Ingersoll Rand Inc. (IR) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ingersoll-Rand second quarter 2015 earnings conference call. [Operator Instructions] Now, I'd like to introduce your host for today's conference Ms. Janet Pfeffer, Vice President, Treasury and Investor Relations. You may begin, ma'am.

Thank you, Earl, and good morning, everyone. Welcome. We released earnings at 7:00 AM this morning, and the release is posted on our website. We'll be broadcasting in addition to this call through our website at ingersollrand.com, where you'll find the slide presentation that we'll be using this morning. This call will be recorded and archived on our website also. If you would, please go to Slide 2, which is our Safe Harbor statement. Statements made on today's call that are not historic facts are considered forward-looking and are made pursuant to the Safe Harbor provisions of Federal Securities laws. Please see our SEC filings for a description of some of the factors that may cause actual results to vary from anticipated. Our release also includes non-GAAP measures, which are explained in the financial tables that are attached to our news release. With me on the call this morning are Mike Lamach, Chairman and CEO; Sue Carter, Senior Vice President and CFO; and Joe Fimbianti, Director of Investor Relations. And with that, please go to Slide 3, and I'll turn it over to Mike.

Thanks, Janet. Good morning, and thanks for joining us. In the second quarter, our adjusted earnings per share were $1.20. We saw organic revenue growth of 3%, led by strength in the U.S. and European transport in commercial HVAC businesses. Industrial markets were weaker in the quarter, as distributors delayed restocking and some customers deferred purchase decisions. As a result organic revenue in industrial is down 4%. Industrial revenue trends started out weak in quarter two, but strengthened in the last few weeks of the quarter. Not enough to fully recover within the quarter, but giving us some more positive trends going into the second half. Similarly, organic order rates softened in some markets, but remained healthy overall in the second quarter at 4%. Adjusted operating margins were slightly down, but increased 50 basis points, excluding the impact of currency and the accounting impact of bringing Cameron and Frigoblock results into our financial statements for the first year. Adjusted EPS for the quarter was at our guidance midpoint, but there were some puts and takes and we did not perform to our expectations in terms of operating leverage and margin. Revenues were approximately $100 million lower than the midpoint of our guidance forecast. On a percentage basis, we are looking organic growth of 5% to 6% as compared to the actual 3% growth rate for the quarter. Climate came in right on our revenue outlook, the difference was on industrial. For industrial, organic revenues in Europe were down low-single digits, excluding currency. Asia continue to be weak. The U.S. seem to have taken a pause in April and May, and showed some signs of stabilization in June. North America was down 6% on an organic basic in industrial. The earnings impact to the lower volume was offset by corporate spend controls and lower compensation and benefits as well as favorability and other income. We'll talk more about it in the outlook. We're taking aggressive and targeted cost actions, where we see volume weakness. U.S. industrial trends improved in June and have continued thus far in July. So we are partially reflecting that stabilization in our outlook. Before I turn over to Sue to take you through the quarter, we did reach an agreement with the IRS in mid-July to resolve all disputes related to intercompany debt and similar issues for the period 2002 to 2011. The details are in the 8-K, we filed a week ago, and Sue will take you through that in more detail today. So with that, I'll turn it over to Sue. And then, I'll come back to take you through the outlook.

