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INGERSOLL-RAND PLC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause a difference include, but are not limited to, those discussed under Part II, Item 1A - Risk Factors in this Quarterly Report on Form 10-Q; and under Part I, Item 1A - Risk Factors in the Annual Report on Form 10-K for the fiscal year ended December 31, 2013. The following section is qualified in its entirety by the more detailed information, including our financial statements and the notes thereto, which appears elsewhere in this Quarterly Report. Overview Organizational Ingersoll-Rand plc (IR-Ireland), a public limited company incorporated in Ireland in 2009, and its consolidated subsidiaries (collectively, we, our, the Company) is a diversified, global company that provides products, services and solutions to enhance the quality and comfort of air in homes and buildings, transport and protect food and perishables and increase industrial productivity and efficiency. Our business segments consist of Climate and Industrial, both with strong brands and leading positions within their respective markets. We generate revenue and cash primarily through the design, manufacture, sale and service of a diverse portfolio of industrial and commercial products that include well-recognized, premium brand names such as Ingersoll-Rand®, Trane®, Thermo King®, American Standard® and Club Car®. To achieve our mission of being a world leader in creating comfortable, sustainable and efficient environments, we continue to focus on increasing our recurring revenue stream from parts, service, used equipment and rentals; and to continuously improve the efficiencies and capabilities of the products and services of our high-potential businesses. We also continue to focus on operational excellence strategies as a central theme to improving our earnings and cash flows. Trends and Economic Events We are a global corporation with worldwide operations. As a global business, our operations are affected by worldwide, regional and industry-specific economic factors, as well as political factors, wherever we operate or do business. Our geographic and industry diversity, as well as the diversity of our product sales and services, has helped mitigate the impact of any one industry or the economy of any single country on our consolidated operating results. Given the broad range of products manufactured and geographic markets served, management uses a variety of factors to predict the outlook for the Company. We monitor key competitors and customers in order to gauge relative performance and the outlook for the future. In addition, our order rates are indicative of future revenue and thus a key measure of anticipated performance. In those industry segments where we are a capital equipment provider, revenues depend on the capital expenditure budgets and spending patterns of our customers, who may delay or accelerate purchases in reaction to changes in their businesses and in the economy. Current market conditions, including challenges in international markets, continue to impact our financial results. Uneven global commercial new construction activity is impacting the results of our commercial Heating, Ventilation and Air Conditioning (HVAC) business. However, we believe certain segments of the commercial HVAC equipment replacement and aftermarket are recovering. We have seen slower worldwide industrial equipment and aftermarket activity. While U.S. residential and consumer markets continue to be a challenge, we continue to see improvements in the U.S. new builder and replacement markets. As economic conditions stabilize, we expect moderate growth in worldwide construction markets and slow growth in industrial markets, along with benefits from productivity programs for the remainder of the year. Despite the current market environment, we believe we have a solid foundation of global brands and leading market shares in all of our major product lines. Our growing geographic and industry diversity coupled with our large installed product base provides growth opportunities within our service, parts and replacement revenue streams. In addition, we are investing substantial resources to innovate and develop new products and services which we expect will drive our future growth. Recent Developments Allegion Spin-Off On December 1, 2013 (the Distribution Date), we completed the spin-off of our commercial and residential security businesses to our shareholders (the spin-off). After the Distribution Date, Allegion became an independent public company trading under the symbol "ALLE" on the New York Stock Exchange. Allegion's historical financial results for periods prior to the Distribution Date are reflected in our Consolidated Financial Statements as a discontinued operation. See "Discontinued Operations and Divestitures" within Management's Discussion and Analysis of Financial Condition and Results of Operations and also Note 15 to the Consolidated Financial Statements for a further discussion of our discontinued operations. 35-------------------------------------------------------------------------------- Table of Contents In connection with the spin-off of Allegion, the Company and Allegion entered into several agreements covering administrative and tax matters to provide or obtain services on a transitional basis, as needed, for varying periods after the spin-off. The administrative agreements cover various services such as information technology, human resources and finance. The Company expects all services to be substantially complete within one year after the spin-off. During the three months ended June 30, 2013, we incurred $21.0 million of professional service fees related to the proposed spin-off. These costs are reported in Selling and administrative expenses in the Condensed Consolidated Statements of Comprehensive Income. See Note 12 for a discussion of restructuring activities. IRS Exam Results In 2007, we received a notice from the IRS containing proposed adjustments to our tax filings in connection with an audit of the 2001 and 2002 tax years. The IRS did not contest the validity of our reincorporation in Bermuda. The IRS proposed to ignore the entities that hold the intercompany debt incurred in connection with our reincorporation in Bermuda (the "2001 Debt") and to which the interest was paid and impose 30% withholding tax on a portion of the interest payments as if they were made directly to a company that was not eligible for reduced U.S. withholding tax under a U.S. income tax treaty. The