-single digits. The remainder of the region will be fairly flat. We've seen impact, for example, in Thailand from the political unrest there. The full-year outlook for residential HVAC markets is still for mid-to high single-digit growth in unitary volumes -- industry volumes.

Transport markets had a good start to the year, particularly in Europe and in marine. Bookings growth has been front-end loaded for both trailer and container. We expect booking rates to moderate in the second half. We expect the full-year North America trailer market to be flat to slightly up on a unit basis but up high single digits on a dollar basis due to mix of car-compliant product. Industrial markets were somewhat improved in the quarter. The latter half of the quarter showed some recovery in China.

Based on the first half results of our outlook for the second half, we are raising our full-year revenue. We see revenues up about 4% from the prior guidance of up 3% to 4%. It's really not much change in the aggregate to our climate revenue outlook. The change is in industrial where we are raising revenue expectations. Our updated forecast is for industrial to be up 2% to 3% versus the prior forecast of flat to up 2%. The increased outlook was in our core industrial businesses as [Gulf] markets are expected to be flat to down for the year.

Please go to slide 13. The third quarter guidance refer to the middle column on this chart, although we've included quarter-four on the chart, just to save you some math. Third quarter 2014 revenues are forecasted to be up approximately 4%. We expect growth to be stronger in climate than in industrial but both should be in the low to mid-single digit range. Third quarter GAAP continuing earnings-per-share are forecasted to be in the range of $1 to $1.04. Restructuring costs are expected to be about $0.01 in the quarter. So on an adjusted basis, the EPS range is $1.01 to $1.05.

The currency situation in Venezuela is evolving. We are continuing to evaluate the impact that have included about $10 million, or about $0.03 per share foreign exchange losses related to Venezuelan currency in the third quarter forecast. We are assuming an average share count of 273 million shares and a tax rate of 25%. There was EPS bridge versus last year's third quarter in the appendix for your reference.

For the full year, as I said, we see revenue growth of about 4%. We are raising our full-year 2014 earnings outlook to a range of $3.13 to $3.21 on a reported basis. Prior comparable range was $2.95 to $3.10, which included $0.10 of restructuring. For the full year, we now expect to spend about $0.05 in restructuring. So $0.05 of the change in guidance is from change in restructuring outlook. And recall a $0.03 foreign exchange that we have in for Venezuela in Q3 guidance, which flows through to the full year. The core earnings forecast is going up by about $0.13 at the midpoint. There is no change to the full-year average share count guidance of 275 million shares and the tax rate of 25%.

So in closing, we're pleased to have delivered above our earnings commitment in the second quarter with excellent performance in the segments. I continue to feel good about our positioning and our focus we had in the latter half of the year. With that, Sue and I will be happy to take your questions.

(Operator Instructions)

Julian Mitchell, Credit Suisse.

I just had a quick question on the margin guidance by segment for this year. You've obviously updated the revenue assumptions. You talked about climate before up about 40 to 80 BPS, industrial flat to up 20. How do those look now to you?

So, Julian, when we look at those, we're leaving the industrial segment at as flat to up 20 basis points. And then on climate, as you pointed out, we were at 40 to 80 basis points and it now looks like about 80 to 110 basis points. So we did take that up with the guidance increase.

Thank you. And then just within the margin bridge in aggregate, the productivity number was very good in Q2. Do you see that as kind of a good ongoing rate balance of this year and when you look out into 2015 and 2016? Just because I think you're only halfway covered on the value streams of the cost base and so on.

Julian, the thing that is important there is the pipeline that we measure. And as I said in the past, we try to keep that pipeline between 110% and 150% of what's required, understanding that there's timing issues and some things don't work that we're planned. So the health of the pipeline looks like it's still intact, both from materials perspective as well as a direct and indirect labor perspective. So I would say that we're not forecasting any real changes in productivity. However, that's always subject to the pipeline and timing of when projects actually hit.

Andrew Obin, Bank of America.

Very pleasantly surprised on industrial growth revision. Can you give us a little bit more detail as to what's really happening by region in North America and Europe?

Well the core industrial markets, which is [non-Gulf], are doing better than we anticipated. Europe clearly is better than we anticipated across the board. Sue mentioned that we're up 20% in EMEA in the quarter and the order book there looks great. North America a little bit stronger but, again, stronger parts and services as well. China, which showed a little bit more strength in latter two months of the prior quarter has a decent outlook for the balance of the year in terms of the pipeline. But there, frankly, Andrew, it's large equipment orders typically that become more of a timing issue as to whether it's fourth quarter, first quarter of next year. But all in all, we felt that the core industrial businesses deserve a little bit of a fresh look.