Thank you, Mike. Before I go into details on the quarter, I wanted to take you through the reported versus adjusted results, given a larger difference due to the impact of the tax agreement. On a reported basis, our continuing EPS was $0.31. To get to adjusted earnings per share, we're making three adjustments totaling $0.89, which we think are appropriate, given the nature of the items. First, the tax agreement resulted in a charged income tax expense equaling $0.84. Second, as we guided all year, we are adjusting the inventory step up component of acquisitions. This now includes both Cameron and Frigoblock, but the great majority is Cameron. In total, that adjustment is $0.04 this quarter. And finally, we had $0.01 of restructuring in the second quarter. So that's the breakdown of the $0.89 to get you from reported continuing of $0.31 to the adjusted earnings per share of $1.20. Now, let's go to Slide 4. Orders for the second quarter of 2015 were up 2% on a reported basis and up 6%, excluding currency. On an organic basis, which excludes both currency and acquisitions, orders were up 4%. Climate orders were up 3% and up 6%, excluding currency. Orders in the industrial segment were down 1% on a reported basis and up 5%, excluding currency. Organic orders for industrial were down 1%. We saw organic orders decrease by low-single digits in the air and industrial product and improve by high-single digit in Club Car. Let's go to Slide 5. If you look at the revenue trends by segment and region, the top-half of the chart shows revenue change for each segment. For the total company, second quarter revenues were up 2% versus last year on a reported basis and up 3% on an organic basis, which excludes both foreign exchange and acquisitions. Climate revenues increased 2% on a reported basis and 5% on an organic basis. Industrial revenues were down 1% on a reported basis and down 4% organically. I'll give more color on each segment in the next few slides. The bottom chart shows revenue change on a geographic basis as reported and organic. Organic revenues were up 4% in the Americas; up 3% in Europe, Middle East and Africa, both led by strong HVAC and transport performance; and Asia was down 4%. Let's go to Slide 6. This chart shows the change in operating margin from second quarter 2014 of 13.1% to second quarter 2015, which was 12.6% on a reported basis and 13% on an adjusted basis. Volume, mix and foreign exchange collectively were a 70 basis point headwind to operating margin versus prior year. Within that, about 40 points was from constant currency and about 30 points was from volume and mix. Price and direct material inflation contributed 20 basis points to margin, with positive price and very little direct material inflation. Productivity versus other inflation was positive 90 basis points Year-over-year investments and other items were 90 basis points. That breaks into three pieces. This is the first year in which Cameron is included in results, and as expected, impacted margins by 50 basis points due to inventory step-up and intangible amortization. In the box, you can see 30 basis points of headwind from investments and 10 basis points from higher restructuring costs. In the grey box at the top of the page, overall leverage on an adjusted basis was 10%. Backing out currency and acquisition, organic leverage was approximately 30%. Now, let's 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 $2.8 billion. That is up 2% versus last year on a reported basis and up 6%, x currency. Climate bookings were up 6%, excluding currency. Global HVAC orders, excluding currency, were up high-single digits with growth in all geographic regions, except Latin America, led by double-digit growth in North America. Thermo King orders were down slightly versus 2014 second quarter, excluding currency. Organic orders increased in North America and were down in Europe, Latin America and Asia. Second quarter organic HVAC revenues were up mid-single digits, led by a mid-teens increase in the North American applied business. Excluding currency, HVAC revenues in North America increased by mid-single digits in the quarter compared with last year, and increased by a high-single digit percentage in Europe and Middle East. The North American residential HVAC market continued an orderly transition to the new regional SEER standards. Weather impacted end-market demand in part of the quarter, but we saw positive trends in June and have been continuing in July. HVAC revenues, excluding currency, increased by a mid-single digits percentage in Latin America, as revenues in Asia were down by a low-single digit percentage in the second quarter compared with last year. Thermo king revenues were up high-single digits, x currency, with strong gain in North American truck trailer and auxiliary power units. In Europe, organic revenues were up low-single digits. The adjusted operating margin for climate was 14.4% in the quarter, 20 basis points higher than second quarter 2014 due to productivity and volume mix, partially offset by other inflation, currency and higher investment spending. Now, let's go to Slide 8. Second quarter revenues for the industrial segment were $785 million, down 1% on a reported basis and down 4% organically, which excludes the Cameron acquisition and currency. Air systems and services, power tools, fluid management and material management organic revenues were down mid-single digits versus last year. Organic revenues in both North America and overseas market were down mid-single digits. As Mike noted, order and shipment trends in the U.S. were unfavorable in the first two months of the quarter and strengthened in June, with the push outs in customer request moved some revenue out of the quarter and impacted results. For the balance of the year, based on the backlog and order trends over the past several weeks, we see some recovery, but are reducing our revenue and profit outlook for the second half in industrial to reflect the lower volume. At the consolidated level that volume is essentially offset by an improved volume outlook for climate, we are also taking appropriate actions to increase productivity in the impacted businesses to mitigate as much of the profit impact as possible. Mike will take you through the entire forecast in a few minutes. Club Car organic revenues in the quarter were down slightly. Organic orders were up high-single digits versus prior year. Industrial's adjusted operating margin of 13.3% was down compared with 16.4% last year. The Cameron acquisition, including non-purchase accounting impact and negative currency, account for 180 basis point of the decline. The remainder was due to lower volume, inflation and investment, partially offset by price and productivity. Let's go to Slide 9. We took a few minutes to walk you through the agreement with the IRS. On July 17, we signed an agreement with the IRS to resolve all disputes and litigations surrounding the treatment of intercompany debt. The agreement encompasses the years 2002 to 2011. We previously disclosed, the IRS had asserted Ingersoll-Rand out approximately $774 million in taxes plus additional amounts for penalties and interests during the 2002 to 2006 tax years. And the company expected the IRS to raise similar claims for the 2007 to 2011 period. We believe that this agreement is in the best interest of the company and our shareholders. Once, final, it will provide greater certainty around the company's tax structure, effective tax rate and financial position going forward; and avoid the risk, expense and time commitment, inherent with litigation in a complex multi-year matter. The agreement covers all aspect of the dispute before the U.S. Tax Court, the Appeals Division and the Examination Division of the IRS. Under the agreement, no penalties will apply with regard to any of the tax years 2002 to 2011. The company will pay $230 million in withholding tax, plus interest with respect to the 2002 to 2006 years. And no additional tax will be owed with respect to this intercompany debt and related matters for the years 2007 to 2011. The next step is for the agreement to be reported to the Congressional Joint Committee on taxation or the JCT for review. The agreement cannot be finalized until the IRS considers the views, if any, expressed by the JCT about the agreement. In connection with this agreement, we recognized a charge of $227 million to income tax expense in the second quarter of 2015. And expect to have a net cash outflow in the second half of 2015 of approximately $375 million, consisting of the $230 million in tax and $145 million of net interest. We will fund the payment from cash flow and commercial paper. We've gotten some questions regarding how this will impact our capital allocation for the year and in the future. First, the amount of the payment is manageable within our current leverage targets. We expect no impact to our ratings. We still plan to repurchase $250 million of shares in 2015, as we've guided all year. What has changed is that based on the pipeline we currently see, our M&A spend for the second half of 2015 will be pretty minimal. If opportunities emerge over the next few months, we'll evaluate them. But as of today, I don't see much usage of cash for M&A in the back half. You may recall that we had a $350 million placeholder for M&A. That reduction in essence funds the majority of the IRS tax payment. For the future, this does not change our balanced capital allocation strategy, which includes investing in the businesses, paying out a competitive dividend, share repurchase to at a minimum offset share creep and value accretive M&A. Now, let's go to Slide 10. For the second quarter working capital as a percentage of revenue was 5.8%. The increase versus prior year is primarily inventory. This include some incremental inventory related to the regional standards change in residential HVAC with good collections in the quarter with our days sales outstanding and our days payable outstanding, both improving over the prior year. Our balance sheet remained very strong. We have no debt maturities this year. Our cash balance is at normal level. We continue to expect adjusted free cash flow in 2015 to be in the range of $950 million to $1 billion, which excludes the IRS payment. And with that, I'll turn it back to Mike, to take you through guidance.