IRS asserted that we owe additional taxes with respect to 2002 of approximately $84.0 million plus interest. We strongly disagreed with the view of the IRS and filed a protest. In 2010, we received an amended notice from the IRS assessing penalties of 30% on the asserted underpayment of tax described above. We have so far been unsuccessful in resolving this dispute and in 2013 received a Notice of Deficiency from the IRS for 2002. The Company filed a petition in the United States Tax Court in November 2013 contesting this deficiency. In its January 2014 answer to our petition, the IRS asserted that we also owe 30% withholding tax on the portion of 2002 interest payments made on the 2001 Debt upon which it did not previously assert withholding tax. A 30% withholding tax on this $85.0 million interest payment would increase the total tax liability proposed for 2002 to $109.0 million ($84.0 million referred to in the paragraph above plus this additional $25.0 million) plus 30% penalties and interest. In 2013, we received notices from the IRS containing proposed adjustments to the Company's tax filings in connection with an audit of the 2003-2006 tax years. In these notices, the IRS asserts that we owe a total of approximately $665.0 million of additional taxes, as described more fully below, in connection with our interest payments on the 2001 Debt for the 2003-2006 period, plus penalties and interest on these unpaid taxes. The IRS continues to take the position on the 2001 Debt, which was retired at the end of 2011, that it previously took for our 2002 tax year and which is described above. As a result of this recharacterization, the IRS asserts that we owe approximately $455.0 million of withholding tax for 2003-2006 plus 30% penalties. The IRS also proposes to extend its position further and to treat all of the interest income from the 2001 Debt as creating earnings and profits at IR-Limited and, as a result, recharacterize the distributions made by IR-Limited during the 2002-2006 tax years as taxable dividends instead of as a return of capital. Consequently the IRS asserts that we owe approximately $210.0 million of income tax on these dividends plus penalties of 20%. Although we expect it to do so, the IRS has not yet proposed any similar adjustments for years subsequent to 2006, as the federal income tax audits for those years are still in process or have not yet begun. In addition, we do not know how the IRS will apply its position to the different facts presented in those years or whether the IRS will take a similar position in future audits with respect to intercompany debt instruments not outstanding in prior years. We have vigorously contested all of these proposed adjustments and intend to continue to do so. Although the outcome of these matters cannot be predicted with certainty, based upon an analysis of the merits of our position, we believe that we are adequately reserved under the applicable accounting standards for these matters and do not expect that the ultimate resolution will have a material adverse impact on our future results of operations, financial condition, or cash flows. As we move forward to resolve these matters with the IRS, the reserves established may be adjusted. Although we continue to contest the IRS's position, there can be no assurance that we will be successful. If the IRS's position with respect to the 2002-2006 tax years is ultimately sustained, we would be required to record additional charges and the resulting liability will have a material adverse impact on our future results of operations, financial condition and cash flows. 2014 Dividend Increase and Share Repurchase Program In February 2014, we announced an increase in our quarterly share dividend from $0.21 to $0.25 per share beginning with our March 2014 payment. In February 2014, our Board of Directors authorized the repurchase of up to $1.5 billion of our ordinary shares under a new share repurchase program upon completion of the current share repurchase program. The new share repurchase program began in April 2014. Share repurchases will be made from time to time at the discretion of management subject to market conditions, regulatory requirements and other considerations. During the six months ended June 30, 2014, we repurchased 17.0 million shares for $1,012.8 million, of which 3.9 million shares for $225.1 million were under the 2014 program. These repurchases were accounted for as a 36-------------------------------------------------------------------------------- Table of Contents reduction of Ordinary shares and Capital in excess of par value, or Retained earnings to the extent Capital in excess of par value was exhausted, as they were canceled upon repurchase. 2013 Share Repurchase Program In December 2012, our Board of Directors authorized the repurchase of up to $2.0 billion of our ordinary shares under a share repurchase program. The share repurchase program was started in April 2013 and was completed in April 2014. During the year ended December 31, 2013, we repurchased 20.8 million shares for approximately $1.2 billion. These repurchases were accounted for as a reduction of Ordinary shares and Capital in excess of par value as they were canceled upon repurchase. Senior Notes due 2019, 2023, and 2043 In June 2013, we issued $1.55 billion principal amount of Senior Notes in three tranches through our wholly-owned subsidiary, Ingersoll-Rand Global Holding Company Limited (IR-Global) pursuant to Rule 144A of the U.S. Securities Act of 1933 (Securities Act). The tranches consist of $350 million of 2.875% Senior Notes due in 2019, $700 million of 4.250% Senior Notes due in 2023, and $500 million of 5.750% Senior Notes due in 2043. The notes were fully and unconditionally guaranteed by each of IR-Ireland, Ingersoll-Rand Company Limited (IR-Limited), and Ingersoll-Rand International Holding Limited (IR-International). Ingersoll-Rand Company (IR-New Jersey) became a co-obligor of the notes in December 2013. Interest on the notes is paid twice a year in arrears. We have the option to redeem the notes in whole or in part at any time, and from time to time, prior to their stated maturity date at redemption prices set forth in the indenture agreement. The notes are subject to certain customary covenants, however, none of these covenants are considered restrictive to our operations. In connection with the issuance of each series of notes, IR-Global, the Guarantors and the initial purchasers of the notes entered into a Registration Rights Agreement. Each Registration Rights Agreement