Just to follow-up, how sustainable is the EMEA strength? And what's driving the strength? Is it market share gain or any particular markets? Because that looked very strong.

Yes. It's actually mostly in Western Europe as well too. So it's a combination of other things, Andrew. I wouldn't just pick one. But clearly we've done well with the efforts to invest feet on the street in the region. We've got, I think, great product at a good price point in the region. I think that oil-free has been a significant gainer for us there as well and, for that matter, across the globe. So, no, I don't think that 20% growth rates are something to plan on in Europe going forward but we are pleasantly surprised to see that we had a great quarter there.

Andrew, let me just add one thing on there. For 2014, we're expecting revenues in EMEA to be mid to high single digits for the year.

Joe Ritchie, Goldman Sachs.

So good quarter. It seems like pricing clearly has been strong for quite some time but may have surprised to the upside this quarter. Europe was good but you didn't really take up your growth expectations significantly. Seems like a lot of the guidance raise is driven by the margins, particularly on the climate side. And so I guess just what gives you the confidence at this point in raising the guidance for the back half of the year?

So, Joe, as we think about the guidance and what we're seeing in the markets in our performance, we're obviously pleased with what we've seen through six months and what we've seen actually gives us some confidence for the year. As you pointed out, we're still in a low to moderate growth environment. And so as we looked at the revenue, the outlook is only a little bit higher and most of the earnings guidance is from higher operating performance. The enterprise leverage is in the mid-40s and the segments leverage is in the mid-30s for the revised guidance. And again, as we looked across at the businesses, the performance that we have, what we see on pricing versus material inflation, productivity, et cetera, we thought this was the right place to land.

Okay. That's helpful. One follow-up on the cadence for 3Q and 4Q, particularly as it relates to the incremental margins, it seems like there's a step down implied in your guidance for the incremental margins for 3Q and then a step back up in 4Q. I just want to make sure I'm thinking about that the right way. And if so, what's causing that in 3Q versus 4Q?

Well I think as you look across the quarters, I think we're still seeing in the third quarter that price is going to offset direct material inflation but at a lower rate. Also, same for the fourth quarter in terms of the overall businesses. And then one of the other things that you see in terms of that leverage is the amount of corporate expenses that are in the fourth quarter.

Corporate last year as we were really truing up half the spend, there was some stock-based comps, benefits changes that came in really in the fourth quarter higher than the normal run rate. So there's a pickup there in the fourth quarter. We also had a flood in China in our industrial businesses, which hopefully won't repeat again this year. So that would be another reason why the fourth quarter leverages looks so much higher than the normal.

Jeff Hammond, KeyBanc.

Just wanted to focus on the applied market and I think you said the Dodge data is still being pretty choppy. But I'm just wondering what you're seeing in the quoting activity. Any signs of infection or building momentum into 2015? And then within that, if you could update us on your VRF strategy, your relationship with Samsung and how you think VRF competes or doesn't compete with the chiller-based systems?

Well there's a lot there, Jeff, as always. So when you look at the applied markets in general, the market in quarter one -- this is the North American market, which is where the data is most available -- was down about 3%. Last year it was down 4% from total to market. Second quarter was down a little bit lower. The market was down 4%. But the market expectations, the third-party prognosticators here, think that it will come back to zero for the full-year, which implies a pretty sizable third and fourth quarter pick up.

Conversely on unitary, the market last year was about 5%. First quarter was strong at 7%. Second quarter was actually 5%. Again, the prognosticators would call that down to 4%. I think it's more likely that you're not going to see the -- you're going to see a ramp-up and improvement in the applied market in the back half of the year. Probably not to the extent that is being prognosticated. I think on the unitary side, those are very strong. If you even take the first two quarters for us, our bookings and unitary were up double digits for the first two quarters. And then the momentum there certainly will slow but not to the extent to bring it down to where the market is calling it. So I think that you'll see more gradual turning of unitary and applied as we go forward.