Great. Thank you, Sue. And please go to Slide 11. In the aggregate, our adjusted EPS forecast has not changed since last update in April, but within the guide we've made some adjustments based on market and performance trends. Let me walk you through some of the geographic regions that is probably the best way to give you some color. North American institutional markets continue their recovery in the second quarter, and we are increasing our revenue forecast here. We also continue to see growth in commercial and industrial buildings and retrofit. Based on this, we expect mid-to-high single-digit growth for 2015 in North American in commercial HVAC markets. The regional standards change in residential HVAC is going as planned. Monthly trends bounce around based on channel stocking levels and weather. At the end of June, channel inventory levels were at normal levels and distributors had begun restocking to maintain those levels. We expect motor bearing unit shipments for the year to be flat-to-up low-single digits. To round out North America, we expect North American transport markets to be up high-single to low-double digit for 2015, reflecting good trends in trailer, truck and APUs. North American industrial markets took a pause in the second quarter. Overall, we did see signs of stabilization in June, which continued so far in July in most businesses, but we did bring down the industrial markets growth outlook for the year, based on the trends. This particularly impacted some of our shorter-cycle businesses in Industrial, such as small-medium compressors, power-tools, material handling and fluid management. Gulf markets are expected to be up low-single digits. We expect Latin American, Asian, European and Middle-East HVAC equipment markets in the aggregate to be up low-to-mid single digits, and constant currency was flat-to-down after considering currency. Within those regions, Europe and Middle East have been relatively strong for us with flat-to-slightly up expectations in Asia, and a decline expected in Latin America. We expect European transport markets to be down including FX, but up at constant currency. Industrial markets in Europe, Middle East, Latin America and Asia are more challenging and we expect them to be flat-to-down for the full year. Aggregating those market backdrops, we expect our reported revenues for full year 2015 to be up 4% to 5% versus 2014. Overall, foreign exchange will be a headwind of about 3 to 4 percentage points. We expect our acquisitions to add 2 to 3 points for the year, so for organic growth, we end up back at 4% to 5% range. That's unchanged from the prior forecast at the consolidated level. However, we did update the ranges for both segments. Based primarily on a stronger outlook in North American HVAC and transport, we now expect climate revenues to be up 3% to 4% on a reported basis and 6% to 7% excluding currency, which was up 4% to 5% in our prior outlook. In the industrial segment, revenues are forecasted to be in the range of up 6% to 7% on a reported basis and organic revenues to be up 1% to 2% versus 4% to 5% in the prior forecast reflecting softness we saw in the second quarter and continued weakness in overseas markets. This forecast requires industrial to have roughly 2% to 2.5% organic growth in the second half versus about flat in the first half. We see a path of that based on the activity that we've seen over the past several weeks in our booked backlog. Also, the Cameron compressor revenue calendarization, that's heavily skewed to the second half and specifically to the fourth quarter based on customer delivery dates that are already in the backlog. The orders are in for about 60% of Cameron's -- 60% of Cameron's revenues were in the back half, and we're focused on the operational execution and coordination, and require the customers needed to deliver on that schedule for those units. For operating margins, we expect climate to be in the range of 13%, which was the midpoint of our prior guidance. We expect industrial adjusted margins to be approximately 14%. That's about 1 point lower than our prior guide, which was a range of 14.5% to 15.5%. Slower industrial markets, particularly in some of our shorter-cycle businesses in North America, Asia and Latin America, geographies and markets where we generate higher than average margin, put pressure on those margins targets, and despite aggressive cost actions and the impacted areas, we do not see a path for the prior range. This does not change our long-term view in the larger potential business, but given the demand environment, we accelerated productivity and action to help mitigate the impact from lower volume. Please go to Slide 12. Transitioning to earnings, our adjusted earnings per share guidance range is unchanged at $3.66 to $3.81, an increase of 10% to 14% versus 2014. That excludes acquisition inventory step-up, restructuring, the Venezuelan currency evaluation and the IRS agreement. Include those items the range reported EPS is $2.59 to $2.74. We are reconfirming our adjusted EPS range. The forecast for the second half reflects some pluses and minuses versus our prior outlook, which are not netted. It reflects lower material inflation. In fact, it's actually deflation for the second half versus first half. And higher levels of productivity from cost control and reduction action, as well as, prioritization of higher returned productivity projects particularly in the businesses where we have seen some weaker market trends. We plan to fully use the top end of the restructuring range at $0.05 that we had guided for the year. In parallel, we're evaluating additional actions and we'll trigger those when needed to further adjust the cost base to market conditions. To focus on the third quarter guidance, see the right hand column on the chart. Third quarter 2015 revenues are forecasted to be up 4% to 5% on a reported basis and 5% to 6% on an organic basis. That compares to on organic growth of 3% in the second quarter. The higher growth rate comes from several areas. Restocking the res HVAC business, which we are seeing that order rates thus far in July and correlates with channel inventory levels; delivery of the scheduled backlog and longer cycle businesses, such as applied HVAC and centrifugal air compressors; some recovery in certain of the shorter cycle industrial businesses such as Club Car, smaller compressors, and fluid management parts; and at this point we've seen improving order rate from low activity in April, May continuing through July. For the third quarter, earnings per share forecasted to be $1.13 to a $1.17. We expect about $0.02 of restructuring costs, and adding these back to get some adjusted basis, adjusted EPS range is $1.15 to $1.19. We've provided EPS ranges for the third quarter in the appendix to give you the walk from year-to-year. I'd conclude by reiterating that although that the midpoint of our earnings guidance from the second quarter, we didn't performed to our own expectation, potentially in terms of operating leverage and margin, we've already taken and we're going to continue to take action to generate the growth in earnings that we have been communicating to you. Our strategies for growth and operational excellence have delivered a multi-year trend of excellent operating leverage, margin and earnings improvement and there remain the right strategies for the future. So our focus is to continue to grow earnings and cash flow through further implementing these strategies. And now, Sue and I will be happy to take your questions. Joe, I'll turn it over to you.