requires IR-Global and the Guarantors to use their commercially reasonable efforts to execute an effective exchange offer registration statement with the SEC no later than 365 days after the closing date of the notes offering and to complete an exchange offer within 30 business days of such effective date. The proceeds from these notes were used to fund the July 2013 redemption of $600 million of 6.000% Senior Notes due 2013 and $655 million of 9.500% Senior Notes due 2014 and to fund expenses related to the spin-off of the commercial and residential security businesses, with any remaining proceeds to be used for general corporate purposes. On April 25, 2014, we filed our exchange offer registration statement with the SEC, which became effective on May 13, 2014, and in June 2014, we completed our offer to exchange the notes for registered notes having terms identical in all material respects to the private notes, except that the registered notes do not contain terms with respect to transfer restrictions, registration rights or additional interest for failure to observe certain obligations in the applicable registration rights agreement. Venezuela Devaluation In February 2013, the government of Venezuela announced a devaluation of the Bolivar, from the pre-existing official exchange rate obtained through the National Center of Foreign Trade (CENCOEX, formerly CADIVI through April 2014) of 4.29 Bolivars to the U.S. dollar to 6.3 Bolivars to the U.S. dollar. We have one subsidiary with operations in Venezuela. As a result of the devaluation, we realized a foreign currency translation loss of approximately $3.8 million during the six months ended June 30, 2013. In January 2014, the Venezuelan government significantly expanded the use of the Supplementary Foreign Currency Administration System (SICAD) I exchange market and created a third exchange market called SICAD II. These markets have exchange rates significantly less favorable than the CENCOEX rate. The Venezuelan government also indicated that the CENCOEX rate will be reserved for purchases of "essential goods and services." The results of our Venezuelan subsidiary as of June 30, 2014, are reflected at the CENCOEX rate and not the June 30, 2014 SICAD I (10.6 Bolivars to $1.00) or SICAD II (49.98 Bolivars to $1.00) rates due to our belief that our imports will continue to qualify for the official rate and our intent to continue to pursue this rate for future exchanges. As of June 30, 2014, we had net monetary assets of approximately 215.8 million Bolivars. For 2013, annual net revenues of our Venezuela subsidiary were approximately 247.8 million Bolivars. Further devaluation of the Bolivar, or our inability to convert our net monetary assets denominated in bolivars into US Dollars at certain of the exchange rates discussed above, could negatively impact our results of operations, financial condition, or cash flows. For additional information, refer to the "Risk Factors" discussion contained in our Annual Report on Form 10-K for the period ended December 31, 2013. 37-------------------------------------------------------------------------------- Table of Contents Results of Operations - Three Months Ended June 30 % of % of In millions, except per share amounts 2014 revenues 2013 revenues Net revenues $ 3,542.9 $ 3,398.4 Cost of goods sold (2,439.9 ) 68.9 % (2,377.5 ) 69.9 % Selling and administrative expenses (639.7 ) 18.1 % (633.4 ) 18.6 % Operating income 463.3 13.1 % 387.5 11.4 % Interest expense (53.0 ) (61.9 ) Other, net 8.6 (2.4 ) Earnings before income taxes 418.9 323.2 Provision for income taxes (103.7 ) (48.7 ) Earnings from continuing operations 315.2 274.5 Discontinued operations, net of tax (4.6 ) 50.2 Net earnings 310.6 324.7 Less: Net earnings attributable to noncontrolling interests (4.6 ) (7.5 ) Net earnings attributable to Ingersoll-Rand plc $ 306.0 $ 317.2 Diluted net earnings (loss) per ordinary share attributable to Ingersoll-Rand plc ordinary shareholders: Continuing operations $ 1.13 $ 0.89 Discontinued operations (0.01 ) 0.16 Net earnings $ 1.12 $ 1.05 The discussions that follow describe the significant factors contributing to the changes in our results of operations for the periods presented. Net Revenues Net revenues for the three months ended June 30, 2014 increased by 4.3%, or $144.5 million, compared with the same period in 2013, which resulted from the following: Volume 3.6 % Pricing 0.7 % Total 4.3 % The increase in revenues was primarily driven by higher volumes and improved pricing across both segments. Operating Income/Margin Operating margin for the three months ended June 30, 2014 increased to 13.1% from 11.4% for the same period of 2013. The increase was primarily due to productivity benefits in excess of other inflation (1.0%), favorable product mix and volume (0.6%) and improved pricing net of material inflation (0.5%), partially offset by increased investment spending (0.4%). Interest Expense Interest expense for the three months ended June 30, 2014 decreased $8.9 million, compared with the same period of 2013, primarily as a result of lower average interest rates obtained through our debt refinancing completed in July 2013. 38-------------------------------------------------------------------------------- Table of Contents Other, Net The components of Other, net for the three months ended June 30 were as follows: In millions 2014 2013 Interest income $ 3.6 $ 2.6 Exchange gain (loss) 2.8 (7.4 ) Earnings (loss) from equity investments 3.4 1.7 Other (1.2 ) 0.7 Other, net $ 8.6 $ (2.4 ) The increase in Other, net for the three months ended June 30, 2014, resulted primarily from favorable foreign currency impacts. Included within Earnings (loss) from equity investments for the three months ended June 30, 2014 and 2013 are $3.4 million and $1.7 million of losses on the Hussmann equity investment, respectively. The Company's ownership percentage in Hussmann Parent, an affiliate of private equity firm Clayton Dubilier & Rice, LLC, was 37.2% as of June 30, 2014 and is recorded using the equity method of accounting. The Company's equity investment in the Hussmann Parent is reported within Other noncurrent assets. Provision for Income Taxes For the three months ended June 30, 2014, the effective tax rate was 24.8%, which is lower than the U.S. Statutory rate of 35% primarily due to earnings in non-U.S. jurisdictions, which in aggregate, have a lower effective tax rate, partially offset by a net increase to our liability for unrecognized tax benefits and the tax costs of certain legal entity restructurings. For