Specific to VRF, remember, our strategy is multi-fold. We produce some VRF in our own factories. We have an arrangement with Samsung as well as two other VRF manufacturers that we utilize for components. So all in, our unitary business is doing well across the world, which includes VRF. And of course our VRF growth rates are growing much faster than the industry VRF growth rates because of the fact that we're working off smaller numbers there. But just as the [ductless] growth rates are increasing, so too is the [ducted] components globally for us. So from a unitary perspective, we've had really good growth across the world in unitary through the first two quarters, both in ducted and ductless.

Great. And just -- I don't know if I missed this. Can you give us an update on what you think corporate is and maybe what the run rate is exiting 2014? And is that how to think about the go-forward run rate?

Jeff, what we've talked about for corporate spending was a range of around $200 million for the year. When we're talking about today and what we're thinking about is a range of around $200 million to $220 million, depending on how some of the things that Mike referenced earlier like the stock-based comp, the benefit plan true-ups and investment spending comes in for the year. But that gives you sort of a $50 million to $55 million quarter range for corporate expenses. But as we look at that, and I talk about $200 million to perhaps $220 million, I want to be clear that the restructuring spend and the stranded costs that were taken off from the allegiance spend were taken out in late 2013 and early 2014. If the number was above the $200 million range, it would be because we had decided to do more investments or we had items, again, in stock-based comp or in benefit plan true-up.

Steve Volkmann, Jeffries.

I'm wondering if we're getting any better visibility into the next iteration of [SEER] requirements here in the states and how that might impact your business, whether we might see some pre-buy or perhaps that's not an issue. Just any update on that?

Well I think to your point, it's probably gotten more murky as opposed to less -- more clear. The standards, really at this point in time, as you probably are aware, are a bit up in the air again. We've got activity happening in the next couple of quarters where DOE will lead some panels to go through the enforcement changes to SEER standards in 2015. But those really won't become rules for sometime in 2015 so it's very difficult to tell the impact would be. I would say probably what you won't see is a quarter or two ago, the thought was that those rules would be in place. We might see some last-minute manufacturing of 2013 SEER systems. And I think that that probably will not be the case but we believe that you'll probably see 2013 SEER systems manufactured and sold throughout the country sometime into and through 2015. That's a bit more speculation on my part.

Great. Thanks. And then can you comment on where you think inventory channel -- channel inventory is and whether it might need to be adjusted moving forward?

Are you talking about residential HVAC or what part of the business?

I'm assuming you're on mute at this point. I apologize. I'm going to assume that's residential HVAC. And they're at about normal levels at this point in time. We are running higher bookings in the first quarter, shift a lot of those bookings to the second quarter towards fairly low at the beginning of the second quarter. So fairly normalized levels for us, which tend to be a little bit lower than some of what our industry competitors pull. And if you go back over a long period of time, largely we've been trying to do a better job on cycle times from the factory to the dealer to allow distribution to actually hold less inventory at different times during the year. So to answer your question, in short form, fairly normalized.

Andy Casey, Wells Fargo Securities.

Just a couple follow-ups. A lot's been asked. Within the industrial order improvement asking -- I think it was Andrew's question a little bit different -- are you seeing any specific pockets of strength by type of customer as opposed to region?

Well, yes. You do see some. Even in China, as you look through it, as an example you wouldn't see strength in areas like some of the heavy metals businesses in China. But you would see some in some of the verticals that we would play more into. So of course food and beverage and nuclear would be a big market right now in China where we're doing well in those markets. But staying away from a lot of the heavy industry, over capacitized places that China has outlined would be an example. In the [UA] it's a bit broader-based than that. And then from a technology perspective, it certainly -- as we said, oil-free parts and services are stronger. And frankly, the parts and services piece of that is consistent with some of the investments that were made earlier in the year around putting some additional feet on the street both in terms of selling capabilities but also in terms of technical service strength -- filling some pockets we have there.

Okay. Great. Thanks, Mike. And then returning to a prior question, again, I think last quarter you called out some improvement in the applied unit order growth within the climate orders. Did you see that continue? I know what you said about the industry forecast. But I'm just wondering within your orders, did you see that continue?

Yes. We have. And we actually have what we believe is a much more reliable proprietary view of that, which is a pipeline view, which goes all the way from an early conversation with a customer or the identification of a project all the way through to following it through a pipeline with a percentage estimate of closed and so on and so forth. And so you do see a larger pipeline going through, but again, I don't see that there's an immediate inflection point in applied that some of the third-party market data points would suggest. I think it's a more gradual improvement through 2015 with a more gradual moderating in the unitary business in 2015 as well. But, yes, we're seeing that as well.