[Operator Instructions] And our first question comes from Nigel Coe from Morgan Stanley.

Mike, you sort of answered my first question a little bit in your closing remarks. The 5% or 6% organic for 3Q just feels on face, it's a little bit aggressive, but you talked about the swing on residential, and talked about the shipments and some of the backlog businesses and commercial HVAC business. But there's still some -- obviously you've seen recovery in short-cycle. I'm just wondering, what's the great promise do you have in that 5% to 6%. And if you got to haircut that number, would you be comfortable seeing some acceleration from the 3% we saw in 2Q?

I saw your note this morning, because Q2 and Q3 are fairly flat, and there was some question about the normal seasonality of the business, but there are few things that go on here. First, third quarter North American commercial HVAC bookings, Thermo King, are going to continue at high levels and that really underpins the climate forecast there. We had excellent bookings and growth in second quarter. A lot of that in the schools market, so I'm pretty confident that we're not going to see weakness at North America with HVAC and TK in the quarter. We also have seen the restocking of the res channel take place in late June and through July and believe it should match results where we had in our direct model. So that goes well. And we had a good quarter in res for Q2 and I think that will continue in Q3. Now, China is interesting because it's a place you wouldn't expect for us to see a lot of growth, but if you go back to the fourth quarter of 2014 we had bookings of about 33% growth in the fourth quarter in China. A lot of that now ships in Q3 and those projects are being delivered into vertical markets that are growing, so we don't see any real risk in delivering those as planned. Now, the industrial segment moves from really negative revenue comparisons in the second quarter to really a low-single digit rate and that's based on a couple of things. First, Club Car had a strong June, kind of plus 18% and that's really a delay, if you will, in Club Car business from Q2 to really Q3. So I think that we'll see that pick up. We're seeing a tickup, an example, June's, our compressed air business was up by 22% in bookings, most of that being in small and midsized compressors, which we feel like we'll book in turn. Then as you look at late Q3, and I know this goes down into Q4, this is where we get into just delivering on the backlog of large machines, whether the Cameron or Ingersoll-Rand, so I think that it's a little bit maybe unusual from a seasonal pattern for us, but I think all the pieces makes sense that we should be able to deliver that. We have put in place a lot of actions by compressing the productivity schedule, looking at discretionary spend, looking at investments spend, triggering many things now, and in fact things got weaker or they mature up in the top line, we're looking between the third and forth quarter to make sure that we manage the bottomline. So that's probably more than you asked for in your question, but that's the answer.

By the way 3% is still isn't too shabby, compared to some of your peers. The follow-on be the headwind from volume mix, the 30 bps this quarter, big swing from the plus 100 last quarter. It sounds to me that that's more of a geographic mix than a product mix. Can you maybe just confirm that and maybe talk about the big swing that we're seeing in Q-over-Q and what's caused that swing?

The mix, it's a bit of a worse case mix that we saw, if you set back, as your higher margin, industrial segment that is just down everywhere averaging at the gross margin of the business. And if you unpack that, you end up with a very disproportionate growth rate and deleverage happening in the highest margin businesses, which are going to be tool, fluid management, material handling. Then if you look at it on a geographic basis, it's particularly weak in Asia and Latin America, which historically have been very good profitable markets. So when you look at that sort of mix challenge, it's squarely into the industrial segment for us, in essence, climate did well and offset mix with extra volume and so really hit expectations both for leverage and topline.

Our next question comes from Jeff Sprague from Vertical Research.

First, just a follow up on industrial, Mike, again, if you could, and then a separate question, but in industrial bookings that strength does sound quite remarkable just given kind of the general tone in industrial land, after this earnings season. Can you give a little color on kind of vertical markets where you're actually seeing that level of activity? And then as part of the industrial outlook, it does look like Cameron is actually coming down quite hard. You mentioned it's typically seasonally backend loaded, but certainly on a year-over-year basis, it looks like it was very weak here.

Jeff, actually Cameron is not as bad as you would think. If you go back to the original idea that we had, we thought that it was up $350 million to $365 million of business where based on that depending on which side of that you take, maybe $15 million to $25-ish million wider overall, it's heavily coming across the smaller businesses and smaller compressors, which go into small industrial customers across the board. So it was really sort of a pause in the industrial economy in the U.S., which was quite unexpected. Most of these things are going to be stock products, they built and didn't turn in the quarter, and so it was pretty tough for that. It's also the business that in June was up 22%, largely in small compressors. We also saw some improvements in fluid business. I mentioned, Club Car was up nearly 20% in June. Haven't seen quite the increase back yet in the tools business, and the material handling for us is really our only oil and gas exposed business and that continues to be very weak there. So the backlog, as I think about big machines, is at this point in time pretty well in the bag. The catch or the key for us here is being sure to deliver that. I mentioned that Cameron's business is 40% skewed toward the fourth quarter, and so that is actual customer request for delivery on big machines, and so it's more of an execution of the backlog question there for the full year.