the three months ended June 30, 2013, the effective tax rate was 15.1%, which is lower than the U.S. Statutory rate of 35% primarily due to earnings in non-U.S. jurisdictions, which in aggregate, have a lower effective tax rate and a net decrease in our liability for unrecognized tax benefits. Revenues from non-U.S. jurisdictions account for approximately 41% of our total revenues, such that a material portion of our pretax income is earned and taxed outside the U.S. at rates ranging from 0% to 38%. When comparing the results of multiple reporting periods, among other factors, the mix of earnings between U.S. and foreign jurisdictions can cause variability on our overall effective tax rate. Results of Operations - Six Months Ended June 30 % of % of In millions, except per share amounts 2014 revenues 2013 revenues Net revenues $ 6,265.9 $ 6,037.4 Cost of goods sold (4,394.8 ) 70.1 % (4,290.0 ) 71.1 % Selling and administrative expenses (1,252.8 ) 20.0 % (1,239.8 ) 20.5 % Operating income 618.3 9.9 % 507.6 8.4 % Interest expense (105.0 ) (122.6 ) Other, net 10.7 (1.9 ) Earnings before income taxes 524.0 383.1 Provision for income taxes (128.3 ) (53.2 ) Earnings from continuing operations 395.7 329.9 Discontinued operations, net of tax (1.7 ) 89.4 Net earnings 394.0 419.3 Less: Net earnings attributable to noncontrolling interests (9.1 ) (14.1 ) Net earnings attributable to Ingersoll-Rand plc $ 384.9 $ 405.2 Diluted net earnings (loss) per ordinary share attributable to Ingersoll-Rand plc ordinary shareholders: Continuing operations $ 1.39 $ 1.06 Discontinued operations (0.01 ) 0.28 Net earnings $ 1.38 $ 1.34 The discussions that follow describe the significant factors contributing to the changes in our results of operations for the periods presented. 39-------------------------------------------------------------------------------- Table of Contents Net Revenues Net revenues for the six months ended June 30, 2014 increased by 3.8%, or $228.5 million, compared with the same period in 2013, which resulted from the following: Volume 3.3 % Pricing 0.7 % Currency exchange rates (0.2 )% Total 3.8 % The increase in revenues was primarily driven by higher volumes and improved pricing across both segments. Operating Income/Margin Operating margin for the six months ended June 30, 2014 increased to 9.9% from 8.4% for the same period of 2013. The increase was primarily due to productivity benefits in excess of other inflation (0.9%), favorable product mix and volume (0.5%) and improved pricing net of material inflation (0.3%), partially offset by increased investment spending (0.2%). Interest Expense Interest expense for the six months ended June 30, 2014 decreased $17.6 million, compared with the same period of 2013, primarily as a result of lower average interest rates obtained through our debt refinancing completed in July 2013. Other, Net The components of Other, net for the six months ended June 30 are as follows: In millions 2014 2013 Interest income $ 6.4 $ 5.9 Exchange gain (loss) (1.4 ) (6.8 ) Earnings (loss) from equity investments 0.4 (2.5 ) Other 5.3 1.5 Other, net $ 10.7 $ (1.9 ) The increase in Other, net for the six months ended June 30, 2014, resulted from less unfavorable foreign currency impacts, improved Earning from equity investments and a gain on sale of an investment included within Other. Further contributing to the increase in Other, net for the six months ended June 30, 2013 is a realized foreign currency translation loss of $3.8 million related to the devaluation of the Venezuelan Bolivar. Included within Earnings (loss) from equity investments for the six months ended June 30, 2014 and 2013 is $0.4 million and $2.5 million of losses on the Hussmann equity investment, respectively. The Company's ownership percentage in Hussmann Parent, an affiliate of private equity firm Clayton Dubilier & Rice, LLC, was 37.2% as of June 30, 2014 and is recorded using the equity method of accounting. The Company's equity investment in the Hussmann Parent is reported within Other noncurrent assets. Provision for Income Taxes For the six months ended June 30, 2014, the effective tax rate was 24.5%, which is lower than the U.S. Statutory rate of 35% primarily due to earnings in non-U.S. jurisdictions, which in aggregate, have a lower effective tax rate, partially offset by a net increase to our liability for unrecognized tax benefits. For the six months ended June 30, 2013, the effective tax rate was 13.9%, which is lower than the U.S. Statutory rate of 35% primarily due to earnings in non-U.S. jurisdictions, which in aggregate, have a lower effective tax rate, a net decrease in our liability for unrecognized tax benefits and the impact of the American Taxpayer Relief Act of 2012 enacted in January 2013. Revenues from non-U.S. jurisdictions account for approximately 41% of our total revenues, such that a material portion of our pretax income is earned and taxed outside the U.S. at rates ranging from 0% to 38%. When comparing the results of multiple reporting periods, among other factors, the mix of earnings between U.S. and foreign jurisdictions can cause variability on our overall effective tax rate. Review of Business Segments The segment discussions that follow describe the significant factors contributing to the changes in results for each segment included in continuing operations. 40-------------------------------------------------------------------------------- Table of Contents Segment operating income is the measure of profit and loss that our chief operating decision maker uses to evaluate the financial performance of the business and as the basis for performance reviews, compensation and resource allocation. For these reasons, we believe that Segment operating income represents the most relevant measure of segment profit and loss. We may exclude certain charges or gains from Operating income to arrive at a Segment operating income that is a more meaningful measure of profit and loss upon which to base our operating decisions. We define Segment operating margin as Segment operating income as a percentage of Net revenues. Climate Our Climate segment delivers energy-efficient solutions globally and includes Trane® and American Standard® Heating & Air Conditioning which provide heating, ventilation and air conditioning (HVAC) systems, and commercial and residential building services, parts, support and controls; and Thermo King® the leader in transport temperature control solutions. Segment operating results for Climate for the three and six months ended June 30 were as follows: Three months ended Six months ended Dollar amounts in millions 2014 2013 % change 2014 2013 % change Net revenues $ 2,748.9 $ 2,635.5 4.3 % $ 4,789.7 $ 4,594.2 4.3 % Segment operating income 389.3 330.1 17.9 % 520.3 401.7 29.5 % Segment operating margin 14.2 % 12.5 % 10.9 % 8.7 % Net revenues for the three months ended June 30, 2014 increased by 4.3%, or $113.4 million, compared with the same period of 2013, primarily related to higher volumes (3.5%) and improved pricing (0.8%). Segment operating margin improved to 14.2% for the three months ended June 30, 2014, compared to 12.5% for the same period of 2013. The improvement was primarily driven by productivity benefits in excess of other inflation (1.2%), favorable volume/product mix (0.4%), pricing improvements in excess of material inflation (0.3%), partially offset by increased investment spending (0.3%). Net revenues for the six months ended June 30, 2014 increased by 4.3%, or $195.5 million, compared with the same period of 2013, primarily related to higher volumes (3.7%) and improved pricing (0.8%), partially offset by unfavorable currency impacts (0.2%). Segment operating margin improved to 10.9% for the six months ended June 30, 2014, compared to 8.7% for the same period of 2013. The improvement was primarily driven by productivity benefits in excess of other inflation (1.2%), favorable volume/product mix (0.5%) and pricing improvements in excess of material inflation (0.4%). Trane commercial HVAC net revenues increased due to improvements in parts, services, and solutions. Trane residential HVAC net revenues increased due to increased volumes in all major product categories. Net revenues in our transport businesses increased driven by gains in all equipment categories and in aftermarket revenues. Industrial Our Industrial segment delivers products and services that enhance energy efficiency, productivity and operations. It includes Ingersoll Rand® compressed air systems and services, power tools and material handling systems, ARO® fluid management equipment, as well as Club Car® golf, utility and rough terrain vehicles. Segment operating results for Industrial for the three and six months ended June 30 were as follows: Three months ended Six months ended Dollar amounts in millions 2014 2013 % change 2014 2013 % change Net revenues $ 794.0 $ 762.9 4.1 % $ 1,476.2 $ 1,443.2 2.3 % Segment operating income 130.1 120.9 7.6 % 209.4 221.7 (5.5 )% Segment operating margin 16.4 % 15.8 % 14.2 % 15.4 % Net revenues for the three months ended June 30, 2014 increased by 4.1%, or $31.1 million, compared with the same period of 2013, primarily related to higher volumes (3.8%) and improved pricing (0.4%). Segment operating margin increased to 16.4% for the three months ended June 30, 2014, compared to 15.8% for the same period of 2013. The improvement was primarily driven by favorable volume/product mix (0.9%), productivity benefits in excess of other inflation (0.4%) and pricing improvements in excess of material inflation (0.2%), partially offset by increased investment spending (1.0%). 41-------------------------------------------------------------------------------- Table of Contents Net revenues for the six months ended June 30, 2014 increased by 2.3%, or $33.0 million, compared with the same period of 2013, primarily related to higher volumes (2.0%) and improved pricing (0.3%). Segment operating margin decreased to 14.2% for the six months ended June 30, 2014, compared to 15.4% for the same period of 2013. The decrease was primarily due to increased investment spending (1.1%) and other inflation in excess of productivity benefits (0.4%), partially offset by favorable volume/product mix (0.2%). Air compressors and industrial products net revenues increased with gains in all major geographic regions. Club Car net revenues declined due to decreased activity in the North American golf market. Discontinued Operations The components of Discontinued operations, net of tax for the three and six months ended June 30 were as follows: Three months ended Six months ended In millions 2014 2013 2014 2013 Net revenues $ - $ 534.3 $ - $ 1,007.6 Pre-tax earnings (loss) from operations $ (18.9 ) $ 88.7 $ (17.4 ) $ 143.8 Pre-tax gain (loss) on sale - - - - Tax benefit (expense) 14.3 (38.5 ) 15.7 (54.4 ) Discontinued operations, net of tax $ (4.6 ) $ 50.2 $ (1.7 ) $ 89.4 Discontinued operations by business for the three and six months ended June 30 are as follows: Three months ended Six months ended In millions 2014 2013 2014 2013 Allegion, net of tax $ 5.7 $ 44.7 $ 12.8 $ 91.1 Other discontinued operations, net of tax (10.3 ) 5.5 (14.5 ) (1.7 ) Discontinued operations, net of tax* $ (4.6 ) $ 50.2 $ (1.7 ) $ 89.4 * Included in Allegion, net of tax for the three and six months ended June 30, 2013 are spin costs of $21.0 million and $32.0 million, respectively. Allegion Spin Off On December 1, 2013, the Company completed the previously announced separation of its commercial and residential security businesses by distributing the related ordinary shares of Allegion, on a pro rata basis, to the Company's shareholders of record as of November 22, 2013. After the Distribution Date, Allegion became an independent publicly traded company. The results of our commercial and residential security businesses are presented as a discontinued operation on the Condensed Consolidated Statements of Comprehensive Income and Condensed Consolidated Statements of Cash Flows for all periods presented. Other Discontinued Operations Discontinued operations, net of tax from previously sold businesses is mainly related to postretirement benefits, product liability, worker's compensation, legal costs (mostly asbestos-related), and tax effects of post-closing purchase price adjustments. Liquidity and Capital Resources We earn a significant amount of our operating income in jurisdictions where it is deemed to be permanently reinvested. Our most prominent jurisdiction of operation is the U.S. We currently do not intend nor foresee a need to repatriate funds to the U.S., and no provision for U.S. income taxes has been made with respect to such earnings. We expect existing cash and cash equivalents available to the U.S., the cash generated by our U.S. operations, our committed credit lines, as well as our expected ability to access the capital and debt markets, will be sufficient to fund our U.S. operating and capital needs for at least the next twelve months and thereafter for the foreseeable future. In addition, we expect existing non-U.S. cash and cash equivalents and the cash generated