Trane Technologies plc (TT) — Q2 2015 Earnings Call Transcript

Thank you, Earl, and good morning, everyone, welcome. We released earnings at 7:00 a.m. 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 historical 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.

Great. 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 and 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 was down 4%. Industrial revenue trends started out weak in quarter 2 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 were looking for 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 all in Industrial. For Industrial, organic revenues in Europe were down low single digits, excluding currency. Asia continued to be weak. The U.S. seemed 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 basis in Industrial. The earnings impact of the lower volume was offset by corporate spend controls, lower compensation benefits as well as favorability in 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 it over to Sue to take you through the quarter, we reached 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 the 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 3 adjustments totaling $0.89, which we think are appropriate given the nature of the items. First, the tax agreement resulted in a charge to income tax expense equaling $0.84. Second, as we've 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 EPS 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 Air and Industrial products and improve by high single digits in Club Car. Let's go to Slide 5. Here's a 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 the second quarter 2014 of 13.1% to the second quarter of 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 were from currency and about 30 points 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 3 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 gray box at the top of the page, overall leverage on an adjusted basis was 10%. Backing out currency and acquisitions, 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% excluding 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 the 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 the 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 they've been continuing in July. HVAC revenues, excluding currency, increased by a mid-single-digit 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, excluding currency, with strong gains in North America truck trailer and auxiliary power unit. 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 the second quarter of 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 markets were down mid-single digits. As Mike noted, order and shipment trends in the U.S. were unfavorable in the first 2 months of the quarter and strengthened in June. But the pushouts in customer requests 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're 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 the prior year. Industrial's adjusted operating margin of 13.3% was down compared with 16.4% last year. The Cameron acquisition, including known purchase accounting impact and negative currency accounted for 180 basis points of the decline. The remainder was due to lower volume, inflation, and investments, partially offset by price and productivity. Let's go to Slide 9. Let me take 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 owed approximately $774 million in taxes, plus additional amounts for penalties and interest 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. When finalized, it will provide greater certainty around the company's tax structure, effective tax rate, and financial position going forward and avoids the risk, expense, and time commitment inherent with litigation in a complex multiyear matter. The agreement covers all aspects 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 these 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 target. 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. With that, let's go to Slide 10. For the second quarter, working capital as a percentage of revenue was 5.8%. The increase versus the prior year is primarily inventory. This includes some incremental inventory related to the regional standards change in residential HVAC. We had good collections in the quarter, with our days sales outstanding and our days payable outstanding both improving over the prior year. Our balance sheet remains very strong. We have no debt maturities this year. Our cash balance is at normal levels. We continue to expect adjusted free cash flow in 2015 to be in a 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. Please go to Slide 11. In the aggregate, our adjusted EPS forecast has not changed since the 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. This is probably the best way to give you some color. North America institutional markets continued 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 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 digits 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. We expect markets to be up low single digits. We expect Latin American, Asian, European, and Middle Eastern HVAC equipment markets in the aggregate to be up low to mid-single digits at constant currency, but flat to down after considering currency. Within those regions, Europe and the 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, the 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 the 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 acquisitions to add 2 to 3 points for the year. So for organic growth, we end up back at the 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 is up 4% to 5% from our prior outlook. In the Industrial segment, revenues are expected to increase by 6% to 7% on a reported basis, with organic revenues projected to rise by 1% to 2%, compared to 4% to 5% in the previous forecast. This adjustment reflects the softness observed in the second quarter and ongoing weakness in international markets. To meet this forecast, Industrial needs to achieve approximately 2% to 2.5% organic growth in the second half, following a relatively flat performance in the first half. We believe this is achievable based on recent activity and our current backlog. Additionally, the revenue recognition for Cameron compressors is heavily weighted towards the second half of the year, particularly in the fourth quarter, according to customer delivery schedules already established in the backlog. About 60% of Cameron's revenues are anticipated to come in the latter half, and we are concentrating on operational execution and aligning with customer requirements to ensure timely delivery of those units. For operating margins, we expect Climate to be in a range of up - 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 is 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 margins, put pressure on those margin targets. Despite aggressive cost actions in the impacted areas, we cannot see a path to the prior range. This does not change our long-term view in the margin potential of the business. Given the demand environment, we're accelerating productivity and actions 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 devaluation, and the IRS agreement. If you include those items, the range for reported EPS is $2.59 to $2.74. We are reconfirming our adjusted EPS range. The forecast for the second half of the year reflects some pluses and minuses versus our prior outlook, which about netted reflects lower material inflation, in fact, it's actually deflation in the second half versus first half and higher levels of productivity from cost control and reduction actions, as well as prioritization of higher-return productivity projects, particularly in the businesses where we have seen some weaker end market trends. We plan to fully use the top end of the restructuring range of $0.05 that we had guided for the year. In parallel, we're evaluating additional actions, and we'll trigger those if needed to further adjust the cost base to market conditions. To focus on the third quarter guidance, so the right-hand column on the chart, third quarter 2015 revenues are forecast to be up 4% to 5% on a reported basis and 5% to 6% on an organic basis. That compares to an organic growth of 3% in the second quarter. The higher growth rate comes from several areas: restocking in the residential HVAC business, which we are seeing in order rates thus far in July and correlates with channel inventory levels; delivery of scheduled backlog in the 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. At this point, we see an improving order rate from the low activity in April and May continuing through July. Reported third quarter earnings per share are forecast to be $1.13 to $1.17. We expect about $0.02 of restructuring costs. And then adding this back to get to an adjusted basis, the adjusted EPS range is $1.15 to $1.19. We've provided EPS bridges for the third quarter in the appendix to give you the walk from year-to-year. I'd conclude by reiterating that although we met the midpoint of our earnings guidance in the second quarter, we didn't perform to our expectations and potential in terms of operating leverage and margin. We've already taken and we'll continue to take action to generate the growth in earnings that we've been communicating to you. Our strategies for growth and operational excellence have delivered a multiyear trend of excellent operating leverage, margin, and earnings improvement. They 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. Earl, I'll turn it over to you.