Mike and Jeff, I think we might have confused you just a tad with one of the slides in terms of Cameron. So let me try to add a little bit of color to what Mike has already said. In the second quarter, there were a mix of revenues in the Cameron business, but it was perhaps nearly 10% of the industrial mix, so it wasn't a big part of that and some of that was actually revenue that shifted over to the third quarter and the back half of the year. On Slide 11 where we talked about organic reported revenues, and we said 2% to 3% for acquisitions and 3% to 4% for FX, our original guidance for the year, as you well know, was that we were going to have about 3% on acquisitions offset by 3% in FX. This a little bit of the rounding puts and takes. I do expect the acquisitions to be right about 3% and FX maybe slightly over 3%, but we won't be at the outer margins of that guidance. So I would say, let's call it back to more of the 3% on acquisitions and maybe just slightly more than that on the FX side.

And just on raw materials. Mike, you touched it a little bit as you were wrapping up your concluding comments. But can you give us a little bit more color on how that plays? Obviously, we're in a pretty severe industrial metal deflation right now. Obviously, you've got hedging and other things, but can you give us a little bit of an update on how we think this should play through? How big of an impact do you see in the back half? And do you see that really undermining anyway your attempts on the other side on the pricing environment?

So Jeff, let me give that a shot. As we look at commodities, first of all, we've said all year that the commodities would turn to a deflationary environment in the second half of the year. And so if we look at that back half, we've got about 70% of our copper bought, and about 40% of our aluminum bought, so that deflationary environment is going to flow through what we've got in the back half. So I don't see a big risk to that. And it does help us from a first half to second half comparison in terms of materials. On the pricing side, and what we talked about with pricing, we consider that we still want to have a positive spread between the direct material inflation in price of about 20 basis points to 30 basis points for the year. That's where we were in the second quarter. We were roughly about 20 basis points. And so I think the back half material deflation is going to give us a little bit wider gap or some more positives there. And we still expect to have some positive price. And the overarched on price and material inflation is that we build our pricing capabilities to get paid for delivering higher value to our customers and to anticipate and react to movements in commodities. And I think that's what we're doing.

Our next question comes from Robert Berry from Susquehanna.

A quick follow-up on the price cost. I think it was down 0.2 in 1Q and up 0.2 in 2Q, so call it neutral for the year. Does that imply that to get to the 20 to 30 for the year, it would be kind of 40 to 60 in the back half, is that kind of order of magnitude?

I think it would be in the 20 to 30 range and a little bit higher than that to get us to in a range, as we said 20 to 34 for the full year, so just slightly higher than that. But again, that's really the material coming down. As you know, we had a slight amount of material inflation in the first quarter, very minimal in the second quarter. So that turns deflationary in back half.

I mean, Robert, your rough math works. Fundamentally, as materials coming down fast, price won't come down as fast, and so you get a little bit bigger spread in the back half of the year, unless something happens with pricing and it just is driving the marketplace, I think that that would be a case. We would see that from a commercial perspective, things have been weak in Latin America and Asia for sometime. So I don't see the pricing deteriorating further there. So I don't think the risk there is great. It does support falling commodities prices sort of moving slower and the spread widening in the back half.

And then maybe just a follow-up on the productivity actions. If you kind of put aside the price cost on materials, it sounds like those are stepped up. Could you quantify how much kind of incremental productivity you now expect versus what you had been expecting? And maybe in that you can touch on, in particular, corporate, I think that was expected to be kind of 230 basis points to 235 basis points. It looked like it really stepped down in 2Q. How was that tracking?

You're right now, Robert. It's probably 30 basis points more productivity in the back half versus the front half. And then, in addition to that, we're really putting together a brief forecast for the balance of the year and reevaluating any sort of investment to the spend and timings. Even some of the CapEx just to kind of go back through that and scrub it through the back half of the year. So we're looking to not only get the 30 basis points second to the front half, but really get a bit of a natural hedge built in through some productivity actions being built in to protect the guess forecast we're giving it.

In the unallocated corporate, Robert, we're taking to sort of 220 basis points to 225 basis points for the year.

Our next question comes from Julian Mitchell from Credit Suisse.

I just wanted a bit more color on what you're seeing in Asia and China, specifically on the Trane side. I guess your margins in Q2 in climate maybe a little bit less than some people have thought. Was there a mix impact from Asia being down within that? And then maybe just give some color on the bookings you're seeing in Asia now, I think carryover is down very significantly in Q2.