Jeff Sprague, Vertical Research.

Can we just get a little bit more granular first on the price side, Mike? Is there any real distinction where you're seeing it? I would guess resi versus unitary and applied? Can you just put some perspective around what's going on in pricing in general?

Jeff, let me give a broad overview on pricing and what we're seeing. So from the perspective of being overall, we still expect the pricing environment to be fairly modest in 2014. So about 50 basis points in price. We still expect to be able to more than offset material inflation. But we think towards the back half of the year, as I said earlier, that the positive gap will look more like what we saw at the end of 2013, which is more in the 20 to 30 basis points ranges as opposed to the 50 basis point range that we're seeing. And I think that across the segments, we are seeing favorability and -- but to your point, resi was a little bit -- was part of the stronger piece of the price.

Jeff, actually we had across the board. So if you look at climate both of resi and commercial and split up commercial by region of our products, we actually had positive price in all areas of that as we did in industrial as well. So there weren't any big gaps. And as Sue just alluded to, maybe one of the biggest surprises was that residential was actually a price leader for us in the quarter.

Right. And then Mike, could you address the comment -- or perhaps, Sue, on inventory running higher to meet demand? It sounds a little counter to what we've been hearing on better flow through the factory and better reaction times and the like. Are you hitting some diminishing returns there? Or is there something in particular in the outlook that you're trying to prepare for?

It's a very inexpensive insurance policy right now with working capital rates where they are in the Company. And in areas where we've got a long lead items, great example might be a diesel engines for [TK] would be a perfect example of that with a really strong bookings backlog. And although we expect it to moderate, we certainly don't want to run out of engines, which can take 12 weeks to come across the water to get here. That would be an example of that and then selective throughout the business.

If you can go to our tools business, there's 25 tools that we just absolutely will not stock out of. And there's been great activity in that business, particularly around some of the product launches with our electronic -- electric power tools that actually have interfaces -- electronic interfaces into customer production systems. That's been a big winner for us. That's not something we're going to back out of. So again, it's really building in advance.

Also campaigns that we're running and certain areas of product growth teams are spearheading. So we talked about the six product growth teams and in areas where they've got a deliberate plan to spearhead something into a particular vertical market or a particular region, we're making sure that the [SIOP] order plans is consistent with what they're trying to do. In other words we're trusting that those product growth teams are going to be able to action out what it is trying to do. Worst thing we want to do is have them do that and not be able to support with product. So it's selective. Product across the board has got nothing to do with the value stream. It's got to do with where there are pockets of growth and where the unique opportunity is being able to take advantage of that. And certainly on really long leads, 12 to 16 week items that come in from suppliers, we want to make sure that we're not running out of those.

David Raso, ISI Group.

The corporate expense year-over-year, the incremental margins this year -- you're targeting around 30%, 31%. Can you give us some puts and takes about how to think about the incremental margin moving looking forward? Just trying to look out to 2015. Just thinking about further productivity improvements. I was happy to see the compressor business, which is usually better incrementals, starting to show some life. Then also maybe Thermo King in North America starting to run up against some tough comp. So I just -- maybe just big picture get your thoughts on how we should think about the segment incremental margins moving forward.

David, for five years we've been running somewhere in the 40% to 50% incremental margin range. I haven't calculated lately but I don't think we wrote it as much in the last year or so. And at some point in time, logic prevails that you're going to be normalizing back towards something that looks like gross margins for the Company. Of course we're trying to drive gross margins of the Company up and of course that have higher incrementals. But anytime we do above 30%, we are truly digging in beyond variable cost. We're digging into the fixed cost base of the Company. So we guided initially to 25%, allowing for some breakage in the business and pipelines that may not materialize. The first two quarters the pipelines did materialize and we were able to take advantage of the opportunities to manage away the risks. But that's not always the case and that's why I caution you and listeners on the call that a good number tends to be the gross margin of the Company. And really a safer number as the gross margin of the Company less the breakage that normally is involved in these sorts of things.

Just trying to think a little bit -- you have the lower share count exiting the year than your average share count. When it comes to things like the tax rate for next year, still think of it as 25 is a good base case?

Actually, I'll pass to Sue because I was talking specifically about segment operating leverage.

Sure. Absolutely. I was as well. I was trying to think of the other puts and takes.

Okay.