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

Yes, Nigel. I saw your note this morning because Q2 and Q3 are fairly flat, so there were some questions about the normal seasonality of the business. But there are a few things that go on here. First, third quarter North American commercial HVAC bookings and Thermo King are going to continue at high levels, and that really underpins the Climate forecast there. We had excellent bookings and growth in the second quarter, a lot of that in the schools market, and so I'm pretty confident that we're not going to see weakness at the North American commercial HVAC and TK in the quarter. We also have seen the restocking of the residential channel take place in late June and through July and believe it should match results that we had in our direct model, so that goes well. In fact, we had a good quarter in residential for Q2 and think that will continue in Q3. China is interesting because it's a place you wouldn't expect 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 in 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 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%, so that's really a delay, if you will, in Club Car business from Q2 to early Q3, so I think that we'll see that pick up. We're seeing a pickup; an example, June's, our Compressed Air business was up like 22% in bookings, most of that being in small and mid-size compressors, which we feel like we'll book in turn. But then as you look at late Q3, and I know this goes now into Q4, this is where we get into just delivering on the backlog of large machines, whether they're 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 make sense that we should be able to deliver that. We have put in place a lot of actions about compressing the productivity schedule, looking at discretionary spend, looking at investment spend, triggering many things now. And if in fact, things get weaker or it doesn't materialize in the top line, we're looking between third and fourth quarter to make sure that we manage the bottom line. So that's probably more than you asked for in your question, but that's the answer.

No, that's incredibly helpful. And by the way, 3% still isn't too shabby compared to some of your peers. The follow-on would be the headwind from volume mix, the 30 bps this quarter, big swing from the plus 100 last quarter. And it sounds from your comments 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 Q-to-Q and what's caused that swing?

The mix, it's a bit of a worst-case mix that we saw. If you step back, it's your higher-margin Industrial segment that is just down everywhere, averaging at the gross margins of the business. Then 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 tools, fluid management, and Material Handling. Then if you look at it on a geographic basis, it's particularly weak in Asia and Latin America, which have historically been very good, profitable markets for us. 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 some extra volume and really hit expectations, both for leverage and top line.

First, just to 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 out here 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 back-end loaded. But certainly, on a year-over-year basis, it looks like it was very weak here?

Cameron isn't as bad as it might seem. Initially, we estimated it to be a $350 million to $365 million business, which could mean it’s about $15 million to $25 million lighter overall. The decline is mostly seen in smaller businesses and compressors serving small industrial customers. This decline was unexpected due to a pause in the U.S. industrial economy. Many of the stock products we produced were completed but didn’t move during the quarter, creating challenges. However, in June, the business was up 22%, particularly in small compressors, and we saw improvements in the fluid business as well, with Club Car reporting nearly a 20% increase. There hasn’t been a significant recovery in the tools sector, and our Material Handling segment, which is our only oil and gas-related business, remains quite weak. Currently, our backlog for larger machines is solid, and the focus now is on ensuring timely delivery, especially since Cameron's business usually sees 40% of its activity in the fourth quarter, driven by customer delivery requests for big machines. Thus, it ultimately comes down to how well we execute on the backlog this year.