Well, any sort of mix in climate maybe to start there first would be that on the res side, we're probably one of the few people that actually mix down the 13% and 14%, sort of the more we pull up the channel and the more we pull the product range. We tend to mix down just a little bit there. We also mix down a little bit when you look at European transport. And this is really weakness in Eastern Europe that it's kind of pulling down some pretty good results in Western Europe, as an example. So there are minor things happening within there. Latin America has been a really soft market for climate, very profitable market for us. There's really no recovery happening in Latin America as we speak. And so those are the mix drags you see to the climate at present. Now, China, it's not unusual. I can think about last couple of years, where we get the seesaw happening between strong bookings and weak revenue and so forth. And granted, it might be weak two quarters, strong two quarters. But as an example, the fourth quarter bookings we had last year kind of coming through into strong revenue in Q3 and good revenue in Q4. When we look at Q3 bookings in China, and this of course is based on pipeline of real deals and real projects, we also expect a strong bookings in Q3 and in Q4 for China in the HVAC business. This happens to be some of the broker markets that we're working in. We'd not be surprised when we find it to be mid-teens, and quarter three is an example in HVAC for bookings. But it's a seesaw there to a certain extent. I think that industrial in China remains weak. I know the power consumption, as an example, was down 2% in China last quarter. Now, compare that to the reported 7% growth in the quarter, and you get a difference between what's happening sort of on ground with a proxy as power consumption and what's reported in terms of GDP growth. And obviously, the more you're focused on heavy industries, sort of the worse off you're going to be, before you're focused on healthcare, data centers, food beverage, pharmaceutical, probably the better you're going to be in that mess.

And then just my follow-up would be with IRS thing potentially an out of the way, you talked about greater clarity or grater certainty in the release on the future effective tax rate. I just wondered if there could be any mechanism to think about bringing that down a little bit in the long run?

Julian, I think we keep the range sort of in our 24 to 26 range with sort of that midpoint at 25. We haven't evaluated anything that would change that from a longer term rate basis.

And our next question comes from Josh Pokrzywinski from Buckingham Research.

Just on some of this near-term improvement Mike that you've seen in the industrial business, I guess, the 22% bookings growth in short-cycle industrial. I would imagine that, given some of the push outs you saw in 2Q that there might be a little bit of hedge to the second half. Can you help us maybe outline the difference between what the backlog supports, what the orders are telling you and what you're baking in the guidance? So I guess maybe the long way around there is that, do you have more push outs baked in? Because I guess from an industrial perspective this doesn't feel like the type of environment, where people are pulling in business and it does seem like there is still a lot of reliance on those fourth quarter bigger projects shipping on time?

Yes, Josh, when you look at sort of if you stand a month in front of the next quarter and look at the visibility that we have at that business, it might be somewhere between 45% and 60%. The other 40% to 55% really comes through those short cycles, small compressors tools, fluid management, business like Club Car, material handling, and larger compressors tend to have just a bit more visibility in what we're looking at. What's a little bit unusual knowledge, as we think about how the Cameron business works, and this is really historical, if you look at the profile of Cameron, they're a big back half, big fourth quarter type of company. If you think about there are top five to 10 customers, their pattern every single year is delivery around that time of the year and so that happens. It's got the benefit of really improving visibility there, and of course we've always had good visibility on our big machine. So it's a pretty fair forecast kind of looking ahead, because we can see that big machine. We can see the Club Car business to the balance of the year. To a certain extent, you're guessing on the overall economy, as it relates to the tools business and some of the small compressor business. So if you had sort of handicapped all of this, there's probably, if you want to net it out further, maybe more upside that could happen on the HVAC businesses, maybe a little bit more weakness on the short-cycle industrials. But at the end of the day, I think we've had it really close and fairly.

And then, just a follow-up on maybe the margin into that on the industrial side. Can you dimension out maybe what was more of a surprise factor in 2Q on the margin versus what gets better by managing that in real-time? And how that relates to kind of the better backlog outlook? So how much of the problems in 2Q just go away, because you're now on top of things and more surprises versus the revenue uptick?

Let me kind of walk you from 16.4% last year to the 13.3%, just a big piece, and you can tell me, so you'll be having your impression about what it can be more top of and what it couldn't. The biggest piece of what we saw was volume and mix, which was 210 basis points of the difference. The FX piece is 110 basis points negative. And then Cameron it's 70 basis points. But that's more mathematical, Cameron adding revenue in that small OI. And now moving toward the back of the year with a really over-absorbed Q3 and they've really absorbed Q4, over-absorbed Q4, so you kind of balance that out. You also end up with investments and other, which were about 1 point, and almost actually the majority of that is just a legal accrual on an old item. So the other way back, you had productivity over other inflation of 120 basis points and price over the direct inflation, which is 60 basis points, for the good guys around productivity in place a 180 basis points. I don't think investments and others is a drag, I think Cameron turned itself around just through absorption in the factories. And then volume and mix is what we've been talking about. You got to place a bet on some of that, both on short-cycle high-margin businesses and some geographic spread on that. But all-in-all, the plans we've taken to address this really are contingencies around if things remain weak. And so I would look for productivity, so then significant would be better than other inflation. And for price, this will be better than direct inflation in this fast-reducing direct material environment that we're in, the price material that's deflating basically.

Next question comes from Joe Ritchie from Goldman Sachs.

This is actually Evelyn Chow for Joe. Maybe just returning a bit to your climate margin guide, I understand that these sales channel that impacts mix, but it seems like your second half margin guidance implies kind of a normalization of incrementals. Can you help us thinking that the puts and takes in margins, as it relates mix, investments spending and other items?

Well, I mean, leveraging climate just in the quarter, it's pretty good. So it was right around 25%. If you take Frigoblock out, it was right around 30%. Just looking at Q3 and frankly Q4, it starts looking around 30% again. So there's really not much of a difference in the leverage that we're seeing and expecting around the climate business, even with the res mix. So maybe you want to fine tune your question, you're missing a little bit, but it's fairly flat and linear there.