Right. So, David, as I think about share count and I think about tax rates, as we are looking at the -- I'll give you an example, for the second quarter, we got about a $0.10 benefit coming out of the share count and a headwind out of the tax rate of about $0.15. And for the full year, you're going to have the same story. You're going to have more of a headwind coming off of tax than the benefit from shares. So as I look to what happens next, obviously we need to go through and do our operating plan. We need to look at the areas where our income is going to come from in 2015 and beyond. But I think from an overall basis, there isn't a reason to think that it would be a lot different than sort of the mid-20s type of range, which is where we've been at for a while. So again, in 2014 you're going to have less benefit from shares than the headwind on taxes and around 25% for the year.

And in that same spirit, thinking about the repo for next year, just, again, I know it's only July but framework -- this year roughly $1.4 billion -- just trying to think of a normal framework for 2015 just given your cash flow and balance sheet. Is $800 million, $900 million number the right way to think about it? Just framework for continuing repo going forward?

I think as we think about it, I would say let's hold onto thoughts about 2015 until we've got later in the year, see more of the activity and continue to evaluate where we are.

Stephen Winoker, Sanford Bernstein.

Mike, nice quarter. Good morning. Could you comment on M&A, Mike, and consolidation? We've talked about it a lot in the past. What's your current thinking on that and where we are at this point in time?

We always have the mirror we hold up, which is share buyback. And you can do something that's more accretive on EPS margin or ROIC, we probably do it if it fit right into our core business. Meaning that it's new technology in a related business that we can use our existing distribution to do or vice versa, we might have a gap in distribution and any distribution actually be more of what we can do today. So frankly, if we found those things, we would do them, Steve. And I think that the key there is being selective as we have been and not being paying ahead of your synergies.

Okay. And then just to follow up your answer to the other question on incrementals and fixed cost reduction. It looks like restructuring opportunity ebbs and flows here, but given how much of the cost base you still have to address on the lean side as well, can you describe the longer-term restructuring runway that's left inside the existing portfolio?

As it relates to factory utilization, which I think is a bit where you're going with lean, you can think about the fact that we've taken so much of the physical footprint out, which has given us the 40%, 50% operating leverage over these past five years. We feel pretty good about the factory footprint at this point in time. And although there's always a thing or two we might consider doing, it's not like we're doing any wholesale changes to that. We're very well utilized across the business. And so lean at this point in time more about making sure that as we see business pick back up, we have the capacity. We have the ability to handle more throughput through the same fixed cost base. And that, again, will help ensure that we're getting operating leverage at least equal to the gross margins of the business, which would be the plan. That's how I would think about it.

Steve Tusa, JPMorgan.

Just on HVAC first, what percentage of your sales this year are going to be 14 SEER and above? And using a rule of thumb, is 15% to 20% higher-priced 14 versus 13 SEER -- is that fair? And then just on HVAC, the commercial stuff -- you talked about the applied markets, it doesn't sound like anything in climate is going to get worse in the second half. It actually sounds like maybe things could get a little bit better but you have a consistent growth rate there. Maybe just talk about that dynamic as well.

Steve, the first part of your question, 14 versus 13 SEER, the industry price is somewhere between 19% and 21% difference between 14 and 13 with the expectation, I think, that when 13 is gone you'd find probably more cost reduction on 14. And therefore probably a lower differential from what was 13 to what would then be 14. I don't have a breakdown in front of me, Steve, on 14 through. We've had nice share gain there so it plays to our strong suit because we are seeing mix up, particularly as are looking at 16 and above being nice action there for us. And then to your point, we're mildly optimistic. Our forecast for applied unitary or commercial HVAC, in general, would tell you that we expect a stronger back half than first half. And so it's marginally some but it's a better second half than a first half. And that's, again, going back to this point that the market prognosticators show that happening. We see that happening, albeit we think at not the very steep inflection points that are more forecast through the industry data.

And any way to quantify that pipeline comment you made whether it's bidding activity or any numbers -- high-level numbers to quantify that? And help us understand how good bit is because I think JCI made the same comments about how optimistic they were maybe carrier this morning as well in North America but it's kind of hard for us to get our hands around it. And any kind of high-level data around that pipeline?