by our non-U.S. operations will be sufficient to fund our non-U.S. operating and capital needs for at least the next twelve months and thereafter for the foreseeable future. Should we require more capital in the U.S. than is generated by our U.S. operations, and we determine that repatriation of non-U.S. cash is necessary, such amounts would be subject to U.S. federal income taxes. In February 2014, we announced an increase in our quarterly ordinary share dividend from $0.21 to $0.25 per share beginning with our March 2014 payment. In addition, our Board of Directors authorized the repurchase of up to $1.5 billion of our ordinary shares under a new share repurchase program upon completion of the current share repurchase program. The new share repurchase program began in April of 2014. During the six months ended June 30, 2014, we repurchased 17.0 million shares for $1,012.8 42-------------------------------------------------------------------------------- Table of Contents million, of which 3.9 million shares for $225.1 million were under the 2014 program. These repurchases were accounted for as a reduction of Ordinary shares and Capital in excess of par value, or Retained earnings to the extent Capital in excess of par value was exhausted, as they were canceled upon repurchase. We expect our available cash flow, committed credit lines and access to the capital markets will be sufficient to fund the increased dividend and share repurchases. The following table contains several key measures to gauge our financial condition and liquidity at the period ended: June 30, December 31, In millions 2014 2013 Cash and cash equivalents $ 929.8 $ 1,937.2 Short-term borrowings and current maturities of long-term debt 915.7 367.7 Long-term debt 2,646.5 3,153.5 Total debt 3,562.2 3,521.2 Total Ingersoll-Rand plc shareholders' equity 6,382.3 7,068.9 Total equity 6,440.1 7,131.3 Debt-to-total capital ratio 35.6 % 33.1 % Short-term borrowings and current maturities of long-term debt consisted of the following: June 30, December 31, In millions 2014 2013 Debentures with put feature $ 343.0 $ 343.0 5.50% Senior notes due 2015 198.9 - 4.75% Senior notes due 2015 299.9 - Other current maturities of long-term debt 7.8 8.0 Other short-term borrowings 66.1 16.7 Total $ 915.7 $ 367.7 Commercial Paper Program The Company uses borrowings under its commercial paper program for general corporate purposes. The Company had $38.5 million and $0.0 million of commercial paper outstanding at June 30, 2014 and December 31, 2013, respectively. Debentures with Put Feature At June 30, 2014 and December 31, 2013, we had $343.0 million of fixed rate debentures outstanding, which only require early repayment at the option of the holder. These debentures contain a put feature that the holders may exercise on each anniversary of the issuance date, subject to a notice requirement. If exercised, we are obligated to repay in whole or in part, at the holder's option, the outstanding principal amount (plus accrued and unpaid interest) of the debentures held by the holder. If these options are not exercised, the final maturity dates would range between 2027 and 2028. Holders of these debentures had the option to exercise the put feature on $37.2 million of the outstanding debentures in February 2014, subject to the notice requirement. No exercises were made. Holders of the remaining $305.8 million in outstanding debentures will have the option to exercise the put feature, subject to the notice requirement, in November 2014. Based on our cash flow forecast and access to the capital markets, we believe we will have sufficient liquidity to repay any amounts exercised as a result of the put feature. Senior Notes due 2019, 2023, and 2043 In June 2013, we issued $1.55 billion principal amount of Senior Notes in three tranches through our wholly-owned subsidiary, IR-Global pursuant to Rule 144A of the Securities Act. The tranches consist of $350 million of 2.875% Senior Notes due in 2019, $700 million of 4.250% Senior Notes due in 2023, and $500 million of 5.750% Senior Notes due in 2043. In connection with the issuance of each series of notes, IR-Global, the Guarantors and the initial purchasers of the notes entered into a Registration Rights Agreement. Each Registration Rights Agreement requires IR-Global and the Guarantors to use their commercially reasonable efforts to execute an effective exchange offer registration statement with the SEC no later than 365 days after the closing date of the notes offering and to complete an exchange offer within 30 business days of such effective date. If a registration default occurs additional interest shall accrue on the notes. The proceeds from these notes were used to fund the July 2013 redemption of $600 million of 6.000% Senior Notes due 2013 and $655 million of 9.500% Senior Notes due 2014 and to fund expenses related to the 43-------------------------------------------------------------------------------- Table of Contents spin-off of the commercial and residential security businesses, with any remaining proceeds to be used for general corporate purposes. On April 25, 2014, we filed our exchange offer registration statement with the SEC, which became effective on May 13, 2014, and in June 2014, we completed our offer to exchange the notes for registered notes having terms identical in all material respects to the private notes, except that the registered notes do not contain terms with respect to transfer restrictions, registration rights or additional interest for failure to observe certain obligations in the applicable registration rights agreement. Other On May 20, 2011, the Company entered into a 4-year $1.0 billion revolving credit facility through its wholly-owned subsidiary, IR-Global (2011 Credit Agreement). On March 20, 2014, the 2011 Credit Agreement was refinanced with a 5-year, $1.0 billion revolving credit facility maturing on March 20, 2019 and the 2011 Credit Agreement was terminated. The Company also has a 5-year, $1.0 billion revolving credit facility maturing on March 15, 2017 through its wholly-owned subsidiary, IR-Global. IR-Ireland, IR-Limited, IR-International, and Ingersoll-Rand Company (IR-New Jersey) have each provided an irrevocable and unconditional guarantee for these credit facilities. The total committed revolving credit facilities of $2.0 billion were unused at June 30, 2014 and December 31, 2013, and provide support for the Company's commercial paper program, as well as other general corporate purposes. Cash Flows The following table reflects the major categories