And then maybe just returning to your comment on China HVAC bookings, potentially being up in the mid-teens in the back half, that seems a little bit in odds from what we heard in that region from your competitors. So what's driving the strength in your business?

It's really not unusual for competitor A to have bookings in one quarter and debookings in the second quarter, just based on what they're working on, and the customer order profiles for major projects. We see it all the time. When we're up 15%, 20%, and look good compared to a competitor and you're flipping around and it may look bad. But all-in-all, one quarter, two quarter differences in the competition is really what we're talking about. There is some differences though, depending on what competitors you talk about. Clearly, we don't have much of a presence in the res business in China. And so I think we've been helped by that, somewhat insulated by that. And we tend to focus on markets, again like pharma, healthcare, electronics, the data centers, food and bev, where we've done better.

And then maybe just returning to Cam briefly, could you provide maybe a little bit more color around what you've seen in the three main businesses there this quarter?

So Evelyn, let me take a look at where we are in the market for the centrifugal compressor business. So first of all, on the processed gas side, we're really more exposed to gas than to oil and gas. So we're seeing a little bit of growth from natural gas and from LNG, and particularly in the U.S. In the Middle East, we do have some project delays that are related more to oil prices, but we see petrochemical doing okay. And we expect power generation to grow for the business. On the engineered air side, we're seeing some of the industrial gas business, particularly in Asia with air separation declining. That's really due to overcapacity in that area. Lower steel demand also has an impact on the engineered air segment. For plant air, we see a slow recovery in North America. So we've got some good markets in auto, in food and beverage, pharma, electric power. So North America stronger, Europe and Asia is slightly softer in the plant air side. And then the fourth really piece of the Cameron centrifugal compressors is the aftermarket. And the aftermarket is stable, but we still have some more opportunities in synergies, again, on the aftermarket side of that business.

Our next question comes from Steve Tusa from JPMorgan.

Sorry, I might have missed this, but what did you say about the resi, how resi kind of ended the quarter and start in July again on your independent distribution channel again. Did you give numbers around that?

Yes, so to go back to the beginning, we saw wholly-owned up double-digits. And in the quarter we had independents down roughly the same, actually down double-digits. And then if you look at that and break it apart further, April and May were incredibly slow, first couple of weeks were frankly a little bit of slow. And last couple of weeks of June were record levels, record levels of shipments, that we have seen, and we're seeing that through July. My guess is that it's going to look a little bit more like the sell-through that we had with wholly-owned. All that, Steve, gets into kind of maybe flat-to-low single-digit, motor bearing sort of markets for the year. But pretty strong last four weeks, five weeks.

So what do you think resi can do in the third quarter, assuming kind of weather is stable in your total resi revs?

Yes, great question. I mean, if that's the case, you're probably looking at double-digits, low-double digit.

And as far as the margin dynamics there, I mean are you starting see -- I know you guys redesigned your 14 SEER. What are you seeing on the margin front there? I would assume that's not fully reflected yet, because there was clearly some pretty wide dynamic in your number. So maybe just talk about how you can convert that with the new 14 SEERs?

Yes, 14 SEER is good, Steve. 13 SEER is what it always has been. And I think if that really comes out of the market, and I would assume for the most part, it would be out of the market relative to HP units by August at that this rate. This is the market that PE pumps in the market live longer than that, but I think that'll you see the margins start to look better and mix back up. I think that for the res HVAC business this year for us was a good growth, probably shared gain and margin expansion again. So I think that they're playing it right, they're right on cue. Good launches coming in the fourth quarter relative to the heating season, those were on track. I think that that's kind of one more nice sort of arrow that they've got to shoot in the third and fourth quarter.

And then lastly on just on your '16 margin targets for industrial, I mean are those kind of off the table here now?

No, it's too soon to really tell on this. I think we need to get through and look at the delivery on Cameron for the year, look at the bookings going in, but structurally nothing changes for me. I guess, before coming out and shooting from the hip, I want to make sure that we've had as much of '15 as we can, look at the bookings, and the really big stuff, and just make sure that we're giving a number that we can live with for '16. So it's too early for me to do that.

Can you buyback stock here? Sorry last one. Do you have the desire to buyback any stock here in the second half of the year, if the stock kind of stays where it is today?

Yes, we're going to buy it all back that we talked about. So it's $250 million.

The $250 million.

Yes, $250 million is what you can expect.

Next question come from Steven Winoker from Bernstein.

Mike, could you comment on the inventory turn number, I guess it came down from 7% to just over 6% in climate versus industrial, what's going on there, a little more detail?

When you end up with sort of getting an air pocket come through and you built inventory and its sitting a bit particularly on those quick turning stock business as you get caught a little bit away sitting there. You also get caught needing to pull some production days out, because you've built inventory and so that even compounds some of the margin problems you see when you've over built. So we've got to work that out in Q3. And then you're going to see obviously the res business start to really move inventory levels down, as you get the independent restocking taking place late June or early July, so no question in my mind that by the end of the year, we'd have turned to the right place at that point. And the teams are working on very detailed plans that they come up by month-by-month on a glide path, certainly by December, and we're doing our best to pull it forward into the third quarter just have a better chance to go and collect it in the fourth quarter.

And it's not weighted disproportionally to industrial that the challenge on that one or it is?

Well, res HD would be a big part of that. And the balance would be industrial FX.

Yes, it's about 50-50. It's not over weighted to industrial.