And Mike and Jeff, I believe we may have caused a bit of confusion regarding one of the slides related to Cameron. Let me clarify what Mike has mentioned. In the second quarter, there was a revenue shortfall in the Cameron business, but it represented only about 10% of the Industrial shortfall, so it wasn't a significant factor. Additionally, some of that revenue actually shifted to the third quarter and the latter part of the year.

That's helpful. And then 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 metals 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 in any way your attempts on the other side, on the pricing environment?

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. Now on the pricing side and what we've talked about with pricing, we consider that we still want to have a positive spread between the direct material inflation and price of about 20 to 30 basis points for the year. And 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 overarching view 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.

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 kind of be 40 to 60 in the back half? Is that kind of order of magnitude?

I think it'll be in the 20 to 30 range, a little bit higher than that to get us to in our range. And we said 20 to 30 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 the back half.

Yes, I mean, Robert, your rough math works. We fundamentally, as material is 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 destroys the marketplace, I think that would be the case. We would see that, from a commercial perspective, things have been weak in Latin America and Asia for some time, so I don't see pricing deteriorating further there. So I don't think the risk there is great. So it does support falling commodities, prices sort of moving slower and the spread widening in the back half.

Got you. 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 to 235. It looked like it really stepped down in 2Q. How is that tracking?

Yes, 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 re-forecasts for the balance of the year and re-evaluating any sort of investment spend and timing. Even some of the CapEx, just to kind of go back through that and scrub it for the back half of the year. So we're looking to not only get to 30 basis points second to front half but really get a bit of a natural hedge built in through some productivity actions being built in to protect the EPS forecast we're giving you.

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

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 may be 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 Carryall was down very significantly in Q2.

Well, any sort of mix in Climate, maybe to start there first, would be that on the residential side, we're probably one of the few people that actually mix down to 13 and 14, sort of the more we fill out the channel, the more we fill out the product range, we tend to mix down on it just a little bit there. We also mix down a little bit when you look at European transport. This is really weakness in Eastern Europe that is kind of pulling down some pretty good results in Western Europe, as an example. So there are minor things happening within that. Latin America has been a really soft market in Climate, a very profitable market for us. There's really no recovery happening in Latin America as we speak, and so those are the mixed drags that you see to Climate at present. Now China, it's not unusual, gosh, I can think about the last couple of years, where we get this see-saw happening between strong bookings, weak revenue, and so on and so forth. Now granted, it might be weak for 2 quarters, strong for 2 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 a pipeline of real deals and real projects, we also expect strong bookings in Q3 and in Q4 for China in the HVAC business. This happens to be some of the vertical markets that we are working in. It would not be surprising to find it to be mid-teens in quarter 3, as an example, in HVAC for bookings. But it's a see-saw there to a certain extent. I think that Industrial in China remains weak. I know that 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 the ground, where the proxy is power consumption, and what's reported in terms of GDP growth. Obviously, the more you focus on heavy industry, sort of the worse off you're going to be. The more you focus on health care, data centers, food, beverage, pharmaceuticals, probably the better you're going to be in that mix.

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

I believe we would maintain the range between 24% to 26%, with a midpoint of 25%. We have not identified any factors that would alter that on a long-term basis.

Just on some of this near-term improvement, Mike, that you've seen in the Industrial business, I get the 22% bookings growth in short-cycle Industrial. I would imagine that, given some of the pushouts you saw in 2Q, that there might be a little bit of a 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 pushouts 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's still a lot of reliance on those fourth quarter bigger projects still shipping on time?

Yes, Josh. When you consider the visibility we typically have a month before the next quarter, it tends to be between 45% and 60%. The remaining 40% to 55% comes from short-cycle small compressors, tools, and fluid management businesses. The larger compressors, along with our Club Car and Material Handling segments, provide a bit more clarity. What's somewhat different now is the pattern of the Cameron business, which has historically been strong in the latter half of the year, particularly in the fourth quarter. Their top customers consistently schedule deliveries around this time, which enhances visibility. We have always had good visibility on our major machine sales, and we can see the Club Car business for the rest of the year. However, we're making educated guesses regarding the overall economy related to the tools and smaller compressor sectors. If we were to analyze this further, there may be greater potential upside in the HVAC sector, while we could see some weakness in the short-cycle industrials. Overall, I believe we've made a fairly accurate projection.