of cash flows for the six months ended June 30. For additional details, see the Condensed Consolidated Statements of Cash Flows in the condensed consolidated financial statements. In millions 2014 2013 Operating cash flow provided by (used in) continuing operations $ 175.9 $ 313.5 Investing cash flow provided by (used in) continuing operations (64.2 ) (122.9 ) Financing cash flow provided by (used in) continuing operations (1,055.2 ) 1,050.7 Operating Activities Net cash provided by continuing operating activities during the six months ended June 30, 2014 was $175.9 million, compared with $313.5 million during the comparable period in 2013. The change in operating cash flows for the six months ended June 30, 2014 reflects improved earnings from continuing operations and changes in restructuring and compensation reserves in 2014 compared to 2013. Investing Activities Net cash used in continuing investing activities during the six months ended June 30, 2014 was $64.2 million, compared with $122.9 million during the comparable period of 2013. The change in investing activities is primarily attributable to a decrease in capital expenditures and a $30.3 million cash dividend received from equity investments during the six months ended June 30, 2014. Financing Activities Net cash used in continuing financing activities during the six months ended June 30, 2014 was $1,055.2 million, compared with net cash provided by continuing financing activities of $1,050.7 million during the comparable period in 2013. The change in financing activities is primarily driven by proceeds received from issuance of long term debt of $1,546.2 million in 2013 and the repurchase of 17.0 million shares for approximately $1,012.8 million during the six months ended June 30, 2014 compared to the repurchase of 8.5 million shares for approximately $477.6 million during the six months ended June 30, 2013. Pensions Our investment objective in managing defined benefit plan assets is to ensure that all present and future benefit obligations are met as they come due. We seek to achieve this goal while trying to mitigate volatility in plan funded status, contribution and expense by better matching the characteristics of the plan assets to that of the plan liabilities. We use a dynamic approach to asset allocation whereby a plan's allocation to fixed income assets increases progressively over time towards an ultimate target of 90% as a plan moves toward full funding. We monitor plan funded status and asset allocation regularly in addition to investment manager performance. 44-------------------------------------------------------------------------------- Table of Contents We monitor the impact of market conditions on our defined benefit plans on a regular basis. None of our defined benefit pension plans have experienced a significant impact on their liquidity due to the volatility in the markets. For further details on pension plan activity, see Note 9 to the condensed consolidated financial statements. For a further discussion of Liquidity and Capital Resources, refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," contained in the Company's Annual Report on Form 10-K for the period ended December 31, 2013. Commitments and Contingencies We are involved in various litigations, claims and administrative proceedings, including those related to asbestos, environmental, and product liability matters. Amounts recorded for identified contingent liabilities are estimates, which are reviewed periodically and adjusted to reflect additional information when it becomes available. Subject to the uncertainties inherent in estimating future costs for contingent liabilities, except as expressly set forth in Note 18 to the condensed consolidated financial statements, management believes that the liability which may result from these legal matters would not have a material adverse effect on our financial condition, results of operations, liquidity or cash flows. Critical Accounting Policies Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with those accounting principles requires management to use judgments in making estimates and assumptions based on the relevant information available at the end of each period. These estimates and assumptions have a significant effect on reported amounts of assets and liabilities, revenue and expenses, as well as the disclosure of contingent assets and liabilities because they result primarily from the need to make estimates and assumptions on matters that are inherently uncertain. Actual results may differ from estimates. Management believes there have been no significant policy changes during the six months ended June 30, 2014, to the items that we disclosed as our critical accounting policies in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2013. Recent Accounting Pronouncements Recently Adopted Accounting Pronouncements In February 2013, the FASB ("Financial Accounting Standards Board") issued ASU ("Accounting Standards Update") 2013-04, "Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date." ASU 2013-04 provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements where the total obligation is fixed at the reporting date, and for which no specific guidance currently exists. This new guidance became effective for annual reporting periods beginning on or after December 15, 2013 and subsequent interim periods. The revised requirements of ASU 2013-04 did not have an impact on the condensed consolidated financial statements. In March 2013, the FASB issued ASU 2013-05, "Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." ASU 2013-05 clarifies the application of GAAP to the release of cumulative translation adjustments related to changes of ownership in or within foreign entities, including step acquisitions. This new guidance became effective for annual reporting periods beginning on or after December 15, 2013 and subsequent interim periods. The Company will apply the new guidance, as applicable, to future derecognitions of certain subsidiaries or groups of assets within a Foreign Entity or of an Investment in foreign entities. In July 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." ASU 2013-11 clarifies guidance and eliminates diversity in practice on the presentation of unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This new guidance became effective for annual reporting periods beginning on or after December 15, 2013 and subsequent interim periods. The Company has applied the requirements of ASU 2013-11 prospectively in preparing the June 30, 2014 condensed