And then on the IRS litigation, assuming that that -- sorry, the settlement that that's all finalized, you're just looking through to Q when your exposures that you had called out publicly before looked like just adding all that up, you were closer to, it looked like something like $1.8 billion to $2 billion depending on how you count the '07 to '11, but this gets rid off all of that, and there is nothing else that's pending out there, right, so this completely removes the litigation as called out in the filing, is that it correct?

'02 through '11 all of issues and items are addressed, so again a lot of clarity on things. And then if you look at sort of '12 and on, I mean these are just normal open audit that the IRS would normally be working within any company. It's something where if you've gone from '02 through '11 and you have changed the '12 through '15 in terms of how you're sort of looking at managing your taxes, it would be very hard to assume, it would assert anything that was already agreed to between '02 and '11. So my guess would be although that '12 through '15 is not part of writing, it would be logical to assume that you wouldn't see those same issues asserted, since we have sort of settled that already.

And then maybe just one last one, on non-resi, one more in-depth there, you guys are really, it sounds like significant strengths, you mentioned, schools, but any place elsewhere that's giving you confidence of really, I guess, long lasting rebound, Mike?

Well, it's interesting for us. I would say, Steve, now as that the institutional markets were really strong, but we're pulling that with controls of performance contracting. And the performance contracting projects, we've booked one kind of in the mid-$30 million range for school this past quarter. We've got some very large ones booking and other verticals in Q3 and Q4 larger than that. They're slow burns, 18 months to 2 years in terms of the projects cycle they have to be managed. They put a little bit of pressure on the gross margin, because you end up a lot of paths through sub-contracts, but they are accretive to the contribution margins, because all of your cost are embedded in those projects, right. Everything down at the commissions for the sales people, if you will, are embedded in the project margin. So I think you might see some larger numbers start coming out there. I think a nice part about it, these are 10, 15, 20 year yields where its equipment, controls, service all bundled together. And it's a really nice project management business that's helping us from a energy retrofit perspective, just being able to take on and do really large projects effectively for customers.

Our next question comes from Jeff Hammond from KeyBanc.

So it looks like you're coming up against some tougher order comps, and I think you mentioned, China up 33 in Q4 and I think you had some really good order growth in back half Europe last year. As you look at kind of quoting activity and thinking about that tougher comp, how should we think about order momentum into the back half?

Quoting activity at commercial HVAC in North America is very strong. Performance in Europe in HVAC continues to be very strong double-digits, again strong, continues to go well in Middle East, same thing double digits, teens type of growth there. Low activity is in really Latin America. Choppy activity as we see really through China, but all of Asia Pacific, and then really an industrial big machines, Sue, kind of highlighted there with strengths, which I won't reiterate that. Probably a little bit more than choppiness, comes back into some of the plant there where you could see some air pockets from once a month, quarter-to-quarter that I think is just indicative of the overall economy.

And then just on residential, I mean you mentioned kind of mixing down, and it seems like the market is kind of going the other way, so can you just talk strategically how you're kind of positioning that business and how you feel like you're doing competitively, it seems like you have a little bit lower growth rates versus some of the competitors?

Q2, that wouldn't be the case actually. The data we got from HR would say it was really good quarter for us in Q2 and actually year-to-date, so it's little tough with all the data you get and reporting people do, but the benefit is, at least the North America and U.S with the HR data we're able to see that relative to the marketplace. So we had a really good quarter and it's been good six month period there. It's hard for our business, Trane, American standard to anything, but mixdown, because historically we only played at one end of the spectrum, so whole strategy has been for years now to build a product line that runs the gamut, so the dealer has the opportunity to use the product line across all aspects of price points customers wants to pay. So it would not be at all unusual for us to see motor-bearing units going up and obviously as you felt '13, '14 the mix goes down a little bit, nothing unusual or unplanned about that at all. In fact, I would say, reiterate that we're getting more of our channel base and a dealer base to use more of the product across their businesses. That piece of parts business and it sees everything down the road including replacements too so, so it's all good.

And our last question comes from Deane Dray from RBC Capital Markets.

Just had a follow up on the IRS settlement, and Sue, said there would be no change at this time to the tax rate. But would there be any change to how you're booking intercompany debt, is your P&L affect, and would we be able to see that?

No, Deane, there shouldn't really be that much of a change, and so really that change has already happened. So if you think back to the inversion debt, which was a big part of this settlement that inversion debt was gone at the end of 2011 and then we've simplified the structure even as we went through the Allegion spend in 2013 and we've really been very conscious of making sure that we're using our IRS domicile in the right ways for moving cash around the globe, but not really being aggressive on any of the different items. We've said a number of times that we've been playing it right down the middle of the fairway. And that has been the case for the last few years and so I don't expect any change to that at all.

Just last question, with copper at a six year low, I know you've always stayed very disciplined in terms of doing your laddered purchasing. You've got 70% already purchased. But with copper at these levels would you ever consider locking in or extending the duration of these hedges or advanced purchasing.

Yes, I think we have a commodity team that looks at all of these different items and a policy that gives us some flexibility when we do have prices that are at an all time low, and so that's something that we continuously monitor and the sourcing group is doing a good job of making sure that where it makes sense that we take advantage of that.

Has that happened yet?

We got about a quarter unlocked in Q3 and about a-third unlocked in Q4, so there is a little bit more room there than we normally have to go take advantage of the stock rates anyway, Deane. End of Q&A

Thank you. I'd like to hand the call back over to Janet Pfeffer for closing remarks, please.

Thank you, Earl, and thank you everyone. Joe and I will be around if you have any follow-up questions. Have a good day. Thank you.