Got you. And then just a follow-up on maybe the margin end of 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 Q2 just go away because you're now on top of things and no more surprises versus the revenue uptick?

Let me explain the shift from 16.4% last year to 13.3% this quarter by highlighting the main factors, and you can share your thoughts on what you think could be managed better. The most significant factor was volume and mix, which accounted for a 210 basis points difference. Foreign exchange had a negative impact of 110 basis points, while Cameron added 70 basis points. However, the impact from Cameron is more mathematical, as it involves the addition of revenue at low operating income and now transitioning towards the latter part of the year, where they tend to over-absorb in Q3 and Q4. There are also investments in other areas, which contributed about 1 point, largely due to a legal accrual related to an old item. On the positive side, productivity surpassed inflation by 120 basis points, and pricing contributed 60 basis points, resulting in a net gain of 180 basis points from productivity and price improvements. I believe the investments in other areas won't hinder progress, and Cameron's performance can be improved through better absorption in the factories. The volume and mix strategy we discussed requires a thoughtful approach, focusing on short-cycle, high-margin businesses and geographic diversification. Overall, our plans to tackle these challenges are focused on contingency measures should we continue to face weakness. I anticipate that productivity will significantly outpace other inflationary pressures, and pricing could improve beyond the direct material translation, as we navigate this environment of declining material costs.

This is Evelyn Chow speaking for Joe. Regarding your Climate margin guide, I understand that the residential channel affects the mix, but it seems your margin guidance for the second half suggests a normalization of incrementals. Could you help us consider the factors influencing margins related to mix, investment spending, and other aspects?

Leverage in the Climate segment for the quarter was quite strong, around 25%. Excluding FRIGOBLOCK, it was approximately 30%. As we look ahead to Q3 and Q4, it appears we will see leverage around 30% again. There isn't much difference in the leverage we're observing and anticipating in the Climate business, even with the residential mix. Feel free to refine your question if I'm missing something, but the situation seems to be relatively stable and consistent.

Okay, understood. And then maybe just returning to your comment on China HVAC bookings potentially being up in the mid-teens. That seems a little bit at 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 B bookings in the second quarter. It's 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%, it might look good compared to a competitor, and you flip it around and it may look bad. But all in all, one quarter, two quarter differences in the competition are really what we're talking about. There is some difference, though, depending on what competitors you talk about. Clearly, we don't have much of a presence in the residential 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, health care, electronics, data centers, food, and beverage, where we've done better.

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

It's Sue, Evelyn. Let me update you on the centrifugal compressor business market. Firstly, on the processed gas side, we are more aligned with gas than oil and gas. We're noting some growth in natural gas and LNG, especially in the U.S. In the Middle East, project delays are largely tied to oil prices, but the petrochemical sector seems stable. We anticipate growth in power generation for the business. On the engineered air side, we are observing a decline in the industrial gas market, particularly in Asia, where air separation is affected by overcapacity and reduced steel demand. For plant air, a slow recovery is happening in North America, which shows strong markets in automotive, food and beverage, pharmaceuticals, and electric power. North America is performing better, while Europe and Asia are a bit softer in the plant air market. Lastly, the aftermarket for Cameron centrifugal compressors is stable, but we still see further opportunities and synergies to explore within that aspect of the business.

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

Yes, so let's 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 strong. The first couple of weeks were frankly a little bit slow, and then the last couple of weeks of June were 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. Now all that, Steve, gets you to kind of maybe flat to low single digits, motor-bearing sort of markets for the year. But pretty strong last 4 weeks, 5 weeks.

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

Yes, great question. In the best case, you're likely looking at low double-digit growth.

That's great to hear. Regarding the margin dynamics, have you started to see any changes? I know you redesigned your 14 SEER units. What are your observations on the margin side? I would expect those changes aren't fully reflected yet due to some pre-buy activity in your numbers, so could you discuss how you plan to leverage the new 14 SEER units to improve that?

Yes, 14 SEER is good, Steve. 13 SEER is what it always has been, and I think that as that really comes out of the market, and I would assume for the most part, it would be out of the market relative to AC units by August at this rate. This is the market. The PT pumps to the market a little bit longer than that, but I think that you see the margins start to look better and mix back up. I think that for the residential HVAC business this year for us, you'll see good growth, probably share gain and margin expansion again. So I think that they're playing it right on cue. Good launches coming in the fourth quarter relative to the heating season; those are 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.