consolidated balance sheet, which resulted in a decrease to noncurrent deferred tax assets of $20.7 million, an increase to noncurrent deferred tax liabilities of $128.9 million and a decrease to noncurrent reserves for uncertain tax positions of $149.6 million. Had the Company applied the requirements of ASU 2013-11 retrospectively to the December 31, 2013 consolidated balance sheet, the impact would have been a decrease to current and noncurrent deferred tax assets of $22.6 million and $20.7 million, respectively, an increase to noncurrent deferred tax liabilities of $128.9 million and a decrease to noncurrent reserves for uncertain tax positions of $172.2 million. Recently Issued Accounting Pronouncements 45-------------------------------------------------------------------------------- Table of Contents In April 2014, the FASB issued ASU 2014-08, "Presentation of Financial Statements and Property, Plant, and Equipment - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." ASU 2014-08 provides new guidance related to the definition of a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. This new guidance is effective for annual periods beginning on or after December 15, 2014 and interim periods within those years. Beginning in 2015, the Company will apply the new guidance, as applicable, to future disposals of components or classifications as held for sale. In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers." ASU 2014-09 provides new guidance related to how an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, ASU 2014-08 specifies new accounting for costs associated with obtaining or fulfilling contracts with customers and expands the required disclosures related to revenue and cash flows from contracts with customers. This new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and can be adopted either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption, with early application not permitted. The Company is currently determining its implementation approach and assessing the impact on the condensed consolidated financial statements. Other than as discussed above, management believes there have been no significant changes during the six months ended June 30, 2014, to the items we disclosed as our recently adopted accounting pronouncements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the period ended December 31, 2013. For a further discussion, refer to the "Recent Accounting Pronouncements" discussion contained therein. Safe Harbor Statement Certain statements in this report, other than purely historical information, are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "forecast," "outlook," "intend," "strategy," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," or the negative thereof or variations thereon or similar terminology generally intended to identify forward-looking statements. Forward-looking statements may relate to such matters as projections of revenue, margins, expenses, tax provisions, earnings, cash flows, benefit obligations, share or debt repurchases or other financial items; any statements of the plans, strategies and objectives of management for future operations, including those relating to any statements concerning expected development, performance or market share relating to our products and services; any statements regarding future economic conditions or our performance; any statements regarding pending investigations, claims or disputes, including those relating to the Internal Revenue Service audit of our consolidated subsidiaries' tax filings; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. These statements are based on currently available information and our current assumptions, expectations and projections about future events. While we believe that our assumptions, expectations and projections are reasonable in view of the currently available information, you are cautioned not to place undue reliance on our forward-looking statements. You are advised to review any further disclosures we make on related subjects in materials we file with or furnish to the SEC. Forward-looking statements speak only as of the date they are made and are not guarantees of future performance. They are subject to future events, risks and uncertainties - many of which are beyond our control - as well as potentially inaccurate assumptions, that could cause actual results to differ materially from our expectations and projections. We do not undertake to update any forward-looking statements. Factors that might affect our forward-looking statements include, among other things: • overall economic, political and business conditions in the markets in which we operate; • the demand for our products and services; • competitive factors in the industries in which we compete; • changes in tax requirements (including tax rate changes, new tax laws and revised tax law interpretations); • the outcome of any litigation, governmental investigations or proceedings; • the outcome of any income tax audits or settlements; • interest rate fluctuations and other changes in borrowing costs; • other capital market conditions, including availability of funding sources; • currency exchange rate fluctuations, exchange controls and currency devaluations; 46-------------------------------------------------------------------------------- Table of Contents • availability of and fluctuations in the prices of key commodities and the impact of higher energy prices; • the ability to achieve cost savings in connection with our productivity programs; • impairment of our goodwill, indefinite-lived intangible assets and/or our long-lived assets; • the possible effects on us of future legislation in the U.S. that may limit or eliminate potential U.S. tax benefits resulting from our incorporation in a non-U.S. jurisdiction, such as Ireland, or deny U.S. government contracts to us based upon our incorporation in such non-U.S. jurisdiction; and • our ability to fully realize the expected benefits of the spin-off of our commercial and residential security businesses. Some of the significant risks and uncertainties that could cause actual results to differ materially from our expectations and projections are described more fully in the "Risk Factors" section of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. There may also be other factors that have not been anticipated or that are not described in our periodic filings with the SEC, generally because we did not believe them to be significant at the time, which could cause results to differ materially from our expectations. |