Steve, actually interesting for us is there's two things going on. One is the pipeline improvement. But there's a second activity here that's making that a little bit difficult to give you an exact answer, which is that in most of our climate businesses, there's a market coverage initiative underway, which is looking to make sure that whether it's by ZIP code or by country or by region or places we get our hands on it, what's our coverage ratio of the market? How many projects are we finding? What's the density of our revenue per available square foot of HVAC content? And what that's doing is driving investments into these markets -- additional salespeople for market coverage. So you've got a combination of market coverage and improved pipeline giving you a larger number than I think what's actually going to be reported by some of our competitors. So I don't want to give you a wild number on that. A year from now, I think we're a bit more normalized there. That would be a number that I hope we could report to you a bit more would be a bit of a leading indicator on pipeline. But I would not be comfortable to throw out a big number at you today.

Deane Dray, Citi.

Mike, if we could stay in the residential mix topic, we did a survey earlier this quarter shows a pretty interesting demand characteristics -- clustered demand both at the very low end, the 13 SEER, but also a lot of interest at the high-end. And you just mentioned at the 16 SEER and above. So how are you positioning the portfolio today as towards that higher-end? You have all of the SEER levels represented and how do you expect that demand for both the highest and the lowest end to play out?

Deane, it's mixing up, which is good always for Trane and for American Standard. It's good for us. Our strategy's always been to make sure that we're shoring up the 13 and 14, which I see as one bucket. And then really however you play 15. But 16 and above would be the higher efficiency systems. And they've always been a strength -- continues to be a strength both in the dealer base but also in the product portfolio. So the key there is we want to continue to have that historical Trane strength, American Standard strength in higher strength systems but making a lot of progress in the 13, 14 as well. And so it's really playing both.

That's helpful. And in showing us these five new chiller products, begs the question what type of growth investment have these chillers and, just broadly in terms of new product introductions, what type of growth investment has this involved and where do you stand on your product vitality?

That set of investments there would be somewhere north of $100 million, which is what you're seeing on that page there. That's been part of what we've been talking about for four or five years. We started on that [ECTV] the project, I think, when I was still running Trane commercial in 2009. So it takes four or five years to do something like that. Now they come out much faster than that, which is a good sign, but vitality is good. The vitality for the Trane applied portfolio, we're really going to be off the charts in the next five years. It won't make any sense. It won't be meaningful. It will be almost a complete transition of the product portfolio. Unitary, we've been asked that and kind of cycling through so it's a more normalized 20% to 30% number that we see there. But applied will be 50% to 100% probably over the next, say, three to five years.

Nigel Coe, Morgan Stanley.

So just wanted to switch to acquisitions. You addressed that question a little bit earlier but obviously some time since you did an M&A deal. And the -- obviously the bias is still towards buybacks but are you actively pursuing acquisition opportunities both on opportunities at this point? And if you are, what are you seeing in terms of pricing opportunities?

Nigel, the same old broken record with me. I can tell you it's well over 100 things that we've looked at in the five years since I've been here in this job. I think it's been three years, maybe five tops that we've had a real interest in for various reasons. So it's not as if we haven't been looking and excising that muscle all the time. It's just for the longest time, certainly was not as good as the share buyback was and we've made the right decisions there. So as we look to the future, we're going to continue to hold up that mirror and understand which is more accretive and over what period of time. That's the same old answer on that one.

Okay. And then just switching back quickly to industrial, the ad business. I know we've kind of had a few questions around that already. But just approaching it from a different perspective, you're clearly outperforming at this [CopCo] and I'm wondering, you mentioned share gains in air-free and particularly in Europe but -- sorry, oil-free -- but if we look at small systems versus larger systems, do you think that this out performance was primarily in mix shift issue or do you sense you're gaining share in both smaller and larger systems?

Well it comes back to basics -- feet on the street in the right places, it's been a constant drum beat on the portfolio innovation there on change. As that continues, it's a similar story as our applied HVAC business in terms of what that road map looks like for the product portfolio going forward. And when we launch those products, we expect to launch them with features that are superior to competition at margins that are superior to what the replacement product was. So the double effect when we launch products that we should have margin expansion and growth and that's what we're seeing there. But there's not a -- there's no magic there. It's been -- that group's been hard at it for five years, like the Trane team has. They had an earlier market recovery when HVAC did and of course had much more sporty incremental margins for the first three or so years of that. And hopefully that's what we'll see in the HVAC business going forward.

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back for any closing comments.

Thank you, Karen. Thank you, everyone. Joe and I will be around for any follow-ups that anyone has. Have a good day.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone, have a good day.