Okay. And then lastly, 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 wait for the delivery on Cameron for the year and assess the incoming bookings. However, structurally, nothing changes for me. Before making any assertions, I want to ensure we evaluate as much of '15 as possible, review the bookings, and consider the significant factors to provide a number we can be confident in for '16, so it's too early for me to determine that.

Okay. Can you buy back stock here? Sorry, last one. Do you have the desire to buy back 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?

Yes, the $250 million.

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

Yes, Steve. When we encounter a situation where we begin to accumulate inventory without selling it quickly, especially in businesses with fast-moving stock, we find ourselves in a difficult position. We may also need to reduce production because of the excess inventory, which further exacerbates the margin issues associated with overproduction. We need to address this in Q3. You will see the residential business start to reduce inventory levels significantly as the independent restocking occurs in late June or early July. I have no doubt that by the year's end, we will have the inventory turns in the right position. Our teams are creating detailed month-by-month plans to ensure we achieve this by December, and we are working hard to expedite this process into the third quarter for a better chance to establish and capture it by the fourth quarter.

Okay. Is the challenge on that one not disproportionately weighted to Industrial?

Well, residential HVAC would be a big part of it, and the balance would be Industrial, I think.

Yes, it's about 50-50. It's not overweighted to Industrial.

Okay. Regarding the IRS litigation, assuming the settlement is finalized, it appears that your exposures, based on previous public disclosures, total approximately $1.8 billion to $2 billion, depending on how you consider the periods from '07 to '11. This resolves all of those issues, and there are no other pending matters, correct?

'02 through '11, all open issues and items are addressed. So again, it's the settled on things. And then if you look at sort of '12 and on, I mean, these are just normal open audits that the IRS would normally be working within any company. It's something where, if you've gone from '02 through '11, and then you have a change, '12 through '15, in terms of how you're sort of looking at managing your taxes, it would be very hard to assume they 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 the agreement in writing, it would be logical to assume that you wouldn't see those same issues asserted since we have sort of settled that already.

Okay, great. And then maybe just one last question. Regarding non-residential, can you provide a bit more detail? It sounds like there's significant strength. You mentioned schools, but are there other areas that give you confidence in a long-lasting rebound, Mike?

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

So it looks like you're coming up against some tougher order comps. And I think you mentioned China up 33% in 4Q, 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 in commercial HVAC, North America is very strong. Performance in Europe in HVAC continues to be very strong, double digits, again strong, continues to go well. Middle East, same thing, double digits, teens-type growth there. The low activity is in really Latin America. Choppy activity is what you see, really, through China but all of Asia Pacific. And then really, in Industrial, big machines, Sue kind of highlighted there what the strengths were, so I won't reiterate that. Probably a little bit more of the choppiness comes back into some of the plant there, where you could see some air pockets from month-to-month, quarter-to-quarter, that I think is just indicative of the overall economy.

Okay. 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.

In Q2, the data from HR indicates that it was actually a strong quarter and year-to-date for us. Although it can be challenging with all the data and reporting, we can see in North America and the U.S. that we performed well relative to the marketplace. Our performance has been solid over the last six months. For our businesses, Trane and American Standard, it's common for the mix to shift downwards since we historically focused on one end of the market. Our strategy has long been to develop a product line that covers a wide range of offerings, allowing our dealers to cater to various price points that customers are interested in. Therefore, it’s not unusual to see an increase in motor-bearing units, and as we sell 13 SEER and 14 SEER models, the mix may decrease slightly. This is neither unexpected nor unplanned. I would emphasize that we are successfully encouraging more of our channel and dealer base to utilize a broader range of products in their operations. This approach supports our parts business and has positive implications for future replacements as well, which is all beneficial.

You mentioned a follow-up on the IRS settlement, and Sue indicated that there would be no change to the tax rate at this time. However, will there be any changes in how intercompany debt is accounted for? Is there a P&L impact, and will 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 spin in 2013. And we've really been very conscious of making sure that we're using our Irish 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.

Great. Just last question. With copper at a 6-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 walking in or extending the duration of these hedges or advanced purchasing?

Yes, we have a commodity team that examines various items and a policy that allows us some flexibility when prices hit an all-time low. This is something we continuously monitor, and our sourcing group is effectively ensuring that we take advantage of those opportunities where it makes sense.

We've got about 1/4 unlocked in Q3 and about 1/3 unlocked in Q4. So there's a little bit more room there than we normally have to go take advantage of stock rates anyway, Deane.

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.